December 2007 — Issue 22

In re Weiss

376 B.R. 867, No. 07 B 6781 (Bankr. N.D. Ill. 2007)

A debtor’s pledge of his membership and partnership interests in numerous LLCs and limited partnerships was unenforceable because the LLC and partnership agreements prohibited transfer or required prior written consent of the manager, members, or partners and such consent was not obtained prior to the debtor’s grant of a security interest in the interests. Although the lender had filed financing statements, the court held that the security interests were invalid because the debtor’s rights in the collateral were not validly assigned. The court concluded that LLC interests are general intangibles like limited partnership interests and, analogizing to limited partnership cases, the pledge of the LLC interests without the required consent under the LLC agreements was not enforceable. Subsequent consent did not cure the defect in the assignment because the LLC agreements required prior consent. The court rejected the argument that the pledge created a valid security interest in “proceeds” of the interests. First, the court pointed out that the debtor purported to assign his entire interests in the limited partnerships and LLCs, not just portions of the interests. Second, the court stated that the term “proceeds” is so broadly defined in Article 9 of the U.C.C. that there is very little difference between proceeds and the entire business interest. Finally, and most importantly, the court stated that the operating agreements prohibited the assignment of any portion or part of the interests without consent, and proceeds, distributions, profits, or income all constitute a part or portion of the interests. The court rejected the lender’s argument that the debtor should be estopped from using his own violation of the operating agreements to benefit himself by avoiding the pledge. The court pointed out that the debtor had informed the lender that he did not have authority to pledge the interests, and he had crossed out a portion of the security agreement that represented he had authority to transfer the interests. The lender also knew that the consent required to assign the interests had not been obtained. The court did not find persuasive the lender’s policy argument that the consent provisions were designed to protect other members and partners and not the assigning party. The court said that the bankruptcy context requires the interests of all creditors to be safeguarded and that the requirements of attachment, perfection, and validity of the security interest could not be ignored.

Marsala v. Mayo

Civil Action No. 06-3846, 2007 WL 3245434 (E.D. La. Nov. 2, 2007)

An LLC member sued his two co-members alleging breach of fiduciary duty and fraud claims. The LLC was a Delaware LLC and its operating agreement contained a Georgia choice of law clause. Applying Louisiana choice of law rules (under which tort claims such as fraud and breach of fiduciary duty are governed by the law of the state whose policies would be most seriously impaired if its law were not applied), the court agreed with the parties that Georgia law applied to the dispute. The court then concluded that the Georgia internal affairs choice of law provision of the Georgia LLC statute required application of Delaware law to the breach of fiduciary claims. Disputed issues of material fact precluded summary judgment on the breach of fiduciary duty claims. Applying Georgia law to the LLC member’s fraud claims, the court concluded that the claims for fraud based on claims of misrepresentations pre-dating the operating agreement were barred because the operating agreement contained a merger clause. The plaintiff’s other fraud claims failed under Georgia law as well, with the exception of one claim based on the alleged misrepresentation of the defendants’ net worth to induce plaintiff to execute personal guarantees.

HLHZ Investments, LLC v. Plaid Pantries, Inc.

Civil No. 06-797-KI, 2007 WL 3129985 (D. Or. Oct. 23, 2007)

An LLC was formed to serve as a joint venture vehicle to acquire a block of stock in a corporation. Several years later, a member of the LLC withdrew from the LLC and, pursuant to the terms of the LLC operating agreement, received shares of stock held by the LLC in the corporation. The shares received by the member caused the member to cross the threshold of ownership specified in the Oregon Control Share Acquisition Act (the “CSA”), and the shares were thus stripped of voting rights unless the board of directors of the corporation waived the provisions of the CSA. The member argued this result was not intended under the operating agreement and that the corporation’s board of directors was required to waive the provisions of the CSA, but the court found that the corporation was not a party to the operating agreement and that the operating agreement could not be read to require the LLC to deliver stock which could be voted in spite of the CSA. The court concluded that there was no basis to read into, or reform the operating agreement to include, additional provisions where the parties simply failed to consider and anticipate the application pf the Oregon CSA. (The court commented at the outset of its opinion that all parties were sophisticated and had been represented by experienced counsel in entering the transaction, and the court expressed its intent to interpret the contracts to mean what they said and no more.) The court also found that failure to disclose the potential application of the CSA was not a basis for a securities fraud claim against the LLC or its manager. The court concluded that the CSA exemption for a transaction with the issuing public corporation was not available because the transaction was with the LLC, and the exemption for a transaction with an affiliate was not available because the member’s interest, although it was a 70% interest in the LLC which owned a controlling interest in the corporation, had limited power under the operating agreement and did not constitute control. Though the court concluded it did not need to rely on the business judgment rule to dismiss the member’s breach of fiduciary duty claim against the LLC manager, the court commented that it did not see anything in the statutes to persuade the court that the business judgment rule would not apply to managers of Oregon LLCs. (The Oregon LLC statute specifies that the duties owed by the manager are the duties of loyalty and care set forth in the statute.)
The court granted summary judgment in favor of the plaintiff member with respect to a counterclaim against the member for breach of the operating agreement. The court strictly construed a right of first refusal provision in the LLC operating agreement and found that the transfer of a portion of the member’s economic interest to the member’s employees as a bonus was not subject to the right of first refusal provision because the provision was not triggered unless there was a bona fide written offer from a person who wished to buy the interest. To provide broader protection, the provision should have been drafted to prevent any transfer of the interest without notification to other members.
The court held that the corporation in which the LLC owned stock was not entitled to attorney’s fees under a provision of the operating agreement that entitled a prevailing party to attorney’s fees in an action to enforce or interpret the operating agreement. The court reached this conclusion based on its holding that the corporation was not a party to the operating agreement. The court discussed Oregon case law extending the reciprocal attorney fee statute to a non-signatory and concluded that the case law extended the entitlement only to one sued on a contract as an assignee.

Advantage Inspection International, LLC v. Sumner, C.A.

No. 6:06-3466-HMH, 2007 WL 2973538 (D. S.C. Oct. 9, 2007)

The defendant sought to dismiss the plaintiff LLC’s complaint on the basis that the LLC was not legally organized because it did not have an LLC agreement as required by the Delaware LLC statute. The court compared the language of the Delaware statute before and after the August 1, 2007 amendments and concluded that the pre-amendment statute did not require an LLC agreement to properly form an LLC. The court found no evidence that the amendment was intended to be retroactive and thus concluded that the plaintiff became a legal entity upon the filing of its certificate of formation. Furthermore, even if an LLC agreement was required, the plaintiff presented evidence that its members agreed to the terms of an operating agreement; therefore, the factual dispute over the existence of an agreement precluded dismissal.

Cox v. Southern Garrett, L.L.C.

__ S.W. 3d __, No. 01-05-01091-CV, 2007 WL 2963756 (Tex.App. 2007)

An LLC member asserted various claims against the LLC and his co-members in connection with the withdrawal and buyout of the member. The member cashed a check tendered by the LLC for his interest but did not sign a letter accompanying the check. The letter contained a release of liability and stated that the member’s signed acceptance of the terms constituted the member’s agreement that his ownership was relinquished. The member argued that the buyout of his interest did not become effective and that he was still entitled to receive membership distributions because the buyout violated transfer restrictions in the LLC membership regulations (i.e., the operating agreement). The transfer restrictions prohibited a member from disposing of all or any portion of his membership interest without complying with specified conditions and stated that any attempted disposition in violation of the agreement was void. The transfer restriction provision referred to the “Person” to whom the membership interest was transferred, and the agreement defined “Person” as having the meaning given the term in the Texas LLC statute. The statute defined the term broadly to include individuals and entities. The court concluded, however, that the transfer restriction only applied to a transfer to a person who was not a member. The court stated that a plain reading of the provision demonstrated that its purpose was to provide rules for disposition of a member’s interest to a non-member. In support of this interpretation, the court pointed to the fact that the phrase “Person to be admitted” was used in various subsections of the transfer restriction provision. The court found that the buyout did not violate the transfer restriction because the transfer did not involve a transfer to a non-member. The court also concluded that the LLC had complied with provisions of the membership regulations governing distributions to a withdrawing member. The court found that the LLC’s offer to purchase the member’s interest substantially complied with the requirement that a withdrawing member receive the fair value of his interest as of the first day of the month following the date of the occurrence giving rise to the member’s withdrawal. The letter stated that the purchase price would be calculated based on the retained earnings of the LLC as of the last day of the month of the member’s withdrawal. Although the member did not sign the letter accompanying the check, the court found that the member accepted the buyout of his interest by signing and depositing the check and completed his withdrawal effective as of the date specified in the letter. The court rejected the member’s claims that the other owners of the LLC breached a fiduciary duty to him in connection with the repurchase of his interest. The member couched his argument in terms of duties owed in the context of a closely held corporation and argued that the defendants had the burden to establish the fairness of the transaction. The court stated that the member’s breach of fiduciary duty claim regarding the voiding of his interest depended upon his argument that the transfer restrictions applied to the purchase of his interest, and the claim thus failed as a matter of law. The court stated that another breach of fiduciary duty claim based on alleged fraudulent transfers of ownership in the LLC related to transactions that occurred after the member’s withdrawal and that the LLC owed him none of the duties owed members after that date.

Concrete Company v. Lambert

510 F.Supp.2d 570, Civil Action No. 2:05cv1026-CSC (M.D. Ala. 2007)

Lack of enforceability of covenant not to compete in operating agreement in connection with purchase and sale of LLC interest

Restoration Industry Association, Inc. v. Certified Restorers Consulting Group, LLC

No. CV-07-227-S-BLW, 2007 WL 2898698 (D. Idaho Sept. 28, 2007)

Scope of liability protection of Idaho LLC statute

Hollingsworth v. Choates

963 So.2d 1089, No. 42-424-CA (La. App. 2007)

Limited liability of individual who signed deed as manager of LLC because individual was not “builder” as defined by New Home Warranty Act

Irrigation Mart, Inc. v. Gray

965 So.2d 988, No. 42,442-CA (La. App. 2007)

Personal liability of individual who purchased supplies under trade names that did not indicate existence of LLCs

Montgomery County v. Wildwood Medical Center, L.L.C.

__ A.2d __, No. 2280, Sept. Term, 2005, 2007 WL 3197225 (Md. App. 2007)

Application of transfer and recordation tax to transfer of title to LLC from family members who claimed to own property as general partnership

Peoples Bank v. Bryan Brothers Cattle Company

504 F.3d 549, No. 06-60582 (5th Cir. (Miss.) 2007)

Individual member’s lack of interest in specific LLC property and inability to grant security interest in such property; insufficiency of certificate of formation filed with Secretary of State to support trial court’s conclusion that LLC existed as matter of law at relevant times in issue

Glickman v. Sollod

2007 WL 3034273 (N.J. Super. A.D. Oct. 19, 2007)

Failure of investors to become members where “formal stockholders’ agreement” contemplated by letter agreement was never executed and operating agreement was not amended to reflect admission of members

Flores v. Murray

2007 WL 3034512 (N.J. Super. A.D. Oct. 19, 2007)

Interpretation of memorandum of understanding and partially executed operating agreement and inapplicability of merger clause in operating agreement to members who did not sign operating agreement; breach of fiduciary duty of member in connection with hidden payments to son and use of LLC funds to pay personal debt; forfeiture of interest and judicial expulsion of member based on breach of obligation to contribute and breach of fiduciary duty

In re Newco Aggregate Company, LLC

No. 7-03-11787 SF, Adversary No. 05-1065 S, 2007 WL 3138637 (Bankr. D. N.M. Oct. 15, 2007)

Propriety of execution of note and security agreement on behalf of LLC where LLC was member-managed and documents were signed by individual who was president of corporation that was majority member of LLC

Taurus IP, LLC v. DaimlerChrysler Corporation

__ F.Supp. __, 2007 WL 3023615 (W.D. Wis. 2007)

Law of state of formation as governing determination of whether corporate form should be disregarded; analysis of alter ego doctrine as applied to numerous Texas and Wisconsin LLCs for purposes of imputing contacts for personal jurisdiction and motion to dismiss