June 2006 — Issue 5

Connolly v. Napoli, Kaiser & Bern, LLP

__ N.Y.S.2d __, 2006 N.Y. Slip Op. 26132, 2006 WL 901675 (N.Y. Sup. 2006)

Potential liability of LLP partners for personal participation in alleged wrongdoing.

Ramone v. Lang

No. Civ.A. 1592-N, 2006 WL 905347 (Del. Ch. April 3, 2006)

For six months, the plaintiff and the defendant discussed and negotiated the formation of an LLC to purchase and operate an indoor swimming and fitness facility, but the parties never finalized their arrangement. Ultimately, the defendant purchased the property. The plaintiff argued that the defendant used the plaintiff’s good name and reputation to the defendant’s advantage and then cut the plaintiff out of the deal. The plaintiff alleged claims based upon breach of fiduciary duty, breach of contract, and promissory estoppel. The defendant claimed it was the plaintiff’s repeated delays, changing desires, and inability to commit to the terms of the deal that made finalizing the transaction impossible. The court analyzed the dealings between the parties at length and concluded that the plaintiff was entitled only to limited relief on the basis of promissory estoppel. The court rejected the plaintiff’s argument that the parties formed a partnership through their conduct and owed one another fiduciary as well as contractual duties. The court reviewed the description of a partnership under the Delaware Revised Uniform Partnership Act and Delaware case law and concluded that the absence of a written agreement, while not always dispositive of the existence of a partnership, was conclusive in this case. Putting it in romantic terms, the court characterized the parties as “engaged ‘to get engaged,’” and stated this type of agreement was insufficient to form a general partnership. The court emphasized that the parties intended to form an LLC and never agreed on their obligations. The court acknowledged that a partnership might result if two parties intended to form an LLC, reached an agreement on the material terms, and conducted business under such terms for a time, but one of the parties later refused to sign the LLC agreement. In this case, however, the court stated that it would be “inequitable and unprincipled” to find that the failure of the parties to reach an accord on the LLC agreement left them as general partners. The court found that promissory estoppel supported limited relief for the plaintiff’s reasonable reliance on the defendant’s promise that the pool would be leased to the plaintiff regardless of what happened with the LLC structure.

Federal Trade Commission v. Peoples Credit First, LLC

No. 8:03-CV-2353-T-TBM, 2006 WL 1169677 (M.D. Fla. May 3, 2006)

The FTC obtained a judgment against two individuals, Olmstead and Connell, and sought to liquidate the assets of several non-party LLCs. Olmstead and Connell objected to the liquidation of the assets as contrary to the Florida LLC statute and argued that the court was at most authorized to enter a charging order against their interests in the LLCs. The court disagreed. The court pointed out that the sole member of each of the LLCs in issue was Olmstead or Connell and concluded that “under these circumstances, the purposes of the statute are not defeated by the proposed liquidation of the assets of these companies which presently all [sic] under receivership.”

In re Capital Acquisitions & Management Corp.

341 B.R. 632, No. 05 B 12554 (Bankr. N.D. Ill. 2006)

The debtor was a 20% member of a Florida LLC, and the court determined that the LLC operating agreement was not an executory contract that may be assumed or rejected and that the right of first refusal provision in the operating agreement was not an unenforceable ipso facto clause. The court found the operating agreement was not an executory contract because the debtor had no current obligations which, if left unperformed, would constitute a material breach. The court acknowledged that if circumstances changed, the debtor might have certain future obligations, such as indemnification of the LLC for loss or liability attributable to the assessment of a tax with respect to the debtor’s share of LLC profits or gains; however, the court did not view such remote potential obligations as sufficient to render the contract executory. The court stated that the Seventh Circuit takes a narrow approach to the definition of an executory contract, and the court noted that it had not been able to locate any published case in the Seventh Circuit in which an LLC agreement was found to be an executory contract. The court stated that its conclusion regarding the LLC operating agreement in this case was consistent with persuasive precedent in which courts have found LLC operating agreements were not executory contracts. The court then analyzed whether the receiver’s sale of the debtor’s interest was subject to the right of first refusal provision in the operating agreement or whether the right of first refusal was an unenforceable ipso facto clause under Section 365(c) or an impermissible restraint on assignment under Section 365(f). The court stated that the provisions of Section 365 are only applicable to an executory contract but that the right of first refusal would still be enforceable even if the operating agreement were an executory contract. The right of first refusal was not triggered by the bankruptcy filing or the appointment of the receiver– it applied to any sale of a member’s interest. The court acknowledged that the debtor might receive a higher price for its interest absent the right of first refusal, but stated that the debtor knew when it signed the operating agreement that any sale would be subject to the right of first refusal, and the receiver took the debtor’s rights as it found them on the date of the petition.

Overhoff v. Scarp, Inc.

12 Misc.3d 350, 812 N.Y.S.2d 809, 2005 Slip Op. 25583 (N.Y. Sup. 2005)

Two members of a three-member LLC took the following actions by a written consent: termination of the LLC’s lease of its premises, termination of the employment of all the LLC’s employees, and acceptance of a notice of default on a promissory note from the LLC. The third member claimed that the action was invalid because the operating agreement’s quorum provision required all members to be present at a meeting and another provision stated that no action may be taken or voted upon unless all members, in person or represented by proxy, are present to vote. The third member argued that these provisions precluded non-unanimous written consents. The two members who executed the written consent relied upon the default provisions of the New York LLC statute regarding written consents, arguing that the operating agreement only addressed meetings and was silent concerning the validity of action taken by written consent. The New York LLC statute provides that, unless otherwise provided by the operating agreement, members of an LLC may take action without a meeting by a written consent signed by members who hold voting interests having not less than the minimum number of votes that would be necessary to authorize the action at a meeting at which all members were present and voted. The LLC’s operating agreement stated that each member entitled to vote at any meeting was entitled to one vote and that any LLC action shall be authorized by a majority of votes cast except as otherwise provided by statute, the articles of organization, or the operating agreement. The court examined the written consent provision of the LLC statute (comparing and contrasting it to the shareholder consent provision of the business corporation law) and the provisions of the operating agreement and concluded that the operating agreement did not alter the default provisions of the statute generally permitting a majority in interest of the members to act by written consent. The court, however, turned its attention to a provision of the operating agreement requiring approval of all members for certain actions. Expressing concern that neither side directed the court’s attention to what the court considered the dispositive provision, the court pointed out that the actions taken in the written consent fell within the following categories of action requiring unanimous consent under the operating agreement: transferring any interest in property, confessing any judgment on behalf of the LLC, or doing any act making it impossible to carry on the ordinary business of the LLC. The court considered the termination of the lease a transfer of an interest in property and an action making it impossible to carry on the ordinary business of the LLC. The termination of all the LLC’s employees likewise made it impossible to carry on the LLC’s ordinary business, and the acceptance of the notice of default on the LLC’s promissory note was akin to a confession of judgment according to the court. The court commented that had the two members simply removed the third member from his employment by written consent rather than terminating all the employees, the action presumably would have been valid under the LLC statute and the operating agreement, but terminating all employees caused the action to fall under the provision requiring consent of all members.

Kasten v. Doral Dental USA, LLC

No. 2005AP995, 2006 WL 861382 (Wis. App. April 5, 2006)

Addressing an issue of first impression in Wisconsin, the court of appeals certified to the Wisconsin Supreme Court the following issues: (1) whether the Wisconsin Limited Liability Company Act (as in effect in 2003-2004) grants members a broad right of access to LLC records that, absent contrary language in the operating agreement, embraces informal and non-financial records, and (2) if the statute grants a broad inspection right, whether e-mails may be classified as “records” that are subject to a member’s inspection. An LLC member sought access to e-mails and drafts of certain documents, and the LLC opposed the member’s access. The trial court held that the member was not entitled to inspect the drafts and e-mails. The court of appeals discussed the arguments made by each side and appeared to lean toward a broad reading of the statute consistent with the member’s position, but the court did not reach a conclusion, deferring instead to the supreme court as the proper judicial authority to decide such a novel and significant issue. The court examined the provisions of the Wisconsin LLC statute and the operating agreement of the LLC in question and observed that the operating agreement appeared to grant inspection rights similar to the statute. The court stated that the LLC’s argument that the statute limited member inspection rights to the enumerated records required to be kept under the statute seemed inconsistent with the statute, which goes further and provides that, unless otherwise stated in the operating agreement, a member’s right to inspect and copy records extends to “any other records” of the LLC. The court acknowledged that the LLC statute borrowed liberally from the corporate and limited partnership statutes, which limit inspection rights to specified formal documents. The court pointed out, however, that the LLC statute, unlike the limited partnership and corporate statutes, explicitly refers to “any other limited liability company record” and states that a member may inspect such other records unless otherwise provided in the operating agreement. The court also commented that courts have tended to define the scope of the inspection right broadly in corporate and partnership cases. With regard to the possible status of e-mails as “records,” the court observed that cases suggesting a broad right of access extending to “correspondence” were decided before e-mail became a primary source of business communication. The court noted that e-mail correspondence is often more frank and unguarded than written correspondence and that it thus may not be appropriate to characterize an e-mail message as a company record. On the other hand, the court stated that distinguishing between e-mail and other informal records, such as correspondence, may be a distinction without a difference. The court noted that e-mail has been admitted into evidence as “records” or “documents” in other contexts and that the Uniform Limited Liability Company Act defines records broadly to include information stored in an electronic form.

Carey v. Howard

__ So.2d __, 1040518 & 1040532, 2006 WL 1119260 (Ala. 2006)

Lack of standing by members to sue for declaratory relief for injury to LLC.

Anderson, LLC v. Stewart

__ S.W.3d __, No. 05-886, 2006 WL 1118892 (Ark. 2006)

Personal liability of LLC member under Deceptive Trade Practices Act; veil piercing.

Connective Tissue Imagineering v. Mitts

No. F046902, 2006 WL 1163817 (Cal. App. 5 Dist. May 3, 2006)

Interpretation of operating agreement arbitration provision as to non-signatories; court’s authority not to enforce arbitration clause to avoid potential inconsistency in outcome and duplication of effort.

Kingston Trading & Transportation Ltd. v. Embarques Golfo, LLC

No. CivA. 05-6337, 2006 WL 861065 (E.D. La. March 24, 2006)

Interpretation of operating agreement arbitration clause as not binding non-signatories, including LLC that did not sign operating agreement.

Continental Casualty Co. v. Duckson-Carlson, LLC

No. A05-1173, 2006 WL 1073075 (Minn. App. April 25, 2006)

Liability of LLC member to insurer for deductible in connection with settlement paid by insurer on malpractice claim under policy covering LLC and member.

Bhana v. Patel

No. Civ.A. 3:05-CV-585BS, 2006 WL 1050519 (S.D. Miss. April 20, 2006)

Demand futility in derivative context under Delaware law; admission of member without capital contribution.

Clockwork Home Services, Inc. v. Robinson

423 F.Supp.2d 984, No. 4:05CV1422JCH (E.D. Mo. 2006)

Personal jurisdiction over LLC member/president; derivative nature of member’s breach of fiduciary duty claims.

Widewaters Herkimer Company, LLC v. Aiello

28 A.D.3d 1107, __ N.Y.S.2d __, 2006 Slip Op. 03215 (N.Y. A.D. 4 Dept. 2006)

Lack of grounds for judicial dissolution; triable issues of fact on propriety of capital call and breach of fiduciary duty and fraud.

Baraby v. Swords

__ N.E.2d __, No. 1-05-76, 2006 WL 1062020 (Ohio App. April 24, 2006)

Limited liability of LLC member as affirmative defense.

Gray Printing Company v. Blushing Brides, LLC

No. 05AP-646, 2006 WL 832587 (Ohio App. March 31, 2006)

Limited liability of LLC member.

Johnson v. Songwriter Collective, LLC

No. 3:05-0320, 2006 WL 861490 (M.D. Tenn. March 28, 2006)

Securities fraud; statutory standard of care of LLC managers under Tennessee law; fiduciary duty of managers.