April 2008 — Issue 26

Venezia Amos, LLC v. Favret

No. 3:07cv146/MCR, 2008 WL 410163 (N.D. Fla. Feb. 12, 2008)

The plaintiff sued an LLC and its managing member for federal securities fraud in connection with the plaintiff’s purchase of a 40% interest in the LLC. The defendants argued that the court lacked personal jurisdiction over them, that the membership interest purchased by the plaintiff was not a security, and that the plaintiff’s allegations failed to meet the heightened pleading requirements of the Private Securities Litigation Reform Act. The court first determined that F & F Developers, LLC (F & F), a Louisiana LLC, and its managing member (Favret), a Mississippi resident, were subject to the court’s specific and general jurisdiction. Favret owned a majority interest in F & F, which in turn owned 50% of Venezia Resort, LLC, a Mississippi LLC engaged in developing residential resort condominiums in Biloxi, Mississippi. Venezia Resort maintained an office in Florida and conducted extensive business there. Favret was the managing member of F & F, and the court found that Favret served as the agent of F & F in connection with Venezia Resort business. Favret was also the managing member of Venezia Resort. Favret attended numerous membership and operations meetings of Venezia Resort in his individual capacity, as the majority interest owner of F & F, as the agent of F & F, and as the managing member of Venezia Resort. Based on these meetings and other activities of Favret in Florida, individually and on behalf of F & F, the court concluded that there was a basis for the exercise of specific and general jurisdiction over both F & F and Favret. The court next determined that the 40% membership interest in F & F purchased by the plaintiff was a security under the Howey definition of an investment contract, rejecting the defendants’ argument that the interest lacked the passivity required to show the expectation of profit was based on the entrepreneurial efforts of a third party. The plaintiff argued that it was a passive member of F & F, having bought its interest for the purpose of investing in Venezia Resort. Further, the plaintiff argued that F & F could not be described as “member-managed” given the numerous provisions of the operating agreement effectively providing for centralized management by the managing member, Favret. The court agreed with the plaintiff. The court pointed out that the day to day management and control of F & F rested in Favret, the operating agreement stated that only Favret had authority to bind, act, or assume any obligation or responsibility for F & F, and the operating agreement gave Favret authority with regard to bank accounts and distribution of capital assets. The court was persuaded that any expectation of profit by F & F members was based strictly on the efforts of Favret, the managing member, even assuming the plaintiff had voting rights and the right to inspect the LLC’s records as argued by the defendants. The court concluded, however, that the plaintiff’s allegations of securities fraud and control liability were not sufficiently particularized to meet the heightened pleading standards of the Private Securities Litigation Reform Act.

Internal Medicine Alliance, LLC v. Budell

__ S.E.2d __, No. A07A2357, 2008 WL 624759 (Ga. App. 2008)

Two doctors, Verbitsky and Budell, formed a manager-managed LLC and agreed that each was a 50% member, that they would share equally in profits and losses, and that they would jointly manage the LLC. After a falling out, Budell agreed to leave and form his own practice. The members agreed that Budell was entitled to a redemption of his interest but were unable to agree on a buy out price for Budell’s interest. In litigation that ensued, the trial court awarded Budell the fair value of his interest, and found that Verbitsky breached her fiduciary duty to the LLC and Budell after Budell’s departure. The trial court found that Verbitsky’s failure to repay Budell his capital contribution did not support a conversion claim. Both parties appealed. With respect to the valuation of Budell’s interest, the court of appeals concluded that the trial court did not err in determining the fair value of the interest without taking into account the future lease obligation of the LLC. Verbitsky testified that she and Budell agreed at the time he left that his interest would be valued based on a portion of the “fixed assets, minus depreciation,” plus what he “brought” to the practice, minus “overhead.” She also testified that she never asked him to assume any obligation for the remaining payments on the lease. This was sufficient evidence to support valuation of Budell’s interest without including the lease obligation in overhead. With respect to the breach of fiduciary duty claim against Verbitsky, the court stated that LLC managers have a fiduciary duty to act with the utmost good faith and loyalty. Verbitsky argued that she did not exercise management over the LLC and that, to the extent she did, it was agreed that Verbitsky and Budell would handle his or her own accounts receivable. Verbitsky argued that another individual who was not a member was the manager of the LLC, but the court concluded he was not a manager because the Georgia statute requires a non-member manager to be designated, appointed, or elected by more than one half of the members, and there was no evidence that the individual was ever chosen as a manager with the approval of both Verbitsky and Budell. The court concluded that after Budell’s departure he became a passive member and Verbitsky became the sole manager with a fiduciary duty to manage the LLC’s affairs in the manner she believed in good faith to be in the best interests of the LLC. At the time Budell left he had generated over $40,000 in receivables owed the LLC, but only a small amount was collected from insurance carriers after his departure. The evidence showed Verbitsky did nothing to collect these amounts and failed to provide the billing clerk guidance when asked what to do about Budell’s outstanding bills. In contrast, Verbitsky hired an additional billing clerk to assist in collecting her bills. Thus, the court of appeals concluded that the trial court was justified in finding Verbitsky failed to act in the best interest of the LLC by failing to take any steps to have Budell’s bills processed and collected after his departure, and given the level of hostility and bad blood, that Verbitsky’s decision was made in bad faith to negatively impact Budell’s ownership interest. The court of appeals found there was insufficient evidence to support the trial court’s finding that Verbitsky was liable for conversion based on her failure to reimburse Budell for his capital contribution while reimbursing herself for hers. The court stated that conversion is not a viable claim when there is nothing more than a failure by a defendant to pay money owed the plaintiff. Budell did not allege that his capital contribution was entrusted to Verbitsky for a specific purpose and then misused by her; therefore, Budell’s claim was nothing more than a claim for money allegedly owed to him and could not serve as the basis for a claim of conversion.

Peregrine Emerging CTA Fund, LLC v. Tradersource, Inc.

No. 07 C 5528, 2008 WL 474369 (N.D. Ill. Feb. 19, 2008)

An LLC that operated a commodities fund sued its manager, which was a corporation, and the manager’s president for breach of contract, negligence, and breach of fiduciary duty in connection with the manager’s alleged failure to monitor and inform the LLC of increased risk parameters caused by actions taken by one of the trading advisors the manager was obligated to monitor. The relationship between the manager and the LLC was governed by an operating agreement containing an exculpatory clause applicable to managers and manager associates. The operating agreement provided that it was to be governed by and construed in accordance with the law of Delaware without regard to Delaware conflict of law provisions, but the LLC argued that Illinois substantive law should be applied to each cause of action and should resolve issues such as the definition of “gross negligence” and whether the LLC had a cause of action for breach of fiduciary duty. The LLC acknowledged that it was formed under Delaware law but stated that it was a resident of Illinois and that all of the alleged conduct and losses occurred in Illinois. The court applied Illinois choice of law rules and concluded that Delaware law governed all of the issues in the case. The LLC did not show that applying Delaware law to interpretation of the operating agreement’s exculpatory clause would violate a fundamental Illinois policy or that Illinois had a materially greater interest in the litigation than Delaware. The court rejected the LLC’s argument that a choice of forum clause selecting Illinois constituted an agreement that Illinois substantive law should apply to the contract. The court concluded that the negligence claims were governed by Delaware law as well because they were specifically related to the contractual relationship and, in such cases, Illinois courts place great weight on the location where the contractual relationship is centered. In this case, the parties centered their relationship in Delaware, and Delaware law applied to the negligence claims arising out of the contractual relationship since Delaware had the greatest interest in the contractual relationship. With respect to the fiduciary duty claims, the court stated that Delaware law applied since such claims are governed by the law of the “state of incorporation,” and the LLC was “incorporated” under Delaware law. The court dismissed the LLC’s negligence and breach of fiduciary duty claims against the manager’s president based on a provision in the operating agreement shielding a “manager associate” (a defined term encompassing the manager’s president) from personal liability for any act or omission in the performance of the manager’s duties to the LLC. The LLC alleged that the defendants failed to monitor and inform the LLC of increased risk parameters caused by actions of a trading advisor, and there was nothing to suggest the manager’s president engaged in any activity outside the scope of the manager’s obligations under the contract. The court rejected the LLC’s arguments that limitations on the scope of indemnifiable conduct evinced an intent to hold manager associates liable under some circumstances. The court stated that the manager associate exculpatory provision trumped the indemnification clause and was intended to exculpate manager associates for all acts within the manager’s duty to the LLC because the exculpatory clause was applicable “notwithstanding any other provision” of the operating agreement. Further, the court held that the negligence and breach of fiduciary duty claims should be dismissed because the allegations of wrongdoing were all related to the operating agreement and were subsumed by the breach of contract claim under Delaware law. Finally, the court held that all claims must be dismissed based on the general exculpatory provision in the operating agreement. Under that provision, a manager could only be held liable for conduct amounting to criminal wrongdoing, fraud, gross negligence, or intentional misconduct. The court found that the LLC’s allegations of failure to monitor and inform the LLC did not amount to allegations of gross negligence. The court stated that none of the facts or conclusions alleged by the LLC came close to an allegation of “gross negligence” as defined under Delaware law, i.e., that the defendants were recklessly uninformed or acted outside the bounds of reason.

Riverboat Development, Inc. v. Indiana Department of State Revenue

881 N.E.2d 107, No. 49T10-0506-TA-52 (Ind. Tax Ct. 2008).

The court held that income of a Kentucky S corporation from a minority interest in an LLC that operated a gambling riverboat in Indiana was not “adjusted gross income derived from sources within Indiana” for purposes of withholding requirements on income passed through to non-resident shareholders. The LLC interest is intangible personal property, and income from intangible personal property is from an Indiana source under the Indiana tax laws if the receipt from the intangible is attributable to Indiana. Receipts in the form of dividends from investments are attributable to Indiana if the taxpayer’s commercial domicile is Indiana, and the S corporation was not domiciled in Indiana. Thus, the income the S corporation received as a result of its membership in the LLC was not “adjusted gross income derived from sources within Indiana” and was not subject to the withholding obligations applicable to such income.

Kistner v. Law Offices of Michael P. Margelefsky, LLC

518 F.3d 433, No. 07-3134 (6th Cir. (Ohio) 2008)

The plaintiff received a collection letter from “The Law Offices of Michael P. Margelefsky, LLC,” and the plaintiff sued the LLC and Margelefsky, its sole member, for violations of the Fair Debt Collection Practices Act. The LLC operated two separate businesses, a law practice and a debt collection agency, and the letter received by the plaintiff contained the address and phone number of the debt collection agency operating under the name of the LLC. The letter did not contain an individual’s signature, but contained a signature block for an “account representative.” Margelefsky testified that he drafted the form letter but did not review the specific letter sent to the plaintiff before it was mailed. The trial court granted Margelefsky summary judgment on the issue of his individual liability, and the plaintiff appealed. The court of appeals acknowledged that Ohio law precludes personal liability for members of an LLC on the basis of the LLC’s liability, but the court discussed a split of authority regarding individual liability under the FDCPA in the context of a corporate structure. The court characterized the Seventh Circuit and a few district courts as concluding that a shareholder, officer, or employee of a corporate debt collector may not be held personally liable without meeting the requirements to pierce the corporate veil. The court described the other side of the split as a series of district court opinions concluding that a shareholder, officer, or employee of a corporation may be held personally liable as a debt collector without piercing the corporate veil where the individual is personally involved in the debt collection at issue. The court found the case of Ditty v. CheckRite, Ltd., a Utah district court decision involving a single member LLC, to be most similar to the instant case. In that case, the court concluded that the LLC’s sole member fell within the definition of a “debt collector” and could be liable without piercing the veil of the LLC. The court rejected the Seventh Circuit’s conclusion that the FDCPA employs the same vicarious liability principles found in Title VII, and the court agreed with the Utah district court’s conclusion in another case that a person who authors collection letters, supervises collection activities, and is the sole attorney in a debt collection firm is a debt collector as defined by the FDCPA. Because Margelefsky drafted the form letter that was sent to the plaintiff, was one of only two attorneys at the law firm, was the sole member of the LLC, was the one who negotiated the terms with the mailing service provider used in the debt collection practice, oversaw compliance with the applicable collection laws, and was the person to whom the plaintiff was directed to make her check or money order payable, the court concluded that Margelefsky was regularly engaged, directly and indirectly, in the collection of debts and was thus a “debt collector” subject to individual liability. The court found that a jury should determine whether the letter in issue was deceptive and misleading – specifically, whether the letter gave the impression that it was from an attorney when it was not. The letter was printed on law firm letterhead, made repeated reference to a law firm, and directed payment to an individual lawyer; however, it also explicitly stated that it was from a debt collector and was signed by an unnamed “account representative.” The court concluded that the letter presented a genuine issue of material fact as to whether one could reasonably conclude, under the “least sophisticated consumer” test, that the collection letter was susceptible to a belief that it was from an attorney.

Hubert Enterprises, Inc. v. Commissioner of Internal Revenue

TC Memo 2008-46, No. 16798-03 (U.S. Tax Ct. 2008)

Interpretation of DRO provision of operating agreement as insufficient to render member payor of last resort as to LLC’s debt for purposes of at-risk rules.

Rice v. Palisades Acquisition XVI, LLC

No. 07 C 4759, 2008 WL 538921 (N.D. Ill. Feb. 25, 2008)

Suit to collect debt as isolated transaction not constituting “transacting business” by foreign LLC.

Segal v. Geisha NYC, LLC

517 F.3d 501, No. 06-2897, 2008 WL 465882 (7th Cir. (Ill.) 2008)

Interpretation of operating agreement of Delaware LLCs regarding expansion of business and use of restaurant name and design by members.

Braunstein v. Dann Ocean Towing, Inc.

383 B.R. 362, Civil Action Nos. 06-10910-WGY, 06-12027-WGY (D. Mass. 2008)

Analysis of “ordinary course of business” for purposes of powers of LLC debtor in possession that owned and managed houseboat; creditor’s reasonable expectations regarding ordinary course of business in light of provisions of LLC’s operating agreement.

Glasnak v. Garmo

No. 275555, 2008 WL 466886 (Mich. App. 2008)

Interpretation of operating agreement; admission as member; capital contribution obligations of member; effect of pre-existing operating agreement on later admitted member.

Murrin v. Fischer

No. 07-CV-1295 (PJS/RLE), 2008 WL 540857 (D. Minn. Feb. 25, 2008)

Limited liability of law firm LLC as governed by LLC statute rather than professional firm statute; limited liability of individual members notwithstanding failure to pay fee required by Professional Responsibility Board and initial absence of required language in articles of organization specifying type of professional services.

Madelone v. Whitten

18 Misc.3d 1131, No. 9929-07, 2008 WL 399175 (N.Y. Sup. 2008)

Interpretation and application of operating agreement provisions regarding involuntary transfer, no-waiver and no-oral amendment; breach of duty/waste derivative claims; business judgment rule; governance shift as irreparable harm; insufficient basis for disqualification of member’s attorney where details of prior representation of LLC and another member not provided.

Cohen v. Looking for Palladin, LLC

No. 07CV6359(HB), 2008 WL 544597 (S.D. N.Y. Feb. 29, 2008)

Interpretation of arbitration provision of operating agreement as encompassing securities claims under subscription agreement.

City of Seattle v. Professional Basketball Club, LLC

No. CO7-1620MJP, 2008 WL 539809 (W.D. Wash. Feb. 25, 2008)

Right to discovery of certain email messages of members as documents under “possession, custody, or control” of LLC by virtue of agency status of members.

Taurus IP, LLC v. DaimlerChrysler Corp

534 F.Supp.2d 849, No. 07-cv-158-bbc (W.D. Wisc. 2008)

Governing law on veil piercing claims; application of Texas veil piercing law to Texas LLC.