August 2007 — Issue 18

Stone v. Jetmar Properties, LLC

733 N.W.2d 480, No. A06-851 (Minn. App. 2007).

The court determined that neither the de facto corporation doctrine nor the corporation by estoppel doctrine applied to a conveyance of real property to an LLC that did not yet exist, and the deed was thus void. Although the promoter had drafted and signed articles of organization, he had made no attempt to file them; therefore, the court concluded that there had been no colorable attempt to organize the LLC under the statute, and the de facto corporation doctrine would not have been satisfied even if it applied. The court went on, however, to conclude that the de facto corporation doctrine has been abolished in Minnesota in both the corporate and LLC contexts. Relying on the reporter’s notes to the Minnesota corporate statute adopted in 1981, the court concluded that the de facto corporation doctrine was abolished by the provision specifying the effective date of a corporation’s articles of incorporation. The court concluded that the provision of the LLC statute specifying that the organization of an LLC is effective upon the filing of articles of organization similarly precludes recognition of de facto existence of an LLC because the corporate provision was the source of the LLC provision. Furthermore, the subsequent formation of the LLC did not result in a conveyance at the time the entity was formed. The court held that a deed to an entity that does not exist at the time of delivery is void. Although the court stated that the corporation by estoppel doctrine survives in Minnesota despite the inapplicability of the de facto corporation doctrine, the court did not reach the question of whether the corporation by estoppel doctrine also applies in the LLC context. Assuming, without deciding, that the corporation by estoppel doctrine applies to LLCs, the court concluded that the doctrine did not apply to the facts of this case because the execution of the deed was done in reliance on false representations, promises, and assurances by the promoter.

McCarthy v. Wani Venture, A.S.

__ S.W.3d __, No. 01-04-00921-CV, 2007 WL 1845088 (Tex. App. 2007).

The court held that corporate veil piercing principles apply to Texas LLCs and that the evidence was sufficient to support the jury’s finding that the defendant, McCarthy, caused an LLC to be used to perpetrate an actual fraud upon the plaintiff for McCarthy’s direct personal benefit. McCarthy and two other individuals were the owners of numerous interrelated companies involved in the case. Among these entities was an LLC of which McCarthy was a one-third member and vice-president. The plaintiff supplied over $1 million of wallboard to the LLC, and the LLC paid for only about $500,000 of the wallboard. The plaintiff sued the LLC, along with several other entities and the three individuals, alleging tort, breach of contract, and veil piercing claims. At the time of trial, all of the original defendants other than McCarthy had filed bankruptcy, been severed out, or been non-suited. An expert testified about the dealings of the entities and individuals and expressed concern about various issues and irregularities. He summed up his findings by referring to “multiple companies that are intermingling,” “monies coming in, monies coming out,” “a lack of documentation,” “a lack of supporting information,” “an accounting nightmare,” “transfers between parties,” “a lot of red flags,” and “inventories that are being shifted and moved.” There was also evidence from which the court of appeals concluded that the LLC concealed material facts about its financial condition and operations and induced the plaintiff to supply the LLC wallboard for which it was never paid. The jury charge included a question that inquired whether McCarthy caused the LLC to be used to perpetrate an actual fraud, and did perpetrate an actual fraud upon the plaintiff, primarily for her own direct personal benefit (i.e., tracking the veil piercing standard specified by the Texas Business Corporation Act). The jury answered this issue in the affirmative, and also found damages in the amount of unpaid invoices owed the plaintiff and attorney’s fees. The trial court entered a judgment against McCarthy based on the findings, and McCarthy appealed. McCarthy argued that the trial court erred in holding her personally liable for the LLC’s debt because the Texas Limited Liability Company Act provides for liability of a member under very limited circumstances and specifically provides that a member is not liable for a debt of the LLC. McCarthy argued that the LLC veil is impenetrable because the LLC statute does not address whether or under what circumstances a litigant may pierce the veil of an LLC. The court disagreed, stating that courts in Texas and other jurisdictions have applied to LLCs the same state law principles for veil piercing that are applicable to corporations. McCarthy also argued that “actual fraud” was improperly defined for the jury, that there was insufficient evidence that the LLC committed fraud, that the evidence was insufficient to support the findings of damages and attorney’s fees, and that there was insufficient evidence that McCarthy caused the LLC to be used to perpetrate a fraud for her direct personal benefit. The court of appeals rejected all of these arguments. A dissenting justice did not challenge the proposition that corporate veil piercing principles apply to Texas LLCs, but disagreed with the majority that the evidence was sufficient to support the jury’s finding that McCarthy caused the LLC to perpetrate a fraud for her direct personal benefit.

Dragt v. Dragt/DeTray, LLC

161 P.3d 473, No. 35046-7-II (Wash. App. 2007).

The court held that non-managing members of a Washington LLC do not owe fiduciary duties to other members unless fiduciary duties are imposed under the operating agreement; therefore, two non-managing members of an LLC formed to develop land owned by the non-managing members were not required to notify the managing member before selling the land to a third party. The non-managing members, Henry and Jane Dragt, owned land that they wanted to develop, but they lacked the funds and expertise to develop the land. They formed an LLC with DeTray, a land developer, who agreed to front the costs and provide his expertise to develop the land. The operating agreement gave the LLC a future option to purchase the land because the Dragts did not want to transfer title to the land to the LLC. After a number of years, the Dragts became frustrated with the progress of the land development and consulted an attorney who advised them that the LLC’s option was unenforceable. The Dragts then sold the land to a third party without informing DeTray. The trial court determined that the option was unenforceable, but found that the parties modified the operating agreement by oral agreement and course of conduct and that the Dragts agreed to hold the property for development by DeTray and to compensate DeTray for his capital contributions out of the sale proceeds of the property. The trial court reasoned that the parties were “partners” who owed one another fiduciary duties, and awarded DeTray damages against the Dragts for breach of contract and breach of fiduciary duty based on their sale of the property without notice to DeTray and their refusal to divide the sale proceeds as called for in the operating agreement. The trial court’s decision that the option was unenforceable was not challenged on appeal, but the court of appeals reversed the other decisions of the trial court. The court of appeals found there was no modification of the contract because there was no changed understanding or circumstance and no separate consideration for a modification. The parties operated pursuant to their understanding of the original agreement. Neither party thought the Dragts were assuming a new obligation to hold the property for the LLC because they believed that the LLC already had an option to purchase the property. Similarly, there was no new or additional consideration; all the promises were made when the parties signed the agreement and remained unchanged. The court noted that the parties discussed and rejected forming a general partnership before forming the LLC. The court next reviewed a right of first refusal provision in the operating agreement and concluded that the Dragts did not breach the agreement by selling the land without giving notice to DeTray because the provision applied to transfers of membership interests, and the Dragts sold their land rather than their membership interests. The court concluded that the Dragts did not breach any fiduciary duty owed to DeTray because the Dragts were merely members of a manager-managed LLC and as such did not owe any fiduciary duties. The operating agreement specifically imposed fiduciary duties on DeTray as manager but did not address fiduciary duties of members. In the absence of Washington case law on the issue, the court relied upon the Uniform Limited Liability Company Act to assist in its interpretation of Washington law. The court cited the provision of ULLCA providing that a member of a manager-managed LLC owes no duties to the LLC or the other members solely by reason of being a member. The court found that the trial court erred in basing damages on the provision of the operating agreement governing the division of LLC profits because the land was owned by the Dragts and the proceeds of the land sale were not LLC profits. The court concluded that the Dragts were unjustly enriched, however, by DeTray’s financial contributions and services to the LLC during the development venture, and the trial court should have acted in equity to award DeTray restitution. The case was thus remanded for the trial court to award DeTray his costs in developing the land (mortgage payments, sewer connection, consultant reports and designs, and access to wastewater treatment) along with the reasonable value of the benefit of his services.

Chadwick Farms Owners Association v. FHC, LLC

160 P.3d 1061, No. 58796-0-I (Wash. App. 2007); Maple Court Seattle Condominium Association v. Roosevelt, LLC, 160 P.3d 1068, Nos. 56879-5-I, 56970-8-I (Wash. App. 2007); Emily Lane Homeowners Association v. Colonial Development, L.L.C., 160 P.3d 1073, No. 58825-7-I (Wash. App. 2007).

Each of these opinions addresses suits by or against dissolved and cancelled LLCs and the effect of a 2006 amendment to the Washington Limited Liability Company Act providing for a three-year post-dissolution survival period within which a claimant may commence an action against a dissolved LLC. The court filed its opinions in these three cases contemporaneously. In Chadwick Farms Owners Association v. FHC, LLC, the court held that the 2006 amendment to the LLC statute providing for a three-year post-dissolution survival period was retroactive, and a suit against an administratively cancelled LLC that was filed within that period could proceed. The LLC was administratively dissolved by the Secretary of State in 1999 due to failure to file its annual report and renewal fee. The plaintiff, a homeowners’ association, brought suit against the LLC in 2004, alleging the LLC was responsible for numerous construction defects. The LLC was cancelled seven moths later because two years had passed since the Secretary of State issued the notice of dissolution. The court analyzed the 2006 amendment providing for the post-dissolution survival period for the commencement of claims and determined the statute had retroactive effect. The court rejected the LLC’s argument that the statute did not permit claims against cancelled LLCs. The court concluded the survival provision applies to dissolved LLCs whether or not a certificate of cancellation has been issued. The court did not think the legislature was anything other than “inartful” in choosing the term “dissolution” and noted that construing the statute otherwise would nullify its stated purpose and render the statute useless since a dissolved LLC could sue and be sued as part of the winding up process prior to the amendment. The court also found that the amendment for survival of claims only applies to actions brought against an LLC, and the LLC’s failure to reinstate was fatal to the pursuit of third party claims it sought to assert against subcontractors. Finally, the court observed that a person winding up an LLC’s affairs who does not comply with the statutory requirements for winding up (i.e., does not make provision for known liabilities of the LLC) may be personally liable to the claimants depending upon the particular facts. In Maple Court Seattle Condominium Association v. Roosevelt, LLC, the court held that an administratively cancelled LLC that had settled condominium owners’ claims regarding construction defects ceased to be a legal entity with standing to sue when it was cancelled. The LLC argued that it was still able to wind up its affairs after being cancelled, but the court stated that such a position ignored the plain language of the statute requiring winding up of an administratively dissolved LLC within two years of dissolution. The LLC could have reinstated after the administrative dissolution, but failed to do so and thus lost the ability to pursue its claims against the subcontractors. The court also held that the project manager, against whom the LLC had brought third party claims and which had paid toward the settlement of the condominium owners’ claims, essentially made a gratuitous payment since the LLC no longer had the capacity to maintain an action against the project manager after the LLC’s cancellation. The project manager could not recover against the subcontractors because the project manager’s rights were essentially derivative of the LLC’s. In Emily Lane Homeowners Association v. Colonial Development, L.L.C., the court held that the amendment to the Washington LLC statute providing for a post-dissolution three-year survival period was retroactive and that a suit against an LLC that had been voluntarily dissolved and cancelled by the members could proceed. The court also stated that the members of a dissolved LLC are not immune from liability if the LLC is not properly wound up in accordance with the statute or if grounds for veil piercing exist.

Kasten v. Doral Dental USA, LLC

733 N.W.2d 300, No. 2005AP995 (Wis. 2007).

The Wisconsin Supreme Court interpreted provisions of an operating agreement granting members access to “Company documents” and concluded that the operating agreement conferred broader access rights than the default provision of the Wisconsin LLC statute that grants access to “records” because the term “Company documents” is a broader category of stored information than “records.” An LLC member sought access to email communications and drafts of documents, and the court concluded that such items were encompassed in “Company documents” (except for email that was of a strictly personal or social nature). The court also addressed how to determine if a request for records (or “Company documents” in this case) is a “reasonable request” as required by the statute (or the operating agreement in this case). In analyzing the plaintiff member’s inspection and information rights, the court examined both the statutory provisions of the Wisconsin LLC statute and the provisions of the operating agreement. The statute provides a member the right to inspect and copy, “upon reasonable request,” any LLC record required to be kept under the statute and, unless otherwise provided in the operating agreement, “any other record” wherever located. The statute further imposes a duty on LLC managers, upon reasonable request of a member, to disclose “true and full information of all things affecting the members.” The operating agreement included a provision giving members access to the LLC’s books of account and all other LLC records at reasonable times. Another provision gave each member, “upon reasonable request,” the right to inspect and copy “Company documents.” The operating agreement did not address the managers’ duty to disclose information to members. The court examined the record inspection provisions of the corporation and partnership statutes and noted differences between each of those statutes and the LLC statute. The limited partnership statute restricts the right to inspect records to those records required to be kept under the statute, and the corporate statute contains numerous limitations relating to shareholder access to records. The court contrasted the lack of restrictions in the inspection provisions of the LLC statute and stated that the scope of a member’s right under the default provisions of the LLC statute is exceptionally broad and hinges on what constitutes an LLC “record” and the degree and kind of restrictions that the requirement of a “reasonable request” imposes. The court characterized the broad rights provided under the LLC statute as consistent with the purposes of simplicity and freedom of contract that are at the heart of the statute. The court stated that the default rules, which do not include cumbersome restrictions, were designed for less sophisticated companies that would be less likely to craft their own inspection rules, while the statute envisions that larger, more sophisticated companies with multiple members may adopt rules that may be more suited to their needs. The court consulted the dictionary definitions of “document” and “record” and concluded that the term “document” is a broader category of stored information than “record.” The court concluded that the term “Company documents” under the operating agreement encompassed document drafts and email (other than purely personal or social email), and the court expressly refrained from addressing whether the statutory phrase “any other records” embraces informal or non-financial records, email, or document drafts. The court did explain that the statutory requirement that managers provide “true and full information of all things affecting members” imposes a duty on managers to provide such information regardless of whether the information is recorded and stored as a record or document. The court construed the phrase “all things affecting the members” to mean all things affecting the requesting member’s financial interest in the LLC. While the member’s right to “true and full information” under this provision is limited to matters affecting the member’s financial interest, the court rejected the argument that a member’s statutory right of access to records is limited to records affecting the member’s financial interest. The court next examined what constitutes a “reasonable request” with respect to member inspection rights. The court rejected the argument that the “reasonable request” requirement limits the types of records subject to inspection, but also refused to interpret the phrase as pertaining only to the time and manner of inspection. While the phrase “reasonable request” applies only to the time and manner of inspection under the limited partnership statute, the court pointed out that the limited partnership statute differs from the LLC statute in that the limited partnership statute authorizes inspection of only specified records. The court discussed various approaches taken in other state LLC statutes and concluded that the absence of a “proper purpose” requirement in the Wisconsin statute is significant but does not mean that the statute is blind to a member’s motive for making an inspection request. The court concluded that the purpose of the “reasonable request” requirement in the Wisconsin LLC inspection provision is to protect the LLC from member inspection requests that impose undue financial burdens on the LLC, and the requirement relates to the breadth of the request as well as the timing and form of inspection. The court provided a non-exclusive list of factors that may be relevant in balancing the statute’s bias in favor of member access against the costs of the inspection to the LLC in determining whether a request is so burdensome as to be unreasonable. The court remanded the case to the trial court for a determination of the reasonableness of the member’s request to inspect email and document drafts.

Barton Properties, Inc. v. King, Purtich, Holmes, Paterno & Berliner

No. B186499, 2007 WL 1830813 (Cal. App. June 27, 2007)

Application of corporate shareholder derivative suit principles to members of LLC; lack of standing by member to pursue direct claims for breach of fiduciary duty and malpractice.

Foster-Thompson, LLC v. Thompson

No. 8:04-CV-2128-T-EAJ, 2007 WL 1725198 (M.D. Fla. June 14, 2007).

Member’s direct claim for breach of fiduciary duties of loyalty and care against managing member under Florida LLC statute.

NDC LLC v. Topinka

__ N.E.2d __, No. 2-05-1206, 2007 WL 1765273 (Ill. App. 2007).

Liability of Delaware LLC that survived merger with Delaware corporation for Illinois franchise tax associated with increase of capital of corporation prior to merger.

Mixon v. Iberia Surgical, L.L.C.

956 So.2d 76, No. 2006-878 (La. App. 2007)

Propriety of expulsion of LLC member under terms of operating agreement permitting expulsion without cause and buy out of interest at book value.

GxG Management, LLC v. Young Brothers and Co., Inc.

Civil No. 05-162-B-K, 2007 WL 1702872 (D. Me. June 11, 2007).

Clarification of earlier opinion regarding standing of Delaware LLC to maintain contract action with respect to boat owned by series of interest in LLC because series is not separate entity with capacity to independently pursue legal claims.

Stearn & Company, L.L.C. v. United States

No. 06-CV-14923-DT, 2007 WL 1888805 (E.D. Mich. June 29, 2007).

Personal liability of sole member of disregarded LLC for penalties and interest on unpaid federal employment taxes.

Spaulding v. Honeywell International, Inc.

__ S.E.2d __, No. COA06-1221, 2007 WL 1890710 (N.C. App. 2007).

Limited liability of LLC member under North Carolina LLC statute; absence of independent duty on part of LLC manager to provide safe workplace for LLC employees; employee’s lack of third party beneficiary status under LLC operating agreement.

Bloodworth v. Aden

No. 01-05-00796-CV, 2007 WL 1845111 (Tex. App. 2007).

Personal liability of attorney member of professional LLC for sanctions.

Wasatch Oil & Gas, L.L.C. v. Reott

__ P.3d __, No. 20060562-CA, 2007 WL 1775009 (Utah App. 2007).

Binding effect of conveyance signed by LLC manager without disclosure of LLC principal; application in LLC context of Utah requirement of written authorization for agent to convey real property; interpretation of operating agreement provision regarding authority to execute conveyance of real estate).

Ivy v. Brown

No. 57832-4-I, 2007 WL 1739696 (Wash. App. June 18, 2007).

Grounds for issuance of charging order.