June 2008 — Issue 28

LLPs: Kuslansky v. Kuslansky, Robbins, Stechel and Cunningham, LLP

50 A.D.3d 1100, 858 N.Y.S.2d 213 (N.Y.A.D. 2 Dept. 2008)

A withdrawn partner sought to recover payment from the remaining partners for the value of his partnership interest under the partnership agreement. The defendant partners argued that they were shielded from liability by the New York LLP provisions, but the court pointed out that the New York Court of Appeals held in Ederer v. Gursky that the LLP liability shield only applies to a partner’s liability to third parties and does not shield a general partner in an LLP from breaches of the partnership’s or partner’s obligations to each other.

LLCs: TravelCenters of America, LLC v. Brog

Civil Action No. 3516-CC, 2008 WL 1746987 (Del. Ch. April 3, 2008)

The question in this case was whether the members of an LLC complied with the advance notice provision of the LLC’s bylaws. The LLC sought to have a law professor testify on whether the advance notice bylaw was consistent with good governance practice and whether the notice submitted by the members complied with federal securities laws as required by the bylaw provision. The court stated that the issue was whether the members’ notice complied with the contractual provision embodied in the bylaws and that there was no issue of fact as to whether the bylaw was consistent with notions of good corporate governance. At most, the members could question the validity of the bylaw, which was a question of law rather than fact. The court stated that Delaware does not impose a legal requirement on LLCs to draft their bylaws to be consistent with “some abstract notion of ‘good corporate governance.’” On the contrary, said the court, LLCs are creatures of contract “designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.” The court did, however, permit the law professor to testify on the issue of whether the notice failed to comply with the notice bylaw because it violated federal securities laws, e.g., by the omission of material facts. To the extent that requirements of the federal securities laws were in issue, these were not issues of Delaware law as to which expert testimony would be precluded. Further, the issue of materiality is generally a mixed question of law and fact, but predominantly fact, as to which expert testimony is permissible.

Georgia Rehabilitation Center, Inc. v. Newnan Hospital

283 Ga. 335, 658 S.E.2d 737, No. S07A1672 (Ga. 2008)

The court held that a member’s request for judicial dissolution was not subject to arbitration because the arbitration clause in the operating agreement required arbitration of any claim arising out of, in connection with, or relating to the agreement. Though the agreement provided for certain causes of dissolution, the court concluded a request for judicial dissolution was an independent legal mechanism and did not arise out of or relate to the terms of the operating agreement.

Montgomery v. eTreppid Technologies, LLC

548 F.Supp.2d 1175, Nos. 3:06-CV-00056-PMP-VPC, 3:06-CV-00145-PMP-VPC (D. Nev. 2008)

In litigation between an LLC and Montgomery, a member and former manager, the LLC resisted certain discovery requests on the grounds of attorney-client privilege. Montgomery claimed that, as a member and former manager of the LLC, he was a “joint client” and that the attorney-client privilege could not be asserted against him with respect to privileged communications during the time he was a manager. The LLC argued that it was the sole client and that the ability to assert the privilege belonged to current management. The issue of first impression for the court was whether an LLC should be treated as a partnership or corporation for purposes of the attorney-client privilege. The court discussed the “hybrid” nature of an LLC and cited LLC cases addressing derivative litigation, the business judgment rule, and veil piercing in which courts have applied corporate law to LLCs. The court stated that Montgomery cited no case law applying the law of partnerships to LLCs and that Montgomery relied only upon the general proposition that members of an LLC owe one another fiduciary duties and a general comparison of the structure of the LLC to that of a partnership. The court agreed with the LLC that, even if the court found the LLC operated like a partnership, partnerships and limited partnerships are treated as corporations for purposes of the attorney-client privilege under federal law. Based on a review of the LLC’s operating agreement, the court concluded that the LLC’s management structure more resembled a corporation than a partnership. Taking into account the case law applying corporate law to LLCs in other areas, Montgomery’s failure to cite case law applying partnership law to LLCs, and the fact that federal courts have treated partnerships as corporations for purposes of the attorney-client privilege, the court concluded that the LLC should be treated as a corporation pursuant to federal common law. The court then discussed the divergent views reflected in the case law regarding who the client is for purposes of the attorney-client privilege. Some courts have held that the corporate entity is the sole client, while others have embraced a “joint client” exception, i.e., have taken the view that the corporate entity and present and former directors are joint clients for purposes of asserting the privilege. The court found the “sole client” line of cases more persuasive and was influenced by the fact that Montgomery was suing to benefit himself individually rather than on behalf of the LLC or in his capacity as a former manager or officer. The court thus held that the LLC was the client for purposes of the attorney-client privilege and that only current management of the LLC was entitled to assert or waive the privilege.

In re Klingerman (Klingerman v. ExecuCorp, LLC)

__ B.R. __, Bankruptcy No. 07-02455-5-ATS, Adversary No. S-08-00017-5-AP, 2008 WL 1446541 (Bankr. E.D. N.C. 2008)

The bankruptcy debtor in possession, Klingerman, sought judicial dissolution and winding up of an LLC of which Klingerman was a founding member. The other member, Parker, alleged that Klingerman ceased to be a member when he filed bankruptcy and thus lacked standing to seek an accounting or judicial dissolution. Parker relied upon the operating agreement and the North Carolina LLC statutes. The operating agreement provided that a member shall not voluntarily withdraw or take any voluntary action that would cause a “Withdrawal Event.” The operating agreement did not define the term “Withdrawal Event,” but the North Carolina Limited Liability Company Act provides that a person ceases to be a member upon specified events of withdrawal including the filing of a voluntary bankruptcy petition. Parker argued that Klingerman ceased to be a member when he filed his bankruptcy petition because the operating agreement did not negate the statutory provisions for withdrawal. Klingerman’s loss of membership status was significant because the North Carolina LLC statute provides for judicial dissolution only where a proceeding is brought by the Attorney General, a member, or the LLC itself. The court stated that Klingerman would not have standing to pursue dissolution if the analysis stopped with the operating agreement and the North Carolina LLC statute, but the court proceeded to consider Bankruptcy Code Section 541(c). Section 541(c)(1) provides that all of the debtor’s interest in property becomes property of the estate notwithstanding any provision in applicable nonbankruptcy law that is conditioned on the commencement of a bankruptcy and that effects a forfeiture, modification, or termination of the debtor’s interest in property. Agreeing with In re Ehmann, the court concluded that all of the debtor’s rights and interest, economic and non-economic, passed to the estate under Section 541(c). The court viewed the converting of a debtor’s membership interest to that of an assignee by operation of a state statute as a modification or termination of the interest that is rendered ineffective by Section 541(c). In so concluding, the court disagreed with In re Garrison-Ashburn, L.C., in which a bankruptcy court concluded that the debtor/member’s bankruptcy estate only had the rights of an assignee. As a member of the LLC, Klingerman’s estate had standing to seek dissolution. The court left for another day the question of whether the request for judicial dissolution should be granted.

Browning-Ferris Industries, Inc. v. U.S.

101 A.F.T.R.2d 2008-1770, 2008-1 USTC ¶ 50,297, No. 2007-5144, 2008 WL 1743903 (C.A. Fed. 2008)

Continuation of existence of corporation that converted to LLC for purposes of standing to file suit for tax refund as agent for consolidated group.

Hampton Island Founders v. Liberty Capital

283 Ga. 289, 658 S.E.2d 619, No. S07A1567 (Ga. 2008)

Analysis of injunctions regarding management of LLCs; lack of grounds for intervention by owners of member of LLC involved in dispute.

ColtTech, LLC v. JLL Partners, Inc.

538 F.Supp.2d 1355, Civil Action No. 07-2545-KHV (D. Kan. 2008)

Application of law of state of organization of foreign LLC to liability of members; liability protection of sole member and related parties for LLC’s debt under Delaware law; lack of evidence and authority to support imposition of liability on private equity firm that was not member of LLC but merely sponsor of one of several member investors.

L & L Holding Company, L.L.C. v. United States

101 A.F.T.R.2d 2008-2081, 2008-1 USTC ¶ 50,324, Civil Action Nos. 05-0794-A, 05-0817-A, 2008 WL 1908840 (W.D. La. 2008)

Liability of sole member of disregarded LLC for unpaid employment and unemployment taxes of LLC.

VanderWerp v. Charter Township of Plainfield

278 Mich.App. 624, __ N.W.2d __, Docket No. 273112, 2008 WL 1808233 (Mich. App. 2008)

Unavailability of homestead exemption under Michigan statutes for property that was residence of settlor/trustee of revocable trust that was sole member of LLC to which property had been transferred.

Hiner v. Boldon

No. A07-0254, 2008 WL 1799772 (Minn. App. April 22, 2008)

Judicial intervention and equitable relief under Minnesota LLC statute where members were deadlocked, had no formal agreement, and had each breached duties, and winding up through liquidation as well as complete equalization of capital contributions was determined to be inequitable.

Abuy Development, L.L.C. v. Yuba Motorsports, Inc.

No. 4:06CV799SNL, 2008 WL 1777412 (E.D. Mo. April 16, 2008)

Interpretation of ambiguous provisions of operating agreement of Delaware LLC in dispute regarding failure to make additional capital contributions and rights of “Defaulting Members” and “Non-Defaulting Members”.

In re House of Lloyd Sales LLC (Stanton v. SGC Partners I, LLC)

Bankruptcy No. 02-40208, Adversary Nos. 05-4014, 06-4283, 2008 WL 957663 (Bankr. W.D. Mo. April 8, 2008)

Discussion and application of Delaware business judgment rule in connection with alleged mismanagement of LLCs.

Regions Bank v. Regional Property Development Corporation

No. 07 CVS 12469, 2008 WL 1836657 (N.C. Super. April 21, 2008)

Possible existence of aiding and abetting breach of fiduciary duty cause of action under North Carolina law; member’s lack of standing to bring claims that belonged to LLC based on application of corporate derivative litigation principles to LLCs.

Ward v. Bullis

748 N.W.2d 397, No. 20070188 (N.D. 2008)

Potential liability of attorney as “agent” under North Dakota Securities Act in connection with sales of interests in LLCs.

Cascade Falls, L.L.C. v. Henning

No. 25134-9-III, 2008 WL 934074 (Wash. App. April 8, 2008)

Estoppel of withdrawn member to claim member status notwithstanding absence of formal written consent of all members to withdrawal as required by Washington LLC statute.