April 2010 — Issue 50

LLC Cases: PT China LLC v. PT Korea LLC

C.A. No. 4456-VCN, 2010 WL 761145 (Del. Ch. Feb. 26, 2010)

Wang, a Singapore resident, sought dismissal of breach of fiduciary duty and breach of contract claims against him on the basis that he was not subject to personal jurisdiction in Delaware. Wang was the sole member and manager of a Delaware LLC which was one of two members of another Delaware LLC, Pine Tree Holdings I LLC (“PT Holdings”). Wang was a member of the management committee of PT Holdings, which was the managing member and minority interest holder of yet another Delaware LLC, Pine Tree Equity LLC (“PT Equity”). The agreements governing these entities included a master joint venture agreement to which Wang was a party. The claims in issue against Wang were various alleged breaches of fiduciary duty to PT Holdings and breaches of provisions of the PT Equity operating agreement and the master joint venture agreement. Wang did not contest his status as a manager of PT Holdings for purposes of Section 18-109 of the Delaware LLC Act, which provides that a manager of a limited liability company is deemed to consent to the personal jurisdiction of Delaware courts for any suit “involving or relating to the business of the limited liability company or a violation by the manager . . . of a duty to the limited liability company, or any member of the limited liability company . . ..” A “manager” is defined for purposes of Section 18-109 to include any person who “participates materially in the management of the limited liability company.” The court noted that even if a person is served pursuant to Section 18-109, the exercise of personal jurisdiction must still be consistent with due process. With respect to the breach of fiduciary duty claims, the court cited Delaware case law in the LLC and corporate context for the proposition that service under Section 18-109 is consistent with due process where an action relates to a manager’s fiduciary duties. Wang did not contest this point but argued instead that the fiduciary duty claims were not supported by the alleged facts and were otherwise duplicative of the breach of contract claims. The court found that sufficient facts had been pled to support a reasonable inference that Wang usurped business opportunities, disclosed confidential information for his own benefit, and misappropriated resources of PT Holdings. As to Wang’s contention that the fiduciary duty claims were duplicative of the breach of contract claims, the court stated that under Delaware law “a contractual claim will preclude a fiduciary duty claim, so long ‘as the duty sought to be enforced arises from the parties’ contractual relationship.’” The court couched the question as whether there existed an independent basis for the fiduciary duty claims apart from the contractual claims, even if both were related to the same or similar conduct. The court permitted the fiduciary duty claims to stand because they arose independently under Wang’s duty of loyalty to PT Holdings. The court pointed out that Wang did not argue that Wang’s duties were limited by any of the governing agreements, and the court additionally noted that Wang’s fiduciary duties arose under a different agreement (i.e., the PT Holdings LLC agreement) from those which governed the breach of contract claims, and may therefore could be considered distinct in scope. With respect to the breach of contract claims, while Wang did not contest that Section 18-109 encompasses service on managers for matters that involve or relate to the LLC, Wang claimed that the exercise of personal jurisdiction over him pursuant to Section 18-109 would not comport with due process. The court stated that the exercise of personal jurisdiction under Section 18-109 would be consistent with due process in this circumstance because “(1) the allegations focused on the defendant’s rights, duties, and obligations as the manager of a limited liability company; (2) the matter was inextricably bound up in Delaware law; and (3) Delaware has a strong interest in providing a forum for disputes relating to the actions of managers of a limited liability company formed under its law in discharging their managerial functions.” Wang argued that the breach of contract claims did not implicate his rights, duties, and obligations as manager of PT Holdings and, because the joint venture agreement was not governed by Delaware law, were not inextricably bound up in Delaware law. The court disagreed, finding that the contract claims involved Wang’s management of both PT Holdings and PT Equity and that, under the totality of the circumstances—including the fact that the breach of contract claims were intertwined with Wang’s management of Delaware LLCs, the potential usefulness of his involvement in the suit, and Delaware’s interest in adjudicating disputes involving the management of its LLCs—the court had personal jurisdiction over Wang to hear the breach of contract claims.

Kelly v. Blum, C.A.

No. 4516-VCP, 2010 WL 629850 (Del. Ch. Feb. 24, 2010)

The plaintiff, who was a founding member, manager, and officer of a Delaware LLC, challenged the merger of the LLC into an affiliate of the controlling members of the LLC whereby the plaintiff’s interest was cashed out. The complaint sought a declaratory judgment that the merger was void based on non-compliance with notice requirements of the LLC agreement and also alleged breach of fiduciary duty claims against the managers and controlling members, a claim for breach of the implied covenant of good faith and fair dealing, and other claims. The court first addressed the plaintiff’s contention that the merger was void because the plaintiff did not receive adequate notice of its approval by written action as required by the LLC agreement and because the merger closed before the notice period required by the LLC agreement elapsed. The court noted that parties may impose requirements with respect to a merger beyond the default approval required by the Delaware LLC statute, as was done in the LLC agreement in this case. The LLC agreement provided that any written consent not executed by any member “must be delivered to such Member no less than five (5) business days prior to the effective date of such consent.” The LLC agreement also provided that in the event a notice was given by fax, a confirmation copy must be sent on the same day of the fax “by first class mail.” The plaintiff asserted that the defendants that approved the merger technically violated this notice provision because the confirmation copy was sent by overnight commercial delivery service the day after the fax. The court held that if the notice provision applied to a written consent (the court acknowledged that it might not apply as the provisions could be construed as ambiguous), the notice was in “substantial compliance,” relying on corporate case law on substantial compliance with notice provisions. The court next addressed the defendants’ motion to dismiss the plaintiff’s other claims. The court looked to corporate case law to determine the distinction between direct and derivative claims as well as to determine whether the plaintiff had standing to assert his derivative claims. The court concluded that the plaintiff lacked standing to maintain a derivative suit because the plaintiff was not a member or assignee of an LLC interest in the surviving LLC after the merger and did not allege that he fell into either of the two exceptions recognized under corporate law whereby a former shareholder may bring a derivative suit following a merger that terminates the shareholder’s interest. These two exceptions are: (1) the merger itself is subject to a claim of fraud being perpetrated merely to deprive shareholders of standing to bring a derivative action, or (2) the merger is in reality merely a reorganization which does not affect the plaintiff’s ownership in the business enterprise. Plaintiff did not allege these situations, and they thus did not apply to this case. The court next addressed the plaintiff’s direct claims that the defendant members and managers of the LLC violated their fiduciary duties of loyalty and care to the plaintiff in approving a self-interested merger on terms unfair to the plaintiff. The court pointed out that Delaware cases interpreting the Delaware LLC statute have concluded that managers and members owe traditional fiduciary duties of loyalty and care to each other and the LLC in the absence of a contrary provision in the LLC agreement. The court stated that, given the contractual freedom provided by the LLC statute, provisions expanding, restricting, or eliminating the operation of traditional fiduciary duties should be clear and unambiguous. The LLC agreement in this case provided in a section entitled “Duties” that the board of managers “shall manage the Company in a prudent and businesslike manner. . ..” The LLC agreement also contained an exculpatory clause eliminating the managers’ liability for all conduct except “willful or fraudulent misconduct or willful breach of . . . contractual or fiduciary duties under this Agreement.” The court found that these clauses did not explicitly disclaim or limit the applicability of default fiduciary duties. Further, the court held that if the defendant managers entered into the merger to profit from squeezing out the plaintiff and obtaining control of property held by the LLC as alleged by the plaintiff, a direct duty of loyalty claim sufficient to survive a motion to dismiss was stated. With respect to the exculpatory provision, the court noted that the Delaware LLC statute permits members to limit or eliminate a manager’s or member’s liability for breach of contract and fiduciary duties except for liability arising from a bad faith violation of the implied contractual covenant of good faith and fair dealing. The court interpreted the exculpatory language set forth in the LLC agreement to require plaintiff to allege a “willful” breach of the defendant managers’ fiduciary duties to have a valid claim. The court did not determine whether “willful” required “evil intent to harm” or “acting recklessly and outside the bounds of reason” as the defendant managers asserted, but found that the plaintiff had satisfied this standard by alleging facts sufficient to suggest that the defendant managers actually and specifically intended to extinguish the plaintiff’s membership interest, knowing that such action would harm the plaintiff. The court also held that the controlling members owed the plaintiff, as a minority member, traditional fiduciary duties, including the duty not to cause the LLC to enter into a transaction that would benefit the controlling members at the expense of the minority member. The court found that the plaintiff sufficiently alleged facts that, if true, showed that the controlling members, with the aid of their appointed managers, effected the merger to benefit themselves at the expense of the plaintiff. Thus, the plaintiff stated a direct claim against the managers and controlling members, and the court denied the defendants’ motion to dismiss these claims. With respect to the plaintiff’s claim that the controlling members breached their implied contractual covenant of good faith and fair dealing under the LLC agreement by approving the merger, not seeking alternative strategies for the LLC, and allowing the LLC to enter into affiliated or self-interested transactions, the court noted that the plaintiff must allege a “specific implied contractual obligation and allege how the violation of that obligation denied the plaintiff the fruits of the contract.” The court found that the plaintiff did not sufficiently allege any specific implied contractual obligation, how it was breached, or how he was damaged by such breach. Additionally, the court noted that the LLC agreement expressly addressed affiliated and self-interested transactions. Therefore, the court granted the motion to dismiss this claim. The court then addressed the plaintiff’s claim that the controlling members’ parent aided and abetted the alleged breaches of fiduciary duties discussed above. The court found that the plaintiff sufficiently alleged the parent’s knowing participation in the breaches of fiduciary duty by the other defendants through the acts of the parent’s officers and its two wholly-owned subsidiaries that directly harmed the plaintiff. Thus, the motion to dismiss this claim was denied. The court dismissed the plaintiff’s claim for a declaratory judgment invalidating the loan agreement between the LLC and one of the controlling members because the plaintiff consented to the loan and pledged his membership interest in the LLC to obtain the loan.

The Homer C. Gutchess 1998 Irrevocable Trust v. Gutchess Companies, LLC
No. 4916-VCN, 2010 WL 718628 (Del. Ch. Feb. 22, 2010)

An LLC member sought judicial dissolution of a Delaware LLC on equitable grounds, and the court denied such relief, distinguishing Haley v. Talcott and In re Arrow Investment Advisors, LLC. The court distinguished this case from Haley because the court in Haley found that the members of the LLC had envisioned co-equal management and, under the circumstances of that case, one of the members had become unable to influence the management of the LLC. In this case, the intention was that one of the members would have 100% voting control over the LLC, and the court did not find it compelling that another member of the LLC disagreed with how that member was managing the LLC. The court acknowledged that the Arrow Investment opinion suggested that, in unusual circumstances, the court’s equitable powers may be invoked in the absence of deadlock and despite a broadly defined purpose. The court pointed out, however, that the court in Arrow Investment held that, where judicial dissolution is requested because of alleged breaches of fiduciary duty, the petition fails to state a claim unless such breaches have been proven in a plenary action and there exists some basis for a dissolution notwithstanding whatever relief was granted in that plenary action. According to the court, whether the manager breached any fiduciary duties owed to the member in this case had little effect on whether the LLC was carrying out the broad business purposes for which it had been organized. In addition, the court concluded that the member seeking dissolution had not alleged the type of absolute frustration or futility required for the court to order judicial dissolution of the LLC in the absence of unachievable business purpose and/or deadlock. The court stated that the petition did not suggest that the member’s grievances (most of which appeared to the court to be remediable through breach of fiduciary duty claims) could not be resolved through less extreme judicial remedies than judicial dissolution of the LLC.

Ly v. Jimmy Carter Commons, LLC

691 S.E.2d 852 (Ga. 2010)

An LLC sought to enjoin foreclosure on its property and to cancel the security deed and various loan documents on which the foreclosure proceedings were based on the grounds that the manager who executed the loan documents on behalf of the LLC was not authorized to do so. Two individuals, Byun and Choi, were the members and managers of the LLC, and Byun signed the loan documents on behalf of the LLC. The operating agreement required both Byun and Choi to approve the loan transaction, and the lender was supplied with unanimous written consents signed by Byun and purportedly signed by Choi in connection with the original loan and a subsequent modification. The trial court determined that it was undisputed that Choi had no dealings with the lender and did not authorize the loan, that Choi’s signatures on the written consents were forged, and that the consents were ineffective to authorize Byun alone to bind the LLC. The Georgia Supreme Court concluded that there was a fact question requiring reversal of the summary judgment even if the undisputed evidence relied upon by the trial court was true. The lender testified that the consent documents were prepared by the lawyers for the lender and sent to the LLC to be signed by Byun and Choi, that the consent documents were brought to the closing with both Byun’s and Choi’s apparent signatures, that it was represented that Choi had signed the documents, and that the lender believed that Choi had signed them. This testimony created a fact issue as to whether the lender knew Choi’s signatures were forged and whether the lender was justified in assuming that the documents authorized Byun’s unilateral actions on behalf of the LLC. The court relied upon provisions of the Georgia LLC statute addressing the binding effect of the act of a manager. Under these provisions, the act of a manager binds the LLC unless the manager acting has no authority and the person with whom the manager is dealing knows of the lack of authority, and no act of a manager in contravention of a restriction on authority binds the LLC to persons having knowledge of the restriction. Based on these provisions, the court stated Byun’s unauthorized act as a manager of the LLC could still bind the LLC if the lender did not know that the manager lacked authority. The court cited agency case law for the proposition that the lender’s belief that the consent documents authorized Byun’s action must be reasonable.

Gasstop Two, LLC v. Seatwo, LLC

225 P.3d 1072 (Wyo. 2010)

A commercial landlord obtained a judgment against an LLC for amounts owed on space leased by the LLC for a Burger King franchise, and the landlord asserted that the trial court erred in not piercing the veil of the LLC to impose personal liability on the member for the judgment. The Wyoming Supreme Court discussed veil piercing law as it applies to LLCs and held that the trial court properly applied the law. The court listed the following corporate veil piercing factors used in LLC cases: fraud, inadequate capitalization, failure to observe company formalities, and intermingling the business and finances of the company and member to such an extent that there is no distinction between them. The court then set forth with approval the trial court’s findings and analysis with regard to the facts as they related to several factors. First, the trial court found that the failure of the business was not due to undercapitalization, but rather was due to poor location, lack of customers, and poor traffic count. In any event, the trial court stated that undercapitalization alone is not a basis to pierce the LLC veil. Next, the trial court addressed the fact that the members themselves as opposed to the LLC held the Burger King franchise. The trial court stated that the evidence indicated that the LLC could not hold the franchise because Burger King required individuals to hold the franchise. The trial court stated that the members used the franchise consistent with the needs of the LLC and that there was no commingling of funds or misuse of the franchise for the members’ benefit. Thus, the trial court concluded that the fact that the members held the franchise in their own names was not sufficient to show a lack of formalities in operating the LLC. The trial court also addressed testimony regarding equipment of the LLC that secured a bank loan. The trial court concluded that the LLC made a good faith effort to liquidate the equipment and that the bank approved the LLC’s action in donating the equipment for a tax credit when they were unable to sell the equipment. Finally, the trial court found there was no indication that the LLC was used to defraud anyone or that it was simply used as an alter ego for the personal business ventures of the members. The trial court stated that the members used the LLC to operate a Burger King on property owned by the landlord and followed required formalities. The trial court noted that the LLC kept separate accounting statements, filed proper paperwork with the Secretary of State, filed separate tax returns, only made small payments to the members on two occasions as employees of the business, and followed all relevant formalities under the law. The supreme court concluded that none of the trial court’s findings of fact were clearly erroneous and that the trial court correctly applied the applicable law in declining to pierce the LLC’s veil.

Ferrell v. Express Check Advance of SC LLC

591 F.3d 698 (4th Cir. 2010)

(dual citizenship of LLC for purposes of diversity jurisdiction under Class Action Fairness Act)

Newell v. Commissioner of Internal Revenue

T.C. Memo 2010-23, 2010 WL 538207 (U.S. Tax Ct. 2010)

(managing member’s interest as interest of “general partner” for purposes of passive activity rules)

Lopes v. Vieira

688 F.Supp.2d 1050 (E.D. Cal. 2010)

(inability of defunct LLC to assert attorney-client privilege because of lack of managers or officers ).

Whittington v. Dragon Group, L.L.C.

Civil Action No. 2291-VCP, 2010 WL 692584 (Del. Ch. Feb. 15, 2010)

(analysis of application of laches to LLC member’s claim in view of analogous twenty-year statute of limitations applicable to contract under seal).

Henderson v. Henderson Investment Properties, L.L.C.

227 P.3d 568 (Idaho 2010)

(interpretation of attorney’s fees provision of LLC operating agreement).

ORX Resources, Inc. v. MBW Exploration, L.L.C.

32 So.3d 931 (La. App. 2010)

(application of corporate veil piercing principles to LLC).

Chiu v. Chiu

896 N.Y.S.2d 132 (App. Div. 2nd Dept. 2010)

(sufficiency of alleged facts to state claim for breach of fiduciary duty by managing member; application of three-year statute of limitations to claim for damages for breach of fiduciary duty).

546-552 West 146th Street LLC v. Arfa

894 N.Y.S.2d 427 (App. Div. 1st Dept. 2010)

(interpreting indemnification provision of LLC operating agreement).

Hotel 71 Mezz Lender LLC v. Falor

926 N.E.2d 1202 (N.Y. 2010)

(attachment in New York of non-resident defendants’ membership interests in numerous foreign LLCs).

Mike Building & Contracting, Inc. v. Just Homes, LLC

901 N.Y.S.2d 458 (N.Y. Sup. 2010)

(absence of elements necessary to pierce LLC veil).