726 F.3d 1306 (Fed. Cir. 2013).
The court affirmed the district court’s exercise of personal jurisdiction over a Texas resident, Spangenberg, and his Texas LLC based on a two-step piercing analysis. First, the court held that Spangenberg, the individual managing member of a Wisconsin LLC, was the alter ego of that LLC, and then the court applied the alter ego theory in reverse to reach Spangenberg’s Texas LLC. The court generally referred to both of the LLCs as “corporations” and applied corporate veil piercing principles. Pursuant to Wisconsin conflict-of-laws principles, the court applied Wisconsin veil-piercing principles to the Wisconsin LLC and Texas veil-piercing law to the Texas LLC. Applying Wisconsin law to the question of whether Spangenberg was the alter ego of his Wisconsin LLC, the court examined whether the evidence supported the first two requirements under Wisconsin law. The first element relates to the control exercised with regard to the transaction attacked. The court identified the relevant transactions as the formation of the Wisconsin LLC and its filing of a patent suit against Daimler-Chrysler in violation of a settlement agreement. These were the alleged unjust acts committed during Spangenberg’s domination and control. Based on the record, the court determined that Spangenberg had complete domination and control over all aspects of the relevant transactions so that the Wisconsin LLC had no separate mind, will, or existence. Although the court stated that this level of control by a single manager is not itself improper, it is sufficient to satisfy the control element of the analysis. The second element of the analysis involves use of the control to commit an unjust act, and the court concluded that Spangenberg improperly sought to use the newly formed Wisconsin LLC to assert a patent claim assigned to it by the Texas LLC to circumvent a settlement agreement that arguably precluded assertion of the claim. Having found that the district court properly found personal jurisdiction over Spangenberg as alter ego of the Wisconsin LLC, the court turned to the reverse piercing analysis required to reach Spangenberg’s Texas LLC. The court stated that Texas law permitted reverse piercing and that the Texas alter ego doctrine, as applied in reverse, requires a unity of interest such that the separateness of the corporation and individual has ceased, and asserting jurisdiction over only the individual would result in injustice. The court agreed with the parties that the Wisconsin and Texas tests are essentially identical, although the court noted that Texas case law has been superseded by statute insofar as failure to observe corporate formalities is no longer a factor in proving alter ego. The court found that Spangenberg, as manager of the Texas LLC, exercised control over the Texas LLC similar to that exercised over the Wisconsin LLC, and the court found that the injustice element was satisfied under Texas law by the possibility that a party would be unable to collect on a valid judgment. Without jurisdiction over the Texas LLC, the district court could not provide the remedy sought by the claimants on their counterclaim as the successor to the Wisconsin LLC under the settlement agreement. Thus, the requirements for the second step in the piercing analysis were met as well.
725 F.3d 184 (2d Cir. 2013).
The plaintiff and defendant were the sole equity owners of an LLC that owned a luxury high-rise apartment building. The detailed operating agreement of the LLC contained an arbitration clause of limited scope that related to a buyout provision that provided that the “Purchase Price” under the buyout provision was to be derived from the “Stated Value.” After the plaintiff exercised its purchase option, the parties were not able to agree on the price, and the plaintiff filed an arbitration demand asking for determination of both the Stated Value and Purchase Price. The arbitrator determined the Stated Value but refused to exercise jurisdiction to determine the Purchase Price. The court concluded that the arbitrator acted properly because the operating agreement expressly provided for arbitration to determine Stated Value but nowhere suggested that the Purchase Price be determined by arbitration. The court also addressed a claim by the defendant against the plaintiff for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing. The defendant argued the plaintiff’s failure to disclose its intent to exercise the buyout option upon the discharge of the defendant’s CEO (an event which triggered the right of the plaintiff to exercise the option under the agreement) was a breach of fiduciary duty and that exercise of the buyout option violated the implied covenant of good faith and fair dealing. The court rejected both claims. The purchase option upon defendant’s discharge of its CEO was the contractual right of the plaintiff, and the plaintiff did not ever make any false representations about the CEO or state that it would not exercise its purchase option if the CEO were terminated. The agreement contained a fair mechanism (arbitration) for resolving a dispute over the price of the buyout, and the plaintiff had no obligation to agree to the defendant’s plea to market the property in an illusory auction to third parties to help determine value. Thus, there was no breach of fiduciary duty. As for the implied covenant of good faith and fair dealing, the operating agreement conferred on the plaintiff the right to buy out the defendant if the defendant’s CEO ceased to be employed by the defendant. The implied covenant cannot create duties that negate explicit rights under the contract. The implied covenant bars a party from taking actions that so impair the value of the contract for another party that it may be assumed the parties did not intend the actions. The mere fact of the plaintiff’s exercise of its contractual buyout right, absent bad faith conduct, could not be deemed a breach of the duty to deal with the defendant in good faith.
__ Fed. App’x __, 2013 WL 6490229 (5th Cir. 2013).
The court discussed the question of whether a series of a Delaware LLC is a separate juridical entity in this wrongful foreclosure action arising out of a judgment of foreclosure obtained in Louisiana by a series of a Delaware LLC that was not named as a defendant in the wrongful foreclosure action. After the series, which was the holder of the note secured by Alphonse’s home, obtained the judgment of foreclosure, Alphonse brought this action in federal court asserting claims under Louisiana law and the Federal Fair Debt Collection Practices Act. Alphonse sued the mortgage servicing company and the Delaware parent LLC of the series. On appeal, the parties agreed that the district court erred in its analysis of the Rooker-Feldman doctrine, but the defendants argued that dismissal was proper on res judicata grounds and because of the separate juridical status of the series. The success of the res judicata argument turned on whether there was an identity of parties between the series and the defendants. The court of appeals held that the defendants did not meet their burden of showing an identity of parties at the motion to dismiss stage. The analysis of this question depended on fact-bound issues involving control and virtual representation, and the court held that the district court’s decision to dismiss before discovery was erroneous. In the course of its discussion, the court of appeals acknowledged that the series that obtained the judgment of foreclosure “is a Series LLC [noting by way of footnote that ‘[a] “Series LLC” is basically a business entity within a business entity’], and Series LLCs only exist to represent the interest of the parent LLC,” but the court characterized the question of the legal separation of the series and its parent as a fact-bound question under Louisiana law. The court next discussed the question of whether dismissal could be upheld on the basis that Alphonse sued the wrong party when it sued the parent LLC rather than the series. Alphonse argued that the series and its parent LLC are not legally distinct entities and that the district court erred in relying on the statutory limitation of liability and capacity and power of a series to sue and be sued in its own name to conclude that the series in this case was a separate juridical entity from its parent LLC and thus responsible for the trade violations alleged in the complaint. The court of appeals took issue with the district court’s conclusion that Delaware law applied under the applicable Louisiana conflict-of-laws provision, which states that “[t]he laws of the state or other jurisdiction under which a foreign limited liability company is organized shall govern its organization, its internal affairs, and the liability of its managers and members that arise solely out of their positions as managers and members.” The court of appeals discussed the distinction between internal and external affairs and stated that it is not clear whether the liability of an LLC, or its series, to third parties like Alphonse is internal or external. Because the district court apparently did not consider “whether the liability as between a third-party plaintiff with respect to a holding company LLC or its Series LLC constitutes internal or external affairs,” the court of appeals remanded the case for consideration of the question. The court suggested that factual development might be necessary to resolve the question.
730 F.3d 427 (5th Cir. 2013).
The claimant in this case sought to recover based on a fraudulent transfer of assets to an LLC, and to hold the owners of the LLC personally liable for the value of the transfers. The claimant argued that it was not required to prove actual fraud to pierce the LLC veil because fraudulent transfer of assets is a tort under Texas law. The court pointed out that the Texas legislature specified that the statutory provisions regulating and restricting veil piercing of corporations in Texas are applicable to LLCs and their members and managers by virtue of an amendment to the LLC statute in 2011 and that a Texas court of appeals has held that a plaintiff seeking to pierce the veil of an LLC not covered by the amendment to the LLC statute must also meet the same requirements applicable to a corporation. These requirements differ depending upon whether a claimant is seeking to recover based on a tort or a contract. The court concluded that it did not have to determine whether the claimants were required to prove actual fraud or merely constructive fraud because there was “ample evidence” of the members’ actual fraud. This evidence included the formation of an LLC ten days after the members’ brother received notice that his debts were being accelerated, transfer of the brother’s interest in another LLC to the newly formed LLC for no consideration, signing a document transferring an asset of the newly formed LLC to another family member for no consideration, failing to disclose the transfer for over a year during the pendency of litigation against the newly formed entity, attempting to evade the Texas Uniform Fraudulent Transfer Act by allowing the new LLC’s charter to lapse, and attempting to evade individual liability by claiming the charter had been reinstated. The court stated that the members were acting for their direct personal benefit with respect to these actions because they had no other interest to serve.
498 B.R. 170 (6th Cir. (B.A.P.) 2013).
After the debtor received her discharge, her wholly-owned LLC filed an action for tortious interference and the lawsuit was settled. The settlement proceeds, net of attorney’s fees, went to the debtor rather than the LLC. A creditor moved to reopen the bankruptcy case so that the proceeds of the settlement could be administered as an asset of the estate. The court affirmed the bankruptcy court’s order reopening the case but remanded for the bankruptcy court to determine the value of the debtor’s interest in the LLC based on the LLC’s recovery in the lawsuit. The court held that it was not an abuse of discretion for the bankruptcy court to reopen the case because the settlement related to a prepetition cause of action held by the LLC, and the cause of action was not disclosed by the debtor in the bankruptcy. Thus, the settlement proceeds received post-discharge were sufficiently rooted in the debtor’s pre-bankruptcy past to require administration by the bankruptcy estate, and the cause of action was not abandoned when the bankruptcy case was closed. While the court agreed with the bankruptcy court that the bankruptcy case should be reopened, it found the record unclear as to what portion of the settlement proceeds belonged to the creditors of the LLC and what portion belonged to creditors of the debtor. Although the debtor listed her interest in the LLC as worth zero, that statement was not accurate because her membership interest had potential value if the LLC recovered on its cause of action. The unresolved issue was the value of the debtor’s membership interest after the LLC recovered on the settlement. The court looked to Ohio LLC law regarding the LLC’s and member’s rights and noted that the debtor’s membership interest was personal property representing her right to share in the profits and losses and right to receive distributions. The debtor had no specific interest in LLC property, and her interest only had value to the extent the assets of the LLC exceeded its liabilities. Under Ohio law, the settlement proceeds should have been paid to the LLC, and the debtor was required to pay creditors before making a distribution to herself. The court stated that if she had listed the LLC’s cause of action on her bankruptcy schedule, the cause of action would have been litigated for the benefit of the bankruptcy estate, and the settlement would have been applied to satisfy creditors of the LLC (including payment of attorney’s fees to the law firm that obtained the settlement for the LLC) and the balance distributed to the bankruptcy estate for payment of debtor’s creditors. With the case reopened, the court stated that the bankruptcy court should determine what portion of the settlement proceeds belong to creditors of the LLC under Ohio law and what portion should be paid into the bankruptcy estate on account of the debtor’s membership interest.
__ So.3d __, 2013 WL 4873073 (Ala. 2013).
Wall and Moultrie, the members of an LLC that owned and operated a Ford automobile dealership, got in a dispute after Moultrie proposed removing Wall as manager of the LLC and general manager of the dealership and selling the LLC or its assets. Moultrie and Wall disagreed over who had the controlling interest in the LLC. Wall and the LLC filed suit against Moultrie, and Moultrie asserted counterclaims. Wall sought and obtained a TRO preventing Moultrie from taking various actions. Based on actions taken by Moultrie after entry of the TRO, Wall filed a petition to hold Moultrie in contempt. By agreement of the parties, the court entered an amended TRO that left in place the original terms of the TRO and prohibited the plaintiffs from taking various actions. Over the next few weeks, Wall filed a second petition to hold Moultrie in contempt for violating the TRO and amended TRO, and Moultrie filed two petitions seeking to hold Wall in contempt for violating the amended TRO. The court conducted a hearing and found Moultrie in contempt for violating the TROs based on his entering into a sales agreement to sell the LLC, removing documents from the dealership, and causing Ford to conduct an audit that resulted in a penalty due in part to the missing documents. The court entered a judgment against Moultrie for contempt and a few weeks later entered a second judgment assessing over $132,000 in attorney’s fees and costs against Moultrie. The court denied Moultrie’s motions seeking return of certain funds from Wall and denied Moultrie’s petitions to hold Wall in contempt. On appeal, the Alabama Supreme Court declined to address the merits of the contempt judgment against Moultrie because his appeal of the contempt judgment was untimely. Moultrie’s appeal of the judgment for attorney’s fees was timely, and the supreme court addressed Moultrie’s argument that the trial court assessed an unreasonable amount of attorney’s fees against him. The court discussed the evidence considered by the trial court and the process the trial court followed and concluded that the trial court did not abuse its discretion in the award of attorney’s fees. In response to Wall’s argument on appeal that Moultrie’s “bad acts” further supported the trial court’s award of fees and costs, Moultrie argued that his actions did not merit such a sanction. However, the contempt judgment found Moultrie guilty of what amounted to flagrant violations of the TROs entered by the trial court. Based on the argument presented by Moultrie on appeal, Moultrie did not affirmatively demonstrate that the trial court exceeded its discretion with respect to the award of attorney’s fees and costs.
In re Collier (McGraw v. Collier)
497 B.R. 877 (Bankr. E.D. Ark. 2013).
An LLC sought to establish nondischargeability of debts owed by the debtor, who was an investment adviser with Stanford Group Company that sold the LLC uninsured CDs. As part of the court’s analysis, it had to determine what the LLC knew in connection with its CD purchase. Although the LLC did not sign a subscription agreement, the court stated that it could be charged with knowledge based on what its managers learned when they signed subscription agreements in their individual capacities. Under the Arkansas LLC statute and agency principles, a manager is an agent of the LLC for the purpose of its business, and the knowledge acquired by a manager is charged to the LLC. Imputation of an agent’s knowledge to the principal will not occur, however, when the agent acts for his own interests or where the agent is without sufficient control of the principal. This exception to imputation is not applicable if the agent is the sole representative of the principal and is not accountable to a superior. The LLC plaintiff in this case was family-owned and had only two adult members, Sutter and Pfeifer. Sutter was the managing member, and Pfeifer, his wife, did not know much about finances, did not see the documents related to the LLC until the litigation, and never participated in the business dealings of the LLC until the LLC’s purchase of the CDs. The court concluded that Sutter controlled the LLC without accountability to a superior and that he was under a duty to consider the knowledge he acquired from the subscription agreement signed individually by Sutter and Pfeifer. Based on what he would have learned from the subscription agreement, the LLC knew it was not an accredited investor when it consummated the transaction by funding the CD purchase through its Stanford account. Thus, the LLC’s role in the transaction called its credibility into account, which was one of the factors the court had to consider in the case.
73 A.3d 480 (Conn. App. 2013).
The question in this appeal was whether the trial court properly applied the appropriate standard in determining that two members who jointly owned 50% of an LLC had standing to initiate this action on behalf of the LLC without the consent of the third member, who owned the remaining 50%. Weinshel and Wynnick together owned 50% of an LLC, and Levine owned the other 50%. Weinshel and Wynnick brought this action on the LLC’s behalf to recover damages for breach of the LLC’s lease agreement with the defendant, and the defendant claimed that Weinshel and Wynnick were without authority to bring the action. After a previous appeal of a default judgment against the defendant and remand of the case, the trial court rejected the defendant’s argument that Weinshel and Wynnick lacked standing. The operating agreement required a majority of the ownership to authorize legal expenditures, and the Connecticut LLC statute provides that approval of a majority in interest is required to make business decisions unless otherwise provided by the operating agreement. The Connecticut LLC statute also provides, however, that the vote of any member who has an interest in the outcome of the suit that is adverse to the LLC shall be excluded. There was no dispute that the dispositive issue in this case was whether Levine had an interest in the outcome of the suit that was adverse to the LLC. The trial court found that Levine had an adverse interest in the outcome of the suit although she did not have a proprietary interest in the defendant. Based on Levine’s adverse interest, the trial court found that Weinshel and Wynnick had standing to bring the action without Levine’s consent. On appeal, the court of appeals agreed with the defendant that the trial court erred in its analysis of whether Levine’s interest was adverse. The trial court focused on evidence of animosity between Levine and the other members rather than on whether Levine’s interest in the outcome of the present litigation was adverse to the LLC. The court of appeals thus remanded for the trial court to use the appropriate standard, which required the trial court to focus on whether Levine’s interest in the outcome of the present suit was adverse to the LLC.
72 A.3d 413 (Conn. App. 2013).
The Coutos obtained a judgment holding Anthony Silvestri personally liable for breach of contract, trespass, and violations of the Connecticut Unfair Trade Practices Act (CUTPA) based on actions of Silvestri and a corporation and LLC owned by Silvestri in connection with the construction and purchase of a home by the Coutos. The Coutos initially contracted with Silvestri’s corporation, Joseph General Contracting, Inc. (“Joseph General”), for the purchase and construction of a home and carriage house. Various problems arose, and the original agreement was orally amended and essentially replaced by terms negotiated with Silvestri. Two additional written agreements pertaining to financial arrangements were executed by the Coutos and Silvestri, individually and on behalf of his LLC, Landel Realty, LLC (“Landel”). The Coutos testified that they were confused throughout this process as to whom they were dealing with. Problems and setbacks continued, and the Coutos eventually had to hire a new contractor to complete their home. The new contractor discovered various problems, including a zoning restriction that Silvestri did not disclose and a large quantity of debris that had been buried under, and caused damage to, the foundation of the carriage house. On appeal, Silvestri argued that the evidence did not support holding him personally liable on the Coutos’ claims. Throughout the court of appeals’ opinion Silvestri’s corporation and LLC are referred to as “corporations.” In a couple of instances, his entities are referred to as “limited liability corporations’ The LLC statute and case law interpreting it are cited in some portions of the opinion, but most of the opinion speaks solely in corporate terms.
With respect to the breach of contract claim against Silvestri, he argued that he was not liable because “he was acting at all times as an authorized corporate officer of one of his two limited liability corporations” and that he therefore was protected from liability by the Connecticut LLC statute. The court responded that the provision of the LLC statute limiting liability of members and managers is “favorable to common-law exceptions” because of the statute’s use of the word “solely.” By stating that a member or manager of an LLC is not liable for the LLC’s liabilities “solely” by reason of being a member or manager, the statute “plainly provides that a limited liability company member cannot be held liable for the malfeasance of a limited liability company by virtue of his membership alone; in other words, he must do more than merely be a member in order to be liable personally for an obligation of the limited liability company. The statute thus does not preclude individual liability for members of a limited liability company if that liability is not based simply on the member’s affiliation with the company.” The court stated that the evidence supported the trial court’s findings that the subsequent actions of the parties after the signing of the original contract were the joint actions of Silvestri, Joseph General, and Landel. Over time, Silvestri’s actions muddied the waters so that it became unclear to the Coutos with whom they were dealing. The Coutos were reasonably entitled to infer from Silvestri’s conduct that he had personally become a party to the contract. The court cited agency principles for the proposition that it was not enough for the Coutos to know of the existence of Joseph General and Landel for Silvestri to avoid personal liability. An agent must disclose both his representative capacity and the identity of the principal to avoid liability. Although Silvestri disclosed the identity of the principals at the outset, he did not clearly inform the Coutos that he continued at all times to be acting in a representative rather than individual capacity.
Silvestri next claimed that he was improperly held liable for tortiously causing debris to be buried on the Coutos’ property. He claimed that all times he was acting as an agent of his two corporations and maintained that he could not be held personally liable because he did not personally bury the debris. The court stated that the uncertainty of whom the Coutos were dealing with in regard to various elements of the construction contract also supported the trial court’s finding in this context. Further, the court cited “black letter law that an officer of a corporation who commits a tort is personally liable to the victim regardless of whether the corporation itself is liable.” Having found that Silvestri caused the debris to be placed on the Coutos’ property, the trial court found him liable not for the tortious conduct of his businesses, but for his own tort. The court of appeals cited Connecticut case law affirming the imposition of tort liability on an agent or officer who commits or participates in the commission of a tort, whether or not he acts on behalf of his principal or corporation. The court quoted the Connecticut Supreme Court’s holding that the provision of the LLC statute that describes the liability protection of a member or manager “evinces no legislative intent to eliminate the right to impose liability on a member or manager of a limited liability company who has engaged in or participated in the commission of tortious conduct. Rather the statute clearly codifies the well established principle that an officer of a corporation does not incur personal liability for its torts merely because of his official position.” Silvestri argued he could not be held liable because there was no evidence he personally ordered the debris to be buried under the carriage house foundation, but the court concluded the evidence supported a reasonable inference that Silvestri ordered or negligently caused the debris to be buried under the carriage house foundation and that the debris damaged the property; therefore, he could be held personally liable for the damage from the trespass.
Finally, the court of appeals rejected Silvestri’s argument that he could not be held personally liable for violations of CUTPA because he was acting as an officer of his businesses. The trial court found that Silvestri personally engaged in tortious conduct directed at the Coutos and held him liable for his own actions, which the trial court described as “unscrupulous, oppressive, unfair and deceptive.” The trial court’s findings, which were supported by the record, justified the trial court’s determination of personal liability under CUTPA. Although CUTPA is primarily a statutory cause of action, it is also recognized that claims under the statute may arise from underlying contract and tort actions. The Connecticut Supreme Court has recognized that individual tort liability can be imposed on a corporate officer who directly participates in tortious conduct regardless of whether the statutory basis for the claim expressly allows liability to be imposed on corporate officers. Therefore, the trial court did not err in finding Silvestri was liable under CUTPA.
C.A. No. 8919-VCN, 2013 WL 6797566 (Del. Ch. Dec. 20, 2013).
Both the plaintiff and defendant claimed to be the managing principal of a Delaware LLC, and resolution of their disagreement depended on which members were the founding principals of the LLC. The plaintiff claimed that a vote by the LLC’s founding principals removed the defendant from his position as managing principal and replaced him with the plaintiff. The LLC’s operating agreement provided that two-thirds of the founding principals could remove and replace the managing principal, but the records of the LLC “had not been perfectly maintained,” and the parties disagreed as to what version of the operating agreement was the final execution copy. The plaintiff relied on a version of the operating agreement circulated by e-mail to twenty individuals that was digitally executed by the plaintiff and defendant and listed three other individuals as founding principals, two of whom later resigned. The defendant argued that the version relied on by the plaintiff was not the final executed version and that it took several months to obtain all the signatures for the fully executed version. Further, the defendant argued that the individual who voted with the plaintiff to remove the defendant as managing principal had declined to become a founding principal and executed the operating agreement in a different capacity. The court denied summary judgment based on a genuine issue of material fact as to which version of the operating agreement was the final executed version.
Civil Action No. 8465-VCG, 2013 WL 6460898 (Del. Ch. Dec. 9, 2013).
A 50% LLC member sued the LLC and its other member, seeking judicial dissolution of the LLC on the basis of a deadlock between the plaintiff and the other member. The defendants moved to dismiss. Although the complaint alleged a breach of the LLC agreement, the court found that the parties had agreed that the motion to dismiss depended on whether the plaintiff would be entitled to judicial dissolution based on the interplay of the judicial dissolution provision of the Delaware LLC statute and certain provisions of the LLC agreement. The court held that the terms of the LLC agreement precluded the plaintiff from seeking judicial dissolution based on Delaware case law and the broad policy of freedom of contract underlying the LLC statute. As previously held in R&R Capital, LLC v. Buck & Doe Run Valley Farms, LLC, judicial dissolution is a default rule that may be displaced by contract. The LLC agreement in the instant case contained a provision specifying events causing dissolution, and judicial dissolution was not included among these events. The LLC agreement also included the following provision in a paragraph addressing distribution rights and denying preemptive rights with respect to additional membership interests: “Except as otherwise required by applicable law, the Members shall only have the power to exercise any and all rights expressly granted to the Members pursuant to the terms of this Agreement.” The court concluded that this provision applied to member rights generally, including the right to seek judicial dissolution. Because judicial dissolution is a default rule, and as such is not ”required by applicable law,” the court concluded that judicial dissolution was intentionally excluded from the LLC agreement and was not available to the plaintiff. In a footnote, the court noted that it need not resolve the issue of whether the parties may, by contract, divest the court of “authority to order a dissolution in all circumstances, even where it appears manifest that equity so requires– leaving for instance, irreconcilable members locked away together forever like some alternative entity version of Sartre’s Huis Clois.”
Civil Action No. 8613-VCG, 2013 WL 4758228 (Del. Ch. Sept. 5, 2013), modified on reargument, 2013 WL 6327510 (Del. Ch. Dec. 5, 2013).
Two individuals, Costantini and Kahn, sought indemnification for their fees and costs in underlying litigation brought against them by an LLC. In the underlying action, the LLC sued Costantini and Kahn for alleged breaches of fiduciary duty, but the action was dismissed based on laches. In this action, Costantini and Kahn sought judgment on the pleadings for indemnification for their fees and costs incurred in defending the fiduciary duty action. The court discussed the claims by Costantini and Kahn separately because Costantini was a member of the board of managers of the LLC and Kahn was not.
With respect to Costantini’s claim for indemnification, the court stated that the same policy reasons supporting indemnification of corporate actors apply to actors for other entities, including LLCs. As creatures of contract, LLCs have broad latitude to allocate the rights and responsibilities of the members, but the LLC in this case chose to track the permissive and mandatory indemnification rights of the Delaware General Corporation Law for members of its board of managers, officers, employees, and agents. Costantini was sued in his capacity as a member of the LLC’s board of managers, and the court held that the operating agreement unambiguously provided indemnification to Costantini under the undisputed facts. Thus, Costantini was entitled to judgment on the pleadings.
The parties had conceded that Kahn was not a member of the LLC’s board of managers and was not an officer, employee, or agent of the LLC; Kahn was apparently sued for breach of fiduciary duty in his capacity as a partner of a partnership that was a member of the LLC. The partnership had the right as a member to appoint a member of the LLC’s board of managers. The court held that, because Kahn was not an officer, employee, agent, or member of the board of managers of the LLC, he did not fall within the categories of persons granted indemnification under the LLC’s operating agreement and was not entitled to indemnification. On reargument, Kahn submitted evidence claiming that he was an agent of the LLC based on brokerage and development management contracts between his corporation and the LLC. The court concluded that Kahn might be an agent or subagent of the LLC based on the agreements and his relationship with his corporation, but there were factual determinations that could not be made from the face of the complaint in that regard. Assuming Kahn was an agent of the LLC, he would be entitled to indemnification if the underlying action against him was brought by reason of the fact that he was an agent of the LLC. Because the indemnification clause in the operating agreement indemnified a person who was sued “by reason of the fact” that he as an agent, which was language borrowed from the Delaware General Corporation Law, the court looked to case law interpreting the corporate statute. Corporate precedent has established that a proceeding is “by reason of the fact” of a corporate position if there exists a causal connection or nexus with the corporate position. Case law in the corporate context further explains that a nexus exists where the corporate capacity is necessary or useful for committing the alleged misconduct. The court concluded that the pleadings were insufficient for the court to determine whether Kahn’s alleged agent status was necessary or useful to commit the acts alleged in the underlying action. Thus, Kahn was not entitled to judgment on the pleadings.
C.A. No. 8864-VCN, 2013 WL 6072249 (Del. Ch. Nov. 19, 2013).
The court resolved two threshold legal questions in this action by the plaintiff for a declaratory judgment that he was not subject to any non-competition agreement with the defendant LLC. The court concluded that (1) an amended and restated LLC agreement did not supersede a previously executed non-competition agreement between the plaintiff and the LLC, and (2) the LLC assumed and was revested with the non-competition agreement under its Chapter 11 bankruptcy plan. In 2005, the plaintiff and the LLC entered into a non-competition agreement. In 2011, the LLC, the plaintiff, and several other parties entered into an amended and restated LLC agreement (the “LLC agreement”). The LLC executed the LLC agreement as the “Company,” and the plaintiff and others executed the LLC agreement as “Members.” The LLC agreement contained a provision purporting to restrict the activities of the plaintiff, but the LLC agreed after the initiation of this action that it would not enforce that provision. The LLC asserted, however, that the 2005 non-competition agreement was still effective, and the primary question before the court was whether the merger and integration clause of the LLC agreement superseded the earlier non-competition agreement. The last sentence of the integration clause stated: “All prior agreements among the Members are superseded by this Agreement, which integrates all promises, agreements, conditions, and understandings among the Members with respect to the Company and its property.” The plaintiff argued that the integration clause unambiguously superseded the non-competition agreement. The court pointed out that the definition of a “Member” under the LLC agreement unambiguously included only those that executed the agreement as members. Further, the integration clause plainly superseded only prior agreements among members. The court held that the LLC did not sign the LLC agreement as a “Member,” and the non-competition agreement, which was an agreement between a member (the plaintiff), and a non-member (the LLC), was not superseded. The court then analyzed whether the non-competition agreement was assumed and retained under the LLC’s plan of reorganization when the LLC emerged from Chapter 11 bankruptcy. The non-competition agreement was not expressly identified in the plan as either an assumed or rejected executory contract, but the plan stated that the LLC assumed and was vested with all executory contracts that were not rejected. The plan also provided that the LLC assumed and was revested with all non-executory contracts. Thus, without needing to resolve whether the non-competition agreement was an executory or non-executory contract, the court found that the LLC assumed and retained it under the plan.
C.A. No. 7639-VCN, 2013 WL 5863010 (Del. Ch. Oct. 31, 2013).
In this direct and derivative action by the nonmanaging member of a Delaware LLC against the managing member and its affiliates, the court addressed a partial motion for summary judgment by the plaintiff and a motion by the defendants to dismiss numerous claims by the plaintiff. The plaintiff sought summary judgment on its claim that the managing member breached its obligations under the LLC agreement by transactions that violated a provision specifying “Prohibited Investments.” The defendants argued that the “Prohibited Investments” provision was not a strict prohibition in light of certain other language in the LLC agreement, but the court analyzed the provisions of the LLC agreement and concluded that the agreement unambiguously prohibited the managing member from acquiring or holding an interest in any entity in which The Renco Group, Inc. or any of its affiliates had an interest. The plaintiff argued that compliance certificates supplied by the defendants established that the defendants had violated the “Prohibited Investments” provision, but the court concluded that the plaintiff had not borne its summary judgment burden because the compliance certificates only characterized certain investments as “possible violations,” and thus were not an unqualified admission by the defendants, and the plaintiff submitted no additional evidence of a violation.
The court then addressed the defendants’ motion to dismiss numerous claims made by the plaintiff. The court dismissed the plaintiff’s claims that the defendants breached fiduciary duties of loyalty and care. The court point out that fiduciary claims that arise from facts underlying obligations addressed by a contract are foreclosed subject to a narrow exception. Under this exception, fiduciary duty claims can survive even though they share “a common nucleus of operative facts” with the underlying contract claims where the fiduciary duty claims depend on additional facts, are broader in scope, and involve different considerations in terms of a potential remedy. Because the plaintiff’s claims that the defendants breached their duties of loyalty and care arose out of obligations the defendants owed under the LLC agreement and a contribution agreement, and the plaintiff failed to allege distinct harms outside of the scope of those contractual agreements, the court dismissed the plaintiff’s breach of fiduciary duty claims as duplicative of contractual claims against the managing member. Dismissal of the breach of fiduciary duty claims necessitated dismissal of the plaintiff’s related aiding and abetting claims as well. The court also dismissed the plaintiff’s tortious interference, unjust enrichment, conversion, and indemnification claims. The court did not dismiss the plaintiff’s claim that it was entitled to certain distributions. Although the defendants suggested that the claim was moot due to the previous issuance of a preliminary injunction, the court pointed out that the preliminary injunction did not provide the plaintiff permanent relief.
C.A. No. 6001-VCP, 2013 WL 5630992 (Del. Ch. Oct. 14, 2013).
After the trial of this derivative action, the court issued an opinion holding that the defendants breached the operating agreement of a Delaware LLC by entering into certain transactions without approval of the Class A unitholders of the LLC. The court found, however, that the breach caused no damage to the LLC and ordered the parties to submit a final, post-trial order. The parties failed to agree on a final order, and the plaintiff sought entry of his proposed final order. The plaintiff sold all of his units in the LLC before the court ruled on his motion, and the defendants moved to dismiss the action, arguing that the plaintiff’s sale of all of his interest in the LLC prior to the entry of a final judgment extinguished his standing to prosecute claims derivatively on behalf of the LLC. The defendants requested that the court apply, by analogy, the “continuous ownership rule” found in corporate law, which requires a plaintiff stockholder suing derivatively on behalf of the corporation to own stock in the corporation throughout the litigation. The court stated that the continuous ownership rule is embodied in the Delaware General Corporation Law and Court of Chancery Rule 23.1. While the court acknowledged that the Delaware General Corporation Law was not directly applicable, the court found no reason not to apply the contemporaneous ownership rule in this LLC case. The court noted that Rule 23.1, to which this action was subject, embodies the spirit of the contemporaneous ownership rule, and further noted that the standing provision of the Delaware LLC statute sufficiently tracks its corporate counterpart as to suggest that the General Assembly intended that the continuous ownership rule would apply in the LLC context. Thus, the court granted the defendants’ motion to dismiss for lack of standing. The court went on to consider the petition of the plaintiff’s counsel for attorney’s fees, and the court awarded fees based on the corporate benefit doctrine.
C.A. No. 8400-VCN, 2013 WL 4734834 (Aug. 30, 2013).
A member of a joint venture Delaware LLC brought a books and records action under the Delaware Limited Liability Company Act and the LLC agreement. The plaintiff sought information for the purposes of appointing a new asset manager and investigating possible mismanagement of the LLC. The plaintiff sued the LLC, its former asset manager, the other members of the LLC and certain other affiliated parties. The defendants other than the LLC moved to dismiss for lack of personal jurisdiction and failure to state a claim.
The plaintiff alleged the court had personal jurisdiction over the former asset manager, an Indiana corporation with an Indiana address, pursuant to the Delaware long-arm statute or the implied consent provision of the Delaware LLC statute. The court declined to exercise jurisdiction over the former asset manager under the Delaware long-arm statute because mere participation in the management of a Delaware entity without allegations of extensive and continuing contacts with Delaware does not subject a party to the court’s long-arm jurisdiction. The plaintiff failed to allege that the former asset manager took any actions within Delaware or that the former asset manager was involved in the formation of the LLC or any related Delaware entities. The court next addressed whether the former asset manager was subject to the court’s jurisdiction under the implied consent provision of the Delaware LLC statute, under which service as a manager of a Delaware LLC constitutes implied consent to the court’s jurisdiction. For purposes of the implied consent provision, the term “manager” means a person defined as a “manager” in the Delaware LLC statute and a person who participates materially in the management of the LLC even though the person is not a manager as defined in the statute; provided, however, that the power to choose or participate in choosing a manager does not alone constitute participation in the management of the LLC. The LLC agreement explicitly provided that the board of directors of the LLC was the manager of the LLC for purposes of the Delaware LLC statute, and the LLC agreement did not name or designate the former asset manager as a manager of the LLC. Therefore, the court held that the former asset manager was not a manager of the LLC as defined in the Delaware LLC statute, and the court turned to the question of whether the former asset manager had participated materially in the management of the LLC. The asset management agreement with the LLC specified that the former asset manager was an independent contractor and was not acting as an agent. Further, the role of the former asset manager was confined to acting as the asset manager and providing specified services in compliance with the LLC’s business plan and budget. The court stated that the management of the underlying assets of an LLC is analytically distinct from management of the LLC itself for purposes of the implied consent provision of the LLC statute. The court did not determine whether the former asset manager’s authority was sufficient to constitute material participation in the management of the LLC because the plaintiff did not allege that the former asset manager actually engaged in any of its contractually authorized conduct. The court stated that merely having the capacity to participate in management does not constitute material participation in management. Thus, the court dismissed the plaintiff’s claim against the former asset manager for lack of personal jurisdiction. The court dismissed the plaintiff’s books and records claim against other members of the LLC and their affiliates because the plaintiff failed to identify any source–either under the LLC agreement or the Delaware LLC statute– of a right to inspect books and records of other members or parties affiliated with other members.
C.A. No. 8119-VCP, 2013 WL 5210220 (Del. Ch. Aug. 30, 2013).
Former employees of an LLC sued the LLC and its board of managers for breach of contract, breach of fiduciary duty, and breach of the implied covenant of good faith and fair dealing in connection with the LLC’s exercise of its right to repurchase the plaintiffs’ membership units in the LLC when the plaintiffs voluntarily terminated their employment. Based on the board’s valuation of the units at $0.00, the LLC cancelled the plaintiffs’ units without paying any consideration. The plaintiffs claimed that the board of managers acted in bad faith in valuing the units at $0.00 and that such action violated both the purchase agreement that governed the repurchase of the units (which required the board of managers to determine the value in good faith) and the LLC agreement (which provided that the board owed to the LLC and its members the duties owed by corporate directors to the corporation and its shareholders). The relief sought by the plaintiffs included a declaratory judgment invalidating the repurchase and an order restoring their ownership of units in the LLC. The court denied in part and granted in part the defendants’ motion to dismiss the breach of contract claims, and the court granted the motion to dismiss the claims for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing because the latter claims were duplicative of the breach of contract claims.
The court first addressed the plaintiffs’ breach of contract claims and concluded that the plaintiffs’ factual allegations were sufficient for the court to conclude that it was reasonably conceivable that the “Fair Market Value” of the units was greater than $0.00 and that the board acted in bad faith in determining the value in breach of the purchase agreement. The purchase agreement provided that “Fair Market Value” of the units was to be “determined in good faith by the Board in its sole discretion after taking into account all factors determinative of value including, but not limited to, the lack of a readily available market to sell such units, but without regard to minority discounts.” The court held that allegations of appraisals by a third party in 2008 for a contemplated acquisition and in 2012 for a completed acquisition bore little if any relationship to the Fair Market Value of the units in 2010 when they were repurchased because the third-party valuations were based on the terms of the LLC agreement rather than the Fair Market Value provision of the purchase agreement and were too long before or after the repurchase valuation date in 2010. The court nevertheless held that it was reasonably conceivable that the Fair Market Value of the units was greater than $0.00 based on an e-mail from the president and CEO of the LLC valuing the units at $200 per unit three weeks after the board determined the Fair Market Value was $0.00. The court noted that the defendants did not argue that any material event occurred during those three weeks that affected the valuation. The court further held that the plaintiffs sufficiently pled that the defendants’ valuation of $0.00 was determined in bad faith based on allegations that the plaintiffs purchased units for $25 per unit on several occasions between 2005 and 2008; there was no indication the LLC’s financial condition was materially worse in 2010 than it was in 2005-2008; shortly before the plaintiffs quit their jobs, the CEO conveyed to LLC managers that the LLC had bright prospects; shortly before the plaintiffs quit their jobs, the CEO expressed his belief that the units were worth roughly $200; plaintiffs quit their jobs; and shortly before the LLC would otherwise have had to deliver financial information to the plaintiffs, the plaintiffs were told without explanation that their units had a Fair Market Value of $0.00 on the date of termination of their employment. Furthermore, the plaintiffs pled a plausible motivation on the part of the defendants to increase the majority owner’s interest in the LLC or to exact retribution for the plaintiffs’ unexpected departure from the LLC at a time when the plaintiffs were important to the future success of the LLC. The court noted that a claim of wrongful inducement, trickery, or deception is not necessary to establish bad faith under Delaware law. The court thus denied the defendants’ motion to dismiss plaintiffs’ breach of contract claim that the board determined the Fair Market Value of the Units in bad faith.
The court next addressed the plaintiffs’ claim that the board’s failure to determine the Fair Market Value in good faith constituted a breach of the LLC agreement. The court concluded that the purchase agreement and LLC agreement were related and intended to be read in tandem and that the fiduciary duty provision of the LLC agreement, which provided that the managers owed the same fiduciary duties as the directors of a corporation, applied to the board’s valuation of the units. A director is liable for breach of the fiduciary duty of care under Delaware law when the director’s actions are grossly negligent. The focus of a duty of care analysis is the process undertaken by directors in making a decision. The plaintiffs made no allegations regarding the board’s valuation process, and the court thus held that the plaintiffs failed to state a claim for breach of the contractual duty of care. The plaintiffs also failed to state a claim of breach of the duty of loyalty on the basis of an interested transaction because the plaintiffs did not allege that the defendants stood on both sides of the repurchase transaction, nor did they allege that the defendants were in a position to benefit from an unfairly low repurchase in a manner not shared equally by all owners of the LLC. However, the duty of loyalty in Delaware encompasses actions taken in bad faith in addition to interested transactions. Thus, the court held that the plaintiffs stated a claim for breach of the contractual duty of loyalty under the LLC agreement by acting in bad faith in determining the Fair Market Value of the units based on the allegations supporting the contractual bad faith claim under the purchase agreement.
The court dismissed the plaintiffs’ claim that the defendants breached the LLC agreement by failing to deliver annual financial statements to the plaintiffs. The LLC agreement provided that “[w]ithin one hundred twenty (120) days after the end of each Fiscal Year of the Company, the Company shall deliver to each Member the Company’s annual financial statements.” A “Member” was defined as “each Initial Member and each other Person who is hereafter admitted as a Member in accordance with the terms of this Agreement and the Act, in each case so long as such Person is shown on the Company’s books and records as the owner of one or more Units.” There was no dispute that the plaintiffs were members on March 31, 2010, the LLC’s fiscal year end, but the plaintiffs’ units were repurchased on July 22, 2010, seven days before the 120-day period expired on July 29, 2010. The question was whether membership on the date of the fiscal year end entitled them to the year-end financial information required to be delivered to members under the LLC agreement. The court concluded that the LLC agreement plainly required delivery of the information to anyone who was a member on the date of delivery. Since the LLC agreement defined a “Member” as a person with a present ownership interest in the LLC, and there was no allegation that the LLC delivered financial information between March 31 and July 22, 2010, the court held that there were no alleged facts upon which the plaintiffs could conceivably prove a breach of the contract based on this provision of the LLC agreement.
The court also dismissed the plaintiffs’ claim that the defendants breached the purchase agreement by “cancelling” the units rather than “repurchasing” them as provided in the purchase agreement. The court agreed with the LLC that it was immaterial whether the parties characterized their actions as a repurchase, cancellation, or both. Once the LLC elected to purchase the units, which it had a right to do under the purchase agreement, the court stated that the LLC was free to do with the units whatever it chose after tendering the required consideration. Here, the required consideration was $0.00, and the LLC thus assumed complete control of the units upon informing the plaintiffs that it was exercising the purchase right. If the LLC breached the purchase agreement, it was because it failed to exercise good faith, not as a result of calling a repurchase a cancellation.
The court dismissed the plaintiffs’ breach of fiduciary duty claim because it was duplicative of and foreclosed by the breach of contract claim. Under Delaware law, a fiduciary duty claim that depends on the same nucleus of operative facts as a breach of contract claim only survives where the fiduciary duty claim depends on additional facts, is broader in scope, and involves different considerations in terms of potential remedies, i.e., where the breach of fiduciary duty claim may be maintained independently of the breach of contract claim. The court rejected the plaintiffs’ effort to distinguish their breach of fiduciary duty claim from their breach of contract claim on the basis that the board’s conduct should be assessed under the entire fairness standard for purposes of the breach of fiduciary duty claim. Because the plaintiffs did not allege that the defendants stood on both sides of the repurchase transaction or that the defendants were in a position to benefit from an unfairly low repurchase in a manner not shared equally by all owners of the LLC, the court held that the plaintiffs failed to articulate a basis to employ the entire fairness standard. The plaintiffs’ claim that the defendants breached their fiduciary duties to plaintiffs when they declared that the units had no value and cancelled them arose from the dispute relating to the contractual repurchase right under the purchase agreement, thus making the case similar to Nemec v. Schrader, in which the Delaware Supreme Court affirmed the dismissal of a fiduciary duty claim arising from a corporation’s exercise of its right to redeem shares of retired nonworking shareholders. The plaintiffs here argued that the facts fit the narrow exception to the general principle that a breach of contract and breach of fiduciary duty claim based on the same facts are duplicative, but the court concluded that the plaintiffs alleged essentially identical facts in support of both their breach of fiduciary duty claim and their claim for breach of the purchase agreement and LLC agreement. Similarly, the breach of fiduciary duty claim was no broader in scope than the breach of contract claim. Finally, the breach of fiduciary duty claim did not implicate potentially different remedies because the requested relief (a declaration that the repurchase of the plaintiffs’ units was invalid and that they still owned their units) was available to the plaintiffs with respect to their breach of contract claim.
Finally, the court dismissed the plaintiffs’ claim that the defendants violated the implied covenant of good faith and fair dealing by failing to act in good faith when valuing the units. The plaintiffs did not allege a specific implied contractual obligation that was breached, but instead focused on the express contractual requirement in the purchase agreement that the board value the units in good faith. Thus, the court concluded that the claim was duplicative of the breach of contract claim. The court explained that its conclusion was consistent with the Delaware Supreme Court’s decision in Gerber v. Enterprise Products Holdings, LLC because the limited partnership agreement in that case arguably had a contractual “gap” in that the duty of a party seeking the benefits of the “safe harbor” or “conclusive presumption” provided by the agreement was not specified. The court stated that the purchase agreement in this case did not have a “gap” for the implied covenant to fill. The plaintiffs’ claim was based on a single clause of the purchase agreement that expressly required the LLC to act in good faith. The plaintiffs essentially contended that the LLC had an implied duty to act in good faith in complying with its contractual duty to act in good faith. The express requirement of good faith did not provide a basis for a valid claim for a breach of the implied covenant. Furthermore, there was no credible basis to reasonably infer the purchase agreement failed to reflect the parties’ expectation at the time of bargaining. The parties obviously foresaw the potential issues with allowing the Fair Market Value of the units to be determined by the board in its sole discretion and addressed the issue by explicitly requiring good faith. The court went on to state that the more significant distinction between Gerber and this case related to the “discretionary rights” at issue. In Gerber, the “safe harbor” and “conclusive presumption” provisions were discretionary rights that the defendants could use to limit or avoid liability, but the contract did not specify any standard for evaluating the defendants’ exercise of the rights. In the absence of a contractual standard, the supreme court determined that the defendants were required to use their discretion in conformity with the implied covenant. By contrast, in the purchase agreement in this case, the parties agreed to a good faith standard to evaluate the reasonableness of the defendants’ exercise of discretion. Thus, in this case, the parties’s express agreement superseded the implied covenant and precluded its application. The court acknowledged that Gerber held that a showing of compliance with a contractual duty of good faith does not automatically extinguish all implied covenant claims, but it does not relieve a plaintiff from the burden of pleading a cognizable claim, and the plaintiffs here did not sufficiently allege a claim because they did not show how the express terms of the purchase agreement failed to account for their legitimate expectations at the time they entered into the contract.
C.A. No. 6793-VCG, 2013 WL 4041495 (Del. Ch. Aug. 8, 2013).
In 2010, the Groves and the Browns started a successful home health care agency, Heartfelt Home Health, LLC (“Heartfelt”). After the first year, the relationship between the Groves and the Browns began to deteriorate when it was discovered that not all four members had made their requisite initial $10,000 capital contributions. The Groves established their own home health agencies in Maryland and Delaware without telling the Browns, and the Browns attempted to remove the Groves by creating another LLC owned solely by the Browns and merging Heartfelt with that company. The Groves sued the Browns for breach of fiduciary duty, and the Browns counterclaimed for breach of fiduciary duty. The Browns also brought claims against family members and friends of the Groves for aiding and abetting the Groves’ breach of fiduciary duty. After trial, the court rendered this opinion. The first issue addressed by the court was the percentage of the parties’ ownership interests in Heartfelt. The Groves argued that the Browns only owned 50% of Heartfelt and thus lacked the legal authority to merge Heartfelt, but the Browns argued that the failure of the Groves to make the required capital contributions resulted in the Browns owning a majority interest in the LLC. The court examined the provisions in the Heartfelt LLC agreement, which stated that the members shall contribute a total of $40,000 to the LLC capital and set forth each individual member’s portion of this initial contribution as $10,000 and 25%. The agreement also provided that profits and losses should be divided among the members “in proportion to each Member [sic] relative capital interest in the company.” Thus, the court concluded that the agreement unambiguously provided that each member was required to contribute $10,000 and that each member had a 25% ownership interest. The court further stated its conclusion would not change if it considered extrinsic evidence because there were membership certificates reflecting 25% ownership by each of the four members. The Browns disputed the validity of the membership certificates because they were undated and lacked the LLC seal, but the court considered the certificates to be overt statements demonstrating the understanding of the members of Heartfelt as opposed to contracts. Other extrinsic evidence consisted of representations by the members to a prospective lender that each was a 25% owner and the way members were treated before they had made their required capital contributions. The court noted that the LLC agreement could have been written to make each member’s interest contingent on the amount of their capital contribution, but the agreement did not do so. It merely required a contribution of $10,000 from each 25% owner. Because the Browns owned only 50% of the LLC, the court held that the purported merger was a legal nullity. Unless otherwise provided by the LLC agreement, the Delaware Limited Liability Company Act requires a merger to be approved by members who own more than 50% of the then current percentage in the profits of the LLC, and the Heartfelt LLC agreement did not address mergers. The court next discussed the Browns’ counterclaims that the Groves violated their fiduciary duties by taking corporate opportunities from Heartfelt. All four members played a role in the management of Heartfelt, and none of the members disputed that they were all managing members. The court noted that managing members of an LLC owe default fiduciary duties to the other members absent contrary language in the LLC agreement. The court held that the Groves violated their fiduciary duties by forming a Maryland LLC, which operated fewer than ten miles from the offices of Heartfelt, and a Delaware LLC with an office in the same building as Heartfelt, each of which engaged in the same business as Heartfelt. Relying on the corporate opportunity doctrine, the court held that the Groves had wrongfully taken for themselves the business opportunities of Heartfelt. Under the corporate opportunity doctrine, a corporate officer or director may not take a business opportunity as his own if: (1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation’s line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation. However, a director or officer may take personal advantage of a corporate opportunity if: (1) the opportunity is presented to the director or officer in his individual rather than corporate capacity; (2) the opportunity is not essential to the corporation; (3) the corporation holds no interest or expectancy in the opportunity; and (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity. Because the corporate opportunity doctrine stems from a director’s duty of loyalty to the corporation, the burden is on the director to show that there was no breach. The evidence at trial showed that the business of the Maryland and Delaware LLCs would clearly qualify as a business opportunity of Heartfelt absent a waiver or disclaimer by Heartfelt of its interest in the opportunity, and the court concluded that the Groves did not satisfy their burden of demonstrating its right to pursue the opportunity. Though the court found all the testimony on the issue to be of questionable credibility, the weight of the evidence favored the Browns’ position that there was no express grant of permission for competing businesses in any location. To the extent there was testimony that the Groves invited the Browns to join them in the competing entities, the court stated that presenting an opportunity to other members is not the same as presenting it to the LLC. As to the aiding and abetting counterclaims against family and friends of the Groves who worked for the competing entities, the court found there was no evidence that these other parties knowingly participated in the Groves’ breach of fiduciary duty. The court determined that the appropriate remedy was for both the Browns and the Groves to account to Heartfelt for profits that they wrongfully kept, i.e., the profits made by the Browns after the invalid merger and the profits made by the Groves in the competing entities. The court commented that, given the bitterness and acrimony between the parties, it was not reasonably practicable to carry on the business of Heartfelt in conformity with its LLC agreement. The court expressed its hope that the parties, in the interest of economy, would present a petition for dissolution to be considered with the accounting.
C.A. No. 7246-VCG, 2013 WL 3215704 (Del. Ch. June 26, 2013).
An LLC’s agreement provided that the operating member “approved” of a payment of a monthly management fee of a specified amount to an affiliate of the other member. In another section, the LLC agreement provided that the operating member could amend property management, asset management, or other similar agreements without the consent of the other member “except . . . with respect to the payment of the asset management fee to” the other member’s affiliate. The plaintiffs argued that these provisions required payment of the specified asset management fee. The defendants argued that the provision approving of the asset management fee did not obligate the LLC to pay the fee and that the provision was merely a standard related-party-transaction provision under which the parties provided a prospective waiver of a potential conflict of interest if an asset management fee were agreed to in the future. The defendants argued that the provision approving the management fee was one of a series of waivers of conflicts of interests that must be read in context together. The court concluded that the provisions created an ambiguity and denied the parties’ cross-motions for judgment on the pleadings.
Omes v. Ultra Enterprises, Inc.
116 So.3d 633 (Fla. App. 2013).
A minority owner of two corporations and two LLCs filed a complaint alleging unlawful denial of access to books and records under the corporate and LLC statutes. The court discussed whether a corporation or LLC that fails to maintain an accounting record specified to be accessible to a shareholder (in this case a statement of annual cash flows) can be ordered to prepare or produce the record or produce the source records that would be required to prepare the statement. The court discussed corporate case law and concluded that corporations are not obligated to prepare records that do not exist.
749 S.E.2d 374 (Ga. App. 2013).
The court addressed the standing of a former member of an LLC who retained an economic interest in the LLC after his removal to sue for breach of the operating agreement and concluded the former member had standing to do so. Kaufman Development, L.P. (“Kaufman Development”) and David Eichenblatt formed a real estate LLC and entered into an operating agreement identifying them as the members and addressing various governance, economic, and operational matters. A few years later, Eichenblatt and Kaufman Development agreed to part ways except for their agreement to continued joint ownership of certain entities. The two parties agreed to amend the operating agreement to remove Eichenblatt as a member in accordance with a particular provision of the operating agreement under which Eichenblatt would continue to receive allocations and distributions to which he would otherwise be entitled but would not have the other powers, rights, or privileges of a member. Accordingly, they amended the operating agreement to add a provision that specified the effective date of Eichenblatt’s removal as a member, his right to receive allocations and distributions to which he would otherwise be entitled, and that he would have no other powers, rights, or privileges of a member, including authority to bind the LLC as a member or vote on any matter requiring member approval pursuant to the operating agreement or the Georgia LLC statute, except that Eichenblatt’s consent was required to approve any amendment that would reduce the amount that would be paid or distributed to him. The amendment also addressed his access to LLC records and entitlement to receive certain fees, and a new provision addressing management of the LLC and transactions with affiliates was added. The amendment stated that it was binding upon and inured to the benefit of the parties and provided that except as expressly modified the operating agreement remained in full force and effect. Eichenblatt sued Kaufman Development for breach of the operating agreement, claiming that Kaufman Development failed to comply with certain provisions governing the management and dissolution resulting in diminished allocations and distributions to Eichenblatt under the agreement. The jury found in favor of Eichenblatt and awarded $625,000 in compensatory damages for breach of the operating agreement. The trial court entered judgment on the jury verdict and denied a motion by Kaufman Development to clarify the judgment to include a finding that Eichenblatt’s interest in the LLC had been extinguished.
On appeal, the court of appeals first addressed Kaufman Development’s argument that Eichenblatt had no standing to sue for breach of the operating agreement since he was no longer a member. The court pointed out that both the operating agreement and the amendment identified Eichenblatt as a party. By expressly removing Eichneblatt as a member, the court said that the amendment modified the operating agreement to exclude him from the term “member” as used in the operating agreement but did not affect his identity as a party to the agreement. The court disagreed with Kaufman Development’s argument that Eichenblatt could not sue for breach of any provision of the operating agreement other than those governing allocations and distributions. The amendment provided that the operating agreement remained in full force and effect except as altered by the amendment, and the provision that stated Eichenblatt had no rights as a member other than allocations and distributions merely prevented him from claiming other rights reserved to the members. Neither the amendment nor the operating agreement specified that standing to enforce their agreement was a “power, right or privilege” limited to the LLC’s members. Further, the court stated that construing the agreement as argued by Kaufman Development would be inconsistent with the addition of a new provision to the operating agreement addressing management and the provision of the amendment stating that the amendment was binding on and inured to the benefit of the parties. According to the court, these provisions made clear that Kaufman Development remained bound by and Eichenblatt continued to benefit from the terms other than those specifically related to allocations and distributions.
The court of appeals next rejected Kaufman Development’s argument that the trial court should have clarified the judgment to specify that Eichenblatt’s interest was extinguished. Kaufman Development argued that the jury’s award represented the liquidated value of Eichenblatt’s interest, but the court concluded that it was not at all clear that the jury intended for the damages award to represent the full value of Eichenblatt’s interest in the LLC or for Eichenblatt to have no interest in the LLC going forward. The jury was not asked to make and did not make any findings about Eichenblatt’s interest, and Kaufman Development was not entitled to rewrite the jury’s verdict through a post-trial motion.
746 S.E.2d 823 (Ga. App. 2013).
When the members/managers of an LLC that sold its day care facility formed a new LLC and opened a new day care facility within three years after the sale, the purchaser sued the selling LLC, its members/managers, and the new LLC for breach of a noncompetition clause. The court of appeals held that the selling LLC did not violate the noncompetition provision, and the members/managers and their new LLC were not bound by the provision. Primary Prep Academy, LLC (“Primary LLC”) sold its childcare facility to the plaintiff pursuant to the terms of an asset purchase agreement (“APA”) that contained a noncompetition clause. The noncompetition clause provided that “Seller agrees that neither Seller nor its agents will” take certain acts within three years after the closing. The parties to the APA were the plaintiff and Primary LLC, and the APA was signed by Marguerite O’Brien in her capacity as a manager of Primary LLC. Within three years after the sale, Marguerite O’Brien and her two daughters (the “O’Briens”), who were the members and managers of Primary LLC, formed East Cobb Children’s Academy, LLC (“East Cobb”) to operate a new child care facility within the ten-mile radius in which the noncompetition clause prohibited the “Sellers or its agents” from opening a child care facility. The trial court granted summary judgment in favor of the defendants, and the plaintiff appealed. The court of appeals first noted that the parties did not contend, and there was no evidence indicating, that Primary LLC was involved in opening the East Cobb facility. Nor was there any evidence that the O’Briens were acting as agents for Primary LLC when they opened the new facility. The key issue was whether the APA barred the O’Briens individually from opening the East Cobb facility. Since Marguerite O’Brien executed the APA in her representative capacity for a disclosed principal, the APA was Primary LLC’s contract and not that of Marguerite O’Brien or of her two daughters, none of whom were even mentioned by name in the agreement. The plaintiffs argued that the words “its agents” unambiguously referred to the O’Briens, relying on the provision of the Georgia LLC statute that every manager is an agent of the LLC for the purpose of its business and affairs. The court acknowledged that the statute so provides, but this general statement that an agent is one who acts for another does not authorize the LLC to bind its agents for the LLC’s contractual obligations. To the contrary, the statute protects the members and agents of an LLC from liability for the LLC’s obligations. Under the statute, a member of an LLC is separate from the LLC and is not a proper party to a proceeding against the LLC solely by reason of being a member. Primary LLC had no authority to bind the O’Briens individually to the noncompetition clause, and merely including the term “its agents” in a contract with an LLC does not bind the members or managers individually under the LLC statute. If the buyer desired to bind the O’Briens individually, it should have made them parties to the APA and required their signatures in their individual capacities. In a footnote, the court mentioned that the plaintiffs did not argue, and there was no evidence, that the existence of Primary LLC should be ignored. The court stated that the same recognition of a corporation’s separate existence “so long as the corporate forms are maintained” applies to an LLC, and courts must exercise great caution in disregarding the legal distinction.
Instituform Technologies, LLC v. Cosmic TopHat, LLC
__ F.Supp.2d __, 2013 WL 4038722 (N.D. Ga. 2013).
In this patent infringement suit, the plaintiffs sought summary judgment piercing the veil of a California LLC to hold the member liable for the LLC’s infringement and vice versa. The court stated that, although the patent infringement claims arose under federal law, the veil-piercing issue was governed by Georgia law. Because the Georgia Supreme Court has rejected outsider reverse corporate veil piercing, i.e., piercing to allow a third-party creditor to reach a corporation’s assets to satisfy the claims of an individual corporate insider, the court rejected the reverse piercing claim in this case and considered only the plaintiffs’ arguments under a traditional piercing theory. The court recognized that a member of an LLC is considered separate from the LLC and is not a proper party to a proceeding by or against the LLC solely by reason of being a member. In order to pierce the veil of an LLC and hold a member personally liable under Georgia law, there must be evidence that the member abused the legal form by which the LLC is maintained as a separate entity from the member’s personal business by showing that the member disregarded the separateness by commingling on an interchangeable or joint basis or confusing the otherwise separate properties, records, or control. The plaintiffs first argued that alter ego liability was appropriate because the LLC failed to observe formalities such as meeting and record keeping. However, the Georgia LLC statute provides that failure of an LLC to observe formalities is not a ground for imposing personal liability on a member, manager, or agent. Next the plaintiffs argued that alter ego liability was appropriate because the member failed to treat the LLC as a separate entity from himself. However, the evidence relied on by the plaintiff may have shown that the member failed to keep the LLC separate from another entity owned by the member but did not show that he failed to keep the LLC separate from himself. The mere fact that the member commonly controlled two entities did not support alter-ego liability. The plaintiffs also argued that alter-ego liability was appropriate because the LLC was undercapitalized. To justify piercing the veil based on undercapitalization, the plaintiffs had to show undercapitalization was coupled with an intent at the time of the capitalization to improperly avoid future debts. The plaintiffs identified no such evidence. Finally, the plaintiffs pointed to the member’s prior conduct in the litigation as requiring piercing to prevent the injustice that would arise if he transferred or disposed of assets through or by means of the LLC in an effort to avoid collection activities. The court responded that this kind of misconduct could only be combated through reverse piercing, which the Georgia Supreme Court has rejected on the basis that more traditional theories of conversion, fraudulent conveyance, and agency law are adequate to deal with the situation where one seeks to recover from the corporation for the wrongful conduct committed by a controlling shareholder. Even if the plaintiffs’ fears were warranted, the court concluded that the plaintiffs had not shown as a matter of law that the member disregarded the separateness of the LLC by commingling on an interchangeable or joint basis or confusing the otherwise separate properties, records, or control.
__ N.E.2d __, 2013 WL 6800983 (Ill. App. 2013).
The plaintiffs, purchasers of a condominium unit from an LLC, sued the LLC and Yale, the managing member of the LLC, for common law and statutory fraud based on misrepresentations made by the LLC through Yale regarding inspections and repairs of the unit. Yale argued that he was protected from personal liability by section 10-10 of the Illinois Limited Liability Company Act, which provides that the debts, obligations, and liabilities of an LLC are solely the debts, obligations, and liabilities of the LLC and that a member or manager is not liable for a debt, obligation, or liability of the LLC solely by reason of being or acting as a member or manager. The plaintiffs argued that this provision does not shield LLC members or managers from personal liability for torts or fraud committed in their capacity as members or managers of the LLC. The plaintiffs asserted that Yale would be liable for fraud based on the alleged misrepresentations if he acted individually and that defrauding the plaintiffs while acting as a member/manager should not provide protection. The court held that the plain language of the statute protected Yale from liability. Section 10-10 of the Illinois statute provides that a member is liable for a debt, obligation, or liability only if a provision to that effect is included in the articles of organization and the member has consented in writing to the provision, and the plaintiffs made no claim that Yale was liable under this exception to limited liability. The plaintiffs pointed to the official comment to section 303 of the Uniform Limited Liability Company Act (ULLCA) because section 10-10 of the Illinois statute is similar to section 303 of ULLCA, and the ULLCA comment is included in the “Historical and Statutory Notes” published by West with section 10-10 of the Illinois statute. The ULLCA comment states that a member or manager is not liable for the debts, obligations, and liabilities of the LLC simply because of the member’s or manager’s status as an agent of the LLC, but a member or manager is responsible for acts or omissions that would be actionable in contract or tort against the member or manager if the person were acting in an individual capacity. The court refused to give the comment persuasive value because the ULLCA comments are not part of the statute and were not adopted by the Illinois legislature. The court contrasted the language of the prior Illinois LLC statute (which provided that a member or manager of an LLC was personally liable for an act, debt, obligation, or liability of the LLC to the extent that a shareholder or director, respectively, of an Illinois corporation is liable under analogous circumstances) to the current language and concluded the legislature intended to change the law by removing language that provided for personal liability. The court relied on other Illinois appellate decisions that stressed the statutory distinction between corporations and LLCs under section 10-10 in the context of an involuntarily dissolved LLC and an unformed LLC.
995 N.E.2d 1021 (Ill. App. 2013).
The plaintiff sued for breach of contract and enforcement of a mechanic’s lien to collect amounts owed by a defendant for grading and site development work the plaintiff performed on a Delaware LLC’s property. The trial court concluded that the plaintiff, also a Delaware LLC, could not claim a lien against the defendant LLC’s property because the plaintiff was a member of the defendant LLC and was therefore jointly interested in the property. The court of appeals began by stating that it was of little import whether the LLCs were formed in Delaware or Illinois. The court acknowledged that an owner or co-owner of property may not claim a lien against his or her own property, but the court pointed out that an LLC is a legal entity distinct from its members, and Illinois LLC law clearly states that membership in an LLC does not confer ownership of the LLC’s property. An LLC member owns only its membership interest in the LLC, and for that reason a creditor of the member may not seize LLC property to satisfy the member’s debt. Given that the plaintiff was a member of the defendant LLC, the plaintiff was not a co-owner of the defendant LLC’s property, and its mechanic’s lien was valid.
991 N.E.2d 971 (Ind. App. 2013).
A member of a member-managed LLC that was the general partner of a family limited partnership that owned certain real estate executed a contract of sale for several tracts of the real estate. The contract resulted from an auction at which the land was put up for bid pursuant to an auction contract under which the partnership had the right to reject any bid. The members of the LLC and the limited partners of the partnership were four siblings. The siblings met before the auction and discussed reserve or minimum prices for the land and agreed that unanimous consent was necessary to sell any of the land. At the auction, the bidding did not reach the minimum prices on which the siblings agreed. The siblings met privately during the auction and did not agree to accept a lower bid, but the auctioneer prepared a purchase contract for the purchase of the land to the high bidder, and one of the siblings, Candace, signed the contract in the name of the LLC in its capacity as general partner of the partnership. The partnership and LLC, through counsel, wrote a letter to the auctioneer demanding that the purchase contract be rescinded, and the partnership did not close on the sale. The partnership and LLC then sued the auctioneer for breach of contract, Candace for breach of fiduciary duty, and the purchaser to quiet title. The purchaser counterclaimed for specific performance and sought summary judgment. The trial court granted summary judgment in favor of the purchaser, and the court of appeals affirmed, concluding that Candace had the power to bind the partnership as a member of the LLC general partner under either common-law apparent authority or the provisions of the Indiana LLC statute.
The court of appeals first analyzed the situation applying common-law apparent authority principles. Apparent authority is the authority that a third person reasonably believes an agent to possess based on a manifestation by the principal. Manifestations made by the agent are not sufficient to create apparent authority. Candace and two of her siblings were present at the auction, and the purchaser knew that Candace and her siblings had met in private during the auction. After the siblings met in private, the auctioneer announced that one of the tracts would not be sold because the bid was too low, but the auctioneer commenced a two-minute countdown for final bidding on the other tracts. The purchaser did not have any indication that the siblings had rejected the purchaser’s bids on the remaining tracts, and the conduct of the siblings and their agent auctioneer thus indirectly communicated to the purchaser that they had accepted the remaining bids at the close of the auction. After the close of bidding, the auctioneer presented a contract to the purchaser and Candace. Candace had previously communicated with the purchaser that the consent of all the siblings was required to sell the property. Because three of the siblings attended the auction and did not indicate that they had rejected the purchaser’s bid and because their auctioneer agent presented a purchase contract, it was reasonable for the purchaser to conclude that Candace had obtained the consent of her siblings and was authorized to sign the contract. As a matter of law, Candace had apparent authority to execute the purchase agreement.
The court of appeals next discussed the application of provisions of the Indiana LLC statute addressing a member’s power to bind the LLC. Under the LLC statute, a member of a member-managed LLC is an agent of the LLC for the purpose of its business, and the act of a member, including execution of an instrument in the LLC’s name for apparently carrying on in the usual way the business of the LLC binds the LLC unless the member does not have authority to act in the matter and the person with whom the member is dealing knows that the member lacks authority. An act that is not apparently carrying on in the usual way the business of the LLC does not bind the LLC unless authorized in accordance with the operating agreement or the unanimous consent of the members. The partnership and LLC argued that Candace’s actions were not apparently for carrying on in the usual was the business of the LLC. The meaning of the statutory language at issue, i.e., “apparently carrying on in the usual way the business or affairs of the limited liability company,” presented the court with a matter of first impression. The partnership and LLC argued that they were not in the business of selling real estate and that sale of the property was a major endeavor and a liquidation of assets. The court of appeals concluded that Candace was apparently carrying on in the usual way the business of the LLC. The business of the LLC was to act as general partner of the limited partnership, which owned the real estate. The limited partnership agreement gave the general partner the full and exclusive power to manage and operate the partnership’s affairs, including the power to buy and sell real property. Thus, when Candace signed the purchase agreement, she was apparently carrying on in the usual way the business of the LLC, which was to act as general partner of the limited partnership. In addition, all the siblings agreed to sell the property at auction and authorized Candace to execute the contract with the auctioneer. The undisputed evidence showed that the purchaser had no knowledge or reason to believe that Candace did not have authority to bind the LLC; therefore, the purchase agreement was enforceable.
No. 12-0591, 2013 WL 1453246 (Iowa App. April 10, 2013).
The court of appeals upheld the trial court’s directed verdict in favor of the defendant in this breach of contract case against a manager-managed LLC because no reasonable juror could find that the non-manager member who signed the contract on behalf of the LLC had actual or apparent authority to do so. The plaintiff operated a bar and sought to enter into a management agreement with an LLC that operated another bar. During the negotiations, before the terms of the management agreement were finalized, it was determined that the LLC needed a licensing agreement in order to open and operate its bar under the name used by the plaintiff, and Martin, a non-manager member, was given authority by the LLC to sign the licensing agreement on behalf of the LLC. He signed the licensing agreement in his capacity as member, and the agreement contained a termination clause that required notification of the LLC’s registered agent to terminate. Later, a management agreement that purported to supersede and replace the previous licensing agreement was signed by Martin on behalf of the LLC. The agreement also recited that the LLC waived any notice of termination required by the previous agreement. Martin told the plaintiff’s representative that he had no authority to sign the management agreement. A second management agreement that purported to replace the first management agreement was signed a little over a month later. Martin also signed that agreement on behalf of the LLC. Martin testified that the plaintiff’s representative told Martin that signed agreements were needed for the plaintiff to obtain financing and would not be used to bind the LLC. The plaintiff’s representative never inquired into Martin’s authority to bind the LLC, and Martin never gave the management agreements to any other member of the LLC. The LLC first became aware of the management agreements when it received a demand letter from the plaintiff’s attorney claiming the LLC was in breach of the management agreement and owed the plaintiff a large sum of money. The court of appeals analyzed the question of whether Martin had authority to bind the LLC on the management agreement based on the Iowa LLC statute and common-law agency principles and concluded he did not. The court pointed out that the Iowa LLC statute, effective January 1, 2011, provides that a member is not an agent solely be reason of being a member. Based on this provision, the court stated that generally only managers can bind an LLC unless another party, such as a member, is authorized to do so by a manager as a principal. The court noted in a footnote that the previous Iowa LLC statute, which was in effect when the LLC was formed, provided that a member, acting solely in the capacity as a member, is not an agent of the LLC. Also, the new statute allows the filing of a statement of authority with the secretary of state. The court stated that neither party argued that the change in the law had any effect on this case, and the court thus did not address the change. The court stated that the party asserting an agency relationship has the burden to prove its existence and explained that agency results from the manifestation of consent by a principal that an agent shall act on the principal’s behalf and subject to the principal’s control, and consent by the agent to do so. The court stated that an agency can be established based on actual or apparent authority, and the court first addressed actual authority. Actual authority is composed of express and implied authority, ant the articles of organization of the LLC in question recited that no member of the LLC had any power or authority to bind the LLC unless authorized by the operating agreement or the managers of the LLC. The court mentioned that the articles of organization were publicly available, but the plaintiff made no effort to access the articles or otherwise learn who had authority to bind the LLC. Since Martin was not a manager of the LLC when he negotiated the contract, he had no express authority to bind the LLC. The court next addressed apparent authority, which is authority the principal has knowingly permitted or held out the agent as possessing. The focus in determining whether apparent authority exists is the principal’s communications to the third party. That is, apparent authority must be determined based on the acts of the principal rather than the acts of the agent. A principal may also be held liable based on the doctrines of estoppel and ratification. In this case, there was no representation by the LLC to the plaintiff that Martin had authority beyond the execution of the licensing agreement. The licensing agreement provided that notice to the LLC’s registered agent must be given to terminate the licensing agreement, and no such notice was provided when the management agreements that superseded the licensing agreement were executed. Nothing in the record showed that the LLC gave the plaintiff any indication that Martin had authority to execute the management agreements. Martin told the plaintiff that he had no authority to bind the LLC and was told by the plaintiff that the agreements were only needed to obtain financing. Thus, the trial court correctly granted a directed verdict in favor of the LLC.
313 P.3d 808 (Kan. 2013).
An operating agreement for an LLC that was formed to develop and operate surgical and other healthcare facilities contained a provision regarding the division of fees for services performed by one of the members (Nuterra Healthcare Management, LLC or “Nuterra”) should Nuterra enter into management agreements with specified other surgical centers. Shortly after the LLC was formed, Nuterra entered into a management agreement with one of the specified surgical centers. The management agreement was to remain in effect for five-year terms unless either Nuterra or the surgical center elected not to renew the contract. Approximately two years after the LLC was formed, Nuterra’s co-member (Iron Mound, LLC or “Iron Mound”) exercised its right to dissolve the LLC. One of Iron Mound’s owners filed a certificate of cancellation for the LLC and conducted the winding up. At the time of dissolution, the only significant asset of the LLC was the interest in management fees generated from the surgical center with which Nuterra had contracted. The LLC’s operating agreement contained a provision addressing liquidation that provided that the members would continue to share in cash flow and profits and losses during the period of liquidation pursuant to the other provisions of the operating agreement. After dissolution of the LLC, Nuterra continued paying Iron Mound a percentage of the gross fee generated under Nuterra’s management agreement with the surgical center until the end of the first five-year term of the agreement. At that time, the surgical center exercised its right not to renew the management agreement but invited Nuterra to negotiate a new agreement. Nuterra and the surgical center entered into a second renegotiated management agreement. Nuterra did not pay Iron Mound any part of the fees from the second management agreement, and Iron Mound sued Nuterra to recover a percentage of the fees based on the provisions of the LLC operating agreement. The trial court concluded the operating agreement was unambiguous and granted summary judgment in favor of Nuterra. The court of appeals concluded that the operating agreement was ambiguous and that there were unresolved issues of fact. The supreme court, applying contract interpretation principles, concluded that the operating agreement was unambiguous and that Iron Mound was not entitled to any of the fees from the second management agreement. The court stated that the operating agreement evidenced a clear intent that Iron Mound’s right to a percentage of revenues was conditioned upon or derived from its membership in the LLC and the terms of the operating agreement. It was undisputed that when Nuterra entered into the second management agreement, the operating agreement had ceased to exist and there was no LLC to receive revenues and no members to whom such revenues could be allocated. It was further undisputed that the second management agreement was a new and separate contract rather than a renewal of the first management agreement. The parties conceded that the right to management fees received from the surgical center under the first management agreement was an asset of the LLC subject to liquidation or distribution in kind, but the court stated that this concession was not relevant to the second management agreement, which could not be an asset of the LLC that had ceased to exist at the time the contract was executed. A contrary conclusion would require a strained reading of the operating agreement and consideration of extrinsic matters. The supreme court stated that its conclusion made it unnecessary to consider the broader question of whether the dissolution of an LLC terminates its operating agreement absent express language to the contrary.
Turner v. Andrew
413 S.W.3d 272 (Ky. 2013).
A truck owned by Billy Andrew and operated by Andrew’s LLC was damaged in an accident, and Andrew sued to recover for damage to the truck as well as loss of income derived from use of the truck in Andrew’s business. The LLC was not named as a plaintiff, and the Kentucky Supreme Court determined that Andrew had no standing to assert the claim for lost income if the LLC was conducting the business in which the truck was being used at the time of the accident. The court noted that Andrew could personally recover for the property damage to the truck since he personally owned the truck. The court explained that an LLC is a legal entity distinct from its members and pointed out that courts across the country have uniformly recognized the separateness of an LLC from its members. The court rejected the reasoning of the court of appeals that Andrew was the real party in interest since he was the sole owner of the LLC, pointing out that cases in the sole-owner corporation context had rejected that reasoning and stating that the same conclusion was mandated here. The court stated that the LLC and its sole member are not “interchangeable” and that “an LLC is not a legal coat that one slips on to protect the owner from liability but then discards or ignores altogether when it is time to pursue a damage claim.” The court acknowledged that there are circumstances when the LLC’s separate existence can be disregarded in the interest of equity but stated this was not such a case because the facts here bore no resemblance to the traditional veil-piercing situation where an unpaid LLC creditor seeks to pierce the veil of an LLC to reach the personal assets of the member. Further, this case was not even an “outsider reverse” piercing case where the creditor of a member seeks to pierce the LLC veil to reach assets of the LLC to satisfy the member’s personal debt. The court acknowledged that there is an “insider reverse” piercing theory adopted by a very few states and employed when strong policy considerations are involved. Here, the only appropriate plaintiff to assert the lost damages claim was the LLC if, as it appeared, the trucking business was being conducted by the LLC at the time of the accident.
__ So.3d __, 2013 WL 6439355 (La. 2013).
The Louisiana Supreme Court analyzed the statutory limitation of liability of LLC members and managers in the context of the plaintiff’s attempt to hold a member of an LLC personally liable for the member’s own actions in connection with the construction of a house that the LLC contracted to build. The member personally operated the bulldozer in preparing the dirt pad for the foundation and supervised the subcontractor that poured the concrete slab. The foundation was faulty beyond repair, and the lower courts held the member was liable as well as the LLC. The supreme court discussed the nature of an LLC and stressed that it is an entity separate from its members and that the liability of its members is governed “solely” and “exclusively” by the law of LLCs. The Louisiana LLC statute provides that a member or manager of an LLC is not liable for any debt, obligation, or liability of the LLC except where the member or manager has committed fraud, a breach of professional duty, or other negligent or wrongful act. The court noted that the statute provides that a member is not a proper party to a proceeding by or against the LLC except when the object is to enforce a person’s rights against or liability to the LLC, but the court declined to address this argument because the member had waived it.
The supreme court first addressed the plaintiff’s arguments that the member committed fraud or breached a professional duty. In the absence of a definition of “fraud” in the LLC statute, the court found that it was appropriate to draw from a longstanding definition in the Civil Code, which provides that fraud is misrepresentation or suppression of the truth, including silence or inaction, with the intent to obtain an unjust advantage or cause loss or inconvenience. The court concluded that the member’s failure to provide proof of insurance until the day of trial did not constitute fraud. Next the court noted the professions for which the Louisiana legislature has made available professional corporations and pointed out that there was no evidence that the individual defendant was a member of any of these professions. The plaintiff suggested that the member’s role as a contractor should equate to a professional role, but the plaintiff failed to offer any evidence to support the argument. To the extent there was evidence in the record of licensure, it appeared that the LLC rather than the member held the contractor’s license. The court stated that it was not suggesting that a mere licensure results in professional status, but the court stated that it may be one factor to consider.
Next the court discussed the exception to limited liability where a claimant “by law” has a cause of action against a member for a “negligent or wrongful act.” The court rejected the member’s argument that the phrase “negligent or wrongful act” applies only to conduct that can be construed as a tort. Because the concept of a “negligent” or “wrongful” act can be found outside of tort law, such as in criminal law and certain more arcane areas of law, the court concluded that the phrase was not limited to torts. The court stated that the following four factors should be considered in determining whether conduct of a member falls within the ambit of a “negligent or wrongful act” for which a member has personal liability under the LLC statute: (1) whether the member’s conduct can be fairly characterized as a traditionally recognized tort; (2) whether the member’s conduct can be fairly characterized as a crime for which a natural person can be held culpable; (3) whether the conduct at issue was required by or in furtherance of a contract with the LLC; and (4) whether the conduct at issue was done outside the member’s capacity as a member. The court discussed each factor as it related to the case before it.
If a traditional tort has been committed against a cognizable victim, such a situation weighs in favor of applying the “negligent or wrongful act” exception to allow the victim to recover against the tortfeasor. The court cited the rule that a corporate officer or agent is liable where the officer or agent is at fault in causing an injury to another to whom a personal duty is owed, whether or not the act inflicting the injury was committed on the corporation’s behalf. The court stated that LLCs were not different from corporations in any sense that would justify a different approach to this type of question of personal liability. In examining whether an LLC member can be personally liable for a tort, the threshold question is whether a duty is owed to the claimant. The duty must be a duty in the tort sense rather than the contract sense. Here, the duty must be more than the duty inherent in the LLC’s contract not to engage in poor workmanship. Otherwise, the general rule of limited liability would be negated in any case where an LLC had a contractual duty not to engage in poor workmanship.
If the conduct at issue constitutes a crime, that fact weighs in favor of applying the “negligent or wrongful act” exception to permit the victim to recover. The court stated that only crimes for which a natural person (as opposed to a juridical person such as an LLC) could be held culpable should be considered. In the instant case, the court recognized that engaging in the business of contracting without a valid contractor’s license is a crime in Louisiana. Thus, if an LLC member personally acts in the capacity as a contractor without proper licensing of the individual or LLC, that situation would weigh in favor of holding the member personally liable. The court stated that it was not necessary that the member actually be convicted of the crime to satisfy the criminal conduct factor. As in the tort context, the critical question regarding a member’s criminal conduct is whether the member breached a duty to the claimant. A court must focus on whether the statute was intended to protect a particular plaintiff from the types of harm that ensued.
The contract factor weighs against holding the member personally liable if the member’s conduct was required by, or in furtherance of, a contract between the claimant and the LLC. If the reason a member is engaged in the conduct at issue is to satisfy a contractual obligation of the LLC, the member will be more likely to qualify for the limitation on liability.
Acting outside the capacity as a member weighs in favor of removing an individual from the protection of limited liability. The court acknowledged that this inquiry may overlap with the tort and/or contract inquiry. As examples of acting “outside” the structure of the business entity, the court noted situations in which a member in his personal capacity becomes a mandatary (agent) for the claimant and breaches a duty, or a member or shareholder contracts on behalf of the LLC or corporation without disclosing the representative capacity in which the member or shareholder is acting.
When determining whether the exception for a member’s “negligent or wrongful act” overrides the general rule of limited liability, a court must evaluate each situation on a case-by-case basis and consider each of the four factors discussed above. The tort factor may be dispositive. In other words, on a showing that a member owed a duty in tort to the claimant, the breach of duty could pave the way to a member’s personal liability for the tort. The evidence here did not show that the member owed the plaintiff a tort duty. His conduct amounted to poor workmanship undertaken in furtherance of the legitimate goals of the LLC under its contract. The court pointed out that the conduct “stands in stark contrast to the oft-commented example of a contractor committing a personal injury while driving, which would present a far clearer justification for finding the existence of a tort duty.” With respect to the criminal conduct factor, the record did not show that the member engaged in any criminal conduct, such as acting as a contractor without proper licensing. The third factor also weighed against imposing liability because the member’s actions were in furtherance of the LLC’s contract with the plaintiff. Finally, the record contained no evidence that the member acted “outside” as opposed to “inside” the structure of the LLC. The court stated that the limitation of liability of a member is a presumption, but the plaintiff failed to overcome the presumption in this case.
__ So.3d __, 2013 WL 6654373 (La. App. 2013).
After dissension developed between the 51% and 49% members of an LLC, the majority member filed suit against the minority member for declaratory relief alleging that the minority member had withdrawn and that the minority member’s actions had breached his duties and the operating agreement. The minority member filed an answer and asserted various claims for relief himself. A “stipulated preliminary injunction” was issued under which the parties agreed that each of them would be enjoined from taking certain actions. A trial was held during which most of the evidence centered on the value of the LLC’s assets. At the conclusion of the trial, the court reached a decision as to the value of the LLC’s assets and the monetary interest of each member in the LLC. The court then scheduled an evidentiary hearing on issues limited to permanent injunctive relief, future participation in the LLC by the parties, dissolution of the LLC, attorney’s fees, and assessment of costs. At this hearing, the parties conceded that they did not desire to continue to work together. The plaintiff opposed dissolution and continued to argue that the minority member had withdrawn, but the minority member asserted that he was still a 49% member. At the conclusion of the hearing, the trial court concluded that the plaintiff failed to prove the minority member had withdrawn. The trial court concluded both parties were “prevailing parties” under the provisions of the operating agreement and awarded each party attorney’s fees as well as court costs from the assets of the LLC. On appeal, the plaintiff argued that counsel for both parties had stipulated that the minority member had withdrawn. The plaintiff argued that both sides operated under the assumption that the minority member had withdrawn and that the evidence thus centered around the value of the assets of the LLC. The court of appeals reviewed the record and found no express stipulation that the minority member had withdrawn as a member of the LLC. Further, the court of appeals agreed with the trial court that the evidence did not show any affirmative action on the minority member’s part indicating an intent to withdraw from the LLC, nor did the record indicate that the minority member tacitly withdrew. The plaintiff also argued that neither party should have been considered a “prevailing party” and that the award of attorney’s fees was erroneous. The court interpreted the operating agreement pursuant to principles of contract law and concluded that the minority member was a prevailing party, but the plaintiff was not. The operating agreement provided that the prevailing party in any litigation arising as a result of or by reason of the operating agreement shall be entitled to reasonable attorney’s fees. The plaintiff filed the initial petition seeking preliminary injunctive relief, damages, and a declaration that the minority member had withdrawn as a member of the LLC. The parties entered into stipulations with regard to the injunction, and the minority member was the prevailing party concerning damages and declaratory relief because the trial court did not award damages and found the minority member had not withdrawn. The minority member agreed to waive his claims with the exception of the valuation of assets and his interest in the LLC, and the court concluded that neither party was the “prevailing party” as to these claims. However, since the minority member prevailed with respect to the plaintiff’s initial petition, the court affirmed the minority member’s award of attorney’s fees and reversed the award of attorney’s fees to the plaintiff.
__ So.3d __, 2013 WL 6492268 (La. App. 2013).
The plaintiff sued two individuals who contracted with the plaintiff in the name “Louisiana Work Release.” The defendants argued that they were acting on behalf of Louisiana Work Release, L.L.C. and thus were not personally liable to the plaintiff. The trial court found that the two individual defendants never advised the plaintiff that they were employed by or acting on behalf of an LLC, and the evidence supported the trial court’s finding. Because the individuals did not disclose their status as agents and the identity of the principal, they were personally liable for payment under the contract. Use of a trade name is not necessarily sufficient disclosure by an individual that he is contracting on behalf of a corporation or LLC. Thus, the appellate court found no error in the trial court’s determination that the individual defendants were personally liable to the plaintiff.
__ So.3d __, 2013 WL 5016455 (La. App. 2013).
Landowners who prevailed in a boundary dispute sought to hold two individuals personally liable for removing trees from the plaintiffs’ property. The individuals were members of an LLC, and the evidence indicated that all their actions took place in their capacities as members or agents of the LLC. Thus, the court concluded they were not personally liable for any liability of the LLC. The court stated that the plaintiffs offered no evidence that the individuals engaged in any fraudulent or ultra vires acts or otherwise acted in a manner that would warrant piercing the corporate veil. Thus, the trial court properly refused to hold the individuals liable with the LLC for the damages.
120 So.3d 338 (La. App. 2013).
The Louisiana Department of Revenue sought to hold Thomas, a Louisiana resident and sole member of a Montana LLC, liable for sales tax and penalties on the LLC’s purchase of a recreational vehicle from a Louisiana seller. The Department acknowledged that LLC members and managers are not liable for the debts, obligations, and liabilities of the LLC under the Louisiana LLC statute, but contended that Thomas committed fraud in setting up an LLC in Montana for the sole purpose of avoiding Louisiana sales tax so that Thomas was individually liable for the sales tax in Louisiana. The Department argued that the LLC’s veil should be pierced under the test for piercing the corporate veil supplied by the Louisiana Supreme Court. The court of appeals concluded that there was no evidence in the record that Thomas committed fraud even if he created the LLC to minimize tax liability. The court explained that tax avoidance, as opposed to tax evasion, is taking advantage of legally available tax-planning opportunities to minimize tax liability. Further, the court stated that the record did not establish the factors set forth by the Louisiana Supreme Court necessary to show the LLC was the alter ego of Thomas and should be pierced. Additionally, the court noted that the record showed that the vehicle was housed in Mississippi and was not being used or housed in Louisiana such that any other tax may be owed.
Williams v. Charles
996 N.E.2d 475 (Mass. App. 2013).
Three members of an LLC brought a derivative suit on behalf of the LLC against the LLC’s managing member. The court of appeals held that the complaint was properly dismissed because the plaintiffs did not have the requisite vote required by the Massachusetts LLC statute for standing to sue. The court of appeals also concluded that the managing member’s mother, who was also a member of the LLC, did not necessarily have an adverse interest in the outcome based on the familial relationship.
The Massachusetts LLC statute provides that suit may be brought in the name of the LLC, whether or not management is vested in managers, by members who are authorized to sue by the vote of members who own more than 50% of the unreturned contributions of the LLC determined in accordance with another provision of the LLC statute; provided, however, that the vote of any member who has an interest in the outcome of the suit adverse to the LLC is excluded from the vote. The operating agreement did not address authorization of members to bring suit, so the court looked to the statute to apply this provision and calculate the percentages of members’ unreturned capital contributions. The statutory provision addressing unreturned contributions provided that a member receives a return of his contribution to the extent a distribution reduces his share of the fair value of the net assets of the LLC below the value, as set in the records of the LLC, of his contribution which has not been distributed to him. The reference to contributions in this provision points to the agreed value of the members’ contributions in the LLC’s records. Exhibit A to the operating agreement set out an amount of cash contribution for each of the six members except Williams, one of the plaintiffs. Exhibit A showed Williams’ cash contribution as zero. Treating Williams’ contribution as zero, the trial judge determined that the plaintiffs together did not have more than 50% of the contributions to authorize the derivative suit. The plaintiffs argued that Williams contributed services, and the court of appeals acknowledged that the statute allows a contribution to consist of services, but the court of appeals concluded that absent an agreed value placed on services, there was no basis to include his contribution in the member vote to authorize the suit. Because Exhibit A set forth percentage interests and the operating agreement allocated profits and losses in proportion to the members’ percentage interests, the plaintiffs argued the members’ percentages should be used to determine their standing. The court concluded, however, that the statute expressly tied standing to the percentage of members’ unreturned contributions unless the operating agreement specified a different manner of determining standing.
The court also addressed whether the mother of the defendant/manager had an interest adverse to the outcome of the suit such that her vote should be excluded from the vote needed to determine standing. The court declined to extend Connecticut case law regarding the treatment of spouses to the parent-child relationship, at least without more particularized allegations. The court held that the particularity requirement applicable to derivative actions under Massachusetts Rule 23.1 of the Rules of Civil Procedure applied to allegations regarding familial relationships, and the allegation that a member was the mother of the defendant managing member was insufficient to show that the mother’s interest was adverse to the LLC’s regarding the outcome of the suit. The additional allegations that the mother voted in alliance with her son at one meeting, along with another unrelated member, and failed to respond to the plaintiff’s concerns also fell short of particularized facts required to show that the mother had significant contrary personal interests to those of the LLC in the lawsuit.
Finally, the court addressed the plaintiffs’ attempts to recast some of their claims as direct rather than derivative claims. The plaintiffs argued that their claims were based on the managing member’s breach of the operating agreement, and that they were entitled to enforce them as parties to the operating agreement because the operating agreement provided that it was binding on and inured to the benefit of the parties and afforded any party the right to injunctive relief. However, the recovery sought by the plaintiffs arose from the managing member’s alleged self-dealing and excessive compensation, and the court held that it belonged to the LLC. The plaintiffs also argued that their claim of a minority freeze-out by the managing member should have been treated as direct. The court acknowledged that a minority freeze-out claim need not be brought derivatively where the wrongs were done to the individual plaintiffs, but the court concluded that this claim was moot because the remedy sought in their freeze-out claim was essentially granted in the judgment entered on the plaintiffs’ claim for an accounting, under which they were granted access to LLC information and an accounting.
415 S.W.3d 163 (Mo. App. 2013).
Damas, the managing member of an LLC owned by Damas and his two brothers, sold his interest to one of his brothers, and his brothers then uncovered facts leading them to believe that Damas breached his fiduciary duty to the LLC. The LLC filed a lawsuit against Damas for breach of fiduciary duty, and Damas filed a counterclaim for indemnification from the LLC. The jury found for Damas on the breach of fiduciary duty claim and on his indemnification claim. The LLC argued that its articles of organization and operating agreement expressly barred the indemnification claim. The articles of organization contained indemnification provisions that were broken down into two paragraphs, one entitled “Direct Actions” and one entitled “Derivative Actions.” The paragraph entitled “Direct Actions” required indemnification of any manager or officer who met specified standards and was a party to an action, suit, or proceeding “other than an action by or in the right of the Limited Liability Company,” and the paragraph entitled “Derivative Actions” required indemnification of any manager or officer who met specified standards and was a party to an action, suit, or proceeding “by or in the right of the Limited Liability Company.” The operating agreement provided that the manager shall be indemnified by the LLC to the fullest extent provided by Missouri law. The LLC argued that the “Direct Actions” provision controlled because the LLC brought the action against Damas directly. Because the “Direct Actions” provision excluded any obligation to indemnify a manager or officer in an action brought by or in the right of the LLC, the LLC argued it had no obligation to indemnify Damas in this case. Construing the articles of organization according to general contract rules, the appellate court concluded that the LLC’s action against Damas fell within the scope of the “Derivative Actions” provision because that provision applied to an action “by or in the right of the Limited Liability Company.” Rather than being in conflict and ambiguous as the trial court found, the two indemnification provisions were harmonious and did not overlap. One provision applied to actions initiated by or in the right of the LLC, and the other did not. The court acknowledged that the LLC’s action could be characterized as a “direct” action under the dictionary definitions of “direct” and “derivative” actions, but parties to a contract are free to define terms as they see fit, and the court stated that it would not employ a dictionary definition that is contrary to the plain meaning of the contract. The court noted that the articles of organization did not contain a provision stating that headings are for convenience only and should not be used to interpret the contract. The operating agreement contained such a provision, and Damas argued that the provision in the operating agreement should be read to apply to the articles of organization as well since the two documents were executed at the same time. The court did not find it necessary to rely on any provision of the operating agreement because the court otherwise concluded that the articles of organization unambiguously required indemnification of Damas.
Magruder v. Pauley
411 S.W.3d 323 (Mo. App. 2013).
Magruder, one of four equal members of an LLC realty agency, withdrew from the LLC. The remaining members refused to comply with the operating agreement, which required the LLC to obtain an appraisal of the business and pay the withdrawing member one-fourth of the appraised value. Magruder sued for specific performance, breach of contract, and prima facie tort. The court bifurcated the equitable claims from the remaining claims and found for Magruder after a bench trial on her claim for specific performance and the remaining members’ counterclaim for declaratory judgment. A partial judgment for specific performance ordered the remaining members to commission and pay for an appraisal and to purchase Magruder’s interest for one-fourth the appraised value. The parties agreed to a dismissal of Magruder’s breach of contract claim because it was filed as an alternative to the specific performance claim, but the remaining claims were tried in the jury trial, which resulted in a judgment in favor of Magruder for compensatory and punitive damages. Over a period of five years, after the bench trial, jury trial, and at least 11 post-trial hearings, the specific performance ordered by the court still was not completed. During that time, an appraisal was eventually performed, but the appraiser failed to include the LLC’s real estate and made certain other errors. Magruder supplied the court the missing information, and Magruder asked the court to exercise its equitable powers to include a final valuation in its final order because it had all the necessary information to do so. Magruder also moved to hold the remaining members in contempt and requested attorney’s fees based on the operating agreement. The trial court denied the contempt motion, and the trial court’s final order merely affirmed the jury verdict and attached the earlier partial judgment without reference to the disputed appraisal or attorney’s fees. On appeal, Magruder argued that the trial court erred in failing to include a valuation, failing to hold the defendants in contempt, and not awarding Magruder attorney’s fees. The court of appeals agreed with Magruder regarding the trial court’s failure to render a valuation and award attorney’s fees but held the trail court did not abuse its discretion on the contempt issue. With regard to the trial court’s failure to include a valuation in the final order, the court of appeals held that the trial court should have acted in equity to do so for three reasons. First, there was sufficient evidence in the record for the court to determine the valuation. Second, specific performance constitutes a remedy for breach of contract. Although the remaining members argued that Magruder could not now ask for a remedy that required a finding of breach of contract, the court’s order for specific performance implicitly found a breach of contract. Third, the trial court sitting in equity had the authority to do what was necessary to afford complete relief. With regard to the Magruder’s contempt motion, the court of appeals recognized that the remaining members’ conduct was egregious but concluded that the trial court’s decision did not constitute a clear abuse of discretion given the subjective analysis of the parties’ actions involved in the trial court’s exercise of discretion. Finally, the court agreed with Magruder that she was entitled to attorney’s fees based on the language of the operating agreement, which provided for recovery of reasonable attorney’s fees by the LLC or any party who obtained a judgment against any other party “by reason of breach of the Agreement.” The remaining members argued that the agreement only provided for attorney’s fees in the case of a “breach of contract.” Because Magruder prevailed on her specific performance claim, the court of appeals held she was entitled to recover reasonable attorney’s fees under the operating agreement. The court of appeals also noted that the trial court could have awarded fees on the basis of non-compliance with the court’s order for specific performance.
311 P.3d 808 (Mont. 2013).
Smith and Weaver formed an LLC. Smith opened a line of credit for the LLC with Tri-County Implements, Inc. (“Tri-County”), and requested that Tri-County perform certain work on a truck on the LLC’s account. The truck was titled in the name of Weaver, and when the invoice was not paid and Tri-County would not release the truck, Weaver sought return of the truck. In the litigation that ensued, the trial court held Weaver personally liable to Tri-County for the charges owed for work on the truck. The Montana Supreme Court reviewed the statutory liability protection provided to members and managers of an LLC under the Montana LLC statute, which states that a member or manager is not liable for an LLC’s debt, obligation, or liability solely by reason of being a member or manager. The court stated that this protection is not absolute in that it does not protect a member from liability for the member’s own wrongful conduct. Relying on previous Montana case law in the LLC context, the court stated that Weaver’s liability as a member depended on whether he engaged in conduct that would give rise to contract or tort liability if he were acting in his individual capacity. Although the trial court concluded that Weaver was liable on the contract with Tri-County, the supreme court found no basis on which to hold Weaver liable on the contract. The agreements with Tri-County for work on the truck were solely between Tri-County and the LLC, and Weaver did not guarantee the LLC’s payments or make any other promises. That Weaver held title to the truck, sued Tri-County, knew about the LLC’s transactions with Tri-County and failed to object, or arranged to make some payments was immaterial. Conflating the LLC’s failure to pay its own debt and Weaver’s failure to pay the LLC’s debt would eviscerate the statutory liability protection provided LLC members. Turning to a tort analysis, the allegation that the LLC was unable to pay its debts did not of itself amount to wrongful conduct that imposes liability on Weaver. It was also immaterial to the tort analysis that Weaver held title to the truck, sued Tri-County, knew about the LLC’s transactions with Tri-County and failed to object, or arranged for some payments to be made. Weaver’s conduct did not amount to an actionable tort. If a member or manager operates an LLC as an empty shell to perpetuate fraud and avoid personal liability, the court said the situation would be different, but those facts were not present here.
JSA, LLC v. Golden Gaming, Inc.
No. 58074, 2013 WL 5437333 (Nev. 2013).
The appellants negotiated a lease with Golden Gaming, Inc. (“Golden Gaming”), and Golden Gaming executed the lease on behalf of a subsidiary, Golden Tavern Group (“Golden Tavern”), the manager of Sparky’s South Carson 7, LLC (the “LLC”), which was listed as the tenant on the lease. The lease did not list Golden Gaming as a tenant, and Golden Gaming refused to guarantee the lease when asked. Golden Gaming provided the LLC’s initial capitalization and recapitalized the LLC on a frequent basis, but the LLC operated in accordance with Nevada gaming law using its own on-site managers. The on-site managers would report to a regional manager at Golden Tavern who would report to Golden Gaming. Upper-level management and operations occurred at Golden Gaming’s offices. Golden Gaming accounted for the LLC through the use of consolidated bank accounts with separate accounting through a coding system. Golden Gaming kept separate books and records for the LLC and filed independent sales tax returns but filed a single consolidated tax return. The LLC did not have an operating agreement, “as one was not required under Nevada law.” The LLC failed, and the appellants sued Golden Gaming alleging various claims and causes of actions. The trial court entered judgment in favor of Golden Gaming on all counts. On appeal, the appellants argued that the trial court erred in concluding that Golden Gaming was not a party to the lease, did not fraudulently or negligently misrepresent its status as guarantor or tenant, and was not the alter ego of the LLC.
The Nevada Supreme Court first discussed the appellants’ argument that it should be able to hold Golden Gaming liable as a party to the lease due to its failure to disclose its alleged agency status and as a “dba” of the LLC. The court concluded that Golden Gaming was not liable on the lease because the LLC was listed on the signature line as the tenant, and the signature line clearly indicated that the lease was being signed by Golden Gaming on behalf of the LLC. Golden Gaming was not an undisclosed or partially disclosed agent and was not liable on the lease under agency principles. The appellants argued that Golden Gaming repeatedly used various LLCs as dba’s for its business operations so that it was rational for the appellants to assume that it was doing so in this case. The court stated that this argument failed when put in the context of the plain language of the lease, which clearly stated that the LLC was the tenant and that Golden Gaming was not signing for itself.
The court rejected the fraudulent misrepresentation claim because there was substantial evidence supporting the trial court’s determination that Golden Gaming did not fraudulently misrepresent the identity of the tenant. A purported fraudulent inducement cannot be something that conflicts with the contract’s express terms. The identity of the tenant as the LLC was clear in the written lease. It was undisputed that Golden Gaming never told the appellants that it would be the tenant, and Golden Gaming was never listed as the tenant on the lease. The court characterized the appellants’ predicament as resulting from a lack of due diligence and erroneous assumptions rather than any action by Golden Gaming.
Finally, the court concluded that substantial evidence supported the trial court’s determination that imposing alter ego liability on Golden Gaming was inappropriate. The court assumed without deciding that the Nevada corporate alter ego statute applies to LLCs.
Under the statute, a court may pierce the corporate veil only when three things are established: (1) the corporation is influenced and governed by the stockholder, director, or officer; (2) there is such unity of interest and ownership that the corporation and the stockholder, director, or officer are inseparable from each other; and (3) adhering to the corporate fiction would sanction fraud or promote manifest injustice. The court stated that the first prong was satisfied, but the second and third prongs were not. With respect to the second prong, the court stated that the use of a single cash management system was insufficient to establish commingling. The level of financial investment by Golden Gaming in the LLC did not even approach undercapitalization because Golden Gaming sustained approximately $1.5 million in losses before closing the business. Finally, the LLC observed all corporate formalities required of a Nevada LLC by filing its own state tax returns, possessing its own gaming license, managing its employees, and employing on-site managers. Furthermore, Golden Gaming separately accounted for and documented all the money it used to recapitalize the LLC. As to the final prong, the court found no fraud or manifest injustice because the appellants were responsible for the loss they suffered by not insisting that Golden Gaming guarantee the lease, and Golden Gaming did not misrepresent that it was the tenant on the lease.
Maya I-215, LLC v. Moore
No. 60095, 2013 WL 3833280 (Nev. 2013).
Maya I-215, LLC (“Maya”) and Screaming Eagle, LLC (“Screaming Eagle”) sued the managers of Screaming Eagle. Screaming Eagle was the manager of Maya, and the two LLCs alleged that the managers of Screaming Eagle received unauthorized fees to the detriment of Maya. The issue on appeal was whether Screaming Eagle, as Maya’s manager, was authorized to initiate the litigation. The district court dismissed the litigation on the basis of member votes based on the interestedness test set forth by the Nevada Supreme Court in In re AMERCO Derivative Litigation. The supreme court held that the district court misread AMERCO, which did not apply, and that the manager had the unambiguous authority to initiate the lawsuit. Thus, the member vote was irrelevant. AMERCO involved the interestedness of corporate officers in declining to institute derivative litigation, and the court held that the corporation’s shareholder could proceed with a derivative action without making demand on the corporations’s officers because a demand would have been futile. The court explained that the AMERCO test did not apply in this case where the district court considered the opposite, i.e., the interestedness of the members in authorizing or discontinuing litigation initiated by the LLC’s manager. Applying contract principles to the interpretation of the operating agreement, the court found clear and unambiguous provisions authorizing the manager of Maya to do all things necessary or convenient to carrying out the LLC’s business, including instituting, prosecuting, and defending actions in the LLC’s name. Except for certain specified matters, the authority to act for the LLC was vested in the manager. Certain decisions were reserved to the members or required member consent, but nothing in the operating agreement allowed members to override the decision of the manager to institute a lawsuit. One of the defendants also argued that the law firm representing Maya in the case could not do so because the members of Maya voted to terminate the LLC’s relationship with the law firm, but the court stated that Screaming Eagle’s authority to initiate the law suit included the authority to choose counsel.
Another issue raised in this appeal was whether the law firm that represented Maya had a conflict of interest because of its previous representation of one of the defendants in a related case. The supreme court was not in a position to address this issue because of its fact-bound nature, but the court stated that this issue of professional ethics merited review by the district court on remand.
498 B.R. 262 (Bankr. D. Nev. 2013).
Two and half years after filing her own Chapter 7 petition, the debtor filed a Chapter 11 petition for a Nevada member-managed LLC of which she was the sole member. The debtor took this action without the knowledge or consent of her Chapter 7 trustee. The debtor listed her LLC in her Chapter 7 petition, and the bankruptcy trustee did not abandon the bankruptcy estate’s interest in the LLC. Between the two bankruptcies, the trustee took no action to remove or replace the debtor as manager of the LLC. The court concluded that the LLC’s bankruptcy filing was not authorized because the trustee controlled the LLC and the debtor lacked standing to file the petition for the LLC. Upon the filing of the debtor’s bankruptcy petition, all her legal and equitable interests became property of the bankruptcy estate. Relying on In re First Protection, Inc., 440 B.R. 821 (9th Cir. BAP 2010), and other cases that have favorably cited In re Albright, the court held that the Chapter 7 trustee automatically succeeds to all the rights of a debtor who is the single member of an LLC without having to take any further actions under state law before exercising management rights. Should any state law provision conflict with this result, the court held that Section 541 trumps state law. The debtor argued that the Nevada Supreme Court’s decision in Weddell v. H2O, a charging order case, compelled a different outcome, but the court stated that the rights provided to a trustee under Section 541 trump the approach taken by the court in that case. A bankruptcy trustee’s powers are broader than those of a judgment creditor. Because the debtor did not have authority to file the bankruptcy petition for her LLC, the court dismissed the LLC’s bankruptcy.
971 N.Y.S.2d 519 (App. Div. 1st Dept. 2013).
The court held that an LLC’s owner was not liable as guarantor of an LLC’s promissory note, but the court could not determine as a matter of law that the owner was not primarily liable on the note. The note recited that “the undersigned hereby jointly and severally promise to pay” the amount owed under the promissory note, and the signature page had two signature lines, each next to the word “Borrower,” one on top of the other. Underneath the top line the words “Tony Yan (Owner)” were typed, and Yan’s signature appeared on that line. Stamped immediately below the typed words “Tony Yan (Owner),” and covering the area above and below the second signature line, was a stamp with the employer ID number, name, and address of the LLC. Yan claimed he signed only in his capacity as the manager of the LLC and was not personally liable, but the court concluded that the lower court erred in dismissing the complaint against Yan because it could not be determined as a matter of law that he was not primarily liable based on the language in the note and extrinsic evidence. The court pointed out that the express “joint and several liability” of “the undersigned” would make no sense if the LLC were the sole obligor. Further, the signature page raised questions as to whether Yan signed in his individual capacity. It was possible to conclude that Yan intended to sign strictly on behalf of the entity, but it was also reasonable to interpret the signature section containing Yan’s signature on one line and the LLC’s stamp on the other as indicating that each was intended to be a borrower. Further clouding the intentions was the fact that the notary did not indicate Yan’s capacity. Next to the words “Notarized by:” appeared the words “For Tony Yan.” Looking to extrinsic evidence to resolve the ambiguities did not eliminate the possibility that Yan had borrowed the funds in his personal capacity. The loan proceeds were paid by a check payable to both the LLC and Yan as payees, and both parties pointed to aspects of their email communications supporting their arguments. In sum, it was error for the trial court to dismiss the claim against Yan individually.
Production Resource Group, L.L.C. v. Zanker
976 N.Y.S.2d 75 (App. Div. 1st Dept. 2013).
The plaintiff sought to hold Zanker, the president of Learning Annex, LLC and LA Expo, LLC, personally liable for purchases approved by Cummings under the trade name “Learning Annex.” The defendants argued that only LA Expo, LLC was liable for the purchases. The plaintiff claimed that “Learning Annex” was a well-known trade name used by Zanker and sought to recover against Zanker on that basis. The court acknowledged that an individual who acts on behalf of a nonexistent corporation can be held personally liable, but the court pointed out that Zanker did not interact with the plaintiff; Cummings did. The plaintiff argued that Cummings was acting as Zanker’s authorized representative, but the court stated that Cummings’ claim that he was Zanker’s agent could not be used to establish the fact of agency. Further, Cummings did not have apparent authority because the plaintiff did not interact with Zanker, and there was thus no conduct by Zanker toward the plaintiff that cloaked Cummings with apparent authority. In sum, there was no basis to hold Zanker personally liable to the plaintiff.
Baker, Sanders, Barshay, Grossman, Fass, Muhlstock & Neuworth, LLC v. Comprehensive Mental Assessment & Medical Care, P.C.
974 N.Y.S.2d 93 (App. Div. 2d Dept. 2013)
(holding claimant adequately pleaded allegations that individual dominated LLC and engaged in acts amounting to abuse of privilege of doing business in LLC form so as to perpetrate wrong or injustice and were thus sufficient to state claim under theory of piercing corporate veil).
974 N.Y.S.2d 58 (App. Div. 1st Dept. 2013).
The court held that the plaintiff’s claim under a provision of an LLC operating agreement requiring distribution of surplus revenue to the members pro rata in accordance with their equity interests could not be asserted derivatively because it was personal to the plaintiff rather than belonging to the LLC. The plaintiff also failed to adequately allege that a pre-suit demand was futile. A pre-suit demand is required in the LLC context as it is in the corporate context, and the plaintiff did not allege that a majority of the individual defendants controlling the managing member were interested in the challenged transaction. The plaintiff alleged that one individual controlled certain entities that owned and operated another hotel to which the LLC’s funds were allegedly diverted but did not specify how the other individual defendants were involved.
974 N.Y.S.2d 54 (App. Div. 1st Dept. 2013).
The court disagreed with the motion court’s ruling that the plaintiff had legal capacity to bring derivative claims on behalf of a dissolved Delaware LLC and dissolved Delaware limited partnerships. The court stated that the plaintiff was required to bring her derivative claims on behalf of the entities after or in conjunction with a successful action to nullify the certificates of cancellation. Rather than file a petition in the Delaware Chancery Court to have the certificates of cancellation annulled, the plaintiff improperly filed a motion in this action seeking nullification of the certificates. With regard to the demand requirement in derivative actions on behalf of LLCs and limited partnerships under Delaware and New York law, the court stated that the motion court’s finding that demand was futile with respect to four of the limited partnerships was supported by allegations that the defendant controlling owner was interested in the sale transactions. The court stated that the motion court properly applied a six-year statute of limitations to the breach of fiduciary duty claim since the derivative action was equitable in nature. The plaintiff continued to be in a fiduciary relationship with the defendant controlling owner and the other limited partners and members, and the statute of limitations thus did not begin to run until the relationship terminated.
973 N.Y.S.2d 137 (App. Div. 1st Dept. 2013).
The court affirmed the dismissal of a complaint because the plaintiff landlord’s allegations of corporate domination and control were wholly conclusory and thus insufficient to support its claim to pierce the veil of the tenant LLC. The individual defendants were employees or officers rather than owners of the LLC, and the complaint provided no explanation as to how any domination was for their personal gain. Finally, failure to allege fraud or unjust conduct was fatal, especially since the tenant performed under the five-year lease for almost four years.
968 N.Y.S.2d 523 (App. Div. 2d Dept. 2013).
Lewis, the managing member and a 38% owner of an LLC, executed a deed conveying LLC property to another LLC also managed by Lewis. The two remaining members, who owned the remaining 62% of the LLC had a special meeting at which they voted to remove Lewis as managing member, and they then signed a contract of sale for the property to the plaintiffs. The plaintiffs filed suit seeking specific performance of the contract of sale. The 62% members sought summary judgment vacating the deed executed by Lewis and directing specific performance of the contract with the plaintiffs. The court held that the lower court properly denied summary judgment vacating the deed and directing specific performance of the contract of sale. The New York LLC statute provides that the transfer of substantially all of the assets of an LLC requires the vote of at least a majority in interest of the members unless the operating agreement provides otherwise. Here, the operating agreement expressly authorized the managing member to make decisions relating to the sale or disposition of the property. Thus, there was no prima facie showing that the transfer by Lewis as the managing member was unauthorized under the operating agreement or LLC statute. Further, the 62% members did not establish as a matter of law that they complied with the provisions of the operating agreement when they called the meeting and replaced Lewis as managing member before entering into the contract with the plaintiffs.
496 B.R. 135 (S.D.N.Y. 2013).
A member of the LLC debtor filed a motion to dismiss the Chapter 11 bankruptcy petition filed by the debtor. The member, Crossroads ABL, LLC (“Crossroads”), asserted that the vote to authorize the filing of the Chapter 11 petition did not satisfy the debtor’s operating agreement. Crossroads was one of the original two members and owned a 40% interest. Under the operating agreement, a supermajority of 62.5% of the common units was required to authorize the filing of a bankruptcy petition, and Crossroads thus had sufficient ownership to block such a decision. However, the operating agreement permitted the manager to raise additional capital by issuing additional common units that could result in impairment of Crossroads’ blocking position. Additional common units were issued to investors who, in accordance with the private placement memorandum, were required to be accredited investors under SEC Rule 501 and who represented in subscription agreements that they were accredited investors. At a members’ meeting, 63.5% of the common units (but not Crossroads) voted to authorize the LLC’s manager to file a Chapter 11 petition. Crossroads argued that the vote was not valid because the debtor LLC had not shown that the additional investors were accredited investors. Crossroads argued that the court must hold an evidentiary hearing to establish whether each of the individuals was an accredited investor when the units were purchased three years earlier. The debtor LLC argued that it was Crossroads’ burden to show the investors were not accredited. The bankruptcy court noted that there is conflicting case law on the burden in a motion to dismiss a petition for lack of authority to file. The court was not persuaded by the cases holding that the burden should initially be on the debtor or should shift to the debtor. The court found the record adequate to sustain the petition and that Crossroads did not sustain its burden to justify the relief it sought. The validity of the issuance of the new units had been argued previously in state court litigation, and Crossroads was unable to convince the state court that there was a substantial likelihood of success on the merits to support a preliminary injunction. Further, Crossroads learned of the purchase by 2011, at the latest, and cited no “state authority that would permit a minority shareholder to challenge a corporate action on such technical grounds years after the fact.” In any event, the court stated it would be wrong as a matter of federal policy to allow additional investigation of this matter to permit the obstruction of the bankruptcy proceeding. Further, the court stated that the controverted issue of whether the investors were accredited investors for purposes of the securities laws was an issue extraneous to the bankruptcy filing. In light of its holding, the court commented that it need not determine the validity of clauses such as the one at bar, that may, in come cases, purport to give minority owners a veto over a Chapter 11 filing. The court recognized that some courts have not hesitated to apply supermajority and other clauses designed to impede a debtor’s entry into bankruptcy. The court characterized such clauses as permitting minority equity holders “to hold a bankruptcy filing hostage even where there is no dispute that there should be a judicial dissolution or reorganization of the debtor.” The court stated that the “mischief” of such clauses was readily illustrated by the present case in which Crossroads, if it obtained dismissal, might be able to continue to burden creditors with its own litigation and prevent the debtor from engaging in legitimate operations and avoid the risk of a potentially meritorious preference suit against Crossroads. The court stated that there was no reason to treat bankruptcy as a “bogeyman,” “fate worse than death,” or “penalty,” and the court found no reason to compound the problem of supermajority clauses, whatever their validity, and create a whole new method of obstructing a bankruptcy filing, by holding that the court must investigate the authority of each LLC member to vote.
Archer Well Company, Inc. v. GW Holdings I LLC
No. 12 Civ. 6762(JSR), 2013 WL 2314271 (S.D.N.Y. May 21, 2013).
The plaintiff, an oil field services provider, contracted with a holding company to pay $630 million for all of the equity interests in four LLCs and a corporation. The plaintiff sued the holding company and its parent/manager based on allegedly false representations and warranties in the purchase agreement. The plaintiff’s claims included securities fraud claims under Sections 10b and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The defendants sought dismissal of the claims as to the LLC interests on the basis that the interests were not “securities”within the meaning of the Exchange Act. The court granted the motion to dismiss on the basis that the plaintiff’s purchase of 100% of the interests of each of the four LLCs was not a purchase of securities. The court set forth the criteria of the Howey test, which applies to investments such as LLC interests that are not explicitly covered by the Exchange Act. Under the Howey test, an interest in an entity is a security it is (1) an investment in a common venture, (2) premised on a reasonable expectation of profits, (3) to be derived form the entrepreneurial or managerial efforts of others. In analyzing what is a “security,” substance prevails over form, and the “economic reality” should be the focus. Because the plaintiff bought the entirety of the membership interests in the LLCs, its investment failed to satisfy both the first and third prongs of the Howey test, and the purchase of the interests thus did not constitute the purchase of securities. The plaintiff asserted three arguments in an attempt to avoid this result. First, the plaintiff argued that, even if it did not purchase securities, the defendant sold securities when it sold its equity interests in the LLCs. The plaintiff based this argument on the fact that the plaintiff was simply a holding company through which numerous passive investors invested in the LLCs. The court distinguished case law involving sellers of limited partnership interests to a general partner and concluded that the economic reality of the purchaser’s purchase of the entirety of the membership interests in this case did not meet the Howey test. Plaintiff’s second argument was that the court should look to the period between the signing of the purchase agreement and the closing of the transaction because the seller was obligated to operate and manage the LLCs for the benefit of the purchaser during that period. The court rejected this argument as well, concluding that the relevant perspective for the economic reality of the transaction was what the plaintiff in fact purchased. Finally, the plaintiff argued that the LLC interests should be treated as securities because the LLCs were identical in form to the corporation purchased by the plaintiff at the same time, and the defendants conceded that the stock in the corporation was covered by the Exchange Act. The court also rejected this argument, pointing out that stock is expressly covered by the Exchange Act regardless of the economic reality or circumstances of the transaction. The court stated that LLC membership interests cannot be “bootstrapped into becoming ‘securities’” merely because the plaintiff also purchased other securities.
753 S.E.2d 331 (N.C. App. 2013).
Anthony Garwood was an officer or manager of both Safefresh Technologies, LLC (“Safefresh”) and American Beef Processing, LLC (“ABP”). In the early 2000s, Garwood, in his capacity as president of Safefresh, communicated with the plaintiff’s president regarding the development of a specific type of valve for food processing, but no contract was entered into with the plaintiff at that time because the plaintiff’s quoted cost for manufacturing the valve was too high. There were no further communications between Garwood and the plaintiff’s president until 2008 when Garwood contacted the plaintiff regarding the production of two types of valves. At this time, the plaintiff’s president that Garwood communicated with in the early 2000s had retired, and his son was president. In this suit against Safefresh by the plaintiff to enforce the 2008 contract, Safefresh claimed that Garwood was acting as president of ABP rather than Safefresh when the contract was entered into. All of the plaintiff’s price quotes were addressed to Safefresh, and Garwood did not inform the plaintiff that he was acting on behalf of ABP rather than Safefresh during the price negotiations. In the email accepting the plaintiff’s offer to manufacture the valves, Garwood did not identify himself as the agent of either Safefresh or ABP. He simply signed as “Tony.” The court discussed basic agency principles and stated that the plaintiff had the burden to show that Garwood was acting as an agent of Safefresh at the time of the contract. A principal is liable on a contract made by its agent if the agent acts with actual authority, or if the agent acts with apparent authority when the third person is without notice that the agent is exceeding the agent’s authority, or if the contract is ratified although it was unauthorized at the time. If the plaintiff raised a fact issue with respect to any of these bases for binding Safefresh, the trial court erred in rendering summary judgment in favor of Safefresh. The court concluded that there was a fact issue as to whether Garwood was acting within his actual authority as a manager of Safefresh when he contracted with the plaintiff. The court reviewed the provisions of the North Carolina Limited Liability Company Act under which, as a default rule, every manager is an agent of the LLC for the purpose of its business, and the act of a manager for apparently carrying on in the usual way the business of the LLC binds the LLC unless the manager in fact has no authority and the person with whom the manager is dealing has knowledge of the lack of authority. Thus, the court stated that Garwood as a manager of Safefresh had authority to bind Safefresh by default unless the articles of organization or operating agreement provided otherwise. The record contained evidence that Garwood had actual authority given that he had previously contacted the plaintiff regarding the manufacture of valves for Safefresh, and the silence on the email combined with that fact that he originally contacted the plaintiff as president of Safefresh was enough to create a genuine issue of material fact whether he acted within the scope of his actual authority for Safefresh in 2008. The court noted that the record was not devoid of evidence suggesting that Garwood was acting in his capacity as manager of ABP, but the plaintiff produced sufficient evidence to create a fact issue as to his actual authority to act on behalf of Safefresh and thus preclude summary judgment in favor of Safefresh.
Town of Midland v. Wayne
748 S.E.2d 35 (N.C. App. 2013).
Wayne, an individual who held record title to a tract, sought to treat his tract and an adjacent tract owned by an LLC in which he owned a 75% interest as a single tract on the basis of unity of ownership. The court held that there was no unity of ownership because Wayne had no interest in the tract owned by the LLC; rather, he only owned an interest in the LLC that owned the tract. The court concluded that case law from the corporate context was the appropriate analogy and rejected Wayne’s claim that the court should look to partnership case law under which the court had found that separate tracts owned by different partnerships could be treated as having a unity of ownership based on the fact that some of the general partners were the same. In that case, the court stated that each general partner had an ownership interest in the partnership property along with the other partners. Here, the court stated that the LLC should be treated like a corporation, which is distinct from the shareholders that own it, and that, where persons have deliberately adopted the corporate form to secure its advantages, they will not be allowed to disregard the existence of the corporate entity when it benefits them to do so. Wayne argued that an LLC should be treated like a general partnership rather than a corporation for purposes of unity of title because partnerships and LLCs are taxed similarly. The court was unconvinced, pointing out that S corporations and partnerships are also taxed similarly.
748 S.E.2d 568 (N.C. App. 2013).
The plaintiffs entered into an agreement to sell a tract of land to Cramer Mountain Development, LLC (“Cramer”), which was owned by Desimone. The agreement was later assigned by Cramer to a newly formed LLC, Moorehead I, LLC (“Moorehead”), whose sole member was Blackmon. On the date the agreement was assigned, the plaintiffs met with Desimone and two real estate brokers and executed various documents, including a deed to Moorehead, prepared by Moorehead’s closing attorney. The plaintiffs brought a lawsuit in which they alleged that Desimone and the real estate brokers made misrepresentations to them about what they were signing and that they were defrauded into closing the transaction under terms different than those agreed upon. The plaintiffs also alleged that Moorehead was in default on a $4.5 million note payable to the plaintiffs. The plaintiffs sought to pierce the veil of Cramer and Moorehead on the basis that Desimone, Blackmon, and the real estate brokers exercised complete domination and control over the entities involved in the transaction. Based on the jury verdict, the plaintiffs obtained a judgment that concluded, inter alia, that Blackmon was the alter ego of Moorehead and was liable for $4.9 million for Moorehead’s breach of contract and that Blackmon was liable for nominal damages of $1.00 for unfair and deceptive trade practices. Blackmon appealed the part of the judgment holding him personally liable.
The court of appeals discussed the statutory liability protection provided to members and managers under the North Carolina LLC statute and the circumstances under which a member can be held personally liable, including veil piercing. The LLC statute provides that a member or manager is not liable for the obligations of the LLC solely by reason of that status and that a member or manager does not become liable by participating, in whatever capacity, in the management and control of the business. The statute goes on, however, to state that a member or manager may become personally liable by reason of that person’s own acts or conduct. The court explained that members of an LLC have the same liability protection as corporate shareholders and may not be held liable based merely on their participation in the LLC’s business affairs, but an LLC member may be held individually liable for the LLC’s obligations if the member engages in individual conduct that subjects the member to liability. In addition, the court explained that LLC members, like corporate shareholders, may be held individually liable for the LLC’s obligations through the doctrine of piercing the corporate veil. In North Carolina, the instrumentality rule forms the basis for disregarding the corporate entity or piercing the veil. The court set forth the three elements of the instrumentality rule, which involve complete domination; use of that control to commit fraud or wrong, violate a duty, or dishonestly and unjustly violate a right; and injury proximately caused by the control and breach of duty. The court listed numerous factors that may be considered in evaluating liability under the instrumentality rule. In this case, the plaintiffs presented evidence of multiple factors, the trial court properly instructed the jury regarding the instrumentality rule, and the jury returned a verdict based on which the trial court entered a judgment decreeing that Blackmon was the alter ego of Moorehead and that Blackmon and his entity were jointly and severally liable for all awards against either of them.
Blackmon argued on appeal that he could not be held personally liable on Moorehead’s promissory note because the jury failed to find him liable for fraud or to award actual damages for fraud or unfair or deceptive practices. The court of appeals stated that Blackmon’s argument completely misapprehended the law with respect to the instrumentality rule. The court stated that a finding that an individual member of an LLC personally engaged in fraud or misrepresentation is necessary to hold a member liable under the LLC statute for the member’s own conduct but is not required to support alter ego liability under the instrumentality rule. A showing of actual fraud in the legal sense is not required to pierce the corporate veil; piercing the veil under the instrumentality rule requires that a member used his control to commit fraud or wrong, to perpetrate the violation of a statutory or other positive or legal duty, or a dishonest and unjust act in contravention of the plaintiff’s legal rights. Similarly, the fact that the jury found only nominal damages for unfair and deceptive trade practices had no bearing on the trial court’s ability to pierce Moorehead’s veil and hold Blackmon liable for Moorehead’s breach of contract.
The court of appeals next discussed Blackmon’s challenge to the judgment insofar as it held him individually liable for unfair and deceptive trade practices. The court of appeals explained that fraud is not a required element of an unfair or deceptive trade practices claim, and an award of actual damages is not required to support a finding that the plaintiffs were injured by the acts complained of. The jury awarded nominal damages to the plaintiffs to compensate for the injuries found by the jury to be proximately caused by the various defendants’ unfair and deceptive acts. The jury’s findings were sufficient to support the trial court’s judgment against both Blackmon and Moorehead for unfair and deceptive trade practices.
837 N.W.2d 359 (N.D. 2013).
An LLC brought various claims against the ex-wife of a member. One of the claims was for misappropriation of a large sum of money. The trial court dismissed the claim on the basis that misappropriation is a statutory cause of action that relates only to the wrongful acquisition or disclosure of a trade secret, that the allegations were the same as the plaintiff’s conversion claim and were redundant, and that North Dakota does not recognize a claim for misappropriation. The plaintiffs argued that there was a cause of action for misappropriation and that courts have broad equitable powers to remedy it. However, the supreme court pointed out that the case relied on by the plaintiffs involved shareholders of a corporation suing the controlling shareholder and director for misappropriation of corporate funds and seeking relief under a provision of the North Dakota Business Corporation Act that authorizes equitable remedies when a corporation or officer or director violates the Act. The court stated that the LLC statute authorizes equitable remedies when an LLC member brings an action against the LLC or a manager or governor for violating the statute, but the defendant was not an officer, director, manager, or governor of the LLC. Thus, this case was distinguishable from the case on which the plaintiffs relied, and the lower court did not err in dismissing the misappropriation claim.
997 N.E.2d 1238 (Ohio App. 2013).
Beaujean and Germano formed an LLC in 2007 to operate a pizza franchise. The two agreed that that they would be equal owners, that Beaujean would provide financing for the LLC, and that Germano would provide on-site management. Other than the articles of organization, which listed both men as members, there was no written operating agreement. In 2009, Beaujean and his wife divorced, and Beaujean’s wife was awarded half of his membership interest in the LLC. The divorce decree was subsequently amended to provide that Beaujean was permitted to buy out the wife’s share of the LLC. In 2010, Germano began paying himself a management fee retroactive to the beginning of the venture. He also began paying a bookkeeping fee to a restaurant supply company he owned as well as transferring LLC funds to a separate account accessible only to him. Beaujean objected to these expenditures, but Germano refused to return the funds. Beaujean sued Germano for breach of fiduciary duty, and Germano counterclaimed for a declaratory judgment that Beaujean’s ownership of the LLC was only 25% and that Beaujean made no capital contribution and had no management rights. At trial, the parties agreed that their intent was for each of them to own 50% of the LLC and that Germano would earn his half through “sweat equity” while Beaujean would finance the company. They disagreed regarding Germano’s right to compensation. Beaujean claimed that Germano’s compensation would come through a distributive share of the profits and any value of the company, but Germano claimed it was never part of the agreement that he would manage the LLC without pay in perpetuity. Beaujean’s ex-wife testified that by the time of trial Beaujean had completed the purchase of any interest she was granted in the divorce and that she never held a membership interest. The trial court found that Germano was not entitled to transfer funds outside the reach of Beaujean and that the parties had an agreement that Germano would not charge management fees. The court ordered Germano to return these amounts and also ordered that Germano stop paying his other company bookkeeping fees and return fees paid in excess of $15 per hour. The court further ordered Germano to provide financial records to Beaujean. The court denied Germano’s counterclaims and issued a declaration that the parties were both 50% owners and that Beaujean’s ex-wife did not have and never had any membership interest in the LLC.
On appeal, Germano argued that the trial court erred in finding him liable for breach of fiduciary duty, but the court of appeals stated that the judgment did not expressly hold him liable for breach of fiduciary duty, but rather for taking unauthorized actions. The Ohio LLC statute defines fiduciary duties of loyalty and care addresses the authority of members in the management of an LLC. A member or manager may act as an agent of the LLC, but a member’s act must be authorized by the other members to be binding if it is not apparently for carrying on the business of the LLC in the usual way. The court of appeals concluded that Beaujean’s testimony at trial could form the basis for the trier of fact to conclude that Germano’s actions were unauthorized. Further, the court pointed out that the acts were patent departures from prior practice so that the trial court could conclude that Germano was not carrying on the business in the usual way. Since Germano was enriched by acts antithetical to the statute, the trial court could properly order the return of the money derived from the breach.
The court of appeals also upheld the trial court’s declaration that Beaujean owned a 50% interest in the LLC. Germano argued on appeal that Beaujean’s membership was divided between him and his ex-wife as a result of the divorce decree and that Beaujean’s interest was thus reduced to 25%. The court of appeals noted that a “member” is defined in the Ohio LLC statute as a person whose name appears on the records of the LLC as an owner of a membership interest, and a “membership interest” is a member’s share of the LLC’s profits and losses and the right to receive distributions. The court set forth the provisions of the Ohio statute regarding admission of members after the filing of the articles of organization. The statute provides that a person acquiring an interest directly from the LLC can become a member only as provided by the operating agreement or if not provided by the operating agreement by written consent of all members, and an assignee can become a member if the transferring member has the power under a written operating agreement to admit the assignee as a member. The court stated that there was no written operating agreement and no written consent of all members for Beaujean’s ex-wife to become a member. Further, her name did not appear in the LLC’s records as having a membership interest, so she could not have become a member in that manner. The divorce was granted in Michigan, but the court stated that Michigan law could not supersede Ohio business organizations law. Although Beaujean’s ex-wife might have a claim under the decree, the court found it unnecessary to address it in this case because Beaujean’s ex-wife “never became any part of a member” absent compliance with one of the statutory methods. Likewise, Beaujean’s “membership was never diluted.”
The court of appeals held that the trial court did not err in refusing to declare that Beaujean made no capital contribution and had no management rights. The court pointed out that the Ohio LLC statute provides that a contribution may consist of services or any other benefit provided to an LLC. There was some testimony that the parties initially sought bank financing, but it was later decided that Beaujean would loan the start-up funds. Beaujean obtained financing for the LLC in any event, and the court stated that the source of the loan was not relevant. The initial agreement that the parties would each be a 50% owner reflected that Germano found Beaujean’s services of obtaining financing constituted a sufficient contribution, and the trial court did not err in recognizing that fact.
No. 9971, 2013 WL 6175210 (Ohio App. 2013).
An individual signed a credit application on behalf of an LLC, and the LLC purchased goods on credit. Included in the credit application was the following language: “By signing this agreement you are both personally and corporately liable for the total of purchases by you or anyone designated to sign for your purchases on your account.” The seller sought to hold the individual personally liable, and the court of appeals agreed with the trial court’s conclusion that the individual agreed to be personally liable for the LLC’s purchases by signing the credit application.
991 N.E.2d 1225 (Ohio App. 2013).
Suglio, the owner of an LLC that performed concrete work on a driveway for Garber, appealed a judgment holding Suglio personally liable for violations of the Ohio Consumer Sales Practices Act (CSPA) and Ohio Home Solicitation Sales Act (HSSA). Suglio argued that Garber knew that he was dealing with an LLC. The court of appeals acknowledged that employees and proprietors of corporations and LLCs are not generally answerable for the debts or responsibilities of the company. In some situations, however, including violations of the CSPA, individuals can be liable for the actions of the company. Ohio courts have held that officers or shareholders who take part in or direct actions that constitute violations of the CSPA or HSSA may be held individually liable. In this case, the failure of Suglio and his LLC to provide Garber a cancellation notice when contracting for the work on the driveway was a violation of the HSSA and CSPA for which Suglio could be held individually liable.
313 P.3d 289 (Okla. App. 2013).
A judgment creditor that received a judgment in Texas filed a notice of foreign judgment in Oklahoma and sought a writ of special execution for seizure of the debtor’s units, both economic and voting interest, in an LLC. The Oklahoma trial court granted the writ and ordered the debtor to assign his entire membership interest, both economic and voting, in his units of the LLC. On appeal, the debtor argued that the trial court erred in ordering him to transfer both his economic and voting interest, and the court of appeals agreed. The court of appeals relied on the charging order provision of the Oklahoma LLC statute, which allows a court to charge the membership interest of a judgment debtor, but provides that the judgment creditor has only the rights of an assignee of the membership interest. The charging order provision further provides that a charging order cannot be converted into a membership interest through foreclosure or otherwise and the charging order provision is the exclusive remedy of a judgment creditor with respect to the judgment debtor’s membership interest. Although the Oklahoma LLC statute defines a “membership interest” to include both economic and voting/management rights, the court stated that the charging order provision narrows the meaning of a membership interest to the flow of profits and surplus from the member’s economic interest. Further, the statute specifically states that the judgment creditor has only the rights of an assignee, which are limited under the LLC statute to economic rights. The court of appeals thus concluded that the trial court erred in charging the debtor to transfer both economic and voting rights. The court went on to further discuss the trial court’s order as it pertained to transfer of the debtor’s voting interest in the LLC. With respect to transfer of a member’s membership interest, the Oklahoma LLC statute provides that a member may assign the economic rights associated with the membership interest, but an assignment of the economic rights does not entitle the assignee to participate in the management of the LLC or become or exercise the rights and powers of a member unless otherwise provided in the operating agreement. Because the operating agreement determines if and how a membership interest other than economic rights is transferred, the court examined the operating agreement of the LLC at issue. The operating agreement required the written consent of all remaining members for a transfer of units to a non-member. The LLC (which had filed a special appearance in favor of the judgment creditor’s writ) submitted to the trial court a resolution containing the written consent of two of the three members other than the debtor, but the debtor’s wife, who was also a member, did not consent in writing. Thus, the court stated that the terms of the operating agreement were not satisfied, and the trial court erred in ordering the debtor to assign his voting interest in the LLC.
747 S.E.2d 770 (S.C. 2013).
The plaintiff sought to hold an LLC member liable for negligent supervision of subcontractors in a construction project of the LLC. In a previous opinion, a majority of the South Carolina Supreme Court held that the provisions of the South Carolina Uniform Limited Liability Company Act do not shield a member of an LLC from personal liability for his own torts committed while working in furtherance of the LLC’s business. The supreme court withdrew its previous opinion and substituted this opinion in which the court concluded that it need not reach the question of whether the Uniform Limited Liability Company Act shields an LLC member from personal liability for his own torts because the member in question did not commit an actionable tort. The circuit court concluded that the Residential Home Builders Act imposed a legal duty on the member based on his status as a the holder of a residential builder license. The supreme court examined the language of the statute and determined that the Residential Home Builders Act did not create such a legal duty.
826 N.W.2d 357 (S.D. 2013).
The South Dakota Supreme Court held, as a matter of first impression, that an individual who is not a licensed attorney may not appear to represent an LLC pro se. The court followed many other federal and state courts that have extended the rule that a corporation must be represented by a licensed attorney to LLCs and thus dismissed an LLC’s appeal because it was filed by the LLC’s manager, a non-lawyer.
497 B.R. 525 (Bankr. E.D. Tenn. 2013).
A creditor of an LLC sought to establish a nondischargeable debt on the part of the LLC’s member in the member’s bankruptcy. Although the transaction that formed the context for the creditor’s claim was with the LLC, the court stated that it had jurisdiction and authority to adjudicate the plaintiff’s claim and award damages. The court pointed out that the member could be liable to the plaintiff under Tennessee law. The quoted the Tennessee LLC statute, which provides that a member, employee, or agent of an LLC does not have personal liability for the acts, debts, and obligations of the LLC or for the acts or omissions of others, but may become personally liable in contract, tort, or otherwise by reason of such person’s own acts. Relying on agency law principles, the court stated that the debtor, the managing member of the LLC, was liable for any tortious or fraudulent conduct perpetrated against the plaintiffs in that role.
__ S.W. 3d __, 2013 WL 6628628 (Tex. App. 2013).
A Texas LLC argued that it was a “hospital district management contractor” within the meaning of a provision of the Texas Health and Safety Code that treats a hospital district management contractor as a governmental unit for purposes of the Texas Tort Claims Act. The Health and Safety Code defines a “hospital district management contractor” as “a nonprofit corporation, partnership, or sole proprietorship that manages or operates a hospital or provides services under contract with a hospital district that was created by general or special law.” The LLC admitted it was an LLC but argued that the undefined term “partnership” in the statute should be construed broadly to include LLCs that elect to be taxed as partnerships for tax purposes under Texas and federal law. The court concluded that an LLC does not fall within the ordinary meaning of “partnership” even if the LLC elects partnership tax treatment. The court explained that an LLC has some characteristics of a partnership but also has some characteristics of a corporation. The legislature chose to make only nonprofit corporations, partnerships, and sole proprietorships eligible for the protections of a hospital district management contractor, and the court stated that it was not the role of the court to question the wisdom of the statute or rewrite it.
415 S.W.3d 548 (Tex. App. 2013)
The court relied on previous Texas case law for the proposition that the policies governing corporate veil piercing also apply to LLCs and held that there was no evidence of actual fraud, i.e., no evidence of dishonesty of purpose or intent to deceive, so as to hold a member or manager of the LLC liable. The court noted that the legislature specifically authorized single-member LLCs and limited the liability of a member or manager. The evidence did not establish who the principals of the LLC in this case were, but even if the evidence showed there was only one principal of the LLC, there was no evidence of actual fraud to support holding him liable and thus no basis to hold the sole principal liable for the LLC’s debt.
__ S.W.3d __, 2013 WL 4482976 (Tex. App. 2013).
An Iowa LLC challenged the trial court’s exercise of personal jurisdiction over the LLC, and the court of appeals affirmed the trial court. The question was whether the actions of Cox, a a Texas resident and member of the LLC, were attributable to the LLC for purposes of specific jurisdiction. Under the Iowa LLC statute, a person is not necessarily an agent simply because the person is a member, but the statute provides that a person’s status as a member does not prevent other law from imposing liability on the LLC because of the person’s conduct. The court of appeals relied heavily on an Iowa court of appeals decision, Three Minnows, LLC v. CREAM, LLC, which explained that an Iowa LLC is presumed to be managed by its members unless the members agree that the LLC will be managed by managers. As the court in Three Minnows further explained, the party asserting an agency relationship must prove its existence, and an agency results from manifestation of consent by a principal that an agent shall act on the principal’s behalf and subject to the principal’s control and consent by the agent to do so. In Three Minnows, where the LLC was manager-managed, a member did not have authority to bind the LLC to a contract. The LLC’s articles of organization in that case expressly provided that no member, agent, or employee of the LLC had any power to bind the LLC unless authorized by the operating agreement or the managers of the LLC. Here, by contrast, the LLC’s operating agreement provided that the LLC’s business and management was to be exercised by the members. Although the members were permitted to delegate to officers, the officers remained subject to the direction and control of the members. Thus, the court concluded that Cox had express authority to act on behalf of the LLC. The LLC argued that it did not control Cox and that Cox was not its agent for purposes of the jurisdictional analysis, but the operating agreement expressly provided that the management of its business would be conducted solely by its members. Cox was recruiting dealers to contract with the LLC, and the court relied on the general rule that the actions of a corporate agent are generally deemed the corporation’s acts. As a member of a member-managed LLC with express authority to conduct the LLC’s business, Cox was the LLC’s agent. As an agent, he recruited dealers to contract with the LLC, and the LLC contracted with recruited dealers, evidencing both the LLC’s consent for Cox to act and Cox’s consent to do so. The LLC, not Cox, controlled the terms of the contractual relationships with the recruited dealers. Thus, the court concluded that Cox’s contacts with Texas were attributable to the LLC for purposes of the specific jurisdiction analysis. The court went on to find the other requirements for the exercise of specific jurisdiction were met as well, i.e, that the contacts were purposeful and were done to obtain a benefit for the LLC, and the exercise of jurisdiction would not offend notions of fair play and substantial justice.
412 S.W.3d 749 (Tex. App. 2013).
Ghosh and Grover, through their respective entities of Cinemawalla, Inc. (“Cinemawalla”) and 87 Minutes, LLC (“87 Minutes”), formed an LLC to produce a movie entitled 97 Minutes. Ghosh and Grover orally agreed that Grover and 87 Minutes would contribute the rights to a screenplay and written commitments for the project along with $600,000 in cash and $400,000 of previous expenditures in exchange for 87 Minutes’ membership interest, and Ghosh and Cinemawalla, in exchange for its membership interest, would obtain the release of $4 million that had been placed in escrow under a contract between Cinemawalla and a third party (“San Luis Cine”) for the production of another movie. Grover and 87 Minutes satisfied their obligations, and Ghosh repeatedly assured Grover that San Luis Cine had agreed to reallocate the escrowed funds to the production of 97 Minutes, but San Luis Cine never released all the funds. After Ghosh offered various excuses and asserted that various actions needed to be taken before San Luis Cine would release the funds, Grover began to question Ghosh’s credibility and demanded that their agreement be reduced to writing. Ghosh refused to do so, and Grover and 87 Minutes sued Ghosh and Cinemawalla. The plaintiffs’ causes of action included breach of contract, conversion, and fraud, and the jury found in favor of the plaintiffs on each cause of action. On appeal, Ghosh and Cinemawalla argued, inter alia, that the statute of frauds barred the breach of contract claim, that the evidence did not support the jury’s verdict on the conversion claim, and that the statute of frauds prevented the plaintiffs from recovering benefit-of-the-bargain damages for their fraud claim.
The court of appeals first addressed the enforceability of the oral agreement by the defendants to cause the $4 million being held in escrow for production of another movie to be redirected to the LLC’s movie project. The Texas LLC statute provides that a promise to make a contribution or otherwise pay cash or transfer property to an LLC is not enforceable unless the promise is in writing and signed by the person making the promise.
“Contribution” is broadly defined in the statute to include any tangible or intangible benefit that a person transfers to an entity for an ownership interest or otherwise in the capacity as an owner or member. The benefit includes cash, services rendered, a contract for services to be performed, a promissory note or other obligation to pay cash or transfer property, or securities or other interests in or obligations of an entity. The plaintiffs argued that the defendants’ did not promise to contribute anything directly to the LLC, but rather to obtain the release of the escrowed funds to Cinemawalla, who would then use the funds to pay vendors and others providing services needed to make the movie 97 Minutes. The court stated that the statutory language is not limited to direct contributions. Here it was clear that the oral agreement to access the $4 million in escrow and invest it to fund the production of the LLC’s movie project constituted a promise to make a contribution to the LLC and was unenforceable because it was not in writing and signed as required by the statute.
The plaintiffs’ conversion claim was based on checks Ghosh wrote to herself from the LLC’s bank account. To recover for conversion, a plaintiff must have had legal possession or the right to possession of the money converted. The money in the LLC’s bank account was deposited by 87 Minutes, but 87 Minutes no longer owned, possessed, or controlled the money once it was deposited in the LLC’s account. Grover argued that he had the right to immediate possession of the money because he was entitled to rescind the fraudulently induced contract, but there was no legally enforceable contract due to the statute of frauds provision discussed above, and thus this argument failed even assuming it otherwise had merit.
The defendants made several arguments attacking the damages awarded on the fraud claim. With respect to the measure of recovery, the court of appeals held that the plaintiffs were not permitted to recover based on the benefit of their bargain with the defendants because the oral agreement was unenforceable as discussed above. Thus, the plaintiffs could not recover the lost profits they sought. The plaintiffs could, however, recover out-of-pocket damages incurred as a result of the defendants’ misrepresentations. The evidence regarding the expenses incurred by the plaintiffs’ did not support the amount of expenses found by the jury, but there was evidence that the plaintiffs suffered some out-of-pocket damages, and the court thus remanded for a new trial on the fraud claim.
410 S.W.3d 889 (Tex. App. 2013).
The court held that there was no evidence to support piercing an LLC’s veil to hold the sole member liable for the return of a deposit owed by the LLC. The court noted that the Texas legislature specifically authorized single-member LLCs and that the statutory liability protection afforded members and managers only gives way when a plaintiff can show that the LLC was used for the purpose of perpetrating and did perpetrate an actual fraud for the member’s or manager’s direct personal benefit. The court relied on previous Texas case law for the proposition that the policies governing corporate veil piercing also apply to LLCs and equated actual fraud to dishonesty of purpose or intent to deceive. The court concluded that the member’s “use of a single-member LLC, as statutorily authorized by the legislature, combined with an ordinary personal loan to purchase equipment for the company’s use secured by that equipment, amounts to no evidence of actual fraud even in combination with” other facts in the case. Even assuming the evidence showed that the LLC used some of the deposit as operating funds in violation of its agreement with the plaintiff and without disclosing the fact to the plaintiff, the court stated that there was no evidence that this action resulted in any direct personal benefit to the LLC’s member. Additionally, although the member shut down the LLC in the face of the plaintiff’s demand for its deposit (which the LLC was not yet obligated to return), the evidence showed that the LLC shut down due to declining business and not to avoid returning the deposit.
__ S.W.3d __, 2013 WL 3943078 (Tex. App. 2013).
In 1996, Jacob Kohannim (“Jacob”) and Mike Khosravikatoli (“Mike”) formed an LLC to purchase and hold real property on which a corporation owned by them operated a restaurant. Jacob and Mike were the managers and each owned a 50% interest in the LLC. The member agreement contained transfer restrictions that provided the LLC and the other member the opportunity to purchase a member’s interest in the event of a proposed sale of the interest or a transfer to a member’s spouse in a divorce. In 2003, Mike’s wife, Parvenah, filed for divorce, and the divorce court issued temporary orders prohibiting Mike and Parvenah from transferring assets. During the pendency of the divorce, Mike purported to transfer a 5% interest in the LLC to Jacob. In 2005, the divorce decree was entered. In the divorce decree, the district court found the transfer was void because it was an attempt to transfer community property in violation of the court’s order enjoining such a transfer. The divorce decree further awarded to Parvenah “[o]ne hundred percent (100%) of the husband’s interest” in the LLC, “which interest is equivalent to a fifty percent (50%) interest in such company.” The decree required the husband to execute and deliver to the wife’s attorney a stock transfer certificate and/or assignment of interest. Before the divorce decree was entered, Jacob closed an LLC bank account and transferred $160,000 in the account to the restaurant’s bank account as a “payment to owner.” After the divorce decree was entered, Parvenah’s attorney raised with Jacob the issue of the $160,000 payment and demanded a meeting for an accounting and to discuss management of the LLC. The following month, Jacob advised Parvenah that he intended to start the process of determining the value of the LLC for purposes of the buyout provision in the member agreement. Jacob never consented to Parvenah’s admission as a member. At the end of 2005, his attorneys informed her that she had no right to vote at an upcoming meeting regarding Jacob’s compensation and that Jacob intended to vote his 55% interest in favor of a $50,000 payment to him as compensation for his services in 2005. Jacob received the $50,000 payment over Parvenah’s objections. In 2006, Parvenah sued Jacob and the LLC, seeking a declaration of her rights with respect to the LLC and the validity of the member agreement and asserting claims based on constructive fraud, breach of fiduciary duty, oppression, waste, gross mismanagement and abuse of control, and unjust enrichment. The trial court appointed a receiver for the LLC and ordered the receiver to sell the LLC’s assets. The trial court eventually approved a sale of the LLC’s property for $1,300,100. The trial court’s final judgment contained findings as to the amount of assets held by the receiver and how the assets should be divided based on the court’s finding that Jacob and Parvenah each held a 50% beneficial interest in the assets. The trial court also found that Jacob, with malice and intent to defraud, engaged in wrongful acts and omissions that damaged Parvenah by decreasing the value of Parvenah’s interest in the LLC, and the trial court awarded Parvenah actual and punitive damages based on the wrongful acts and omissions. Jacob appealed on numerous issues but did not challenge the trial court’s division of the LLC’s assets.
The court of appeals sustained Jacob’s challenge to Parvenah’s recovery for breach of fiduciary duty. Although the trial court’s conclusions of law stated that Jacob owed a fiduciary duty to the LLC and breached that duty, the trial court did not make Parvenah’s requested findings that Jacob owed Parvenah a fiduciary duty or that he breached that duty. Thus, the court of appeals held that Parvenah could not recover for her breach of fiduciary duty cause of action.
The court of appeals also held that Parvenah coud not recover on her fraud and constructive fraud claims. She failed to plead a cause of action for actual fraud, and the court concluded the issue of actual fraud was not tried by consent. With respect to Parvenah’s constructive fraud claim, the court of appeals held that Parvenah could not recover because constructive fraud is premised upon the existence of a breach of fiduciary duty, and the trial court refused to find that Jacob owed Parvenah a fiduciary duty and that he breached that duty.
The court of appeals rejected Jacob’s challenge to the legal sufficiency of the evidence to support Parvenah’s oppression claim. The court of appeals stated that “a member oppression claim may exist when: (1) a majority shareholder’s conduct substantially defeats the minority’s expectations that objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture; or (2) burdensome, harsh, or wrongful conduct, a lack of probity and fair dealing in the company’s affairs to the prejudice of some members, or a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.” Jacob contended that an oppression claim can only be asserted by a minority member or shareholder, and Jacob conceded that Parvenah owned a 50% interest. The court of appeals rejected the argument that only a minority owner may assert an oppression claim because the Texas Business Organizations Code provides for a receivership of a domestic entity based on oppression by the directors or “those in control” of the entity. The court of appeals went on to examine whether there was any evidence of oppressive acts. Jacob argued that there was no evidence that he oppressed Parvenah’s rights by refusing to allow her to participate in management given that she was not a member. The court explained that a membership interest is personal property and that Mike’s 50% membership interest was community property awarded in its entirety to Parvenah under the divorce decree. Mike executed a document transferring and assigning the membership interest to Parvenah as required by the divorce decree, but the assignment of the interest did not include the right to participate in management under the Texas LLC statute. Under the statute, the right to participate in management is not community property, and assignment of a membership interest does not entitle the assignee to participate in the management and affairs of the LLC, become a member, or exercise any rights of a member. An assignee is entitled to become a member only with the approval of all of the members, and Jacob never consented to Parvenah becoming a member. Thus, she did not have any right to participate in the management of the LLC. Jacob next contended that there was no evidence that he oppressed Parvenah’s rights by failing to make distributions to her. The LLC’s regulations (i.e., operating agreement) provided for quarterly distributions to members of “available cash” provided available cash was not needed for reasonable working capital reserves. The LLC statute provides that an assignee is entitled to receive any distribution the assignor is entitled to receive to the extent the distribution is assigned. Because the district court awarded the entire community interest to Parvenah, she had a right to receive distributions. The district court found that Jacob paid himself for services that were not performed and that he failed to make any distributions to Mike or Parvenah even though $250,000 in undistributed profits had accumulated since the mortgage on the LLC’s property was paid off. The court of appeals concluded this was some evidence supporting the trial court’s finding that Jacob failed to make profit distributions. The court also agreed that the established facts demonstrated that Jacob engaged in wrongful conduct and exhibited a lack of fair dealing to the prejudice of Parvenah.
The court of appeals agreed with Jacob’s challenge to the trial court’s finding on Parvenah’s unjust enrichment claim. The trial court found that Jacob wrongfully utilized funds and assets of the LLC for his own use and unilaterally obligated the LLC to pay himself for management services that were not performed at all or were performed in a manner that damaged the LLC. A claim for unjust enrichment on these facts belonged to the LLC rather than Parvenah.
The court next addressed Jacob’s challenge to the legal sufficiency of the evidence to support the actual and punitive damages award. Because the court of appeals sustained Jacob’s challenges to Parvenah’s other causes of action, the only viable cause of action to support a damage award was the shareholder/member oppression claim. The court of appeals stated that the standard of review on this issue was not the traditional sufficiency analysis as asserted by Jacob, but rather was abuse of discretion because the receivership statute that provides for an oppression action authorizes a court to fashion an equitable remedy if the acts of those in control of an entity are oppressive. The court of appeals concluded that the trial court’s methodology for finding actual damages was not an abuse of discretion. The trial court calculated Parvenah’s damages by calculating the difference between the value of the LLC’s assets at the time of the trial court’s judgment in this case and the value of the LLC at the time of the divorce, increased by the amount taken from the LLC’s bank account by Jacob before the divorce decree. The court of appeals rejected Jacob’s argument that the trial court erred by adding back the amount taken from the LLC’s bank account prior to the divorce. Because Jacob’s removal of the LLC’s funds reduced the value of Parvenah’s interest, the court of appeals concluded the trial court did not err by adding that amount back into the value of the LLC. Next the court of appeals rejected the argument that the member agreement required the LLC to be valued as of the date of the divorce petition.
The court of appeals stated that the trial court found that the member agreement did not apply to Parvenah. Assuming it applied to Parvenah, the court of appeals stated that it was inapplicable here because Jacob did not comply with the provision addressing a buyout on divorce by intervening in the divorce proceeding to enforce the provision. Mike had agreed to the intervention, but Jacob did not do so. Jacob next argued that the LLC regulations provided that the valuation of Parvenah’s interest must be based on book value because the regulations contained a provision for purchase of a member’s interest at book value or appraised value on request of a party who deems the book value to vary from market value by more than 20%. The provision of the regulations relied upon by Jacob addressed death, dissolution, retirement, or bankruptcy of a member. The court stated that the provision did not address how damages are calculated in a lawsuit based on oppression, and the court relied on other case law in which the court in an oppression action concluded that it was not an abuse of discretion to order a buyout for fair value when a buy-sell agreement provided for redemption at book value. The court of appeals pointed out that receivership is one remedy for shareholder/member oppression and that the trial court ordered a receivership and authorized a sale of the LLC’s assets. Jacob did not complain concerning the receivership or sale. However, the court concluded that Parvenah was not limited to a recovery of her proportionate share of the sale proceeds and that courts have equitable powers to fashion appropriate remedies for oppressive conduct, including a buyout. Here, the court concluded that sufficient evidence supported the values found by the trial court and that Jacob did not argue, and the court of appeals did not perceive, that the trial court’s methodology constituted an abuse of discretion. The court of appeals sustained Jacob’s challenge to punitive damages because the only causes of action that could support a punitive damages award were actual fraud and breach of fiduciary duty.
Finally, the court concluded that Jacob’s challenges to the trial court’s declarations that the member agreement was void or inapplicable to Parvenah did not impact the judgment given that: Jacob did not challenge the declaration that Parvenah owned a 50% interest or the 50/50 allocation of the LLC’s assets; the court of appeals sustained Jacob’s contentions that an award of damages could not be based on Parvenah’s breach of fiduciary duty, constructive fraud, and unjust enrichment claims; and attorney’s fees under the Declaratory Judgment Act were supported by the unchallenged declarations of the trial court.
406 S.W.3d 216 (Tex. App. 2013).
The court of appeals affirmed an order of the trial court’s order setting aside a receiver’s sale and sanctioned the judgment creditor’s attorney given circumstances that included the following: the sale occurred without notice to the judgment debtor while a motion for new trial was pending and the parties were in settlement negotiations; the sales price appeared to be grossly inadequate; the sale covered LLC interests without obtaining a charging order; and, after the receiver’s sale, the judgment debtors entered into a settlement in full satisfaction of the judgment without knowledge that all of their property had been sold in the receiver’s sale. Nearly two months after the judgment creditor’s attorney filed a satisfaction of judgment based on the settlement, the judgment creditor’s attorney filed a motion for approval of the receiver’s sale. The court of appeals discussed the legal requirements and circumstances surrounding the turnover orders and receiver’s sale and concluded that the trial court did not abuse its discretion by setting aside the receiver’s sale. The trial court also did not err in setting aside the turnover orders because the turnover orders had no further force or effect once the judgment was satisfied. In its order sanctioning the judgment creditor’s attorney for filing groundless or bad faith pleadings, the trial court listed, inter alia, the turnover order that ordered the judgment debtors “to turn over their interests in various L.L.C.s, which is prohibited by statute,” and the motion to approve the receiver’s sale even though the judgment creditor’s attorney “was aware that the sale was held without notice, purported to convey L.L.C. interests which were prohibited by statute and that the judgment had already been satisfied.” In the course of analyzing whether the trial court’s order of sanctions was an abuse of discretion, the court of appeals pointed out that the judgment creditor’s attorney sought the sale of interests in numerous LLCs and that he “asked for a turnover order as to these interests, but he did not do so via a charging order.” The court of appeals cited the Texas limited partnership charging order provision and parenthetically quoted the portion that reads: “The entry of a charging order is the exclusive remedy by which a judgment creditor of a partner or of any other owner of a partnership interest may satisfy a judgment out of the judgment debtor’s partnership interest.”
307 P.3d 584 (Utah 2013).
In 2000, Storey, Holladay, Woodcock, and several other individuals formed an LLC to construct and operate an inn. Storey was appointed manager of the LLC. After the withdrawal of some of the members in early 2003, Storey, Holladay, and Woodcock executed an amended operating agreement under which Storey remained as manager and Storey, Holladay, and Woodcock each held a one-third interest in the LLC. In June 2003, Holladay and Woodcock took over Storey’s management duties, and later in 2003 litigation between the parties ensued. Storey asserted derivative claims and a demand for judicial accounting and dissolution or purchase of his interest. Holladay and Woodcock asserted claims against Storey for breach of fiduciary duty and other causes of action and sought Storey’s expulsion as a member and removal as a manager and a judicial accounting and dissolution of the LLC. The case was governed by the Utah Revised Limited Liability Company Act in effect at the time. Initially, the court granted a motion by Storey for a partial summary judgment declaring that Storey could not be removed as a manager based on the terms of the operating agreement, noting that Holladay and Woodcock had not expressly invoked the provisions of the LLC statute providing for judicial removal of a manager. The court stayed implementation of the judgment to allow Holladay and Woodcock to request an injunction removing Storey under the statutory provision, and the court later issued a preliminary injunction removing Storey as manager on a motion by Holladay and Woodcock in 2005 invoking the statutory removal provision. Based on a stipulation of the parties in December 2003, the trial court permitted Holladay and Woodcock to enter into a franchise agreement for the sale of the inn. Following a bench trial in 2009, the trial court removed Storey as the manager of the LLC, expelled Storey as a member effective December 31, 2005, and valued Storey’s interest as of December 31, 2005. Storey’s removal as a manager was based on the trial court’s findings of numerous instances of mismanagement and misconduct. The trial court ordered Storey’s expulsion as a member for the same reasons as his removal as a manager and based on his unlawful conduct that adversely and materially affected the LLC’s business or conduct making it not reasonably practicable to carry out business with the members. The trial court also found Storey breached his fiduciary duties to the members. The court made the expulsion and valuation of Storey’s interest retroactive to December 31, 2005, based on the parties’ conduct. The court found this date was appropriate because of Storey’s mismanagement, misconduct, dishonesty, breach of fiduciary duty, and lack of success as a manager on that date. The trial court also justified the valuation date on the failure of Holladay and Woodcock to adhere to the amended operating agreement and timely access the court to implement their decisions and pursue their remedies. The trial court also found that the decision to convert to a franchise was a substantial reason for the success of the LLC during and after 2005.
On appeal, Storey argued that the statute did not authorize the trial court to backdate his expulsion and the valuation of his interest. The court of appeals discussed in detail the statutory provisions and the Utah Supreme Court’s decision in CCD, LC v. Millsap and concluded that the trial court correctly determined that it had authority to make the expulsion of Storey and valuation of his interest retroactive. The court of appeals stated that the trial court could have chosen to backdate the expulsion to as early as 2003 based on his misconduct, but the trial court also appropriately took into account the delay by Holladay and Woodcock in complying with the amended operating agreement and LLC statute until 2005. Storey argued that he became an assignee under the statute when he ceased to be a member upon his expulsion and that he retained his interest until the judicial determination of dissolution in 2009. The court reconciled the provisions of the Utah statute by concluding that an expelled member becomes an assignee upon expulsion but that the assignee status continues only until valuation of the interest and does not preclude the retroactive valuation of the expelled member’s interest when appropriate. Thus, the trial court had the discretion to set the valuation based on the equities of the case, and the evidence supported the valuation date chosen by the trial court.
The court of appeals also addressed a few other issues, including whether the trial court properly declined to award punitive damages against Storey. The trial court concluded that it did not have the authority to award punitive damages because that would result in “double punishment” inasmuch as the trial court had chosen a retroactive date of expulsion and valuation. The court of appeals held that the retroactive date served the purpose of compensating Holladay and Woodcock and pointed out that breach of fiduciary duty is an independent tort that can serve as the basis for punitive damages. Thus, the court remanded for the trial court to properly evaluate whether punitive damages should be awarded. Finally, the court of appeals held that the trial court erroneously failed to grant a request for attorney’s fees because Holladay and Woodcock prevailed on their breach of fiduciary duty claim, and “breach of a fiduciary obligation is a well-established exception to the American rule precluding attorney fees in tort cases generally.”
In re Virginia Broadband (Official Committee of Unsecured Creditors v. Virginia Broadband, LLC)
498 B.R. 90 (Bankr. W.D. Va. 2013).
The authorization of a Virginia LLC’s bankruptcy filing by a majority of the managers of the LLC depended on whether the removal and replacement of certain managers was valid, which depended on whether one of the members, Chapman, who voted for the removal and appointment of the managers in question had the right to vote at the time the members took such action or at the time of a later ratification of such action. The Unsecured Creditors’ Committee argued that Chapman’s bankruptcy filing resulted in his dissociation and transformation of his interest into that of an assignee. If Chapman was only an assignee at the time he voted to remove and replace the managers, he was not entitled to participate in the management and affairs of the LLC, and his vote would not have counted. The analysis was complicated by the fact that Chapman filed bankruptcy before the original vote to remove and replace the managers (the “August Consent”), but his bankruptcy was dismissed before a later ratification of the August Consent (the “October Consent”). The October Consent was made retroactively effective as of the date of the August Consent. The question addressed by the court was whether Chapman’s noneconomic rights as a member were property of the bankruptcy estate that revested upon the dismissal of the bankruptcy such that Chapman was entitled to vote on the October Consent.
The bankruptcy court held that Chapman’s noneconomic rights along with his economic rights became property of the estate when he filed bankruptcy and that they revested when the bankruptcy was dismissed. The court first distinguished the economic rights associated with a member’s membership interest, which are transferable under the Virginia LLC statute, from the noneonomic governance rights, which are not transferable. Under the Bankruptcy Code, property of the estate includes all legal and equitable interests a debtor has in property at the commencement of the case. The Virginia LLC statute purports to strip the member of his noneoncomic rights on the filing of bankruptcy, and the court concluded that this provision of the statute is an unenforceable ipso facto clause. The Unsecured Creditors’ Committee argued that In re Garrison-Ashburn, L.C., 253 B.R. 700 (Bankr. E.D. 2000), supported its position that the Virginia statute was effective to strip Chapman of his management rights, but the court pointed out that the question in In re Garrison-Ashburn was whether a member could invoke a provision in the LLC operating agreement to prevent the LLC from selling property where the signature of the debtor, who was manager of the LLC, was required for the sale. The court concluded that the operating agreement was not an executory contract so that the ipso facto prohibition of the Bankruptcy Code did not apply. The court here was only concerned with determining whether Chapman’s noneconomic rights became property of the estate, and the court stated that In re Garrison-Ashburn supported the court’s conclusion that Section 541(c)(1) makes Chapman’s noneconomic interest property of the estate. According to the court, to say that Section 541(c)(1) makes only the economic interest property of the estate confuses the issue of what becomes property of the estate with what rights and powers the debtor has in that property upon the commencement of the case. The court recognized in a footnote that its conclusion that a member’s noneconomic rights become property of the estate conflicted with the bankruptcy court’s conclusion in In re Williams, 455 B.R. 485 (Bankr. E.D. Va. 2011), but the court stated that the holding in that case should be confined as much as possible to the “unique circumstances” in that case. Having found that Chapman’s noneconomic rights became property of the estate when he filed bankruptcy, the court concluded that the dismissal of his case caused the noneconomic interest to revest in Chapman pursuant to Section 349(b)(3). Thus, Chapman had the right to vote his interest at the time of the October Consent ratifying the August Consent, and the managers’ authorization of the LLC bankruptcy was valid because the action of the members removing and appointing managers under the August Consent was valid.
752 S.E.2d 299 (W. Va. 2013)
The West Virginia Supreme Court held that the West Virginia Uniform Limited Liability Company Act does not preclude application of the equitable remedy of piercing the veil, and the court set forth a two-prong test and a non-exclusive list of factors that may be relevant in determining whether the test is met. The court addressed this issue based on a certified question from a circuit court in a case in which the plaintiff sought to pierce the veil of a West Virginia LLC to hold the two members of the LLC liable for tort claims against the LLC arising out of an altercation in a bar owned and operated by the LLC. (The court noted that the type of liability presented to the court was distinguishable from holding an LLC member or manager personally liable based upon his or her own tortious actions and suggested that LLC managers may be held liable for their own participation in tortious or criminal activity even when performing their duties as managers.) To answer the question before it, the supreme court first examined the statutory provision limiting liability of LLC members and managers. Applying maxims of statutory interpretation, the court concluded that the statute was unambiguous in declaring that a “member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager.” The court pointed out that the statute only allows a member or manager to be held liable based solely on that status if the articles of organization contain a provision to that effect, and a member who is liable on that basis has consented in writing to the provision. The court concluded that the legislature implicitly left intact the prospect that a member or manager could be held liable on grounds not based solely on the status of member or manager and cited case law from other jurisdictions illustrating that the court’s conclusion that the West Virginia statute does not preclude veil piercing is consistent with the manner in which other courts have interpreted similar statutes. The court next addressed the circumstances under which imposition of veil-piercing liability is appropriate since the legislature did not do so. The court discussed case law from other jurisdictions and concluded that most courts addressing the question apply the same test used to analyze piercing the corporate veil, while recognizing that certain elements of the test may not apply at all or apply in a different manner than they would in the corporate context. The court thus considered West Virginia common law standards for piercing the corporate veil in order to establish guidance for lower courts faced with veil-piercing claims in the LLC context. The court set forth a list of 19 factors it had identified in a prior corporate veil-piercing case and stated that many of them may be relevant in the LLC context, but the court was hesitant to adopt a test that sets out specific factors since the court had previously stressed the case-by-case analysis that is required in determining whether the pierce the corporate veil. Consequently, the court held, as it has in the corporate context, that the following general test must be met to pierce the veil of an LLC: (1) there exists such unity of interest and ownership that the separate personalities of the business and the individual member(s) or manager(s) no longer exist, and (2) fraud, injustice, or an inequitable result would occur if the veil is not pierced. The court stated that this is a case-by-case, fact-driven analysis and that the failure of the LLC to observe usual company formalities or requirements relating to the exercise of its powers or management may not be a ground for imposing personal liability on members or managers.