December 2008 — Issue 34

LLPs: iCore Networks, Inc. v. McQuade Brennan LLP

No. 1:08cv748 (JCC), 2008 WL 4550988 (E.D. Va. Oct. 7, 2008)

(limited liability of partner)

LLCs: Greetham v. Sogima L-A Manager LLC

C.A. No. 2084-VCL, 2008 WL 4767722 (Del. Ch. Nov. 3, 2008)

The parties formed an LLC and acquired several portfolios of tax liens and related property, but a dispute developed over who would service the assets acquired. The plaintiffs relied upon a draft servicing agreement and a side letter in asserting that the parties agreed the plaintiffs’ entity would be the sole and permanent servicer. As a threshold issue, the court determined that Delaware law applied to the dispute. The plaintiffs argued that Delaware law applied based on the choice of law provision in the operating agreement, which provided that the agreement shall be governed and construed in accordance with Delaware law and that the parties agreed that any dispute arising in connection with the agreement shall be resolved in the Delaware Chancery Court. Alternatively, the plaintiffs argued that there were no significant differences between the relevant Delaware and New Jersey law. The defendants maintained that there were slight differences between Delaware and New Jersey law and that New Jersey law should govern under the “most significant relationship” test. Guided by the principle that Delaware courts will honor contractual choice of law provisions so long as the jurisdiction bears some material relationship to the transaction, the court concluded that Delaware law applied. The court stated that there was a material relationship with Delaware because the key entities underlying the transaction were Delaware entities. The court also recognized that the entities, operating in several different states, sought a “‘reliable body of law to govern their relationship.’” The court then analyzed the draft servicing agreement and circumstances of the negotiations and concluded that the draft agreement was not intended to be the final agreement. The court concluded that the record overwhelmingly established that the draft servicing agreement and side letter were no more than an agreement to agree. The court also concluded that the plaintiffs failed to demonstrate that the defendants promised that the plaintiffs’ entity would serve as the sole servicer and that the plaintiffs relied upon this purported representation. Thus, the court rejected the plaintiffs’ promissory estoppel claim as well.

Olson v. Halvorsen

C.A. No. 1884-VCL, 2008 WL 4661831 (Del. Ch. Oct. 22, 2008)

The dispute in the case arose among the founders of a hedge fund LLC when one of the founders was removed from the LLC. An unsigned LLC agreement provided that a founder was entitled to a multi-year earnout, in this case purportedly worth more than $100 million, when the founder left the LLC. The court held that the one-year provision of the Delaware statute of frauds applies to LLC operating agreements, and the multi-year payment structure set forth in the unsigned operating agreement was thus unenforceable. The court noted that the Delaware LLC statute expressly allows oral operating agreements, but does not address whether the statute of frauds applies to such agreements. Commentators disagree as to whether the statute of frauds applies to Delaware LLC agreements, and the court stated that there appeared to be no case law in Delaware or elsewhere on the subject. The court noted that few oral LLC agreements are likely to contain any term or provision that cannot possibly be performed within one year, and the statute of frauds would not limit the enforcement of an oral agreement if it contained no such provisions. If, however, an oral LLC agreement contains a provision or provisions that cannot possibly be performed within one year, the court held that such provision or provisions are unenforceable based on the policy underlying the statute of frauds. The court analyzed the payment provisions in the unsigned LLC agreement and concluded that the payout obligation fell within the one-year statute of frauds provision because all amounts except the first payment could not possibly be calculated until after one year following the alleged agreement, and there were additional substantive obligations and restrictions on the remaining members extending for multiple years. The court analyzed exceptions to the statute of frauds involving multiple writings and part performance and concluded that these did not apply in this case. Other writings relied upon by the removed member did not clearly and specifically reference the unsigned operating agreement or the payout provision. The court followed the majority rule that an agreement not performable within one year (in contrast to a contract involving the sale of land) is not validated by part performance; therefore, the part performance exception was not available to the removed member.

Ronald A. Chisholm (U.S.A.) Inc. v. Anpro Trading, L.L.C.

Civil Action No. 06-3300, 2008 WL 4691213 (E.D. La. Oct. 22, 2008)

The sole member of an LLC sought dismissal of the plaintiff’s attempt to hold the member personally liable on a contract of the LLC. The plaintiff argued that the totality of the circumstances demonstrated that it was entitled to pierce the veil, but the only specific contentions were that the LLC was undercapitalized and failed to follow formalities. The evidence of undercapitalization was testimony by the member that he would write a check from the LLC to himself for salary in whatever figure he thought the LLC could allow itself, and the initial capitalization of the LLC was $1,000. The court held that this evidence did not establish undercapitalization per se, and the court stated that the plaintiff did not provide any other evidence concerning the LLC’s financial status to establish de facto undercapitalization. With regard to formalities, the plaintiff relied upon the LLC’s failure to hold annual meetings. The member testified that the organizational documents permitted meetings to be held in person or by telephone and did not require minutes. When asked whether the informal meetings were held by telephone or otherwise, the member testified that the meetings were basically him having a meeting with himself. The court stated that, because the LLC was a single member LLC, the failure to hold meetings did not raise a fact issue with regard to adherence to corporate formalities. The court found that the undisputed facts established “substantial compliance” with corporate formalities. The court also stated that courts have usually applied more stringent standards for piercing the corporate veil where the liability is based on contract because the party seeking relief is presumed to have voluntarily and knowingly entered into an agreement with a corporate entity whose shareholders have limited liability. The plaintiff offered no evidence rebutting this presumption, and the court granted the member’s motion for summary judgment.

Potluri v. Yalamanchili

No. 06-13517, 2008 WL 4793382 (E.D. Mich. Nov. 3, 2008)

Potluri asserted various causes of action in connection with his claim that he and Yalamanchili orally agreed to acquire various businesses in which each would own an equal share regardless of the legal form or owner of record. One of the businesses formed was an LLC, and Potluri and Yalamanchili agreed to list a third party as owner and CEO to disguise the ownership of the LLC because Potluri was subject to a non-compete agreement and they did not want to risk violating that agreement. When the record owner and Yalamanchili refused to recognize Potluri’s claim to ownership in the LLC, Potluri sued them asserting various causes of action. The court held that Potluri’s claims for promissory estoppel and unjust enrichment were barred by his “unclean hands” in knowingly misrepresenting his ownership interest to enable creation of a business in violation of his non-competition agreement. Because the agreement to form and be equal owners of the LLC could be performed within one year, the court rejected the argument that it violated the statute of frauds. The court rejected the argument that the agreement violated a Michigan statute requiring agreements for the sale or transfer of securities to be in writing because the evidence did not show that the ownership interest purportedly created by the agreement was a security under Michigan law and Yalamanchili offered no legal support for his argument that an ownership interest in an LLC is generally considered a security. Potluri’s breach of contract claim survived summary judgment because a fact question remained as to whether the contract existed and what rights it conferred on Potluri. Yalamanchili argued that Potluri was not a member of the LLC because he was not admitted as a member in any of the ways provided by the Michigan LLC statute. The court pointed out, however, that Potluri was not claiming to be a member; rather, Potluri alleged that Yalamanchili breached their oral agreement by failing to recognize him as an equal owner. Furthermore, the court stated that no provision of the Michigan LLC statute requires an owner to be a member. According to the court, the fact that Potluri was not a member was relevant, but not dispositive, in deciding whether he had an ownership interest in the LLC.

Ewie Company, Inc. v. Mahar Tool Supply, Inc.

Docket No. 276646, 2008 WL 4605909 (Mich. App. Oct. 9. 2008)

In late 2004, Ewie, the 51% member of an LLC, notified Mahar, the 49% member, that Ewie wished to dissolve and wind up their LLC, which had been formed several years earlier to provide inventory supply and management services to a GM plant. The articles of organization stated that the term of the LLC ended on December 31, 2004, but the operating agreement also contained specific provisions regarding dissolution along with a non-competition provision and an integration clause. Mahar did not want to dissolve the LLC and refused Ewie’s suggestion that Mahar buy out Ewie’s share. Nevertheless, Ewie paid Mahar for its interest and notified GM that the LLC dissolved. GM terminated its contract with the LLC and awarded a new contract to PSMI, a company formed by the principals of Ewie. After dissolution of the LLC, Ewie sold the LLC’s assets to PSMI. When Mahar refused to permit the winding up of the LLC, Ewie filed suit on its own behalf and on behalf of the LLC for judicial winding up under the Michigan LLC statute. Mahar filed a counterclaim against Ewie, PSMI, and the two individual principals of those entities alleging numerous business torts and violations of the LLC statute. Ewie sought summary judgment on the basis that it was the majority member and properly sought dissolution under the articles of organization and operating agreement in light of the dissolution date of December 31, 2004. Ewie further argued that it was forced to seek judicial dissolution and that Mahar lacked standing to bring its counterclaims because the LLC dissolved on December 31, 2004, and Ewie’s conduct seeking dissolution was not unfair or oppressive. Ewie argued that the non-compete provision had not been violated because it was PSMI and not Ewie that contracted with GM. The court held that the operating agreement was ambiguous as to whether unanimous consent of the members was required to dissolve upon the termination date specified in the articles of organization, and the trial court thus erred when it ruled that the LLC automatically dissolved on the date specified in the articles of organization. The court also held that it was error for the trial court to grant summary disposition on the dissolution question because, regardless of the dissolution date in the articles of organization, Mahar presented evidence that Ewie and its principals took steps prior to the dissolution to take over the LLC’s contract with GM. Though Ewie argued that Mahar had no standing to assert the LLC’s claims, the court stated that Mahar had statutory authority under the Michigan LLC statute to bring an action to establish that Ewie, a controlling member, engaged in fraudulent, willfully unfair, or oppressive conduct. Ewie argued that it was within its rights to force dissolution of the LLC, but the Michigan LLC statute permits winding up of an LLC by the members who have not “wrongfully dissolved” the LLC, and the court held that Mahar presented evidence that could lead a reasonable jury to conclude that Ewie “wrongfully dissolved” the LLC because of Ewie’s desire to usurp the GM contract. Further, the statute requires “good cause” for a judicial winding up, and the court stated that “good cause” would not include formation of a new company to take over the LLC’s business. The court also held that a jury must decide whether Ewie violated provisions of the operating agreement requiring the members to discharge their duties in good faith, with ordinary care, and in a manner reasonably believed to be in the best interests of the LLC and that a jury should consider whether the conduct of Ewie and its owners violated the non-compete clause in the operating agreement. Relying on provisions of the Michigan LLC statute and the operating agreement, the court stated that Ewie, as managing member, was required to disclose to Mahar that Ewie’s principals were forming PSMI to take over the GM contract and to obtain Mahar’s consent to transfer substantially all of the assets of the LLC to PSMI. In sum, the court held that a jury must determine the intent of the parties with regard to the dissolution provision and the various claims arising out of the events surrounding the purported dissolution. The court also addressed a discovery dispute between the parties. The court held that Mahar’s request for approximately one year of documents related to PSMI was reasonable. The court directed the trial court on remand to reconsider its blanket refusal to allow Mahar to obtain additional documents of Ewie, PSMI, and their owners, officers, and employees, as well as documents of Comerica Bank, related to acquiring Mahar’s interest in the LLC, dissolution of the LLC, or transferring or selling the assets of the LLC. Finally, the court directed the trial court to reconsider its refusal to allow Mahar to depose two attorneys of the LLC. The court stated that either attorney’s work or advice to individuals would be privileged, but Mahar, as a member of the LLC, was entitled to information from the attorneys about their representation of the LLCs. Moreover, the court stated that the privilege would not apply to the extent one of the attorneys may have acted with Ewie to fraudulently withhold information to which Mahar was entitled.

NEFT, LLC v. Border States Energy, LLC

297 Fed.Appx. 406, No. 07-6084 (6th Cir. 2008)

(limited liability of members under Kentucky law; limited nature of members’ guaranty)

Towerhill Wealth Management, LLC v. Bander Family Partnership, L.P.

C.A. No. 3830-VCS, 2008 WL 4615865 (Del. Ch. Oct. 9, 2008)

(scope of arbitration clauses in operating agreements and investment advisory agreements)

Downey v. Ambassador Development, LLC

568 F.Supp.2d 28, Civil Action 08-982 (JDB) (D.C. 2008)

(interpretation of DC LLC statute as permitting suits against dissolved LLC during winding up; capacity of dissolved LLC to retain legal counsel and engage in winding up matters)

Johannsen v. Utterbeck

146 Idaho 423, 196 P.3d 341, No. 34023 (Idaho 2008)

(ambiguity of operating agreement requiring a member to contribute “certain real property” to LLC; application of clearly erroneous standard in judicial dissolution context absent specified standard in Idaho LLC statute)

Kroupa v. Garbus

583 F.Supp.2d 949, No. 08 C 2691 (N.D. Ill. 2008)

(application of case law governing corporate derivative suits in LLC context under Delaware law; derivative nature of member’s claim against member-manager for breach of fiduciary duty; LLC as indispensable party with respect to claim for removal of manager)

Regions Bank v. Ark-La-Tex Water Gardens, L.L.C.

997 So.2d 734, No. 43604-CA (La. App. 2008)

(limited liability of LLC members and managers; liability of professionals for personal negligence)

Nightingale & Associates, LLC v. Hopkins

Civ. Docket No. 07-4239 (FSH), 2008 WL 4848765 (D. N.J. Nov. 5, 2008)

(application of Delaware law under operating agreement choice of law provision; non-existence of “minority shareholder oppression” cause of action under Delaware law; absence of Delaware or New Jersey law supporting member’s claim for “wrongful misconduct” in connection with member’s removal)

Estate of Stuart v. Oklahoma Tax Commission

195 P.3d 1280, No. 104,409 (Okla. App. 2008)

(application of Oklahoma estate tax to non-resident decedent’s interest in Texas limited partnership where limited partnership was sole member of Oklahoma LLC owning ranch in Oklahoma)

Commonwealth Land Title Insurance Company v. M.S.I. Holdings, LLC

No. C.A. 08-217ML, 2008 WL 4681775 (D. R.I. Oct. 21, 2008)

(limited liability of member; potential liability of member for member’s own tort liability)

Ehresmann v. Muth

757 N.W.2d 402, No. 24734 (S.D. 2008)

(potential personal liability of LLC member where member’s capacity in overseeing construction and sale of property was unclear)