January 2008 — Issue 23

Brown v. T-Ink, LLC, Civil Action No. 3190-VCP

2007 WL 4302594 (Del. Ch. Dec. 4, 2007)

This action was filed by an LLC member (“Brown”) to enjoin another member (T-Ink, LLC or “T-Ink”) from proceeding with an arbitration. T-Ink argued the court should dismiss the case on the grounds that the arbitrator should decide matters of substantive arbitrability (i.e., whether T-Ink’s claims are arbitrable) as well as procedural arbitrability (i.e., whether T-Ink complied with the terms of the arbitration clause). The LLC agreement required arbitration of disputes “concerning the interpretation or performance of this Agreement,” and the court determined that the federal majority rule that substantive arbitrability is determined by the arbitrator did not apply because the clause did not refer all disputes to arbitration. The court compared the language used in the arbitration clause to broader language used in the waiver of jury trial contained in the LLC agreement, as well as suggested and sample clauses of the American Arbitration Association and National Arbitration Forum, and concluded that the reference to disputes concerning “interpretation or performance” of the LLC agreement did not refer all disputes to arbitration. The court found no other evidence indicating a clear and unmistakable intent to refer questions of substantive arbitrability to the arbitrator because a reference to the American Arbitration Association rules in the clause was not alone sufficient to establish an intent to commit the question of substantive arbitrability to the arbitrator. The court determined that T-Ink’s fraud claims fell outside the narrow scope of “interpretation and enforcement” of the LLC agreement (in contrast to the scope of broader language encompassing disputes “arising out of or relating to”the agreement as suggested by the American Arbitration Association and used in the waiver of jury trial contained in the agreement). T-Ink’s fiduciary duty claims arising from general fiduciary duty principles under Delaware law, and not related to specific aspects of the LLC agreement, also were not encompassed by the arbitration clause because those claims did not concern “interpretation and performance” of the LLC agreement. Fiduciary duty claims arising at least in part by virtue of specific obligations created by the LLC agreement involved “interpretation and enforcement” of the LLC agreement, but claims based on fiduciary duties arising by virtue of any statutory, common law, or other requirement as a consequence of the formation of the LLC without regard to the specific terms of the LLC agreement were not subject to arbitration. Stating that wrongful enforcement of an arbitration clause constitutes irreparable harm, and balancing the equities, the court enjoined T-Ink from arbitrating its fraud claims and breach of fiduciary duty claims springing from general fiduciary duty principles under Delaware law. The court dismissed the aspects of Brown’s claims premised on issues of procedural arbitrability because, unlike substantive arbitrability, matters of procedural arbitrability are presumptively for the arbitrator to decide.

Bernstein v. TractManager, Inc.

C.A. No. 2763-VCL, 2007 WL 4179088 (Del. Ch. Nov. 20, 2007)

An LLC converted to a corporation, and the corporation’s bylaws provided for mandatory advancement of expenses to current and former officers and directors of the corporation. The corporation asserted claims against Bernstein, a director of the corporation who was also a co-founder and manager of the predecessor LLC, based on actions taken prior to the conversion. The LLC operating agreement provided for mandatory indemnification but not mandatory advancement. The court acknowledged that the LLC’s obligation to indemnify Bernstein under the operating agreement was preserved in the conversion, but the operating agreement did not provide for mandatory advancement, and the court rejected Bernstein’s claim that he was entitled to advancement of expenses under the bylaws. Bernstein argued that the bylaws provision granting advancement rights to any person made a party to an action “by reason of the fact that he or she is or was a director or officer of the corporation” should be read to include managers of the predecessor LLC. The court distinguished the instant case as involving a more fundamental change in identity than a case relied upon by Bernstein in which a corporation reincorporated in another state. The court pointed to the differences in the corporate and LLC statutes regarding indemnification and the fact that the bylaws provided for mandatory advancement only for directors and officers of the corporation when they easily could have included language granting advancement rights to managers and officers of the LLC. The court stated that the operating agreement should control just as it would if the tables were turned, i.e., if later adopted bylaws were more restrictive regarding the rights applicable to officers and directors of the corporation. The court thought it unlikely that a court in such a case would infer a silent intention to alter the more generous arrangements previously enjoyed by the managers or officers of the predecessor LLC.

Hamby v. Profile Products, L.L.C.

361 N.C. 630, 652 S.E.2d 231, No. 507A06 (N.C. 2007)

An employee of an LLC was injured, and the employee sought to hold the LLC’s sole member (which was also an LLC) liable for negligence in managing the LLC’s safety program. Under the North Carolina workers’ compensation law, the exclusivity protection extends beyond the employer to “those conducting [the employer’s] business,” and the North Carolina Supreme Court concluded that the LLC’s member was conducting the LLC’s business and was protected under the exclusivity provision. The LLC and its parent were Delaware LLCs, and the LLC’s member was charged with exclusive management of the LLC’s business under the LLC’s operating agreement. The North Carolina LLC statute provides that the liability of a foreign LLC’s managers and members is governed by the laws of the LLC’s state of formation, and the court applied Delaware law to the question of the member-manager’s liability, noting that the Delaware and North Carolina statutes are similar in this regard. The court cited the provisions of the Delaware LLC statute regarding management and authority and shielding member-managers from liability. The court concluded that member-managers are specifically shielded from liability when acting as LLC managers, stating that “when a member-manager acts in its managerial capacity, it acts for the LLC, and obligations incurred while acting in that capacity are those of the LLC.” The court also found support for its conclusion in corporate case law in which the court found that the exclusivity provision applied to the president and sole shareholder of a corporation.

In re Green Power Kenansville, LLC

No. 04-08384-8-JRL, 2004 WL 5413067 (Bankr. E.D. N.C. Nov. 18, 2004).

(Although this opinion was issued more than three years ago, it has just recently appeared on Westlaw.) The sole member of an LLC assigned its interest to another entity, and the LLC’s new owner caused the LLC to file a Chapter 7 bankruptcy. The LLC’s lender argued the bankruptcy filing violated provisions of the LLC’s loan documents and its operating agreement and was unauthorized and invalid. The court reviewed provisions of the loan documents and operating agreement pertaining to the issue and determined that the assignment of the sole member’s interest was invalid because a pledge agreement of the sole member prohibited any change of control of the LLC and provided that the member’s voting rights would become vested in the lender upon an event of default. The sole member’s president conceded in testimony that he lacked authority to make the challenged assignment. The operating agreement provided for an independent manager whose written approval was required for any bankruptcy-type filing of the LLC. The independent manager could not be removed without amending the operating agreement, and an amendment required approval of all members and all material creditors of the LLC. The court noted that the North Carolina LLC statute permits the authority of a manager to be delegated to persons other than managers if and to the extent the operating agreement provides, and the court concluded the statute authorized the provision of the operating agreement “displacing” the manager with the independent manager as the sole person who can make decisions in a certain area. The court also concluded that the new owner was bound by the operating agreement when the interest was transferred, whether the new owner knew of the agreement or not, because the North Carolina LLC statute provides that a member is bound by any operating agreement which was in effect at the time the member became a member if the agreement was in writing or its terms were known to the member. Since the provisions of the written operating agreement regarding a bankruptcy filing were not followed, the bankruptcy filing was without authorization and the court dismissed the filing nunc pro tunc.

In re Moore (Cadle Company v. Brunswick Homes, LLC)

379 B.R. 284, Bankruptcy No. 06-31859-SGJ-7, Adversary No. 06-3417 (Bankr. N.D. Tex. 2007)

A judgment creditor sought to reverse pierce the veil of an LLC to impose liability on the LLC for the creditor’s judgment against an individual debtor. The court applied Texas law to the veil piercing claims based on the rule that the law of the state of incorporation applies to corporate veil issues. The court discussed the development of both traditional and reverse corporate veil piercing under Texas law and concluded that the doctrine of reverse veil piercing is applicable under Texas law although the doctrine has rather “thin roots” in Texas. Noting that neither the Texas Supreme Court nor the Texas legislature has opined on reverse veil piercing, the court relied upon Fifth Circuit case law that has recognized the doctrine under Texas law. The court, however, was troubled by the fact that the doctrine of reverse piercing has evolved and been accepted into the mainstream of Texas veil piercing jurisprudence at the same time the Texas legislature has been limiting traditional veil piercing and without meaningful discussion of what the doctrine in substance accomplishes. The court concluded that the concept should be applied only when it is clear that it will not prejudice non-culpable shareholders or other stakeholders (such as creditors) of the corporation. The court applied corporate veil piercing principles to the LLC in issue, stating that whether an entity is a corporation or an LLC is a “distinction without a difference” for purposes of veil piercing. The fact that reverse piercing was sought with respect to an individual who was not a record or nominal equity owner of the LLC did not preclude the claim since the plaintiffs sought to establish that the individual had a de facto interest in the LLC. The court concluded that fact issues precluded summary judgment for the LLC on the reverse veil piercing claim and a claim for constructive trust on the LLC’s assets. The court held that the ten year statute of limitations for enforcement of a judgment applied to the reverse alter ego and constructive trust claims since the claims were being pursued to collect a judgment.

Flores v. DDJ, Inc.

No. 1:99 CV 5878 AWI DLB, 2007 WL 4269259 (E.D. Cal. Nov. 30, 2007)

Lengthy discussion of veil piercing evidence and its insufficiency to establish individual owner as alter ego of LLC and corporation for purposes of adding owner to judgment obtained against entities.

In re J.S. II, L.L.C.

No. 07 B 3856, 2007 WL 4233090 (Bankr. N.D. Ill. Nov. 29, 2007)

Dispute re rights of member admitted under document reserving determination of member’s rights; application of operating agreement voting provisions in context of sale of assets; determination that sale of assets did not constitute sale of substantially all LLC’s assets.

Wachovia Securities, LLC v. Neuhauser

__ F.Supp.2d __, No. 04 C 3082, 2007 WL 4246894 (N.D. Ill. 2007)

Limited liability of agent of LLC; inapplicability in LLC context of Illinois statutory provision imposing liability on director or shareholder of dissolved corporation; retroactive nature of reinstatement of dissolved LLC; insufficiency of evidence to pierce veil of LLC.

Gas Technology Institute v. Rehmat

__ F.Supp.2d __, No. 05 C 2712, 2007 WL 3374590 (N.D. Ill. 2007)

Analysis of direct versus derivative claims in LLC context.

Cement-Lock v. Gas Technology Institute

__ F.Supp.2d __, No. 05 C 0018, 2007 WL 3374401 (N.D. Ill. Nov. 8, 2007)

Members’ standing to bring claims derivatively; analysis of breach of fiduciary duty claims under Delaware law, including discussion of business judgment rule and contractual provisions addressing duties and liabilities; analysis of various claims (including self-dealing, misappropriation of intellectual property, actions conflicting with LLC’s interest, and failure to set up internal controls) asserted against LLC member, affiliates, and individuals serving on LLC’s operating board; veil piercing analysis under Delaware law in connection with potential liability of LLC member’s parent for breach of fiduciary duty.

In re Schwab

378 B.R. 854, No. 07-60188 (Bankr. D. Minn. 2007)

Determination that equipment used by LLC belonged to LLC’s sole member; reverse piercing of LLC by sole member to claim ownership of LLC’s accounts receivable where LLC had no debts or obligations of its own at time member filed bankruptcy, receivables consisted of charges for member’s labor, and member had no other source of earnings.

In re Storer

__ B.R. __, Bankruptcy No. 07-6011607, Adversary No. 07-00023, 2007 WL 4097693 (Bankr. D. Mont. Nov. 15, 2007)

Application of Montana corporate veil piercing principles to LLC; insufficient basis to pierce veil of LLC because LLC not used as subterfuge to pepetrate fraud; insufficient showing of fraud required for dischargeability exception under Section 523(a)(2)(A).

Wilcke v. Seaport Lofts, LLC

45 A.D.3d 447, 846 N.Y.S.2d 133 (N.Y. A.D. 1 Dept. 2007)

Fairness of real estate transaction approved by interested managers where independent appraisal and bids received; availability of derivative action under New York law.

D’Esposito v. Gusrae, Kaplan & Bruno PLLC

44 A.D.3d 512, 844 N.Y.S.2d 214 (N.Y. A.D. 1 Dept. 2007)

Rejection of plaintiff’s claim of member status in PLLC, though he was identified as partner in Martindale-Hubble, on firm’s letterhead and on tax return, and received distributions of profits; application of statute of frauds to oral promise to make plaintiff full partner/member where alleged agreement called for performance of indefinite duration and was terminable within one year only by breach.

Intercept Corp. v. Calima Financial, LLC

741 N.W.2d 209, No. 20060307 (N.D. 2007)

Individual’s status as member of LLC and not merely employee; veil piercing of LLC under corporate veil piercing principles applicable to North Dakota LLCs.

In re Olympus Construction, LC (Matthews v. Olympus Construction, LC)

173 P.3d 192, No. 20060739-CA (Utah App. 2007)

Interpretation of judicial dissolution and receivership provisions of Utah LLC statute; trial court’s power to extend statutory period for rejecting claims.