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June 2010 -- Issue 52

LLP Cases: Edlinger v. United States

No. 3:10-cv-148, 2010 WL 1485951 (N.D.N.Y. April 14, 2010)

(limited liability of LLP partner absent partner’s own wrongful conduct, partner’s direct supervision of someone who engaged in wrongful conduct, or limitation of scope of liability protection by partnership agreement).

LLC Cases: Spurlock v. Begley

308 S.W.3d 657 (Ky. 2010)

An LLC member, Griffin, orally announced his intention to give another individual, Begley, a 25% interest in the LLC in order to pay off a $75,000 note from the LLC to Begley. This agreement was never reduced to writing. Begley later entered into an agreement with Spurlock regarding the purchase by Spurlock of Begley’s interest in the LLC. A bare-bones agreement referring to the transfer of 25% ownership in the LLC was prepared. Begley sued Spurlock when Spurlock failed to pay according to the terms of the agreement, and Spurlock alleged a failure of consideration on the basis that Begley did not own a 25% interest in the LLC. The jury found that Griffin transferred to Begley a 25% ownership interest, and the court entered a judgment in favor of Begley. On appeal, the supreme court discussed the provisions of the Kentucky LLC statute regarding membership and ownership. The court noted that the LLC statute does not speak of “owners,” but instead refers to such persons as “members.” The court stated that the evidence at trial made clear that Begley was not a member because there was no evidence of an operating agreement and no evidence that all of the members consented in writing to his membership as required by the statute in the absence of a provision governing admission to membership in the operating agreement. The court pointed out that a member may assign the economic rights associated with a membership interest, and if the non-transferring members do not approve of the transfer, the interest is divided into its economic rights, which are transferred, and the governance rights, which are not transferred. The court said that the statutory provisions lead to the conclusion that simply acquiring economic rights does not, in and of itself, equate to “ownership” or “membership” in the LLC. At most, the evidence showed that Begley had an economic interest in the LLC, and the court stated that such an interest did not equate to an “ownership interest.” Begley drafted the agreement to sell his “25 percent ownership” of the LLC, and the court noted that Kentucky courts have long held that a contract susceptible to two meanings will be construed against the drafter. The court stated that “ownership” and “membership” are synonymous in the context of LLCs, that Begley had no ownership interest to convey to Spurlock, and that there was thus a failure of consideration. In addition, the court held that the jury instructions submitted by the trial court were incorrect and that the trial court should have submitted Spurlock’s requested instruction that “a member (owner) of a Kentucky limited liability company means a person who has been admitted to membership as set forth within the limited liability company’s operating agreement or, if an operating agreement does not so provide in writing, upon the written consent of all members.”

Allen v. Dackman

991 A.2d 1216 (Md. 2010)

The plaintiffs alleged that they were injured by lead paint while living at a property owned by an LLC, and the issue addressed by the court was whether a member of the LLC could be held liable for the injuries. The member argued that he could not be liable as a matter of law because he only dealt with the property through the LLC and never visited the property, never intended to lease it to anyone, was unaware that the plaintiffs were occupying the property until after the LLC acquired it, and successfully took legal action to remove the plaintiffs. The court concluded that the member could be held liable under the Baltimore Housing Code, which imposes liability on an individual who “owns, holds, or controls” the title to a dwelling. The court concluded that a reasonable trier of fact could find that the member controlled title to the property. The court based this conclusion on evidence that the member was responsible for running the day-to-day affairs of the LLC, executed the deed certification when the LLC acquired the property, signed the complaint removing the plaintiffs, and signed the deed when the LLC sold the property. The court disagreed with the member that his status as an LLC member necessarily shielded him from liability under the facts of this case. The court concluded that a reasonable trier of fact could find that the member personally committed, inspired, or participated in the alleged tort and would thus be liable under principles applicable to corporate officers and agents who personally commit, inspire, or participate in torts in the name of the corporation. Although the Baltimore Housing Code was silent on the liability of LLC members while expressly providing that a corporation’s violation shall be deemed to be the violation of the individual directors, officers, or agents who authorized, ordered, or performed any of the acts, the court did not view the omission of LLCs from the ordinance as reflecting an intent to exclude LLC members from personal liability because the provision of the Housing Code on liability of corporate directors and officers was enacted prior to the recognition of LLCs in Maryland.

Duray Development, LLC v. Perrin

792 N.W.2d 749 (Mich. App. 2010)

An individual signed a contract on behalf of an LLC prior to the filing of the articles of organization and sought to avoid personal liability on the contract under the doctrines of de facto corporation and corporation by estoppel. The court discussed the Michigan de facto corporation doctrine at length and concluded that the corporate and LLC statutes should be interpreted in a consistent manner, that the de facto corporation doctrine should be extended to LLCs, and that the elements of the doctrine were satisfied with respect to the LLC in question. The court also discussed the application of the corporation by estoppel doctrine to LLCs and concluded that it may reasonably be extended to LLCs. Though the court stated that the record supported a finding of LLC by estoppel, the court concluded that the trial court did not commit plain error in failing to do so because the individual asserting the doctrine on appeal did not raise it in the trial court, and the trial court did not make a clear and obvious mistake in failing to raise the doctrine sua sponte since there was no precedent on the application of the doctrine to LLCs at the time.

Birkenmeier v. Keller Biomedical, LLC

312 S.W.3d 380 (Mo. App. 2010)

Birkenmeier discussed with the Kellers the formation of an LLC. The Kellers’ lawyer drafted an agreement for the formation of an LLC, but Birkenmeier never signed a final version and testified that he believed the parties had an oral agreement with details to be worked out later. The Kellers filed articles of organization forming a Missouri LLC. Birkenmeier testified that he believed he was a member of the LLC pursuant to an oral agreement. After the Kellers transferred the assets of the LLC to another company they owned, Birkenmeier sued the Kellers. On appeal, Birkenmeier complained of the trial court’s summary judgment against him on breach of fiduciary duty claims against the Kellers. The court of appeals concluded that Birkenmeier never became a member and thus was not owed fiduciary duties. The court stated that formation of the LLC did not establish that Birkenmeier was ever a member. Under the Missouri LLC statute, a member is a person that signs or is otherwise a party to the operating agreement at the time the LLC is formed and is identified as a member in the operating agreement and any person subsequently admitted as a member in accordance with the statute and the operating agreement. The court pointed out that a formal operating agreement was never finalized, and Birkenmeier’s testimony showed that the terms of an agreement had not been defined and worked out. The court acknowledged that an operating agreement may be oral, but stated that there must still be an agreement and that the record showed there was no agreement as to material terms. Absent such an agreement, Birkenmeier could not have been a member when the LLC was formed, and he had no claim for breach of fiduciary duty.

In re Hydrogen, L.L.C

431 B.R. 337 (Bankr. S.D.N.Y. 2010)

The Committee of Unsecured Creditors in this case asserted various claims against officers and directors of the debtor, an Ohio LLC, and its parent corporation. The claims included claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, deepening insolvency, unjust enrichment, and equitable subordination. With respect to the breach of fiduciary duty claim, the court engaged in a choice of law analysis under New York law and concluded that Ohio law (the law of the debtor LLC’s state of formation) governed the claim under the internal affairs doctrine. The court stated that officers and directors of the debtor LLC clearly owed a fiduciary duty to the LLC under Ohio law, but the court found no Ohio law directly addressing whether officers and directors of the parent of a wholly-owned subsidiary owe fiduciary duties to the subsidiary. Based on the weight of authority around the country holding that officers and directors of a parent corporation owe no fiduciary duties to a wholly-owned subsidiary, the court concluded that there was no basis for the proposition that the defendants who served only as officers and directors of the parent owed any fiduciary duty to the LLC. Furthermore, the court concluded that the allegations were too vague and general to allege a breach of fiduciary duty even if the court were to find that such duties existed. The court noted that the complaint also alleged breach of fiduciary duties to creditors of the debtor LLC and that Ohio case law is split as to whether directors and officers owe any fiduciary duty to the corporation’s creditors upon the corporation’s insolvency. The court found it unnecessary to reach the question of whether the Ohio Supreme Court would recognize the existence of any fiduciary duty to creditors. With respect to the aiding and abetting breach of fiduciary duty claim, the court noted that case law in the Southern District of New York is split as to what choice of law principle applies. Under the internal affairs doctrine, Ohio law would apply to the claim, but New York law would apply under tort conflict of laws principles because the principal place of business of the debtor LLC was in New York, and New York would be the locus of the aiding and abetting claim. The court proceeded to analyze the aiding and abetting claim under both Ohio and New York law and found that the claim would not survive dismissal under either law. The court stated that it was unsettled whether Ohio law recognizes aiding and abetting liability generally, and aiding and abetting breach of fiduciary duty in particular. In any event, the court found that the complaint contained only conclusory assertions that the defendants aided and abetted breaches of fiduciary duty without any factual enhancement supporting the two elements of the claim required to the extent it has been recognized in Ohio. Although a cause of action for aiding and abetting breach of fiduciary duty is clearly recognized in New York, the claim failed to survive dismissal because the breach of fiduciary duty on which the aiding and abetting was premised was deficiently pled. With respect to the deepening insolvency claim, the court applied an interest analysis under New York choice of law principles on the basis that deepening insolvency is a tort cause of action. Giving the greatest weight to the place where the tort was committed (which the court concluded most likely occurred in the context of management decisions made at the debtor LLC’s principal place of business in New York), the court concluded that New York law should govern. Because New York does not recognize deepening insolvency as an independent cause of action and no viable cause of action to which the theory of damages could attach withstood dismissal, the court dismissed the deepening insolvency claim as well. The Committee’s unjust enrichment claim was based on allegedly excessive bonuses and other compensation, and the court performed an interest analysis under New York choice of law principles and concluded that the law of the place where the actions giving rise to the unjust enrichment were taken should govern. Given that the compensation decisions were likely made in New York where the debtor LLC’s principal place of business was located, the court applied New York law. The court concluded that the complaint failed to contain adequate allegations supporting the third element of the claim, namely that “equity and good conscience militate against” allowing the defendants to retain the payments. The Committee sought equitable subordination of any claims of the defendants under Section 510 of the Bankruptcy Code. To state a claim for equitable subordination, the complaint must allege that the defendant-claimants engaged in “inequitable conduct” that caused injury to the creditors or conferred an unfair advantage on the defendant-claimant. The court specified the following three paradigms in which inequitable conduct has been found: (1) fraud, illegality, or breach of fiduciary or other legally recognized duties, (2) undercapitalization, and (3) control or use of the debtor as a mere instrumentality or alter ego to benefit another. Because the complaint failed to adequately allege the breach of fiduciary duty and unjust enrichment claims and contained no relevant allegations as to control or use of the debtor as an instrumentality, the court turned to the remaining paradigm for inequitable conduct, i.e., undercapitalization. Although the complaint contained some allegations of undercapitalization, the court nevertheless concluded that the complaint failed to adequately allege inequitable conduct, relying on case law holding that undercapitalization alone is not a sufficient allegation of inequitable conduct. Given the deficiency or absence of pleadings with respect to the other types of inequitable conduct, the court dismissed the equitable subordination claim.

Abbey v. Fortune Drive Associates, LLC

No. A124684, 2010 WL 1553616 (Cal. App. 1 Dist. April 20, 2010)

(constraints on amendment of LLC operating agreement by less than unanimous vote notwithstanding authorization of non-unanimous amendment by agreement).

Naples v. Keystone Building and Development Corporation

990 A.2d 326 (Conn. 2010)

(lack of evidence of injustice to support piercing LLC veil under instrumentality or identity tests).

Resort Point Custom Homes, LLC v. Tait

C.A. No. S08C-04-020-ESB, 2010 WL 1443274 (Del. Super. April 7, 2010)

(requirement that dissolved LLC pay or make reasonable provision for claims).

Risk Management Services, L.L.C. v. Moss

40 So.2d 176 (La. App. 2010)

(availability of expulsion under LLC operating agreement or under provision of LLC statute regarding considerations of equity; sufficiency of evidence to support finding of managing member’s breach of fiduciary duty).

Trotter v. Charles M. Fife, Jr. & Associates, LLC

36 So.2d 426 (La. App. 2010)

(personal liability of LLC member for fraud).

In re Wyatt & McAlister, PLLC

No. 09-04354EE, 2010 WL 1709920 (Bankr. S.D. Miss. April 23, 2010)

(individual’s continued status as member of PLLC where individual resigned as employee but not as member; lack of authority of 50% member to file bankruptcy petition for PLLC).

Graham v. Dietze

Nos. A-08-796, A-09-088, 2010 WL 1600562 (Neb. App. April 20, 2010)

(ineffectiveness of expulsion of member of LLC engaged in ophthalmology practice where agreement did not provide for expulsion; member’s right to continue sharing in profits after exclusion from business).

United States ex rel. DeKort v. Integrated Coast Guard Systems

705 F.Supp.2d 519 (N.D. Tex. 2010)

(veil piercing of LLC under False Claims Act; lack of basis to estop LLC members from denying liability as joint venturers).

In re Hickory Ridge, LLC

No. 07-1251, 2010 WL 1727968 (Bankr. N.D. W.Va. April 27, 2010)

(dissociation of LLC member and termination of member’s authority by virtue of member’s bankruptcy).