June 2007 — Issue 16

City of Bridgeport v. C.J. Fucci, Inc.

No. X03CV065008250S, 2007 WL 1120537 (Conn. Super. March 28, 2007)

Limited liability of partner.

Littriello v. United States

__ F.3d __, No. 05-6494, 2007 WL 1093723 (6th Cir. (Ky.) 2007).

The plaintiff, the sole member of several disregarded LLCs, was deemed to be the sole proprietor of the businesses under Internal Revenue Code Section 7701, and the IRS sought to levy on the plaintiff’s property in connection with unpaid employment taxes arising from the LLCs’ operations. The plaintiff challenged the check-the-box regulations on several grounds. The court rejected the plaintiffs’ challenges, holding that the check-the-box regulations are a reasonable interpretation of ambiguous provisions of Section 7701 and a valid exercise of agency authority by the Treasury. The court also concluded that the plaintiff’s failure to make an election under the check-the-box regulations dictated that the LLCs be treated as disregarded entities under the regulations and prevented them from being treated as corporations; therefore, the plaintiff was deemed to be the sole proprietor of the businesses under Section 7701 and had personal liability for the employment taxes arising from the businesses. Finally, the court rejected the plaintiff’s claim that the regulations impermissibly altered the legal status of the LLCs as separate entities under state law. While the plaintiff’s LLCs were entitled to whatever advantages state law provided, the court concluded that state law could not abrogate his tax liability. The court noted that, after the plaintiff filed his notice of appeal in this case, the IRS proposed amendments to its entity classification regulations that would shield individuals in the plaintiff’s circumstances from personal liability, but the court rejected the argument that the proposed regulations should be deemed to reflect the Treasury’s current policy and applied to the plaintiff’s case. The court concluded that the proposed regulations did not in any way undermine the determination that the current regulations are reasonable and valid.

In re Modanlo (Modanlo v. Mead)

Civil Action No. DKC 2006-1168, 2006 WL 4486537 (D. Md. Oct. 26, 2006).

The sole member of a Delaware LLC filed bankruptcy, and the trustee took several steps in order to take control of the LLC and a corporation owned by the LLC. The steps taken by the trustee in this regard included a “Written Consent of and Agreement Regarding Admission of Personal Representative of Last Remaining Member” under Section 18-806 of the Delaware LLC Act. In that document, the trustee consented to the continuation of the LLC effective as of the date of the occurrence of an event described in Section 18-801(a)(4) of the Delaware LLC Act (i.e., the bankruptcy of the last remaining member) and, as personal representative of the last remaining member, agreed to the admission of the trustee as a member as of that date. The court agreed with the trustee that the LLC was dissolved upon the bankruptcy of the sole member because, under Section 18-304(1) of the Delaware LLC Act, a person ceases to be a member upon the person’s bankruptcy, and, under Section 18-801(a), an LLC is dissolved if it has no remaining members. Under Section 18-801(a)(4), there is an exception to dissolution upon the termination of the last remaining member if a successor member is appointed within 90 days, but the trustee was not appointed until more than 90 days after the filing of the member’s bankruptcy; therefore, this exception was not available to the trustee. The LLC was resuscitated under Section 18-806, however, which permits the personal representative of the last remaining member of an LLC to avoid the dissolution and winding up of an LLC by consenting in writing to the continuation of the LLC and agreeing to become a member of the LLC. The court found that the bankruptcy trustee’s consent met these requirements. The court analyzed the definition of a “personal representative” under the Delaware LLC Act and concluded that a bankruptcy trustee falls within the definition. Section 18-101(13) defines a “personal representative” broadly to include “as to a natural person, the executor, administrator, guardian, conservator or other legal representative thereof....” Because the scope of the term “other legal representative” is not clear on its face, the court looked to decisions analyzing the same language in other contexts and examined the policy rationale behind other sections of the Delaware LLC Act. The court concluded that the Delaware Supreme Court would likely hold that a bankruptcy trustee meets the statutory definition of a “personal representative.” The court rejected the debtor’s argument that the bankruptcy estate held only an economic interest and that the trustee could not become a member or participate in the LLC’s management. The court stated that the debtor’s argument ignored the effect of Section 18-806, and the court distinguished other Delaware cases in which the bankruptcy of a member occurred in the context of an LLC that had other remaining members.

ConnectU LLC v. Zuckerberg

__ F.Supp.2d __, No. 2004-11923-DPW, 2007 WL 1098163 (D. Mass. March 28, 2007).

The court analyzed the membership of a Delaware LLC in order to determine whether diversity jurisdiction existed and concluded that the LLC plaintiff had no members for purposes of diversity jurisdiction at the time the suit was filed; therefore, the LLC was "stateless" and destroyed diversity jurisdiction. In the course of its opinion, the court engaged in a lengthy analysis and discussion of the provisions of the Delaware LLC Act relating to formation of an LLC and admission of members. Because an LLC has the citizenship of each of its members, and one of the defendants was a citizen of New York, a principal focus of the court's analysis was whether Narendra, a New York citizen who was admitted as a member under a retroactive operating agreement entered eleven months after the complaint was filed and more than a year after the LLC was formed, was a member of the LLC when the suit was filed for purposes of determining diversity jurisdiction. Although the court acknowledged that the Delaware LLC Act permits an LLC agreement to have retroactive effect (i.e., the statute permits an LLC agreement to be entered after the filing of a certificate of formation and to be effective as of the formation of the LLC), the court concluded that the analysis must turn on the facts as they existed at the time the complaint was filed without reference to the later executed operating agreement. Thus, the court proceeded to determine who, if anyone, was a member of the LLC under Delaware law at the time the suit was filed on September 2, 2004. The court looked to the statutory definition of a "member" and the provisions addressing admission of members in connection with the formation of an LLC. The court stated that the documentary evidence made clear, and the parties did not appear to dispute, that no one became a member of the LLC at the time the certificate of formation was filed on April 6, 2004. The court observed that this was "perfectly acceptable" under Delaware law and did not in any way implicate the validity of the LLC. The court acknowledged that the individuals named in the subsequently executed operating agreement eventually became members in connection with the formation of the LLC, but the court's concern was with what occurred prior to the time the suit was filed. The court stressed that "there simply is no requirement under Delaware law that there be members of an LLC at formation" and concluded that there were none for purposes of the diversity jurisdiction question. Moving on to consider membership subsequent to formation of the LLC, the court examined whether the statutory conditions for admission of any members had been met at the time the suit was filed. The court stated that, since there were no members of the LLC at formation, there were no members to consent to the admission of a member, and there were no records reflecting the admission of members before the date the complaint was filed. The court examined evidence of the parties’ intentions and course of conduct and found that the record did not establish that the LLC had any members on the date the complaint was filed. The testimony of the individuals who ultimately became members under the operating agreement reflected that they gave little, if any, thought to who the members were at the time the LLC was formed because they were concentrating on getting the business going. The court refused to consider tax returns identifying the members since they were prepared after the suit was filed. The court also found unpersuasive two documents that identified members of the LLC prior to the date the suit was filed. One of the documents was a bank signature card, and it was unclear who printed the word “member” on the card and whether it was there when the card was signed by those identified as members. The other document was an application to do business in Connecticut that was prepared and signed by someone other than the members identified. Though the court’s opinion referred to testimony that indicated there may have been an understanding at the time of formation regarding who was a member and who was not, the court apparently found the intentions too vague to warrant a conclusion that the LLC had members at the time. Though the court commented that the parties had struggled valiantly to establish that the LLC had members on the date the complaint was filed, the court concluded that, "in the snapshot of Delaware law, there were none."

Endico v. Fontes

__ F.Supp.2d __, No. 07 Civ. 2398(LAK), 2007 WL 1215140 (S.D. N.Y. 2007).

The plaintiff brought suit under Section 10(b) of the Exchange Act and Rule 10b-5, alleging that he was defrauded in connection with his sale of a 2/3 membership interest in an LLC. The court determined that the sale did not involve the sale of a Asecurity@ and dismissed the case. The plaintiff sued in his own right and derivatively on behalf of the LLC, claiming that the defendants tricked the plaintiff into transferring a 2/3 membership interest without paying for it, caused the LLC to buy property with the plaintiff’s money, mortgaged the property, and looted the proceeds from the LLC. Though the plaintiff tried to establish that he was a passive investor in order to establish that the membership interest was an investment contract under the Howey test, the court concluded that the record did not establish that the interests sold by the plaintiff were passive. Focusing on what the plaintiff sold, the court pointed out that the defendants became the managing members of the LLC and certainly were not passive investors. Thus, the court said it was extremely doubtful that the interests he sold were securities even if the plaintiff was thereafter a passive investor. Moreover, the court concluded that the plaintiff retained important elements of control after the sale such that he was not a passive investor even if the court looked exclusively at the plaintiff’s status following the sale. The court pointed out that the plaintiff was a signatory on the LLC’s checking account and had a veto right over the sale and mortgage of LLC property. Thus, based on the record, the court found no material prospect that the plaintiff would succeed in establishing that the interests he sold were securities and thus no material prospect that he could prevail on the securities fraud claim.

Babb v. Bynum & Murphrey, PLLC

__ S.E.2d __, No. COA06-876, 2007 WL 1119389 (N.C. App. April 17, 2007).

The plaintiffs sued Bynum and Murphrey, two members of a law firm LLC, alleging that Bynum engaged in numerous acts of fiduciary fraud in connection with the handling of a trust. The plaintiffs alleged claims against Murphrey for negligence, negligent supervision, and breach of fiduciary duty. The plaintiff argued that Murphrey had a duty to them under the North Carolina Limited Liability Act and the firm’s operating agreement. First, the court cited the statutory provision protecting a member from liability for the obligation of the LLC but providing that a member may become liable for the member’s own acts or conduct. Though the plaintiffs claimed that they were seeking to hold Murphrey liable for his own acts and omissions, the court concluded that the plaintiffs failed to allege any direct acts by Murphrey and were relying on Murphrey’s failure to act. The court concluded that the LLC statute did not impose a duty on Murphrey to investigate Bynum if Murphrey did not have any actual knowledge, which the record established Murphrey did not have. The court also rejected the plaintiffs’ claim that the operating agreement created a duty on the part of Murphrey. Although the operating agreement stated that a member shall be liable for his own professional negligence and that a member must comply with the rules of professional conduct, the court concluded that the plaintiffs were not third party beneficiaries of the agreement. The court said that the intent of the parties was to benefit the law firm and its members, not to directly benefit the plaintiffs. Thus, the plaintiffs were at most incidental beneficiaries and not third party beneficiaries with standing to sue.

Baca v. Depot Sales, LLC

Civil Action No. 06-cv-00714-EWN-PAC, 2007 WL 988061 (D. Colo. March 30, 2007)

Application of successor liability principles to LLC that acquired sole proprietorship.

BRJM, LLC v. Output Systems, Inc.

100 Conn.App. 143, 917 A.2d 605 (Conn. App. 2007)

Pre-formation contract.

Meneo v. Patrick

No. CV065004523, 2007 WL 1053511 (Conn. Super. March 23, 2007)

Insufficient grounds to pierce veil of single member LLC.

Rizzo v. Joseph Rizzo and Sons Construction Company, Inc.

No. Civ.A. 2551-VCS, 2007 WL 1114079 (Del. Ch. April 10, 2007)

Jurisdiction of Chancery Court to hear LLC member’s ejectment claim when brought derivatively.

Flentye v. Kathrein

__ F.Supp.2d __, No. 06 C 3492, 2007 WL 1175576 (N.D. Ill. 2007)

Application of corporate veil piercing principles to LLC; sufficiency of allegations to state alter ego claim.

Heer v. Price

No. 1:06CV-114-R, 2007 WL 1100693 (W.D. Ky. April 11, 2007)

Interpretation of derivative suit provisions of North Carolina LLC Act as not precluding jurisdiction of court outside North Carolina.

Kranz v. Koenig

__ F.Supp.2d __, Civil No. 06-3380 (PAM/JSM), 2007 WL 1192386 (D. Minn. 2007)

Lack of standing of party that is not LLC, receiver, or other person winding up LLC’s affairs to assert illegal distribution claims under Minnesota LLC Act.

Harada v. Doiron

No. 2:04-CV-1320-PMP-RJJ, 2007 WL 983843 (D. Nev. March 30, 2007)

Limited liability of member.

In re Bayou Group, L.L.C.

Nos. 06-22306 (ASH), 06-Civ-6837 (CM), 2007 WL 437675 (S.D. N.Y. Feb. 5, 2007)

Court’s power to appoint receiver as exclusive managing member under federal receivership law and inherent equity power.