673 F.3d 352 (5th Cir. 2012)
Nicholas Gray sued his employer, an LLC that owned a nightclub, and one of its owners, Michael Powers, for alleged violations of minimum wage standards under the Fair Labor Standards Act (FLSA). Gray alleged that Powers was personally liable with the LLC for the FLSA damages as an “employer” under the FLSA. The court applied the “economic reality” test to determine whether there was an employer/employee relationship between Powers and Gray. Under this test, the court considers whether the alleged employer: (1) possessed the power to hire and fire employees; (2) supervised and controlled employee work schedules or conditions of employment; (3) determined the rate and method of payment; and (4) maintained employment records. Applying this test, the court held that Powers was not Gray’s employer. With respect to the power to hire and fire, Gray argued that Powers had the inherent power to fire Gray as a member and officer of the LLC. The only evidence Powers cited was the collective power of the LLC members to hire and fire the general manager, but the court stated that this participation in a joint decision with co-owners proved nothing about whether Powers had the authority individually to control employment terms of lower-level employees. In the absence of specific facts in this regard, Gray argued that the court should infer such authority from the position of member and officer. The court rejected this argument and stated that a status-based inference of control alone cannot suffice to create a fact question on the issue of whether Powers had the power to hire and fire bartenders. Similarly, the court found no evidence upon which a reasonable jury could find that Powers controlled employee work schedules or conditions of employment, determined the employees’ rate or method of pay, or maintained employment records. In sum, Powers was not sufficiently involved in the operation of the nightclub to be an employer.
692 F.3d 593 (7th Cir. 2012)
Investors in a real estate LLC asserted fraud claims against the attorneys who drafted the LLC’s formation documents based on the participation of one of the attorneys in a presentation by the promoter. The court concluded the attorneys had no attorney-client relationship with the investors and that the attorneys were not liable on any of the theories asserted by the investors. The promoter of a venture to buy, rehabilitate, and sell or refinance and rent real estate contacted an attorney, White, to form two LLCs (one of which would be owned by the promoter and two other individuals and the other of which would be owned by the first LLC and investors solicited through private offerings), and White brought in a senior partner, Beaman, who had more expertise in corporate law. The promoter held an investment seminar to present the idea to potential investors, and the promoter talked at length about his investment plan. After about an hour, the promoter asked White whether he would like “to add anything on the creation of the company.” White began by addressing a concern raised by a prospective investor about potential conflicts of interest with the promoter’s other companies, and White explained that these issues could be addressed in the operating agreement. White also noted that he and his firm were looking into how to avoid certain securities-law concerns issues that might arise from the creation of the LLC and generally explained how structuring the investment venture as an LLC would insulate the investors from personal liability. The promoter added comments in which he stated that the attorneys represented the LLC rather than the promoter personally and “[t]hat means they represent you as well.” As co-owners of the LLC, the promoter and the other investors all had interests that needed to be protected and that the attorneys “are working for you just like they are working for me.” White stood next to the promoter during these comments and did not make any attempt to clarify or correct them. In the following weeks, Beaman drafted, executed, and filed articles of organization and also drafted operating agreements for both LLCs and loan documents. The plaintiffs invested more than $1 million, and a little over a year later the promoter informed the investors that their investments were gone and he was filing bankruptcy due to the downturn in the real estate market. The investors, believing that the promoter had bilked them, filed suit against the promoter and others, including White, Beaman, and their law firm. Eventually, the only defendants remaining were White, Beaman, and the law firm. The district court granted summary judgment in favor of the defendants, and the court of appeals agreed with the district court that the attorneys could not be held liable on claims for legal malpractice, state and federal securities fraud, actual and constructive fraud, or conspiracy. First the court of appeals held that there was no attorney-client relationship between the defendants and the investors, thus precluding their malpractice and constructive fraud claims. The attorneys were hired to prepare the formation documents for the LLCs and had no further involvement with the companies after they completed this task. The court recognized that there was an attorney-client relationship with the two LLCs, but there were no alleged breaches of duty in the drafting of the LLC formation documents. Most of the plaintiffs never met White, Beaman, or any other member of the firm, and the plaintiffs’ relied upon White’s presence and participation at the investment seminar and the limited interaction between a few of the plaintiffs and White and Beaman. The court found White’s brief, seven-minute presentation at the investment seminar was insufficient for any investor to reasonably believe the attorneys would be involved in the venture beyond the point of the LLCs’ formation. The court also concluded that the promoter’s monologue was insufficient to imply an attorney-client relationship. Taken in context, the promoter’s statements were intended to assure the investors that the attorneys were hired to represent the two LLCs during their formation, and the potential investors could not reasonably believe they had a personal attorney-client relationship for the indefinite future. The court also stressed that the plaintiffs signed an operating agreement that included prominent language (in all caps right above the signature lines) stating that they had been given the opportunity to review the operating agreement with their legal counsel and/or accountant. The court rejected the argument that the defendants owed them a duty even absent an attorney-client relationship under the Indiana Rules of Professional Conduct. The court stated that the rule addressing dealings with unrepresented persons clearly does not create a legal duty. The absence of a legal duty also impacted the plaintiffs’ securities fraud claim. The plaintiffs’ based their claim on White’s silence as to certain matters during the investment seminar, but an omission cannot be fraudulent absent a duty to speak. The plaintiffs’ actual fraud claims revolved around future conduct or existing intent as to future matters, which did not support an actual fraud claim. Finally, the court rejected the plaintiffs’ claim that the attorneys conspired with the promoter to commit various torts. There was no evidence the work the promoter hired the attorneys to do was unlawful, and the attorneys had no involvement in soliciting or managing investments. The drafting of the formation documents for the LLC was lawful work for a lawful purpose and was completed before the first investment was made. Thus, even if the promoter acted improperly with respect to the investments, the attorneys could not be liable for acting in concert with the promoter ro commit an unlawful act or to accomplish an unlawful purpose through unlawful means.
686 F.3d 361 (7th Cir. 2012)
A group of LLC borrowers challenged the authority of the vice president of the LLCs (the vice president was itself an LLC managed by an individual, Okun) to consent on the LLCs’ behalf to the assignment by Morgan Stanley of Morgan Stanley’s obligations under an escrow agreement that was part of a loan transaction between Morgan Stanley and the LLCs. After Morgan Stanley made the loan to the LLCs, it sold the loan, and the vice president executed borrower’s escrow instructions on behalf of the LLCs in connection with the sale of the loan. The court held that the LLCs had fostered in the vice president and the vice president’s manager, Okun, the authority or apparent authority to consent on the LLCs’ behalf because each LLC’s operating agreement provided that third parties dealing with the LLC were entitled to conclusively rely on the signature of the vice president as evidence of authority of the vice president to execute the loan documents on behalf of the LLC and to bind the LLC, and the consent of owners executed for each LLC in connection with the loan transaction identified as vice president the entity that consented to the assignment. Thus, the court concluded that Morgan Stanley had the consent of the LLCs to assign both Morgan Stanley’s rights and obligations under the escrow arrangement. Whether or not the vice president was permitted to grant the consent did not alter Morgan Stanley’s right to rely on the vice president’s representations that it had the power to do so.
484 B.R. 360 (9th Cir. (BAP) 2012)
In this involuntary bankruptcy proceeding, the court analyzed the location of the debtor’s LLC and LLLP interests for purposes of determining proper venue of the bankruptcy proceeding. The petitioning creditor argued that venue was proper in the District of Nevada because the debtor’s principal assets were his interests in a Nevada LLC and a Nevada LLLP. Under the Bankruptcy Code, a bankruptcy case may be commenced in the district where the debtor’s domicile, residence, principal place of business in the United States, or principal assets in the United States have been located for180 days immediately before the proceeding. The debtor stated that he had resided in Washington since 2007 (after previously residing in California) and that he conducted no business in Nevada, had no place of business in Nevada, and had no property in Nevada. The debtor admitted that his principal assets were his interests in a Nevada LLC and a Nevada LLLP, but he explained that the LLLP was a holding company for a number of non-Nevada entities that held real estate outside of Nevada, that the partnership’s records were maintained in Idaho, that its bookkeeping was done in California, and that it conducted no business in Nevada. The debtor further explained that the LLC was the general partner of the LLLP, that the LLC’s only asset was its interest in the LLLP, and that the LLC had no offices or place of business in Nevada. The bankruptcy court concluded that the intangible LLC and LLLP interests had no physical location and that venue of the bankruptcy case in Nevada was improper since there was no other basis for venue in Nevada. Alternatively, the bankruptcy court concluded that, to the extent the interests had any cognizable location, they were located in the debtor’s state of residence, applying the common law and analogizing to Article 9 of the UCC with respect to the place of perfection of a security interest in a general intangible. The appellate panel reversed, concluding that the interests at issue were located in Nevada and venue was thus proper in Nevada under the facts and circumstances of this case. The bankruptcy appellate panel acknowledged that the location or situs of intangible property is a legal fiction but noted that courts frequently ascribe a location to intangible assets for particular purposes, and the court rejected the bankruptcy court’s “one-size-fits-all,” “bright line” approach in favor of a “common sense, context-specific” approach to determining the location of the interests for purposes of bankruptcy venue. The court found no case law addressing the location of intangible assets for bankruptcy venue purposes, but the court viewed Ninth Circuit case law outside the bankruptcy context as mandating a “‘context specific’ analysis that employs a ‘common sense appraisal of the requirements of justice and convenience in particular conditions.’” The court further believed that the location of assets should be determined in a manner “‘most resonant with the functional concerns of the administration of the bankruptcy estate.” The court stated that it was important to consider what rights a bankruptcy trustee would have to seize and liquidate the debtor’s interests in the LLC and noted that Nevada law governed the LLC and the partnership. The court discussed the charging order remedy available to a judgment creditor of an LLC member or partner of an LLLP under the Nevada LLC and limited partnership statutes, emphasizing the exclusivity of the charging order remedy under both statutes and stating that a judgment creditor or bankruptcy trustee seeking to obtain a charging order would be required to seek the charging order in Nevada state court. The court noted a Washington case in which the court concluded that the situs of an interest in a Washington LLC was Washington for purposes of a creditor’s action for a charging order. The appellate panel also commented on the potential ability of the trustee to liquidate the interests. The court stated that the interests would constitute property of the bankruptcy estate and that the trustee, standing in the shoes of the debtor as a member or partner of the entities, could seek to judicially dissolve the entities and distribute their assets to the members. The court reasoned that such a judicial dissolution proceeding would have to be brought in Nevada state court because the Nevada LLC and limited partnership statutes grant exclusive jurisdiction for a judicial dissolution proceeding to Nevada district courts. The court also noted that courts in several states in analogous situations have held that jurisdiction to dissolve a corporation exists only in the courts of the state of incorporation. The court thus concluded that the Nevada statutes implicitly treat a member’s or partner’s interest as located in Nevada, and the court concluded that Nevada should likewise be considered the location of the interests in the context of this case for bankruptcy venue purposes. The court stated that its conclusion was bolstered by notions of convenience and justice. The debtor availed himself of the benefits of establishing the Nevada LLC and LLLP and transferred all of his assets to those entities. The court found it disingenuous for the debtor to now argue Nevada was not a proper venue for his creditors to pursue their efforts to seize and liquidate his assets after taking advantage of Nevada laws to create the entities into which he transferred all his assets. Further, the Nevada appeared to be the most convenient venue for administration of the bankruptcy case given that it would be necessary to come to a Nevada court to obtain a charging order or judicial dissolution. The court concluded by reiterating that the bankruptcy court’s decision that intangible assets may have no situs or be located where the debtor’s residence is located might be defensible under different facts, but common sense, context, justice, and convenience in this case led the appellate panel to the conclusion that the LLC and LLLP interests were located in Nevada for purposes of venue in this involuntary proceeding. A dissenting member of the panel argued that the majority erroneously treated a “context specific” analysis as a “case specific” analysis. The dissent argued that the bankruptcy court correctly looked to Article 9 of the UCC to decide the location of the debtor’s intangible interests in the LLC and LLLP.
477 B.R. 196 (Bankr. D. Colo. 2012)
A Colorado LLC issued 108 promissory notes, and the LLC’s sole member, Yellen, executed a Membership Pledge and Security Agreement in which he pledged a pro rata portion of his membership interest to each note holder. The LLC defaulted on the payment of the notes in 2007, and in 2011, Yellen, acting as sole member and manager of the LLC, adopted a unanimous consent authorizing and directing the filing of the LLC’s Chapter 11 bankruptcy petition. Certain note holders challenged Yellen’s authority to file the bankruptcy. These note holders asserted that the terms of the security agreement for the pledge of the membership interest divested Yellen of control of the LLC. The note holders argued that the security agreement was self-executing, relying on language in the security agreement that provided that the “rights of the Pledgor to vote and give consents...shall cease in case default shall occur and be continuing” and that the “Secured Party, subsequent to any default, may transfer or cause to be transferred into the names of his nominee or nominees any or all of the Pledged Interest” and “also may vote any or all of the Pledged Interest (whether or not transferred) and give all consents, waivers and ratifications...as though they were the outright owners thereof.” The security agreement also gave to the secured party a proxy and power of attorney to act for the pledgor. The court held that the note holders were precluded from taking the position that the security agreement was self-executing as to voting rights because the note holders had taken conflicting positions in other lawsuits in Colorado state courts in which the note holders had argued that Yellen was the sole member of the LLC and that the note holders were not members and had not exercised any rights under the security agreement. The note holders argued next that they did not have to be members of the LLC to exercise their rights per the proxy and power of attorney granted by the security agreement, but the court relied upon a California bankruptcy case and the Colorado LLC statute in concluding that only the members or managers of an LLC are entitled to vote or exercise management rights notwithstanding a pledge of a membership interest. The court relied upon the provision of the Colorado LLC statute that specifies the rights of an assignee or transferee are limited to financial rights and that an assignee or transferee does not have any right to participate in the management of the business and activities of the LLC or to become a member. The note holders argued that the transfer provisions of the operating agreement overrode the provisions of the Colorado LLC statute because the operating agreement permitted a member to transfer his interest in the LLC without consent of any other person. The court stated that this provision of the operating agreement allowed Yellen to transfer his interest if he so chose without consent of any other person, but the provision did not necessarily allow any other person to divest Yellen of his interest. The court stated that it did not appear Yellen had ever divested himself of his “member” interest and, in any event, had not ceased being the manager. Furthermore, even if the transfer provision allowed the involuntary ouster of Yellen, it was undisputed that the note holders had not exercised or foreclosed on their security interests, nor had any additional members been admitted to the LLC. In sum, the court concluded that consistent with various state court rulings in litigation involving the note holders, Colorado law requires a secured creditor to enforce the security agreement and become admitted as a member before voting rights associated with pledged membership interests can be exercised. To hold otherwise, said the court, would permit someone who is not a member or manager to control an LLC.
LaFond v. Sweeney
__ P.3d __, 2012 WL 503655 (Colo. App. 2012)
This dispute over the distribution of attorney’s fees from a contingent-fee case pending at the time of the dissolution of a two-member LLC law firm presented the court with a matter of first impression in Colorado. LaFond and Sweeney formed a law firm as an LLC, and they orally agreed to share equally in all the profits of the firm without regard to who brought the cases into the firm or who did the work on them. LaFond represented a client in a whistle-blower action on a contingency fee basis. After a considerable amount of work was done on the case, LaFond’s firm dissolved. Once the firm dissolved, LaFond continued to represent the client in the action. At the time of the dissolution, there was no written agreement describing how the firm’s assets should be distributed, and no written agreement existed regarding how the contingent fee generated by the case would be distributed. LaFond and Sweeney were unable to reach an agreement as to the division of the fees that were potentially going to be earned from the whistle-blower case, and LaFond filed a declaratory judgment action seeking a determination by the court as to how the potential fee should be distributed. The trial court determined that the whistle-blower case had been an asset of the law firm, and the value of the case as an asset of the firm was its value at the time the firm dissolved. The oral agreement between LaFond and Sweeney required any profit from the whistle-blower case to be divided equally, so if LaFond recovered a contingent fee from the case, the trial court held that Sweeney would be entitled to one half of the recovery up to a ceiling of an amount calculated based on the work done and costs advanced as of the date of the dissolution. The whistle-blower case then settled, and although LaFond and Sweeney agreed that their oral agreement required them to divide the profits from the case equally, they disagreed on how those profits should be calculated. On appeal, Sweeney contended that she was entitled to half of the entire contingent fee awarded to LaFond in the whistle-blower case, and LaFond argued that the trial court properly calculated the value of the case recovery awarded to Sweeney, which was based on an hourly valuation of attorney’s fees and costs expended by the firm as of the date of its dissolution. The appellate court agreed with Sweeney. In reaching its decision, the court of appeals discussed three principles. First, cases belong to clients, not to attorneys or law firms. Attorneys and law firms must not engage in conduct that would impermissibly interfere with a client’s right to choose counsel, and disputes between attorneys over a fee due or that may become due should not affect the client’s right to choose counsel. Here, the client did not seek new counsel after dissolution of LaFond’s firm, and the client manifested his intention that La Fond fulfill the continuing obligation of the firm. The court found no indication that the client’s right to choose his counsel was adversely affected by the dispute between LaFond and Sweeney. Second, when attorneys handle contingent-fee cases to a successful resolution, they have enforceable rights to the contingent fee provided the contingent-fee agreement satisfies the general requirements for contracts and the special requirements of professional ethics. Here, the client was required to pay the fee when the case settled because the agreed upon work was completed, and cases limiting a discharged attorney’s recovery to quantum meruit were thus inapposite to the issue presented in this case. The final principle addressed by the appellate court is that a contingent fee may constitute an asset of a dissolved law firm organized as an LLC, and the fee is to be divided among its members once it is earned. The court looked at case law in other states and concluded that the principles of partnership law applied in those cases furnished appropriate guidance for resolution of the issue in this case. Here, a contingent-fee case was brought into the law firm before it dissolved, and LaFond continued to handle the case after dissolution until the case was resolved. Importantly, dissolution did not terminate the LLC law firm. Instead, the entity continued as to all existing matters for the purpose of winding up its unfinished business. The pending whistle-blower case was unfinished business to be completed in the process of winding up the LLC law firm, and dissolution of the firm did not void or negate the contract or release the firm from its obligations to the client. An attorney such as LaFond who carries on the representation of a client and completes an existing case following dissolution does so on behalf of the dissolved firm. Thus, any income received by a member from winding up unfinished business belongs to the dissolved firm, and any attempt by a member to convert such business solely to his or her own business violates the duty owed to the dissolved firm absent a contrary agreement by the members. The contingent fee earned by LaFond was the firm’s asset because it constituted the completion of unfinished business of the LLC at its dissolution. As an asset of the dissolved firm, Sweeney also had rights in the contingent fee earned. The court relied on the California case of Jewel v. Boxer and numerous other out-of-state cases and emphasized that its decision was in line with the great majority of states where courts have concluded that contingent fees ultimately generated from cases that were pending at the time of dissolution of a law firm must be divided among the former partners according to the fee-sharing arrangement that was in place when the firm dissolved, absent a contrary agreement. LaFond owed the dissolved law firm fiduciary duties, including the duty to divide the firm’s assets with Sweeney according to the oral fee-sharing agreement in place when the firm dissolved, and the duty extended to the contingent fee. The court of appeals pointed out a distinction (overlooked in many jurisdictions applying the majority rule) between a pending contingent-fee case as being unfinished business to be completed in winding up a dissolved firm and the fee generated by that pending case as being property of the firm. The court felt it was an important distinction in the context of this appeal. The court noted that the allocation of firm assets generally must be based on their value at the time of dissolution, but the value of an as-yet-unearned contingent fee cannot be ascertained until the case is completed – only then does the asset come into existence. The trial court characterized the whistle-blower case as a firm asset and ascribed to it a value determined by employing a form of quantum meruit analysis based on totaling the hourly attorney’s fees and costs as of the date of dissolution. The trial court’s ruling attempted to bring finality to the dissolution of the firm, but it did not take into account the fact that the LLC firm did not terminate upon dissolution but instead continued to exist until all pending business was complete. Although most of the court’s analysis was based on similarities between partnership and LLC law, the court noted an important difference between the partnership and LLC statutes in Colorado resulting in the conclusion that LaFond was not entitled to compensation beyond his share of the contingent fee for winding up the whistle-blower case on behalf of the dissolved law firm. Unlike the Colorado Uniform Partnership Act, which states that a partner is entitled to reasonable compensation for services in winding up the business of the partnership, the Colorado Limited Liability Company Act does not expressly authorize compensation to former members who wind up the LLC’s business. The court found that the exclusion of such language from the LLC statute represented an intentional choice by the legislature. In addition, the court cited Jewel and other out-of-state cases rejecting the concept of awarding an attorney extra compensation for winding up a contingent-fee case. In sum, LaFond had a duty to wind up unfinished business of the dissolved law firm, including continuing to represent the client in the whistle-blower suit, and the contingent fee earned in the case was the dissolved firm’s asset, which was subject to an equal division between LaFond and Sweeney based on their pre-dissolution oral agreement to share equally in all the firm’s profits. Further, LaFond was not entitled under Colorado LLC law to compensation beyond his share of the contingent fee.
277 P.3d 916 (Colo. App. 2012)
Four LLCs, each having between four and seven members, including Young and Bush, were formed to acquire and develop real estate. Bush was the founder and sole manager of the LLCs. Young began questioning Bush’s management of the LLCs, and after an unsuccessful settlement and release, Young filed this action asserting numerous claims, individually and derivatively, against Bush, Bush Development, Inc., and the LLCs. The LLC members held a special meeting attended by Young, the other LLC members (either in person or by proxy), counsel for Young and the LLCs, and special counsel for the LLCs. Bush was not present at the meeting. The special meeting was for the purpose of determining whether the derivative action was in the best interests of the LLCs. All members other than Young agreed the action was not in the LLCs’ best interests. The defendants moved for dismissal of the action or for summary judgment arguing that based on the applicable statutory provision dismissal was required because a majority of the independent members had determined that pursing the derivative action was not in the best interests of the LLCs. Young responded that genuine issues of material fact existed as to whether the determination that the action was not in the LLCs’ best interests had been made by independent members and whether the determination was based upon an adequate inquiry, two requirements for dismissal under the statute. The trial court interpreted the applicable statute as allowing it to liberally construe a member’s vote and his independent status regarding the derivative proceeding, and the court found that the plaintiff had the burden under the statute to prove the lack of independence and inadequate inquiry. The trial court entered summary judgment in favor of the defendants concluding that Young failed to prove the lack of independence of the members agreeing not to pursue the derivative action or the inadequacy of the members’ inquiry. On appeal, Young alleged that the trial court erred in dismissing his derivative claims because it incorrectly applied a cursory “liberal” standard in addressing the independence of the members who voted that the action was not in the best interests of the LLCs rather than applying case law applicable to corporate and limited partnership derivative actions. In addition, Young contended that the trial court erred because there was a genuine issue of material fact as to the independence of those members as well as the adequacy of the inquiry on which their determination was based. The appellate court held that the case was to be remanded to the trial court for the plaintiff to conduct discovery on the issues of independence and adequate inquiry, and the trial court was to then assess, under the standard set by the appellate court, whether the derivative claim should be dismissed based on the applicable statute. The court of appeals discussed the history of the enactment of the Colorado Limited Liability Company Act and its amendment in 2002 to provide for derivative actions by members. On its face, the provision requires a court to dismiss a derivative action against an LLC if the decision makers described in the provision determine in good faith, after conducting an inquiry upon which the determination was based, that maintenance of the derivative action is not in the best interests of the LLC. The decision makers must be independent, but they are not deemed to lack independence based solely on enumerated circumstances, and the burden is on the plaintiff to prove that the decision makers are not independent, the inquiry was inadequate, or the determination was not made in good faith. No reported appellate cases address the provision, no other states’ statutes are identical or substantially identical, and the legislative history does not shed light on the general assembly’s intent in enacting the provision. At issue in the present case were the independence of the decision makers and the adequacy of their inquiry. “Independent” and “inquiry” are not defined in the provision, so the court was left to determine these standards. The parties disagreed on the extent to which the appellate court could rely on case law addressing dismissal of derivative actions in the context of other business entities. The appellate court determined that additional standards based on case law were applicable as long as those standards were not inconsistent with the specific language chosen by the general assembly to apply to dismissal of derivative actions against LLCs. First, the appellate court considered the standard for determining whether a decision maker recommending dismissal of a derivative action was independent. The determination of independence is highly fact-sensitive, but the fundamental question was whether the decision maker had any interest (i.e., not solely pecuniary but also personal interest in the challenged transaction) in the litigation and relationship with the defendant that was likely to interfere with the ability to exercise an independent, unbiased judgment with respect to the litigation. The court determined that substantial business relationships and close personal or family ties, while not necessarily dispositive, could create a material question of fact as to the independence of the decision makers. In deciding Young’s challenge to the independence of the LLCs’ members who voted against maintaining the derivative action, the trial court did not base its decision on standards developed under case law. Instead, the trial court concluded that the provision, which enumerated circumstances that did not by themselves establish lack of independence, allowed the court to construe “liberally” the vote and the independent status of the LLCs’ members, that the business and family relationships cited by Young did not show that the members were incapable of voting independently, and that case law regarding independence in the corporate context were inapplicable and factually inapposite. The appellate court disagreed and held that the provision did not foreclose further analysis under case law on the independence issue. Looking at Colorado case law in the corporate and limited partnership context, case law in other jurisdictions, and the LLC statute itself, the appellate court stated that deference to the substantive decision of the members was required in that both the statute and case law directed courts to defer to the business judgment of an independent person or entity recommending dismissal of a derivative action. However, the appellate court concluded that the provision did not itself establish a lenient standard of review or permit a court to forgo further inquiry into the independence of the persons whose substantive decision regarding maintaining the derivative action would be binding on the court. By identifying circumstances that did not alone cause a person to not be considered independent, the general assembly indicated that independence was a matter of degree rather than an absolute. Unlike case law and other LLC statutes, the provision placed the burden on the plaintiff to show the lack of independence by the decision makers. Placing the burden on the plaintiff to disprove the existence of the statutory requirements could suggest a legislative intent to afford more deference to the decision makers or allow a presumption of the requirements of independence, good faith, and adequate inquiry. However, such deference was not unlimited, and such a presumption was not irrebuttable. If a plaintiff proved that a decision maker was not independent due to having a stake in the litigation or a relationship with a defendant that would interfere with his or her ability to make an unbiased judgment as to what was in the best interest of the LLC, the court would not defer to the decision makers’ business judgment and dismiss the derivative action. In sum, the independence of a decision maker within the meaning of the provision depends on whether he or she has a stake in the litigation or a relationship with a defendant that precludes him or her from making an unbiased judgment as to whether dismissal of the derivative action was in the best interest of the LLC. Business, personal, or familial relationships with a defendant raised a question about whether a decision maker was independent, but such relationships were not dispositive. That is, a court could find that the specific relationship at issue would not interfere with the decision maker’s independence. Applied to this case, the defendants submitted minutes of the special meetings of the LLCs establishing who was in attendance and that all members other than Young voted that maintaining the derivative action was not in the best interests of the LLCs. Young submitted an affidavit stating that numerous members had familial and business relationships that caused them not to be independent for the determination of whether to proceed with the suit. The affidavit also requested discovery, including taking depositions of some of the members whose independence was in question, to determine their relationships with and financial connections to the defendants Bush and Bush Development for the purpose of assessing their independence. The trial court denied the requested discovery and dismissed the derivative action based on the members’ vote. The appellate court reversed the trial court’s decision and held that the facts set forth in Young’s affidavit showed business and familial relationships sufficient to create a material question of fact as to the independence of the LLC members who made the best interests determination. The appellate court remanded on the issue of independence to allow discovery to establish whether the relationships interfered with the members’ ability to exercise independent, unbiased judgments regarding maintenance of the derivative action. On remand, the trial court was to determine the issue of independence based on the facts discovered applying the standards set forth above. Next, the appellate court considered whether the inquiry on which the decision makers based their decision not to proceed with the derivative action was adequate within the meaning of the provision and applicable case law. Young argued to the trial court that the LLCs’ members did not make a reasonable inquiry, if any at all, into the allegations of the complaint. Young noted there was no evidence of any investigation by the members and there was no report. Young requested leave for discovery to depose members regarding their inquiry into the allegations and any parties on whose investigation the LLC members relied, asserting such information was relevant as to whether the best interest determination was based on a sufficient inquiry. The trial court found that the statute did not require a report, that the minutes showed the LLCs’ counsel had conducted an inquiry and reported his conclusions to the members, and that Young had not met his burden to show that the inquiry was inadequate. The trial court held there was no issue of material fact regarding the adequacy of the defendants’ inquiry and therefore denied Young’s request for further discovery on the issue. The appellate court considered the provision and case law and disagreed with the trial court. According to the appellate court, the LLC statute does not appear to contemplate the production of a written report or an investigation as extensive as those required in corporate derivative actions but does require that there be an inquiry to produce facts sufficient to enable LLC members to make an informed and good-faith decision on whether maintenance of the derivative action is in the LLCs’ best interests. Although analysis is fact-sensitive, the fundamental principle gleaned from case law was that the focus of the judicial review regarding the adequacy of the inquiry should be on the procedures followed rather than on the substantive conclusion reached by the investigation. Under the business judgment rule, the substantive conclusion was not subject to judicial review, however a court may properly determine the adequacy and appropriateness of the investigative procedures used. There is no single standard for assessing the adequacy of an inquiry or investigation, but some relevant factors include the length and scope of the investigation, the use of experts, the business entity’s or defendant’s involvement, and the adequacy and reliability of the information supplied to the decision makers. The appellate court noted that the provision referred to an “inquiry” rather than an “investigation” as discussed in many corporate and limited partnership cases. An inquiry is less thorough than an investigation, so its use by the legislators indicates that they intended an inquiry in the context of the provision to be less searching and detailed than an investigation. The use of this term recognizes that LLCs may have fewer members and fewer resources than a large corporation, and an adequate inquiry can be conducted without retaining experts or independent outside counsel, although a lack of outside counsel may relate to issues of the decision makers’ independence and good faith. Thus, the appellate court concluded that an inquiry under the provision could be less searching and detailed than investigations described in the case law. However, it did not follow from this that no inquiry was required or that the trial court could undertake only a cursory review of the inquiry on which the LLCs’ members based their determination as to whether to maintain the derivative action. In sum, although no written report was required and the members could rely on an independent attorney’s bona fide investigation, the record had to show that the investigation produced information bearing on the substance of the allegations made by the plaintiff and that the members had before them sufficient information on which to base their decision of whether maintaining the derivative action was in the best interests of the LLCs. The appellate court determined that the record did not establish whether the inquiry was sufficient. On remand, Young would be entitled to discovery on this issue, and the trial court should then decide based on the facts discovered and the standards set forth above whether the LLCs’ decision was based on an adequate inquiry into Young’s allegations. Finally, the appellate court addressed whether Young’s claims for relief were direct rather than derivative such that he should have been allowed to pursue them despite the trial court’s dismissal of the derivative action. A member of an LLC may assert a direct claim when the member suffered injuries separate and distinct from the injury to the LLC or other members. Although Young’s complaint stated that each claim was asserted by him individually and as a member of the LLCs, he argued in response to the defendants’ motion to dismiss that his third claim for breach of his settlement agreement with Bush was a direct claim only. The trial court did not address this contention when it dismissed all the claims. After the notice of appeal was filed, the defendants filed a response indicating their willingness to stipulate that Young’s third claim was an individual direct claim and asked the court to reinstate that claim against defendant Bush only. The trial court entered the order so stating, but it lacked jurisdiction to do so because the notice of appeal had been filed. The appellate court affirmed the trial court’s ruling that Young’s claim for breach of his settlement agreement with Bush was a direct claim that could be maintained regardless of the trial court’s decision regarding the dismissal of the derivative action. Although Young did not amend his complaint to clarify this allegation, the defendants were on notice from the substance of the allegations that Young was alleging an injury separate and distinct from any injury suffered by the LLCs or other members of the LLCs. Also, if Young were to prevail on this claim, relief would go to him personally rather than to the LLCs. The appellate court remanded to permit Young to reassert his breach of settlement claim as a direct claim if he chose to do so. The appellate court held that the trial court did not err in dismissing and refusing to reinstate claims for access to records and an accounting where Young failed to clarify prior to judgment that the claims were asserted only directly rather than derivatively.
Martin v. Freeman
272 P.3d 1182 (Colo. App. 2012)
An LLC contracted with Martin for Martin to construct an airplane hangar, and the LLC sued Martin in 2006 for breach of the construction contract. In 2007, while the litigation was pending, the LLC sold its only asset, an airplane, for $300,000 and distributed the proceeds to the LLC’s sole member/manager, who paid the LLC’s litigation expenses. In 2008, a judgment was entered in favor of the LLC, and Martin appealed. In that appeal, the court of appeals determined that the LLC’s damages were speculative and remanded the case with instructions to enter judgment for Martin. On remand, the court declared Martin the prevailing party and awarded him $36,645 in costs. Martin initiated this action to pierce the veil of the LLC and hold the member personally liable for the costs in the previous case. The trial court pierced the veil, and the court of appeals affirmed on appeal. The court of appeals stated that, in order to pierce the LLC veil, the court must conclude (1) the corporate entity is an alter ego or mere instrumentality; (2) the corporate form was used to perpetrate a fraud or defeat a rightful claim; and (3) an equitable result would be achieved by disregarding the corporate form. The court addressed the defendants’ argument that the first and second prongs were not satisfied. (Although the caption identifies the LLC as a Delaware LLC, there is no indication that any question regarding the governing law was raised, and the court applied Colorado law without discussion of any conflict-of-laws issue.) The court listed nine factors that are considered in determining alter ego status and listed the following findings of the trial court with regard to the alter ego determination: commingling of the LLC’s assets with the member’s personal assets and the assets of another LLC owned by the member; maintenance of negligible corporate records by the LLC; inadequate records concerning the LLC’s substantive transactions; facilitation of misuse by a single individual serving as the sole member and manager; thin capitalization of the LLC; undocumented infusions of cash to pay the LLC’s operating expenses, including litigation expenses; the fact that the LLC was never operated as an active business; disregard of legal formalities; the member’s payment of the LLC’s debts without characterizing the transactions; use of the LLC’s assets for non-entity purposes in that the plane was used by the member’s other LLC without agreement or compensation; operation of the LLC as a mere assetless shell and diversion of the proceeds of sale of its only significant asset to the member’s personal account. The defendants argued that: LLCs have fewer restrictions than corporations concerning maintenance of formal records; member-owners are permitted to fund LLCs; thin capitalization is not a reason to disregard the corporate form; and third-party payment of attorney fees is proper. The court of appeals, however, concluded that the trial court considered the appropriate factors and that its findings supported the conclusion that the LLC was the member’s alter ego. The defendants also argued that the trial court erred in finding that the second prong of veil piercing was satisfied because the court did not find wrongful intent or bad faith. The court of appeals rejected this argument, concluding that showing the corporate form was used to defeat a creditor’s rightful claim is sufficient and that further proof of wrongful intent or bad faith is not required to pierce the veil. In finding that the corporate form was used to defeat a rightful claim, the trial court relied upon the LLC’s sale of its only asset and diversion of the proceeds to the member during litigation with Martin. The defendants argued that the sale of the airplane in 2007 did not support the second prong because Martin did not have a rightful claim until the cost award in 2009. The court of appeals concluded that defeating a potential creditor’s rightful claim is sufficient to support the second prong. The court stated that the member drained the LLC of all assets during litigation while the LLC was exposed to liability because it had sued Martin. Without a finding of veil piercing, the court stated that leaving the LLC with no assets would have defeated Martin’s potential claims. The defendants further argued that the second prong was not satisfied because the trial court found that all of the known or reasonably possible debts were fully provided for at the time of the distribution. The court of appeals held that this finding was not relevant to the veil-piercing analysis because it was made in analyzing Martin’s claim that the defendants violated the Colorado statutory restriction on distributions by an LLC. A strenuous dissent argued that the majority’s decision was contrary to controlling Colorado precedent requiring the party seeking to pierce the veil to prove, at a minimum, wrongful conduct in the use of the corporate form.
43 A.3d 607 (Conn. 2012)
An LLC brought an action against its commercial tenant seeking to enforce a lease agreement and collect rent. The defendant tenant alleged that the LLC lacked standing because the two members who authorized the lawsuit held only a 50% ownership interest and therefore did not have a majority interest as required to file suit on behalf of the LLC. The remaining 50% interest was held by Levine, a member whose spouse was an owner of the defendant tenant. The operating agreement was silent as to whether and when a member was disqualified from voting his or her interest, so the LLC relied on a provision of the Connecticut LLC statute providing that in determining the vote required to bring suit, the vote of any member who has an interest in the outcome of the suit that is adverse to the interest of the LLC is to be excluded. The LLC alleged that Levine had an adverse interest and that her 50% ownership was thus properly excluded in determining whether a majority interest authorized filing the suit on behalf of the LLC. The defendant tenant claimed the LLC lacked standing because Levine’s interest was not adverse and should thus be included in determining whether a majority interest authorized the litigation on behalf of the LLC. The trial court interpreted the meaning of “adverse interest” in the statute and concluded that to be adverse a member must have had a proprietary, or ownership, interest in the defendant. The court found that Levine did not have a proprietary interest in the defendant and did not have an adverse interest simply because she was the wife of a co-owner of the defendant, so her interest was insufficient to disqualify her as a voting member of the LLC. The court of appeals concluded that the record supported the trial court’s finding that Levine had no individual proprietary interest in the outcome of the litigation adverse to the LLC’s interest, and her husband’s ownership interest in the defendant was not significant enough to attribute to her an interest adverse to the outcome of the action based on their personal relationship alone. At the time the LLC voted on whether to file suit against the defendant, Levine was not facing claims against her by the other members, but the court of appeals noted that a member’s exclusion from voting for having an adverse interest in the outcome of the suit had to pertain to the litigation in question for the vote. According to the court of appeals, actions pending with different parties and separate issues were not applicable to the determination of whether an adverse interest existed. The Connecticut Supreme Court reversed and remanded, holding that the plain meaning of the term “adverse” in the statute excluding a member’s vote in the context of authorizing litigation on behalf of the LLC encompassed any interest of a member that was contrary to or opposed to the LLC’s interest in the outcome of the litigation. The court stated that an adverse interest is not limited to circumstances in which a member has a direct, adverse proprietary interest and that when a member’s spouse holds an interest or maintains a position of control in a defendant company, that member’s interest is considered adverse to the outcome of a lawsuit by the LLC against the defendant company. The court noted that the law generally affords a different treatment to spouses than to other parties, and the court concluded that the sweeping scope of the term “adverse” in the provision of the LLC statute at issue requires the interests of a member’s spouse to be imputed to the member. The court explained that this categorical rule allows members to be aware of whether their votes will be excluded because of a spouse’s interest and reduces litigation among members over whether their votes should be counted. If the members of an LLC do not want to be bound by this rule, the statute allows them to modify the rule in the operating agreement. Based on the interpretation of the statute adopted by the supreme court, the ownership interest of Levine’s spouse in the defendant was imputed to Levine such that Levine had an interest adverse to the outcome of the litigation the LLC brought against the defendant. Because Levine’s interest was adverse, she was properly excluded from the vote on whether to file suit against the defendant, and the other 50% had a majority ownership interest that could move forward with filing suit. Alternatively, the defendant contended that the provision of the LLC statute relied upon by the LLC did not apply because the LLC’s operating agreement was silent as to whether it adopted or incorporated by reference the provision. The supreme court disagreed. The court stated that the statutory provision governing the exclusion of a member’s vote applies to all LLCs unless an LLC’s operating agreement provides for a different rule that conflicts with the statute or provides that the statute does not apply. If the operating agreement is silent as to the applicability of the statute in this regard, the statute controls. Here, the LLC’s operating agreement did not include any provision concerning how to calculate votes for the purpose of bringing a lawsuit on behalf of the LLC. Because the default rule on this issue was not negated, it controlled.
480 B.R. 561 (D. Del. 2012)
The trustee in this LLC bankruptcy asserted numerous claims against the debtor’s sole member and related entities and individuals, and the defendants sought dismissal of the claims. The trustee’s claims included a veil piercing claim and claims for breach of fiduciary duty and unjust enrichment as well as direct and derivative claims for tortious interference and conversion. The trustee sought to pierce the veil of the debtor, a Delaware LLC, to impose liability on the debtor’s sole member, a Minnesota LLC, and an affiliated corporation (described by the court as being owned by the same family trusts that owned the Minnesota LLC). The trustee’s complaint alleged that the debtor was an alter ego of its sole member and/or the affiliated corporation. The court explained that Delaware law permits a court to pierce the corporate veil of a company where there is fraud or the company is in fact a mere instrumentality or alter ego of its owner. To pierce the corporate veil under the alter ego theory requires a showing that the corporation and its shareholders operated as a single economic entity and that an overall element of injustice or unfairness is present. The court found that the trustee failed to state a cause of action to pierce the corporate veil between the debtor and the affiliated corporation because the alter ego theory only applies when one seeks to hold liable the controlling owner of the company, and the only member of the debtor was the Minnesota LLC. The court noted that a member of an LLC is the equivalent of a shareholder of a corporation. The court next analyzed whether the trustee had adequately pled the factors required to show that the debtor and its sole member were in fact a single economic entity for purposes of the alter ego theory. The complaint included allegations that the member ignored the corporate fiction to favor its own interest over that of the debtor, but the court stated that this allegation more directly addressed a breach of the duty of loyalty rather than the alter ego theory. The complaint also alleged that (1) the member required payment of dividends by the debtor from the time of its formation that left it consistently undercapitalized, (2) there existed no corporate formalities between the member and related entities and individuals as evidenced by the provision of legal and accounting services by the affiliated corporation to the family trusts that owned the member and to individual family members, and (3) the debtor’s secretary was directed to keep bare-bones minutes and was not included in executive sessions so there would be no minutes. The court found that the only facially plausible allegation was the allegation regarding dividend payments, which only addressed undercapitalization. The second allegation involved lack of corporate formalities by entities other than the debtor, and the third allegation regarding “bare bones minutes” did not permit the court to infer more than the mere possibility of misconduct. While the allegation regarding dividend payments was a facially plausible allegation of undercapitalization, one element of the single economic entity test is not alone enough to support the existence of a single economic entity. Thus, the trustee failed to meet his pleading burden on this veil piercing count. The trustee brought breach of fiduciary duty claims against individual directors and officers of the debtor LLC, and the defendants sought to dismiss the claims based on a provision of the LLC agreement exculpating them for any breach of fiduciary duty of care or loyalty. The trustee argued that the exculpatory clause was an affirmative defense and not a basis for a motion to dismiss, and the court agreed. The defendants attempted to distinguish an LLC agreement from a corporate charter on the basis that the fiduciary duties owed under a corporate charter derive from common law while the fiduciary duties owed under an LLC agreement derive from the contract itself. The court relied upon the chancery court’s opinion in Auriga Capital Corp. v. Gatz Properties for the proposition that an exculpatory clause in an LLC agreement is functionally akin to an exculpatory charter provision authorized under Delaware law in that they both serve to limit common law fiduciary duties. The court stated that the duties owed by fiduciaries are the same in a corporation or an LLC and thus characterized the fiduciary duties owed by the defendants as derived from common law and not dependent on the LLC agreement. Further, the court held that an exculpatory clause is an affirmative defense and not a proper basis for dismissal under Rule 12(b)(6). The defendants also sought dismissal of unjust enrichment claims that were based on the alleged breaches of fiduciary duty. The defendants argued that the unjust enrichment claims should be dismissed because a claim for unjust enrichment is not available when a contract governs the relationship of the parties. Because the court concluded that the fiduciary duties are the same common law duties owed under a corporate charter, the court rejected the defendants’ argument. The court acknowledged that the duties owed in an LLC may be modified or eliminated by the LLC agreement, but the court rejected the argument that the duties are created by the agreement. Because the unjust enrichment claims were not based on the parties’ contract, the court denied the motion to dismiss. The debtor’s bankruptcy trustee asserted an unjust enrichment claim against two trusts that were the owners of a Minnesota LLC that was the sole member of the debtor LLC. (These LLCs were part of a larger family of companies involved in real estate development. The founder of the enterprise established a trust for his children and a trust for his grandchildren, and these two trusts owned all of the interests of the Minnesota LLC that was the sole member of the debtor as well as all of the stock of another corporation that also functioned as a holding company in the family of entities.) The unjust enrichment claim was based on alleged payments by the debtor to satisfy its portion of tax obligations. The trustee alleged that the debtor overpaid, thereby unjustly enriching the trusts. The defendants argued that the debtor was a disregarded entity whose tax returns were consolidated with its parent, the Minnesota LLC, which was a pass-through entity that passed all its gains and losses to the trusts. Thus, the defendants argued that any overpayment collected by the trusts was not unjust. The court stated that the defendants cited no law, case, or provision of the LLC agreement to support their argument. Assuming the allegations of the complaint were true, the court concluded that the trusts were enriched by retaining the overpayment, and the debtor was impoverished. If the overpayment was improper as claimed by the trustee, the complaint adequately stated a claim for unjust enrichment. The court held that the debtor’s bankruptcy trustee did not have standing to bring a direct claim for tortious interference and conversion involving property of the debtor’s wholly owned subsidiary LLC. As sole member of the subsidiary LLC, the debtor did not have any interest in the LLC’s property, including any cause of action for tortious interference with, or conversion of, the LLC’s property. The trustee argued that he had standing to bring a derivative action, and the court acknowledged that the Delaware legislature allows derivative suits to be brought by members on behalf of LLCs. The court stated that Delaware case law governing corporate derivative suits applies equally to suits on behalf of LLCs; therefore, the trustee would have standing to bring a derivative suit on behalf of the LLC subsidiary because the debtor was the sole member of the LLC. The defendants argued that the trustee failed to satisfy the pleading requirements of Rule 23.1 regarding the making of a demand or the reason for not doing so. The trustee asserted in his response to the defendants’ motion to dismiss that a demand would have been futile because the LLC’s registration was cancelled and it no longer existed. Nowhere in the pleadings, however, did the trustee describe making a demand on the LLC to bring an action or explain any reason he did not. Because the trustee did not plead with particularity in his complaint facts that established demand futility, the trustee failed to state a derivative action.
56 A.3d 1023 (Del. 2012)
The court held that a foreign company was subject to personal jurisdiction under the Delaware long-arm statute in this civil conspiracy action by an LLC member alleging that the foreign company conspired to cause the dissolution of the LLC (which was co-founded by the plaintiff) and to deprive the plaintiff of its interest. The alleged co-conspirators transacted business in Delaware by filing a certificate of cancellation of the LLC in Delaware. Since the foreign company’s alleged co-conspirators transacted business in Delaware, the foreign company was subject to personal jurisdiction under the long-arm statute. The trial court found there was no record support for one of the minimum contacts requirements, i.e., that the foreign company knew or had reason to know that the conspiracy had a Delaware nexus. However, the supreme court concluded that the facts supported an inference that the foreign company knew or should have known that the LLC was located in Delaware, and the facts satisfied the requirement that an act in Delaware was the direct and foreseeable result of conduct in furtherance of the conspiracy.
Feeley v. NHAOCG, LLC
62 A.3d 649 (Del. Ch. 2012)
The non-managing member of an LLC alleged breach of fiduciary and breach of contract claims against the managing member (“AK-Feel LLC” or “AK-Feel”) and AK-Feel’s managing member (“Feeley”). The non-managing member also sought a declaratory judgment that it had the unilateral right under the operating agreement to cause the LLC to cease business operations. The non-managing member’s claims for breach of the operating agreement were based in part on alleged self-dealing by usurpation of opportunities belonging to the LLC. The court dismissed the breach of contract claim insofar as it was based on allegations of usurpation of opportunity because the operating agreement did not impose an obligation to present opportunities to the LLC, and AK-Feel thus had no obligation as a matter of contract (as opposed to a fiduciary duty). The operating agreement imposed on the non-managing member a contractual obligation to present opportunities to the LLC but did not impose such an obligation on the managing member. Certain other breach of contract allegations survived or were not addressed. To the extent the non-managing member pled a breach of contract claim, the court held that the non-managing member’s claim that Feely aided and abetted the breach of contract survived. Although Delaware does not recognize the concept of aiding and abetting a breach of contract, the Delaware Supreme Court in Gotham Partners held that persons who were not parties to a limited partnership agreement, but controlled the general partner, could be held responsible for the general partner’s breach of contractual duties that supplanted traditional fiduciary duties. Assuming the operating agreement in this case imposed a duty of care and avoidance of intentional wrongdoing on AK-Feel (which was not challenged by AK-Feel), then the non-managing member stated an aiding and abetting claim against Feeley as managing member and sole decision maker of AK-Feel with respect to AK-Feel’s alleged breach of that contractual duty. With respect to the non-managing member’s breach of fiduciary duty claims against the managing member, the court concluded that the managing member owed default fiduciary duties that were not limited or eliminated by the operating agreement. The court discussed the Delaware Supreme Court’s opinion in Gatz Properties, LLC v. Auriga Capital Corp., 59 A.3d 1206 (Del. 2012)), in which the supreme court stressed that the question of whether default fiduciary duties are owed by LLC managers under the LLC statute had not been answered by the supreme court. The court in this case viewed the chancery court’s analysis in Gatz (which the supreme court characterized as dictum) as having the weight of a law review article, and the court here found the chancery court’s analysis in Gatz persuasive. The court stated that the long line of chancery court precedents and Chancellor Strine’s dictum in Gatz provide persuasive reasoning to apply default fiduciary duties to managers of a Delaware LLC until the supreme court speaks on the issue. AK-Feel argued that the operating agreement eliminated any default fiduciary duties it might have, but the court did not read the agreement in that manner. The agreement provided exculpation for certain types of claims but did not limit or eliminate the duties. “By limiting or eliminating the prospect of liability but leaving in place the duty itself, a provision adopted pursuant to Section 1101(e) restricts the remedies that a party to the LLC agreement can seek. Monetary liability may be out, but injunctive relief, a decree of specific performance, rescission, the imposition of a constructive trust, and a myriad of other non-liability-based remedies remain in play.” Thus, an exculpation provision achieves a different result than a provision that modifies, restricts, or eliminates the fiduciary duty itself. The agreement in this case stated that a member was not liable in damages to the LLC or the other members for any act or failure to act in connection with the LLC or its business unless the act or omission was attributable to gross negligence, willful misconduct, or fraud or constituted a material breach of the agreement. The same section of the agreement also required the LLC to pay for any insurance the managing member decided to purchase to protect a person entitled to indemnification against liability for actual or alleged breach of fiduciary duty. The court pointed out it would be inconsistent for the same section of the agreement to recognize exceptions to exculpation and to authorize insurance against actual or alleged breach of fiduciary duty if the provision eliminated fiduciary duties. The exculpation clause in this case did not eliminate fiduciary duties, but rather assumed that default fiduciary duties existed, limited the potential availability of a monetary (but not injunctive or other equitable) remedy, and restored the availability of damages as a remedy for gross negligence and willful misconduct. The court examined the allegations and concluded that the non-managing member alleged claims for gross negligence and willful misconduct against AK-Feel and Feeley. The willful misconduct claims were based on Feeley’s alleged negotiation of deals on his own behalf. AK-Feel argued that Feeley acted in his personal capacity rather than on behalf of AK-Feel, but the court stated that Feeley, who controlled AK-Feel, could not “mentally segregate his decision making into an AK-Feel category and a not-AK-Feel category.” If Feeley learned of a deal and shunted it to a different entity, that decision was not only his, but AK-Feel’s. With respect to the gross negligence claims against Feeley, the non-managing member alleged that Feeley breached his duty of care in his capacity as the “actual manager” of the LLC and as the person in control of the managing member. The court held that the non-managing member sufficiently alleged a claim based on Feeley’s status as “actual manager” (though that capacity could be read to implicate his status as President and CEO of the LLC, which was governed by an employment agreement that required claims against Feeley in that capacity to be submitted to arbitration). With respect to the allegation that Feeley breached his duty of care as the person in control of the managing member, the court held that the non-managing member did not state a claim because Feeley could not be sued in that capacity for breach of the duty of care. The court explained that USACafes (which recognizes that individuals and entities that control a general partner of a limited partnership may be sued for breach of fiduciary duty to the limited partners, and which has been extended to LLCs), has not been extended beyond duty of loyalty claims, specifically, the duty not to use control over the property of the partnership or LLC to benefit the controlling person at the expense of the partnership or LLC. The court next addressed the non-managing member’s argument that the LLC operating agreement gave it the unilateral right to cease the business operations of the LLC. The court examined the language of the LLC operating agreement and concluded that the agreement did not provide the non-managing member, a 50% member, that right. The operating agreement specified that the LLC would be dissolved and wound up on the first to occur of several events. These events did not include a right on the part of the member to unilaterally cause dissolution and winding up but did include the vote of a majority in interest of the members. The member relied primarily on a provision that referred to an obligation of the non-managing member if the member determined that the LLC shall cease operations, but the court stated that this provision did not create a right; rather, it was a condition that triggered an obligation on the part of the member. The court stated that this provision dovetailed with the dissolution and winding up provision such that the obligation described would be triggered if the member joined in a vote to dissolve the LLC.
Gatz Properties, LLC v. Auriga Capital Corp.
59 A.3d 1206 (Del. 2012)
Minority members of an LLC that held a long-term lease on a golf course sued the LLC’s manager and the individual (“Gatz”) who controlled the manager. Gatz and his family had majority voting control over the LLC and owned the golf course leased to the LLC and subleased by the LLC to a golf management corporation. When it became apparent that the golf management corporation would not renew the sublease, the LLC’s manager did not take any steps to find a new strategic option that would protect the LLC’s investors. Rather, the manager eventually conducted a sham auction to sell the LLC at which Gatz, on behalf of the manager, was the only bidder. The manager acquired the LLC at a nominal amount over the debt and then merged the LLC into the manager. Minority members of the LLC sued the manager and Gatz for breach of their contractual and fiduciary duties to the LLC and the minority members based on actions designed to squeeze out the minority members and deliver the LLC to the Gatz family on unfair terms. The chancery court found in favor of the plaintiffs. After the chancery court’s opinion, Gatz appealed and the manager filed a Chapter 11 bankruptcy petition. After the bankruptcy court granted relief from the automatic stay, the Delaware Supreme Court proceeded with Gatz’s appeal. The court affirmed the chancery court’s award of damages and attorney’s fees, holding that Gatz violated a contractual fiduciary duty to satisfy the equitable entire fairness standard in a conflict-of interest transaction with the LLC by refusing to negotiate with a third-party buyer and by engineering an auction at which the LLC was sold to himself at an unfair price. First, the supreme court held that the chancery court correctly concluded that Gatz owed contracted-for fiduciary duties to the other members based on a provision of the operating agreement that prohibited a related-party transaction without consent of a majority of the non-affiliated members if the transaction was on terms and conditions less favorable to the LLC than the terms and conditions of similar agreements that could be entered into with arms-length third parties. The court found that this provision contractually adopted the entire fairness standard (fair dealing and fair price). Because a majority of the minority did not approve the transaction, Gatz had the burden to establish the fairness of the transaction. The court determined that the record supported the chancery court’s finding that Gatz did not establish the fairness of the transaction and breached his contracted-for fiduciary duty to engage in fair dealing and obtain a fair price. The record showed the LLC was worth more than Gatz paid, Gatz rebuffed an interested third-party buyer, and the auction was a “sham.” Second, the supreme court rejected Gatz’s argument that the LLC agreement exculpated him. The record showed that Gatz acted in bad faith and engaged in willful misconduct in the course of breaching his contractual duties, and his conduct thus fell outside the exculpation clause. Gatz’s misconduct included failing to exert any serious effort to look for another golf course operator, refusing to cooperate with a credible buyer, and pursuing a distress sale auction when the LLC’s cash reserves would have allowed it to continue to operate while searching for a buyer. The supreme court next addressed the chancery court’s analysis of whether default fiduciary duties are imposed in the LLC context under the Delaware LLC statute. The court chided the chancery court for addressing this issue since the LLC agreement specified the applicable duty and controlled the issue. The supreme court stated that “reasonable minds could differ” as to whether the Delaware LLC statute does or does not impose default fiduciary duties, and the supreme court characterized the chancery court’s discussion of the issue as dictum without any precedential value. Finally, the supreme court affirmed the award of equitable damages and attorney’s fees. The damages award was based on “conscience and reason,” and attorney’s fees were justified in view of the chancery court’s finding that Gatz engaged in bad faith litigation conduct.
50 A.3d 434 (Del. Ch. 2012)
The plaintiffs, affiliates of ASB Capital Management, LLC (collectively “ASB”) who prevailed in this action to obtain reformation of three LLC agreements governing real estate joint ventures between ASB and affiliates of The Scion Group (collectively “Scion”), sought to enforce fee-shifting provisions in the LLC agreements and recover attorney’s fees and costs incurred in this Delaware action and three other suits filed by Scion in federal courts. After ASB notified Scion of erroneous provisions in the three LLC agreements, Scion preemptively filed suit over one of the agreements in federal court in Wisconsin where the real estate that was the subject of that joint venture was located. ASB then filed this action in Delaware, and Scion then filed two more suits in federal court in Illinois and Florida where the real estate for the other two joint ventures was located. The court was critical of Scion’s decision to file multiple suits making the litigation as difficult and expensive as possible for ASB and creating “overlapping, redundant, and otherwise unnecessary activities” which could have led to a “multi-jurisdictional train wreck” absent emergency applications to the Delaware court for an expedited decision. In addition to prevailing on the reformation claims, ASB prevailed on counterclaims asserted by Scion for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing. Each of the three LLC agreements at issue contained a fee-shifting provision under which the non-prevailing party in any action to enforce the provisions of the agreement was required to reimburse the prevailing party for all reasonable attorney’s fees and costs incurred in connection with such enforcement. Scion argued that ASB could not recover fees and costs related to Scion’s counterclaims for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing but the court found that these causes of action fell within the fee-shifting provision. The breach of fiduciary duty claim asserted by Scion related to ASB’s status as de facto managing member of one of the LLCs after ASB removed Scion as managing member. Scion invoked the provisions of the LLC agreement describing the fiduciary duties of the managing member, and Scion’s claim thus fell within the scope of the fee-shifting provision. As the non-prevailing party, Scion was responsible for ASB’s fees and costs. Scion’s implied covenant claim also sought to enforce the LLC agreement. Under Delaware law, an implied covenant claim sounds in contract, not tort. The court described and discussed the implied covenant of good faith and fair dealing at length in concluding that such a claim fell within the fee-shifting provision of the LLC agreement. In particular, the court discussed whether a culpable mental state is required to breach the implied covenant, and the court concluded that proving such a claim does not depend on the breaching party’s mental state. Because Scion’s counterclaim for breach of the implied covenant sought to enforce an implied term of the LLC agreement, the fees and costs incurred by ASB as prevailing party qualified for reimbursement under the fee-shifting provision. Scion also argued that ASB was not entitled to recover its costs and fees in the federal cases because ASB failed to plead for recovery of these expenses in the federal cases themselves. Scion relied on Federal Rule of Civil Procedure 9(g), which Scion argued required ASB to plead attorneys’ fees as special damages in a federal case. The chancery court noted that Scion appeared to misstate the law but concluded that the procedural rules that could have applied in the federal cases did not govern ASB’s recovery in this case. The court stated that all four cases formed one single controversy, and Scion’s contract claims in each case sought to enforce the erroneous agreements as drafted. ASB was forced to defend each case to preserve its right to reformation, and a judgment in Scion’s favor in any of the federal cases would have had preclusive effect in the Delaware proceeding. ASB thus incurred its fees and costs in the federal actions in connection with an action to enforce the LLC agreements, and the fees and costs fell within the fee-shifting provision. The court evaluated the reasonableness of the fee award of over $3,000,000 sought by ASB and concluded it was reasonable. With regard to Scion’s claim that the fees must be allocated separately such that each Scion affiliate would be liable for a specific amount to each ASB affiliate for each of the three joint ventures, the court concluded that the fees and costs not associated with the breach of fiduciary duty and implied covenant claims (which related to only one of the three entities) need not be allocated and that each of the three Scion affiliates that were members in the three LLCs should be jointly and severally liable for the fees and costs incurred with respect to the litigation over the issues other than the breach of fiduciary duty and implied covenant claims (i.e., the claims relating to the erroneous provisions in the three LLC agreements that resulted from a scrivener’s error and were replicated because the first erroneous agreement was used as a template for the other two). The fees and cost related to the breach of fiduciary duty and implied covenant claims related only to one LLC and were to be borne solely by the Scion affiliate that was a party to that LLC agreement.
Matthews v. Laudamiel
C.A. No. 5957-VCN, 2012 WL 2580572 (Del. Ch. June 29, 2012)
The plaintiff, a member and manager of a Delaware LLC, sued the managers of the LLC and two other companies on claims relating to the dissolution of the LLC. The defendants asserted numerous defenses and brought multiple counterclaims. The plaintiff sought partial summary judgment on his claim that the defendants breached the LLC agreement by causing the dissolution and winding up of the LLC without the plaintiff’s consent and his claim that the wrongful dissolution of the LLC resulted in an unlawful conversion of his units in the LLC. The plaintiff argued that his vote was required to approve the dissolution and winding up of the LLC under a particular provision of the LLC agreement. The court held that the plain language of the provision did not require the plaintiff’s vote to dissolve the LLC but may have required the plaintiff’s vote to wind up the LLC. The plaintiff argued that the discrepancy in the LLC agreement between the vote required for dissolution and the vote required for winding up must be a scrivener’s error. The court rejected the claim for reformation of the LLC agreement because the plaintiff did not satisfy either of the standards for reformation, i.e., that there was a mutual mistake of the parties or a unilateral mistake by the plaintiff of which the defendants were aware but remained silent. The plaintiff argued in the alternative that another voting provision in the LLC agreement required his vote for the dissolution of the LLC and that the vote to dissolve the LLC without his approval thus breached the LLC Agreement. The defendants argued that the plaintiff’s refusal to attend the meeting at which the vote was taken created a deadlock that would have allowed the defendants to dissolve the LLC without plaintiff’s approval in any event. The court denied the plaintiff’s motion for summary judgment on this issue on the basis that the matter should be resolved on a more well-developed factual record. With respect to the plaintiff’s claim that the defendants’ breached the LLC agreement by winding up the LLC without his approval, the court held that, absent an affirmative defense, the defendants would be liable for breach of the LLC agreement because the voting provision of the LLC agreement expressly required the unanimous approval of the board of managers to wind up the LLC. The court rejected the defendants’ argument that “unanimous approval of the Board” meant unanimous approval of the managers present at a meeting. The defendants alleged as an affirmative defense that any breach of the agreement by winding up the LLC without the plaintiff’s approval was excused by the plaintiff’s prior material breaches of the LLC agreement, such as the plaintiff’s alleged refusal to approve or disapprove contracts requiring his approval and his alleged improper approval of contracts that also required another manager’s approval. The court, noting that only a material breach will excuse another party from performing under a contract, stated that the issue of materiality is principally a question of fact and is not generally susceptible to disposition by summary judgment. The court held that the alleged breaches by the plaintiff were not so severe or so insignificant as to allow the court to determine their materiality on the facts presented. Thus, the court declined to grant the plaintiff’s motion for partial summary judgment on the breach of contract claim with respect to the winding up of the LLC. Since the plaintiff was not granted summary judgment on his breach claims, which were the foundation for his conversion claim, the court also denied summary judgment on his conversion claim.
Paul v. Delaware Coastal Anesthesia, LLC
C.A. No. 7084-VCG, 2012 WL 1934469 (Del. Ch. May 29, 2012)
Dr. Leena Paul challenged her removal as a member of an LLC of which she was a 25% member. The other three members voted by written consent to terminate Paul’s membership in the LLC and then gave Paul written notice of her termination. The operating agreement provided that a member could be terminated at any time with 90 days written notice by the LLC acting by vote of 75% of the holders of the LLC’s shares. Paul claimed the operating agreement only allowed members to vote their shares at a meeting of the members, relying on provisions of the operating agreement addressing notice of meetings and voting of membership shares. The defendant members relied upon Section 18-302 of the Delaware LLC statute, which allows action by written consent of members, without prior notice and without a meeting, unless otherwise provided in an LLC agreement. After examining the operating agreement, the court found that it did not specify the method by which votes terminating membership must be taken, and nothing in the operating agreement specifically disallowed votes by written consent. Thus, the operating agreement did not “otherwise provide” so as to preempt the statutory default rule allowing action by written consent.
C.A. No. 5843-VCL, 2012 WL 1869416 (Del. Ch. May 16, 2012)
Members of three real estate ventures structured as Delaware LLCs sued for reformation of the LLC agreements based on an error in a waterfall distribution provision in each of the agreements. The members seeking reformation were affiliates of ASB Capital Management, LLC (collectively “ASB”). The members resisting reformation and seeking to enforce the provision as written were affiliates of The Scion Group, LLC (collectively “Scion”). Scion also asserted counterclaims for breach of fiduciary duty and breach of the implied contractual covenant of good faith and fair dealing. The parties negotiated the terms of a sales proceeds waterfall provision in their initial venture essentially providing for distributions in proportion to their equity investments up to a specified preferred return followed by return of the members’ invested capital. Only after invested capital was returned would Scion receive a promote payment equal to a percentage of excess profits, with the members continuing to receive the remaining profits pursuant to their equity-ownership ratio. Another venture based on these terms followed closely on the heels of the first. In a subsequent venture, which was ultimately aborted, Scion sought greater compensation through a two-tier promote approach. By email correspondence in May of 2007, the representatives of ASB and Scion agreed to the terms of a two-tier promote (the “May 2007 Terms”) on “a go forward basis.” After agreeing to the May 2007 Terms, Scion and ASB worked on the Breckenridge venture. A lawyer for ASB prepared the initial draft of the Breckenridge LLC agreement using the LLC agreement of the previous venture as a template. The first draft of the Breckenridge LLC agreement did not reflect the May 2007 terms. In the course of revising the draft, the missing first-tier promote was placed after the first preferred return but before the return of capital in the sales proceeds waterfall. This placement meant that Scion would begin to earn its first promote immediately after the preferred return and before ASB and Scion received back their capital. Thus, on a money-losing deal, after the initial preferred return, Scion would receive a percentage of each dollar originally invested by ASB. A representative of Scion testified that he noticed the placement of the first-tier promote and recognized its favorable implications but did not say anything. He claimed that it was normal for opposing counsel to give away a significant deal point for nothing. The lead lawyer for ASB testified that she could not recall if she read the draft with this formulation before it was circulated, but she admitted that she did not focus on the language if she did read it, characterizing the language as “just wrong” and a “terrible translation” of the May 2007 terms. The lawyer who prepared the draft said that she lacked the experience at the time to understand the terms of the promote. At the instance of comments of a representative of ASB, some wording of the sales proceeds waterfall provision was revised before the Breckenridge LLC agreement was executed, but the erroneous inverted placement of the first-tier promote and return of capital paragraphs (and a telling awkward misplacement of the word “and” between the paragraphs) was not changed. The ASB Investment Committee approved the Breckenridge deal based on an internal memorandum that described the sales proceeds waterfall provision with the return of capital coming before the first-tier promote as it should have been drafted. In two subsequent joint ventures between ASB and Scion, the same lawyer for ASB that created the Breckenridge LLC agreement electronically copied that agreement and made deal-specific changes. The inverted placement of the first-tier promote and return of capital provision was perpetuated in these agreements. Neither the lead lawyer for ASB nor ASB’s representative read the agreements carefully, believing that the Breckenridge LLC agreement accurately reflected the agreed-upon deal structure and that it had been duplicated in these subsequent deals with minor deal-specific changes. In a deal between Scion and ASB that required a new set of documents because Scion could not participate as an equity holder or lender, the lead lawyer for ASB was heavily involved. In drafting these documents to mimic the compensation as a joint venturer under the May 2007 Terms, ASB’s lawyer placed the return of capital before the first-tier promote, and Scion’s representative did not object to the provision, indicating that Scion’s representatives knew that it correctly reflected the deal and that the other LLC agreements were wrong. When Scion exercised a put right under one of the LLC agreements containing the error, ASB’s representatives identified the scrivener’s error and were very upset. ASB’s representative had a “very, very tough conversation” with ASB’s law firm, and ASB put the firm on notice of a malpractice claim. ASB brought suit to reform the erroneous waterfall provisions, and Scion sought to enforce the agreements as written. The chancery court found that all of the requirements for reformation were met and that all of Scion’s defenses failed. First, the court concluded that a specific prior contractual understanding existed that conflicted with the terms of the written agreement based on the May 2007 Terms. The evidence showed that a “promoted interest” or “promote” is a term of art that contemplates the return of invested capital when used in the context of a capital event and refers to a share of the profits or upside of a project. Scion’s own expert admitted that he had never heard of a deal in the real estate industry in which a promote was paid before the return of capital in a capital-event waterfall provision. In agreeing to the terms, the parties operated based on the established industry meaning of a “promote” as shown by the terms of the agreements in which ASB’s lead lawyer was heavily involved. The court found ASB’s witnesses credible and coherent in this regard and found the testimony of Scion’s witnesses to be self-serving and contradictory. Second, the court found that ASB proved that it entered into the three agreements with the inverted promote and capital return provisions under the mistaken belief that the agreements reflected the May 2007 Terms. Evidence supporting this conclusion included the explanation of the waterfall provision in internal memoranda on which the ASB Investment Committee relied and the shocked reaction of ASB’s representatives when they were presented with Scion’s put calculation. Finally, ASB proved that Scion knew the terms of the sales proceeds waterfall as written did not reflect the May 2007 Terms but intentionally remained silent. The court was convinced that Scion’s representative recognized the scrivener’s error and tried to take advantage of the mistake, and the court rejected the contrived testimony of Scion’s representative explaining how he did not intentionally remain silent. The court noted that the knowing silence of Scion’s vice president and general counsel was imputed to the Scion members based on the basic agency principle that the knowledge of an agent acquired while acting in the scope of the agency is imputed to the principal. The court also rejected each of Scion’s affirmative defenses: (1) the failure of ASB’s representative to read the agreements; (2) ASB’s ratification of the agreements; and (3) ASB’s unclean hands. With respect to Scion’s argument that ASB’s representative failed to read the agreements, the court believed that ASB’s representative read the agreement of the initial venture and thereafter relied on ASB’s lawyer and others to advise him about changes, brief him on terms, and provide him portions to read. The court stated that Delaware law does not require a senior decision maker to read every agreement in haec verba, and the court found that ASB’s representative adequately and properly oversaw the negotiation process and was informed about the terms of the ventures as negotiated. Further, even assuming ASB’s representative did not read the agreements before approving them, this failure to read the agreements would not foreclose a claim for equitable reformation. As for Scion’s argument that ASB ratified the agreements, the court stated ratification for purposes of reformation requires that the ratifying party have actual knowledge of the error. The court concluded that all of the acts on which Scion relied to establish ratification occurred before ASB had actual knowledge of the error. Finally, the court rejected Scion’s unclean hands defense. This defense was based on an eight-month delay by ASB in paying the undisputed portion of Scion’s put calculation, and the court concluded that this conduct, which was cured by payment plus interest, did not threaten to tarnish the court’s good name so as to invoke the doctrine of unclean hands. Because ASB proved by clear and convincing evidence that it was entitled to reformation of the sales proceeds waterfall provisions in the disputed LLC agreements, the court reformed the provisions to place the return of capital and promote provisions in the proper sequence. The court also addressed a counterclaim by Scion for breach of fiduciary duty. After ASB removed Scion as managing member of Dwight Lofts, LLC, and Scion exercised a put right under the LLC agreement, Scion asserted that ASB breached its fiduciary duties by suppressing the summer revenue of Dwight Lofts and failing to inform appraisers of Scion’s interest about an alleged oral agreement for extended summer leasing by the college that leased Dwight Lofts. The court assumed for purposes of this claim that ASB became de facto managing member after removal of Scion from that position and took on the fiduciary duties of that position. Under the Dwight Lofts LLC agreement, the managing member was required to exercise its power and authority under the agreement and perform its duties as managing member in good faith, in a manner the managing member reasonably believed to be in the best interest of the LLC and with the care a prudent real estate professional in a like position would use under similar circumstances. The LLC agreement further provided that the managing member was undertaking fiduciary duties and responsibilities to the LLC and its members “identical to those a general partner undertakes in a limited partnership to its limited partners under the statutes and case law of the State of Delaware applicable to a limited partnership form of business organization.” The agreement prohibited the managing member from intentional acts or failures to act constituting gross negligence, willful misconduct, a material breach of fiduciary duty, fraud, misapplication of funds, theft, misappropriations of an LLC asset, or intentional misrepresentation. An exculpatory clause provided that a member was not liable for damages arising out of acts or omissions in good faith on behalf of the LLC or members, reasonably believed to be within the scope of authority granted to the member by the agreement, and reasonably believed to be in the best interests of the LLC or the members. The exculpatory clause did not eliminate liability for acts or omissions resulting from fraud, gross negligence, or willful misconduct. The court reviewed the evidence relating to ASB’s dealings with the college and concluded that ASB acted reasonably to maximize Dwight Lofts’ summer revenue within the constraints of the master lease with the college and participated in the appraisal process in good faith and candor. Thus, ASB did not breach any fiduciary duties that would be owed as de facto managing member. Scion also argued that ASB breached the implied covenant of good faith and fair dealing based on a failure to maximize summer revenue and failure to disclose the alleged oral agreement with the college regarding extended summer leasing to the appraisers of Scion’s interest. The court rejected Scion’s claim of breach of the implied covenant because ASB did not suppress the value of Dwight Lofts and participated in good faith in the contractual appraisal process after Scion’s exercise of its put right.
C.A. No. 3148-VCN, 2012 WL 1564805 (Del. Ch. April 30, 2012)
The plaintiffs, minority holders of preferred membership interests and secured notes of a Delaware LLC, brought various claims related to a merger of the LLC with another entity pursuant to which their preferred interests were severely diluted. The defendants consisted of other preferred members of the LLC (the “investor defendants”) and directors appointed by the investor defendants (the “director defendants”). The merger was proposed to the members in a letter that explained the LLC’s dire financial circumstances and included a written consent to be executed by the members consenting to the merger. The letter also stated that each member would be required to contribute their notes to the acquiring entity (the “compelled contribution”). Additionally, the consent included an amendment to the LLC agreement whereby a return of capital provision would be eliminated. The investor defendants and director defendants, who comprised a majority of the board and a majority of the holders of the preferred interests, approved the merger as required under the LLC agreement and also approved the compelled contribution and the amendment of the LLC agreement. The plaintiffs claimed that the defendants did not have the power to effect the compelled contribution and breached the LLC agreement by adopting the amendment eliminating the return of capital provision. The plaintiffs also claimed that adoption of the amendment and approval of the compelled contribution breached duties owed to the plaintiffs, and the plaintiffs brought intentional misconduct and gross negligence claims relating to the merger, the compelled contribution, and the amendment. The court began its analysis of the plaintiffs’ claims by rejecting the plaintiffs’ argument that the investor defendants constituted a control group that owed fiduciary duties to the minority equity holders of the LLC. The court recognized that a number of equity holders can collectively form a control group where those equity holders are connected in some legally significant way to work together toward a shared goal, but the court found that the plaintiffs had not shown there was a legally significant connection between the investor defendants sufficient to establish a control group. With respect to the notes, the plaintiffs argued that the defendants did not have the power to effect the compelled contribution. The defendants countered that the compelled contribution could be effected in connection with the merger without express authorization in the LLC agreement because a merger may eliminate “vested rights” of equity holders of pre-merger entities, including rights in the nature of debt. The court indicated that the cases cited by the defendants for this argument all involved rights related to equity interests (e.g., voting, options, preferences, and dividends). The court said that parties to contracts are free to provide that contractual rights and obligations will not survive a merger, but they must do so in “clear and unambiguous terms.” The court held that the plaintiffs had two distinct relationships with the LLC, one as holders of preferred interests and another as holders of the notes, and the notes conferred a separate set of rights from those related to the preferred interests. The court found that neither the LLC agreement nor the notes stated clearly and unambiguously that the notes could be eliminated in connection with a merger. The court held that a broad grant of authority to the board did not constitute “clear and unambiguous” authority to eliminate the notes. The court also concluded that a drag-along provision requiring members to “execute all documents containing the same terms and conditions as those executed by holders of Preferred Interests and as reasonably directed” in connection with a transaction such as the merger also was not “clear and unambiguous” so as to permit the compelled contribution. Finally, the defendants argued that the compelled contribution was appropriate and permissible because the LLC was approaching insolvency and the notes would not have had any value if the merger was not consummated. The court found that while this argument may be relevant in a fiduciary duty context, a company’s financial distress does not grant its directors and owners powers they do not otherwise possess. Thus, the court granted the plaintiffs’ request for a declaratory judgment that the notes remained valid, enforceable, and outstanding following the merger. Next the court addressed the amendment of the LLC agreement that removed a provision that “[n]otwithstanding anything to the contrary” in the LLC agreement, the buyer in the sale of the LLC must cause the LLC to distribute in cash to the holders of the preferred interests an amount equal to their unreturned capital contribution. The amendment provision of the LLC agreement provided that the LLC agreement could be amended by written instrument adopted by a majority of the board of directors of the LLC. The plaintiffs argued that the defendants breached the LLC agreement by eliminating the return of capital provision in adopting the amendment. The plaintiffs essentially argued that the “notwithstanding” language in the return of capital provision caused the amendment provision of the LLC agreement not to apply to the return of capital provision. The court held that this claim failed because the amendment provision was not inconsistent with the return of capital provision, and the board thus had the authority to amend the return of capital provision pursuant to the amendment provision. The plaintiffs further argued that the defendants breached the implied covenant of good faith and fair dealing by adopting the amendment. The court discussed the implied covenant of good faith and fair dealing under Delaware law and concluded that there was no breach in this case. The plaintiffs sought to apply the implied covenant as a gap filler, but the court found that there was no gap to fill in this case because the amendment provision granted broad power to the board to amend the LLC agreement. The plaintiffs’ bad faith claim also failed because the directors were motivated to approve the merger, the amendment, and the compelled contribution by the threat of the LLC’s insolvency. The court next addressed the plaintiffs’ claims that the defendants committed intentional misconduct in consenting to the merger, the compelled contribution, and the amendment and that the director defendants were grossly negligent in approving the merger. The court first examined the LLC agreement to determine if the defendants had duties. The LLC agreement provided that “[n]o Member, Director or Officer shall have any duty to any Member or the Company,” except as expressly set forth in the agreement. The LLC agreement further provided that “no Member, Director or Officer of the Company shall be liable to the Company or to any Member for any loss or damage sustained by the Company or any Member, unless the loss or damage shall have been the result of gross negligence, fraud or intentional misconduct of such Member, Director or Officer” The court concluded that the LLC agreement eliminated all duties that could be eliminated under the LLC statute and that the provision eliminating liability unless there was gross negligence, fraud, or intentional misconduct did not itself operate to create any duties and would apply only if other provisions in the LLC agreement created fiduciary or contractual duties. In any event, the court found that even if the defendants were subject to a duty not to act with gross negligence and to refrain from intentional misconduct, those claims would fail because the plaintiffs did not properly plead a gross negligence claim and because intentional misconduct requires an examination of the defendants’ state of mind, as to which there was no direct proof of intentional misconduct. The court found that the defendants’ motivation in approving the merger, the amendment, and the compelled contribution, was to salvage value from the LLC, which might have become insolvent if the merger had not occurred. The plaintiffs also brought fiduciary duty claims against an officer of the LLC, but the duties imposed on officers under the LLC agreement were owed to the LLC only and not to the preferred interests. Because the plaintiffs did not sue derivatively, those claims failed. Finally, the court addressed the defendants’ argument that the doctrine of laches should bar all of the plaintiffs’ claims. Because the defendants failed to demonstrate any prejudice from a delay in bringing the claims, the court rejected the defendants’ laches argument.
Zimmerman v. Crothall
C.A. No.6001-VCP, 2012 WL 707238 (Del. Ch. March 5, 2012)
The plaintiff claimed that certain issuances of preferred units and convertible debt in a Delaware LLC benefitted some of the directors and investors and unfairly diluted the common members. The plaintiff argued that the directors’ actions violated the duty of care and the duty of loyalty and breached the LLC agreement by authorizing additional units of existing series of units and creating a new series of units without the approval of a majority of the common members. The defendants included directors of the LLC and certain venture capital investors in the LLC. The defendants sought summary judgment. The court granted the defendants’ motion for summary judgment on the plaintiff’s breach of duty of care claim. The defendants argued that the LLC agreement limited the directors’ liability to only breaches of the duty of loyalty. The court concluded, however, that “recklessness,” which was included in the list of behaviors for which damages were recoverable under the LLC agreement, was equivalent to “gross negligence,” and the LLC agreement thus implicated the duty of care. Nevertheless, the court found that the defendants’ conduct did not amount to gross negligence because the board’s actions must be evaluated under the business judgment rule. In order to overcome the business judgment rule, the plaintiff had to prove that the board’s decision-making process involved reckless indifference or deliberate disregard of the owners or actions outside the bounds of reason. The court held that the plaintiff was not able to meet this onerous standard. The LLC was in need of capital, and the board contacted many potential investors, which led to only a few serious discussions. Although the board ultimately decided to raise capital from current investors, the defendants showed that the board received updates on the financial condition of the LLC and discussed various financing options. With respect to the plaintiff’s breach of duty of loyalty claim, the plaintiff alleged that the directors approved self-dealing transactions in bad faith, that they were on both sides of the transactions, and that the entire fairness analysis should thus be applied. Proof of bad faith required the plaintiff to show that the board’s decision was so egregious or irrational that it could not have been based on a valid assessment of the company’s best interests. Also, the court noted that intentional dereliction of a known duty is a higher standard than a standard of recklessness. The court granted the defendant’s motion for summary judgment on the plaintiff’s bad faith claim for the same reasons it granted the motion on the breach of duty of care claims. With respect to his claim of self-dealing, the plaintiff argued that a majority of the directors that approved the transactions were standing on both sides of the transactions and that the venture capital investor defendants constituted a control group that also stood on both sides of the transactions. A shareholder is “controlling” if it owns a majority interest or it exercises actual control over the board. The court noted that it is very difficult to show that a shareholder is a “controlling shareholder,” but the venture capital investors together held 66% of the voting shares and at least two of the five directors’ seats. In addition, the investors were early-stage investors, and there were communications of the defendants that tended to show the investors had considerable influence in the actions the board decided to pursue. The court thus denied the defendants’ motion for summary judgment on the claim that the venture capital investors were a control group. Turning to the plaintiff’s claim that a majority of the board was interested, the court determined that two of the five directors participated in the transactions individually and another was the managing partner of one of the venture capital investors. Therefore, it was possible that the plaintiff could show a majority of the board was interested. In addition to showing that the majority of the board was interested or that the venture capital investors were a control group, the plaintiff also had to show that those on both sides of the transaction received a benefit exclusive to them. The issuance that took place in 2009 was not open to all current unitholders of the LLC. The defendants argued that the offering price was consistent with the price in other recent transactions, but the plaintiff’s claim was that the issuance took place at a price that was improperly low and that the overall value of the LLC was thus diluted. The court concluded that the fact that the price was similar to other recent prices at the time did not warrant granting summary judgment. The defendants were not entitled to summary judgment on the plaintiffs’ self-dealing claim with respect to the 2009 transaction because it was possible it was subject to the entire fairness standard, and whether it met that standard could not be determined without expert valuations. The other challenged transactions did not treat all unitholders equally in that the defendants were given the opportunity to subscribe for the new interests first, and the common holders were only able to purchase if any interests were left. Because of the way they were structured, the court determined that these transactions conferred an exclusive benefit on the defendants because they were given the opportunity to participate first and fully in the additional offerings. The court denied summary judgment as to these transactions and determined that they involved self dealing and were subject to an entire fairness review. The LLC agreement included a safe harbor provision that might have overridden the entire fairness review in the event that two of the five directors were independent and disinterested as alleged. The safe harbor provision closely tracked the interested director provision of the Delaware General Corporation Law, and the defendants argued that it entitled them to have the transactions at issue reviewed under the business judgment rule. However, the plaintiff argued that the safe harbor provision did not address monetary damages and only rendered the transaction itself not void or voidable solely because it was an interested transaction. The court agreed with the plaintiff’s interpretation. The plaintiff also argued that the defendants had not satisfied the safe harbor provision in any event because the venture capital investors were a control group and the transactions were taken in bad faith. The court denied the defendants’ motion for summary judgment in accordance with its earlier discussion regarding whether the venture capital investors were a control group and granted it on the plaintiff’s bad faith arguments. The court granted the defendants’ motion for summary judgment with respect to the aiding and abetting claims regarding a breach of the duty of care because the plaintiffs failed to show an underlying breach of the duty of care. The court denied the motion with respect to the aiding and abetting claims regarding breach of the duty of loyalty. The court granted the motion for summary judgment on the aiding and abetting claims based on a breach of contract because there is no cause of action for aiding and abetting a breach of contract under Delaware law. Finally, the plaintiff claimed that the defendants breached the amendment provisions of the LLC agreement by creating a new preferred series of units without the consent of a majority of the common members. Section 15.11 of the LLC agreement provided that amendments required the vote of a majority in interest of the common members. The only exception referenced in Section 15.11 was with respect to the “issuance of additional Units” as provided in Section 3.8 of the LLC agreement. Section 3.8 of the LLC agreement provided that the board could “issue additional units…or create additional classes or series of units….” The defendants claimed that Section 3.8 gave the board blank check authority to create, authorize, and issue new units. Because another provision of the LLC agreement used both the terms “create” and “authorize,” the plaintiff argued that “create” in Section 3.8 had a meaning distinct from “authorize.” The plaintiff also contended that the exception to the majority in interest vote requirement in Section 15.11 only spoke to “issuance” of additional units and not the creation of a new series of units. The court determined that the language of the LLC agreement on this matter was ambiguous and denied the defendants’ motion for summary judgment on the breach of contract claim.
40 A.3d 839 (Del. Ch. Jan. 27, 2012)
Minority members of an LLC that held a long-term lease on a golf course sued the LLC’s manager and the individual (“Gatz”) who controlled the manager. Gatz and his family had majority voting control over the LLC and owned the golf course leased to the LLC and subleased by the LLC to a golf management corporation. When it became apparent that the golf management corporation would not renew the sublease, the LLC’s manager did not take any steps to find a new strategic option that would protect the LLC’s investors. Rather, the manager eventually conducted a sham auction to sell the LLC at which Gatz, on behalf of the manager, was the only bidder. The manager acquired the LLC at a nominal amount over the debt and then merged the LLC into the manager. Minority members of the LLC sued the manager and Gatz for breach of their contractual and fiduciary duties to the LLC and the minority members based on actions designed to squeeze out the minority members and deliver the LLC to the Gatz family on unfair terms. The court rejected the manager’s claims that the operating agreement displaced the traditional fiduciary duties of the manager, that Gatz and his family were able to exercise their voting rights as members to veto any option for the LLC and thus properly use a “chokehold” over the LLC to pursue their own interests, and that the LLC was valueless by the time of the auction. The court first discussed at some length the principle that managers of a Delaware LLC owe traditional fiduciary duties of loyalty and care as a default rule. The court based this conclusion on the explicit equitable overlay provided by the LLC statute (Section 18-1104 provides that “[i]n any case not provided for” by the statute, “the rules of law and equity...govern”), the manner in which the statute addresses contractual modification of fiduciary duties (Section 18-1101 permits an LLC agreement to expand, restrict, or eliminate fiduciary duties), existing case law, and problems that would arise if the equitable backdrop contained in the statute were to be judicially excised (disruption of expectations of those who crafted LLC agreements in reliance on equitable defaults that supply a predicable basis for assessing whether a business fiduciary has met its obligations and erosion of Delaware’s credibility with investors in Delaware entities). After explaining that an LLC manager owes traditional fiduciary duties of care and loyalty absent contractual provisions altering the duties, the court turned to the provisions of the LLC agreement in this case and concluded that the agreement did not displace the traditional fiduciary duties of care and loyalty. The court interpreted a provision addressing agreements with affiliates as distilling the duty to prove fairness of a self-dealing transaction to its economic essence (i.e., requiring a showing of fair price) but not otherwise affecting the analysis of the manager’s conduct giving rise to the dispute. The provision placed the burden on the manager to show that the price term of an affiliate agreement was the equivalent of one in an arms-length agreement, and the court found that the manager failed to meet that burden because there was no effort to determine the price at which a transaction could be effected through a deal with a third party. The court also addressed an indemnification and exculpation provision that the court noted was both stronger and weaker than a charter provision authorized by Section 102(b)(7) of the Delaware General Corporation Law in that the provision at issue preserved liability for a breach of the duty of care (gross negligence) but provided exculpation for a breach of the duty of loyalty to the extent the breach was not committed in bad faith or through willful misconduct. Under the exculpation provision of the LLC agreement, Gatz and the manager had no monetary liability for a good faith breach of default fiduciary duties unless the breach was the result of gross negligence, willful misconduct, or willful misrepresentation. Also, the conduct must be on behalf of the LLC and reasonably believed to be within the scope of authority conferred by the agreement. The court found that the provision did not protect the defendants because the auction and follow-on merger were effected in violation of the arms-length mandate of the LLC agreement and thus not authorized by the LLC agreement. Additionally, the court concluded that the exculpation provision did not apply even if it exculpated conduct in violation of the arms-length provision because the court found that the actions related to the auction and merger were taken in bad faith. The court described in detail how Gatz and the manager breached their fiduciary duties of loyalty and care by (1) failing to explore strategic options for the LLC for several years after it became clear that the golf course management corporation would not renew its sublease, (2) rebuffing a credible buyer of the LLC’s long-term lease, (3) taking advantage of the economic vulnerability of the LLC created by their own loyalty breaches to play “hardball” with the minority members by making unfair buy-out offers on the basis of misleading disclosures, and (4) conducting a sham auction that delivered the LLC to the manager for a bid of $50,000 in excess of the LLC’s debt (of which the manager was already a guarantor). As a result of this conduct, the Gatz family re-acquired fee simple ownership of the property, on which the LLC had spent millions of dollars to build a first-rate Robert Trent Jones, Jr.-designed golf course and clubhouse, and the minority members received only $21,000. The court rejected the manager’s defense that the voting power held as a member gave it license to exploit the minority. The court acknowledged that the manager was free not to vote its interest for a sale, but the manager was not free to create a situation of economic distress by failing to explore the LLC’s market alternatives and then to buy the LLC for a nominal price. The court also rejected the manager’s argument that the LLC was worth less than its debt and that any surplus over zero was thus a fair price. The court could not accept this proposition as true on the record before it and stated that the evidence suggested that the LLC was worth more than the manager paid. The lack of concrete evidence of the LLC’s value was the fault of the defendants, who fended off a credible third-party purchaser of the leasehold and conducted an unfair auction, and such ambiguities are construed against the self-conflicted fiduciaries who create them. In the course of discussing the flaws in the auction, the court noted that the manager was not protected by the auctioneer’s expert advice under Section 18-406 of the LLC statute. The court stated that a fiduciary cannot select an unqualified advisor and then claim it was guided by an expert. Furthermore, the manager’s reliance claim was undercut by its full involvement in the development and approval of the marketing plan and terms of sale. The defendants argued that there should be no damages award because the LLC was insolvent at the time of the sale. The court was not convinced that the golf course had no positive value and pointed to several indicators that the property justified a bid above the debt owed. The most important factor to the court, however, was that the defendants themselves were responsible for the evidentiary uncertainty by their selfishly motivated acts of mismanagement. The manager had no duty to sell its interest but was not free to mismanage the LLC so as to deliver the LLC to itself for an unfair price. The court awarded the minority members the full amount of their capital contributions plus an additional amount, which totaled to slightly less than what would have been produced by a sale in 2007 at $6.5 million (there being evidence that if the defendants wanted to buy the LLC in 2007, they would have had to pay a price in excess of $6 million). The court characterized its award as a “modest remedy” and stated that the record could support a higher amount. The court also concluded that a partial fee shifting was warranted and awarded the minority members half their attorney’s fees and costs based on the bad faith exception to the American Rule.
840 F.Supp.2d 287 (D.D.C. 2012)
Jacob, the sole member of a Virginia LLC, entered into a brokerage agreement under which a commission would be paid to the plaintiff for procuring a tenant for the LLC’s property. Jacob and the LLC denied that Jacob was acting as the LLC’s agent, and the court relied upon corporate case law, the Restatement (Third) of Agency, the Virginia LLC statute, and the LLC’s articles of organization and operating agreement to conclude that Jacob was the LLC’s agent and that he had actual or apparent authority to enter into contracts on the LLC’s behalf. The articles of organization designated Jacob as the LLC’s “manager,” which amounted to a designation as an agent under the Virginia LLC statute, and the operating agreement authorized Jacob, as the LLC’s manager, to act in the name and on behalf of the LLC, including executing any and all agreements, contracts, and documents necessary or convenient for the development, management, maintenance, and operation of any properties in which the LLC had an interest. Jacob and the LLC did not present any evidence showing that Jacob lacked authority to act as the LLC’s agent. Although Jacob and the LLC argued that Jacob was a mere “facilities manager,” they failed to proffer any evidence that caused the contention to become a genuine factual issue for trial. Turning to the question of whether Jacob had actual or apparent authority to enter the contract at issue on the LLC’s behalf, the court relied upon the Restatement (Third) of Agency and the operating agreement to conclude that Jacob “acted squarely within the scope of his actual authority when he entered into a brokerage agreement on [the] LLC’s behalf.” Thus, the court granted the plaintiff’s motion for summary judgment to the extent it argued that Jacob was the LLC’s agent and the LLC was a party to the brokerage agreement.
730 S.E.2d 556 (Ga. App. 2012)
Sun Nurseries, Inc. (“Sun”) unsuccessfully attempted to collect past due invoices for landscaping services on a golf course and filed suit against Lake Erma, LLC (“Lake Erma”) and BEC Properties and Holdings, LLC (“BEC”), two LLCs Sun alleged owned and developed the golf course. BEC disputed any interest in the development. Sun also sued five individual owners, operators, and members of Lake Erma. Three of the five members were also members of BEC. Lake Erma and BEC shared office space, and BEC employees performed work for both companies but were paid by BEC. At trial, the evidence showed that Sun provided landscaping services for the golf course from late 2003 through mid 2005. Sun submitted invoices to BEC, and Lake Erma issued the checks to pay the invoices. Sun sought to recover amounts owed on six unpaid invoices. An accountant for Lake Erma testified that he cut a check for the invoices in question but it was apparently lost in the mail. No replacement check was ever sent to Sun despite the accountant’s reassurances that Sun would be paid, and there was conflicting evidence as to whether a replacement check was issued or whether it was issued and held back at the direction of an individual who was a member of both LLCs. Sun threatened to file a lien on the golf course for the unpaid debt prior to a meeting between Sun’s owner and two members of the LLCs to discuss the outstanding balance. Whether the meeting was to discuss concerns that Sun was overcharging or that the golf course project was over budget and did not have the funds to pay was disputed. Sun refused an offer of approximately half of what was owed on the outstanding balance. Sun filed suit in February 2006. During 2005, Lake Erma distributed almost $8.3 million to its members in cash and property. In March 2006, two members of the LLCs used the distributed property to obtain loans for Lake Erma and then transferred the proceeds of the loans and the property back to Lake Erma. During the trial, Sun’s accounting expert testified that the distribution left Lake Erma insolvent at the end of 2005, but the expert later conceded that using the market value in her analysis (rather than the purchase price plus development costs) Lake Erma was marginally solvent in that it had sufficient funds to pay its existing liabilities with some excess as of the end of 2005. At the close of Sun’s case, the trial court granted a directed verdict for the individual defendants and the LLCs on Sun’s claim of fraud and for the individual defendants on all other claims. On appeal, Sun argued that the trial court erred in ordering a directed verdict on its fraud claim because there was some evidence to show that statements by Lake Erma’s accountant to Sun’s owner that Sun would be paid were intended to fraudulently dissuade Sun from filing a lien and that Lake Erma’s distribution constituted a fraudulent conveyance designed to defeat the rights of its creditors in violation of state law. Sun also argued that Lake Erma’s veil should be pierced so as to hold the members of the LLC liable for the LLC’s debts. The appellate court found that the evidence was insufficient to support Sun’s claim of fraud because there was no evidence that the accountant’s statements were a willful misrepresentation of a material fact. No evidence showed that the accountant knew his statements regarding Sun being paid were false or that he intended to deceive Sun’s owner and prevent him from asserting Sun’s lien rights. In addition, Sun failed to establish any culpability of the individual defendants for the accountant’s representations regarding the payment of Sun’s invoices. No liability existed for the LLC members simply by reason of their status as members of Lake Erma because a member of an LLC is separate from the company and does not have personal liability for the LLC’s obligations unless the member personally participates or cooperates in a tort committed by the LLC or directs it to be done. Here, Sun presented no evidence demonstrating that any of the individual defendants personally participated or cooperated in any of the accountant’s representations or that they directed him to make representations with the intent to mislead Sun. Therefore, the trial court properly granted a directed verdict on Sun’s claim of fraudulent misrepresentation. The appellate court also concluded that the trial court properly granted a directed verdict on Sun’s fraudulent conveyance claim because Sun did not present evidence of actual intent to hinder, delay, or defraud Sun in the collection of its debt even assuming there was evidence of insolvency. In support of its fraudulent conveyance claim, Sun asserted that Lake Erma made the distributions with the intent to defeat the rights of its creditors, including Sun, because the transfers rendered Lake Erma insolvent and unable to pay its debts. The appellate court determined that there was no evidence that the distributions caused Lake Erma to be insolvent, and even if the initial analysis by Sun’s expert, which was calculated with limited documentation, could be considered as some evidence of Lake Erma’s insolvency, Sun failed to demonstrate that the distributions were made with an actual intent to hinder, defraud, or delay Sun’s collection of its debt as required by the statutory provision relied on by Sun. Sun did not present sufficient evidence of the statutory badges of fraud to support a finding of actual intent, and a directed verdict on the fraudulent conveyance claim was thus proper. Finally, Sun maintained that it presented evidence to support piercing the veil of Lake Erma and that the trial court thus erred in granting a directed verdict in favor of the individual defendants. Sun contended that the March 2006 transfer of property from Lake Erma to two of its members for the purpose of securing a loan demonstrated a use by its members of corporate assets interchangeably without regard to Lake Erma’s corporate identity. Since an LLC has a legal existence separate from its members, evidence of an abuse of the LLC form was necessary to pierce the veil. Sun did not show that the members disregarded the separateness of the LLC as a legal entity. There was no evidence of the members commingling or confusing Lake Erma’s records, assets, or finances with their own. Although Lake Erma transferred property to two of its members to facilitate a loan for the benefit of the LLC, the loan proceeds and transferred property were immediately returned to Lake Erma. The transaction was not concealed and was properly reflected on the LLC books and in the public record. Sun failed to demonstrate that the distributions were fraudulent or otherwise illegal or improper. The mere existence of transfers or loans between an LLC and its members did not of itself represent an abuse of the LLC form, especially when such transactions were properly reflected on the corporate books and in the public record, as in this case. The appellate court concluded that the distribution and loan transaction were insufficient evidence that the individual defendants disregarded the LLC’s separate identity because there was no indication that the individual defendants commingled Lake Erma’s finances with their own, appropriated the LLC’s assets for their own personal use, or otherwise used Lake Erma as a mere instrumentality for the transaction of their own personal affairs. Accordingly, piercing the veil of the LLC would be improper, and the individual defendants were not liable for the LLC’s unpaid debts based on any cause of action.
475 B.R. 622 (Bankr. N.D. Ill. 2012)
Craig and Kim Campbell, the debtors in a Chapter 7 bankruptcy, each owned a 50% interest in OPAR, LLC (“OPAR”), a manager-managed LLC that in turn owned 100% of three member-managed LLCs. The debtors also owned 77% of the limited partnership interests of a limited partnership, the general partner of which was one of the LLCs wholly owned by OPAR. Craig Campbell was the manager of OPAR. The court discussed what was property of the estate with respect to these entities in connection with certain transactions involving the entities that were the basis for an objection to discharge by the trustee. The trustee argued that the chain of ownership enabled the trustee, as successor in interest to the debtors, to exercise all the debtors’ economic and non-economic rights in the entities, including the rights to dissolve, wind up, and liquidate the entities. Under the trustee’s analysis, that power transformed the entities and their assets into property of the estate. The debtors argued that even if their property rights as members of OPAR passed to the estate, the powers and responsibilities of the manager of OPAR (Craig Campbell) did not pass to the estate because these powers and responsibilities were not interests in property. The court agreed with the debtors that the powers and responsibilities of the debtor as manager were not property of the estate. Thus, OPAR’s ownership interests in the three wholly owned member-managed LLCs and the interest of one of those LLCs as general partner in the limited partnership did not automatically become property of the bankruptcy estate. The court acknowledged the broad scope of Section 541(a)(1) and the preemption of state law by Section 541(c) as to the types of property interests that may be transferred, but the court pointed out that state law determines the nature and scope of property interests that comprise the property of the estate in bankruptcy. The court held that the interest of a manager of a manager-managed LLC is not a property interest that can be transferred based on the Illinois LLC statute’s provisions on appointing and removing managers. In a footnote, the court stated that the member’s management rights in a member-managed LLC would constitute property of the estate under Section 541 based on the provision of the Illinois LLC statute providing that each member in a member-managed LLC has equal rights in the management and conduct of the business and that any matter relating to the management of the LLC may be decided by a majority of the members. The court stated that unless and until the trustee, acting as sole member of OPAR, removed and replaced Craig Campbell as manager, Craig Campbell retained that role after filing his bankruptcy petition. The court explained further in a footnote that the trustee would have to take the preliminary step of replacing the manager of a manager-managed LLC in order to make management decisions pertaining to its winding up and distribution of its assets, and the trustee would have to dissolve and wind up the LLC in accordance with the LLC statute and the operating agreement, while ensuring that obligations to the LLC’s creditors were fulfilled, in order to distribute the assets of the LLC to the estate. The court went on to point out that a member is not a co-owner of, and has no transferable interest in, property of an LLC under the Illinois statute. Thus, the debtors’ membership interests in OPAR became property of their bankruptcy estate, but OPAR’s assets, including the subsidiary LLCs, did not automatically become property of the estate, and the trustee had not yet taken the steps required under Illinois law to bring that property into the estate. Likewise, the court stated that property of real estate LLCs owned by the debtors did not automatically become property of the estate, but their organization as member-managed LLCs would make it easier for the trustee to reach that property. The court also pointed out the distinction between personal bank accounts of the debtors that were property of the estate (and thus subject to the limitations of Section 727(a)(2)) and bank accounts of the LLCs that were not property of the debtors or their estates (and thus not within the scope of Section 727(a)(2)).
Bank of America, N.A. v. Freed
983 N.E.2d 509 (Ill. App. 2012)
A bank brought this action to foreclose on a $205 million loan guaranteed by the defendants, an individual and an LLC. The defendants argued on appeal that the trial court erred by entering charging orders with respect to interests of the defendants in 72 LLCs and limited partnerships because the plaintiff did not join the 72 LLCs and limited partnerships as parties to the litigation. The defendants argued that the LLCs and limited partnerships were “necessary parties.” The charging order provisions of the Illinois LLC and limited partnership statutes provide that a court having jurisdiction may enter a charging order against the distributional or transferable interest of a judgment debtor member or partner upon application by the judgment creditor. The defendants argued that these provisions require a court to obtain jurisdiction over the LLC or limited partnership in order to charge a judgment debtor’s distributional interest in them. The court distinguished a case involving a judgment creditor’s remedy with respect to a judgment debtor’s interest in a land trust because a charging order confers very limited rights as compared to the transfer of a beneficial interest in a land trust. The court reviewed provisions of the Illinois Limited Liability Company Act addressing the rights obtained or potentially obtained by virtue of a charging order. Under the Illinois statute, a judgment creditor with a charging order has only the right to receive distributions to which the member would otherwise be entitled, and a member is not a co-owner of LLC property and has no transferable interest in the LLC’s property. If the charging order is foreclosed, the purchaser has only the rights of a transferee of a distributional interest and may become a member only if all other members consent. A transferee has the right to distributions but not the other rights of a member, such as the right to participate in the management or conduct of the business, the right to require access to information about the LLC’s transactions, or the right to inspect or copy LLC records. In sum, the court concluded that an Illinois LLC has no interest that is affected when a charging order is entered on a judgment debtor’s distributional interest because the holder of a charging order is not an owner of the LLC, has no authority over the LLC’s affairs, and has only the right to receive distributions. Thus, the LLC has no interest that needs protection and need not be made a party. The court stated that it would be impractical and unnecessarily costly to require a lender seeking a charging order to serve all the entities in which a borrower has an interest, particularly in a case like this where there were 72 LLCs and limited partnerships. Because the statute supports the conclusion that a court only needs to have jurisdiction over the judgment debtor, the trial court did not err in entering the charging orders in this case.
980 N.E.2d 641 (Ill. App. 2012)
The plaintiff, a 40% member of a member-managed LLC, sued the majority members and the LLC, asserting claims individually and on behalf of the LLC. The plaintiff essentially contended that the majority members excluded the plaintiff from the management of the LLC and formed a competing company. The plaintiff pled in the alternative that he was and was not currently a member, but the defendants unequivocally maintained in their verified pleadings that the plaintiff remained a member of the LLC. The LLC moved for a protective order to prevent disclosure of materials protected by the attorney-client privilege until the plaintiff’s membership status was determined. The plaintiff filed a motion to compel production of the withheld documents. The trial court granted the motion to compel, and the defendants appealed. The defendants first asserted that the trial court’s discovery order violated due process by improperly making certain factual findings suggesting the plaintiff remained a member when no evidence had yet been presented. The court of appeals noted that the trial court’s order made no clear finding on this matter, but the court of appeals was unpersuaded that it would have been improper for the trial court to make a determination for discovery purposes under these circumstances. In any event, the court stated that the defendants were bound by representations they made in verified pleadings that the plaintiff remained a member, and their pleadings provided the trial court with more than an adequate basis for that determination. Next, the court of appeals addressed the defendants’ argument that the trial court improperly required them to produce materials protected by the attorney-client privilege. The court of appeals held that the defendants did not meet their burden of demonstrating, as an exception to the plaintiff’s right to discover relevant documents, that the requested records were protected by the attorney-client privilege. The court stated that cases concerning application of the attorney-client privilege to corporations did not control, and the court looked to the plaintiff’s rights under the Illinois LLC statute and the operating agreement in the course of applying Illinois Supreme Court Rule 201, which governed the discovery dispute. Determining whether the defendants established the existence of a privilege required the court to examine whether the defendants could have reasonably believed that the communications sought would remain confidential, and the court pointed out that both the operating agreement and the Illinois LLC statute specifically granted members the right to inspect the LLC’s books and records. Thus, the defendants and their counsel could not have reasonably believed that records of communications regarding the LLC’s business could be kept confidential from the plaintiff. Even assuming the plaintiff ceased to be a member, he would be entitled under the Illinois LLC statute to inspect records pertaining to the period of his membership. The court rejected the defendants’ suggestion that the records could not include correspondence with attorneys, noting that the statutory list of required records does not constitute an exclusive definition of records or state that members have no rights to see other types of records created or kept by the LLC. The court also concluded that the statutory requirement of a “proper purpose” did not help the defendants because, regardless of the plaintiff’s purpose as to any specific request, the fact that there are circumstances under which members or former members have a clear right to the records means that the defendants could not reasonably believe the records regarding the LLC’s communications with its attorneys would be confidential from the plaintiff during a period in which he could demand access to the records for a proper purpose. The court also noted that the LLC statute does not define what constitutes a proper purpose, and the defendants, who bore the burden of demonstrating that the information sought was privileged, did not outrightly assert that the plaintiff sought the records for an improper purpose. Since the LLC statute as well as the operating agreement provided the plaintiff with management rights, it seemed “inarguable” to the court that the plaintiff had a proper purpose in protecting the LLC’s financial interests as well as his own. Finally, the court reiterated that the plaintiff’s right to obtain records in discovery during litigation was governed not by the Illinois LLC statute or the operating agreement, but by Illinois Supreme Court Rule 201, which required only that the plaintiff was seeking disclosure for the purpose of obtaining relevant evidence. The defendants’ also asserted that the trial court erred in determining that the dual representation doctrine prevented the defendants from invoking the attorney-client privilege. The same law firm simultaneously represented all the defendants, i.e., the LLC, the majority members, and the competing company formed by the majority members, and they began working adversely to the plaintiff and the LLC during the time period in question. The majority members, individually and as representatives of the LLC and the competing company, were aware that the same law firm represented all of them, and the defendants thus had no reasonable expectation that communications between them and their law firm regarding the LLC and is business during the dual representation would be kept confidential. The court stated that the plaintiff did not need to be a joint client of the law firm for the doctrine to apply; the dual representation doctrine applied because the law firm simultaneously represented the majority members, the LLC, and the competing company. The court commented that the creation of unprivileged communications might have been avoided if the law firm had advised the defendants of the conflict and they had prudently caused the dual representation to end because they might then have been able to demonstrate that they reasonably believed their communications with counsel were confidential.
Wells Fargo Bank, N.A. v. Continuous Control Solutions, Inc.
No. 11-1285, 2012 WL 3195759 (Iowa App. Aug. 8, 2012)
Judgment creditors obtained charging orders against the judgment debtors’ interests in three LLCs, and the LLCs objected to provisions of charging orders that ordered the LLCs to provide counsel for the judgment creditors periodic statements specifying “any and all disbursals, distributions, inflows, or payments in order to ensure compliance with this charging order.” The LLCs argued on appeal that there was no statutory authority for the disclosure orders, and the court of appeals agreed. The court of appeals explained that a charging order under the Iowa LLC statute is a lien on a judgment debtor’s transferable interest in an LLC, and after entry of a charging order, the debtor member no longer has the right to future LLC distributions to the extent of the charging order but retains all other rights that it had before execution of the charging order, including the managerial interest. The judgment creditors relied upon the provision of the charging order statute that authorizes the court to “[m]ake all other orders necessary to give effect to the charging order,” but the court of appeals concluded that this statutory provision cannot be read as broadly as the judgment creditors argued. Another provision of the charging order statute permits the court to appoint a receiver “with the power to make all inquiries the judgment debtor might have made.” The court explained that this provision, which mirrors a provision in the Revised Uniform Limited Liability Company Act (RULLCA), contemplates a receiver for the distributions and not the LLC. The commentary to the receivership provision of RULLCA states that the primary advantage provided by the provision is an “expanded right to information.” However, the court of appeals noted that the provision relied upon by the judgment creditors does not specifically refer to an expanded right to information, and the comments to the comparable RULLCA provision do not mention an expanded right to information as an example of an order necessary to give effect to a charging order. The court stated that the provision relied upon by the judgment creditors authorizes ancillary orders that affect only economic rights rather than governance rights, and the court concluded that the expanded right to information (i.e., the power to make inquiries that the judgment creditor may have) is limited to a receiver appointed under the receivership provision. The court found its conclusion bolstered by the fact that the Iowa LLC statute provides a transferee of a member’s interest is generally not entitled to access to records or information. The court did not think that the holder of a lien on the member’s economic interest should have access to the LLC’s records if a transferee is not entitled to such access. Because the court concluded that the Iowa statute only authorized a court to order an LLC to disclose financial information to a court-appointed receiver, and there was no statutory authority for the district court’s disclosure orders, the court of appeals vacated the part of the charging orders requiring disclosure. The court of appeals indicated, however, that the district court had faced a challenging task in view of the absence of case law from which the district court could have drawn guidance.
383 S.W.3d 465 (Ky. App. 2012)
Berling was the sole owner and member of Westview Development, LLC (“Westview”), an Ohio LLC. Westview contracted with Howell Contractors, Inc. (“Howell”), a Kentucky corporation, for Howell to provide services and materials for a development in Ohio. Howell sued Westview as well as Berling and various entities owned by Berling (collectively, the “Berling entities”) in Kentucky for the unpaid balance allegedly due. Howell sought to disregard the status of Westview as an LLC and hold the Berling entities liable for the debt under veil-piercing doctrines. The trial court granted summary judgment in favor of Berling and the Berling entities, holding that the LLC veil should not be pierced so as to hold them liable for the services and materials provided to the LLC. On appeal, Howell argued that the trial court erred in denying its motion for summary judgment and granting partial summary judgment in favor of the Berling entities on the issue of their liability under the doctrines of veil piercing, instrumentality, and alter ego. The appellate court disagreed with Howell and affirmed. First, the appellate court noted that Westview was formed under Ohio law and that the real estate development which gave rise to the debt at issue was located in Ohio. By analogy to corporate law, the rights, duties, and obligations of an Ohio LLC and its members were governed by Ohio law. Although the Berling entities argued that veil piercing does not apply to an LLC, the court stated that the Ohio Supreme Court has set forth the showing required to pierce the veil of a corporation or LLC. The court characterized Ohio case law as requiring a “stringent level of wrongdoing” in order to pierce the veil of an LLC. Here, the appellate court stated that although Howell demonstrated Berling’s control over Westview and the Berling entities, the conduct complained of did not rise to the level of fraud, illegality, or other unlawfulness required to pierce the LLC veil and hold the Berling entities liable for Westview’s debt. The appellate court also explained that its conclusion would be the same if Kentucky’s standards for entity piercing applied. Howell demonstrated its inability to collect a debt owed by Westview, but Howell did not establish fraud or unjust enrichment on the part of the Berling entities that would justify piercing the veil of the LLC. In fact, the record showed that Berling put money (mainly his own in the form of unsecured loans) into Westview rather than siphoning money or assets out of the LLC. The appellate court noted that Westview had assets in the form of a failed real estate development, and Howell should be able to collect its judgment when Westview’s property was sold. The appellate court thus affirmed the trial court’s finding that the LLC’s veil should not be pierced.
86 So.3d 910 (Miss. 2012)
As a matter of first impression, the Mississippi Supreme Court held that the evidence supported the trial court’s order to dissolve a Mississippi LLC on the ground that it was not reasonably practicable to carry on the LLC in conformity with the operating agreement where the operating agreement stated that the LLC’s purpose was to acquire, develop, and sell real estate, but its real estate remained undeveloped ten years later. Perkins, Fordham, and Thompson entered into a business venture to acquire, develop, and sell real estate in 2001. Each man contributed cash and land to an existing LLC previously formed by Fordham and Thompson, and the contributions were structured so that each would own one-third of the LLC. Following the contributions in 2001, the operating agreement of the LLC was amended to reflect a purpose to acquire, develop, and sell commercial and residential properties near a specific area of Mississippi where its land was located and other locations to be decided by the company as well as to conduct any other lawful business, purpose, or activity as decided by the members. When the men entered into their venture, Perkins lived out of state, and he stated at trial that he relied on Fordham and Thompson, who had experience in the mobile home business, to devote their time and energy to developing the LLC property. In early 2009, the LLC negotiated an option contract for the sale of a portion of its land, but the deadline expired before closing. Also in 2009, the LLC listed its property for sale for $5.2 million but was unsuccessful in selling it. Fordham requested approval to list the property for $3.5 million, but Perkins did not approve. Perkins filed an application for judicial dissolution of the LLC in 2010. As of the beginning of trial, the LLC property remained undeveloped and essentially unchanged after ten years. Fordham and Thompson cited several reasons outside of the members’ control for the delay in the development, but they had successfully developed at least two other subdivisions with approximately 200 houses within 25 miles of the LLC’s property. The trial court found that it was not reasonably practicable to carry on the business of the LLC based on the property’s history, the LLC’s inability to obtain funding for development, and the uncertainty regarding the economic climate in the area. The trial court ordered the LLC to be dissolved. On appeal, Fordham, Thompson, and the LLC (collectively the “appellants”) alleged the trial court erred in ordering the dissolution of the LLC. Specifically, the appellants argued that the trial court erred in ordering the dissolution of a solvent LLC based on the application of one dissatisfied member. The Mississippi Supreme Court affirmed the trial court’s order of dissolution, holding that the judgment dissolving the LLC was supported by substantial evidence and was not an abuse of discretion. The trial court ordered dissolution on the basis that it was not reasonably practicable to carry on the business in conformity with the LLC operating agreement, a basis for judicial dissolution under the Mississippi Limited Liability Company Act. The statute did not define “not reasonably practicable,” and no Mississippi cases had interpreted the standard. Thus, the supreme court examined how other jurisdictions had considered the matter. Although no definitive test existed for determining reasonable practicability, the court recognized it was widely accepted that dissolution was appropriate when an LLC was not meeting the economic purpose for which it was established. The LLC in this case was formed for the purpose of acquiring, developing, and selling commercial and residential property; however, more than 10 years after Perkins became a member, the property remained entirely undeveloped. At trial, the appellants offered numerous reasons as to why the development had been delayed, including zoning and sewage access issues, Hurricane Katrina, city regulations, and the economic downturn and national housing market decline. Despite the alleged hindrances, Fordham and Thompson had successfully formed two other LLCs and developed at least two other subdivisions within 25 miles of the property at issue during the ten-year period since Perkins joined the LLC. Furthermore, the appellants presented no evidence that the LLC would have been able to develop the property as intended within the foreseeable future because the LLC was unable to obtain additional funding or bank loans needed to begin development. The appellants maintained that it was reasonably practicable for the LLC to continue operating because its assets exceeded its liabilities and the local economy showed signs of improvement. The court disagreed with the appellants because they failed to show that the LLC could actually meet its stated purpose of developing and selling its property. In addition, the appellants contended that Perkins blocked the LLC from taking advantage of business opportunities such as selling the property at a reduced price or offering lots. The court found that the appellants presented no evidence that buyers were ready to purchase the property or portions of it at those prices. More than 10 years after its formation, the LLC had not met, and would not meet in the near future, its purpose of developing and selling property. Substantial evidence existed to support the trial court’s finding that it was not reasonably practicable for the LLC to carry on business in conformity with its operating agreement. Therefore, the court held that the trial court did not err by granting the petition for dissolution and remanded to the trial court to address winding up the affairs of the LLC.
84 So.3d 32 (Miss. App. 2012)
Schafer and Brick formed three LLCs to operate restaurant franchises: (1) Restaurant of Hattiesburg LLC (“Hattiesburg”) to operate a franchise in Hattiesburg, (2) Restaurant of Jackson LLC (“Jackson”) to operate a franchise in Jackson, and (3) SouthEastern Restaurant LLC (“SouthEastern”) to manage the accounting and payroll of both restaurants. Hotel and Restaurant Supply, Inc. (“HRS”) established an account to deliver restaurant supplies to Jackson. Jackson was unsuccessful, and after six months it closed and SouthEastern ceased paying HRS on behalf of Jackson. HRS sued Jackson, SouthEastern and John Does 1 though 10 to recover the debt owed by Jackson for the restaurant supplies. The trial court granted summary judgment in favor of HRS and found Jackson and SouthEastern jointly liable to HRS. HRS was unable to collect the debt because of the lack of funds in SouthEastern’s bank account. After numerous legal filings by HRS in its attempts to collect, Brick appeared at a judgment-debtor exam on behalf of Jackson and SouthEastern without bringing requested financial records. Brick testified that SouthEastern managed the payroll and accounting for both Jackson and Hattiesburg. Both LLC restaurants deposited their incomes into SouthEastern’s bank account, SouthEastern kept track of the separate incomes and expenses of both restaurants, and SouthEastern paid both restaurants’ payroll and bills. Brick also testified that Hattiesburg had opened its own separate bank account after the Jackson restaurant closed because there were no longer multiple restaurants to operate and SouthEastern’s consolidated services were not needed. Bank records showed that SouthEastern had issued Brick and Schafer checks as repayment of a loan and reimbursement of expenses. HRS filed suit against Hattiesburg, Schafer, and Brick, requesting that the court pierce the veil of Jackson and SouthEastern and hold the defendants jointly and severally liable for the judgment debt. HRS moved for summary judgment arguing that the parties did not observe corporate formalities, commingled assets, and failed to produce financial document and comply with post-judgment discovery. The trial court granted summary judgment in favor of HRS, and the defendants appealed. On appeal, the court recognized that an LLC is a different type of entity from a corporation but concluded that the trial court was correct in relying on the three-prong test for piercing the veil of a corporation under Mississippi case law. Thus, the court of appeals held that to pierce the veil of an LLC, the complaining party must prove LLC membership along with the following: (1) some frustration of contractual expectations, (2) flagrant disregard of LLC formalities by the LLC members, and (3) fraud or malfeasance by the LLC members. The court noted that Mississippi has a strong public policy in favor of recognition of corporate entities and avoidance of piercing the corporate veil, and the court found this public policy extends to LLCs as well. The court held that the trial court erred in granting summary judgment because a material disputed fact issue existed as to the first part of the three-prong test. The court found that HRS contracted with Jackson rather than Schafer or Brick individually. As an incorporated business, HRS understood the distinction between an individual and an LLC, and the court stated there was no evidence that HRS believed it was selling restaurant supplies to Schafer and Brick as individuals. HRS’s own representative testified that HRS did not deal with Schafer until after HRS attempted to collect unpaid invoices. HRS did not seek a personal guarantee from Schafer or Brick while continuing to tender goods to Jackson, which it knew to be an LLC. In addition, HRS did not name the defendants in the first suit, which undercut HRS’s argument that it expected the defendants to be responsible for paying the debt. In relation to Hattiesburg, there was some evidence that a manager of Jackson told HRS that the restaurant was connected to Hattiesburg. Further, SouthEastern, which managed the proceeds from both restaurants’ accounts, wrote checks to HRS for Jackson’s invoices. These facts could have created some expectation that each restaurant was jointly responsible for the other’s debts, but the evidence was clearly not undisputed. HRS’s representative testified he thought Hattiesburg already had an account, but he chose to set up a separate account for Jackson. The court emphasized that the common ownership of Jackson, SouthEastern, and Hattiesburg was not itself sufficient to treat the three LLCs as one, and Mississippi has never adopted the “single business enterprise” theory to hold affiliated LLCs jointly liable for each other’s debts. A shared bank account alone was not sufficient to show actual frustration of contractual expectations, and HRS’s frustration with the performance of Jackson and SouthEastern was not the type of frustration that warranted disregarding the LLC’s separate entity and piercing the LLC veil. Although the failure to conclusively establish the first prong of the test was alone enough to reverse the summary judgment, the court also addressed the evidence in relation to the other two prongs. The court stated that the second prong, flagrant disregard of LLC formalities, is more difficult to prove with an LLC than with a corporation because LLCs impose fewer formalities on its members than do corporations. Importantly, the traditional lack of formalities (e.g., failure to conduct regular meetings, failure to appoint officers and directors) does not necessarily signal abuse. The trial court in this case held that LLC formalities had been flagrantly disregarded because the three LLCs did not maintain separate checking accounts and Brick failed to produce documents at the judgment-debtor exam showing the observance of formalities. The court of appeals stated that the sharing of bank accounts by the LLCs was not a per se abusive practice. Evidence that SouthEastern kept the income and expenses of Jackson and Hattiesburg separate created a factual dispute as to whether the common bank account showed flagrant disregard for the LLCs formalities. As to the failure to produce documents, Brick asserted that they were in the possession of the accountant, which was some evidence that the documents existed. The court held that the trial court erred in holding that Brick’s failure to produce financial records at the judgment-debtor exam undisputably proved a flagrant failure to keep LLC records. Finally, the court analyzed the third prong of whether there was a demonstration of fraud or other equivalent malfeasance on the part of the defendants. Failure to pay a debt did not rise to the level of fraud needed to pierce the veil. Some bad action other than the underlying claim must be shown. HRS did not produce evidence that Schafer and Brick committed fraud by trying to use a business entity to shield themselves from personal liability or contracted with HRS for supplies to be used for their personal use with no intention of paying HRS. Evidence did show SouthEastern made payments to Schafer and Brick, but Brick testified those payments were legitimate reimbursements for Jackson expenses. It was also not fraudulent for Schafer and Brick to set up multiple LLCs for their restaurant operations to limit the liabilities of each restaurant to its own debts. The court noted, however, that SouthEastern had claimed the income of Hattiesburg until the judgment was entered against SouthEastern and Jackson, which was somewhat suspicious. The key evidence as to the third prong was the fact that Hattiesburg opened its own bank account following the judgment. HRS argued this action was intended to divert funds from paying the judgment owed to HRS. The defendants contended that they opened the separate account because there was no need for consolidated accounting services without multiple restaurants. Although the court acknowledged the trial court’s skepticism of the defendants’ explanation, there was a factual dispute on the third prong making summary judgment inappropriate. Because the evidence showed that each part of the three-part veil-piercing test was factually disputed, summary judgment in favor of HRS allowing the LLC veil to be pierced was erroneous.
274 P.3d 714 (Mont. 2012)
Tim Clavin (“Tim”) began attempting to establish a bar and casino business in 1994. Tim’s mother, Lila Clavin (“Lila”), and Robert Gilbert (“Gilbert”) founded Pastimes, LLC in 1996, and the LLC did business as a gaming parlor. Lila and Gilbert executed an operating agreement in which each was listed as a member of the LLC with a 50% ownership interest. The events of dissolution specified by the operating agreement included the death of a member unless at least two members remained who agreed to continue the business of the LLC. Upon dissolution, the agreement provided that the LLC’s assets were to be divided in accordance with each member’s capital account and then in proportion to each member’s membership interest. Lila died in 2000, and Tim served as the personal representative for her estate. Tim and Gilbert were unable to agree on the value of Lila’s share of the LLC at the time of her death. The disagreement led the two men to reach an oral agreement for Gilbert to continue operating the LLC in hopes of realizing a return on their investments. Gilbert served as manager after Lila’s death, and he attributed 50% of the LLC’s tax liability to the estate on the tax return for the LLC each year. In 2005, Gilbert filed a complaint seeking a declaratory judgment on behalf of the LLC that Lila’s interest in the LLC should be valued as of the date of her death. The estate filed counterclaims against the LLC and Gilbert, including a claim regarding the proper valuation of the estate’s interest in the LLC. The estate argued that the proper value of the interest was its present-day value as of the date of trial. After a bench trial, the trial court held that the correct value of the interest was the time of trial. The court determined that the estate did not dissociate from the LLC after Lila died, as contemplated in the LLC’s operating agreement. That is, no dissolution of the LLC occurred at Lila’s death because Tim and Gilbert voluntarily agreed to continue operating the LLC to allow the parties to earn a return on their investments. The oral agreement by the parties modified the LLC operating agreement and eliminated the need for the trial court to determine the value of the estate’s interest pursuant to the operating agreement. The trial court acknowledged that following Lila’s death Gilbert had contributed to the business while the estate had not. However, without Lila’s initial contribution the business would not have existed, and Gilbert had escaped years of tax liability for the LLC by attributing 50% of the income tax of the LLC to the estate. Following expert testimony, the trial court valued the estate’s interest in the business at the time of trial to be over $682,000. On appeal, the LLC contended that the trial court erred in determining the value of the estate’s interest as of the date of trial rather than the date of Lila’s death. The LLC argued that under the provisions of the LLC’s operating agreement the LLC dissolved immediately and automatically upon Lila’s death and that the value of the member’s interest should be as of the date of her death. Under the Montana Limited Liability Company Act, the LLC’s operating agreement controlled which events caused the LLC to wind up. Based on the operating agreement, Lila’s death was an event that caused the LLC to automatically dissolve, and Gilbert had a duty as the only remaining member to wind up the LLC. Instead, Tim and Gilbert voluntarily agreed to continue to operate the LLC with the benefit of Lila’s investment in the hopes of growing both Lila’s and Gilbert’s investments in the business and realizing a profit. The Montana Supreme Court agreed with the trial court that the dissolution provisions of the operating agreement did not apply due to the parties’ decision to continue operating the business. Gilbert’s and Tim’s agreement and Gilbert’s continued operation of the LLC constituted a fully executed oral agreement, as allowed by Montana law to alter a written contract. The LLC statute provides that an estate or personal representative acting as a member dissociates from the LLC once the estate receives its entire right to distributions from the LLC. Thus, nothing in the statute caused an automatic dissociation of the estate at Lila’s death. The operating agreement itself allowed for a member’s legal representative to have all the rights of the member for the purpose of settling the member’s estate. The oral agreement between Tim and Gilbert was fully executed in that the parties performed its terms. Gilbert did not liquidate the LLC, and the estate, acting as a member of the LLC, chose to forgo a payout in order to wait for a potentially higher return on Lila’s initial investment. Gilbert continued to manage the LLC after Lila’s death. The supreme court held that because the parties had modified the dissolution provisions of the LLC’s operating agreement, the trial court properly valued the estate’s interest in the LLC at the time of trial rather than at the time of Lila’s death and affirmed that portion of the judgment. The supreme court held that the parties did not modify other provisions of the operating agreement such as the applicable interest rate and indemnification provisions in relation to attorney’s fees and costs awarded to the estate. The trial court improperly interpreted the indemnification provision in the operating agreement to support an award of attorney’s fees and costs to the estate, and the requirements of the LLC statute also did not justify an award of attorney’s fees. The estate had to rely on its statutory right to the costs of litigation in the absence of a provision in the operating agreement, and here the estate did not meet the statutory time requirements to recover costs. The interest rate, attorney’s fees, and costs were improperly awarded by the trial court and therefore reversed by the supreme court. The supreme court remanded to the trial court for recalculation of the judgment and interest.
810 N.W.2d 677 (Neb. 2012)
The plaintiff sued to recover payment for court reporting services. After concluding that the evidence supported the trial court’s finding that the law firm of Hathaway & Switzer, LLC (as opposed to the firm’s clients) was liable for the bills on which the plaintiff sued, the Nebraska Supreme Court addressed whether the trial court erred in holding Switzer individually liable. The supreme court recognized that members and managers of LLCs are not generally liable for the debts and obligations of the LLC and stated that a court will disregard a company’s identity only where the company’s identity has been used to commit fraud, violate a legal duty, or perpetrate a dishonest or unjust act in violation of another’s rights. A plaintiff seeking to impose liability must prove that the company’s identity should be disregarded to prevent fraud or injustice to the plaintiff. There was no such proof in this case. The evidence did not show that Switzer contracted individually with the plaintiff or that he ever ordered services from the plaintiff other than in his capacity as member of the firm. Nor was there any evidence of fraud or injustice supporting disregard of the firm’s identity as an LLC. In sum, there was no evidence to support the trial court’s judgment against Switzer individually.
271 P.3d 743 (Nev. 2012)
In a dispute between the members of two LLCs, the Nevada Supreme Court analyzed the effect of a charging order against the interest of one of the members and concluded that the judgment creditor had only the rights of an assignee of the member’s interest. The court also concluded that a party’s notice of pendency on an option to purchase an LLC membership interest was unenforceable because the action on which the notice was based concerned an alleged expectancy in the purchase of a membership interest and not a direct legal interest in real property. Stewart and Weddell were the members of two LLCs, Granite Investment Group, LLC (“Granite”) and High Rock Holding, LLC (“High Rock”), and Weddell was initially the manager of each LLC. Stewart, the majority member, purported to remove Weddell as manager of each LLC and elect himself as manager. In an unrelated matter, a judgment creditor of Weddell obtained a charging order against Weddell’s membership interests in Granite and High Rock. Subsequently, Stewart purported to purchase Weddell’s membership interest in Granite pursuant to buyout provisions of the operating agreement concerning voluntary transfers. The trial court concluded that the charging order divested Weddell of both membership and managerial rights in Granite and High Rock upon the tender of purchase money by Stewart and concluded that Stewart was the sole manager of both LLCs. The supreme court noted that the trial court’s language concerning the divestiture of both membership and management right was “troublesome” and stated that it appeared the trial court conflated the purpose of a charging order with the provisions contained in the parties’ operating agreements. The court reviewed the general nature of LLCs and the Nevada statutory framework before presenting a historical overview of the charging order remedy. The court concluded that a judgment creditor with a charging order does not unequivocally step into the shoes of a member, and the limited access of a judgment creditor includes only the rights of an assignee. A judgment creditor or assignee is only entitled to the judgment debtor’s share of the profit and distributions. Thus, after the entry of a charging order, the debtor member no longer has the right to future distributions to the extent of the charging order but retains all other rights possessed before the charging order, including managerial interests. Applying these principles in this case, the charging order only divested Weddell of his economic rights, not his managerial rights. The court further concluded that the charging order triggered the involuntary transfer provisions of Granite’s operating agreement rather than the voluntary transfer provisions. The involuntary transfer provisions explicitly included charging orders, and the court remanded for the trial court to resolve whether Stewart complied with these provisions and whether, as a consequence, Weddell was divested of his membership interest in Granite. The court also directed the trial court to determine whether Weddell retained his managerial rights or whether Stewart had elected himself co-manager pursuant to the Granite operating agreement, which required a unanimous vote of the members to remove a manager. The court agreed with the trial court’s conclusion that Weddell was voted out as a manager under the High Rock operating agreement, which did not that specify a unanimous vote was required to remove a manager. The court concluded that the trial court did not abuse its discretion by canceling Weddell’s notice of lis pendens because the filing of a notice of lis pendens is limited under Nevada law to actions directly involving real property. Weddell sought enforcement of an option to purchase the membership interest in a geothermal company that apparently owned real property. However, a membership interest is personal property, and the doctrine of lis pendens therefore did not apply.
44 A.3d 472 (N.H. 2012)
The plaintiff sought to recover damages for injuries to her daughter from lead poisoning in an apartment managed by an LLC owned and managed by the defendant. The plaintiff alleged that the defendant was liable on two grounds: (1) the defendant’s personal participation in the activity that caused the injury; and (2) veil piercing based on the defendant’s transfer of the LLC’s business to a new LLC after the plaintiff brought her claims. The trial court dismissed the plaintiff’s direct claim and granted the defendant summary judgment on the veil-piercing claim. The New Hampshire Supreme Court concluded that the plaintiff had adequately alleged a direct claim for negligence and that genuine issues of material fact precluded summary judgment on the veil-piercing claim. The court first analyzed the plaintiff’s claim that the defendant had direct liability based on his own tortious conduct. The court acknowledged the statutory liability protection provided members and managers of a New Hampshire LLC but stated that a member remains personally liable for the member’s own acts because the statute only protects members and managers from liability “solely by reason” of their status in the LLC, i.e., it only governs vicarious liability for an LLC’s debts and obligations. The court stated that a member or manager is protected from liability when making a contract for a disclosed LLC because only the LLC is a party to the contract. The defendant argued that he did not owe any duty to investigate, remedy, or warn the plaintiff about the dangers of flaking lead paint because the owner of the property contractually delegated duties only to the LLC. The court noted that it had abolished specialized tests for landlord negligence and, applying general common law negligence principles, concluded that the defendant had a tort duty independent of any contractual obligation because a reasonable person under these circumstances would exercise a certain degree of care for the protection of a vulnerable tenant. The defendant’s management of the apartment and superior knowledge of its hazardous condition sufficed to establish an individual tort duty, and the plaintiff’s negligence claim survived the defendant’s motion to dismiss. With respect to the plaintiff’s veil-piercing claim, the court noted that it had not yet addressed whether members and managers of an LLC can be held personally liable for the LLC’s debts under corporate veil-piercing theory, but the parties had assumed that corporate veil-piercing cases apply to LLCs, so the court did the same. The plaintiff argued that the LLC never had many assets and that the defendant simply decided to cease operations and move his clients to a new LLC with a different name but the same address and telephone number as the original LLC. The defendant’s explanation for what the court characterized as “this unusual and ostensibly arbitrary business decision” was that he “‘[j]ust wanted to start fresh.’” The court acknowledged that the defendant had every right to establish a new LLC and transfer the original LLC’s clients to it but stated that making this “fresh start” when his company was a party to this case could permit a finding that the limited liability entity was used to promote an injustice on the plaintiff. The court stated that it did not need to address the impact of the plaintiff’s contention that the LLC failed to insure itself adequately because the fact issues surrounding the LLC’s transfer of its accounts made summary judgment improper in any event.
Pappas v. Tzolis
982 N.E.2d 576 (N.Y. 2012)
In January of 2006, Pappas, Ifantopoulos, and Tzolis formed an LLC for the purpose of entering into a long-term lease on a building in Lower Manhattan. Pappas and Tzolis each contributed $50,000, and Infantopoulos contributed $25,000. Disputes arose among the members regarding the building, and Tzolis bought the membership interests of the other two members of the LLC in January of 2007. Tzolis bought Pappas’s interest for $1 million, and he bought Ifantopoulos’s interest for $500,000. At closing, the members executed an assignment and assumption agreement and a certificate in which Pappas and Ifantopoulos represented that they had performed their own due diligence, had their own legal counsel, were not relying on representations made by Tzolis or his representatives, and that Tzolis had no fiduciary duty to Pappas and Ifantopoulos in connection with the assignment. Eight months later, Tzolis, now the sole owner of the LLC, assigned the lease to a development company for $17.5 million dollars. Pappas and Ifantopoulos came to believe that Tzolis had negotiated the arrangement with the development company before buying their interests in the LLC, and they sued Tzolis alleging numerous causes of action centered on the fact that Tzolis failed to disclose his negotiations with the development company. The trial court dismissed the plaintiffs’ complaint in its entirety based on the assignment and assumption agreement and the certificate. A divided appellate court reversed and allowed four of the plaintiffs’ claims to proceed: breach of fiduciary duty, fraud and misrepresentation, conversion, and unjust enrichment. The dissenting appellate court judges would have affirmed and dismissed all of the causes of actions. The appellate court granted Tzolis leave to appeal and certified the question of whether its order was proper, and New York’s highest court reversed the appellate court and answered the certified question in the negative in this opinion. First, the plaintiffs’ claimed that Tzolis was a fiduciary and breached his fiduciary duty of disclosure. Tzolis argued that by executing the certificate the plaintiffs expressly released him from all claims based on fiduciary duty. Relying on Centro Empresarial Cempresa S.A. v.America Movil, S.A.B. de C.V., the court explained that a sophisticated principal is able to release its fiduciary from claims when the principal understands that the fiduciary is acting in its own interest and the release is knowingly entered into by the principal. The test is essentially whether at the time of the release, given the nature of the parties’ relationship, the principal is aware of information about the fiduciary that would make reliance on the fiduciary unreasonable. The plaintiffs were sophisticated businessmen represented by counsel. In addition, the plaintiffs’ allegations made clear that at the time of the buyout the relationship between the parties was not one of trust; therefore, reliance on Tzolis’s representations as a fiduciary would not have been reasonable. The release contained in the certificate was valid, and the plaintiffs could not prevail on their cause of action alleging breach of fiduciary duty. Practically, the court noted that the plaintiffs were in a position to make a reasoned judgment as to whether to agree to the sale of their interests in the LLC, and the need to reach an independent assessment of the value of the lease should have been obvious given the offer to buy their interests for 20 times what they had paid for them a year earlier. The plaintiffs’ claim alleging fraud and misrepresentation was subject to dismissal for similar reasons. The plaintiffs contended that Tzolis represented to them that he was not aware of any prospects of selling the lease for more than $2.5 million; however, in the certificate, the plaintiffs clearly stated that they were not relying on any representations made by Tzolis or his representatives as to the matter on which they later claimed they were defrauded (i.e., Tzolis’s failure to disclose negotiations with the development company to sell the lease to the building). While a party may later challenge a release as fraudulently induced if the party alleges a fraud separate from any contemplated release, the plaintiffs did not allege that the release was induced by any action separate from the alleged fraud of Tzolis’s failure to disclose the negotiations to sell the lease. Next, the court addressed the plaintiffs’ conversion cause of action in which they argued that Tzolis appropriated to himself, without authority, the plaintiffs’ membership interests in the LLC. This claim likewise failed. Since Tzolis had purchased the plaintiffs’ interests in the LLC, there could be no interference with their property rights as required for a conversion claim. Finally, the court rejected the plaintiffs’ claim that Tzolis was unjustly enriched at their expense. A party may not recover based on unjust enrichment when the parties have entered into a contract that governs the subject matter. Here, the sale of the interests in the LLC was controlled by contracts. Therefore, the unjust enrichment claim failed as a matter of law. Because the court found that none of the four claims allowed to proceed by the appellate court were valid, the court answered the certified question in the negative, reversed the appellate court, and dismissed the plaintiffs’ complaint in its entirety.
957 N.Y.S.2d 527 (App. Div. 4th Dept. 2012)
The plaintiff argued that the de facto merger doctrine applied to impose liability on a lawyer for a line of credit extended to the lawyer’s solely owned professional LLC (“Juan E. Irene, PLLC” or the “PLLC”) before dissolution of the PLLC and continuation of the law practice by the lawyer in his individual capacity. The lawyer executed the line of credit and security agreements securing the line of credit in his capacity as sole member of the PLLC and did not co-sign or guarantee the line of credit. Thereafter, the PLLC was dissolved by filing articles of dissolution with the New York Department of State. Following the dissolution, the lawyer practiced law at the same location where the PLLC was located under the name “The Law Office of Juan Irene, Esq.” Personal injury cases that were being handled by the PLLC before its dissolution were transferred to the lawyer, and the lawyer did not dispute that the plaintiff had a security interest in a portion of the attorney’s fees generated by those cases; however, the plaintiff also argued that the lawyer was liable as a “successor by merger” to the PLLC. The court concluded that the de facto merger doctrine did not apply to this situation because the New York LLC statute does not permit merger of an LLC with an individual. The court explained that the corporate de facto merger doctrine “‘creates an exception to the general principle that an acquiring corporation does not become responsible thereby for the [preexisting] liabilities of the acquired corporation.’” The court rejected the plaintiff’s argument that the de facto merger doctrine rendered the lawyer liable to the plaintiff on the line of credit as a successor by merger because the LLC statute clearly allows a merger between a professional service LLC and business entities “other than a natural person.” The court stated that the plaintiff had failed to identify any New York authority permitting a New York corporation or professional service LLC to merge with an individual doing business as a sole proprietorship, i.e., a natural person, or that imposes a merger or de facto merger doctrine to that situation. The court was unpersuaded by a Wisconsin case cited by the plaintiff in which a court applied successor liability in a products liability action that involved acquisition of the assets of a sole proprietor by a corporation. The court noted that the New York Business Corporation Law limits mergers to corporations and other business entities. Thus, the court concluded that neither a professional LLC nor a corporation is permitted by statute to merge with a natural person, individual, or sole proprietor, and the de facto merger doctrine did not apply to this case.
944 N.Y.S.2d 623 (App. Div. 2nd Dept. 2012)
The purchasers of real property filed suit against the seller LLC and the LLC’s sole managing member alleging fraud and breach of warranty. The LLC dissolved prior to the commencement of the plaintiffs’ suit. The trial court granted the defendants’ motion to dismiss the complaint as to the member, holding that the plaintiffs failed to state a cause of action under the doctrine of piercing the corporate veil to justify holding the member personally liable for actions he took as the LLC’s sole managing member at the time of and until the dissolution of the LLC. On appeal, the court determined that dismissal of the complaint against the member was error. Generally, a member of an LLC cannot be held liable for the LLC’s obligations by virtue of status as a member of the LLC; however, a member of an LLC may be held individually liable for the LLC’s debts based on the doctrine of piercing the corporate veil. To state a viable veil-piercing claim, a plaintiff must allege facts that, if proved, indicate that the member exercised complete domination and control over the LLC and abused the privilege of doing business in the LLC form to perpetuate a wrong or injustice. Factors to consider in determining whether a member engaged in such conduct include the failure to adhere to LLC formalities, inadequate capitalization, commingling of assets, and the personal use of LLC funds. The plaintiffs’ suit alleged, among other actions, that the member dissolved the LLC shortly after closing title to the property at issue and that the defendants failed to reserve funds for the purposes of contingent liability. The appellate court found that these allegations adequately pled allegations against the member that he engaged in acts amounting to an abuse or perversion of the LLC form to perpetuate a wrong or injustice against the purchasers as required to pierce the veil of an LLC for its alleged fraud and breach of warranty.
939 N.Y.S.2d 384 (App. Div. 1st Dept. 2012)
The plaintiff sought to recover amounts allegedly owed in connection with his work in an investment firm and his ownership in two LLCs. He alleged that the managers of the LLCs violated the LLC agreements and breached their fiduciary duties to the plaintiff by failing to properly calculate and pay amounts owed by the LLCs to the plaintiff under the LLC agreements, which were governed by Delaware law. The plaintiff’s claims included a claim for breach of the implied covenant of good faith and fair dealing based on the alleged willful refusal of the managers to pay amounts they acknowledged were due and owing under the agreements. Although it was undisputed that the managers were not contractually obligated to the plaintiff to pay the amounts owed by the LLCs, the plaintiff, relying on Kuroda v. SPJS Holdings, L.L.C., 971 A.2d 872 (Del. Ch. 2009), argued that the managers were not entitled to dismissal of the breach of contract claims because the managers had the authority to control the LLCs and the agreements did not explicitly exempt them from liability under the circumstances alleged. The court held that the breach of contract claims were precluded by a “limitation of liability” provision in the LLC agreements, which provided that no manager shall have any liability to any member for any loss arising out of any act or omission of the manager if the manager performs its duty in compliance with the standard set forth in another section of the agreements addressing duties. The provision addressing duties set forth duties of the managers and stated that the managers were required to act in good faith and in the best interest of the LLC and with the care that an ordinarily prudent person in a like position would use under similar circumstances. The exculpatory provision did not protect a manager from liability for loss or damage resulting from intentional misconduct, knowing violation of law, gross negligence, or a transaction from which the manager received a personal benefit in violation or breach of the agreement. The court concluded that the plaintiff’s allegations of breach of contract did not allege any breach of the managers’s duty to act in good faith and in the best interest of the LLC and that absent any such allegation the managers’ liability was limited to the specific tortious acts of intentional misconduct, knowing violation of law, gross negligence, or self dealing, none of which was alleged. The court agreed with the managers that a breach of contract claim under Delaware law is not an allegation of intentional misconduct, knowing violation of law, gross negligence, or self dealing. As such, the court stated that neither the willful conduct or bad faith alleged in the breach of contract causes of action constituted the act of intentional misconduct referred to in the exculpatory provision. The court stated that the fiduciary duty claims were based on the same factual allegations as the breach of contract claims and were properly dismissed. According to the court, resurrecting the breach of fiduciary duty claims would impermissibly allow the plaintiff to plead his breach of contract claims under a different guise. The court went on to distinguish the contractual provisions in this case from those at issue in the decision of the Delaware chancery court in Kelly v. Blum, and the court stated that Kelly v. Blum does not stand for the proposition that contractual provisions cannot eliminate fiduciary duties that would otherwise exist at common law without specific elimination. The court found that the provisions here imposed only specific limited contractual obligations on the managers, thus eliminating the traditional fiduciary duties imposed under Delaware law by virtue of the principle of expressio unius est exclusio alterius. Two justices agreed with the majority’s conclusion that the breach of contract and good faith and fair dealing claims against the managers should be dismissed but dissented as to the dismissal of the plaintiff’s breach of fiduciary duty claims. The dissent relied upon the similarity between the contractual provisions at issue in this case and those in Kelly v. Blum and the holding of the chancery court in Kelly v. Blum that the provisions failed to eliminate traditional fiduciary duties because no clause in the agreement “explicitly restricts or eliminates the default applicability of fiduciary duties.” According to the dissent, the plaintiff’s breach of fiduciary duty claims survived to the extent they did not duplicate a claim for breach of contract or fall within the terms of the exculpatory clause because the LLC agreements in this case did not explicitly eliminate traditional fiduciary duties. The dissent acknowledged the overlap between the breach of contract and breach of fiduciary duty claims in this case but concluded that the plaintiff’s factual allegations of acts by the managers amounting to a manipulation of their control to ensure the plaintiff would not be paid and to benefit at the plaintiff’s expense went sufficiently beyond the contract to sustain a breach of fiduciary duty claim at this early pleading stage. The dissent then proceeded to address the hurdle presented by the exculpatory provision and concluded that the plaintiff’s allegations were sufficient to fit into the intentional misconduct exception because the plaintiff alleged facts suggesting that the managers knew the plaintiff was owed significant amounts but deliberately caused the LLCs to withhold payment and then used the plaintiff’s money for themselves and certain other parties. The dissenting justices would have sustained the claims for breach of fiduciary duty because these allegations supported a claim that the managers used their control of the LLCs to enrich themselves at the plaintiff’s expense.
Rev O, Inc. v. Woo
725 S.E.2d 45 (N.C. App. 2012)
The plaintiff leased a tract of commercial property from an LLC managed by Marilyn Woo (“Woo”). The sole member of the LLC was the Paul W. Woo Revocable Trust. Woo was the widow of Paul Woo, but she was not an owner or member of the LLC. The lease between the LLC and the plaintiff contained a provision that made the plaintiff responsible for obtaining any liquor license for the sale of alcohol on the premises, and the lease was expressly conditioned on the issuance or revocation of such a license. Initially, the plaintiff paid the LLC the required security deposit and rent, but the plaintiff was unable to obtain a liquor license, and the LLC and the plaintiff terminated the lease. A few months later, in September of 2007, the LLC sold its real estate, including the property previously leased by the plaintiff. The plaintiff filed suit against the LLC in August of 2008, seeking reimbursement of the deposit and rent it had paid the LLC. The plaintiff obtained a default judgment against the LLC but was unable to collect the amount of the judgment because the LLC had no assets following the sale of its real estate. The LLC filed articles of dissolution in 2009. In April of 2009, the plaintiff sued Woo claiming that Woo had violated the North Carolina LLC statute by wrongfully assenting to or participating in the sale and distribution of the LLC’s assets and that her actions rendered her personally liable to the LLC, which would enable the LLC to pay the debt owed to the plaintiff. The action against Woo was based on claims of unjust enrichment, unfair or deceptive trade practices, and veil piercing. Woo claimed that as the manager of the LLC she did not have liability for its obligations and did not act in violation of the North Carolina LLC statute so as to be liable to the LLC. Woo sought summary judgment supported by an affidavit in which Woo stated that no assets from the LLC had been distributed to her from 2007 forward, she had not been enriched or received anything of value from the LLC from 2007 forward, as manager of the LLC she implemented the policies and directions of the member, and she could not completely control or dominate the LLC since it was solely owned by the member, which had the ability to remove her as the manager at any time. The trial court granted Woo’s motion for summary judgment. On appeal, the plaintiff argued that genuine issues of material fact existed as to whether Woo violated the provisions of the North Carolina LLC Act that limit distributions, and whether Woo was unjustly enriched, committed unfair or deceptive practices, or violated public policy. The provisions of the North Carolina LLC statute at issue prohibit a distribution by an LLC if the LLC would not be able to pay its debts as they become due in the usual course of business or the LLC’s total assets would be less than its total liabilities. Additionally, a manager who votes for or assents to a distribution in violation of the statute is personally liable to the LLC for the amount of the distribution that was impermissible. The plaintiff’s theory was that Woo approved a distribution to the LLC’s member in violation of the statute, Woo was thus liable to the LLC, and the plaintiff would be entitled to benefit from Woo’s liability because the liability would enable the LLC to pay plaintiff’s judgment against the LLC. The court of appeals was not persuaded that there was any evidence that a violation of the statute occurred or that any violation would support a damage recovery in favor of the plaintiff. The plaintiff did not produce any evidence tending to show that at the time of the sale and related distribution the LLC was unable to pay its debts that became due in the usual course of business or that its liabilities exceeded the value of its assets in violation of the statute. The plaintiff also did not establish that the default judgment entered against the LLC more than a year after the challenged sale and distribution was a debt that had become due in the usual course of business. The plaintiff did not file suit and assert its claim for reimbursement until almost a year after the lease with the LLC had been terminated and all of the LLC’s assets had been sold, and there was no evidence the plaintiff had informed the LLC of the existence of its reimbursement claim prior to the sale and distribution in question. Additionally, the plaintiff failed to present any evidence that the LLC should have anticipated, at the time of the distribution, that the plaintiff would have a successful claim for reimbursement for the deposit and rent payments the plaintiff had made prior to the lease being terminated. Although the lease was conditioned on the issuance of a liquor license, the lease contained no provision that the plaintiff would be entitled to reimbursement of any money paid if the lease was terminated due to failure to obtain a liquor license. The plaintiff identified no statutory provision or common law principle giving it the right to reimbursement for payments made prior to the termination of the lease. Thus, there was no basis to hold that the challenged sale and distribution of the LLC’s assets violated the LLC statute. Furthermore, even if the distribution of the LLC’s assets violated the LLC statute, the court reasoned that any liability on the part of Woo would be a cause of action in favor of the LLC and not the plaintiff. The plaintiff did not argue it had the right to force the LLC to sue or seek recovery from Woo, that the LLC was legally required to seek recovery from Woo pursuant to the statute, or that the plaintiff had the ability to enforce any rights the LLC may have had against Woo. The plaintiff also did not show how any violation of the statutory distribution provisions supported the plaintiff’s claims of unjust enrichment and unfair or deceptive trade practices. With respect to the unjust enrichment claim, the plaintiff failed to provide any evidence that Woo may have received a distribution from the LLC or its member after 2007. Thus, the unjust enrichment claim could not survive summary judgment. Similarly, the plaintiff failed to identify any support in the record for its assertion that Woo’s conduct as the LLC’s manager constituted unfair or deceptive trade practices. Finally, the court rejected the plaintiff’s claim that Woo’s approval of the sale of the LLC’s assets was against public policy in that it created a windfall for the LLC’s member at the expense of the LLC’s creditors. The court explained that the plaintiff did not demonstrate it was in fact a “creditor” of the LLC at the time of the challenged sale and distribution or that Woo or the LLC should have foreseen at that time that the LLC might be liable to the plaintiff. The plaintiff also did not show that the LLC had any obligation at the time of the disputed sale and distribution to reimburse it for payments made to the LLC under the lease. Under these circumstances, the court was unable to see what “public policy” was violated when the challenged distribution occurred, and the plaintiff provided no authority or argument explaining why the alleged public policy implications of Woo’s actions as manager of the LLC supported overturning the trial court’s summary judgment.
Colclasure v. Colclasure
295 P.3d 1123 (Okla. 2012)
The Oklahoma Supreme Court determined that the trial court in a divorce action erred in its valuation of the husband’s interest in an LLC owned by the husband and wife. The court held that the trial court was not bound by the valuation date specified in the buyout provision triggered by divorce under the operating agreement, and the provision of the operating agreement permitting members to compete did not preclude the court from considering the loss in value to the LLC caused by the husband’s competition. The LLC was originally owned and operated by the wife for several years before the marriage. On January 1, 2004, while they were engaged to be married, the husband and wife entered into a Unit Purchase Agreement for the wife’s sale of a 49% interest in the LLC to her husband for $5,000. No valuation of the LLC was made at the time, but the husband’s expert in the divorce proceeding indicated that the LLC had gross receipts of $635,549 and gross profits of $126,431 for the calendar year 2003. After they got married, the husband and wife eventually signed an operating agreement that provided for dissolution and winding up of the LLC or a buyout upon the divorce of a member. The operating agreement designated the wife as manager, and both spouses worked in the business, the wife as manager/bookkeeper and the husband as sales representative. After five years of marriage, the wife filed for divorce. During the pendency of the divorce, the spouses’ relationship further deteriorated, and the wife terminated the husband from his role as sales representative of the LLC. The husband started his own business in direct competition with the LLC. After a trial at which experts for the husband and wife testified about the value of the LLC and the husband’s interest, the trial court valued the business at $480,000 and the husband’s interest at $235,200, which were the amounts calculated by the husband’s expert. The wife’s expert used a valuation date of December 31, 2009, because the records were better and the divorce was filed on December 28, 2009. The wife’s expert further took into account a loss in value of the LLC based on the diversion of business by the husband after his termination as sales representative in 2010. The wife’s expert took into account the diverted business even though it occurred after the valuation date because it was known and knowable when he was performing the valuation. The husband’s expert used a valuation date of November 30, 2009, because that was the date required to be used under the buyout provision of the operating agreement. The husband’s expert did not take into account the diverted business because it was not known or knowable on the valuation date. The supreme court concluded that the trial court erred in not taking into account a reduction in value of the business caused by the husband’s competition and in basing the valuation on the valuation date in the operating agreement. The husband argued that the date of valuation under the buyout agreement controlled, that his competition after that date could not alter the valuation, and that he could not be penalized for his actions by a reduction in his property award because the operating agreement permitted competition. The supreme court acknowledged that the trial court had wide discretion, but the supreme court concluded the trial court’s property division was clearly contrary to the weight of the evidence. The supreme court stated that the trial court was not bound by the valuation date set in the operating agreement because the parties had not followed the deadlines and appraisal procedures specified in the agreement, and the trial court was obligated by statute to ensure a fair and just division. The court commented that, had the parties followed the procedures in their own operating agreement, the matter could have been settled without the need to involve the trial court in the valuation process. The husband’s argument that the agreement permitted him to compete did not preclude taking into account the loss in value to the LLC based on his competition because the husband was not being sued for breach of fiduciary duty. The issue was not one of permission or breach, but rather whether his actions lowered the value of the LLC so that he received more money in the property settlement than he should have. Because the trial court did not determine how much the LLC increased in value from the date the husband became a member, did not determine how much double-dipping took place when the husband received money that was not deducted from the property settlement, and did not determine how much the husband’s competition devalued the LLC, the trial court’s determination of the value of the LLC and the husband’s portion of the property settlement were against the great weight of the evidence. Three justices dissented. The dissent argued that there was evidence to support the trial court’s property division and that there was no abuse of discretion in acknowledging the terms of the agreement between the parties and holding them to the strictures of it. The abuse, according to the dissent, was the majority’s stepping in to make a property division that “looks fair” but was not what the parties negotiated and clearly intended.
280 P.3d 360 (Okla. App. 2012)
Winningham contracted on behalf of an LLC with AT&T Advertising, L.P. (“AT&T”) for yellow pages advertising in 2007 and 2008. AT&T did not receive payment for the advertising and filed suit against Winningham to collect the balance owed on the contracts. Winningham claimed that he signed the contracts on behalf of the LLC and thus was not personally liable for the debt, but AT&T argued that Winningham was personally liable because the LLC had been cancelled by the Secretary of State before Winningham signed the contracts. The trial court found that the LLC was not a legal entity in existence when the contracts were signed due to its cancellation and granted AT&T’s motion for summary judgment holding Winningham personally liable for the debt. The question presented to the appellate court was whether an LLC, which had been cancelled by the Secretary of State for non-payment of fees, provided a liability shield for its agent. Winningham relied on a provision of the Oklahoma Limited Liability Company Act that provides that a member of an LLC is not liable for the LLC’s debts solely by reason of the LLC’s failure to file annual certificates and pay annual fees to the Secretary of State or by reason of the LLC ceasing to be in good standing or duly registered. Winningham argued that once an LLC is created, its members are free from liability for acts on behalf of the LLC until the LLC voluntarily files for dissolution. AT&T countered that the provision of the statute applied when the LLC was not in good standing and only until the LLC was either dissolved or cancelled, and the LLC in this case had been cancelled. Furthermore, if the court adopted Winningham’s interpretation of the provision, an LLC would have no motivation to ever pay the fees or file the required certificate. The appellate court agreed with AT&T. The statute provides that an LLC may be cancelled either by filing a notice of dissolution (voluntary cessation) or by being deemed cancelled for failing to file the annual certificate or pay the annual fee within three years of the due date (involuntary cessation). The provision relied on by Winningham includes express language distinguishing a cancelled LLC from one not in good standing, and Winningham would have been correct had the LLC simply ceased to be in good standing. However, once three years had passed from the due date for the certificate or fee, the statute provided for a more serious penalty, i.e., cancellation of the LLC. Following cancellation, an LLC is no longer required to make the annual filing and pay the annual fee, and the court interpreted this result to indicate that the legislature intended cancellation to mean the LLC no longer existed. That is, once cancelled, an LLC is no longer a separate legal entity. The record here did not dispute that the LLC was cancelled during the time all of the contracts at issue were executed. Because the LLC was cancelled, it was not a legal entity and did not afford its members the liability shield typically in effect for LLC members. The appellate court was also not persuaded by Winningham’s claim that the LLC was “suspended” because the Secretary of State record stated the LLC was cancelled and because the statute did not include “suspension” as a status for an LLC. Next, Winningham alleged that the LLC was reinstated after the contracts were executed, which resulted in the liability shield being effective as if the LLC were never cancelled. The appellate court disagreed. The LLC was cancelled July 1, 2007, and it filed articles of conversion to form a corporation on July 14, 2009. The statute was amended effective January 1, 2010, to allow reinstatement as an LLC. Thus, at the time the LLC became a corporation, reinstatement as an LLC was not even possible. The statute also implied no relation back for liability purposes. Nothing in the record showed that the LLC sought reinstatement as an LLC after it was cancelled. When the LLC incorporated, it was not converting, as there was no legal entity in existence to convert from, but rather it was forming an entirely new business entity. In addition, even if the LLC had the ability to convert, the statute provided that conversion of an LLC to another business entity did not affect any liabilities of the LLC or its agents incurred before the conversion. From July 1, 2007, to July 14, 2009, the LLC was not a legally cognizable entity. Thus, the appellate court affirmed the trial court’s judgment holding Winningham personally liable for the amount owed on the contracts with AT&T during that time.
294 P.3d 478 (Or. 2012)
Three LLC venture capital funds that made a loan to the defendant argued that the manager of the LLCs lacked authority to bind the LLCs to an amendment to the loan agreement extending the time of payment. The manager of the LLCs also served as board chairman and treasurer of the borrower as well as owning a significant amount of stock in the borrower. The LLCs argued that the manager lacked authority to amend the loan agreement based on limitations in letter agreements entered into by the manager with certain members of the LLCs or, alternatively, because the manager had a conflict of interest when executing the amendment. Based on provisions of the Oregon LLC statute and the operating agreement regarding the manager’s authority, the court concluded that the manager had actual authority to bind the LLCs to the amendment to the loan agreement; however, the court concluded that the manager had a conflict of interest that might deprive him of authority to act in the transaction. The court discussed the common law agency principle that an agent cannot bind his principal in a matter in which the agent’s own interest conflicts with his duty to the principal, and the court agreed with the LLCs that the manager had a conflict of interest because he was acting as agent of the LLC lenders and the borrower at the same time. Furthermore, the manager had a personal interest in the transaction because he owned a substantial amount of stock in the borrower, and foreclosure of the LLCs’ security interest would have made his shares worthless. Under the Oregon LLC statute, however, a manager’s duty of loyalty to the LLC does not prohibit self-interested transactions if they are fair to the LLC. Because the amendment to the loan agreement at least arguably favored the borrower, the court concluded there was a genuine issue of material fact whether the amendment was fair to the LLCs. The borrower next argued that a provision of the operating agreement allowed the manager to act regardless of any conflict of interest. The court analyzed the provision of the operating agreement in light of the provisions of the Oregon LLC statute addressing conflict-of-interest transactions and modification of the duty of loyalty and concluded that the operating agreement did not authorize the manager to engage in conflict-of-interest transactions that breached his duty of loyalty. The operating agreement relieved “members” of liability or an obligation to account for investing in or managing other businesses. The manager was identified as the “managing member” in the LLC agreements, and the borrower argued that this provision thus included the managing member. The court stated that this designation equated to a “manager” under the statute and that the LLCs were “manager-managed” rather than member-managed based on the definitions of a “manager” and a “manager-managed” LLC in the Oregon LLC statute. The court noted that the distinction between a member-managed LLC and manager-managed LLC was important because the management type often determines what statutory provisions apply. Here, it was significant because a manager has extensive powers and duties under the statute, but members of a manager-managed LLC are “little more than passive investors” and owe no duty to the LLC. The LLC statute requires majority consent of the members for a manager to enter into a conflict-of-interest transaction unless otherwise provided by the articles of organization or an operating agreement. The court rejected the argument that the operating agreement provided otherwise, holding that the reference to “members” in the provision at issue did not include the managing member. The court noted that a principal’s authorization of an agent’s conflict-of-interest transaction at common law must be specific, and the Oregon LLC statute imposes a similar requirement in the provision permitting the operating agreement to “identify specific types or categories of activities that do not violate the duty of loyalty....” The court concluded that the operating agreements did not specifically allow the manager to engage in transactions where he had a conflict of interest that breached his duty of loyalty because the provision did not suggest, much less specifically state, that a managing member may bind the LLCs to transactions when the managing member had a conflict of interest. The court next addressed whether the borrower knew of the manager’s conflict of interest so as to know the manager lacked authority to enter into the amendment to the loan agreement on behalf of the LLCs. The operating agreements contained a provision that a person may rely without further inquiry on the manager’s authority, but the court stated that this provision missed the point. Everything that the manager knew could be imputed to the borrower because he was an agent of the borrower. Furthermore, the borrower actually knew that the manager acted in the transaction as both manager of the LLCs and agent of the borrower, and the borrower knew all of the details of the transaction. Thus, the borrower had both imputed and actual knowledge of the conflict of interest. In sum, the manager had actual authority to enter into the type of transaction represented by the amendment to the loan agreement, but (contrary to the holding of the court of appeals and the trial court) there was a genuine issue of material fact as to whether the manager lost the authority to enter into the transaction based on a conflict of interest. The manager had a conflict of interest based on his acting as agent for both the lender LLCs and the borrower and based on his personal interest in the transaction. A fact finder could conclude that the transaction was unfair to the LLCs and breached the manager’s duty of loyalty, thus depriving the manager of authority to enter into the amendment to the loan agreement. The borrower had knowledge of the conflict of interest and resulting lack of authority. The court also rejected the borrower’s argument (which was not reached by the trial court or court of appeals) that the LLCs ratified the amendment as a matter of law based on the length of time that elapsed before the LLCs objected to the amendment. The court stated that this was ordinarily a question of fact and the record did not indicate the absence of a fact issue in this case. Thus, the court reversed both the trial court’s summary judgment in favor of the borrower and the decision of the court of appeals that affirmed the trial court’s judgment.
274 P.3d 202 (Or. App. 2012)
The plaintiff, an injured worker employed by an LLC, sued the sole member of the LLC asserting claims under the Oregon Employer Liability Law (“ELL”) and for common law negligence. The member defended on the basis that the member was protected from liability by the exclusive remedy of the workers’ compensation law, that the member was protected from liability under the Oregon LLC statute, and that the member did not exercise sufficient control for the ELL to apply. The trial court granted summary judgment in favor of the member, and the court of appeals reversed. The court of appeals first analyzed the exclusive remedy provision of the workers’ compensation law and concluded that it did not apply to members of an LLC employer. The workers’ compensation statute shields employers from liability and extends that protection to various persons, including directors of a corporation, but does not list an LLC owner or member as a person to whom the protection is extended. The court emphasized that an LLC is a separate legal entity from its members so that the application of the exclusive remedy provision to an LLC employer does not necessarily extend to its members. Next the court pointed out that the LLC statute contains a provision that states that another Oregon statute will apply to the members of an LLC without managers when the other statute “applies to both ‘partners’ and ‘directors.’” Since the exclusive remedy provision of the workers’ compensation statute does not list partners as well as directors, and the LLC at issue was member-managed, the exclusive remedy provision did not apply to the member in this case. The court noted that the legislature amended the workers’ compensation law the same year it enacted the LLC statute and presumably would have provided for the exclusive remedy provision to apply to LLC members (either by listing partners or expressly including members in the exclusive remedy provision) if it had intended the provision to apply to LLC members. The court stated that its conclusion was also supported by case law in the corporate context that suggests that a shareholder, unlike an officer or director, is not shielded by the exclusive remedy provision, but rather enjoys liability protection under the corporate statute. With respect to the member’s argument that it was protected from liability by the LLC statute, the court acknowledged that the statute protects members from liabilities of the LLC, but the court stated that the statute does not shield members from their own tortious conduct. The court relied on commentary to the Uniform Limited Liability Company Act on which the 1999 version of the Oregon LLC statute was modeled. The court also cited testimony before the House Committee on Business and Consumer Affairs by a member of the LLC task force that drafted the revision of the Oregon LLC statute. Finally, the court of appeals addressed the plaintiff’s claim against the member of the LLC employer under the ELL. Liability under the Oregon ELL extends to persons or entities who (1) engage in a “common enterprise” with the direct employer, (2) retain the right to control the manner or method in which the risk-producing activity was performed, and (3) actually control the manner or method in which the risk-producing activity was performed. The court discussed each of these requirements and concluded that none of them were met. There was no “common enterprise” because the member was not in charge of or responsible for the forklift that caused the injury. Rather, the forklift was owned and controlled by the LLC. There was also no retained or actual control by the member over the forklift. Thus, the member was entitled to summary judgment on the ELL claim. The plaintiff’s negligence claim was not barred by the failure of the ELL claim.
Park Regency, LLC v. R & D Development of the Carolinas, LLC
741 S.E.2d 528 (S.C. App. 2012)
In this action to dissociate a member from a real estate LLC, the court interpreted and applied the terms of an Agreement Among Tenants in Common (the “TIC Agreement”) executed by the members before they formed the LLC and transferred the property to the LLC. The members did not execute an operating agreement for the LLC, and the trial court found that the parties had adopted the TIC Agreement as the LLC’s de facto operating agreement. This finding was not challenged on appeal. The TIC Agreement contained various provisions about financial matters and transfers of tenants’ interests, including on events of default. The trial of the dissociation action resulted in an order dissociating the defendant member and ordering the buyout of the dissociating member’s distributional interest upon the bona fide sale or transfer of the property or sooner if the remaining members elected to do so. The trial court’s valuation of the dissociating member’s interest was the subject of this appeal. The remaining members complained on appeal that the trial court failed to consider certain evidence affecting the fair value of the dissociating member’s interest, including the LLC’s obligation to repay debt to the other members and conditions impairing the marketability of the real estate. The court of appeals first addressed the nature of the proceeding as it affected the standard of review and concluded that an action to dissociate a member, like a dissolution action, sounded in equity so that the appellate court could determine facts in accordance with its own view of the preponderance of the evidence. The court discussed the nature and role of an operating agreement and principles of contract interpretation applicable to operating agreements. The appellate court approved of the trial court’s efforts to craft a solution by application of provisions of the TIC Agreement but modified the trial court’s order in one respect to avoid a payout to the dissociating member that would exceed what it would have received had it remained a member or what the remaining members would receive. In general, the court approved of the trial court’s efforts to fashion an equitable solution to a complex problem based on provisions of the TIC agreement. The court of appeals “agree[d] with the trial court that the remedy in this case should be based upon the entirety of the TIC Agreement and not solely the dissociation provisions.” The appellate court explained how the trial court “discard[ed] some requirements of the dissociation provisions and impose[d] other requirements found elsewhere in the TIC Agreement” and generally agreed with the trial court’s application of the provisions. The trial court’s order allowed the remaining members to elect to purchase the dissociating member’s interest for $265,438 at any time before the sale of the LLC’s property, or the remaining members could wait and pay the dissociated member for its interest after the sale of the LLC’s property based on the actual purchase price of the property but not to exceed $265,438. The appellate court made an adjustment to the calculation of the amount that would be due the dissociating member in the event the payout did not occur until the sale of the property to take into account contributions of two of the remaining members. The appellate court rejected the remaining members’ argument that the trial court erred in offsetting the amount of certain liabilities of the dissociating member against the fair value of its interest rather than entering an immediately enforceable judgment against the dissociating member in such amount. The cause of action for these liabilities belonged to the LLC, and the appellate court concluded the trial court’s decision to subtract amounts owed by the dissociating member from the purchase price of its distributional interest was consistent with both the LLC statute and the TIC agreement. A dissenting justice disagreed with the majority’s resolution of the fair value of the dissociating member’s distributional interest, stating that the majority placed too much emphasis on the TIC Agreement and noting that a provision of the South Carolina LLC statute lists an agreement among the members as one factor a court shall consider in determining fair value. Considering all the indicators of the fair value of the dissociating member’s interest and offsetting the dissociating members’ liabilities to the LLC, the dissent concluded that the dissociating member was not due any payment for its interest.
735 S.E.2d 459 (S.C. 2012)
Michael Brown and his nephew purchased some property as tenants in common in 2006. They borrowed $3.5 million to purchase the property, and the note required interest-only payments for 2 years and a balloon payment for the principal at the end of 2 years. Due to the recession, the value of the property declined significantly over the 2-year period, and refinancing the loan proved problematic. Mr. and Mrs. Brown had extensive security holdings, but the depressed state of the stock market meant that they would realize losses if they liquidated their securities to pay off the loan. Mrs. Brown formed an LLC for the purpose of borrowing $3.5 million to acquire the note and mortgage on the property. Mr. and Mrs. Brown guaranteed the note and pledged several investment accounts to secure it. The original lender assigned the note and mortgage to the LLC in exchange for the proceeds of the loan to the LLC and an additional payment by Mr. Brown. The assignment of the note and mortgage to the LLC preserved the first lien of $3.5 million over later encumbrances of the property, including judgments against the nephew in unrelated matters. The nephew’s judgment creditors sought to pierce the veil of the LLC as the alter ego of Mr. Brown so as to characterize any payments by the LLC to the original lender as payments by Mr. Brown resulting in payoff of the note and satisfaction of the mortgage. The court characterized Mrs. Brown’s use of the LLC to acquire the note and mortgage as a legitimate use of a legal mechanism to protect her and her husband’s financial interests by protecting their bona fide interest in their property without having to liquidate assets. There was no fraud, injustice, or contravention of public policy. The court noted testimony by bankers that it was “common business practice” to form an LLC for the purpose of purchasing, holding, and enforcing negotiable instruments, and the court stated that there was no inequity or fraud since the priorities of the judgment creditors did not change and they were no worse off than they would have been if the original lender had foreclosed (in which case the judgment liens would actually have been extinguished). Thus, disregard of the LLC was not warranted.
728 S.E.2d 448 (S.C. 2012)
The plaintiff sought to hold a member of an LLC liable for negligent acts the member committed while acting in furtherance of the LLC’s construction business, and the member argued that the South Carolina Uniform Limited Liability Company Act shielded the member from personal liability for negligence he committed while working for the LLC. As a matter of first impression in South Carolina, the supreme court concluded that the General Assembly did not intend to abrogate the common law rule that a tortfeasor is liable for the tortfeasor’s own actions. The statutory provision at issue provided: “Except as otherwise provided in subsection (c), the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager.” Subsection (c) provides that a member is liable for debts, obligations, or liabilities of the company if there is a provision to that effect in the articles of organization and the member has consented in writing to be bound by the provision. The record did not contain the articles of organization, so the court was not able to determine whether subsection (c) would apply in this case. The court noted that a majority of states examining similar language have concluded that a member is always liable for the member’s own torts and cannot rely on member status as a shield, but the court cited a few cases in which courts appeared to have concluded otherwise. The court acknowledged that the statute’s plain language could be read to shield a member from personal liability for torts committed in furtherance of the LLC’s business because the LLC’s liability would derive from the acts of a member, manager, or other agent acting in that capacity, and the statute protects a person from liability “solely by reason of being or acting as a member or manager.” Additionally, the statute provides that these obligations are “solely” those of the company. Nevertheless, because the right to sue one’s tortfeasor is a long-standing right, the court was unwilling to find it was abrogated by statute absent “clear legislative intent.” The court was not persuaded that it was the General Assembly’s intent to abrogate the common law rule for several reasons. First, the prevailing interpretation of similar language by other courts is that a member is liable for the member’s own torts, and this interpretation also comports with the comments to the statute and to the analogous section of the Revised Uniform Limited Liability Company Act. More important, said the court, was the fact that this is the rule for shareholders and officers of a corporation, an organizational structure from which LLCs heavily borrow. The court stated that it might appear that its interpretation was eliminating one of the main reasons a person would choose to form an LLC, particularly a single-member LLC, but the court noted that there are myriad other benefits available to those who choose to form an LLC, and the court was not convinced that limiting the shield to vicarious liability would undermine the core of the LLC form of entity. In sum, the court concluded that the statute only protects members from vicarious liability and does not insulate a tortfeasor member from personal liability for his own actions. Thus, the trial court did not err in finding the member in this case personally liable for torts he committed in furtherance of the LLC’s business. Two justices dissented, arguing that the clear and unambiguous language of the statute is not amenable to an interpretation that a member tortfeasor is personally liable for torts committed in the furtherance of the LLC’s business (emphasizing that the statute protects a member or manager from liability for “a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager”) and citing the principle that the court has no authority to rewrite a statute even though the court may find fault with the wisdom of the statute.
727 S.E.2d 773 (S.C. App. 2012)
In 2004, Clary and Borrell created an LLC to buy and sell residential real estate. Clary and Borrell each made initial contributions of approximately $70,000, and they entered into an operating agreement that contained provisions relating to subsequent capital contributions. Under the operating agreement, a “Required Interest,” defined as 100% of the members, was to determine and notify each member of the need for a capital contribution if the LLC needed money to properly operate and discharge its liabilities. The notification was required to contain a statement in reasonable detail of the proposed uses of the capital contributions and a date by which the capital contributions must be made. The operating agreement also provided that if a member advanced funds to or on behalf of the LLC to pay its obligations, the advance constituted a loan from the member and not a capital contribution. The operating agreement provided that profits and losses would be allocated 50% to Clary and 50% to Borrell, and the agreement also stated that with regard to third parties, except as otherwise expressly agreed in writing, no member was liable for the debts, obligations, or liabilities of the LLC. By agreement of the parties, Clary managed the day-to-day operations of the LLC while Borrell acted as a silent partner with no control over such matters. In early 2006, Clary and Borrell mutually agreed to suspend operations due to the LLC’s unprofitability and lack of capital to continue operating. In 2008, Clary and the LLC filed suit against Borrell for breach of contract, alleging that Clary and Borrell contributed equally to the LLC for a time but that Borrell later refused to provide a 50% contribution as required by the operating agreement, which caused Clary to provide additional funds to make up for Borrell’s shortfall. Clary also alleged that Borrell refused to pay his equitable share of expenses and losses in connection with outstanding obligations of the LLC, relying on the equal allocation of profits and losses under the operating agreement. Borrell filed a motion for summary judgment asserting that there was no evidence he breached the operating agreement. Specifically, Borrell argued that the provision of the operating agreement allocating profits and losses only determined allocations for tax purposes and did not require him to make 50% contributions to the LLC to match funds contributed by Clary. Borrell maintained that he made the required initial contribution and that any subsequent capital contributions to the LLC were governed by the operating agreement, which would have required Borrell’s vote and agreement as a prerequisite to mandatory contributions of the members. According to Borrell’s interpretation of the agreement, any additional contributions Clary made to the LLC were loans to and liabilities of the LLC and would be owed by the LLC rather than Borrell to Clary, and Borrell pointed out that the obligations of the LLC were only obligations of the LLC based on the provision of the operating agreement that no member was liable for the debts and obligations of the LLC. Borrell also asserted that the LLC was not a proper party to litigate the matter against Borrell because Clary and Borrell were each 50% owners, and a vote regarding the LLC’s litigation against Borrell would be deadlocked. Clary responded that Borrell had made additional contributions to the LLC after the initial capital contribution and provided his creditworthiness on behalf of the LLC in connection with several loans for purchases of property. Clary stated that Borrell agreed to make subsequent contributions to zero out the LLC once they determined they needed to close the business; however, Clary claimed Borrell refused to pay once he was presented with the amount he supposedly owed. Clary submitted as evidence a handwritten document allegedly signed by Borrell which Clary claimed constituted Borrell’s vote to contribute to paying the LLC’s debts. The document stated, “Jeff, when the accounts are settled if I owe you I will pay you.” Borrell countered that Clary produced no evidence that would indicate Borrell voted to approve subsequent capital contributions as required by the agreement, waived his right to do so, or actually made subsequent capital contributions. Borrell contended the documentation regarding the only specific subsequent capital contribution alleged by Clary showed that the funds provided by Borrell for the purchase of a piece of property by the LLC was a loan to the LLC, not a subsequent capital contribution. Borrell argued that acting as a personal guarantor of loans for the LLC did not qualify as a capital contribution in that the guarantees would be liabilities of Borrell rather than the LLC and would add no value to the LLC. As for the handwritten document, Borrell maintained that it could not reasonably be interpreted to constitute a vote or agreement by Borrell to make or call for a subsequent capital contribution, and any money paid by Clary to settle the debts of the LLC was a loan advanced by Clary to the LLC. The trial court granted summary judgment in favor of Borrell, holding that there was no genuine issue of material fact that Borrell failed to make a capital contribution as provided in the operating agreement and that Borrell’s personal guarantee for the LLC’s loans did not constitute additional capital contributions. The trial court also found there was no evidence that the LLC was a proper plaintiff as there was no legal basis for joining the company in the suit. Clary appealed, arguing that the evidence created a genuine issue of material fact as to whether Borrell breached the operating agreement by failing to make subsequent capital contributions. The appellate court stressed the primacy of the operating agreement in governing the relations among the members, managers, and LLC and found that the handwritten document relied on by Clary met none of the requirements set forth in the operating agreement for subsequent capital contributions. For Borrell to be required to make a subsequent capital contribution pursuant to the operating agreement, Borrell had to determine along with Clary that such a contribution was necessary for the operation of the LLC or the discharge of LLC obligations, and Borrell had to be notified of the need by a notice containing a statement in reasonable detail of the proposed uses of the subsequent capital contribution and a date by which the contribution must be made. Clary also argued that the handwritten document at issue was a blanket acquiescence by Borrell for the payment of the LLC’s debts that was a contract in and of itself, but because Clary never raised this argument to the trial court it was not preserved for review. The appellate court also found there was no evidence that Borrell contributed more than the initial capital contribution pursuant to the agreement. Even if Borrell did personally guarantee and obtain loans on behalf of the LLC, such actions did not meet the requirements for subsequent capital contributions under the operating agreement. Rather, additional funds advanced to the LLC were considered loans from the member to the LLC under the terms of the operating agreement. In addition, assuming Borrell made contributions to the LLC beyond the required initial capital contribution, the additional contributions had no effect on Clary’s allegation that Borrell failed to make subsequent capital contributions and breached the agreement.
AHF Arbors at Huntsville I, LLC v. Walker County Appraisal District
__ S.W.3d __, 2012 WL 2052948 (Tex. 2012)
Two LLCs that owned low-income housing apartment complexes asserted that they met the statutory requirements for exemption from ad valorem taxation available to a community housing development organization (“CHDO”) under Section 11.182 of the Texas Tax Code. The principal issue addressed in this opinion was whether a CHDO must have legal title to property to qualify for the exemption, and the Texas Supreme Court held that equitable title is sufficient. The sole member of each of the two LLCs in this case was a nonprofit corporation exempt from federal income taxation under Section 501(c)(3) and certified as a CHDO by the Texas Department of Housing and Community Affairs. Section 11.182(b) of the Texas Tax Code provides a tax exemption to an organization on “property it owns” if it is organized as a CHDO and “owns the property for the purpose of” providing low- or moderate-income housing without profit. The LLCs argued that their apartments were exempt because ownership, within the meaning of the statute, includes equitable title, which the LLCs’ sole member, a certified CHDO, held by virtue of its complete control of the LLCs. The appraisal district argued that ownership means legal title, and that the LLCs were not entitled to an exemption since there was no evidence they themselves were CHDOs. The court looked to Section 11.182(e) of the Tax Code as an indication that ownership in subsection (b) included equitable title. Section 11.182(e) allows property “owned by a limited partnership” to be tax-exempt in certain instances if 100% of its general partner is controlled by a CHDO meeting the requirements of subsection (b). The court was unconvinced that limited partnerships are the one exception to subsection (b)’s requirement of legal ownership by a CHDO and saw no reason to distinguish between a general partner’s control of a limited partnership and other types of corporate control over related entities, such as the CHDO’s complete ownership of its subsidiary LLCs in this case. The court characterized the purpose of subsection (e) as limiting exemptions for limited partnerships to those in which the CHDO wholly owns the general partner rather than as carving out an exception for non-CHDO limited partnerships. The court observed that this construction acknowledges the realities of the commercial housing industry, in which lenders often require that property be purchased by a single-asset entity. The court also noted that tiered ownership allows greater flexibility for investors, encouraging the involvement of private funds in developing low-income housing consistent with the purpose in creating the concept of CHDOs. The court rejected several arguments made by the appraisal district, including an argument that entities that are separate for purposes of imposing liability should not be treated as one for purposes of qualifying for tax exemptions. The court pointed out that federal tax law disregards the separate identity of some entities (e.g., the LLCs in this case, which are disregarded as separate entities from their owner), and the court stated that there was no reason why Section 11.182 should not do the same. The court discussed five cases in which courts of appeals adopted varying constructions of Section 11.182. The court agreed with the reasoning in TRQ Captain’s Landing v. Galveston Central Appraisal District, 212 S.W.3d 726 (Tex. App.–Houston [1st Dist.] 2006, pet. granted, appeal abated), in which the court of appeals upheld an exemption for a limited partnership that was wholly owned by an LLC whose only member was a CHDO. Applying the rule that a CHDO’s equitable ownership of property qualifies for an exemption under Section 11.182 to the facts in the instant case, the court concluded that the CHDO had complete control over the LLCs and equitable title to the property–the power to compel the transfer of legal title. The court acknowledged that each of the LLCs had managers, which were the governing authority of the entities, but concluded that the member CHDO had complete control over the LLCs because managers serve at the pleasure of the members. The court noted that it was not addressing and expressed no view on numerous other issues raised by the parties, including the appraisal district’s arguments that the LLCs were not charitable organizations, that their apartments were not used for low- and moderate-income housing, and that other requirements of Section 11.182 and of federal law were not met. A dissenting justice pointed out that the companies were asking the court to pierce the corporate veil that they themselves created. He argued that Texas law respects corporate formalities and usually limits piercing to circumstances of fraud or other malfeasance. He commented that the legal and business communities would be astounded if taxing authorities could routinely look to the parent to pay taxes on property of a subsidiary, and the granting of a tax exemption to a subsidiary struck the justice as equally untenable. The dissenting justice viewed the legislature’s failure to provide a provision similar to the one provided for limited partnerships in Section 11.182(e) as reason enough to disagree with the majority. Though he found it unnecessary to consider why the legislature would treat the two entities differently, he pointed out various differences between limited partnerships and LLCs that might provide plausible reasons for drawing a statutory distinction, and he stated that he would respect what he viewed as the legislature’s policy choice to treat LLCs and limited partnerships differently.
376 S.W.3d 202 (Tex. App. 2012)
The plaintiff sought to hold Wasserberg and Felt liable as guarantors for amounts owed for goods and services sold by the plaintiff to Waterhill Companies Limited (“WCL”). In 2002, Wasserberg and Felt signed a credit application on behalf of Waterhill Company, LLC, in which Wasserberg and Felt purported to “personally guarantee all indebtedness hereunder” in order to obtain credit from Flooring Services of Texas, L.P. Waterhill Company, LLC converted into WCL in 2003, and Flooring Services of Texas, L.P. merged into Flooring Services of Texas, LLC (the “plaintiff”) in 2007. Goods and services were provided on credit before and after these transactions. The guarantors argued that they were not liable for debts incurred after these transactions (i.e., debts incurred by WCL, the converted entity, for goods and services provided by the plaintiff, the survivor of the merger) because the terms of a guaranty must be strictly followed and “‘neither the party seeking to enforce the guarant[ies] nor the party whose performance was guaranteed is named in the existing document.’” The court of appeals held that the trial court properly concluded that the guaranties were applicable to debts incurred after Waterhill Company, LLC converted into WCL because the Texas conversion statutes and the articles of conversion filed with the Secretary of State provided that the converting entity continues in existence in the organizational form of the converted entity. (Relying on a statement in the articles of conversion, the court erroneously referred to the Texas Business Corporation Act rather than the Texas Limited Liability Company Act, but the Texas conversion statutes for partnerships, corporations, and LLCs all contained similar language.) The court of appeals also rejected the argument that the guaranties did not apply to indebtedness for goods and services provided by the plaintiff, Flooring Services of Texas, LLC, as the survivor of a merger with Flooring Services of Texas, L.P. The guarantors argued that the guaranties did not cover these post-merger transactions because the guaranties did not name the plaintiff or refer to its “successors or assigns.” The court noted that the Texas merger statutes provide that all rights of the parties to the merger are allocated and vested in the surviving entity without the need for any formal transfer or assignment. The court also distinguished other Texas cases relied upon by the guarantors. According to the court, unlike a guaranty that covered payment for goods sold by Ford Marketing Corporation (which was held not to be enforceable by Ford Motor Company for goods sold by it as the post-merger successor), the document in this case referred to “all indebtedness hereunder” and was not limited to goods and services provided by Flooring Services of Texas, L.P. Additionally, the court rejected the argument that Texas cases have required language extending a guaranty to actions by a successor entity in order for a successor to enforce the guaranty.
371 S.W.3d 267 (Tex. App. 2012)
This case involved a dispute over the existence and breach of fiduciary duties in a business venture that operated by means of a limited liability company and limited partnership. An individual who was both a minority member of the LLC and a limited partner of the limited partnership sued the individual who was both the controlling member of the LLC and a fellow limited partner to recover withheld profit distributions. The trial court entered a judgment on the jury verdict that found the controlling member breached his fiduciary duties to the minority member. The court of appeals reversed and remanded holding: (1) the LLC agreement imposed fiduciary duties on the controlling member; (2) the limited partner relationship by itself did not give rise to a direct fiduciary duty between the individuals; (3) the trial court committed harmful error by commingling valid and invalid theories in instructing the jury that the controlling member had fiduciary duties with respect to operations of both the LLC and the limited partnership; and (4) any withheld profit distributions originated from the operations of the limited partnership in which the controlling member’s fiduciary duties had been contractually disclaimed. In February 2003, Wimberly and Strebel went into business together. They formed an LLC, and they and their spouses executed an amended and restated LLC agreement effective January 2004 in which they memorialized terms and provided specifics as to the business. Under the amended agreement, Strebel and Wimberly were the members, with 60% and 40% sharing ratios, respectively; Strebel, Wimberly, and their spouses comprised a board of managers who had to be consulted on certain major decisions; and Strebel was designated as the “Managing Manager and CEO” of the LLC with broad decision-making and management powers. In addition, the agreement provided that the managers had fiduciary duties to the LLC and the members equivalent to the fiduciary duties of directors of Delaware corporations, and members had fiduciary duties to the LLC comparable to stockholders of Delaware corporations. Wimberly, Strebel, and their spouses also formed a limited partnership in 2005. Under the limited partnership agreement, the LLC was designated as the general partner with broad authority to control the limited partnership, and Wimberly, Strebel, and their spouses became limited partners who agreed not to act for the limited partnership. The limited partnership agreement provided that the general partner had no duties except those expressly set forth in the agreement, and no provision in the agreement imposed fiduciary duties on the general partner. In 2007, Wimberly and Strebel had a disagreement regarding the profit distributions related to their business ventures. Wimberly sued Strebel to recover profit distributions Strebel allegedly withheld. Wimberly asserted numerous causes of action contending essentially that Strebel acted in bad faith and breached his fiduciary duties to deprive Wimberly of distributions by retroactively reducing Wimberly’s distribution percentages and shifting money from profit to bonuses to reduce funds available for profit distributions. The trial court instructed the jury that Strebel owed Wimberly fiduciary duties based on their relationship as co-owners of the LLC (with Strebel as the majority owner and managing manager) and their relationship as partners in the limited partnership. The jury found that Strebel breached his fiduciary duties to Wimberly. Strebel appealed arguing that he did not owe Wimberly any fiduciary duties and that any acts allegedly depriving Wimberly of distributions were permitted based on the parties’ contractual agreements. The court of appeals analyzed the existence and application of fiduciary duties Strebel owed Wimberly. The parties agreed that whether Strebel owed Wimberly fiduciary duties based on their limited liability company relationship depended on the interpretation of the language in the LLC agreement. The LLC agreement was governed by Delaware law. Under the Delaware LLC Act, parties are given broad freedom to contract, and the existence and scope of fiduciary duties must be determined by reference to the LLC agreement. Here, the LLC agreement stated that managers shall have fiduciary duties to the LLC and the members equivalent to the fiduciary duties of directors of Delaware corporations except as otherwise provided in the agreement. Strebel contended that as the managing manager he owed fiduciary duties to the LLC and its members collectively rather than to Wimberly individually. Wimberly responded that such an interpretation was illogical as it was contrary to the plain meaning of the language of the agreement, which included fiduciary duties to members. Wimberly also asserted that, unless default fiduciary duties are specifically disavowed by contract, Delaware courts have treated LLC members as owing each other the traditional fiduciary duties that directors owe a corporation. The court of appeals sided with Wimberly and held that the trial court correctly interpreted the LLC agreement as imposing fiduciary duties on Strebel as the managing manager to Wimberly as an individual member. The court viewed the reference in the agreement to the duties of corporate directors as describing the type of duties owed, not limiting those to whom the duties are owed. The language of the LLC agreement specified that the managers shall have fiduciary duties to members. According to the court, any other interpretation would render the phrase superfluous. Thus, the trial court did not err in instructing the jury that Strebel owed Wimberly fiduciary duties as the managing manager of the LLC. In the remainder of the opinion, the court analyzed whether Strebel owed Wimberly fiduciary duties based on their limited partnership relationship, which depended on whether limited partners owe each other fiduciary duties under Texas law. The limited partnership agreement was governed by the Texas Revised Limited Partnership Act, and the agreement here was silent as to any fiduciary duties owed between and among the limited partners. The court concluded that the mere status as a limited partner does not give rise to fiduciary duties despite broad language in some cases to that effect. However, a party’s status as a limited partner does not insulate that party from the imposition of fiduciary duties that arise when a limited partner also takes on a nonpassive role by exercising control over the partnership in a way that justifies recognition of such duties or by contract. In this case, the relationship between Strebel and Wimberly as limited partners in the limited partnership did not give rise to a direct fiduciary duty to each other. The trial court’s instruction that Strebel owed Wimberly fiduciary duties as partners in the limited partnership was thus erroneous. Furthermore, the instructions were erroneous to the extent they conveyed that Strebel owed Wimberly fiduciary duties in Strebel’s capacity as the managing manager of the LLC that served as the general partner of the limited partnership because the limited partnership agreement expressly disclaimed any fiduciary duties owed to the limited partners by the general partner itself. The trial court’s jury instruction failed to account for the legal effect of this disclaimer. Thus, the trial court wrongly included in its jury instructions the existence of fiduciary duties owed by Strebel to Wimberly in relation to the limited partnership. Strebel argued that the trial court committed harmful error in the jury instructions by commingling valid and invalid theories. The trial court instructed the jury that Strebel owed Wimberly fiduciary duties based on the LLC agreement, which was correct, and because of the limited partnership relationship, which was incorrect. Because of the commingling, it was impossible to determine if the jury finding that Strebel breached his fiduciary duties was based on a valid or invalid theory. Furthermore, the court of appeals concluded that Wimberly’s recovery under the improper jury question failed on causation grounds. The damages alleged by Wimberly were caused by the actions of the limited partnership’s general partner (i.e., the LLC) in exercising its exclusive authority to run the limited partnership and Strebel’s alleged control of the general partner. Courts have recognized that general partners in a limited partnership owe fiduciary duties to limited partners, but courts have also acknowledged the importance of honoring parties’ contractual terms defining the scope of their obligations and agreement, including limiting fiduciary duties that may otherwise exist. In this case, there was an express contractual disclaimer in the limited partnership agreement of fiduciary duties owed by the Strebel-controlled general partner to the limited partners, and there was no jury question regarding breaches by the general partner. Because Wimberly sought recovery based on actions that were all taken in Strebel’s capacity as managing manager of the general partner, the court held that the waiver of fiduciary duties in the limited partnership agreement foreclosed Wimberly’s recovery on his breach of fiduciary duty claim. Applying the fiduciary duties Strebel owed Wimberly in the LLC relationship, as Wimberly urged, would render meaningless the express disclaimer of fiduciary duties in the limited partnership agreement under which the parties were operating. Since Wimberly failed to demonstrate that Strebel took actions that caused Wimberly’s lost distribution damages while acting within the scope of any fiduciary duties that existed between the parties (inasmuch as the parties had contractually disclaimed the fiduciary duties related to the actions by Strebel at issue) the judgment, which was based on the jury’s finding of breach of fiduciary duty, was reversed. The case was remanded for consideration of alternative liability and damages findings.
368 S.W.3d 604 (Tex. App. 2012)
The Waldens entered into two contracts with an LLC under which the LLC would convey a residential lot to the Waldens and construct a residence on the lot. Disputes relating to the construction work arose, and there was a protracted delay in transfer of the title to the lot. The Waldens sued the LLC, and its two members/managers, Shook and Jaehne, asserting numerous tort and contract theories. The jury found that the LLC breached the construction contract, that Shook and Jaehne were liable for the LLC’s contractual liabilities on the basis of alter ego and single business enterprise, and that the LLC was operated as a sham. The trial court entered judgment against the LLC, Jaehne, and Shook based on these findings. Shook appealed. On appeal, the Waldens conceded that the single business enterprise finding could not support a judgment against Shook because the Texas Supreme Court rejected the single business enterprise theory in SSP Partners v. Gladstrong Investments (USA) Corp. Thus, the alter ego and sham theories remained as potential bases for the judgment against Shook. Shook did not dispute that the concept of veil piercing applied to an LLC but argued that the Waldens were required to prove that he used the LLC to perpetrate a fraud for his direct personal benefit in order to impose on him the contractual liability of the LLC. The Waldens argued that the common law corporate veil-piercing principles articulated in Castleberry v. Branscum, which only required constructive fraud, applied in the absence of any statutory standards in the LLC context. The court reviewed the development of Texas veil-piercing law going back to the Castleberry case. Prior to 1989, Article 2.21 of the Texas Business Corporation Act mandated that the liability of a shareholder of a Texas corporation was limited to the value of the shareholder’s shares and did not reference any exception under which a shareholder could be held individually liable for the corporation’s obligations. Notwithstanding this statutory language, courts had long held that a corporation’s separate existence could be disregarded as a matter of equity in certain circumstances. In 1989, however, the Texas Business Corporation Act (“TBCA”) was amended to partially codify and limit judicial application of veil-piercing principles in reaction to the Texas Supreme Court’s 1986 decision in Castleberry, in which the court stated that piercing the corporate veil on the basis of “sham to perpetrate a fraud” merely required a showing of constructive fraud regardless of whether the underlying claim arose in tort or contract. Article 2.21 of the TBCA was amended in 1989 to provide that a corporation’s contractual obligation could not be imposed on a shareholder “on the basis of actual or constructive fraud, or a sham to perpetrate a fraud” except on proof that the shareholder “caused the corporation to be used for the purpose of perpetrating and did perpetrate an actual fraud” on the claimant “for the direct personal benefit of the shareholder.” The 1989 amendments also provided that a shareholder had no liability for a contractual obligation of the corporation “on the basis of the failure of the corporation to observe any corporate formality.” Article 2.21 was further amended in 1993 and 1997 in several respects, which included broadening the actual fraud requirement to any obligation “relating to or arising from” a corporation’s contractual obligation and to claims based on alter ego or any other similar theory. Meanwhile, as these developments regarding corporate veil piercing were taking place, the legislature authorized the creation of LLCs by passing the Texas Limited Liability Company Act (“TLLCA”) in 1991. The TLLCA was later recodified in the Business Organizations Code (“BOC”). Article 4.03 of the TLLCA provided that LLC members and managers were not liable for the debts, obligations, or liabilities of the LLC without mention of veil-piercing principles as an exception. This approach was carried forward in the BOC until the legislature added new Section 101.002 of the BOC in 2011 specifying that the BOC provisions applicable to corporate veil piercing also apply to LLCs, their members, and their managers. Shook acknowledged, however, that the 2011 amendment did not impact this case, which was governed by prior law. Shook relied upon state and federal decisions that have applied corporate veil-piercing standards to LLCs, but the court of appeals pointed out that courts in those cases have done so without analysis of why the corporate standards apply. The Waldens argued that comparison of the corporate and LLC statutes evidenced a legislative intent that the veil-piercing standards applicable to corporations not apply to LLCs (at least prior to 2011) since the legislature conspicuously omitted from the LLC statute the types of restrictions it imposed in the corporate context. In the absence of any statutory standards for veil-piercing of LLCs, the Waldens reasoned that the equitable principles set forth in Castleberry applied. The court of appeals noted that its research had revealed a Wisconsin federal district court veil-piercing decision governed by Texas law in which the court had essentially employed the same reasoning advanced by the Waldens. The court of appeals noted as an incidental matter that the legislative history of the 2011 amendments to the LLC statutes reflected that the amendments were in part a response to perceived confusion generated by the Wisconsin federal court’s decision. The court of appeals agreed with the Waldens that the veil-piercing restrictions and limitations in the TBCA did not, as a matter of statutory construction, extend to LLCs at any time relevant to this case and that the veil-piercing remedy in this case would be governed by extra-statutory equitable principles. However, the court stated that it did not automatically follow that proper application of those principles to the LLC must track Castleberry as the Waldens presumed. The court discussed the balancing of competing principles required in the application of veil-piercing principles and concluded that the legislative policy judgments made in the aftermath of Castleberry and the balancing of interests must necessarily inform judicial application of equitable veil-piercing principles to LLCs. The court stated that it was following the example set by the Texas Supreme Court in the context of equitable prejudgment interest. In that context, the supreme court overruled prior precedent in deference to legislative policy judgments and conformed preexisting equitable accrual and compounding methodologies to statutory standards even in cases that the statute did not reach. Although the Waldens stressed that the legislature did not enact a statute to govern veil piercing of LLCs at times relevant to this case, the Waldens offered no reason why the relative equities present with respect to claims to pierce the veil of an LLC with respect to a contract claim would categorically differ from those present in the corporate context. The court thus concluded that courts should be guided by the framework provided by the legislature in determining equity with respect to veil-piercing claims against LLCs. The court observed that its conclusion was consistent with the results in other Texas cases although the reasoning was admittedly not made explicit in those cases. The court also noted that a contrary conclusion was not suggested by the fact that the legislature later saw fit to amend the LLC statute to explicitly incorporate the veil-piercing standard prescribed in the corporate statutes. Deferring to and applying the legislative actual fraud standard governing veil-piercing of corporations required reversal of the judgment against Shook because there were no findings or proof that Shook caused the LLC to be used to perpetrate actual fraud for his direct personal benefit. A dissenting justice argued that the equitable standard set forth in Castleberry was the correct approach in this case given the absence of a statutory standard. Because an actual fraud finding is not required under Castleberry, the dissenting justice would have affirmed the judgment imposing personal liability on Shook based on the jury’s findings (which the dissenting justice considered to be supported by the record) that the LLC was operated as the alter ego of Shook and as a sham.
367 S.W.3d 355 (Tex. App. 2012)
This case dealt with a dispute arising from the redemption of a minority interest owned by Allen in a closely held LLC engaged in natural gas exploration and development. The LLC redeemed Allen’s interest in 2004 based on a $138.5 million appraisal of the LLC performed in 2003. In 2006, the LLC was sold for $2.6 billion. The increase in value of the LLC was essentially due to advancements made in horizontal drilling. Allen claimed that Rees-Jones and the LLC made misrepresentations and failed to disclose facts regarding the LLC’s future prospects and that he would not have sold his interest in 2004 if he had known these material facts. Allen alleged that the LLC and Rees-Jones, the LLC’s manager and majority owner, fraudulently induced him to redeem his interest. Allen brought claims for common law and statutory fraud, breach of fiduciary duty, shareholder oppression, and violations of the Texas Securities Act. In a lengthy opinion analyzing numerous issues bearing on the various claims, the court held, inter alia, that there was a formal fiduciary duty owed by Rees-Jones as the majority member/sole manager of the LLC to Allen as a passive minority member in the context of the redemption of Allen’s interest, that Rees-Jones did not conclusively establish that he owed no duty of loyalty to members individually under the terms of the exculpation clause in the LLC’s articles of organization, and that summary judgment was properly granted on Allen’s shareholder oppression claim. Based on an alleged fiduciary relationship between Allen and Rees-Jones, Allen alleged that the redemption was a breach of fiduciary duty by Rees-Jones. Allen asserted that Rees-Jones owed Allen a formal fiduciary duty on two bases: (1) a fiduciary duty owed to minority shareholders by a majority shareholder who dominates control over a business, and (2) a fiduciary duty owed by a closely held company’s officers and shareholders to a shareholder who is redeeming stock. The court recognized that the entity at issue was an LLC, but the court discussed and applied case law addressing closely held corporations because Allen relied on these cases and the LLC was a closely held LLC that operated much like a closely held corporation. The court noted that the vast majority of intermediate appellate courts in Texas have declined to recognize a formal fiduciary duty by a majority shareholder to a minority shareholder in a closely held corporation while recognizing that an informal fiduciary duty could exist under particular circumstances. Given “this overwhelming weight of authority,” the court did not agree with Allen that Texas recognizes a broad formal fiduciary relationship between majority and minority shareholders in closely held companies that would apply to every transaction among them, and the court thus declined to recognize such a fiduciary relationship between members of an LLC on this basis. The court concluded, however, that “there is a formal fiduciary duty when (1) the alleged-fiduciary has a legal right of control and exercises that control by virtue of his status as the majority owner and sole member-manager of a closely-held LLC and (2) either purchases a minority shareholder’s interest or causes the LLC to do so through a redemption when the result of the redemption is an increased ownership interest for the majority owner and sole manager.” The court noted that the scope of the fiduciary duty is not necessarily the same as for other fiduciary duties, and the court did not decide the scope of the duty. The court based its conclusion on the fact that Rees-Jones had essentially the powers and responsibilities of a general partner, a role in which the law imposes fiduciary obligations. Furthermore, the court relied upon corporate case law applying the “special facts” doctrine and concluded that the “special facts” doctrine supports recognizing a formal fiduciary relationship when an LLC’s member-manager communicates a redemption offer to the minority members that may benefit the member-manager individually. The court also discussed Rees-Jones’s fiduciary duty under the LLC’s articles of organization. The articles of organization contained a provision largely tracking Section 7.001 of the Texas Business Organizations Code. Since the LLC was an LLC rather than a corporation, the LLC was not covered by the restrictions in Section 7.001 on the limitation and elimination of liability for governing persons, and the court stated that the LLC’s members were free under the LLC statute “to expand or eliminate, as between themselves, any and all potential liability of [the LLC’s] manager, Rees-Jones, as they saw fit.” In the articles of organization, rather than completely eliminate Rees-Jones’s potential liability to the LLC or its members, the members eliminated the managerial liability of Rees-Jones except for the categories of liability for which Section 7.001 of the Texas Business Organizations Code does not permit elimination or limitation of liability for a corporate director. One of these categories was expressed in the articles of organization as “a breach of [Rees-Jones’s] duty of loyalty to [the LLC] or its members.” Allen relied upon this provision in arguing that Rees-Jones owed him a fiduciary duty. Rees-Jones argued that the articles of organization listed the exact duties owed by Rees-Jones as manager and created duties but that the duties ran to the LLC and the members collectively rather than to individual members. The court disagreed with Rees-Jones’s argument that the word “members” was intended to refer only to the members as a whole and not to include members individually or in groups of less than all. Furthermore, the court stated that the reference to the LLC or its members was ambiguous at best, thus creating a fact question for the jury. Thus, Rees-Jones did not conclusively establish that he did not owe a duty of loyalty to Allen under the articles of organization, nor did he conclusively establish that his duty of loyalty was not implicated since the redemption resulted in an increase in his ownership percentage and the duty of loyalty places restrictions on a governing person’s ability to participate in transactions on behalf of the company when the person has a personal interest in the transaction. The court noted that the LLC did not define or limit Rees-Jones’s duty of loyalty in the LLC documents and that the Texas Business Organizations Code does not define the duty of loyalty in the LLC context. The court stated that it typically looks to the common law when the statutes are silent. The court of appeals upheld the trial court’s summary judgment on Allen’s shareholder oppression claim. The court stated that the doctrine of shareholder oppression protects a minority shareholder of a closely held corporation from the improper exercise of majority control, citing the two alternative definitions of shareholder oppression commonly relied upon by Texas courts, i.e., (1) majority shareholders’ conduct that substantially defeats the minority’s expectations that, objectively viewed, were both reasonable under the circumstances and central to the minority shareholder’s decision to join the venture; and (2) burdensome, harsh, or wrongful conduct; a lack of probity and fair dealing in the company’s affairs to the prejudice of some members; or a visible departure from the standard of fair dealing and a violation of fair play on which each shareholder is entitled to rely. The court concluded, however, that the alleged “wrongful conduct” of fraud by misrepresentations and omissions and breach of fiduciary duty was not similar to the typical wrongdoing in shareholder oppression cases, i.e., termination of employment, denial of access to books and records, wrongful withholding of dividends, waste of corporate funds, payment of excessive compensation, lock-out from corporate offices, or squeeze-out. Further, the court stated that there is little necessity for the oppression cause of action when the minority shareholder has nondisclosure and breach of fiduciary duty claims. The court noted that it was expressing no opinion as to whether a member of an LLC may assert a claim for shareholder oppression.
Banyan Investment Company, LLC v. Evans
292 P.3d 698 (Utah App. 2012)
A passive minority (20%) member of an LLC filed direct claims against the other five members, who managed and participated in the day-to-day affairs of the LLC, for breach of fiduciary duty, unjust enrichment, and an accounting based on alleged conduct for the personal profit of the defendant members to the detriment of the LLC. The trial court dismissed the plaintiff’s claims on the basis that they were derivative in nature and that the plaintiff was thus required to comply with the procedural requirements applicable to shareholder derivative suits. The plaintiff argued that its direct claims were permissible under the closely held corporation exception enunciated by the Utah Supreme Court in Aurora Credit Services, Inc. v. Liberty West Development, Inc. This exception permits a trial court to allow a minority shareholder in a closely held corporation to proceed directly under certain circumstances. The defendants argued that the closely held corporation exception does not apply to LLCs and that, even if it does, the exception was unavailable to the plaintiff in this case because it did not plead that it suffered injury distinct from the LLC’s injury. The court of appeals saw no reason to deny members of LLCs the opportunity to invoke the closely held corporation exception. In a 2009 opinion, the Utah Supreme Court noted the similarities between closely held LLCs and closely held corporations in the course of holding that the procedural requirements applicable to shareholder derivative suits also apply to LLC member derivative suits. The court of appeals concluded that the supreme court’s reasoning in that case supported application of the Aurora closely held corporation exception to closely held LLCs. Next, the court of appeals concluded that the plaintiff was not required to demonstrate that it suffered injury distinct from that of the LLC to maintain a direct action under the closely held corporation exception. The court stated that the injury analysis required for the closely held corporation exception is that the injury suffered by the plaintiff is distinct from that suffered by other shareholders. To impose a requirement that the plaintiff’s injury be distinct from the LLC’s as argued by the defendants would effectively do away with the closely held corporation exception because such an injury would give rise to a direct cause of action and make the exception unnecessary. The court explained that the closely held corporation exception applies where a minority shareholder suffers uniquely as a result of majority shareholders’ wrongdoing of a type that would ordinarily give rise only to a derivative claim. That was the situation alleged by the plaintiff in this case. The defendants asserted that the trial court’s dismissal should nevertheless be affirmed because invoking the closely held corporation exception is within the discretion of a trial court. However, the record showed that the trial court had dismissed the plaintiff’s direct claims only because the trial court mistakenly concluded that the closely held corporation exception did not apply to LLCs. The trial court commented that this case was a “perfect fit” for the exception if the exception applied to LLCs. Since the court of appeals concluded that the closely held corporation exception is available in the LLC context and this case was a “perfect fit” for the exception, the court of appeals held that the plaintiff could bring his claims directly under the exception.
724 S.E.2d 718 (Va. 2012)
Four individuals who owned Orthopedic & Sports Physical Therapy Associates, Inc. (“OSPTA”) approached three doctors in Orthopedic Specialty Clinic (“OSC”) and five other individuals from Cardiology Associates of Fredericksburg (“CAF”) to form Massaponax Medical Properties, LLC (“MMP”). MMP intended to purchase land in the Massaponax area, build a medical office building, and then sell the finished property to a third party with OSPTA, OSC, and CAF as tenants. In October, 2007, the members of CAF submitted an offer to MMP to purchase the property. After submission of that offer, the members of OSC approached CAF and asked to join them in purchasing the property. The members of OSC and CAF then formed Summit Group Properties, LLC (“Summit”) in December, 2007, to purchase and operate the building. OSPTA executed a lease with MMP in January, 2008, and OSC and CAF entered into identical leases. Summit eventually purchased the building and assumed the leases in September, 2008. Prior to opening the Massaponax office building, OSC was the largest referral source for OSPTA as OSC did not have its own physical therapy practice. OSPTA made its decision to enter into a long-term lease based on its assumption that it would continue to receive referrals from OSC. During 2007, one of OSC’s doctors decided that OSC would begin offering physical therapy services at the new Massaponax office. The opening of OSC’s Massaponax office significantly hurt OSPTA’s practice, and OSPTA vacated its space, thereby breaching its lease, in 2009. When Summit sued OSPTA and its owners for breach of the lease, OSPTA filed a counterclaim for fraud in the inducement. OSPTA argued that Summit’s ordinary course of business was purchasing and leasing the Massaponax office building and that members of OSC who were also members of Summit concealed and misrepresented information to induce OSPTA to sign the lease. Summit’s theory of the case was that any misrepresentations or concealment took place before Summit was formed and assumed the leases and was done in the course of OSC’s business. OSPTA requested, and the trial court gave, the following instruction: “An act of a member, including the signing of an instrument in the limited liability company name, for apparently carrying on in the ordinary course the limited liability company business or business of the kind carried on by the limited liability company, binds the limited liability company, unless the member had no authority to act for the limited liability company in the particular matter and the person with whom the member was dealing knew or had notice that the member lacked authority.” The Virginia Supreme Court characterized this instruction as accurately stating the law applicable where a fraudulent act was committed in the ordinary course of an LLC’s business. The trial court also gave the following instruction offered by Summit: “The Plaintiff Summit Group Properties, LLC, is a limited liability company. In order for you to find that Summit Group Properties, LLC, is guilty of fraud, you must find that the fraudulent activity was authorized by the members of Summit Group Properties, LLC.” Summit relied upon the part of the LLC statute that provides that an act of a member that is not apparently for carrying on in the ordinary course the LLC business binds the LLC only if authorized by the other members. The Virginia Supreme Court concluded that this instruction was erroneous because it lacked the “not for apparently carrying on in the ordinary course of business” language that would have modeled it after the statute. The court stated that an instruction based on an act in the ordinary course or an act not in the ordinary course may be appropriate depending upon the nature of the act at issue in a particular case. In this case, the alleged fraudulent acts were lies and omissions by OSC, whose members were three of the eight members of Summit. The court said that the dispositive question was thus whether the actions by OSC’s members were in the ordinary course of Summit’s business. If the fraud was committed in the ordinary course of Summit’s business, then fraudulent acts by one member would bind it. If, however, the fraud was not committed in the ordinary course of business, then the jury would have to find that the fraudulent activity was authorized by the other members. The court concluded that the danger of omitting necessary language from Summit’s instruction was that the jury might be misled into thinking that the activity must have been authorized by the members of Summit even if the fraudulent act was within the ordinary course of Summit’s business. The court could not conclude that the error was harmless because the court could not tell whether the jury believed the act occurred in the ordinary course of OSC’s business or the ordinary course of Summit’s business. One justice concurred in part and dissented in part, agreeing with the majority that the trial court erred in giving Summit’s instruction but arguing that the error was harmless. The dissenting justice argued that there was no evidence that the concealment by OSC of its plans to provide its own physical therapy services occurred in the ordinary course of Summit’s business, which was limited to purchasing a building and assuming the leases entered into between MMP and its tenants. Because Summit was a separate and distinct entity from the medical practices operated by its members, the dissenting justice argued that any misrepresentations made by the members of OSC in the course of their medical practice could not have been made in the course of Summit’s real estate business.
Cordts-Auth v. Crunk, LLC
479 Fed. App’x 375 (2nd Cir. 2012)
(interpretation of provisions of operating agreement regarding “performance units” and admission to membership; lack of standing of recipient of performance units who was never admitted as member to bring derivative action on behalf of LLC)
Ross v. Thomas
460 Fed. App’x 16 (2nd Cir. 2012)
(interpretation of operating agreement of Delaware LLC as to whether loan was “capital transaction” within meaning of agreement)
Health and Body Store, LLC v. Justbrand Limited
480 Fed. App’x 136 (3rd Cir. 2012)
(fiduciary duties of members of Pennsylvania LLC to other members and LLC equivalent to duties of partners of partnership; fiduciary obligations of individual acting as agent of LLC)
693 F.3d 491 (5th Cir. 2012)
(LLC member’s lack of standing to assert tortious interference with LLC’s contract; dissolution of LLC raised on appeal insufficient to confer standing on member to assert LLC’s claim because standing must be established as of time suit is brought)
Grand Rapids Associates Limited Partnership v. Coop Properties, LLC
495 Fed. App’x 598 (6th Cir. 2012)
(application of corporate veil piercing principles to LLC without discussion of fact that entity was LLC rather than corporation)
GeoSynFuels, LLC v. Gorman
493 Fed. App’x 713 (6th Cir. 2012)
(subscriber’s payment not condition precedent to formation of contract regarding investment in Delaware LLC under subscription agreement governed by New York law; sufficiency of evidence of mutual assent between LLC and investor regarding purchase and sale of shares in LLC)
Superior Seafoods, Inc. v. Hanft Fride, P.A.
482 Fed. App’x 188 (8th Cir. 2012)
(lack of capacity of suspended California LLC to pursue appeal)
Woods View II, LLC v. Kitsap County
484 Fed. App’x 160 (9th Cir. 2012)
(lack of standing of sole member to assert claims against county for injury to LLC)
484 B.R. 766 (9th Cir (BAP) 2012)
(inability of debtor to avoid lien as continuous interest in homestead where debtor conveyed property to LLC and then reacquired property from LLC; member’s lack of direct interest in LLC property)
Alexander v. Adelberg
497 Fed. App’x 816 (10th Cir. 2012)
(application of statutory liability protection provided by Colorado LLC statute to individual and inapplicability of provision imposing liability on members with respect to certain distributions in liquidation of dissolved LLC where LLC’s assets were sold in court-approved sale in receivership proceeding)
883 F.Supp.2d 1128 (N.D. Ala. 2012)
(veil piercing of Alabama LLCs; IRS levy of funds owed LLCs to satisfy obligations of member and spouse on basis LLCs were alter egos of member and member’s spouse)
279 P.3d 1156 (Alaska 2012)
(manager’s fraud as material breach of operating agreement excusing obligation to pay premium for manager’s interest; interpretation of noncompete provision as binding shareholder of manager; tolling of limitations against manager based on manager’s fraud)
856 F.Supp.2d 1084 (D. Ariz. 2012)
(personal liability of sole member of Utah LLC (under Utah or Arizona law) for participating in LLC’s breach of fiduciary duty to LLC’s partner)
276 P.3d 11 (Ariz. App. 2012)
(analysis of Arizona LLC statute authorizing award of attorney’s fees in derivative actions and characterization of statute as fee-sharing rather than fee-shifting provision)
469 B.R. 314 (Bankr. E.D. Ark 2012)
(limited liability of LLC member; personal liability of LLC member if member’s conduct amounts to fraud)
844 F.Supp.2d 1078 (S.D. Cal. 2012)
(discussion of whether LLC members owe one another fiduciary duties under Nevada law; fact issue as to whether member assumed role of managing member so as to create fiduciary duty; interpretation and application of choice of forum and choice of law clauses in LLC operating agreement)
48 A.3d 130 (Conn. App. 2012)
(sufficiency of evidence that payment to LLC member was loan rather than investment of capital in return for membership)
46 A.3d 175 (Conn. App. 2012)
(limited liability of member or manager of LLC; personal liability of member or manager who participates or engages in tortious conduct)
Gatz Properties, LLC v. Auriga Capital Corporation
59 A.3d 1223 (Del. 2012)
(per curiam) (denial of appellee’s request for attorney’s fees without prejudice to pursue in court of chancery due to factual nature of bad faith issue)
C.A. No. 7639-VCN, 2012 WL 6681994 (Del. Ch. Dec. 5 and 21, 2012)
(preliminary injunctive relief based on probability managing member breached LLC agreement by not making preferred return distribution)
Henson v. Sousa
C.A. No. 8057-VCG, 2012 WL 6628817 (Del. Ch. Dec. 19, 2012)
(failure to show irreparable harm required to obtain TRO against other two members restraining them from dissolving LLC, terminating LLC’s employees, disrupting customer relationships, and transferring LLC’s assets to new entities owned by other two members)
C.A. No. 7599-VCP, 2012 WL 6096586 (Del. Ch. Dec. 7, 2012)
(subject matter jurisdiction over former members’ claims for breach of redemption agreements under Delaware LLC Act and over related claims under clean-up doctrine; sufficiency of allegations to support claim for mutual mistake requiring reformation of redemption agreements to include agreement limiting tax liability; interpretation of forum selection clause)
C.A. No. 7304-VCL, 2012 WL 4859157 (Del. Ch. Oct. 12, 2012)
(ineffectiveness of attempts by non-managing member to replace managing member and terminate president and CEO of LLC)
C.A No. 6840-VCP, 2012 WL 3224351 (Del. Ch. Aug. 7, 2012)
(plaintiff’s ability to proceed in Delaware on claim that manager improperly withheld distributions despite earlier filed litigation in New York)
MICH II Holdings LLC v. Schron
C.A. No. 6840-VCP, 2012 WL 2499507 (Del. Ch. June 29, 2012)
(inapplicability of forum selection clause requiring claims against Delaware LLC to be brought exclusively in Delaware in action against manager; stay of claims against manager for breach of fiduciary duty and breach of operating agreement because of earlier filed litigation in New York)
C.A. No. 6902-VCP, 2012 WL 1955279 (Del. Ch. May 30, 2012)
(application of choice of forum and choice of law provisions in employment agreement with LLC; stay of Delaware litigation involving repurchase option under LLC agreement where related litigation was pending in New Mexico)
Whittington v. Dragon Group, LLC
C.A. No. 2291-VCP, 2012 WL 2052792 (Del. Ch. May 25, 2012)
(determination of scope of LLC’s authorization of payment of attorney’s fees incurred to defend members and LLC; payment of members’ attorney’s fees as not constituting de facto distribution; defendant members’ unsuccessful outcome of litigation not alone sufficient to make authorization of payment of their attorney’s fees improper)
C.A. No. 6380-VCP, 2012 WL 2045857 (Del. Ch. May 22, 2012)
(fraud of member in misrepresenting investment track record, employment history, and personal financial situation to induce other members to go into business with him; member’s breach of fiduciary duties by failing to correct misrepresentations and making additional misrepresentations after formation of LLC)
C.A. No. 7304-VCL, 2012 WL 966944 (Del. Ch. Mar. 20, 2012)
(court’s in rem jurisdiction under Delaware LLC statute to determine who validly holds office as manager of Delaware LLC; court’s personal jurisdiction under Delaware LLC statute over member who participated materially in management by removing managing member and purporting to remove employee and officer; jurisdiction over other counts arising out of common nucleus of operative fact)
Jefferson v. Collins
__ F.Supp.2d __, 2012 WL 5941953 (D.D.C. 2012)
(limited liability of LLC member; application of corporate veil piercing principles under District of Columbia law to LLC)
840 F.Supp.2d 287 (D.D.C. 2012)
(agent status of sole member and manager of Virginia LLC; manager’s actual authority under operating agreement to bind LLC to contract)
Horizons A Far, LLC v. Plaza N 15, LLC
__ So.3d __, 2012 WL3044271 (Fla. App. 2012)
(interpretation of waiver of right to receiver in dissolution/liquidation provision of operating agreement as not precluding receiver in action for breach of fiduciary duty)
724 S.E.2d 894 (Ga. App. 2012)
(absence of futility exception to demand requirement for derivative action under Georgia LLC statute)
State v. Hill
296 P.3d 412 (Idaho App. 2012)
(refusal of one-third member’s request for one-third reduction of restitution payment to two other members of LLC where one-third member convicted of grand theft from LLC)
289 P.3d 50 (Idaho 2012)
(separate existence of LLC and its members absent veil piercing grounds; separate existence of commonly owned corporation and LLC)
479 B.R. 781 (Bankr. N.D. Ill. 2012)
(analysis of inside reverse veil piercing claim under Delaware law)
Matter of Wish (Joyce v. Wish)
472 B.R. 763 (Bankr. N.D. Ill. 2012)
(veil piercing of LLC under Illinois law; analysis of LLC investor’s claim for exception to discharge against LLC manager debtor)
97 So.3d 595 (La. App. 2012)
(limited liability of LLC member; application of corporate veil piercing principles to LLCs)
94 So.3d 782 (La. App. 2012)
(limited liability of member of LLC; personal liability of member for personal negligence or breach of professional duty)
Matter of Cat Island Club, L.L.C.
94 So.3d 75 (La. App. 2012)
(judicial dissolution on grounds it was not reasonably practicable to carry on LLC’s business where vote was two members in favor and two against dissolution and members were unable to work toward goals or reasons for continued association; court’s authority to appoint liquidator to wind up LLC)
92 So.3d 660 (La. App. 2012)
(sufficiency of promise to guarantee and secure line of credit for LLC as capital contribution for 24% interest in LLC; ratification by LLC of issuance of 24% membership interest by accepting benefits of line of credit secured by 24% member; interpretation of anti-dilution provision of operating agreement)
99 So.3d 730 (La. App. 2012)
(separate existence and absence of successor liability of LLC formed after death of sole proprietor to continue restaurant business of sole proprietor)
468 B.R. 1 (D. Me. 2012)
(absence of evidence of conflict of interest triggering “entire fairness’ standard on part of managers who approved settlement agreement on behalf of LLC; authority of majority of managers designated pursuant to Chapter 11 plan, which equated to operating agreement under Delaware LLC statute; ability of two out of three LLC managers to act under Delaware law without consultation with or consent of third manager)
45 A.3d 883 (Md. Spec. App. 2012)
(common law fiduciary duties owed by managing members of Maryland LLCs; analysis of usurpation of opportunity claim against managing member under reasonable interest or expectancy test, which requires more than mere proximity of geography or management)
478 B.R. 523 (Bankr. D. Mass. 2012)
(application of corporate veil piercing principles to LLCs under Massachusetts law)
467 B.R. 427 (Bankr. E.D. Mich. 2012)
(effect of conveyance of 100% of voting rights of LLC and appointment of new sole managing member; lack of authority of former member to file bankruptcy petition for LLC)
Martindale v. Hortman Harlow Bassi Robinson and McDaniel PLLC
__ So.3d __, 2012 WL 4497756 (Miss. App. 2012)
(interpretation of law firm LLC operating agreement expulsion and buyout provision; court’s absence of power to fashion equitable relief when operating agreement is clear and unambiguous and has not been breached; duty of majority members to act in intrinsically fair manner in buyout of member; analysis of implied covenant of good faith and fair dealing)
870 F.Supp.2d 708 (W.D. Mo. 2012)
(managing member’s use of auto not owned by LLC as within course of LLC’s business for purposes of insurance coverage notwithstanding intervening personal errand; instructive but not controlling nature of respondeat superior principles in analysis of nature of managing member’s use of vehicle for purposes of coverage under LLC’s insurance policy)
286 P.3d 895 (Mont. 2012)
(satisfaction of grounds for judicial dissolution where member disproportionately enriched itself to detriment of LLC and managing member engaged in various wrongful acts; sufficiency of uncontested acts to show frustration of economic purpose, conduct making it not reasonably practicable to carry on LLC business, and unduly prejudicial actions)
856 F.Supp.2d 280 (D.N.H. 2012)
(gross negligence or willful misconduct standard of liability of member or manager for breach of fiduciary duty under New Hampshire LLC statute; absence of statutory duties and liability of former members and managers under New Hampshire LLC statute; failure of wrongful dissociation claim in absence of showing of damages)
In re G-1 Holdings, Inc.
477 B.R. 542 (Bankr. D.N.J. 2012)
(analysis of direct versus derivative claims in LLC context under Delaware law)
472 B.R. 679 (Bankr. D.N.J. 2012)
(freedom of members of New Jersey LLC to restrict or expand rights and duties of managers and members; persuasive value of Delaware decisions in analyzing corporate law issues under New Jersey law; traditional duties of loyalty and care owed by managing members to non-managing members of New Jersey LLC absent contrary provisions in operating agreement; absence of fiduciary duties of non-managing members under New Jersey law; duty of disclosure owed by managing member to LLCs rather than non-managing members; derivative nature of claims for misappropriation and usurpation of opportunity by managing member of LLCs)
52 A.3d 214 (N.J. Super. 2012)
(availability of charging order and writ of execution against minority member’s interest in LLC as remedy in favor of ex-spouse/custodial parent for unpaid support arrears of member)
482 B.R. 344 (D.N.M. 2012)
(absence of technical trust relationship sufficient to create fiduciary relationship between member and LLC under New Mexico LLC statute for purposes of exception to discharge under Bankruptcy Code; ability of member of New Mexico LLC to sue derivatively on behalf of LLC)
842 F.Supp.2d 502 (S.D.N.Y. 2012)
(absence of grounds to nullify filing of certificate of cancellation of Delaware LLC; application of corporate veil piercing principles to LLC under Delaware law)
475 B.R. 334 (Bankr. E.D.N.Y. 2012)
(rights of investors with respect to LLC membership interests held in name of debtor purchased with funds provided by investors; rights of assignees under New York LLC law)
99 A.D.3d 117, 950 N.Y.S.2d 24 (App. Div. 1st Dept. 2012)
(interpretation of indemnification provisions of LLC operating agreement and New York LLC statute as not entitling prevailing members and managers to recover fees expended in successful action to obtain indemnification)
98 A.D.3d 947, 951 N.Y.S.2d 77 (App. Div. 2nd Dept. 2012)
(LLC veil piercing)
96 A.D.3d 839, 946 N.Y.S.2d 248 (App. Div. 2nd Dept. 2012)
(denial of minority member’s petition for judicial dissolution where LLC tattoo shop was achieving purpose and was financially feasible)
96 A.D.3d 667, 948 N.Y.S.2d 34 (App. Div. 1st Dept. 2012)
(enforcement of unambiguous provision of operating agreement giving individual sole discretion to alter plaintiff’s sharing ratio)
96 A.D.3d 603, 947 N.Y.S.2d 450 (App. Div. 1st Dept. 2012)
(modification of capital call procedures of Delaware LLC agreement by course of conduct; breach of contract established as matter of law based on failure to provide required notice for capital calls; fact issue regarding claim for usurpation of LLC opportunity to participate in option to purchase stock)
96 A.D.3d 446, 946 N.Y.S.2d 133 (App. Div. 1st Dept. 2012)
(interpretation of operating agreement provision allowing penalty for failure to make required contribution)
94 A.D.3d 539, 942 N.Y.S.2d 81 (App. Div. 1st Dept. 2012)
(interpretation of buyout provisions of operating agreement; inapplicability of implied covenant of good faith and fair dealing where buyout governed by express contract provisions)
94 A.D.3d 506, 941 N.Y.S.2d 620 (App. Div. 1st Dept. 2012)
(no personal liability of former members of law firm LLC who did not sign lease; no successor liability of law firm that hired former members of LLC tenant absent showing of express or implied assumption, consolidation or merger, mere continuation, or fraudulent attempt to escape rent obligations)
93 A.D.3d 1281, 940 N.Y.S.2d 740 (App. Div. 4th Dept. 2012)
(interpretation of appraisal and arbitration clauses in LLC operating agreement)
93 A.D.3d 1253, 941 N.Y.S.2d 371 (App. Div. 4th Dept. 2012)
(application of corporate veil piercing principles to reverse pierce LLC veil)
93 A.D.3d 444, 940 N.Y.S.2d 49 (App. Div. 1st Dept. 2012)
(insufficiency of mistake regarding value of in-kind contribution for LLC interest to support rescission based on mutual mistake)
92 A.D.3d 449, 938 N.Y.S.2d 57 (App. Div. 1st Dept. 2012)
(enforcement of unambiguous obligation of LLC under option agreement to issue 1/3 ownership interest for $1,000 without regard to capital contribution requirement in operating agreement)
Blythe v. Bell
No. 11 CVS 933, 2012 WL 6163118 (N.C. Super. Dec. 10, 2012)
(ability of members under North Carolina LLC statute to transfer both economic and control membership interests to other members without unanimous member consent absent contrary agreement)
820 N.W.2d 357 (N.D. 2012)
(limited liability of member of LLC; necessity of underlying LLC liability for veil piercing liability to be imposed; liability of member for acts and contracts entered into in individual capacity where member did not disclose he was acting on behalf of LLC)
Huttenbauer Land Company, LLC v. Harley Riley, Ltd.
No. C-110842, 2012 WL 4760871 (Ohio App. Oct. 5, 2012)
(limited liability of LLC member; fraud or illegal act requirement of Ohio veil piercing of LLC)
Brooks Capital Services, LLC v. 5151 Trabue Ltd.
No. 12AP-30, 2012 WL 6520232 (Ohio App. 2012)
(interpretation of ambiguous provision of Ohio LLC statute regarding authority of member and manager to execute documents providing for acquisition, mortgage, or disposition of LLC property; absence of statutory authority of member of manager-managed Ohio LLC to bind LLC; absence of evidence of apparent authority of member who provided lender forged operating agreement reflecting his authority)
Lamar Advantage GP Co. v. Patel
No. CA2011-10-105, 2012 WL 2988819 (Ohio App. July 23, 2012)
(personal liability of individual who claimed to sign contract as representative of LLC where neither LLC’s name nor its unregistered trade name preceded individual’s signature and no representative capacity was indicated)
Rybak v. Main Sail, LLC
No. 96899, 2012 WL 1884705 (Ohio App. May 24, 2012)
(analysis of propriety of tax distribution payments to members of LLC and sufficiency of evidence to support conclusion that distributions were not made to deny employee profit bonuses under employment agreement)
Park Place Estates Neighborhood, LLC v. Oyola
No. 25921, 2012 WL 723775 (Ohio App. 2012)
(propriety of homeowner association LLC treasurer’s authorization of payment by LLC to treasurer’s husband where treasurer obtained approval from majority of homeowner members)
Huskin v. Hall
No. 2011-T-0048, 2012 WL 553136 (Ohio App. Feb. 21, 2012)
(personal liability of managing member of LLC where contract signed as representative of registered fictitious name of LLC without disclosure of LLC as actual principal)
Evergreen West Business Center, LLC v. Emmert
296 P.3d 545 (Or. App. 2012)
(common law fiduciary duty owed by member apart from LLC statute based on member’s undertaking to handle LLC’s loan; breach of fiduciary duty by LLC member who orchestrated foreclosure of LLC’s property and purchase for personal profit; unavailability of constructive trust remedy against member who breached fiduciary duty but was found liable for only nominal damages)
278 P.3d 44 (Or. App. 2012)
(propriety of capital calls by LLC; ratification by member of expenditures by acquiescence in informal procedures; interpretation of attorney’s fees provision of operating agreement and Oregon statute regarding reciprocity of recovery of attorney’s fees)
40 A.3d 145 (Pa. Super. 2012)
(sufficiency of evidence to establish managing member of LLC personally assumed responsibility for quality of construction of plaintiffs’ home)
45 A.3d 509 (R.I. 2012)
(interpretation of buyout provisions of settlement agreement and operating agreement regarding purchase of deceased member’s interest)
852 F.Supp.2d 682 (D.S.C. 2012)
(absence of evidence to support veil piercing of three related LLCs under Delaware law or treatment of three LLCs as one and the same under South Carolina amalgamation of interests theory; absence of South Carolina law to support imposing direct liability for acts and omissions of landfill LLC on related non-owner entities that directly control property)
479 B.R. 746 (Bankr. E.D. Tenn. 2012)
(application of corporate veil piercing principles to LLC under Tennessee law)
Faulkner v. Kornman
No. 10-301, 2012 WL 1066736 (Bankr. S.D. Tex. March 28, 2012)
(admission of member’s receiver as member of LLC)
Energy Maintenance Services Group I, LLC v. Sandt
__ S.W.3d __, 2012 WL 1038043 (Tex. App. 2012)
(sufficiency of evidence to support statutory fraud finding against individual and LLC in connection with LLC’s issuance of additional units decreasing plaintiff’s share of LLC ownership; failure of statutory fraud claim on part of defrauded plaintiff’s wife where claim was based only on use of community funds to purchase LLC units)
276 P.3d 1178 (Utah App. 2012)
(lack of evidence creating fact issue as to whether individual authorized improper distributions under Utah LLC statute)
727 S.E.2d 80 (Va. 2012)
(lack of reasonable reliance by plaintiff on LLC’s representations as to value of plaintiff’s LLC shares where plaintiff and LLC were in adversarial relationship, parties were represented by counsel in negotiation of settlement agreement under which shares were purchased by LLC, plaintiff’s representative was denied access to books and records while agreement was being negotiated, and settlement agreement stated LLC was considering range of options including stock sale that could lead to a different valuation)
842 F.Supp.2d 1111 (E.D. Wisc. 2012)
(nature of claims for self dealing and improper distributions as derivative claims belonging to LLC; plaintiff member’s standing to bring derivative claims notwithstanding defendant member’s claim that plaintiff was no longer member where tax form showed plaintiff had 10% interest)
853 F.Supp.2d 576 (N.D. W. Va. 2012)
(limited liability of LLC members under West Virginia and Nevada law; personal liability of LLC members under West Virginia and Nevada law for individual wrongdoing; veil piercing of LLCs under West Virginia law)
480 B.R. 641 (N.D. W. Va. 2012)
(violation of automatic stay by members who attempted to exercise right under operating agreement to dissociate member who filed bankruptcy; analysis of operating agreement as not constituting executory contract under Section 365; debtor member’s right to participate in affairs of LLC as well as economic rights as property of the estate; invalidity under Section 541(c) of operating agreement provision resulting in dissolution of LLC on bankruptcy of member; limitation of trustee’s rights and powers to those of debtor as member of LLC)