July 2008 — Issue 29

Fisk Ventures, LLC v. Segal

Civil Action No. 3017-CC, 2008 WL 1961156 (Del. Ch. May 7, 2008)

Disagreements between the members of two classes of membership interest in a Delaware LLC led to a deadlock, and one of the Class B members filed a petition for dissolution. Segal, a Class A member who was the LLC’s founding member, president, and sole officer, filed counterclaims and third-party claims against the Class B members. Johnson, a Class B member, filed a motion to dismiss Segal’s claims against him for lack of personal jurisdiction, and the other Class B members filed a motion to dismiss Segal’s counterclaims and third-party claims for failure to state a claim. The court granted Johnson’s motion to dismiss for lack of personal jurisdiction as well as the motion of the other Class B members to dismiss Segal’s claims for failure to state a claim.
Segal argued that Johnson was subject to the court’s jurisdiction under the Delaware long arm statute because Johnson had insisted, as a condition to investing in the LLC, that the LLC be formed under Delaware law and that its governing contracts utilize Delaware law. Also, Johnson had attended some board meetings and had appeared in TV advertising broadcast in Delaware. Segal’s claims against Johnson, however, did not arise from or have any nexus with these contacts. In addition, the court found that Johnson was not a de facto manager and did not otherwise materially participate in the management of the LLC for purposes of the consent to jurisdiction provision of the Delaware LLC statute (which applies to managers of LLCs or those who “participate[] materially in the management” of the LLC). The statute explicitly distinguishes between managers and the people who appoint them, by specifying that the power to elect or otherwise select or to participate in the election or selection of a person to be a manager is not by itself participation in the management of the LLC. The court said that occasionally conferring with the representatives to the board elected by Johnson did not constitute material participation in the management of the LLC. Further, the fact that Johnson had rights as a member under the LLC agreement to affect the activities of the LLC through his representatives to the board did not mean that he was participating materially in the management of the LLC.
The court also dismissed Segal’s claims against other members on the basis that Segal failed to state a claim. The breach of contract claim failed because it was based on breaches of duties not found in the LLC agreement. The court stated that the LLC agreement in no way obligated one class of members to acquiesce to the wishes of the other simply because the other believed its approach to be superior or in the best interests of the LLC. The LLC agreement contained provisions limiting the duties of members except as expressly set forth in the agreement and waiving liability absent gross negligence, fraud, or intentional misconduct. Segal argued that this provision established a duty to act without gross negligence, fraud, or intentional misconduct, but the court stated that the provision did not create a code of conduct resulting in liability for any damage caused by gross negligence, willful misconduct, or a knowing violation of law. The court stated that Segal’s arguments regarding other provisions of the agreement were “similarly tortured” and the court “decline[d] to follow Segal’s invitation to turn an expressly exculpatory provision into an all encompassing and seemingly boundless standard of conduct.” Further, even if the agreement did somehow create a code of conduct, the court stated that Segal failed to allege facts sufficient to support an inference that the members acted with gross negligence, willful misconduct, bad faith, or in knowing violation of law.
The court dismissed Segal’s claim that the Class B members breached the implied covenant of good faith and fair dealing by blocking financing opportunities presented by Segal. The agreement expressly provided for the vote required to approve financing, and the court stated that mere exercise of one’s contractual rights, without more, cannot constitute a breach of the implied covenant of good faith and fair dealing.
The court also dismissed Segal’s breach of fiduciary duty claims. Segal relied upon the same provisions in the LLC agreement for his breach of fiduciary duty claims that he relied upon with respect to his breach of contract claims. The court stated that the agreement greatly restricted and even eliminated fiduciary duties as permitted by the Delaware LLC statute, but, even assuming the validity of Segal’s argument that there remained a duty not to act in bad faith or with gross negligence, he failed to allege facts to support such a breach of duty.
Finally, the court dismissed Segal’s claim for tortious interference with his employment contract since the employment contract allowed the LLC to replace Segal as CEO by a vote of 50% of the board at any time after the second anniversary of the agreement.

Federal Trade Commission v. Olmstead

528 F.3d 1310, No. 06-13254 (11th Cir (Fla.) 2008)

The FTC obtained a judgment against two individuals, and the district court granted an order compelling the individuals to surrender to a receiver their membership interests in several non-party, single-member LLCs organized under Florida law. A subsequent order authorized the receiver to liquidate the assets in the individuals’ LLCs and to pay the proceeds to the FTC. The individuals challenged the district court’s order requiring them to surrender the assets of their non-party, single-member LLCs. The individuals argued that the district court’s order was contrary to the Florida Limited Liability Company Act, which provides that a judgment creditor may obtain a charging order and that the judgment creditor has only the rights of an assignee. Because the charging order provision does not distinguish between single-member and multi-member LLCs, the individuals contended that the charging order is the only remedy available to a member’s judgment creditor even if the member is the sole member of the LLC. The FTC argued that the overall statutory context leads to the conclusion that a charging order is a senseless, and non-exclusive, remedy for a judgment creditor against the membership interest in a single-member LLC. The FTC pointed to the origins of the common law charging order remedy and its purpose of protecting non-debtor partners from being forced into partnership with a partner’s creditor. That rationale is lost in a single-member LLC where no non-debtor members need protection, and the FTC argued that other provisions of the LLC statute demonstrate that application of the charging order remedy would produce absurd results. For example, the FTC argued that the provision of the LLC statute specifying that an assignee can become a member with the consent of members other than the judgment debtor would lead to absurd results if single-member LLCs were treated the same as multi-member LLCs because an assignee would not be able to become a member in a single-member LLC. The FTC also argued that application of the charging order provision in the single-member LLC context would conflict with provisions of the Florida LLC statute providing that an LLC member ceases to be a member upon assignment of the member’s interest and that an LLC is dissolved when there are no members. According to the FTC, if the charging order is the only remedy of a judgment creditor of a member of a single-member LLC, the LLC would be left without a member to manage and wind up the LLC. The FTC argued that the assignment of a member’s interest to a judgment creditor of a member of a single-member LLC should necessarily enable the creditor to step in and liquidate the LLC’s assets in order to harmonize the statutory provisions. The court of appeals determined that Florida law was not sufficiently well-established for it to determine with confidence whether the district court’s order was permissible, and the court thus certified to the Florida Supreme Court the question of whether, under the charging order provision, a court may order a judgment debtor to surrender all right, title, and interest in the debtor’s single-member LLC to satisfy an outstanding judgment. The court stated that it did not intend to limit the issues to be considered by the Florida Supreme Court and asked for guidance.

In re Global Ship Systems, LLC

391 B.R. 193 (Bankr. S.D. Ga. 2007)

An LLC’s lender, who was also a Class B interest holder whose consent was required for the LLC to file bankruptcy, challenged the involuntary bankruptcy of the LLC filed by three individuals who claimed to be creditors and who were solicited or encouraged by one of the members to file the involuntary case. The court concluded that the case fell within the parameters which classically define a bad faith filing, stating that the involuntary case was a pure subterfuge for a voluntary petition, filed by creditors at the instigation of the LLC or its managers/members The court stated that Georgia law is clear in permitting, to the maximum extent possible, parties to exercise freedom of contract in structuring an LLC. The court acknowledged that an absolute waiver of the right to file bankruptcy violates public policy if asserted by a lender, but the operating agreement clearly gave the lender, in its role as a member, the right to prevent a voluntary bankruptcy by withholding consent. In view of the Georgia legislature’s determination that LLCs should be granted broad discretion in the organization and management of their affairs, the court concluded that the lender retained a separate right, as an equity holder, to refuse to consent to a voluntary bankruptcy. The court emphasized that the filing of an involuntary case at the suggestion of a debtor to circumvent limits on the filing under the debtor’s governing documents is only suggestive of, not conclusive evidence of, bad faith. The court distinguished In re Kingston Square Assoc., in which an orchestrated filing was permitted because a bankruptcy in that case could preserve equity for unsecured creditors and limited partners. In contrast, the debt held by the lender in this case far exceeded the value of the collateral, and there was no basis to believe that unsecured creditors and equity holders would be any worse off after foreclosure. The court found that there were other causes for dismissal in addition to its finding of bad faith, and the court also granted the lender’s motion for relief from the stay to permit foreclosure in the alternative. The court discussed in a footnote the relationships of the petitioning creditors with the LLC and stated that its finding of bad faith depended upon that of the LLC and its management and not that of the petitioning creditors.

In re 37-02 Plaza LLC

387 B.R. 413, No. 07-40313-ess (Bankr. E.D. N.Y. 2008)

Chan, a former member of a New York LLC, sought to collect on promissory notes executed by the LLC as payment for the buy-out of Chan’s interest by Tomasino, the managing member of the LLC. The note was signed by Tomasino individually and in his capacity as managing member. The LLC argued that the notes were legally unenforceable for lack of consideration and that payment of the notes would violate the statutory restriction on distributions under the New York LLC statute. The court stated that the LLC bargained for a benefit to a third party, Tomasino, in exchange for its obligation on the notes and that this benefit to a third party was consideration for the LLC’s obligation on the notes. In addition, the court held that the notes were supported by consideration because the LLC bargained for a detriment to Chan in the form of Chan’s surrender of his interest in the LLC. The court also rejected the LLC’s argument that payments on the notes amounted to distributions to Tomasino and Chan in violation of the New York LLC statute, which prohibits distributions to members of an LLC when the LLC is insolvent or the distribution would render it insolvent. The court concluded that payments on the note did not constitute “distributions” as defined by the statute because they were not payments to a person in his or her capacity as a member. Chan was no longer a member, and, while the payments resulted in a benefit to Tomasino, they were payments made pursuant to the LLC’s contractual obligation on the note rather than payments to Tomasino in his capacity as a member. Thus, payments under the note were not impermissible distributions under the New York LLC statute.

OLP, LLC v. Burningham

185 P.3d 1138, No. 20060178-CA (Utah App. 2008)

Wilson and Burningham, the members of a Utah LLC, had a falling out, and Wilson filed suit alleging various causes of action, including a claim for repudiation. Burningham asserted various affirmative defenses and brought counterclaims including a request for dissolution of the LLC under the Utah LLC statute. Throughout the litigation, Burningham sought judicial dissolution and winding up of the LLC under the Utah LLC statute, and the district court eventually agreed that the LLC had been effectively dissolved by the parties’ inability to cooperate in the management and control of the LLC. Instead of proceeding with dissolution proceedings under the statute, however, the court determined that there was an initial fact question as to whether Burningham owed Wilson damages for repudiating the parties’ agreement. The jury found in favor of Wilson and awarded damages.
Burningham argued that the Utah LLC statute is a comprehensive act governing all aspects of an LLC’s formation, existence, and dissolution and that it abrogates any preexisting common law action for repudiation, but the court of appeals held that a cause of action for money damages for repudiation of an LLC exists independently of the LLC act. The court relied upon partnership law recognizing a cause of action for repudiation and concluded that permitting an LLC to sue for damages when the other members wrongfully repudiate the LLC agreement and convert the assets to their own use does not conflict with the provisions of the LLC statute. Burningham argued that there can be no wrongful dissolution of an LLC when the LLC is rightfully dissolved under the LLC statute, and Burningham argued that the court’s order (entered at the time of trial in 2004) determining that the LLC was dissolved no later than August 31, 2001, was a rightful dissolution. The court of appeals was not convinced that the district court’s order was intended to be a formal order of dissolution as opposed to a cut-off date for Wilson’s claim to lost profits if the jury found that Burningham breached the parties’ agreement in a manner that did not constitute a repudiation. In any event, the court distinguished a claim for repudiation from one seeking dissolution and concluded that Wilson could recover damages for repudiation based on events occurring prior to dissolution. Burningham pointed out that the Utah general partnership statutes contain wrongful dissolution provisions whereas no such provisions are contained in the Utah LLC statute, and the court agreed with Burningham that the legislature apparently did not intend to allow LLC members to unilaterally dissolve an LLC in contravention of the parties’ agreement, but the court did not think permitting a wrongfully excluded member to recover money damages was inconsistent with the legislature’s intent to make an LLC more difficult to dissolve. Since the jury determined that Wilson had been wrongfully excluded prior to any dissolution by the district court, it was proper to award Wilson damages without regard to any subsequent dissolution.
The court also rejected Burningham’s argument that the district court should have conducted a judicial winding up. The court stated that the LLC statute gives courts considerable discretion in handling dissolved LLCs, and the court found nothing in the statute that precluded the court from allowing the members themselves to conduct the winding up. The court found it was appropriate for the district court to simply allow Burningham to wind up the LLC, since he was the member who was most ably situated to do so after his exclusion of Wilson and conversion of the assets and since he was the member who had requested the winding up. The court noted that it would exceed the scope of the case to decide the effect of a repudiation claim on the membership and ownership status of an LLC’s various members, and stated that it agreed with the district court that Wilson had disclaimed any continuing interest or membership in the LLC by rejecting equitable proceedings and obtaining a money judgment against Burningham.
The court rejected Burningham’s argument that he was deprived of equitable claims and defenses and stated that it was not improper for the jury to consider the repudiation claim first although it turned on the same operative facts as Burningham’s alleged equitable defenses.
The court also rejected Burningham’s argument that a repudiation claim should be limited to situations in which the repudiating party denies the parties’ business organization, be it a partnership or LLC, ever existed. The court stated that the definition of a repudiation used by the district court – that a party repudiates a contract when that party does or says anything indicating that he does not intend to perform the contract, and that repudiation is not the mere breach of the contract or some of its terms – appeared to be consistent with prior case law. The court refused to adopt a narrower rule that requires a member or partner of a company such as an LLC to deny the existence of the LLC.
Finally, the court rejected Burningham’s argument that the district court erred in allowing the jury to consider the LLC as a going concern. The court reiterated its view that the district court may or may not have dissolved the LLC by its order, and the court stated that operation of the LLC after August 31, 2001, the date on which the court determined the LLC had effectively dissolved, could not violate the court’s order because the order was not entered until the time of trial in 2004. Even if operation of the LLC did conflict with the statute, the court stated that its operation did in fact occur. Since it was Burningham who had wrongfully ousted Wilson and continued operating the LLC, the court stated that any violation would seem to be attributable to Burningham rather than Wilson or the district court. The court also stated that a claim for repudiation is not incompatible with a claim for judicial dissolution and that Wilson was not required to choose to pursue only one remedy since Utah law permits a party to seek remedies in the alternative. In any event, the court concluded that Burningham had failed to show how he was prejudiced when the district court allowed the jury to consider the LLC as a going concern.

Capco Properties, LLC v. Monterey Gardens of Pinecrest Condominium

982 So.2d 1211, No. 3D08-1127 (Fla. App. 2008)

(protection of financial records of LLC from discovery).

Westmeyer v. Flynn

889 N.E.2d 671, No. 1-07-2946 (Ill. App. 2008)

(applicability of corporate veil piercing principles under Delaware law to Delaware LLC)

Construction, LLC v. Gravelroad Entertainment, LLC

Civil Action No. 6: 07-155-DCR, 2008 WL 2038878 (E.D. Ky. May 12, 2008)

(application of Kentucky law to veil piercing claim involving contract of Tennessee LLC; insufficiency of evidence to support veil piercing)

In re Hausman

51 A.D.3d 922, 858 N.Y.S.2d 330 (N.Y. A.D. 2 Dept. 2008)

(applicability of de facto corporation doctrine to LLCs; absence of attempt to file articles of organization as precluding de facto LLC status)

A.B. Medical Services PLLC v. Travelers Indemnity Company

20 Misc.3d 509, 858 N.Y.S.2d 574 (N.Y. Dist. Ct. 2008)

(effect of suspension of license of member of professional LLC on LLC’s status and ability to maintain suit)

Roemmich v. Eagle Eye Development, LLC

526 F.3d 343 (8th Cir. (N.D.) 2008)

(application, as matter of first impression, of North Dakota six year statute of limitations to breach of fiduciary duty claim arising under North Dakota LLC statute; propriety of district court’s decision in favor of majority member on minority member’s breach of fiduciary duty and oppression claims; propriety of award of attorney’s fees against minority member who prevailed on some claims)

Tri-County Metropolitan Transportation District of Oregon v. Butler Block, LLC

Civil No. 08-259-AA, 2008 WL 2037306 (D. Or. May 7, 2008)

(continuation of membership of administratively dissolved LLC in Delaware LLC)

Stokes v. Rodda

No. 60142-3-I, 2008 WL 2174434 (Wash. App. May 27, 2008)

(lack of standing of LLC member to maintain derivative suit based on determination that member was not “fair and adequate” representative)

Stokes v. Anesthesia Associates of Monroe, PLLC

No. 59304-8-I, 2008 WL 2174419 (Wash. App. May 27, 2008)

(lack of standing of LLC member to maintain derivative suit based on determination that member was not “fair and adequate” representative and was no longer member at time of commencement of suit)

Swartz v. Deutsche

No. C03-1252MJP, 2008 WL 1968948 (W.D. Wash. May 2, 2008)

(discussion of circumstances under which fiduciary relationships arise under Washington law; sufficiency of allegations of bad faith in advancing illegal tax shelter scheme as basis for breach of fiduciary duty claim notwithstanding provision of Delaware LLC agreement disclaiming fiduciary relationship between members and waiving any claim for breach of fiduciary obligations to full extent permitted by law; sufficiency of LLC investor’s allegations of securities fraud under Exchange Act and Washington securities law)