Assignment by Operation of Law: Meaning and Consequences

What is Assignment or Delegation by Operation of Law?

A true assignment under a direct agreement between the parties is not what we refer to as an "assignment by operation of law." An assignment by operation of law, would be an assignment that is not done under a voluntary agreement; rather, it occurs automatically by law. Such assignments occur, for instance, in bankruptcy cases, divorces, death, and where there is a provision in the Operating Agreement or Bylaws that prevents an assignment, but that prohibition is not valid to the successor.
Assignment by operation of law occurs in a bankruptcy to the Debtor’s estate. The Debtor owns the LLC interest as a property right capable of being assigned, just like any other programming interest that is property of the Estate. So in a Chapter 7 bankruptcy, title to the individual member’s interest (dividend) in the company is transferred to the Trustee, who acts on behalf of the Debtor.
In some instances, such as a divorce, a judgment may be entered by a court distributing the LLC or other closely held corporation interest to a spouse. For example , if an individual was gonna walk away with $10,000, but the business was valued at $25,000, then they would be it would be reasonable to give 50% of the LLC interest to the person that is entitled to $15,000. However, most situations are not so clean, and for a controlling interest, the Court will not order a transfer. In such case, the membership interest would need to be sold and apportioned.
Similarly, on the death of a Member in many instances, the interest will pass immediately to the heir(s) of that member. However, this is subject to the terms of the Operating Agreement. In this respect, a properly drafted Operating Agreement is essential. For example, the Operating Agreement may allow the transfer to the estate of the member in the event of the person’s death.
In some circumstances, an Operating Agreement prohibits transfer of a membership interest; however, if that interest is an economic interest, then the provision to the extent it is against public policy, will be disregarded. For example, one may not prohibit a landlord from receiving assignable rents.

Situations Where Assignment or Delegation Can Occur By Operation of Law

An assignment by operation of law may occur in the following ways:

• (1) Death of a partner or member: On the death of a partner, the legal representative of the deceased partner is entitled to either (a) be admitted to the firm as a partner or (b) receive his share in money. Tex. Bus. Org. Code § 152.802. If there is no contrary provision in the partnership agreement, if one partner dies during the partnership term, the right to become a partner in the surviving firm or to demand his share immediately belongs to the estate of the deceased partner.
• (2) Events affecting general partners: Under the Texas Business Organizations Code, changes in the partnership terminates the partnership unless otherwise provided in the partnership agreement. Thus a partner ceases to be a partner or becomes bankrupt, the partnership is dissolved unless the partnership agreement contains language to the contrary. Tex. Bus. Org. Code § 152.801. A general partner who is a party to his own bankruptcy is an "assigned client matter" and not subject to the former Texas Rule 1.08(l)(1). In such a situation, the general partner’s files must be turned over to the bankruptcy trustee or estate representative.
• (3) Merger by the filing of a certificate of merger with the secretary of state that contemplates the continuation of the existing business entity is also treated as an assignment, although a contributing factor to the problem is the language "continue the existing business entity." For example, in attending a name change, the partners may be continued without reference to the original partners. A new partnership may be formed without the original partners or heirs.
• (4) At the will of the parties. Where the parties mutually agree to an assignment of the partnership interest, a new partnership agreement is executed. Parties may elect to split the business either geographically as with a Harris County firm splitting north and south with Michael Mackey and the Houston office opening its doors as "Mackey Harris and Associates" on October 1, 2007. Parties can also decide to split revenues 50-50 down the hall into a separate suite with John O’Quinn in 30 years.

What Effect Does Assignment or Delegation by Law Have on Contracts and Obligations?

The concept of assignment by operation of law presupposes that the subject matter of the assignment is already covered by a qualified contract. In such a case, the contract terms will dictate how, when and whether the assignment will take effect. If the party issuing the assignment in law is declared bankrupt, the contract will pass to and be enforceable by the trustee in bankruptcy. The trustee may exercise the rights and obligations arising out of the contract on behalf of the bankrupt party.
The contract would also likely provide for what happens upon default by either party. For example, the contract may declare an assignment as a default event, or might provide that the party has a right to withdraw the contract upon bankruptcy of the other party. In such a situation the assignment will take effect only if the non-defaulting party waives its rights under the contract. Further, under certain circumstances, an assignment may count as a default event or trigger a right to rescission. In addition, assignment by operation of law is subject to state laws and can be invoked by a trustee. As a result, the risk posed by such assignment can be material to the contractual parties in at least two ways: it can trigger a default, mixed up with other bankruptcy risk or result in a court ordered assignment, if a counter party chooses to have the contract terminated.
From the perspective of the party that receives the assignment the question to consider is to what extent the rights and obligations under the contract have changed due to assignment by operation. The nature of the assignment and the conditions to it must be analyzed to determine what the deal would have looked like had parties negotiated it afresh. Failure to do so could lead to a situation where a party could be stuck between two conflicting contracts and two sets of obligations. This can result in increased financial exposure and perhaps, a voidable contract.
Examples of the aforementioned questions may include the following: Is the contract non-assignable? If so, is there are a number of conditions to an assignment (e.g., post-assignment consent or registration requirement)? Are any of the obligations to be performed within a specific period of time? What about the rights and obligations for which the contract has been assigned? Do they remain available to the trustee in bankruptcy? At this stage, it is expected that the privileges, reserving rights and lien rights, in particular, will persist, especially if otherwise stipulated in the contract.
A simple test to see how the process for assignment by operation in such circumstances is typically managed may be presented as follows. Assume a licensed operator runs a gambling establishment under a concession with the relevant state regulator and that such operator finds itself under bankruptcy protection. The bankruptcy trustee in bankruptcy may wish to delegate the management of the establishment for as long as possible, in order to maximize the value of the business. The trustee may instruct a third party manager to run the establishment for the benefit of the estate. During the licensee’s bankruptcy period, the trustee may want to transfer the license for the purpose of allowing the operator to continue to operate until the debt situation of the licensee’s estate is settled. At the end of the bankruptcy process, the operator will become the permitted operator based on the terms set out in the contract between the trustee, the relevant regulator and the new operator.

Assignment by Operation of Law in Real Property

Assignment by operation of law occurs in the real estate context as a distributive mechanism after divorce, in estate planning through bequests or in a foreclosure situation. When divorce is involved, it is not unusual for the non-title spouse to be awarded title to the marital home after the dissolution of the marriage, even if he or she did not contribute as a joint owner of the property during the marriage. Upon death, assignment by operation of law allows the executor or trustee to divide real estate to beneficiaries according to the terms of the will or the trust and the laws of intestacy when a decedent died without a will. When a property owner is foreclosed upon and loses marketable title to the foreclosing party, that title passes by assignment according to law.
In divorce situations, usually the fair market value of the house is determined, and an equitable distribution is made through the creation of other assets to retain the house and credit the other spouse. In some instances, a house will remain as joint title holders with the former spouse retaining his or her own interest, particularly when minor children need to be considered . In these cases, the home’s equitable division may be deferred until the minor children have reached thirty years of age, or become emancipated at which time the house will be sold and the proceeds divided accordingly. As long as there are no encumbrances on the property, the award of the marital home is called deemed appreciation, and community funds are awarded to the other spouse as a means of equitable distribution of the property.
In the case of a foreclosure, the home will be sold on the courthouse steps, or via an online auction, and the proceeds will then be divided among the foreclosing mortgagee and any other lienholders and then between the owner and the other co-owners according to their interests in the real property.
Under Pennsylvania law, when a foreclosure occurs, the successful bidder at the sheriff’s sale can obtain a deed, and title to the property passes by operation of law from the judgment debtor to the successful bidder upon confirmation of the sale.

What Legal Protections are Available for Assignment or Delegation by Law?

Several provincial and federal statutes impose limits on the ability of a debtor or a secured creditor to assign its rights or obligations under certain types of contracts. Statutory protections for insured rights include the following:
• Compulsory automobile liability insurance (Automobile Insurance Compulsory Insurance (AB), s. 30); and
• Disability insurance (Insurance Companies Act, RSC 1970, s. 140 (1) and Workers’ Compensation Act (MB), s. 12).
Alternatively, statutory restrictions on assignments under certain contracts include the following:
• Electric energy agreements between the Northwest Territories Power Corporation and its customers (Public Utilities Act (NT), s. 78); and
• Excise agreements between local authorities and the Excise Corporation (Excise Tax Regulation (NL), s. 19 (2)).
A statutory principle that protects the assignment of rights under a contract is the common law rule that a right seeking a sum of money is freely assignable as long as the agreement required the payment of money. However, the rule has been strictly interpreted in the case of statutory assignments in a surprise decision of the Supreme Court of Canada releasing funds held in court in the case of Royal Bank of Canada v. Northland Properties Ltd., 2016 SCC 35 (see our post here).
An additional statutory principle is the statutory exception to assignment of rights by way of stipulation pour autrui, which prohibits interpretation of an executed or executory contract that benefits a third party as an assignment of any right under the contract. Stipulation pour autrui is the most frequently successful argument in Canadian litigation to oppose arguments made in favour of an assignment of a right under a contract.

Conclusion and Practical Considerations

In conclusion, this practice note aims to set out some of the key principles from which assignment by operation of law can be better understood. Simply, it is acknowledged that assignment by operation of law is in essence assignment where a positive legal right or asset is transferred from one party to another party, by the act of law, without the intention of the assignor.
From above, it is also clear that in most instances, especially in cases of leases or succession contracts, assignment by operation of law occurs in circumstances of factual impossibility i.e. death or bankruptcy. In such instances, assignment by operation of law will trigger the assignment and the law will automatically deem that the beneficiary of the lease/succession contract has been assigned to the outgoing tenant/party.
As a result of the above conclusions, assignment by law may be stated to be a result of a variety of situations, including the death of a partner of the outgoing tenant or party, a corporate merger or acquisition, a business re-structure or a sale of assets by the outgoing tenant or party .
Some practical considerations that are to be noted when dealing with assignment by operation of law are:

• Quick legal advice must be sought in a situation where assignment by operation of law may occur so as to prevent the risk of loss.
• Professional indemnity insurance cover must be checked to see whether it covers the loss of assignment.
• Depending on the insurance policy, a claim for loss of assignment must be raised as soon as possible so that an investigator may investigate the loss of assignment claim.
• Assignments by operation of law are rare in comparison to normal financial assignments so assignment by operation of law must be examined with a critical eye.

At any stage, it is recommended to seek legal advice in circumstances where assignment by operation of law arises.