February 2007 — Issue 12

Edward B. Elmer, M.D., P.A. v. Santa Fe Properties, Inc.

No. 04-05-00821-CV, 2006 WL 3612359 (Tex.App. Dec. 13, 2006).

Two professional associations were partners in a partnership that was sued for breach of a commercial lease. The plaintiff sued the partnership and its two partners. The plaintiff obtained a judgment against the partnership, and that judgment was severed and became final. After the plaintiff was not able to collect the judgment from the partnership, the plaintiff obtained a summary judgment against one of the partners. The partner appealed arguing that the plaintiff’s suit against the partner was barred because the plaintiff initially obtained judgment against the partnership alleging it was an LLP. The partner also argued that it was not liable because it maintained the type of insurance required by the Texas Revised Partnership Act. The court held that the partner was not protected from individual liability because the partnership was not a properly registered limited liability partnership at the time it incurred the lease obligations. The Texas LLP provisions require that an LLP carry insurance or meet certain financial responsibility requirements. The court noted that, unlike the limited partnership statute, the LLP provisions contain no substantial compliance language. Therefore, the court concluded that strict compliance with the statute is required. Although the partner itself carried errors and omissions insurance, the court pointed out that the policy did not appear to cover the partnership or the other partner. Because the partnership did not have the required insurance or other forms of financial responsibility designated by the statute, it was not a properly registered LLP, and the partner was not protected from liability.

Majkowski v. American Imaging Management Services, LLC

__ A.2d __, C.A. No. 1797-N, 2006 WL 3627111 (Del. Ch. 2006).

The court rejected an individual’s argument that advancement of expenses was required under an indemnification provision in an LLC agreement that required the LLC to “indemnify and hold harmless” members and various other persons. The plaintiff argued that the phrase “hold harmless” included an advancement right. The court analyzed the meaning of this phrase at length and concluded it was an unambiguous term of art that did not encompass a right to advancement as it functions within the rubric of Delaware LLC law. An LLC is only obligated to advance litigation expenses when its agreement expressly states the intention to mandate advancement.

Bakerman v. Sidney Frank Importing Co., Inc.

No. Civ.A. 1844-N, 2006 WL 3927242 (Del. Ch.Oct. 16, 2006).

A 5% member of an LLC brought direct and derivative claims arising out of the sale of the LLC’s assets. The LLC was a non-wholly owned subsidiary, and the plaintiff (who was chief legal counsel for the parent of the LLC) and several other individuals owned membership interests they had received in exchange for their work in organizing the LLC. The transaction giving rise to the suit was a multi-billion dollar sale of the vodka business of the parent and its three subsidiaries. The LLC’s operating agreement required unanimous consent of the members for any sale of all or substantially all of the LLC’s business or assets, and the plaintiff claimed that his consent was coerced. The plaintiff also claimed that the LLC managers breached their fiduciary duty in approving the allocation of most of the proceeds of the transaction to the parent. The court applied the two-prong demand futility test developed in the corporate context in Aronson v. Lewis and determined that the plaintiff’s pleadings were sufficient to establish that demand on the managers of the LLC was excused. The court found that the plaintiff’s complaint met either prong of the Aronson test because it contained particularized facts creating a reasonable doubt as to the disinterestedness and independence of the managers as well as particularized facts creating a reasonable doubt as to whether the transaction was the product of a valid exercise of business judgment. The court also rejected the defendants’ challenge to the adequacy of the plaintiff’s derivative representation. The court found that the plaintiff’s role as legal counsel for the parent did not disqualify him from serving as a derivative plaintiff in this instance, and the court concluded that the plaintiff could be an adequate representative even if the other 95% of the ownership interests did not support the lawsuit. The court declined to dismiss the plaintiff’s derivative claim for breach of fiduciary duty, which was based on three grounds: (i) artificial suppression of transfer pricing in vodka sales between the LLC and its parent prior to the sale transaction; (ii) misallocation of the purchase price in the sale transaction; and (iii) failure to disclose conflicts of interest related to the allocation. The court found that the plaintiff’s allegations were sufficient to infer that (i) the plaintiff was not aware of the transfer pricing and thus did not acquiesce in or ratify it; (ii) the plaintiff was coerced into approving the sale transaction; and (iii) the plaintiff was unaware of the managers’ holdings in the parent and resulting conflict of interest. The court found that the plaintiff could pursue direct claims for breach of the operating agreement and breach of the implied covenant of good faith and fair dealing. The court dismissed the plaintiff’s derivative claim for unjust enrichment because the complaint alleged an express, enforceable contract (the operating agreement) that controlled the parties’ relationship. The court also dismissed the plaintiff’s tortious interference claim because the defendants were parties to the contract (the operating agreement) with which they allegedly interfered.

Federalpha Steel LLC Creditors’ Trust v. Federal Pipe & Steel Corporation

No. 06 C 3188, 2006 WL 3626767 (N.D. Ill. Dec. 8, 2006).

A creditors’ trust asserted a number of claims against one of the members of a bankrupt Illinois LLC. The LLC had two corporate members, and the operating agreement designated a third corporation to manage the LLC and provided that neither member was an agent of the LLC or had any authority to act for the LLC. The court first addressed the management structure of the LLC because the defendant member relied upon differences between manager-managed and member-managed LLCs under Illinois law in arguing that certain claims should be dismissed on the basis that the LLC was manager-managed. Under the Illinois LLC statute, a manager in a manager-managed LLC owes certain duties to the LLC, but a non-manager member of a manager-managed LLC owes no duties solely by reason of being a member. The court stated that it could not determine at this stage of the litigation whether the LLC was manager-managed because, while the operating agreement gave sole control of the LLC’s affairs to a manager, one of the provisions of the operating agreement referred to a section of the Illinois LLC statute that addressed dissociation from a member-managed LLC. The court said this reference could suggest that the members considered the LLC to be member-managed or not entirely manager-managed. Additionally, the court stated that the articles of organization, which had not been provided to the court, would also be relevant to determining whether the LLC was manager-managed because the statute defines a manager-managed LLC as an LLC which is so designated in the articles of organization. Finally, taking as true allegations by the plaintiff that the LLC was actually run as a joint venture or partnership and that the defendant member exercised de facto management authority over the LLC, the court stated that the LLC could be viewed as a de facto member-managed LLC. The court also declined to dismiss claims that the defendant member argued were released in a withdrawal agreement between the LLC and the member. The court found that the plaintiff made a cognizable argument that the withdrawal agreement (and the release of claims in that agreement) was ineffective because the agreement was executed by the president of the LLC rather than the manager who was vested with exclusive authority to enter agreements on behalf of the LLC under the operating agreement. The court dismissed a claim by the plaintiff that the defendant member failed to make required contributions, finding no provision in the operating agreement that imposed a contribution obligation and holding that the provisions of the Illinois LLC statute do not impose a legal obligation to contribute, but simply provide that a contribution obligation is not excused by a member’s death or disability if a member has such an obligation. The court found that the plaintiff had stated a claim for wrongful dissociation against the defendant member (the operating agreement prohibited voluntary withdrawal and provided that such a withdrawal would be considered a wrongful dissociation) based on the defendant member’s alleged de facto withdrawal and subsequent formal withdrawal pursuant to a withdrawal agreement. The court also found that the alleged wrongful dissociation could form the basis of a breach of fiduciary duty claim. The court declined to dismiss breach of fiduciary duty claims against two directors of the corporate manager of the LLC because the LLC was a shareholder of the corporate manager, and the court stated that the directors owed the LLC duties by virtue of the LLC’s status as a shareholder of the corporation. The court also declined to dismiss a claim for inducement of breach of fiduciary duty against a corporation that sought to acquire the defendant member’s parent and allegedly directed the defendant member to withdraw from the LLC. The court addressed several other claims, including a claim that the defendant member breached a non-competition clause in the operating agreement. The court found that the LLC was a third party beneficiary of the non-competition provision of the operating agreement and the plaintiff thus had standing to pursue this claim even though the LLC was not a party to the operating agreement.

Holdeman v. Epperson

857 N.E.2d 583, 111 Ohio St.3d 551, No.2005-1642 (Ohio 2006).

The 51% member of a two-member LLC died, and the Ohio Supreme Court held that the rights of the executor of the deceased member were not confined to those of an assignee, and the executor was entitled to exercise all the rights possessed by the deceased member prior to his death for the purpose of settling the estate. The court relied upon a provision of the Ohio LLC act that provides as follows: “If a member who is an individual dies or is adjudged an incompetent, his executor, administrator, guardian or other legal representative may exercise all of his rights as a member for the purpose of settling the estate or administering his property, including any authority that he had to give an assignee the right to become a member.” The operating agreement of the LLC stated that the successor in interest of a deceased member succeeded to the interest of the member but did not become a member unless admitted in accordance with the agreement. The surviving member relied upon various provisions of the Ohio LLC statute in arguing that the deceased member withdrew from the LLC upon his death and that his executor obtained only the rights of an assignee. The court stated that the operating agreement was consistent with the general provisions of the Ohio LLC statute regarding rights of assignees and membership interests, but pointed out that the provision regarding the rights of a legal representative of a deceased member does not state that it applies “except as otherwise provided in the operating agreement.” The court thus inferred that the General Assembly did not intend for that provision to be restricted by contrary language in the operating agreement. Accordingly, the court held that an executor of a deceased member of an LLC has all rights the member had prior to death for the limited purpose of settling the deceased member’s estate or administering his property. A dissenting justice argued that the operating agreement should control the relationship of the remaining member and the executor. In the dissenting justice’s view, the Ohio LLC statute provides that an executor has only the rights of an assignee and not the full rights of a member unless the operating agreement provides otherwise. Additionally, the dissenting justice argued that the majority ducked the real controversy and failed to provide needed guidance by not defining the rights the executor possessed “for the purpose of settling [the member’s] estate or administering his property.” The dissenting justice viewed the proper scope of the phrase as only those actions necessary to collect, evaluate, and distribute assets due the estate.

In re Kilroy

__ B.R. __, Bankruptcy No. 05 90083, Adversary No. 06-03324, 2006 WL 3720366 (Bankr. S.D. Tex. 2006).

The plaintiffs sought to pierce the veil of a Delaware LLC and treat the LLC as the alter ego of the debtor in order to attribute to the debtor false representations made by the LLC in a private placement memorandum and pursue certain other claims for fraud, embezzlement, and breach of fiduciary duty that depended upon the disregard of the LLC’s separate existence. Applying Texas conflict of laws principles (citing the Texas Business Corporation Act), the court stated that Delaware substantive law determined whether the veil of a Delaware LLC should be pierced. In a previous suit, a Texas state court had found the LLC in question to be the alter ego of the debtor, and the court found that Delaware law dictated that the law of collateral estoppel of the state where a judgment was rendered determines the scope of collateral estoppel in the second case. Applying Texas offensive collateral estoppel principles, the court concluded that it could pierce the veil of the LLC based on the finding in state court that the LLC was the alter ego of the debtor. Alternatively, the court found that the same result could be achieved using Delaware offensive collateral estoppel. Additionally, even if offensive collateral estoppel under Texas or Delaware law could not be applied to prevent the debtor from denying that the LLC was his alter ego, the court concluded that the LLC’s veil could be pierced by directly relying on the alter ego doctrine under Delaware law. The court discussed the factors relevant to an alter ego determination under Delaware law and concluded that the plaintiff’s allegations were sufficient to support such a claim. The court acknowledged the dearth of Delaware case law on the issue of whether an LLC’s veil may be pierced using corporate veil piercing principles, but concluded that the Delaware Chancery Court has conceptually endorsed the application of corporate veil piercing principles to LLCs.

Fausak’s Tire Center, Inc. v. Blanchard

__ So.2d __, No. 2050633, 2006 WL 3526744 (Ala. Civ. App. 2006).

Enforceability of oral buy-sell agreement regarding LLC interest.

Chuang v. Ming Ter Chen

No. B185791, 2006 WL 3518228 (Cal. App. 2 Dist. Dec. 7, 2006).

Breach of fiduciary duty; misappropriation of LLC funds; failure to account; failure to satisfy capital call.

Ptasynski v. CO2 Claims Coalition, LLC

Civil Action No. 02-cv-00830-WDM-MEH, 2006 WL 3746122 (D. Colo. Dec. 15, 2006).

Procedure required for change in number of managers; immunity of managers with respect to good faith performance of duties in manner reasonably believed to be in best interests of LLC and with care of ordinarily prudent person.

Connecticut Light & Power Company v. Westview Carlton Group, LLC

No. CV020469715S, 2006 WL 3719484 (Conn. Super. Dec. 6, 2006).

Application of instrumentality veil piercing doctrine to single member LLC.

Shamrock Holdings v. Arenson

456 F.Supp.2d 599, Nos. CIV. 04-1339-SLR, CIV. 06-62-SLR (D. Del. 2006).

Interpretation of exculpation clause in LLC agreement; direct versus derivative claims; sufficiency of allegations of breach of fiduciary duty.

O’Neal v. Blackerby

__ So.2d __, Nos. 1D06-2524, 1D06-2465, 2006 WL 3741001 (Fla. App. 2006).

Ambiguity of operating agreement provision for dissolution upon “sale or other disposition of all or substantially all of [the LLC’s] property and assets” with respect to sale of LLC’s real property where LLC still had cash proceeds on hand and operating agreement contained provision for reinvestment of net cash flow.

Dialogo, LLC v. Bauza

__ F.Supp.2d __, No. 05-30076-MAP, 2006 WL 3721051 (D. Mass. 2006).

Interpretation of capital contribution provisions of operating agreement.

Mastromatteo v. Mastromatteo

No. 061329C, 2006 WL 3759512 (Mass. Super. Nov. 28, 2006).

Application of Rule 23.1 to closely held LLC; direct versus derivative claims; fiduciary duties of members of closely held LLCs.

Quebecor World (USA), Inc. v. Harsha Associates, L.L.C.

455 F.Supp.2d 236, No. 06-CV-6002L (W.D. N.Y. 2006).

Limited liability of LLC member notwithstanding variance in LLC’s name in contract; application of corporate alter ego doctrine to LLC; insufficiency of veil piercing allegations; sufficiency of successor liability allegations.

BLD Products, LTC v. Technical Plastics of Oregon, LLC

Civil Case No. 05-556-KI, 2006 WL 3628062 (D. Or. Dec. 11, 2006).

Application of corporate veil piercing to Oregon LLC.

Brew City Redevelopment Group, LLC v. Ferchill Group

724 N.W.2d 879, No. 2004AP3238 (Wis. 2006).

Personal liability of members or managers for acts of tortious interference in individual capacity; intracorporate conspiracy doctrine.