April 2011 — Issue 59

April 2011 - June 2011

LLC Cases: United States v. Roe

421 Fed. Appx. 881 (10th Cir. 2011).

Kelly and Christopher Roe challenged IRS summonses issued to them as members of Roe Ecological Services, LLC. The affidavit of the agent who issued the summonses stated that the summonses were issued to aid in the determination of the LLC’s taxable income for specified calendar years and that the members of the LLC would be taxed on the LLC’s taxable income because the LLC was a pass-through entity, a purpose the court stated facially fell within the authority of the IRS to examine records and other data that may be relevant to determining the liability of any person for any internal revenue tax.The Roes argued that the summonses were improper because: (1) the LLC was a disregarded entity and thus not the proper object of a summons; and (2) the LLC was not in any event subject to income tax, and the summonses thus could not be for the purpose of investigating its taxable income. The court of appeals characterized the argument that the LLC was a disregarded entity, and as such not subject to an IRS summons, as a “non-starter” because the LLC had more than one member and was thus by default treated as a partnership. The court rejected the Roes’ argument that, as a married couple, they should be treated as a single member. The court also rejected the Roes’ argument that it was still improper for the IRS to issue summonses to inquire into the income of the LLC as a partnership because the Roes rather than the LLC would be liable for paying the taxes on partnership income, characterizing this argument as inconsistent with the plain wording of the governing statute and case law. Finally, the Roes argued that the IRS summonses violated their Fourth and Fifth Amendment rights. The court of appeals agreed with the district court that the Roes could not assert these personal rights to oppose summonses seeking materials from the LLC, a collective entity. The court compared the LLC in this case to the three-member partnership in Bellis v. United States, a United States Supreme Court case in which the court explained that the partners could not object to a grand jury subpoena seeking partnership materials on Fifth Amendment grounds because the partnership had a collective identity distinct from its partners. Here, the LLC had been in existence more than a decade, was organized under Colorado state law giving it special rights and powers, maintained bank accounts, and had its own letterhead, logo, website, and phone. The court acknowledged that the Supreme Court in Bellis had speculated that a different case might be presented if it involved a small family partnership, but the court noted that “in the thirty-six years since Bellis was decided, the Supreme Court has done nothing to transform this hypothetical musing into a substantive limitation on the applicability of the collective-entity principle, and a number of circuits have expressly declined to do so without further direction from the Court.” The court stated that the Roes’ objection that they might eventually be required to submit documents and testimony implicating their own Fifth Amendment rights was premature and that the Roes could object to the district court in the event that they were presented with requests for information to which they could validly assert concrete and particularized personal objections under the Fifth Amendment.

Walsh v. Kindred Healthcare

798 F.Supp.2d 1073 (N.D. Cal. 2011)

Residents of a skilled nursing facility sued the facility, related facilities, and parent and related corporations, LLCs, and other entities, alleging violations of California health and safety, unfair competition, and consumer protection statutes. The plaintiffs sought to hold the facilities and parent and related entities liable for the acts of one another under the alter ego doctrine. The court discussed and applied corporate alter ego principles under California law (noting that the alter ego doctrine applies equally to LLCs), and the court held that the allegations were insufficient to invoke the alter ego doctrine. Without arguing that Delaware law applied, the defendants argued that the allegations were also insufficient under Delaware law. The court noted that a forum will generally apply its own rule of law unless a party timely invokes the law of another state. The court stated that the defendants in this case had failed to make the necessary showing that application of Delaware law would further the interest of Delaware. Further, the court stated that the California governmental interest test would require the court to determine that the laws of Delaware and California were materially different in order to apply Delaware law, and the court stated that it did not appear the laws of Delaware and California were materially different on the issue of alter ego. To invoke the alter ego doctrine under California law, there must be allegations that (1) there is such a unity of interest and ownership that the separate personalities of the two corporations no longer exist, and (2) if the acts are treated as the acts of only one corporation, an inequitable result will follow. The court found the allegations sufficient to allege unity of interest and ownership with respect to the parent entities and facilities, but not with respect to the relationship between the parent entities or between the facilities, and the court stated that the plaintiffs failed to allege how certain entities fit into the corporate structure and that they should be held liable for the acts of other entities or vice versa. Further, the court stated that allegations of setting up empty shells, siphoning of funds, and promotion of injustice and inequity were sufficient to allege an injustice based on the parent entities’ attempt to avoid liability, but the allegations did not clearly show whether the parent entities misused the corporate form to siphon funds from the facilities and did not allege what injustice would result if other facilities and related entities were not held liable. The court gave the plaintiffs leave to amend.

Hartsel v. The Vanguard Group, Inc.

C.A. No. 5394-VCP, 2011 WL 2421003 (Del. Ch. June 15, 2011)

Acadian Asset Management, LLC, a Delaware LLC (“Acadian”), was a financial advisory firm exercising managerial and operational oversight over the investment strategy of a fund that was a series of a Vanguard Delaware statutory trust. Stockholders of funds including the fund managed by Acadian sued Acadian and others in connection with the purchase by the funds of allegedly illegal foreign online gambling businesses. The defendants included individuals comprising the boards of trustees of the Vanguard trusts of which the funds were series, financial advisory firms to the funds, and employees of the financial advisory firms. The plaintiffs argued that the defendants breached their fiduciary duties as managers and advisors of the funds by causing the funds to purchase shares in the illegal businesses. The individual defendants that were employees of Acadian moved to dismiss the action against them on the basis that the court lacked in personam jurisdiction over them. The plaintiffs argued that these defendants, as officers of a Delaware LLC, were subject to the court’s jurisdiction under the implied consent provision of the Delaware LLC statute (Section 18-109(a) of the Delaware LLC Act). The plaintiffs asserted that these defendants qualified as managers of Acadian because they shared responsibility for implementing the challenged investments, and the investments involved or related to Acadian’s business. The plaintiffs interpreted Section 18-109(a) of the Delaware LLC Act in the disjunctive so that it applied in two distinct situations: (1) actions involving or relating to the business of an LLC or (2) actions claiming a violation by a manager of a duty to the LLC the manager manages. The court acknowledged that a literal reading of the LLC statute provided support for this position but noted that broadly reading the “involving or relating to” language could lead to the assertion of personal jurisdiction in circumstances that did not satisfy the minimum requirements of the Due Process Clause. In order to avoid an unconstitutionally broad application of Section 18-109(a), the court held that the plaintiffs must establish that the exercise of personal jurisdiction over the defendants would not offend traditional notions of fair play and substantial justice when invoking the “involving or relating to” clause. The court stated that the due process requirement would be met if: (1) the allegations against the defendant-manager focused centrally on the manager’s rights, duties, and obligations as a manager of a Delaware LLC; (2) the resolution of the matter was inextricably bound up in Delaware law; and (3) Delaware had a strong interest in providing a forum for the resolution of the dispute relating to the manager’s ability to discharge the manager’s managerial functions. Additionally, the court concluded that the “rights, duties and obligations” language of this test referred to the LLC managed by the defendants. Here the plaintiffs claimed that the alleged managers of Acadia breached duties owed to the plaintiffs and the trusts. The court held that these claims did not involve or relate to Acadian’s internal business as required by the Delaware LLC statute and the Due Process Clause. Thus, Section 18-109(a) did not provide a basis for personal jurisdiction. The court also rejected the plaintiffs’ other claims of jurisdiction under a conspiracy theory and the Delaware long-arm statute. The court pointed out that in addition to demonstrating a statutory basis for personal jurisdiction as to each defendant, the plaintiffs would have to show that the court’s exercise of jurisdiction over them met the so-called minimum contacts requirement. With respect to the employees of Acadian, the court found that although they worked for a Delaware LLC, they lived and worked outside of Delaware and did not own real property or any other assets in Delaware. Thus, the court concluded that the plaintiffs had not shown that these defendants had the requisite minimum contacts with Delaware to justify subjecting them to personal jurisdiction in Delaware.

American Institutional Partners, LLC v. Fairstar Resources Ltd.

C.A. No. 10-489-LPS, 2011 WL 1230074 (D. Del. March 31, 2011)

This action was brought by judgment debtors whose interests in numerous entities, some of which were Delaware LLCs, were the subject of charging orders issued by a Utah court in which the judgment was entered. The Utah court ordered foreclosure of the charging orders by constable’s sale and specified that the buyers would acquire all rights in a purchased company if a judgment debtor was the company’s sole member. The Utah court rejected the judgment debtors’ objections to the constable sales and determined that Utah law applied to all execution proceedings in the matter, including the foreclosure of a member’s interest in a domestic or foreign LLC. The judgment debtors filed suit in the Delaware Chancery Court seeking a declaratory judgment that the foreclosures on membership interests in eight Delaware LLCs (the “Subject LLCs”) were invalid under Delaware law as well as a declaration of the identity of the members and managers of the Subject LLCs. The judgment creditors removed the suit to federal court and sought dismissal of the claims or transfer of venue to Utah. The judgment creditors sought dismissal on the basis that the court lacked personal jurisdiction over them or on the grounds that the complaint failed to state a claim based on the doctrine of res judicata or the Rooker-Feldman doctrine. The court analyzed the implied consent provision of the Delaware LLC statute and found that the exercise of jurisdiction over one of the judgment creditors was supported by the implied consent provision based on the judgment creditor’s actions in connection with several of the Subject LLCs. The implied consent provision applies to a person who materially participates in the management of a Delaware LLC except that the power to select or participate in the selection of managers does not by itself constitute participation in the management of the LLC for these purposes. The judgment debtors’ allegations that the judgment creditor asserted direct or indirect 100% ownership interests in three of the Subject LLCs and purported to appoint the sole managers of these LLCs along with allegations of certain actions taken or representations made on behalf of the LLCs in other state court and bankruptcy proceedings were sufficient to constitute “material participation” in the management of the LLCs for purposes of the implied consent statute. Further, by foreclosing on Delaware LLCs and taking ownership rights, the court concluded that the judgment creditor had purposefully availed itself of Delaware law and could not be surprised to be haled into a Delaware court for a dispute over the governance of the Delaware LLCs. Due process requirements were thus satisfied. With respect to the other judgment creditor, however, the court concluded that there was no basis for exercising personal jurisdiction because the only basis asserted by the judgment debtors for exercising jurisdiction was an unsubstantiated allegation that the second judgment creditor controlled the judgment creditor that was materially participating in the management of the Subject LLCs as described above. With respect to the res judicata argument, the court found that the claims in the Utah and Delaware actions arose out of the same transaction (i.e., the constable sales of the Delaware LLCs), and the claims in the Delaware action were presented or should have been presented in the first suit in Utah. Thus, res judicata principles precluded assertion of the claims in the Delaware action if both cases involved the same parties or privies. The claims of the judgment debtors were barred because the judgment debtors were parties in the Utah action, but two additional plaintiffs in the Delaware suit (Delaware LLCs which were the subject of foreclosure sales) were not parties in the Utah action, and the court held that their claims were not barred. The court held that the Rooker-Feldman doctrine did not bar the claims because the plaintiffs raised issues not presented in the Utah action (i.e., that the judgment creditors could not gain managerial rights in the foreclosure sales even under Utah law and a challenge to the demand by the judgment creditors for documents of one of the Subject LLCs). The plaintiffs in the Delaware action sought a declaration of rights in the aftermath of the Utah rulings rather than a stay of the sales as sought in the Utah action, and the Rooker-Feldman doctrine is not a bar where additional claims are asserted in the federal forum even if the claims contradict a legal conclusion made by the state court. The court denied the judgment creditors’ request to transfer venue of the action to the District of Utah. Balancing the great weight given the plaintiffs’ choice of forum against the origin of the claim in Utah, the court concluded that the latter factor did not outweigh the presumption that a case should be litigated in the forum chosen by the plaintiff.

In re Chreky (Barrett v. Chreky)

450 B.R. 247 (D.D.C. 2011)

Under the terms of a District of Columbia LLC owned by Mr. and Mrs. Chreky, Mrs. Chreky alone was a 1% member, and Mr. and Mrs. Chreky were jointly a member with a 99% interest. The bankruptcy court held that a married couple can be a person or entity that is a member of an LLC, but a creditor of Mr. Chreky argued that a married couple must be considered two separate people. The district court agreed with the creditor and held that a married couple may not be a member of a D.C. LLC. Under the D.C. LLC statute, an LLC is defined in terms of having one or more members, and “member” is defined as a “person” that owns an interest in an LLC. A “person” is defined as a natural person over the age of 18 years, various specified entities, or “any other individual or entity in its own name or any representative capacity.” The court reviewed the treatment of a married couple under D.C. case law and legislation and explained that D.C. legislation has overruled the common-law concept of marital unity under which a couple was treated as one person. Because a married couple now consists of two people under D.C. law, the court held that a married couple is neither an individual nor an entity that can be a member in an LLC. The court went on to state, however, that a married person may hold his individual membership in the LLC as a tenancy by the entireties with his spouse because a membership interest is personal property. The district court remanded to the bankruptcy court for findings of who actually held the membership interest held in name by Mr. and Mrs. Chreky and for findings of whether that person held the membership interest as a tenant by the entireties.

Tully v. McLean

948 N.E.2d 714 (Ill. App. 2011)

McLean founded an LLC to purchase and develop Piper’s Alley, a retail and entertainment complex in Chicago’s Old Town. Pursuant to the LLC’s operating agreement, the LLC was manager-managed, and the manager had to be a member of the LLC. The member-manager of the LLC had exclusive responsibility for conducting the LLC’s business. After the LLC bought Piper’s Alley and renovated it, F.P.A., LLC (FPA) invested in the LLC and became a 50% member. McLean-controlled entities owned the other 50% of the LLC. McLean-controlled entities served as the member-manager of the LLC and as the property manager for Piper’s Alley. After FPA discovered financial improprieties in the LLC and McLean refused to cease his involvement in running the LLC, FPA and FPA’s member-manager filed direct and derivative claims for fraud and breach of fiduciary duty against McLean and the entities he controlled that were owners of the LLC or involved in the management of the LLC or its property. FPA sought injunctive relief, receivership, expulsion of the LLC’s member-manager, damages, forfeiture of any compensation received by the defendants during the period of the fraud/breach, and no sharing by any defendant in the damage award. By agreed order, the trial court ordered that McLean and his companies could no longer exercise any control over the LLC’s accounts and that the individual in control of FPA would act as sole manager of the LLC for the duration of the litigation. The defendants filed a counterclaim to dissolve the LLC. After a bench trial, the trial court concluded that the defendants had indisputably misappropriated millions of dollars from the LLC, and the court awarded the plaintiffs compensatory and punitive damages and forfeiture of all management fees. The court found that the LLC’s member-manager should be judicially expelled but that dissolution was not warranted by the operating agreement or the statute. On appeal, the defendants did not contest that McLean’s practices of moving funds between different entities and projects was improper and that they were liable for actual losses, but the defendants asserted that the relief was excessive and inequitable. With respect to the defendants’ claim for dissolution, the court of appeals found that the judicial expulsion of the member-manager as a member triggered a provision of the operating agreement providing for dissolution of the LLC on the removal of a manager. The operating agreement provided that the LLC would be dissolved on the “death, removal, liquidation, dissolution, withdrawal or bankruptcy of a Manager.” The trial court ordered the member-manager “judicially expelled and disassociated from” the LLC based on statutory grounds for expulsion of a member, i.e., wrongful conduct, willful and persistent breach of the operating agreement or a duty owed to the LLC or other members, and conduct making it not reasonably practicable to carry on the business with the member. The trial court declined to apply the dissolution provision of the operating agreement on the basis that the member-manager was not removed as a manager by vote of a majority of the members as provided by the LLC statute. Thus, the question was whether the judicial expulsion of the member-manager as a member under the statute equated to “removal’ as a manager under the operating agreement, thus triggering dissolution under the agreement. The operating agreement did not define or explain “removal” of a manager or how “removal” can come about. Because the Illinois LLC statute provides that it governs to the extent the operating agreement does not otherwise provide, the court of appeals looked to the provisions of the statute. The court acknowledged that the manager was not removed by a vote of the members as provided by the only provision of the statute directly addressing removal of a manager, but the court concluded that the judicial expulsion of the member-manager as a member resulted in the removal of the manager because the operating agreement provided that only a member may serve as a manager. Because the operating agreement called for dissolution upon removal of a manager, dissolution of the LLC was required. With respect to the punitive damages award, the court of appeals found that the trial court did not abuse its discretion in awarding a 3:1 ratio of punitive damages to compensatory damages and in awarding the punitive damages based on the entire amount of compensatory damages even though the amount of compensatory damages actually awarded was reduced by 50% to take into account the defendants’ ownership interests. With respect to the fee forfeiture award, the court of appeals found that the trial court did not err in imposing fee forfeiture on the property manager that managed the property owned by the LLC. The defendants argued that the LLC’s manager bore the fiduciary duty of overseeing the property manager, and that the property manager’s relationship with the LLC was purely contractual and its ministerial duties were not fiduciary in character. The court of appeals concluded that all of the defendants were owned and controlled by McLean and acted in concert so that the property manager was a fiduciary who breached its duty by cooperating in the scheme. The court of appeals also concluded that certain “loan brokerage fees” charged by the LLC’s manager were simply another way of hiding inappropriate transfers, and the trial court did not err in ordering forfeiture of these fees. Finally, the court of appeals held that the trial court did not err in awarding prejudgment interest at the equitable rate of 13%.

In re Whittle (White v. Whittle)

449 B.R. 427 (Bankr. M.D. Fla. 2011)

Persons owning 50% of the membership units of a Florida LLC sought a judgment against the LLC’s manager for misappropriating $650,000 of LLC funds and a finding that the judgment was nondischargeable. The court held that the claimants were not creditors of the debtor because the claims belonged to the LLC. The court relied upon the separate legal existence of an LLC, the fact that the statute provides that an LLC holds its property separate and apart from the property of the members, and the fact that the statute provides that a member’s liability for receipt of a wrongful distribution is to the LLC. The court noted that the statute provides for a right of a member to bring a derivative action, but the plaintiffs had not availed themselves of the statutorily-specified process.

George Wasserman & Janice Wasserman Goldsten Family LLC v. Kay

14 A.3d 1193 (Md. App. 2011)

The plaintiffs, minority investors in two LLCs and five general partnerships (the “investment vehicles”), sued Jack Kay, the managing member of one of the LLCs and de facto managing member or partner of the other investment vehicles, asserting numerous causes of action based on Kay’s secret diversion of investment vehicle funds for investment in Bernard Madoff entities. In addition to suing Kay individually, the plaintiffs sued two entities owned and controlled by Kay that were used to facilitate the investments in the Madoff entities. The plaintiffs brought all of their claims directly and derivatively, and the principal issues in this appeal related to the nature of the claims as direct or derivative. The court first provided a general overview of governance, fiduciary duties, and derivative suits in the corporate, LLC, and general partnership contexts. With respect to LLCs, the court noted that, unlike the corporate and general partnership statutes in Maryland, the LLC statute does not expressly address members’ fiduciary duties. Nevertheless, the court stated that managing members of LLCs owe common law fiduciary duties because managing members are clearly agents of the LLC and the other members, and agents are fiduciaries under common law. The court stated that the underlying fiduciary duties in the corporate and general partnership context pre-existed the statutes so that the duties exist as such unless limited by statute, and the court said the same holds true in the LLC context. Because there is no Maryland statute precluding or even limiting managing members’ fiduciary duties under common law, those underlying duties apply. The court recognized that a Maryland statutory provision governing LLC operating agreements suggests that operating agreements can alter existing duties or create duties that would not otherwise exist, but the allegations in this case did not indicate that the operating agreements for the LLC investment vehicles contained any such provisions. In a lengthy analysis of the nature of the plaintiffs’ claims, the court concluded that the plaintiffs could bring their claims directly with respect to both the general partnership and LLC investment vehicles. The plaintiffs based their claims on Kay’s improper diversion of funds that were required to be held in reserve funds of the investment vehicles and distributed to the plaintiffs directly. The court relied on a Maryland case dealing with a corporate cash-out merger in which minority shareholders claimed that directors/majority shareholders breached their fiduciary duties to the minority shareholders by failing to obtain an appropriate price for the cashed-out shares. The Maryland Court of Appeals held in that case that the directors were subject to direct common law duties of candor and good faith to the shareholders. In distinguishing individual actions from derivative actions in the corporate context, the Maryland Court of Appeals stated that a shareholder may bring a direct action against alleged corporate wrongdoers when either: (1) the shareholder suffers the harm directly; or (2) a duty is owed directly to the shareholder, though such harm may also be a violation of a duty owing to the corporation. Extending the rationale in this case to partnerships and LLCs, the court concluded that the plaintiffs had sufficiently alleged that they suffered harm directly and that Kay, as managing partner/member, violated duties owed directly to the plaintiffs. The court noted that partners are in contractual privity with each other by virtue of the partnership agreement. Further, the Revised Uniform Partnership Act (“RUPA”) specifies that partners owe each other (in addition to the partnership) fiduciary duties, and a partner may maintain an action against the partnership or another partner to enforce the partner’s rights. With respect to Kay’s obligations to other members of the LLCs, the court pointed out that members are in contractual privity because they are parties to an operating agreement, and the court stated that managing members owe fiduciary duties to each other, not just the LLC itself. The court went on to analyze in some depth whether the plaintiffs, as minority partners, could assert claims on behalf of the partnerships given the governance provisions of RUPA. The court concluded that the provisions of RUPA should be tempered when non-plaintiff partners have conflicts of interest so that the partnership claim may be enforced by all of the disinterested partners. In this case, however, the court could perceive no need to permit an action on behalf of the entities since the plaintiffs had adequately alleged individual direct injury. The court rejected the plaintiffs’ derivative claims on behalf of the LLCs for the same reasons. Nevertheless, because the parties had briefed the issue and there was no reported opinion addressing the issue, the court proceeded to analyze whether the LLC statutory provision excusing demand before the filing of a derivative suit when a demand is “not likely to succeed” equates to “futility” in the corporate context. The plaintiffs argued that the “not likely to succeed” requirement was less stringent than the test for “futility” in the corporate context. The Maryland LLC statute provides that a member may bring a derivative action to enforce a right of an LLC to the same extent a shareholder may bring an action for a derivative suit under the Maryland corporation law, and the next subsection of that provision requires demand unless it is “not likely to succeed.” Reading these provisions in harmony, the court concluded that the phrase “not likely to succeed” equates to the “futility” exception in the corporate context. The court then reviewed each of the plaintiffs’ counts to determine whether each stated a cause of action. The court concluded that the plaintiffs had adequately alleged claims against Kay for fraud, tortious interference, breach of the investment vehicles’ partnership and operating agreements, and for negligence, gross negligence, and reckless misconduct as to the LLC investment vehicles and for gross negligence and reckless misconduct as to the general partnership investment vehicles. The plaintiffs failed to adequately allege various other claims against Kay, including claims for conversion, breach of fiduciary duty, and negligence. The claims for conversion failed because Maryland does not recognize a cause of action for conversion of money that is not “specific, segregated, or identifiable.” The breach of fiduciary duty claims failed because an alleged breach of fiduciary duty may give rise to a cause of action under Maryland law, but it does not, standing alone, constitute a cause of action. The allegations here were relevant to other causes of action, such as fraud, tortious interference, breach of contract, and negligence, but they did not constitute a stand-alone nonduplicative cause of action. The court rejected the negligence claim (as opposed to the gross negligence and reckless misconduct claims) with respect to the partnerships because RUPA limits a partner’s duty of care to refraining from gross negligence or reckless conduct, intentional misconduct, or a knowing violation of law. The court stated that no such statutory limitation protects members of LLCs, and the plaintiffs adequately alleged that Kay committed negligence, gross negligence, and reckless misconduct in his capacity as an LLC member. The court rejected the plaintiffs’ claim for punitive damages because the plaintiffs did not allege facts demonstrating actual malice. The court concluded that some of the plaintiffs’ claims against the two entity defendants owned and controlled by Kay survived (such as the aiding and abetting claims with respect to the fraud count) and others did not (such as a beach of contract claim against the management company that contracted with six of the investment vehicles, which the court said could appropriately be brought by the investment vehicles, but not by the plaintiffs directly).

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

60 So.3d 792 (Miss. 2011)

The Mississippi Supreme Court determined on a certified question from the Fifth Circuit Court of Appeals that a deed executed by a minority member of an LLC without actual or apparent authority was void rather than merely voidable. A lender who obtained a deed of trust from the purported grantee of the LLC, in good faith and without notice that the deed from the LLC was unauthorized, argued that the deed from the LLC was merely voidable and that the deed of trust was thus enforceable. The certified question presented was: “When a minority member of a Mississippi limited liability company prepares and executes, on behalf of the LLC, a deed to substantially all of the LLC’s real estate, in favor of another LLC of which the same individual is the sole owner, without authority to do so under the first LLC’s operating agreement, is the transfer of real property pursuant to the deed: (i) voidable, such that it is subject to intervening rights of a subsequent bonafide purchaser for value and without notice, or (ii) void ab initio, i.e., a legal nullity?” It was undisputed that the minority member lacked actual authority to transfer the property because the operating agreement required the affirmative vote of members holding at least 75% of the membership to approve the transfer of all of the LLC’s assets other than in the ordinary course of business. The court thus turned to the question of apparent authority. The court noted the agency provisions of the Mississippi LLC statute applicable to the case (the provisions of the Revised Mississippi Limited Liability Company Act did not apply because the LLCs were formed before January 1, 2011), and the court stated that, under the statute, the minority member was an agent of the LLC for the purpose of conducting the business and affairs of the LLC in the “usual way.” The court noted that an agent generally cannot bind a principal to a contract unless the principal clothes the agent with actual or apparent authority. The minority member knew he had no actual authority to transfer the property, and his knowledge was imputed to his LLC that was the grantee under the deed executed by the minority member. Because the doctrine of apparent authority is unavailable to one who knows an agent lacks authority, the court concluded that the minority member had no apparent authority to transfer the property to his wholly owned LLC. The certified question asked whether the unauthorized conveyance was voidable, i.e., was it an effective transfer unless and until the LLC repudiated it? The court stated that it is settled Mississippi law that an agent is powerless to affect the legal relationship between the principal and others absent some form of legal authority. The court recognized that Mississippi law allows a principal to ratify an agent’s unauthorized act, and the court relied upon the Restatement (Third) of Agency for a description and explanation of the concept of ratification. The court held that a deed executed without actual or apparent authority is void unless and until later ratified. Here, there was no ratification, and the deed was void. There was no need for the LLC to repudiate the unauthorized deed. Once the LLC learned of the purported conveyance, it could have ratified it, but it did not, and the LLC’s rights were thus not affected by the deed.

Wilson v. Thorn Energy, LLC

787 F.Supp.2d 286 (S.D.N.Y. 2011).

The plaintiffs lent money to and invested in several LLCs for the purpose of offshore oil exploration. The plaintiffs sought to pierce the veil of the LLCs to hold the managing member as well as the LLCs liable for repayment of the amounts invested and lent to the LLCs. Based on New York choice-of-law rules, the court applied Delaware law, the law of the state of organization of the LLCs with respect to the veil-piercing claim. Noting that courts have applied the standard for disregarding the corporate form in the LLC context, the court relied upon the Second Circuit’s two-prong distillation of Delaware’s alter-ego standard as follows: “‘(1) whether the entities in question operated as a single economic entity, and (2) whether there was an overall element of injustice or unfairness.’” The court stated that a plaintiff must show a mingling of the operations of the entity and its owner considering various factors, including whether the entity was solvent, whether dividends were paid and other formalities observed, whether the dominant owner siphoned funds, and whether the entity generally functioned as a mere facade for the dominant owner. The court stated that some combination of these factors is required along with an overall element of injustice or unfairness, but actual fraud is not required. Applying this standard to the summary judgment evidence, the plaintiff did not conclusively establish grounds for piercing the veil. With respect to the first prong, i.e., whether the managing member and the LLCs operated as a single economic unit, there were fact issues as to whether the managing member siphoned off funds for his personal use and whether the entities were a mere facade or instrumentality for his personal activities. Because there was a fact issue on the first prong, the court did not need to examine the element of injustice or unfairness.

Mitchell, Brewer, Richardson, Adams, Bruce & Boughman, PLLC v. Brewer

705 S.E.2d 757 (N.C. App. 2011)

At a meeting of the members of a North Carolina PLLC law firm (the “Firm”), two of the members abruptly announced that they were leaving the Firm. A couple weeks later, a third member announced that she was leaving the Firm to join the other two departing members in a new law practice. The members never executed a written operating agreement or other written documents setting forth their rights and responsibilities as members of the Firm. After the Firm’s breakup, representatives of the departing and remaining members met to discuss the departing members’ interests in the Firm. They did not agree on the value of the departing members’ interests because the parties could not agree with regard to the sharing of future contingent fees generated by cases pending prior to the breakup of the Firm. Brewer, one of the remaining members, prepared a memorandum in which he repeatedly referenced the breakup as a “withdrawal” from the Firm by the departing members, though the memo also referred to the “winding up” of the Firm’s operations by the “remaining members.” Brewer’s memo claimed that the disputed contingent fee cases had “no ascertainable present value” and stated that the remaining members were winding up the Firm by paying off the Firm’s debts and distributing the remaining assets according to the members’ membership interests. Final distribution checks were sent to the departing members based on Brewer’s determination of the Firm’s existing debts and obligations, but the departing members did not cash the checks. In a letter sent about a year after the departure of the departing members, counsel for the departing members referred to the breakup of the Firm as a “dissolution.” Eventually, the departing members filed suit, individually and derivatively on behalf of the Firm, seeking an accounting, liquidating distributions, damages, and judicial dissolution. The remaining members challenged the standing of the departing members to assert their claims and asserted various affirmative defenses and counterclaims. The departing members’ theory of the case was based on their argument that they did not withdraw from the Firm and that the Firm must be dissolved pursuant to the North Carolina LLC statute. The remaining members’ theory was that the departing members withdrew from the Firm, which did not dissolve and should not be judicially dissolved. The pivotal issue for purposes of the various claims, counterclaims, and defenses was whether the case was one of dissolution or withdrawal. As an initial matter, the court addressed the remaining members’ challenges to the departing members’ standing to bring the action. The court determined that the departing members did not have standing to cause the Firm to bring suit because the departing members constituted only a minority of the members. The remaining members, as the majority of the member-managers, did not authorize or ratify the claims asserted against them by the Firm, and there was thus no authority for the Firm to assert the claims on its own behalf. The court noted that the remaining members had standing to cause the Firm to assert the counterclaims asserted against the departing members. The court next dismissed all of the individual claims asserted by the departing members and the remaining members because the claims were based on alleged breaches of the members’ fiduciary duties and duty to account, which were duties related to the parties’ relationship as part of the PLLC. The court concluded that the departing members had standing to bring their derivative claims on behalf of the Firm because they had not withdrawn as members, as further discussed below. The court determined that the departing members did not withdraw from the Firm because the North Carolina Limited Liability Company Act provides that a member may withdraw only at the time or upon the happening of events specified in the articles of organization or a written operating agreement. Since the Firm’s articles of organization were apparently silent on withdrawal (the articles of organization were not part of the record, and no party argued that they controlled the issue), and the Firm had no formal written operating agreement, the court concluded the departing members could not withdraw. The court rejected the argument that various writings and emails generated in connection with the Firm’s breakup collectively constituted a written operating agreement because the evidence did not show the members expressly assented to the terms of the various documents but rather showed the parties’ disagreement as to how to handle the breakup of the Firm. The court next analyzed whether the departing members should be estopped to deny that they withdrew from the Firm, applying the rule that equity will not aid a party who has a full and complete remedy at law. The departing members argued that application of equitable estoppel was not required because the North Carolina LLC statute provides an adequate legal remedy in the form of judicial dissolution in a case where the members of an LLC are deadlocked or the assets of the LLC are being misapplied. The court concluded that the inability of the members to agree regarding the division of fees from the disputed contingent fee cases and evidence that the remaining members had not distributed or accounted for profits from one of the disputed contingent fee cases presented a case of deadlock and potential misapplication of LLC assets. The remaining members pointed out that the remedy of judicial dissolution is discretionary because the statute states that a court “may” dissolve an LLC on the grounds specified in the statute, and the remaining members argued that the lower court’s refusal to grant judicial dissolution should thus be upheld. The appellate court concluded, however, that the lower court abused its discretion because the only reason it did not grant dissolution was its erroneous application of the doctrine of equitable estoppel to treat the departing members as withdrawn.

In re Williams (Spain v. Williams)

455 B.R. 485 (Bankr. E.D. Va. 2011)

The plaintiff, Spain, sought a winding up of an LLC in which she claimed to be a member. Spain claimed that she and Williams each owned a 50% interest in the LLC. Williams and his wife, Michele, claimed that Williams owned a 51% interest and that Sprouse owned the other 49% interest. The LLC was formed by filing articles of organization with the Virginia State Corporation Commission (“SCC”). The articles of organization listed Williams as the organizer and Sprouse as the registered agent. Sprouse was identified in the articles of organization as “a member or manager of the limited liability company.” The LLC did not have an operating agreement. The LLC was in the construction business, and Sprouse acted as “Operations Manager” in submitting a subcontractor’s bid on behalf of the LLC. A later modification of the subcontract was signed by both Sprouse and Williams on behalf of the LLC. Williams, Sprouse, Michele Williams, and Spain opened bank accounts on behalf of the LLC on which they were all signatories. A worker’s compensation insurance agreement signed by Williams covered Sprouse and Williams as the officers of the LLC and identified Williams and Sprouse as each owning 50% of the LLC. Williams was identified as president and Sprouse as general manager of the LLC in a safety and health program document issued by the LLC as well as on business cards of the LLC. Spain issued a personal guaranty of the LLC’s credit so that the LLC could rent two pieces of heavy equipment, and Spain allowed Sprouse to use her credit card to rent and purchase other tools and equipment needed by the LLC to perform its subcontract. Sprouse and Williams came to the job site daily, while Spain and Michele Williams were only present on some days. Spain and Michele Williams frequently wrote checks for payroll and other expenses. Spain wrote checks for the workers Sprouse supplied, and Michele Williams wrote checks for the workers Williams supplied. Sprouse and Williams kept separate work logs and stored their business documents in their respective homes. Essentially, Sprouse and Spain appeared to operate as one business and Williams and his wife as another, with each business using the LLC to secure construction work for their businesses. A couple months into the project, Spain abruptly revoked her guaranty. Sprouse abandoned work at the job site, but Williams and his crew continued the work and completed the job. After the completion of that job, Williams performed other work on the same project under the LLC’s name. The LLC was eventually canceled by the SCC for failure to pay its annual registration fee. In order to address the claim for winding up, the court had to determine which parties were members or interest holders of the LLC, the legitimate debts and obligations of the LLC, and how to wind up the LLC. As the court began to undertake its analysis of which parties were members of the LLC, the court first made the point that the LLC was properly constituted as an LLC even though it was “dysfunctional” from its inception in that only the most minimal of formalities were observed. The court pointed out that the SCC issued a certificate of organization for the LLC, which the Virginia LLC statute provides is conclusive evidence that all conditions precedent required to be performed have been complied with and that the LLC has been formed under the statute. Further, the LLC was issued a taxpayer identification number and entered into contracts with third parties. Thus, the court concluded that the LLC was a valid LLC and that the court should not simply disregard its existence. The court next examined the provisions of the Virginia Limited Liability Company Act bearing on the determination of an LLC’s members and characterized the statute as providing “surprisingly little guidance.” The court noted that Virginia law appears to require member-managed LLCs to have at least one member and specifies that an LLC is member-managed unless the articles of organization or an operating agreement provide that the LLC is manager-managed. The court concluded that the LLC in this case was member-managed because the articles of organization did not list any managers and the LLC did not have an operating agreement. The court reviewed the provisions of the Virginia LLC statute regarding determination of membership and found that the LLC did not comply with any of the provisions. The statute specifies that the articles of organization or operating agreement can define the membership of an LLC. Additionally, the statute provides several methods by which members may be admitted to an LLC. Persons acquiring a membership interest from the LLC itself become members upon compliance with the terms of the operating agreement or by a majority vote of the members in a member-managed LLC without an operating agreement. If an LLC had no members at its commencement, its membership can be determined by “any writing signed by both the initial member or members and the managers, if any are designated in the articles of organization, or, if no managers are so designated, the organizers.” Since the court found none of these provisions were satisfied, the court turned to other evidence to determine the membership of the LLC. Given the silence of the Virginia statute on “a method for determining members in a properly constituted limited liability company that does not adhere to any of the organizational formalities,” the court looked to the acts and conduct of the parties to determine the membership of the LLC. The court found the cumulative evidence indicated that Williams and Sprouse were the two initial members of the LLC. The parties did not disagree that Williams was and always had been a member of the LLC, and the court stated that his status as organizer, though not conclusive, supported his membership. Williams signed numerous documents binding the LLC, filed tax returns for the LLC, held himself out as president, and incurred numerous expenses on the LLC’s behalf. Williams insisted that he formed the LLC with Sprouse and that Sprouse was the other member, but Sprouse denied that he was a member and insisted that Spain was the other member. The court found that Sprouse rather than Spain was the other initial member based on the listing of Sprouse as registered agent in the articles of organization, Sprouse’s filing of several forms with the SCC in which the address of the registered office was changed and Sprouse was identified as the registered agent and a “member or manager of the limited liability company,” the listing of Sprouse as “Operations Manager” and a 50% owner of the LLC in the worker’s compensation insurance agreement, and Sprouse’s signature on bank account resolutions in the capacity as manager of the LLC. In addition to this documentary evidence of membership, Sprouse held himself out as the manager of the LLC on multiple occasions during the LLC’s early existence. The court stated that the only way Sprouse could have functioned as a manager in the absence of an operating agreement appointing him manager was as a member-manager. The court thus held that Williams and Sprouse were the initial members and that each held a 50% interest since the only written evidence of the amount of their ownership interests was the insurance agreement. Because Sprouse denied that he was a member and claimed that Spain was the other member, the court concluded that Spain must have acquired Sprouse’s interest in the LLC at some point. Spain behaved as if she were a member by providing her personal guaranty of the LLC’s rental of equipment and contributing other capital to the LLC while Sprouse invested no money in the LLC. Based on the statutory rules regarding assignment of a membership interest and admission of a member, the court concluded that Spain acquired Sprouse’s share of profts and losses of the LLC and the right to any distributions to which Sprouse would have been entitled, but Spain did not acquire all the rights of a member because Williams never voted to admit Spain as a member. The court next discussed the obligations of the LLC and the claims of the interest holders. The court concluded that a default judgment taken by Sprouse against the LLC was not a valid debt of the LLC because Sprouse was both the plaintiff and registered agent of the defendant and obtained the judgment after service on himself without any other representatives of the LLC being made officially aware. The court found it unnecessary to parse voluminous exhibits presented by Williams and Spain documenting expenses incurred in funding the LLC because the court concluded the expenses should be considered capital contributions in the absence of formal debt instruments documenting the LLC’s liability or entries on the books and records of the LLC reflecting any indebtedness to the interest holders. The court characterized any differences between the precise amounts contributed by Williams and Spain as “relatively insignificant” and “irrelevant to the ultimate distribution” of the LLC’s funds. The court held that Williams and Spain, as 50% interest holders, were each entitled to an equal portion of the LLC’s remaining funds after payment of the valid debts. With respect to the method of winding up the LLC, the court noted that the Virginia LLC statute provides that the members may wind up the affairs of the LLC. However, both Williams and Spain had filed bankruptcy cases under Chapter 13. The Virginia Limited Liability Company Act provides that a member is dissociated from the LLC upon becoming a debtor in bankruptcy and the former member continues to hold a membership interest with only the rights of an assignee. Pursuant to Section 541(c)(1)(B) of the Bankruptcy Code, the membership interests of Williams and Spain were vested in their respective bankruptcy estates. Because the Virginia LLC statute provides that a dissociated member has only the rights of an assignee, i.e., only the economic rights of the membership interest, there was no one remaining to wind up the affairs of the LLC and distribute its funds. Thus, the court appointed a liquidating trustee to wind up the LLC’s affairs. The court noted that it had authority to appoint a liquidating trustee because the proceeding was removed to the bankruptcy court from the circuit court on which such jurisdiction is conferred under the Virginia LLC statute.

Capon v. Monopoly Game LLC

193 Cal.App.4th 344, 122 Cal.Rptr.3d 536 (Cal. App. 1st Dist. 2011)

(inability of LLC to use alter ego doctrine to invoke Home Equity Sales Contract Act with respect to property purchased by LLC for residential use of its sole member).

Chapman v. Regional Radiology Associates, PLLC

No. 2010-CA-000131-MR, 2011 WL 1085999 (Ky. App. March 25, 2011)

(financial rights of member upon dissociation).

Bottom Line Equipment, L.L.C. v. BZ Equipment, L.L.C.

60 So.3d 632 (La. App. 2011)

(insufficiency of evidence to pierce veil of LLC on basis of alter ego or single business enterprise).

In Re Wolverine, Proctor & Schwartz, LLC (Riley v. Tencara, LLC)

449 B.R. 1 (Bankr. D. Mass. 2011)

(analysis of insider status in LLC context; discussion of veil piercing principles as applicable to LLCs under Delaware law).

Florence Cement Company v. Vittraino

807 N.W.2d 917 (Mich. App. 2011)

(application of corporate veil piercing principles to LLC; liability of member for improper distributions).

White v. Collins Building, Inc.

704 S.E.2d 307 (N.C. App. 2011)

(discussion of personal liability of individual LLC member or corporate officer for his or her own torts).