February 2008 — Issue 24

LLPs: Ederer v. Gursky

9 N.Y.3d 514, __ N.E.2d __, 2007 WL 4438937 (N.Y. 2007)

A withdrawn partner sued the partnership and its partners for breach of contract and an accounting of funds owed the withdrawn partner under a withdrawal agreement between the partner and the partnership. The partners claimed that they did not have personal liability because the partnership was an LLP, but the court concluded that the New York LLP liability shield only applies to debts and liabilities to third parties and does not protect partners from liability for obligations of the partnership to other partners nor eliminate the right to an accounting. The New York LLP provisions state that “[e]xcept as provided by subdivisions (c) and (d) of this section, no partner of a partnership which is a registered limited liability partnership is liable or accountable, directly or indirectly (including by way of indemnification, contribution or otherwise), for any debts, obligations or liabilities of, or chargeable to, the registered limited liability partnership or each other, whether arising in tort, contract or otherwise, which are incurred, created or assumed by such partnership while such partnership is a registered limited liability partnership, solely by reason of being such a partner.” Subdivision (c) excludes from the liability shield “any negligent or wrongful act or misconduct committed by [a partner] or by any person under his or her direct supervision and control while rendering professional services on behalf of” the LLP. Subdivision (d) allows partners to opt out of or limit the scope of the liability protection. The court reviewed the background and history of LLP legislation and rejected the defendants’ argument that the statutory protection from liability for “any debts” applies to debts of the partnership to the partners as well as debts to third parties. The court concluded that the liability protection under the LLP provisions is restricted to liability to third parties because the phrase “any debts” is part of a provision that has always governed only a partner’s liability to third parties and is part of Article 3 of the New York Uniform Partnership Act (“Relations of Partners to Persons Dealing with the Partnership”) rather than Article 4 (“Relations of Partners to One Another”). The court also rejected the defendants’ two arguments reconciling the right to an accounting in a winding up with their interpretation of the LLP provisions. The defendants argued that their fiduciary duty as partners to account to one another is different from personal liability for debts disclosed by an accounting, and they further argued that a partner is only personally liable for debts disclosed by an accounting that are attributable to that partner’s own torts or wrongful conduct or supervisory lapses. The court responded that the right to an accounting is restitutionary in nature and that it is not limited in the manner argued by the defendants. The court pointed out that the statute confers a right to an accounting absent an agreement to the contrary and stated that partners may thus limit the right to contribution or indemnity or eliminate it altogether, but the partners in this case had no written partnership agreement and were governed by the default provisions of the statute as interpreted by the court. The dissenting opinion pointed out that a former partner is a third party where a partnership is concerned and argued that there is no good reason to treat him more favorably than any other third party. The dissenting opinion describes how the majority’s approach results in odd and perverse results where a withdrawn partner is able to hold remaining partners personally liable for his share when the business of a partnership goes badly after the partner withdraws and before the partner is paid his share.

LLCs: Northwest Energetic Services, LLC v. California Franchise Tax Board

71 Cal.Rptr.3d 642, Nos. A114805, A115841, A115950 (Cal. App. 1st Dist. 2008)

A foreign LLC that conducted no business in California but nevertheless registered to do business in California challenged the levy imposed on it under section 17942 of the Revenue and Taxation Code. The trial court held that the LLC was entitled to a refund of the amounts paid under the provision because the levy was unconstitutional. The trial court also awarded the LLC attorney’s fees in an amount several times greater than the lodestar. The court of appeals affirmed the trial court’s judgment granting a refund, but reversed the award of attorney’s fees and remanded for further consideration consistent with the court’s opinion. The court held that the levy imposed under the pre-2007 version of section 17942 violated the Commerce Clause as applied to the LLC, and the court thus did not reach the question of whether the statute is unconstitutional on its face or whether it violates the Due Process Clause. The levy violated the Commerce Clause because it was imposed on the LLC’s statutorily defined “total income,” wherever earned, without apportionment. The court held that the levy more closely resembles a tax than a regulatory fee and that it was not fairly apportioned under the internal and external consistency requirements. The court also held that the levy, even if treated as a fee, would not pass muster under the Pike balancing test. Finally, the court rejected the argument that the LLC could not bring a Commerce Clause challenge when it voluntarily registered as a foreign LLC and did not elect to be taxed as a corporation, which would have subjected it to a taxation scheme involving apportionment. In affirming the refund of all amounts paid under section 17492, the court noted that, as a general matter, only the portion of the levy that exceeds Commerce Clause limits must be refunded, but the LLC was entitled to a refund of the entire amount it paid under section 17492 because none of its income was derived from California sources.

Tzolis v. Wolff

__ N.E.2d __, 2008 WL 382345 (N.Y. 2008)

In a 4-3 decision, the New York high court held that the omission of derivative suit provisions from the New York Limited Liability Company Law does not constitute a prohibition on such suits, thus resolving a split of authority as to whether derivative suits are allowed on behalf of New York LLCs. The court reviewed the history of derivative suits under New York law in the corporate and limited partnership contexts, where such actions were first recognized by the courts before being codified by statute. The court noted the purpose underlying derivative suits, i.e., to ensure that the victims are not without a remedy when fiduciaries are faithless to their trust, and stated that abolishing derivative suits in the LLC context would be a radical step. The court noted problems abolition of derivative suits would create and pointed to cases in which courts had held that there was no derivative remedy for LLC members as illustrative of some of these problems. The court discussed the legislative history of the New York LLC statute and derivative suit reforms that were being proposed in other legislation at the time and concluded that there was no clear indication that the Legislature intended to eliminate derivative suits in the LLC context. Though the Legislature clearly decided not to include derivative suit provisions in the LLC statute (such provisions having been deleted, at the Senate’s insistence, from the initial bill passed by the Assembly), the court found no evidence that the Legislature thought that the absence of the derivative suit provisions would render derivative suits non-existent. The court acknowledged that some legislators may have expected that there would be no derivative suits while others may have expected the courts to recognize a common law right to sue derivatively (noting testimony by one witness expressing such expectation at a legislative public hearing). The court stated that the Senate may have expected one thing, and the Assembly another, or that neither may have expected anything except that the problem would become the courts’ rather than the Legislature’s. In light of the ambiguity in the legislative history, the court stated that it could not infer that the Legislature intended “wholly to eliminate, in the LLC context, a basic, centuries-old protection of shareholders, leaving the courts to devise some new substitute remedy.” The court differed with the dissent’s assertion that the court was leaving the right to sue derivatively in the LLC context unfettered by safeguards against abuse adopted by the Legislature in other contexts. The court noted that limitations on the right to sue derivatively are not all of legislative origin, pointing out that the current demand requirement in the corporation and limited partnership statutes is a codification of a limitation imposed in the case law in which derivative suits originated. The court stated that, although the question of limitations on the right of an LLC member to sue derivatively was not before the court, it was not holding or suggesting that there are no limitations. A strenuous dissent argued that the legislative history of the LLC statute reflected a conscious decision to omit derivative rights in the LLC context.

In re Silver Dollar, LLC (Jones v. First Community Bank East Tennessee)

Nos. 2:07-cv-25, 2:07-cv-26, 2008 WL 53695 (E.D. Tenn. Jan. 2, 2008)

A Tennessee LLC named “Silver Dollar, LLC” filed an assumed name application for the assumed name “Silver Dollar Stores, LLC,” and property was subsequently conveyed to the LLC in the assumed name. The LLC later executed a deed of trust in favor of a bank to secure several promissory notes. The deed of trust was executed under the assumed name. In the LLC’s bankruptcy, the trustee and a creditor argued that the deed of trust was defective and subject to the trustee’s avoidance powers because it was executed in the LLC’s assumed name rather than its legal name. The bankruptcy court concluded that the deed of trust was valid and could not be avoided, and the district court agreed. The court rejected the argument that the Tennessee LLC statute does not authorize an LLC to own real property in its assumed name and that a transfer of real estate to an LLC in its assumed name is void. In fact, the court found that the statute suggests just the opposite. The court noted that an LLC has the same powers as an individual to do all things necessary to carry out its business, including power to purchase, own, improve, and otherwise deal with real or personal property. Further, the Tennessee LLC statute clearly authorizes an LLC to transact business under an assumed name, and the transaction of business includes purchasing and encumbering real estate. The court distinguished a case in which a conveyance to a fictitious grantee was held to be void, and the court refused to limit the holding of a case in which the Tennessee Court of Appeals recognized a conveyance to a sole proprietor under his trade name. In that case, the court of appeals held that a conveyance to a living or existing legal person described by an assumed name is valid. The district court held that this rule applies to a legal person such as a corporation or LLC as well as an individual. The court also rejected the argument that the deed of trust would not put one on constructive notice that Silver Dollar Stores, LLC was the assumed name of Silver Dollar, LLC. The court stated that nothing in the registration statute or case law supported the position that only recordation of instruments in the Register of Deeds office creates notice to a bona fide purchaser. The court agreed with the bankruptcy court that a hypothetical bona fide purchaser conducting a title search of the property would have discovered that the LLC held title in its assumed name and that the LLC granted the bank a deed of trust under its assumed name. The court stated that even a rudimentary understanding of title law would have caused one to inquire further by examining the records of the Secretary of State where the assumed name certificate of the LLC would have been easily discovered. Thus, a bona fide purchaser would have been unable, under Tennessee law, to defeat the bank’s interest in the LLC’s property, and the bankruptcy court did not err in holding that the deed and deed of trust were valid and in granting the bank relief from the stay.

Mission Residential, LLC v. Triple Net Properties, LLC

654 S.E.2d 888, Record No. 062250 (Va. 2008).

The Virginia Supreme Court held that an arbitration clause in an LLC operating agreement did not require arbitration of a member’s derivative claim because the claim belonged to the LLC and the LLC was not a party to the operating agreement. The arbitration clause in the operating agreement required that the members in good faith use their best efforts to settle “disputes regarding their rights and obligations thereunder” and required arbitration of “all disputes” that the parties failed to resolve. One of the members commenced an arbitration proceeding against the other, asserting a direct claim for breach of contract and a derivative claim on behalf of the LLC. The arbitrator ruled that the plaintiff member lacked standing to assert the direct claim, but allowed the derivative claim to proceed. The defendant member brought an action seeking a declaratory judgment that there was no agreement to arbitrate disputes between it and the LLC. The supreme court stated that a party cannot be compelled to submit to arbitration unless he has agreed to arbitrate, and the court held that the plaintiff member failed to prove the existence of an agreement by the defendant member to arbitrate its disputes with the LLC. The plaintiff member argued that the derivative claim was nothing more than a dispute regarding the defendant’s duties under the operating agreement, but the court disagreed, stating that this argument ignored the separate existence of the LLC, which was not a party to the operating agreement. The court pointed out that an LLC, like a corporation, is a separate legal entity from the shareholders or members and that a derivative action is an equitable proceeding in which a member asserts, on behalf of the LLC, a claim that belongs to the LLC rather than the member. The court stated that the parties might have chosen to employ language committing them to arbitrate their disputes with the LLC, but they did not do so, and there was thus no contractual undertaking by which the defendant member agreed to arbitrate any dispute with the LLC.

Allied Investments v. Lee Pacific, LLC

No. D050164, 2007 WL 4395689 (Cal. App. Dec. 18, 2007)

Discussion of application of corporate successor liability rules (noting that courts generally apply such rules to all types of business entities) and application of de facto merger doctrine to impose liability on LLC that purchased assets from another LLC.

Elecor, LLC v. King

No. CV065006235S, 2007 WL 4578003 (Conn. Super. Dec. 5, 2007)

Dissolved LLC’s standing to sue as part of winding up; member’s lack of standing to sue on LLC’s claims.

Luna v. A.E. Engineering Services, LLC

938 A.2d 744, No. 06-CV-233 (D.C. App. 2007)

Sufficiency of complaint to state claims against individual who allegedly contracted under trade name without disclosing that business was LLC and participated in tortious conduct.

In re Colvin (Hopkins v. Saratoga Holdings, LLC)

Bankruptcy No. 04-42331-JDP, Adversary No. 07-8045, 2007 WL 4553352 (Bankr. D. Idaho Dec. 20, 2007)

Executory nature of buy out agreement between withdrawing member and LLC and other members; trustee’s failure to timely assume executory contract as constituting rejection.

Omega Center for Pain Management, L.L.C. v. Omega Institute of Health, Inc.

__ So.2d __, No. 07-CA-558, 2007 WL 4554068 (La. App. 2007)

Fiduciary duties of LLC member or manager under Louisiana law.

Ahern v. Ahern

938 A.2d 35, Docket No. Han-06-738 (Me. 2008)

Propriety of trial court’s refusal to nullify LLC and treat property as marital property; exclusivity of statutory grounds for judicial dissolution of LLC.

In re Northlake Development, LLC (Kinwood Capital Group, LLC v. Northlake Development, LLC)

Bankruptcy No. 06-01934-NPO, Adversary No. 06-00171-NPO, 2007 WL 4375226 (Bankr. S.D. Miss. Dec. 13, 2007)

Minority member’s lack of authority to execute deed of LLC’s property to minority member’s wholly owned entity under Mississippi LLC law and operating agreement; inability of bank which took deed of trust from minority member’s grantee to rely on apparent authority since it did not take its deed of trust from LLC.

Columbus Steel Castings Company v. Transportation & Transit Associates, LLC

No. 06AP-1247, 2007 WL 4340558 (Ohio App. Dec. 13, 2007)

Ability of LLC to assert compulsory counterclaim and raise affirmative defense notwithstanding statutory prohibition on maintaining action until it has registered.

GDT CGT1, LLC v. Oklahoma County Board of Equalization

172 P.3d 628, No. 104,354 (Okla. Civ. App. 2007)

Ad valorem tax exemption of property “used exclusively and directly for charitable purposes” and leased rent-free from for-profit corporation by nonprofit single member LLC owned by 501(c)(3) corporation.

Bramante v. McClain

Civil Action No. SA-06-CA-0010 OG (NN), 2007 WL 4555943 (W.D. Tex. Dec. 18, 2007)

Sufficiency of summary judgment evidence to raise fact question on reverse veil piercing of LLCs and fraudulent transfer and fraudulent transfer conspiracy.