July 2006 — Issue 6

Haynes Downard Andra & Jones, LLP v. Southeastern Commercial Finance

924 So.2d 687 (Ala. 2005)

Nature of LLP as same entity that existed prior to registration; venue in suit against LLP.

Eureka VII LLC v. Niagra Falls Holdings LLC

899 A.2d 95, C.A. No. 1203-N (Del. Ch. 2006)

The plaintiff, a 50% member of a Delaware LLC, sought a declaration that the other member had relinquished its membership and retained only economic rights based on the defendant’s alleged material breaches of the LLC agreement. The court determined that the defendant breached the LLC agreement in at least four instances and that the defendant’s breaches resulted in a creditor of the defendant’s owner gaining ownership and control of the defendant in violation of anti-transfer provisions in the LLC agreement. The LLC agreement was silent as to the remedy for breach, and the plaintiff suggested a remedy inspired by Section 18-702(b)(3) of the Delaware Limited Liability Company Act, which provides that a member ceases to be a member upon assignment of all the member’s LLC interest. Although the statutory provision did not literally apply to the case, the court found that the requested remedy was entirely fitting and proportionate because the defendant’s breaches implicated a clear contractual goal reflected in the LLC agreement (i.e., to ensure that the plaintiff did not find itself owning the LLC with a partner it did not approve), and the breaches led to the very situation the agreement was designed to prevent. The court also noted that the defendant’s breaches ultimately had the same effect as a complete assignment for the benefit of creditors, a type of assignment that results in the divestiture of membership under the Delaware LLC statute. The court clarified that the remedy it crafted left the defendant with the rights of an assignee, which do not include the right to participate actively in management, but do include the right to bring a derivative action if the plaintiff were to breach a contractual or fiduciary duty to the LLC. The court dismissed the defendant’s counterclaims, which were based on the plaintiff’s failure to close on the purchase of the defendant’s interest after the defendant invoked a buy/sell provision. The court concluded that the defendant was in no equitable position to invoke the buy/sell provision because the defendant had committed an undisclosed material breach of the LLC agreement prior to invoking the buy/sell provision. Furthermore, there was no evidence that the defendant was able to buy out the plaintiff at the price set by the defendant. Finally, the court dismissed the defendant’s claim for dissolution. According to the court, the only plausible basis for dissolution was that continuation of the LLC was impracticable because the plaintiff and the party controlling the defendant did not get along. The impasse no longer existed, however, because the defendant was left with only the rights of an assignee, and the plaintiff had authority to act as the sole member.

Minnesota Invco of RSA #7, Inc. v. Midwest Wireless Holdings, LLC

No.Civ.A 1887-N, 2006 WL 1596675 (Del. Ch. June 7, 2006)

The minority interest holders of a Delaware LLC sued the majority holder for specific performance of a broad right of first refusal provision in the LLC agreement. The minority interest holders also sued the individuals serving on the LLC’s board of managers for breach of fiduciary duty based on the board’s amendment of the LLC agreement to eliminate the right of first refusal provision. The plaintiff argued that the right of first refusal provision was triggered by the approval of the acquisition of the majority member in the form of a sale of substantially all of its assets (including its units in the LLC). The court agreed with the defendant, however, that a subsequent restructuring agreement giving the majority member drag along rights conflicted with the right of first refusal provision and that the restructuring agreement controlled because it contained a clause specifying that the restructuring agreement governed in the event of any conflict with the LLC agreement. The court also rejected the plaintiff’s challenge to the amendment of the LLC agreement removing the right of first refusal provision. The board of the LLC amended the agreement in order to facilitate bidding for the acquisition of the majority member, and the majority member voted its LLC units in favor of the amendment. The court rejected the plaintiff’s argument that the majority member was an “acquiring person” under the LLC agreement and as such precluded by the agreement from exercising majority voting power. The court refused to read the LLC agreement’s “acquiring person” clause as encompassing the majority member because doing so would turn the arrangement crafted by the restructuring agreement on its head. The court also concluded that the LLC’s board did not breach its fiduciary duty in approving the amendment. The court recited the business judgment rule as it applies to corporate directors, stating: “[T]he directors of a corporation are presumed to act on an informed basis, in good faith, and in the honest belief that the action taken is in the best interest of the company. [footnote omitted] However, ‘to invoke the rule’s protection, directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them.’” The court found that the LLC’s board members did not breach their duty of care because they were fully informed and acted in the best interest of the LLC’s unit holders. The evidence showed the board members acted on advice of counsel and the LLC’s investment banker, and in the good faith belief that, by clarifying that the right of first refusal did not apply, the amendment would help maximize the sale price of the majority member and get the best possible value for its unit holders and for the plaintiff. The court also rejected the plaintiff’s “formulaic” argument that the board breached its duty of loyalty by acting as a rubber stamp for the majority member. The court did not find that the board was dominated or controlled by the majority member or lacked independent judgment when it approved the amendment.

HWB, Inc. v. MetalPro Industries, LLC

Civil Action No. 05-6665, 2006 WL 1581329 (E.D. La. June 7, 2006)

The plaintiffs sued an LLC and its managing member for patent infringement, conversion, and negligence in connection with the LLC’s refusal to return a piece of equipment lent to the LLC by the plaintiffs. The plaintiffs argued that the managing member was liable in his individual capacity for his individual tortious and infringing conduct. The Louisiana LLC statute provides that a member, manager, employee, or agent is not liable “in such capacity” for a debt, obligation, or liability of the LLC, and the court stated that this language implies that the law may not protect an LLC member against personal liability for his own tortious conduct. In addition, the statute goes on to provide that the statute does not affect the rights a person may have against a member or manager based on any fraud, breach of professional duty, or other negligent or wrongful act of the member or manager. Relying on a Louisiana Court of Appeals decision intrepreting the statutory provision in issue, the court held that an LLC member may be liable for his individual negligent or wrongful conduct only if the conduct was outside his capacity as a member. The court concluded that the allegations were insufficient to support a finding or fair inference that the managing member acted outside his capacity as a managing member in a manner subjecting him to liability in an individual capacity. The complaint explicitly stated that the plaintiffs dealt with the managing member in his capacity as managing member, and the complaint implied that the managing member was authorized to use the borrowed piece of equipment in the same capacity as the LLC. Furthermore, the claims alleged against the managing member arose from acts attributed by the plaintiffs to both the LLC and the managing member, and the plaintiffs did not suggest how the managing member acted in a capacity exceeding that of the LLC. The court noted, but did not address substantively, the possibility that an independent basis for dismissal of the plaintiffs’ claims might be found in the statutory provision prohibiting claims against an LLC and any of its members in a single lawsuit.

Purcell v. Southern Hills Investments, LLC

847 N.E.2d 991, No. 49A05-0504-DV-191 (Ind. App. 2006)

One of the members of a two-member Indiana LLC sued the manager appointed by the other member for breach of fiduciary duty and acts of self-dealing. After a bench trial, the trial court issued findings and entered a judgment for damages against the manager. The manager appealed. The court of appeals agreed with a federal district court’s opinion imposing common law fiduciary duties on officers and members of Indiana LLCs in the absence of contrary provisions in the operating agreement and held that “common law fiduciary duties, similar to the ones imposed on partnerships and corporations, are applicable to Indiana LLCs.” The court proceeded to analyze whether the evidence supported the trial court’s findings that the manager breached his fiduciary duty. The court of appeals found that the trial court could reasonably infer from the evidence that the manager knowingly failed to forward payments to which the LLC was entitled and instead retained the moneys in the entity member owned by the manager. Additionally, even if the manager did not know that the LLC was entitled to the payments at the time he retained the money, the evidence showed that he was not forthcoming when he was told to forward the amounts due the LLC. Thus, the court did not find that the manager acted “fairly, honestly, and openly” (the fiduciary standard applied by the court based on Indiana case law in the corporate context) with the LLC and the plaintiff member. The court of appeals also rejected the manager’s challenge to the trial court’s conclusion that the manager acted willfully and recklessly within the meaning of the Indiana LLC statute. The Indiana LLC statute specifies that, unless otherwise provided in a written operating agreement, a member or manager is not liable for damages to the LLC or its members for any action taken or failure to act on behalf of the LLC unless the act or omission constitutes “willful misconduct or recklessness.” The court explained that willful misconduct or recklessness requires knowledge of an impending danger or consciousness of a course of misconduct calculated to result in probable injury and indifference to the consequences of the conduct. The court found that the manager exhibited indifference to the consequences of his conduct by using funds rightfully belonging to the LLC to repay a personal loan made by the manager to the entity member owned by the manager. Finally, the court rejected the manager’s claim that the plaintiff member did not have standing to assert its claims in a direct action. The court discussed the distinction between a direct and a derivative claim and pointed out that Indiana case law in the closely held corporation context has recognized that shareholders in a close corporation may sometimes bring derivative claims in a direct action. The court ultimately concluded, however, that it need not investigate whether this type of exception was applicable because the court characterized the plaintiff member’s claim as a direct claim in its own name for breach of fiduciary duties owed to it as a member of the LLC rather than a derivative claim of corporate harm in the name of the LLC under the guise of direct harm. The court also concluded that the statutory language supported a direct claim based on willful misconduct and recklessness.

Lakes Gas Co. v. Terminal Properties, Inc.

No. 05-1266, 2006 WL 1229934 (Iowa App. April 26, 2006)

A minority member of an Iowa LLC sought to intervene in a suit against the LLC and its largest member. The suit was brought to collect on a promissory note of the defendant member and to foreclose a security interest granted in the assets of the LLC to secure that member’s indebtedness under the note. The trial court granted the minority member’s motion to intervene, and the plaintiff appealed. The court of appeals found that the trial court did not err in permitting the intervention. The right of an LLC member to intervene in a proceeding to defend the interest of the LLC was a matter of first impression in Iowa, and the court looked to federal case law in the corporate context for guidance. The court noted that federal courts have found a shareholder’s interest insufficient to grant intervention when the interest was a purely economic or financial interest derivative of the corporation’s interest. The court found the reasoning of the federal cases consistent with Iowa’s law on shareholder derivative actions and applicable to the context of the case even though the case involved an LLC rather than a corporation and an intervention to defend the company’s interest rather than an action to assert a claim for an injury to the company. The court noted that the Iowa LLC statute provides for derivative actions by LLC members, and the court saw little distinction between a right to bring a claim on behalf of the company and a right to defend the company against the claim of another. Because the minority member alleged that it sought to protect the assets of the LLC and the value of the members’ interests (allegations which addressed an economic injury common to all members), the member lacked standing to intervene in its individual capacity under the reasoning of the federal intervention case law. The court concluded, however, that the member was entitled to intervene in its own right under the unique circumstances of the case. The court observed that there was a split of authority regarding the right of a shareholder in a closely held corporation to bring an action in the shareholder’s individual capacity when the claim belongs to the corporation. The court discussed the American Law Institute’s discretionary approach and found it consistent with Iowa policy on shareholder derivative suits. The court determined that permitting the minority member to intervene in defense of the LLC advanced the policy concerns underlying the rule on derivative actions. Because the LLC was closely held and the remaining members were working, either actively or passively, against the LLC’s interests, the court found the intervening minority member’s interest sufficient to intervene.

Galaz v. Oshita

Nos. B181278, B187428, 2006 WL 1461134 (Cal. App. 2 Dist. May 30, 2006)

Transfer of membership interest; attorney’s fees claim in inspection action.

In the Matter of Estate of Davis

No. 05-0230, 2006 WL 1278733 (Iowa App. May 10, 2006)

Analysis of evidence regarding admission of member; distinction between assignee and member.

Alliance Associates, L.C. v. Alliance Shippers, Inc.

No. 265101, 2006 WL 1506687 (Mich. App. June 1, 2006)

Derivative suit demand requirement under Michigan LLC statute.

Maryville Hotel Associates I, LLC v. IHC/Maryville Hotel Corp.

No. 4:05 CV 1493 DDN, 2006 WL 1237264 (E.D. Mo. May 5, 2006)

Interpretation of right of first refusal provision prohibiting indirect transfers by LLC member.

Schwan v. CNH America, LLC

No. 4:04CV3384, 2006 WL 1215395 (D. Neb. May 4, 2006)

Veil piercing; application of forum state’s law to “external” affairs.

Teitlebaum v. Halleck St. Properties, LLC

2005 WL 4022328 (N.J. Super. A.D. May 22, 2006)

Authority of member of member-managed LLC to transfer real estate.

Delta Financial Corp. v. Morrison

__ N.Y.S.2d __, No. 011118/2003, 2006 WL 1233000 (N.Y. Sup. May 9, 2006)

Application of attorney client privilege to email communication between LLC and its attorney in action by member against LLC.

In re First Connecticut Consulting Group, Inc.

No. 2:04-CV-230, 340 B.R. 210 (D. Vt. 2006)

Transfer of LLC ownership without transfer of certificates.

Finley v. Takisaki

No. C05-1118JLR, 2006 WL 1169794 (W.D. Wash. April 28, 2006)

Members’ lack of standing to assert claim for LLC’s injury.

Heartland, L.L.C. v. McIntosh Racing Stable, L.L.C.

__ S.E.2d __, 2006 WL 1312358 (W. Va. May 12, 2006)

Validity of pre-formation deed to LLC.