January 2010 — Issue 47

LLC Cases: Vichi v. Koninklijke Philips Electronics N.V.

2578-Vcp, 2009 WL 4345724 (Del. Ch. Dec. 1, 2009)

Vichi made a loan to a Delaware LLC which was a subsidiary of a joint venture between two foreign companies. The LLC went bankrupt and defaulted on the loan to Vichi. Vichi then sued various parties. Among other claims, Vichi brought breach of fiduciary duty claims against an individual citizen of Singapore who resided in China and was an officer of the joint venture and employed by a subsidiary of the joint venture that was the sole member and manager of the LLC. The individual successfully moved for dismissal of the claims against him for lack of personal jurisdiction because neither the Delaware long-arm statute nor the implied consent provision of the LLC statute provided a basis to exercise jurisdiction over him. The court determined that the formation of the LLC in Delaware and the alleged breaches of fiduciary duty owed to the LLC provided no basis for specific jurisdiction over the individual as to any of the claims asserted against him. The implied consent provision of the LLC statute did not apply because the individual was not a manager of the LLC appointed pursuant to the operating agreement nor did he participate materially in its management. The individual was employed by the sole member and manager of the LLC but had no personal stake in the LLC. No specific facts were alleged showing the individual personally participated in the management of the LLC rather than acting at the direction of and as a representative for the member/manager and its parent. However, the court stated that even if it had not dismissed the claims against him for lack of personal jurisdiction, it would have dismissed the breach of fiduciary duty claims for failure to state a claim because Vichi failed to establish that his fiduciary claims were cognizable under Delaware law. The court stated that creditors of a Delaware corporation that is insolvent or in the zone of insolvency have no right to assert direct breach of fiduciary claims, and the court concluded that the same rule applies in the LLC context. The court then analyzed whether Vichi’s fiduciary claim was direct or derivative based on who suffered the alleged harm and who would receive the benefit of recovery. The court found that Vichi alleged that the individual breached his fiduciary duty to Vichi as a creditor and that Vichi had personally suffered damages. Moreover, Vichi’s prayer for relief demanded that he personally receive recompense for the value of the notes, among other damages. The court therefore concluded that Vichi’s breach of fiduciary duty claims were direct, and Vichi, as a creditor of a Delaware LLC, could not bring a direct claim for breach of fiduciary duty. Thus, Vichi had failed to state a claim for which relief could be granted under Delaware law with respect to his fiduciary duty claims.


Lola Cars International Limited v. Krohn Racing

CA Nos. 4479-VCN, 4886-VCN, 2009 WL 4052681 (Del. Ch. Nov. 17, 2009).

Lola Cars International, Ltd. (“Lola”) and Krohn Racing, LLC (“Krohn”) formed a Delaware LLC and agreed to equal representation on the governing board although Lola owned a 51% interest in the LLC and Krohn held a 49% interest. Krohn appointed its manager, Hazell, as its director, and agreed to contribute Hazell’s services as the LLC’s CEO. Lola brought two suits against Krohn and Hazell, and the defendants moved to dismiss both of Lola’s complaints. Lola’s first complaint alleged that Krohn breached the LLC operating agreement, Hazell breached his fiduciary duties of loyalty and care, and Krohn aided and abetted Hazell’s disloyalty. Lola sought the following relief: (1) dissolution of the LLC and appointment of a liquidating receiver; (2) an injunction to prohibit the LLC from taking action outside the ordinary course of business; and (3) damages against Krohn and Hazell. Krohn argued that the LLC should not be dissolved under the Delaware LLC statute because the facts alleged by Lola could not support a finding that it was “not reasonably practicable to carry on the business” of the LLC. Krohn interpreted the reasonable practicability standard to mean that the business had been abandoned or its purpose was not being pursued. The court rejected this interpretation and applied the test from Fisk Ventures, LLC v. Segal, under which the court considers the following factors: (1) whether the members’ vote is deadlocked at the board level; (2) whether there exists a mechanism within the operating agreement to resolve the deadlock; and (3) whether there is still a business to operate based on the company’s financial condition. The court found all three Fisk factors were at issue in this case. First, Lola and Krohn were deadlocked over whether to replace Hazell as CEO. Second, although the operating agreement contained a buy-out provision in event of a member dispute, it was entirely voluntary. Third, there was serious doubt as to whether the LLC could continue in light of its financial condition because Lola had been providing significant additional capital to keep the LLC running. Additionally, Lola’s claims of Hazell’s mismanagement and disloyalty, together with the LLC’s poor performance and Hazell’s apparent entrenchment, supported the reasonable conclusion that dissolution may be appropriate. Krohn also argued that judicial dissolution was inappropriate because the operating agreement defined the circumstances upon which it could be terminated, and such circumstances did not include judicial dissolution. Assuming that judicial dissolution as provided by statute can be contractually eliminated, the court concluded that the self-termination options and lack of explicit provision for judicial dissolution in the operating agreement did not render statutory judicial dissolution unavailable. The court thus denied the defendants’ motion to dismiss the claim for judicial dissolution. Krohn moved to dismiss Lola’s fiduciary claims on the ground that Lola failed to plead demand futility with particularity as required by the Delaware LLC statute. The court noted that it relies on corporate precedent in interpreting this requirement and that demand is considered excused in the corporate context when allegations in the complaint create a reason to doubt that (1) the directors are disinterested and independent, or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. The court denied Krohn’s motion because Lola satisfied the particularized pleading standard by claiming that Hazell faced a substantial risk of liability due to his failure to maintain appropriate inventory levels and pay state taxes in a timely fashion and his use of LLC assets for Krohn’s benefit in violation of his duty of loyalty to the LLC. Furthermore, the court noted that where the directors of a two-director board have equal voting power and one is interested, demand should be excused because that one interested director alone has the power to preclude litigation. Krohn moved to dismiss Lola’s claim of breach of the implied covenant of good faith and fair dealing because the operating agreement specifically stated that Hazell was to be CEO and that Krohn could replace him if he resigned from that position. The court agreed with Krohn that the implied covenant could not be applied to matters covered by contract, but the court determined that Krohn’s refusal to even consider replacing him or attend board meetings to discuss the matter allowed the court a reasonable inference of a breach of the implied covenant. Lola’s second complaint relied on the termination clause in the operating agreement, which allowed a member to terminate the agreement after a breach by the other by notifying the breaching party of the breach and the consequences of a failure to rectify the breach. Under this provision of the agreement, the breaching party had 21 days to rectify the breach before the non-breaching party was permitted to terminate. Lola argued that its first complaint served as the requisite notice to Krohn and that more than 21 days had passed since the first complaint was filed, thus entitling Lola to terminate the agreement. Also, Lola contended that it should receive the right to manage and control the LLC after termination of the agreement because of its majority position. Lola requested temporary and permanent injunctive relief prohibiting Hazell and Krohn from interfering with Lola’s control of the LLC or acting as its agents. The court denied Lola’s request for interim injunctive relief, and refused to declare a termination of the operating agreement because Lola’s first complaint did not notify Krohn of the consequences of failing to rectify the breach. Lola moved for leave to file a supplemental complaint, alleging that it sent Krohn a letter giving notice that Krohn had materially breached the agreement and outlining the consequences of Krohn’s failure to rectify its breach and that more than 21 days had passed since the letter was sent. In the alternative, Lola asked the court to dismiss its second complaint without prejudice so that it could file a new complaint that incorporated the letter to Krohn, and the court granted this request.


Brandt v. Tabet Divito & Rothstein, LLC

419 B.R. 351 (Bankr. N.D. Ill. 2009)

The trustee sought to recover payments from the LLC debtor to an LLC member (Forte) who owned a 12% interest and was one of five members of the LLC’s board of managers. Because the payments were within a year of the bankruptcy, but not within 90 days, the payments were not recoverable unless Forte was an insider. The court noted that an LLC fits within the definition of a “corporation” for purposes of the Bankruptcy Code but that no consensus has developed with respect to the appropriate approach to determine whether a member or manager of an LLC is an insider of the LLC. The court described two conflicting approaches in the case law. One approach focuses on the alleged insider’s control of the debtor, and Forte relied upon this approach to argue he was not an insider. The other approach focuses on the similarity of the alleged insider’s position to the per se categories of an insider. The trustee advocated that this test be applied, and the court chose to follow this approach as the better interpretation of the statute. Under the definition of an “insider,” a corporate director or officer is an insider regardless of their ability to control the corporation. Forte’s position as one of five managers gave him a position equivalent to a director according to the court. The debtor was a Delaware LLC, and the court found Forte’s position as a manager and member of the LLC accorded him the same relationship to the LLC as a director has to a corporation.


Matter of Hausman

921 N.E.2d 191 (N.Y. 2009)

The grandchildren of a decedent argued that property conveyed to an LLC prior to the decedent’s death was not conveyed to a valid LLC and that it should be part of the estate subject to their distributive interests as stated in the decedent’s will. The decedent’s two living children executed articles of organization for an LLC on October 4, 2001, but the articles of organization were not filed with the Department of State until November 16, 2001. On November 2, 2001, two weeks before the articles of organization were filed, the decedent deeded the property to the LLC. The court saw no principled reason why the de facto corporation doctrine should not apply to LLCs, and the court thus agreed with the parties that it did. The de facto corporation doctrine may be invoked when there exists (1) a law under which the corporation may be organized, (2) an attempt to organize the corporation, and (3) an exercise of corporate powers thereafter. Under the New York LLC statute, articles of organization must be executed and filed to form an LLC. Here, no attempt to file the articles of organization was made before conveyance of the property. The decedent’s son argued that a de facto entity may exist even where it has failed to make an attempt to file statutorily required organizational papers, but the court concluded that merely executing articles of organization and an operating agreement is insufficient to meet the requirements of a de facto entity. Because it was undisputed that there was no bona fide attempt to comply with the ministerial but essential requirement of filing the articles of organization prior to the time of the conveyance, there was no entity in existence capable of receiving title to the property.


In re BH S&B Holdings LLC

420 B.R. 112 (Bankr. S.D.N.Y. 2009).

This case arose out of the bankrupt Steve & Barry’s clothing stores and the subsequent bankruptcy filing by the purchaser, BH S&B Holdings, LLC (“Holdings”) and its subsidiaries. The Official Committee of Unsecured Creditors (the “Committee”) sought to recover money for the estate through veil piercing, breach of fiduciary duty, and equitable subordination or recharacterization claims. Holdings was owned by another LLC (“Holdco”), and an intermediate holding LLC (“Intermediate Holdco”) was later interposed between Holdings and Holdco. The entire structure was formed and funded by York Capital Management (“York”), four entities collectively referred to as “Bay Harbour”, Steve and Barry’s co-founders (Steven Shore and Barry Prevor), and Hilco SB LLC. The Committee alleged that Bay Harbour’s and York’s domination and control of Holdings via Holdco gave rise to a veil piercing claim and that Bay Harbour, York, and individual employees of these entities should be liable for debts and obligations of the debtor. The Committee also alleged that Holdco as well as Bay Harbour and York employees and officers of Holdings breached their fiduciary duties to Holdings. (The court stated, and the parties agreed, that the veil piercing and breach of fiduciary duty claims were governed by Delaware law since Holdings, Holdco, and most of the other entities were Delaware entities.) Finally, the Committee brought an action to equitably subordinate or recharacterize as equity a loan by a Holdings affiliate. The court discussed at length the Committee’s veil piercing claims. Initially, the court discussed how many veils must be pierced, i.e., whether each separate entity’s veil had to be pierced or whether it was only necessary to pierce Holdings’s veil to reach Bay Harbour, York and their employees. The court concluded that it did not need to reach the question of whether each entity’s veil must be separately pierced because the court found the Committee had not adequately pled its veil piercing claim. The court discussed the allegations regarding inadequate capitalization, failure to observe corporate formalities, and whether Holdings was a facade such that equity and fairness required piercing the veil. With respect to inadequate capitalization, the court concluded that, even assuming Holdings was inadequately capitalized, the complaint did not support an inference that Holdings served an illegitimate purpose. The court stated that it is a rare instance in which the veil should be pierced because of undercapitalization, and the circumstances here were not unusual enough to support veil piercing. With respect to corporate formalities, the court noted that somewhat less emphasis is placed on formalities in the LLC context than the corporate context because fewer such formalities are required for LLCs. The court observed that the Delaware LLC statute requires little more than a proper certificate of formation, maintenance of a registered agent and registered office in Delaware, and maintenance of certain records. Also, the Delaware law permits non-natural persons to serve as managers of an LLC whereas the directors of a corporation must be natural persons. The court stated that wholly-owned subsidiaries may share officers, directors, and employees with their parent without giving rise to an inference that the subsidiary is a mere instrumentality. That Holdings’s parent retained decision-making authority was also insufficient to pierce the veil. Furthermore, since Holdings was an LLC, the lack of officers or a board of managers other than its parent was not necessarily a persuasive veil piercing factor. The court commented that the Delaware LLC statute permits members of an LLC to be other entities, thus impliedly permitting those entities to serve in an entity capacity in which they continue to owed fiduciary duties to their own members. None of the allegations suggested impropriety or abuse of the corporate form, and the failure to hold board meetings did not support piercing because Delaware law did not require Holdings to hold board meetings or observe other formalities. The remaining allegations (that Holdings lacked a CEO until a few weeks before the bankruptcy filing, that CFO duties were outsourced, and that its management was kept in the dark) were either not required under Delaware LLC law or were too conclusory to survive a motion to dismiss. In sum, the Committee failed to plead adequate facts supporting an inference that Holdings’s failure to observe corporate formalities was so severe as to overcome the presumption of independence from its parents. Finally, the court found the allegations insufficient to show that Holdings was a sham and existed as a vehicle for fraud or injustice. Again, the court emphasized the conclusory nature of the allegations, that an overlap in ownership, officers, and directors is common and permissible, and that Delaware law permitted Holdings’s parent to be the sole manager. The Committee also failed to sufficiently alleged breach of fiduciary duty claims. The court first noted that a manager of an LLC owes the traditional duties of loyalty and care to the members of an LLC under Delaware law, but parent corporations do not owe wholly-owned subsidiaries fiduciary duties. The court stated that when directors sit on the board of a wholly-owned subsidiary, the fiduciary duties run to the parent rather than the subsidiary. Thus, Delaware law does not embrace the concept that a director of a wholly-owned subsidiary owes a duty to second-guess the judgment of its parent corporation. Further, the court noted exculpatory provisions in the Holdco operating agreement (which exculpated managers from liability except for acts or omissions constituting fraud, willful misconduct, bad faith, or gross negligence), and provisions of the Holdings operating agreement indemnifying the member (except for gross negligence, willful breach of the agreement, or willful violation of law). The court stated that the Delaware LLC statute permits provisions eliminating or limiting liabilities to a person who is a party to the operating agreement or is otherwise bound by the agreement, and the court characterized a creditor as a person who may be “otherwise bound” by an agreement that expressly waives fiduciary duties when the creditor steps into the shoes of an equity holder. In this case, however, the Holdco operating agreement limited the Bay Harbour board manager’s fiduciary duties to Holdco or its unitholders to the type of fiduciary duties of loyalty and care owed by directors and officers of a business corporation under the Delaware General Corporation Law, necessitating an analysis of the fiduciary obligations under the corporate statute. The court stated that Delaware courts have found that the standard for breach of the duty of care is “gross negligence” and that the exculpatory clauses thus did not eliminate the duty of care. Even if the employees of Bay Harbour and York owed fiduciary duties to Holdings, the court found the Committee’s pleadings did not adequately allege breaches of the duties of loyalty and care. The pleadings failed to overcome the presumption of the business judgment rule. There was no allegation that the individuals were interested in the alleged wrongful transactions, and the Committee did not demonstrate that the individuals failed to act in good faith, in the honest belief that the action was in the best interest of the company, or on an informed basis. The court found the duty of loyalty allegations against the Bay Harbour and York employees deficient as well. With regard to the duty of care claims against Holdings’s officers, the court concluded that the Committee had standing to assert the claims and that the officers may have owed a duty to Holdings, but the Committee’s pleadings failed to overcome the presumption of the business judgment rule. The court analyzed the Committee’s pleadings with respect to its claim that a loan by a Holdings affiliate should be equitably subordinated or recharacterized as equity and found that the Committee had not sufficiently pled facts supporting the factors relevant to either claim. The Committee was given leave to amend its pleadings on the equitable subordination claim, but the recharacterization claim was dismissed with prejudice.


In re Longview Aluminum, L.L.C. (Brandt v. Tabet Divito & Rothstein,LLC)

419 B.R. 351(Bankr. N.D. Ill. 2009).

The trustee sought to recover payments from the LLC debtor to an LLC member (Forte) who owned a 12% interest and was one of five members of the LLC’s board of managers. Because the payments were within a year of the bankruptcy, but not within 90 days, the payments were not recoverable unless Forte was an insider. The court noted that an LLC fits within the definition of a “corporation” for purposes of the Bankruptcy Code but that no consensus has developed with respect to the appropriate approach to determine whether a member or manager of an LLC is an insider of the LLC. The court described two conflicting approaches in the case law. One approach focuses on the alleged insider’s control of the debtor, and Forte relied upon this approach to argue he was not an insider. The other approach focuses on the similarity of the alleged insider’s position to the per se categories of an insider. The trustee advocated that this test be applied, and the court chose to follow this approach as the better interpretation of the statute. Under the definition of an “insider,” a corporate director or officer is an insider regardless of their ability to control the corporation. Forte’s position as one of five managers gave him a position equivalent to a director according to the court. The debtor was a Delaware LLC, and the court found Forte’s position as a manager and member of the LLC accorded him the same relationship to the LLC as a director has to a corporation.


Academic Imaging, LLC v. Soterion Corp.

352 Fed.Appx. 59, 2009 WL 3805807 (6th Cir. 2009)

(fiduciary duties of members of Ohio LLC; parol evidence rule in context of buy-out of member).


Cheney v. IPD Analytics, L.L.C.

No. 08-23188-CIV, 2009 WL 3806171 (S.D. Fla. Aug. 28, 2009)

(member’s right to inspect books and records; non-existence of fiduciary duty of member who was not agent of LLC).


In re Lull (Kotoshiro v. Zapara)

Bankruptcy No. 06-00898, Adversary No. 08-90074, 2009 WL 3853210 (Bankr. D. Hawaii Nov. 17, 2009)

(analysis of “insider” status of co-member of debtor member of LLC).


Aqua Thick, Incorporated v. Wild Flavors, Incorporated

No. 08 C 6278, 2009 WL 4544696 (N.D. Ill. Dec. 1, 2009)

(limited liability of managing member and inapplicability of rule that corporate officer or director is liable for participation in tort of entity).


Moede v. Pochter

No. 07 C 1726, 2009 WL 4043418 (N.D. Ill. Nov. 20, 2009)

(fiduciary duty of LLC member in manager-managed LLC).


J. Stan Developments, LLC v. Lindo

No. 2008-CA-001796, 2009 WL 3878084 (Ky. App. Nov. 20, 2009)

(personal liability of LLC member for violation of Kentucky securities laws).


Gordon v. Elite Consulting Group L.L.C.

No. 08-CV-10772, 2009 WL 4042911 (E.D. Mich. Nov. 19, 2009)

(potential liability of LLC registered agent and manager as “controlling person” under federal securities laws).


Pint v. Breckner

No. 08-CV-5340(JMR/SRN), 2009 WL 4042905

(D. Minn. Nov. 19, 2009) (apparent authority of member to execute mortgage of LLC property).


Mathis v. ERA Franchise Systems, Inc.

25 So.2d 298 (Miss. 2009)

(discussion of circumstances under which member may bring derivative claims directly in closely held LLC context).

Capricorn Investors III, L.P. v. CoolBrands International, Inc.

897 N.Y.S.2d 668 (N.Y. Sup. 2009)

(insufficiency of LLC veil piercing allegations)


Prehall v. Weigel

221 P.3d 157 (Or. App. 2009)

(legal versus equitable nature of relief requested in accounting for damages based on amounts owed under operating agreement)