August 2006 — Issue 7

Brennan v. Lehn

Nos. X10UWYCV054010237S(CLD), X10UWYCV054010238S(CLD), 2006 WL 1577598 (Conn. Super. May 17, 2006).

In 1997, two individuals entered an operating agreement and formed an LLC for the purpose of operating and managing certain real property. The individuals, Brennan and Aiello, were equal members, and they operated the LLC until the death of Aiello in 2001. Brennan and the administrator of Aiello’s estate, Lehn, disagreed regarding the disposition of Aiello’s interest in the LLC. Brennan sought a declaration that he was entitled under the operating agreement to purchase Aiello’s interest, and Lehn sought a declaration that Aiello’s death constituted a dissolution of the LLC and that Brennan was not entitled to purchase Aiello’s interest. Brennan relied upon Section 5.02 of the operating agreement, which provided that the LLC was entitled to purchase the interest of a member upon the member’s death. Lehn relied upon Section 7.01 of the operating agreement, which provided that the LLC shall be dissolved and wound up upon an event of dissociation unless there are at least two remaining members and the business is continued by consent of a majority in interest of the remaining members. Another section of the operating agreement defined an event of dissociation as an event that causes a person to cease to be a member. The death of a member is an event of dissociation under the Connecticut Limited Liability Company Act unless otherwise provided in the operating agreement. Brennan argued that the buy-out provision would be rendered a nullity if it did not control because the LLC only had two members. The court concluded that Aiello’s death triggered the dissolution provision and that applying the agreement in this manner allowed Sections 5.02 and 7.01 to co-exist harmoniously. Applying the dissolution provision did not render the buy-out provision a nullity because, although the LLC always had only two members, it was not restricted to having only two members. The buy-out provision could have come into play, explained the court, if two or more members remained after the death of a member and agreed to continue the business. The court went on to comment that, even if Brennan’s construction of the agreement prevailed, the LLC would be dissolved by operation of law under the provisions of the Connecticut LLC Act in effect at the time the operating agreement was executed. At that time, the statute required that an LLC have at least two members. Although the statute was amended to permit single member LLCs shortly after the operating agreement was executed, the court said that the amendment was substantive and did not have retroactive effect; therefore, the LLC continued to be governed by the version of the LLC statute in effect when the agreement was entered. The court stated that the amendment authorizing single member LLCs must be given prospective application unless the legislature clearly expressed an intention to the contrary, and the court discerned no contrary intention.

Milk v. Total Pay and HR Solutions, Inc.

__ S.E.2d __, No. A06A0709, 2006 WL 1898592 (Ga. App. 2006).

The plaintiff sued an LLC and its managing member for amounts owed under a contract to provide payroll services to the LLC. A default judgment was entered against the LLC, and the plaintiff sought summary judgment holding the managing member personally liable. The court denied the plaintiff’s motion for summary judgment, pointing out that the filing of the articles of organization served as conclusive proof that all conditions for formation had been satisfied and that the LLC’s existence thus began on that date. By statute, a member is separate from the LLC and is ordinarily not a proper party to a proceeding by or against an LLC. The court also pointed out that the member’s signature did not appear on the agreement in any capacity nor was there any evidence the member guaranteed payment under the contract. The court went on to specifically reject numerous arguments raised by the plaintiff. The plaintiff first argued that it was entitled to summary judgment against the managing member because the LLC dissolved before an operating agreement was entered. The managing member denied that the LLC had dissolved, but the plaintiff sought to bind the managing member to an admission made by the LLC. The court held that the LLC and the managing member did not hold joint interests under the circumstances of the case and that the member thus was not bound by the LLC’s admission. Additionally, the court commented that, even if the admission was binding on the member, the plaintiff would not be entitled to summary judgment because dissolution alone does not cause an LLC to cease to exist or render its members personally liable for the LLC’s debts. Furthermore, the court said that the formation of an LLC as an entity separate from its members is predicated on the public filing of the LLC’s articles of organization, not on whether or when an operating agreement is executed. The court next rejected the plaintiff’s argument that the LLC veil should be pierced because the member undercapitalized the LLC. The court stated that undercapitalization is a basis to pierce the veil when it is coupled with evidence of an intent, at the time of capitalization, to avoid payment of future debts of the LLC. The court found there was a lack of evidence of such intent, concluding that the evidence did not establish that certain withdrawals and alleged payments were used for improper purposes. Finally, the court acknowledged that an LLC member may be personally liable if he or she personally participates in or directs a tort committed by the LLC, but the court found the evidence did not establish a fraud or conversion.

In re McCabe (Braunstein v. Panagiotou)

345 B.R. 1, Civil Action No. 05-12208NMG (D. Mass 2006).

The debtor filed bankruptcy and listed a 50% interest in a Delaware LLC as part of his property. The trustee brought an action against the LLC’s other member, Panagiotou, based on Panagiotou’s post-petition unilateral amendment of the LLC agreement to reduce the debtor’s interest to 5% and increase Panagiotou’s interest to 95%. Panagiotou also reduced the LLC’s 100% interest in two other LLC’s to 5% and gave himself a 95% interest in those LLCs. Panagiotou argued that the reallocations of membership interests were in accordance with the LLC agreements, which permitted additional capital contributions with the agreement of all members and required amendment of the agreements to reflect the additional contributions. The debtor did not dispute that Panagiotou had made additional capital contributions, but claimed that he never assented to the amendments formally realloacting the membership interests. The trustee sought summary judgment that Panagiotou violated the automatic stay, and Panagiotou argued that his conduct did not violate the automatic stay because no “property” of the debtor’s estate was affected and Panagiotou’s actions were “purely ministerial.” Panagiotou argued that his actions merely formalized the pre-existing status and that the membership interests were altered by the additional capital contributions rather than the subsequent written documentation of the reallocation. According to Panagiotou, the debtor consented to the additional capital contributions and the amendments were automatic and mandatory. The court rejected these arguments and stated that the proper course of action for Panagiotou would have been to move for relief from the stay rather than engage in self-help. The court stated that it could not conclude the debtor’s legal interest was not affected even if the debtor lacked an equitable interest in the LLC. Further, Panagiotou’s efforts were not in accordance with the LLC agreement because it required that the amendment be duly executed by all members. That the members were mandated to amend the agreement did not make amendment “automatic.” The court also rejected Panagiotou’s argument that his conduct was proper based on the debtor’s authorization, in a letter six months prior to the bankruptcy, of Panagiotou’s exercise of the debtor’s ownership rights. The court said that Panagiotou’s reliance on the letter to justify amending the agreement violated the automatic stay provision prohibiting acts to enforce a lien.
The court addressed several other arguments in addition to those related to violation of the automatic stay. Pointing out that an LLC interest is personal property under the laws of Massachusetts (the forum state), Delaware (the LLC’s state of formation), and Idaho (the state in which the LLC’s real property was located), the court rejected Panagiotou’s argument that the debtor’s estate lacked a property interest that could be subject to turnover and avoidance of post-petition transfer. Similarly, the court held that the debtor’s LLC interest was personal property that could be the subject of a conversion claim. The court found that there was a basis for the trustee’s accounting claim against Panagiotou but not against the LLC because the existence of a fiduciary relationship is a pre-requisite to an accounting claim under Massachusetts law. The defendants did not deny that Panagiotou owed fiduciary obligations to the debtor (a fellow member), but the trustee provided no evidence that the LLC owed a fiduciary duty to the debtor (a member of the LLC).

Bischoff v. Boar’s Head Provisions Co., Inc.

436 F.Supp.2d 626, No. 06 Civ. 106(DC), 2006 WL 1793653 (S.D. N.Y. 2006)

The principal issue in this case was whether a member of a New York LLC may bring a derivative action on behalf of the LLC. The New York LLC statute is silent regarding derivative actions, and the federal district court for the Southern District of New York, relying on an opinion of the federal district court for the Eastern District, had previously held that the silence of the statute did not preclude recognition of a common law right to sue derivatively. Subsequently, several New York state courts (three trial courts and one appellate court) concluded that derivative actions are not permitted under state law in the LLC context. The court in this case reviewed and discussed the various available resources on the issue (the common law, the text and history of the New York LLC statute, similarities between LLCs and other corporate forms, federal cases construing state law, and state court decisions) and held that a member of a New York LLC may bring a derivative suit on behalf of the LLC. The court remanded the case to state court because the citizenship of an LLC is determined by that of each of its members, and diversity jurisdiction was lacking since the LLC was a defendant that shared its citizenship with the plaintiff member.

Trident-Brambleton, L.L.C. v. PPR No. 1, L.L.C.

No. 1:05cv1423, 2006 WL 1880986 (E.D. Va. July 5, 2006)

A minority member of a Michigan LLC alleged that the LLC’s managing member breached various common law, statutory, and contractual duties and obligations by selling the LLC’s options to buy adjacent properties to an affiliate for less than fair market value. The managing member sought summary judgment on the grounds that the minority member lacked standing to raise the claims, that the claims were barred by the applicable statutes of limitations, and that the managing member did not breach any duties because the operating agreement authorized the managing member’s action.
The court agreed with the managing member’s argument that the minority member’s claims for breach of common law fiduciary duties and breach of a manager’s statutory duties of good faith and due care were required to be brought derivatively under procedures that were not followed by the minority member, but found that the Michigan LLC statute clearly confers standing on an individual member to bring a cause of action for willfully unfair and oppressive conduct. The court also stated that the minority member had standing to bring claims that were based on breach of the operating agreement.
With respect to the limitations defense, the court agreed with the managing member’s argument that the statutory duty and oppression claims were barred by the applicable limitations provisions in the Michigan LLC statute. The limitations provisions required that the claims be brought within three years after the cause of action accrued or within two years after the cause of action was discovered or reasonably should have been discovered, whichever occurred first. The court relied upon case law addressing a similar limitations provision in the Michigan corporate context and concluded that the three year provision is both a statute of limitations and a statute of repose and thus cannot be tolled by fraudulent concealment. Claims based on the sale of two of the options were barred because the sales took place more than three years prior to the filing of the minority member’s claims. One of the options was sold within three years of the filing of the claim, and the court thus examined when the minority member knew or should have known of that claim. Giving the minority member the benefit of the doubt, the court did not treat the two year provision as a statute of repose, but rather considered it a traditional statute of limitations that can be tolled under the fraudulent concealment statute. The court found, however, that the minority member’s claim was time-barred because the minority member had notice of its claim more than two years prior to the filing of the claim. The court applied Virginia’s two year “catch all” statute of limitations to the common law breach of fiduciary duty claim and determined that the managing member’s failure to disclose the transfer of the options to an affiliate in the financial statement notes describing related party transactions was mere silence and not an affirmative act of fraudulent concealment that would toll the statute of limitations.
The court went on to analyze the impact of provisions in the operating agreement on the managing member’s common law and statutory duties. Although the operating agreement gave the managing member unilateral authority over the day to day operations of the LLC, including authority to sell property to affiliates, the court pointed out that the agreement did not explicitly release the managing member from the duty to act in good faith and in the best interests of the LLC, nor did it protect the managing member from claims of oppressive conduct toward non-managing members. The court found the exculpation language in the agreement, which exculpated the managing member from liability except for willful misconduct, gross negligence, fraud or bad faith, to be consistent with a duty to act in good faith. The agreement specifically abrogated the common law fiduciary duty not to usurp opportunities of the LLC; therefore, the court found that the parties agreed to bypass statutory or common law fiduciary duties with respect to competing ventures. In view of these provisions, the court concluded that the minority member could not rest its claim on usurpation of opportunity but could argue that the managing member breached its duty of good faith by selling an asset of the LLC at below market value. This argument failed, however, because the court concluded that the minority member was not entitled to recover lost profits, which would in effect allow recovery for usurpation of an opportunity when the operating agreement permitted the managing member to usurp opportunities. The harm for which the minority member was entitled to recover was the difference in the price at which the options were sold and their market value. The minority member produced insufficient evidence of the market value of the options, while the managing member provided valuations showing the property to be worth less than the purchase price specified in the options.

Argentum International, LLC v. Woods

__ S.E.2d __, No. A06A0698, 2006 WL 1899773 (Ga. App. 2006)

Fiduciary duty of manager to equity interest owners; statutory duty of good faith and ordinary care and inability to limit liability for intentional misconduct.

Sayers v. Artistic Kitchen Design LLC

__ S.E.2d __, No. A06A0570, 2006 WL 1789856 (Ga. App. 2006)

Inapplicability of statutory dissociation provision to member who seeks reorganization of a different member.

DeShazo v. Estate of Clayton

No. CV 05-202-S-EJL, 2006 WL 1794735 (D. Idaho June 28, 2006)

Interpretation of operating agreement and Idaho Limited Liability Company Act regarding member’s obligation to contribute real property acquired by member.

ERA Franchise Systems, Inc. v. Mathis

931 So.2d 1278, No. 2005-IA-00350-SCT (Miss. 2006)

Direct versus derivative action.

DeBold v. Case

452 F.3d 756, No. 05-3401 (8th Cir. 2006)

Immunization of member under Missouri business judgment rule and operating agreement.

NetJets Aviation, Inc. v. LHC Communications LLC

No. 02 Civ.7441 (DAB), 2006 WL 1627899 (S.D. N.Y. June 12, 2006)

Application of law of state of formation to veil piercing of Delaware LLC; analysis of alter ego evidence.

Team EJP Racing, LLP v. Dollar

No. 5:06-CV-17-V, 2006 WL 1875333 (W.D. N.C. July 5, 2006)

Limited liability of member; application of law of state of formation to veil piercing of LLC.

Mountain Funding, LLC v. Blackwater Crossing, LLC

No. 3:05CV513-MU, 2006 WL1582403 (W.D. N.C. June 5, 2006)

Inapplicability of “aggregate” theory to question of personal jurisdiction over LLC.

Canter v. Ebersole

No. E2005-02388-COA-R3-CV, 2006 WL 1627288 (Tenn. Ct. App. May 13, 2006)

Insufficiency of veil piercing evidence.

People Place Auto Hand Carwash, LLC v. Commissioner of Internal Revenue

126 T.C. No. 19, No. 10708-05, 2006 WL 1642339 (U.S. Tax Ct. June 14, 2006)

Scope of automatic stay in LLC member bankruptcy as regards action against LLC for employment tax liability; existence of LLC after dissolution for purposes of litigating claim against LLC.