July 2011 — Issue 60

July -September 2011

LLC Cases: CML V, LLC v. Bax

28 A.3d 1037 (Del. 2011)

The Delaware Supreme Court agreed with the chancery court in this case that creditors of an insolvent Delaware LLC do not have standing to sue derivatively for breach of fiduciary duty to the LLC. A creditor of an insolvent LLC asserted derivative claims on behalf of the LLC for breach of fiduciary duty by the managers in connection with certain acquisitions and sales by the LLC. The chancery court dismissed the claims for lack of standing because the Delaware LLC statute states that the plaintiff in a derivative suit must be a member or assignee. The supreme court found the language of the Delaware LLC statute unambiguously limited derivative standing to members and assignees and thus affirmed the chancery court’s judgment. The court rejected the argument that the legislature intended to take the corporate rule of derivative standing for creditors of insolvent corporations and apply it to LLCs. Given the unambiguous language of the statute, the court stated that it “must apply the plain language without any extraneous contemplation of, or intellectually stimulating musings about, the General Assembly’s intent.” According to the court, applying the plain language did not yield an unreasonable or absurd result. The court found it logical for the General Assembly to limit derivative standing and exclude creditors given the contractual freedom provided to interested parties to define their relationships in the LLC context, which “affords creditors significant contractual flexibility to protect their unique, distinct interests.” The court also rejected the argument that the statutory limitation of derivative standing to members and assignees is an unconstitutional curtailment of the chancery court’s equitable jurisdiction. Based on the historical equity jurisdiction of the High Court of Chancery of Great Britain and the fact that LLCs did not exist at common law, the court concluded that the Delaware constitution only guarantees the chancery court’s jurisdiction to extend derivative standing to prevent failures of justice in cases involving corporations. When adjudicating the rights, remedies, and obligations associated with Delaware LLCs, the courts must look to the Delaware Limited Liability Company Act because it is the only statute that creates those rights, remedies, and obligations. Although the statute provides that common law principles of equity supplement the express provisions of the statute, courts cannot interpret the common law to override the express provisions the General Assembly adopted. “Supplementing express provisions is altogether different from displacing them or interpreting them out of existence under the guise of articulating and applying equitable principles.” In any event, the court concluded that there was no threat of a failure of justice that would justify application of equity even if the court had the jurisdiction to extend derivative standing (which the court emphatically stated that it did not). The court pointed out that the creditor here chose to lend on what later turned out to be unfavorable terms. As examples of provisions that the creditor could have obtained to protect itself, the court stated that the creditor could have negotiated for a provision that would convert its interests to that of an assignee in the event of an insolvency or a provision that would give the creditor control of the LLC’s governing body in an insolvency. The fact that the creditor did not craft its loan documents to adequately protect its legal remedies in the event of the LLC’s insolvency did not amount to a threat to the interests of justice that would justify an equitable extension of derivative standing.

Achaian, Inc. v. Leemon Family LLC

25 A.3d 800 (Del. Ch. 2011)

After dissension among the three members of a Delaware LLC arose, one of the members purported to transfer its entire 30% membership interest to a 20% member. Achaian, Inc. (“Achaian”) then filed this suit for judicial dissolution of the LLC claiming that there was a deadlock between Achaian and the remaining member, Leemon Family LLC (“Leemon”), which owned a 50% membership interest. Leemon claimed that the 30% member’s assignment of its membership interest to Achaian was only effective to give Achaian an additional 30% economic interest and that the LLC agreement required Leemon’s consent to admit Achaian as a member with respect to the newly acquired 30% interest. The court framed the question presented as follows: “may one member of a Delaware limited liability company assign its entire membership interest, including that interest’s voting rights, to another existing member, notwithstanding the fact that the limited liability company agreement requires the affirmative consent of all of the members upon the admission of a new member, or, must the existing member assignee be readmitted with respect to each additional interest it acquires after its initial admission as a member?” Reading the LLC agreement as a whole, the court concluded that it allowed an existing member to transfer its entire membership interest, including voting rights, to another existing member without obtaining the other member’s consent. The court reviewed the default provision of the Delaware LLC statute, which provides that an assignment of a limited liability company interest only entitles the assignee to economic rights and does not entitle the assignee to exercise the rights or powers of a member, but the court focused on the LLC agreement since it contained provisions addressing transfer of interest in the LLC. The court noted that the LLC agreement defined a member’s interest as “the entire ownership interest” of a member and that the agreement permitted a member to transfer “all or any portion of” its interest to any person at any time. The agreement also provided that no person shall be admitted as a member without the written consent of the members. Leemon argued that the agreement did not reverse the default rules under the Delaware LLC statute or that the LLC agreement unambiguously distinguished between the transferability of a member’s economic interest and voting rights. The court, however, agreed with Achaian that the agreement as a whole allowed the transfer of all of the rights accompanying an interest–including the voting rights–to an existing member without the written consent of the other members. The court concluded that the definition of a member’s interest as “the entire ownership interest” of the member was best read to include the voting rights of a member, especially in the context of other provisions of the agreement. The court concluded that the provision of the agreement requiring written consent of the members to admit any person as a member did not require a person who was already a member to be readmitted in order to acquire additional voting rights with the acquisition of additional interests in the LLC. Because Achaian was already admitted as a member at the time it acquired the additional interest, the court did not view the consent requirement as having any application. The court found nothing in “the LLC Act, the Uniform LLC Act, or learned commentaries and treatises on alternative entities suggesting that such a serial admission scheme is standard practice.” Given that Achaian acquired the voting rights with respect to the 30% interest transferred to it, Achaian and Leemon held identical 50% interests, and the court found that Achaian had alleged the recognized three prerequisites for a judicial dissolution, analogizing (as it has on past occasions) to the prerequisites for judicial dissolution of a joint venture corporation. First, Achaian and Leemon were coequal 50% owners with an equivalent corresponding 50% right to manage the LLC. Second, Achaian pled that the two members were engaged in a joint venture. Leemon’s allegation that Achaian purchased the additional 30% interest in an effort to purchase a “phony deadlock” was not appropriate for consideration at the motion to dismiss stage. Finally, Achaian alleged that it and Leemon were unable to agree on the management of the LLC, and the LLC agreement did not provide a “reasonable exit mechanism” or other provision to break the deadlock. Thus, Achaian’s pleadings were sufficient to give rise to the inference that the management of the LLC was deadlocked, and the court denied the motion to dismiss.

Phillips v. Hove

C.A. No. 3644-VCL, 2011 WL 4404034 (Del. Ch. Sept. 22, 2011)

In this post-trial opinion, the court addressed a number of claims asserted in connection with an LLC joint venture governed by a four-page document characterized by the court as “little more than a term sheet.” The matters in dispute included the status of an entity as one of the original 50% members or merely an assignee of a 50% interest in the LLC, the LLC’s rights with respect to certain domain names, the court’s personal jurisdiction over a non-resident individual who took over the operations of the LLC, breaches of the duty of loyalty owed to the LLC by individuals involved in its operations, and the existence of grounds for judicial dissolution of the LLC. The LLC at the center of this dispute was an online candle business the terms of which were negotiated by Phillips and Schifino. Soon after signing the four-page document setting forth the terms of their venture, Phillips and Schifino began to have serious disagreements that led to a total breakdown in their relationship. Phillips and Schifino each reached out to a third individual, Hove, and Hove eventually took over the operations of the LLC. Unbeknownst to Phillips, Hove had provided all of the funding for Schifino’s investment in the LLC. Eventually, Hove disclosed to Phillips that he owned an interest in an entity (Firehouse Gallery, LLC or “Firehouse”) that held Schifino’s interest in the LLC and that Hove had an option to buy out Schifino’s interest in Firehouse. After Hove exercised this option and became the sole owner of Firehouse, Hove proposed to buy out Phillips’ interest in the LLC. When they were unable to agree on the terms of a buyout, Phillips filed this litigation in Delaware. Hove filed a bankruptcy petition on behalf of the LLC in Florida and worked with Schifino to impede the litigation in Delaware. Eventually, the bankruptcy was dismissed by Hove, and the Delaware litigation proceeded. The first issue resolved by the court was whether Firehouse was a 50% voting member of the LLC or merely an assignee of Schifino. In denying an earlier motion for summary judgment, the court had previously found the provisions of the term sheet regarding ownership of the LLC to be ambiguous. The term sheet contained references to both Schifino individually and Schifino’s investment entity. The court concluded that the ambiguous provisions authorized Schifino to invest in the LLC either directly or through an entity. The court considered various communications, documents, and circumstances surrounding the transaction in reaching this conclusion. Based on this evidence, the court concluded that Phillips and Firehouse were the original members of the LLC, each holding a 50% interest. The parties had no agreement restricting transfers at the Firehouse level, and Firehouse thus remained a member of the LLC after the transfer of Schifino’s interest in Firehouse to Hove. The court next considered the LLC’s rights with respect to various domain names. Under the term sheet, Phillips granted a purchase option and exclusive license for the primary domain name used by the LLC, and the term sheet provided that Phillips had the right to terminate the license and purchase option in the event of the LLC’s bankruptcy. The court considered the effect of the bankruptcy and its dismissal on the terms of this purchase option and exclusive license and concluded that the termination provision was an unenforceable ipso facto clause and that the LLC continued to hold the purchase option and license. The court concluded that various other domain names were owned by the LLC pursuant to a provision of the term sheet under which Phillips transferred “all of the assets...used in” his previous retail and wholesale candle business. Next the court addressed Hove’s argument that he was not subject to the court’s personal jurisdiction. The LLC did not have a written LLC agreement, and the term sheet did not specify that the LLC would be managed by managers. The term sheet contemplated a board of directors and president but did not harmonize these roles with LLC management concepts. Because the members did not agree to the contrary, management was vested in the members, and Hove argued the court lacked personal jurisdiction over him because he was not officially a manager. The held that it had personal jurisdiction over Hove under the implied consent provision of the LLC statute, which extends to a person who “participates materially in the management” of an LLC regardless of whether the person is a manager as otherwise defined in the statute. The court based its conclusion that Hove participated materially in the LLC’s management on Hove’s taking over the day-to-day operations of the LLC and filing and dismissing a bankruptcy petition on the LLC’s behalf. The court rejected a claim by Phillips against Hove for civil conspiracy but found that both Hove and Phillips breached their fiduciary duty of loyalty to the LLC. The court noted that member-managers of a Delaware LLC owe traditional fiduciary duties to the LLC and its members unless the duties are limited or eliminated by the operating agreement. By taking on the role of president and assuming control over the LLC’s operations, Hove assumed fiduciary duties to the LLC and its members. He breached his duty of loyalty by taking control of the LLC’s inventory and cash and selling products from the LLC’s inventory through a competing online candle business he established. Phillips also breached his duty of loyalty by using the domain name exclusively licensed to the LLC for his own benefit and by continuing to operate his previous candle business in competition with the LLC when he was obligated under the term sheet to exit that business. Although the court concluded that Hove breached his duty of loyalty by filing the LLC’s bankruptcy petition in bad faith, the court refused to award Phillips relief because Phillips also engaged in bad faith conduct in connection with the bankruptcy proceeding. The court awarded Firehouse its requested relief of judicial dissolution of the LLC based on the deadlock between Firehouse and Phillips. The deadlock of the members and absence of any effective mechanism to break the deadlock made it not reasonably practicable to carry on the business of the LLC in conformity with the LLC agreement. Given the history of disputes between the parties, the court further found cause to appoint a liquidating trustee to wind up the affairs of the LLC. Finally, the court refused the request of Phillips to shift his fees and expenses to the defendants under the bad faith exception to the American Rule. The court found that Schifino, Hove, and Phillips all engaged in litigation conduct that could support fee shifting.

Showell v. Pusey

C.A. No. 3970-VCG, 2011 WL 3860419 (Del. Ch. Sept. 1, 2011).

Pusey, Hatter, and Showell were members of an LLC accounting firm. After Showell became less active in the firm, Showell and Pusey, who together comprised 90% of the membership interests of the firm, agreed that Showell should retire, but they could not agree on the amount to which Showell was entitled to be paid on his retirement. The operating agreement specifically addressed the repurchase of a member’s interest upon a “Retiring Event,” but the voluntary retirement of Showell agreed to by the parties was not included in the definition of a “Retiring Event” in the operating agreement. Showell, a 29% member, argued he was entitled to 29% of the value of the LLC as a going concern based on the provision of the Delaware Limited Liability Company Act that entitles a member to his proportionate share of the “fair value” of the LLC if the LLC agreement allows resignation but does not specify the member’s right to payment on resignation. The LLC and its remaining members argued that, since the operating agreement did not permit Showell to retire and specifically provided for the payment of the retiring member’s share of liquidation value on the retirement events permitted, Showell was not entitled to any compensation or, alternatively, was only entitled to his share of liquidation value. The court interpreted the LLC agreement as a whole in the context of what had occurred, i.e., given that Showell and Pusey (whose combined interests satisfied the 75% vote required to amend the operating agreement) agreed to modify the agreement to allow Showell to “retire,” Showell in fact had retired, and the parties failed to reach an agreement on their respective rights and responsibilities on Showell’s “retirement.” The court concluded that the LLC agreement read as a whole showed careful planning for the obligations of the LLC on a member’s retirement. Although Showell’s reason for retirement was not included in the definition of a “Retiring Event” under the terms of the operating agreement, Showell and Pusey, representing 90% of the interests of the LLC, agreed that Showell could retire and that his interest would be purchased by the LLC. Because the parties contemplated the effects of retirement as evidenced by the provisions of the operating agreement, the court rejected Showell’s argument that the statutory default provision applied. The parties permitted Showell to retire and agreed to the purchase of his interest; therefore, the court concluded that the LLC’s purchase obligation was as set out in the operating agreement.

DFG Wine Co., LLC v. Eight Estates Wine Holdings, LLC

C.A. No. 6110-VCN, 2011 WL 4056371 (Del. Ch. Aug. 31, 2011)

A member of an LLC holding company sought to inspect books and records of the LLC and its wholly owned subsidiary for the stated purposes of valuing the member’s interest in the LLC and determining whether to exercise the member’s right to appoint a representative to sit on the board of managers of the LLC. The member brought this action after the LLC refused to provide all of the information requested by the member. The LLC agreement provided that, upon written request for purposes reasonably related to its interest, the member had a right to obtain information in specified categories required to be maintained by the LLC under the agreement as well as any other data required to be provided under the Delaware Limited Liability Company Act. The court determined that the purposes stated in the plaintiff’s demand were proper purposes, but the court noted that the documents related to the purpose of determining whether to appoint a representative to the LLC’s board of managers would seem to be very limited in nature. The LLC argued that neither the LLC agreement nor the Delaware LLC statute gave the member the right to inspect the books and records of its subsidiary, but the court noted that Delaware courts have recognized a right to inspect the records of a subsidiary where “the facts at least suggested the absence, in reality, of separate entities.” Although the LLC agreement did not specifically require maintenance and delivery of documents of the LLC’s subsidiary, the court concluded that the member was entitled under the Delaware LLC statute to receive copies of the subsidiary’s books and records as they related to proper purposes under the statute. The parties did not dispute that the value of the LLC’s subsidiary accrued to the LLC and that the LLC had no value apart from the subsidiary. Further, the LLC had no budget, business plan, or projections apart from the subsidiary’s; the LLC and its subsidiary shared the same address; and the subsidiary did not have its own board of managers, but rather was managed by the LLC. Thus, the facts more than “suggested the absence, in reality, of separate entities.” The court next discussed defenses asserted by the LLC with respect to divulging certain information. The court determined that the LLC could refrain from divulging certain information pertaining to its relationship with creditors on the basis that its managers had a good faith belief that divulging the information would not be in the LLC’s best interest, but the court found that the LLC had failed to establish the managers’ good faith belief that divulging certain other information would not be in the best interest of the LLC. The court permitted the LLC to redact information that the LLC’s managers reasonably believed to be trade secrets. The court concluded that the subsidiary’s production of confidential documents in a pending arbitration proceeding in California between the subsidiary and parties affiliated with the plaintiff did not satisfy the plaintiff’s right to receive copies of the subsidiary’s documents, but the court suggested that releasing the plaintiff’s affiliate from its confidentiality obligation in the arbitration proceeding might be an alternative to providing the documents to the plaintiff. The court next addressed each of the plaintiff’s specific requests and concluded that: the plaintiff was entitled to receive copies of the state tax returns of the LLC and its subsidiary; the plaintiff was not entitled to receive internal records of the LLC’s board of managers because the plaintiff had not shown why the records were necessary to value the plaintiff’s interest; the plaintiff was entitled to receive copies of business plans, budgets, documents concerning inventory and non-inventory assets, and employment agreements of the subsidiary’s key employees, subject to reasonable redaction of information related to trade secrets; the plaintiff was entitled to receive copies of the subsidiary’s general ledger; the plaintiff was not entitled to receive copies of documents (other than financial statements) reflecting payments to managers of the LLC because the plaintiff had not established how the documents would be necessary for the purpose of valuing the plaintiff’s interest or determining whether to appoint a representative to the board of managers; and the plaintiff was entitled to information regarding grape contracts because of their importance to the subsidiary’s wine business and thus the value of the LLC, but the LLC would be permitted to produce a summary of the contracts in lieu of the contracts themselves because the contracts would contain information (possibly involving trade secrets) beyond that necessary to value the LLC.

QVT Fund LP v. Eurohypo Capital Funding LLC I

C.A. No. 5881-VCP, 2011 WL 2672092 (Del. Ch. July 8, 2011)

The defendants sought to dismiss this action involving whether a series of payments to holders of participation certificates in a German bank triggered a payment obligation to the plaintiffs as investors who held preferred securities issued through a pair of Delaware LLCs and trusts. The plaintiffs were entitled to dividend payments if the bank met certain profitability targets or made payments on other preferred securities. The bank did not make sufficient profits to trigger a payment under the profit prong for the year at issue, and the right to payment turned on whether the participation certificates were “preference shares” under the LLC agreements, which did not define the term. The plaintiffs also alleged that the defendants violated the implied covenant of good faith and fair dealing by failing to make payments on their preferred securities and by ceasing to be a profit-seeking entity. The court denied the motion to dismiss. A significant threshold issue was whether German or Delaware law governed the determination of whether the participation certificates were “preference shares” under the LLC agreements. The defendants argued that the internal affairs doctrine required the court to apply German law to determine where the participation certificates ranked in the capital structure of the bank since the bank was a German corporation. The court concluded that German law was only applicable for the limited purpose of identifying the characteristics of the participation certificates in order to determine whether they were “preference shares” within the meaning of the relevant agreements. The court concluded that Delaware law would determine whether the participation certificates fell within the meaning of “preference shares” once the characteristics of the participation certificates were determined. The court stated that interpretation of this term under Delaware law was consistent with the investors’ expectations and was bolstered by the choice-of-law provisions in the agreements. While the parties chose Delaware law as the governing law in general, the parties carved out certain exceptions where German law would apply. The absence of any reference to German law in the provisions at issue undermined the defendants’ argument that German law governed the dispute. Further, applying Delaware law in determining whether the participation certificates were “preference shares” in this dispute would not determine the rights of the holders of the participation certificates or any stockholder or manager of the bank. Following the Delaware approach of classifying securities based on their functional characteristics rather than the label attached to the securities, the court concluded that the participation certificates had a number of characteristics of preferred shares and thus could plausibly qualify as “preference shares” under the LLC agreements. The court also concluded that both parties proffered reasonable interpretations of the timing effect of “pusher provisions” in the LLC agreements, and the defendants’ were not entitled to dismissal based on those provisions. Finally, the court concluded that the plaintiffs alleged facts sufficient to survive dismissal of their implied covenant claim based on a specific implied obligation to protect the holders of the preferred interests in the event the bank ceased to be a profit-seeking enterprise. The court understood the alleged implied obligation to arise out of the provision of the LLC agreement requiring payment on the preferred interests when the bank met certain profitability targets. The complaint alleged facts to support a reasonable inference that the reason the bank did not meet the profitability targets was that the bank entered a domination and profit surrender agreement giving the controlling entity the ability to force the bank to take actions adverse to the bank’s financial interests. This circumstance was not specifically addressed in the LLC agreements and might not have been foreseeable to the holders of the preferred interests, who reasonably might have expected the bank to remain a profit-seeking entity and might have bargained for protection if they had considered the possibility. The plaintiffs also adequately alleged breach of the implied obligation to protect the holders of the preferred interests and resulting injury; therefore, the plaintiffs stated a claim for breach of the implied covenant of good faith and fair dealing.

Canyon Creek Development, LLC v. Fox

263 P.3d 799 (Kan. App. 2011)

Fox was a 50% member in two LLCs of which Julian and Horn were the other members. Fox failed to satisfy capital calls made by Julian on behalf of the LLCs, and the LLCs filed this action for breach of contract. The trial court granted summary judgment in favor of the LLCs in the amount of the capital calls. On appeal, Fox first argued that Julian had no authority to make capital calls to cover the LLC’s debt service when Julian and Horn did not hold a majority interest in the LLCs because the operating agreement generally required a decision to make a capital call to be made by a majority of the members. However, the operating agreement provided that, notwithstanding the general requirement of majority member approval, members were required to contribute such additional capital as was required to pay debt service, insurance, and real estate taxes owed by the LLC. Julian held a management position, and the capital calls were made to remain current on real estate loans to the LLCs. Because Fox failed to raise a fact issue as to the amount of additional capital needed or the reasons for the capital calls, there was no factual dispute on this issue. Thus, the trial court was correct in concluding that it was unnecessary for Julian to consult with Fox before making a capital call to satisfy a current obligation on outstanding loans. The court of appeals then turned to the more difficult issue of the proper remedy for Fox’s breach. Fox argued that the trial court erred in holding him personally liable for the capital contribution rather than limiting the remedy to a reduction of his ownership interest as provided for in the operating agreements. The court examined default provisions of the Kansas LLC statute and the provisions of the operating agreement and reached the conclusion that in a case such as this, where the operating agreements prohibited withdrawal from the ventures, subjecting an investor to personal liability for potentially endless capital calls to prop up a failing venture was neither contemplated by the parties nor envisioned by the LLC statutes. The statute insulates the members from liability for debts of the LLC and claims of third parties against the LLC, and the operating agreements of the LLCs also contained clauses limiting the personal liability of a member for debts or losses “beyond” the member’s capital contributions. With respect to capital contributions, the operating agreements contained separate provisions regarding the initial capitalization of the LLCs and later increases in capital. The court explained that the provisions of the operating agreements regarding initial contributions were consistent with the provisions of the Kansas statute contemplating that a contribution may consist of cash, property, services rendered, or a promissory note or other obligation to contribute cash or perform services since the operating agreements measured the initial capital contributions by their “net fair market value,” a concept that would not be necessary if initial contributions were limited to cash. On the other hand, the provisions of the operating agreements regarding later capital infusions required such contributions to be in cash unless the manager otherwise consented. The court stated that this made perfect sense in that a venture in need of additional resources to meet current obligations such as debt service would need cash for those purposes, and the court concluded that the statutes and operating agreements contemplated different remedies for defaults in the payment of initial capital contributions and additional capital calls. The court noted the statutory default rule that a member is obligated to perform any promise to contribute cash or property or perform services, even if a member is unable to perform, and that a member may be required at the option of the LLC to contribute an amount of cash equal to the agreed value of the contribution that has not been made. This option is available as a default rule under the statute in addition to any other rights the LLC may have against the noncontributing member under the operating agreement or other law. The operating agreements of the LLCs did not contain a contrary provision. However, the court pointed out that the provisions of the operating agreements regarding additional cash capital contributions specifically addressed the remedy available against a member who fails to make an additional contribution. In that case, the operating agreement specified the LLC’s remedy was to dilute the interest of the defaulting member to the extent the other members covered by making additional capital contributions. The court pointed out that the Kansas LLC statute provides that a member who breaches an operating agreement is subject to specified penalties and consequences, and the statute specifically permits an LLC operating agreement to provide for a number of remedies for failure to make a required contribution. Although the capital call provisions of the operating agreement did not state that reduction of a noncontributing member’s interest was the sole remedy, the provisions also did not state that additional remedies were available. The court found it significant that the remedy of damages, the most fundamental remedy for breach of contract, was conspicuously absent from the provisions of the operating agreement dealing with additional capital contributions. The court contrasted the provisions of the operating agreement regarding withdrawal, which provided that a member who attempted to improperly withdraw would be subject to an action for damages. Thus, the court concluded that the failure to include such a fundamental remedy as damages when a member fails to contribute additional capital was not an oversight but rather expressed a clear intent that damages are not recoverable from a member who fails to contribute additional capital after the venture is up and running.

Town of Lebanon v. East Lebanon Auto Sales LLC

25 A.3d 950 (Me. 2011)

The town of Lebanon filed a land use complaint against an LLC land owner and the sole member of the LLC based on the use of the property as an illegal automobile graveyard and junkyard. The trial court rendered a judgment against the LLC and the individual member. There was no dispute that the individual was the sole member of the LLC land owner as well as another LLC that operated the business on the property, and the trial court found that “[the member] and her various corporations and entities appeared to be closely inter-connected and fully under her control.” The Maine Supreme Court concluded that this finding was insufficient to hold the member personally liable. The court cited the liability protection provided by the Maine LLC statute and stated that a plaintiff may not hold a member individually liable unless the plaintiff demonstrates, at a minimum, that (1) the individual abused the privilege of a separate corporate identity, and (2) an unjust or inequitable result would occur if the court recognized the separate corporate existence. The court stated that the record contained no evidence that suggested, and the trial court made no findings, that the member abused the privilege of incorporating or that an unjust result would occur if only the LLC were held liable on the town’s complaint.

Grand Legacy, LLP v. Gant

66 So.3d 137 (Miss. 2011)

Gant, an individual, had a letter of intent to purchase property, and Gant offered to sell the property to Grand Legacy, LLP (“Grand Legacy”) once Gant purchased the property. Grand Legacy agreed to purchase the property through a partnership to be formed in the future with Gant. Gant executed a contract of sale to purchase the property from its current owner. A second contract of sale, specifying the seller as Gant and the purchaser as a limited partnership to be formed between Grand Legacy and Gant, was executed. Eventually, a limited partnership consisting of Grand Legacy as the general partner and Gant & Shivers, LLC (an LLC owned by Gant and another individual, Shivers) as the limited partner, was formed to purchase the property. Subsequently, the contract of sale with Gant as seller was amended to make the LLC the seller. The purchase of the property closed in simultaneous closings of the sale of the property to the LLC and from the LLC to the limited partnership. Grand Legacy claimed that it did not learn until over two years later that Gant, Shivers, and their LLC profited from the transaction by selling the property to the limited partnership for more than the LLC paid for the property. Grand Legacy and the limited partnership sued Gant, Shivers, and the LLC for fraud and breach of fiduciary duty, but the supreme court upheld the trial court’s summary judgment in favor of the defendants. Alleged oral statements made prior to formation of the limited partnership were held to be of no force and effect because of merger clauses in the sales contracts. Further, although the court found that the partners in the limited partnership owed duties of loyalty and care and a duty to account for profits derived from any transaction connected with the formation of the partnership without consent of the other partners, the court concluded that disclosure of the difference in sales price in an acknowledgment provided at closing was sufficient to satisfy the duty of the LLC as a partner in the limited partnership. The court also addressed a separate summary judgment motion on the part of Shivers as to his individual liability. The plaintiffs argued that Shivers had personal liability for his role in the alleged fraud of the LLC. Shivers argued that he was protected from personal liability by the Mississippi LLC statute, but the plaintiffs argued that the LLC shield is inapplicable to a member’s own acts or omissions and that the LLC veil may be pierced when fraud is involved. The plaintiffs argued that Shivers’ signature on an allegedly false HUD-1 statement should subject him to liability. The court distinguished cases from other jurisdictions in which LLC statutes state that the liability shield does not apply to a person’s “own acts or conduct.” The court also distinguished a case in which a member was found liable for conduct before formation of the LLC. Here, the court pointed out that all of Shivers’ actions took place after the formation of the LLC and that a court applying a statute identical to the Mississippi statute held that the mere act of signing a contract on behalf of an LLC in the capacity of member did not make the individual a signatory in his individual capacity. The plaintiffs further argued that the veil of an LLC may be pierced where fraud or misrepresentation is involved. The court again distinguished case law from other jurisdictions as involving evidence dissimilar to that in this case or law that did not control. The court stated that “[t]he law of Delaware, as applied by its own courts and those of other jurisdictions, ‘allows a court to pierce the corporate veil of an entity when there is fraud....’” Since the trial court applied a Mississippi statute, however, the supreme court stated that “Delaware business-association law, however persuasive, does not lead to a finding of error.”

Sutherland v. Sutherland

348 S.W.3d 84 (Mo. App. 2011)

The plaintiff member of an LLC in an unsuccessful derivative suit against the managers and related parties complained on appeal that the jury instruction on the business judgment rule did not accurately state the rule. The instruction stated: “A fiduciary is presumed to have discharged his duties with due care and good faith and in the honest belief that he was acting in the best interests of the limited liability company, absent a showing that he put his personal interests ahead of the interests of the limited liability company.” The court of appeals described the business judgment rule as protecting directors and officers of a corporation from liability for intra vires decisions within their authority made in good faith, uninfluenced by any consideration other than the honest belief that the action serves the best interests of the corporation. The court stated that the rule as applicable to LLCs has been codified in the Missouri LLC statute, which the court stated provides that LLC directors and officers shall not be liable for business decisions that they believe in good faith are in the best interests of the LLC. The plaintiff argued that the instruction was erroneous because it did not contain an instruction that the burden shifts in an equitable action to recover profits where it has been established that the director or officer had an interest in the transaction. The court stated that it had found no case law indicating that a business-judgment-rule instruction cannot be given without also instructing that the burden may shift in an equitable action to recover profits, and the plaintiff failed to demonstrate any prejudice. Further, the court pointed to separate instructions given on breach of fiduciary duty as to each of the managers, and the court stated that the jury would have found a breach of fiduciary duty if the evidence established the managers put a personal interest before the LLC. The court stated that the plaintiff’s real complaint seemed to revolve around the failure of the court to give a proposed instruction that “[a] fiduciary puts his personal interest before the interest of the company when an entity in which he has an interest engages in a transaction with the company.” The court concluded that this sentence misstates the law in that it describes an irrebuttable presumption any time a fiduciary engages in a transaction with the company, rather than a rebuttable presumption as described by case law. The court also noted that the Missouri LLC statute provides that a member or manager may transact business with the LLC and, subject to other law, has the same rights and obligations in the transaction as a person who is not a member or manager. The court viewed this as a determination by the Missouri legislature that there is nothing inherently insidious about a manager doing business with the LLC. The plaintiff next complained that the trial court erred in instructing the jury on the doctrine of ratification. The plaintiff argued that Missouri law does not permit the members of an LLC to retrospectively ratify acts or transactions of its managers. The court rejected this argument based on language in the Missouri LLC statute, which provides that the act of a member or manager which is not apparently for carrying on in the usual way the business of the LLC does not bind the LLC unless authorized in accordance with the terms of the operating agreement, “at the time of the transaction or at any other time.” The plaintiff complained that an instruction setting forth the defense of reliance on counsel was erroneous because it failed to require proof that the defendants had fully disclosed all of the material facts to counsel in obtaining the advice. The court concluded that the instruction substantially reflected the elements of the defense set forth in the Missouri LLC statute and that the instruction implicitly included the requirement of disclosure of the material facts by requiring the jury to find that the defendants “reasonably relied” upon the advice received. The court also reviewed the evidence supporting the defense of reliance on advice of counsel and found the record supported the jury’s finding in favor of the defendants. Finally, the plaintiff complained that the trial court erred in allowing the LLC to participate to any extent in the trial. The court held that the plaintiff failed to preserve this issue for appeal, but the court went on to explain that the trial court did not err in any event. The court noted the general rule that a corporation cannot participate in the defense on the merits of a derivative action unless the derivative action threatens rather than advances the corporate interests. The court stated that a specific example of a situation where the interests of the corporation are threatened is where an action attempts to interfere with internal management and there is no allegation of fraud or bad faith. Here, the plaintiff challenged the process by which the owners of the LLC ratified the decisions of management, and the trial court limited the LLC’s participation to that issue, allowing the LLC to defend its management process. The trial court’s order did not allow the LLC’s counsel to make any comments or remarks regarding the claims made against the LLC’s management. Thus, the court held that the trial court did not abuse its discretion in crafting a ruling that allowed the LLC to defend its management process while requiring the LLC to remain neutral in other respects.

Pappas v. Tzolis

932 N.Y.S.2d 439 (App. Div. Dept. 1 2011), rev’d, __ N.E.2d __, 2012 WL 5906685 (N.Y. 2012)

Tzolis, the defendant, and Pappas and Infantopoulos, the plaintiffs, formed a Delaware LLC for the purpose of entering into a long-term lease on a building. About eight months after the lease commenced, Tzolis suggested to the plaintiffs that they assign their interests in the LLC to Tzolis for 20 times what they had invested one year earlier. The plaintiffs agreed and negotiated buyouts to become effective on a later date if certain events occurred. Pappas, a 40% member, was to receive $1,000,000, and Infantopoulos, a 20% member, was to receive $500,000 for his interest. In addition to the assignment agreement, the plaintiffs signed a handwritten certificate stating that each of the plaintiffs performed their own due diligence in connection with the assignments, engaged their own legal counsel, and did not rely on any representation by Tzolis or his representatives. The plaintiffs further acknowledged in the certificate that Tzolis owed them no fiduciary duty in connection with the assignments. The operating agreement also contained a provision stating that a member could engage in other business ventures of any nature, whether or not in competition with the LLC, without any obligation to the LLC or its members. The assignments became effective, and six months later the LLC (wholly owned at this time by Tzolis) assigned its lease to another entity for $17.5 million. Pappas claimed that he later discovered Tzolis had begun negotiating the sale of the lease months before the assignment of the plaintiffs’ interests. The plaintiffs asserted numerous causes of action, and Tzolis moved to dismiss the complaint in its entirety. Tzolis argued that he and the plaintiffs never intended to enter into a fiduciary relationship and that Delaware law permitted the elimination of fiduciary duties among members, which was achieved by the paragraph in the operating agreement permitting members to pursue other business opportunities. Tzolis also relied upon the certificate signed by the plaintiffs. The motion court concluded that the operating agreement eliminated the fiduciary relationship that would have otherwise existed among the members and granted the motion to dismiss. The appellate court disagreed with the lower court’s interpretation of the operating agreement and reinstated a number of the plaintiffs’ claims. The court stated that the operating agreement may have permitted Tzolis to pursue a business opportunity unrelated to the LLC for his exclusive benefit without having to disclose it to the plaintiffs or present it to the LLC, but the clause did not permit the behavior here, which was to surreptitiously engineer the lucrative sale of the LLC’s sole asset without informing his fellow members. The court stated that the agreement did not eliminate all fiduciary duties that the parties owed one another because managers owe traditional fiduciary duties under Delaware law unless the LLC agreement explicitly restricts or eliminates those duties. The court concluded that the plaintiffs adequately alleged that Tzolis breached a fiduciary duty to keep them informed of any and all opportunities he was pursuing on behalf of the LLC. With respect to the certificate, the court relied upon Blue Chip Emerald v. Allied Partners, in which the court stated that “a fiduciary cannot by contract relieve itself of the fiduciary obligation of full disclosure by withholding the very information the beneficiary needs in order to make a reasoned judgment whether to agree to the proposed contract.” Accordingly, the court here concluded that the motion court erred in dismissing the plaintiffs’ claims for breach of fiduciary duty and fraud. The court also reinstated the plaintiffs’ claims for conversion and unjust enrichment. The dismissal of a claim for misappropriation of business opportunity by Tzolis was upheld because it was the LLC that assigned the lease, and the court held that claims based on or related to breach of contract were properly dismissed. Because the plaintiffs’ assignment of their interests might be voidable, the court held that the plaintiffs had standing to assert a derivative claim on behalf of the LLC, but the derivative claim for breach of fiduciary duty to the LLC was properly dismissed because the allegations showed that the LLC received $17.5 million for the lease. Two justices dissented on the basis that the contractual disclaimers by the plaintiffs precluded the causes of action asserted. The dissent argued that the majority’s reliance on Blue Chip Emerald v. Alliance Partners was misplaced and that the disclaimers in the certificate effectively released the plaintiffs’ claim for breach of fiduciary duty based on Centro Empresarial Cempresa S.A. v. America Movil, a case in which the New York Court of Appeals held that the broad release signed by the minority shareholders of a closely held corporation was effective to release breach of fiduciary duty, fraud, and unjust enrichment claims. The dissent argued that the fraud claim failed under New York’s “special facts” doctrine, which imposes a duty to disclose absent a fiduciary duty only where one party’s superior knowledge is such that nondisclosure would render the transaction unfair. According to the dissent, the offer to buy their interests for 20 times what the plaintiffs invested should have alerted them to the fact that a deal was in the offing, and their failure to investigate was unreasonable as a matter of law and fatal to their claim. On appeal, New York’s high court reversed the appellate division and held that the contractual disclaimers were effective to release the plaintiffs’ claims.

HL 1, LLC v. Riverwalk, LLC

15 A.3d 725 (Me. 2011)

(lack of standing of third party who was not creditor of LLC to seek judicial dissolution of LLC).

Marino v. Grupo Mundial Tenedora

S.A., 810 F.Supp.2d 601 (S.D.N.Y. 2011)

(absence of fiduciary duties of non-managing minority members of Delaware LLC; absence of control where minority members are not related but simply vote together; failure to state claim of breach of fiduciary duty where operating agreement permitted forced sale without appraisal or fair market value determination; enforceability of exculpatory clause in Delaware LLC agreement).

Rhodes v. Paragon Molding, Ltd.

No. 24491, 2011 WL 3808102

(Ohio App. Aug. 26, 2011) (lack of evidence of fraud or illegal act of members of LLC as required to pierce veil to impose personal liability on members).

Michael E. Siska Revocable Trust v. Milestone Development, LLC

715 S.E.2d 21 (Va. 2011)

(application of necessary party doctrine to LLC in derivative suit).

Knight v. TCB Construction and Design, LLC

248 P.3d 178 (Wyo. 2011)

(rescission and replacement of individual’s pre-formation contract with post-formation agreement entered into by LLC).

Thorkildsen v. Belden

247 P.3d 60 (Wyo. 2011)

(nature of action as enforcing or preventing breach of operating agreement for purposes of recovery of attorney’s fees under terms of operating agreement).