March 2007 — Issue 13

Ederer v. Gursky

35 A.D.3d 166, 826 N.Y.S.2d 210, 2006 N.Y. Slip Op. 09045 (N.Y. A. D. 1 Dept. Dec. 5, 2006)

Scope of NY LLP statute as not exempting partners from liability to account to withdrawing partner, or for breach of firm-related agreements between them.

Software Publishers Association v. Scott & Scott, LLP

Civil Action No. 3:06-CV-0949- G, 2007 WL 92391 (N.D. Tex. Jan. 11, 2007)

Potential personal liability of managing partner of LLP law firm based on partner’s alleged control over firm with respect to alleged wrongdoing.

Fogarty v. Parker, Poe, Adams, and Bernstein, L.L.P.

__ So.2d __, 1040335, 2007 WL 80794 (Ala. 2007).

The Alabama Supreme Court issued this modified opinion replacing its prior opinion of August 18, 2006. The modified opinion is almost identical to its prior opinion, and the court reached the same conclusions regarding the claims asserted by minority members of an Alabama LLC against a North Carolina law firm and two of its attorneys based on the attorneys’ role in denying them access to the books and records of the LLC. The plaintiffs alleged that the attorneys threatened legal action against them if they continued to seek access to the LLC’s records, misrepresented Alabama law by stating that Alabama law did not entitle them to access to the LLC’s books and records, and removed the books and records from Alabama to prevent the plaintiffs from having access to them. The court held that the Alabama Legal Services Liability Act (ALSLA) was not the exclusive remedy for the minority members’ claims because the ALSLA applies only to allegations of legal malpractice, i.e., claims against legal services providers that arise from the performance of legal services. The court stopped short of saying, as it had in its original opinion, that the ALSLA applies only to claims brought by the one who receives legal services; however, the court stated, as it had in its original opinion, that it appeared the ALSLA did not apply to the plaintiffs’ claims because the plaintiffs’ complaint did not allege tortious conduct resulting from the receipt of legal services from the attorneys and because the attorneys expressly stated that they never provided legal services to the plaintiffs. Furthermore, the ALSLA did not apply to the attorneys because they were not licensed to practice law in Alabama, and the ALSLA applies only to attorneys licensed in Alabama. The court next held that Alabama recognizes a private cause of action for the unauthorized practice of law in Alabama and concluded that the plaintiffs stated a claim for relief by alleging that the attorneys were not licensed in Alabama and that the plaintiffs were injured as a result of representations made concerning Alabama law for the majority owners and the LLC itself. The court also found that the plaintiffs had stated a claim against the attorneys based on the statutory inspection provisions of the Alabama Limited Liability Company Act. The court pointed out that the statute provides for personal liability of “any agent, member, or manager” of an LLC who refuses to permit a member to inspect the books and records without reasonable cause. The plaintiffs alleged that the attorneys were acting as the LLC’s agent and that they refused to permit the plaintiffs to inspect certain records without reasonable cause; therefore, the allegations supported a claim for relief under the statute, which provides for a penalty in an amount up to 10% of the fair market value of the membership interest of the member in addition to other damages.

W. J. Spano Company, Inc. v. Mitchell

943 So.2d 1131, No. 2005 CA 2115 (La. App. 2006.

The Mitchells sought to hold an LLC and its member liable for faulty landscape architecture services. The member argued that he was not liable based on the provision of the Louisiana LLC statute that insulates members, managers, and employees from liability for a debt or obligation of the LLC. The court acknowledged the liability protection provided by the LLC statute, but stated that the member could be liable in his capacity as a professional landscape architect for negligence in performing his professional duties. The court stated that the LLC statute clearly provides for a cause of action against a member, manager, or employee of an LLC for breach of professional duty, as well as for any fraud or other negligent or wrongful act. The court distinguished another Louisiana case, Curole v. Oschner, in which the court concluded that an LLC member could not be personally liable for the alleged wrongful termination of an LLC employee because the act was undertaken in his capacity as a member of the LLC. The court stated that the member in the instant case was engaged in the practice of a profession and that the Louisiana statutes are not intended to shield professionals from liability for personal negligence.

In re Dreiling

No. 05-64189, 2007 WL 172364 (Bankr. W.D. Mo. Jan. 18, 2007).

The court analyzed the creation and perfection of a security interest in the debtors’ one-third LLC interest and concluded that the security interest was not properly perfected and was thus unenforceable against the trustee. The creditor asserted a secured claim based on an assignment that provided that the debtors “hereby assign to the [creditor] a security interest in their ownership shares of [the LLC].” The assignment further provided that the debtors acknowledged and understood that the assignment gave the creditor a sufficient security interest in the ownership of the LLC to allow the creditor to receive payment in a specified amount plus interest from the proceeds of any sale of the debtors’ share of the LLC or the sale of the debtors’ share of the assets of the LLC. The court analyzed the rights of the trustee as a lien creditor under Kansas law since the LLC was a Kansas LLC. The creditor asserted that the debtors assigned a portion of their ownership interest in the LLC and that such assignment was valid under the Kansas LLC statute because the statute provides that an LLC interest is assignable in whole or in part except as provided in the operating agreement. The court concluded, however, that the assignment did not purport to assign the debtors’ ownership interest, but rather a security interest in the one-third ownership interest. The court reviewed the treatment of an LLC interest under the Kansas UCC and concluded that the LLC interest was not a security governed by Article 8 but rather a general intangible governed by Article 9. Assuming without deciding that the creditor had a valid security interest that attached to the debtors’ interest when the assignment was executed, the court concluded that the lien was not properly perfected because the creditor did not file a financing statement. Since the lien was not properly perfected, the trustee took the LLC interest free of the lien and could liquidate it for the benefit of all unsecured creditors.

In re Tsiaoushis (Meiburger v. Endeka Enterprises, L.L.C.)

Bankruptcy No. 05-15135-RGM, Adversary No. 06-1167, 2007 WL 186536 (Bankr. E.D. Va. Jan. 19, 2007).

The court determined that an LLC agreement providing for dissolution and liquidation of the LLC on the bankruptcy of a member was not an executory contract; therefore, Section 365(e)(1) was not applicable and the automatic dissolution clause was not an unenforceable ipso facto clause. The court rejected the argument that all partnership agreements and LLC agreements are executory contracts. The court characterized the determination of whether a partnership or LLC agreement is or is not an executory contract as an individualized analysis. The debtor was not a manager (having ceased to be a manager prior to the filing), and had no unperformed duties arising as a member of the LLC. The debtor and another individual were the largest interest holders, and the other member was the sole manager. The other member argued that the debtor might have a fiduciary duty to vote for an additional capital contribution in certain circumstances, but the court stated that “[t]he failure to perform a remote and speculative fiduciary duty, if one exists, is not a ‘material breach excusing performance of the other.’” The court stated that there is no per se rule and that the outcome depends upon an analysis of each particular operating agreement utilizing Professor Countryman’s definition of an executory contract. The court stated that this was the analysis that was employed by the court in the Garrison-Ashburn case and noted that the instant case was very similar to that case. The court discussed other cases in which courts have examined LLC agreements and noted the absence of a per se rule. Summing up the results in other cases, the court stated that when the court determines there are no unperformed obligations on the part of the parties, the operating agreement is not an executory contract. If, on the other hand, there are unperformed obligations of both the debtor and the other party, the court must determine whether, if not performed, non-performance would constitute a material breach excusing the other party from further performance. If so, the operating agreement is an executory contract. The court pointed out that the reported cases went no further; i.e., none of the cases, after determining that the operating agreement was an executory contract, took the next step of evaluating the applicability of Section 365(e)(2), which exempts certain executory contracts from the application of the ipso facto prohibition.

Bishop of Victoria Corporation Sole v. Corporate Business Park, LLC

__ P.3d __, Nos. 33579-4-II, 33909-9-II, 2007 WL 241079 (Wash. App. 2007).

The court of appeals concluded that an LLC member’s actions in connection with the LLC’s real estate venture did not breach the member’s fiduciary duty or contract in this case. Joseph Finley (“Finley”) and the Bishop of Victoria Corporation Sole (“BV”) formed a real estate development LLC. The members testified that Finley agreed to contribute his labor and expertise and BV agreed to contribute financially. There was no evidence that either party’s obligation to contribute was quantified, and the operating agreement did not specify a time in which Finley was required to sell the property. After the proceeds of the first financing and a refinancing of the property were exhausted, BV made the monthly mortgage payments for a time, but BV stopped making payments after a change in leadership of BV. The new leadership’s priority was the sale of the property and satisfaction of the debt even if it meant the LLC forfeited any profit. After BV stopped making the payments, the lender instituted foreclosure proceedings on the property. BV began exploring options to satisfy the foreclosure judgment, and eventually the property ended up being deeded to an entity that purchased the judgment and decree of foreclosure with the proceeds of debentures sold by BV. Finley sued BV and prevailed on breach of contract and breach of fiduciary duty claims, but the court of appeals reversed. Finley argued that BV breached its fiduciary duties when it defaulted on the mortgage and embarked on a cause of action adverse to Finley and the LLC. The court stated that an LLC may be manager-managed or member-managed under Washington law, and concluded that the LLC in this case was member-managed because the operating agreement specified that both BV and Finley were managers. The court stated that the fiduciary duties imposed in member-managed and manager-managed LLCs are the same in Washington. The court next noted that a member is obligated to perform a promise to contribute, and an obligation to contribute arises from the parties’ contractual agreement. Because the LLC operating agreement did not require a member to make additional contributions, the court concluded that BV did not breach any contractual obligation by ceasing to make mortgage payments and causing the LLC to default on the mortgage. Stating that the role of members in a member-managed LLC is analogous to that of partners in a general partnership, the court described the fiduciary duties of partners; however, the court concluded that a member’s obligation to contribute cannot be expanded beyond the members’ agreements by reference to a general fiduciary duty of loyalty. The court also rejected Finley’s arguments that various actions taken by BV to satisfy the foreclosure judgment breached its fiduciary duty. With respect to a settlement offer that would have released BV but not the LLC or Finley, the court relied upon the principle that a partner does not violate a duty or obligation merely because the partner’s conduct furthers its own interest. The court found that BV’s sale of debentures without informing Finley was not a material non-disclosure and did not provide a basis for breach of fiduciary duty, and the court also rejected Finley’s claim that the transfer of the property to the entity that purchased the judgment with the proceeds of the debentures was a breach of fiduciary duty. Finley fared no better on his breach of contract claims. The court rejected Finley’s arguments that BV breached its contractual duties to Finley by defaulting on the mortgage payment to the lender, desiring to liquidate the property, and developing an expectation that the property would sell quickly. Because the operating agreement did not state that BV was obligated to make payments for the LLC, and the trial court had ruled that parol evidence was inadmissible to alter the terms of the agreement, the court rejected Finley’s claim that BV breached a contractual duty by defaulting on the mortgage payment. When the new leadership of BV determined that it no longer wished to make payments on behalf of the LLC, it entered an addendum with Finley regarding the amounts it had advanced and stating that BV was not obligated to make further advances. The operating agreement provided that the LLC would be “engaged solely in the business of investing in, developing and marketing real property located in the State of Washington.” The agreement also contained a provision under which the members agreed that it was unreasonable for the parties to have or rely on an expectation not reflected in the agreement and that a member would immediately inform the managers and other members and seek an amendment of the agreement if a member developed an expectation contrary to or in addition to the contents of the agreement. The court stated that the desire not to make payments on behalf of the LLC may have been an expectation contrary to the contents of the operating agreement, but the amendment after the change in BV’s leadership complied with the operating agreement. The court concluded that BV’s desire to liquidate the property to satisfy the foreclosure judgment was reasonable and that BV did not develop an unreasonable expectation in violation of the operating agreement.

Oviedo v. Grace

No. B188018, 2007 WL 316519 (Cal. App. 2 Dist. Feb. 5, 2007).

Application of arbitration clause in LLC operating agreement to LLC derivative action notwithstanding LLC did not sign agreement.

Management VI Properties v. Greenberg-Gale

No. G036833, 2007 WL 264782 (Cal. App. 4 Dist. Jan. 31, 2007).

Inapplicability of attorneys’ fees provision of operating agreement to LLC’s successful slander of title action against member because LLC was not party to operating agreement.

Magten Asset Management Corporation v. Paul Hastings Janofsky & Walker

No. Civ.A.04-1256-JJF, 2007 WL 129003 (D. Del. Jan. 12, 2007).

Interpretation of Montana LLC derivative suit provisions.

Optowave Co., Ltd. v. Nikitin

No. 6:05-cv-1083-Orl-22DAB, 2007 WL 129009 (M.D. Fla. Jan. 13, 2007)

Personal liability of individual who signed for LLC as President/CEO without use of LLC designator in LLC name.

Allstate Insurance Company v. A & A Medical Transportation Services, Inc.

Nos. 260766, 261504, 2007 WL 162477 (Mich. App. Jan. 23, 2007).

LLC clinic’s entitlement to payment under no fault insurance statute notwithstanding alleged improper organization under general LLC provisions rather than professional LLC provisions of Michigan LLC statute.

In re Valley X-Ray Co. (Shapiro v. VPA, P.C.)

__ B.R.__, Civil No. 06-12463, 2007 WL 37755 (E.D. Mich. 2007)

Absence of basis to characterize 51% member and LLC as alter egos under principles of corporate veil piercing applicable to LLCs.

Yassky v. Meltzer, Lippe, Goldstein & Schlissel

__ N.Y.S.2d __, 2007 N.Y. Slip Op. 00049, 2007 WL 14629 (N.Y. A.D. 1 Dept. 2007)

Determination that failure to publish notice of LLC’s formation was not responsibility of attorney hired to represent LLC in eviction proceeding.

Wolf v. Summers-Wood, L.P.

__ S.W.3d __, No. 05-06-00377-CV, 2007 WL 259197 (Tex. App. 2007)

Application of fiduciary shield doctrine to preclude exercise of jurisdiction over non-resident officers of LLC; insufficiency of evidence to pierce LLC veil for personal jurisdiction purposes.