March 2009 — Issue 37

American Electric Power Company v. Affiliated FM Insurance Company

556 F.3d 282 (5th Cir. 2009)

In this case, the court held that an insurance policy that covered “any subsidiary corporation now existing or hereafter acquired” was unambiguous and did not include LLCs. American Electric Power Company (“AEP”) sued its insurer after it discovered losses that occurred in 1999 due to employee theft at two LLC subsidiaries of Central & Southwest Corporation (“CSW”), a conglomerate acquired by AEP in 2000. AEP claimed that the losses were covered under the prior loss clause of its policy with Affiliated FM Insurance Company (“Affiliated”). The Affiliated policy was amended to include CSW and its subsidiaries in 2000 when AEP acquired CSW, and the prior loss clause provided coverage for earlier losses if those losses would have been covered under an insurance policy in existence at the time of the loss. At the time of the theft, CSW was covered by a policy issued by Chubb Insurance Group (the “Chubb policy”), which expressly covered CSW and “any subsidiary corporation now existing or hereafter acquired.” The court applied Louisiana contract interpretation principles but noted that the outcome would remain the same under Texas law. The court concluded that the district court did not err in finding that the term “corporation” was unambiguous and excluding parole evidence. The court rejected AEP’s argument that the common understanding of “corporation” extends to unincorporated entities like LLCs. The LLCs in issue were Oklahoma LLCs, and the court cited Oklahoma law defining an LLC as “an unincorporated association or proprietorship.” The court also cited the Louisiana LLC statute, which provides that “[n]o limited liability company organized under this Chapter shall be deemed, described as, or referred to as an incorporated entity, corporation, body corporate, [etc.].” AEP pointed to numerous judicial and legal references to “limited liability corporations,” but the court stated that these were merely imprecise references that did not alter the fundamental distinction between the two types of entities. The court found nothing “absurd” in interpreting the term “corporation” to cover a particular type of subsidiary and not others. AEP also argued that the district court should have reformed the Chubb policy to include LLCs. Although AEP filed affidavits from both Chubb and CSW stating that LLCs were intended to be covered under the general heading of “corporation” in the Chubb policy, the court found that the district court did not err in refusing to reform the policy because Affiliated assumed the coverage obligations under the unambiguous terms of the Chubb policy and there was no indication that Affiliated knew or should have known of any understanding between Chubb and CSW regarding the meaning of the term “corporation.” Further, the court stated that use of the term “corporation” was not the type of clerical error that reformation is intended to remedy, and the court characterized AEP’s argument for reformation as an attempt to make an end-run around the parol evidence rule.

State Capital Title & Abstract Company v. Pappas Business Services, LLC

Civil Action No. 3:08-cv-3619-FLW, 2009 WL 114160 (D.N.J. Jan. 15, 2009)

The plaintiff sought to pierce the veil of a closely-held LLC and hold Gary and Mary Pappas, who were members and the sole officers of the LLC, liable for the LLC’s alleged fraudulent breach of contract. The defendants moved to dismiss the veil piercing claim, arguing that their LLC was no different than any other closely held LLC and that the plaintiff’s theory threatened to undo the presumption of limited liability afforded to shareholders and officers of a corporate entity. The court agreed with the defendants and dismissed the veil piercing claim. The court noted that the corporate veil applies with equal force to an LLC and applied corporate veil piercing principles. Taking the allegations as true, Gary and Mary Pappas, through their LLC, fraudulently induced the plaintiff to enter into a contractual relationship. The court concluded that, even assuming the members’ conduct was of the type sufficient to justify piercing the corporate veil, the plaintiff failed to allege any of the following factors: undercapitalization, siphoning of funds, or disregard of corporate structure and record keeping. Neither defendant was alleged to have so dominated the corporate structure as to render the corporate structure a sham. The court stated that it appeared that the LLC was “an example of a small, closely held corporation that is comprised of less than five members, not a sham corporate entity set up to defraud individuals and businesses and evade personal liability” and that the court “is not obligated to pierce the corporate veil of a corporation that is comprised of only one shareholder or member because, quite obviously, that one member must dominate the corporate entity if the business is to function and be profitable.” The court characterized veil piercing as an extraordinary exception to the principle of limited liability of shareholders and members of a corporate entity and stated that, under the plaintiff’s logic, the members of a small, closely held corporation would be individually liable in any instance where they are accused of a fraudulent breach of contract.

Ruffing v. Masterbuilt Tool & Die, LLC

No. 1:09-CV-01264, 2009 WL 185950 (N.D. Ohio Jan. 23, 2009)

An employee of an LLC sought to pierce the veil and hold a parent corporation and sister LLC liable for breach of the employment contract and related claims. The defendants argued that it was never appropriate to pierce an Ohio LLC and that, even if an LLC can be pierced, it is never appropriate to impute liability from one sister corporation to another. The court rejected the argument that an LLC is immune from the general law of corporate veil piercing and also rejected the contention that piercing is always inappropriate between sister corporations. The parties agreed that Ohio law governed the plaintiff’s veil piercing claim, and the court applied Ohio corporate veil piercing principles. The court pointed out that the Ohio LLC statute, on which the defendants relied for their argument that piercing does not apply to LLCs, provides that members and managers of an LLC are not personally liable for the debts of the LLC solely by reason of being a member or manager. That is, the statute does not state that no one other than the LLC can be held liable for the LLC’s debts, but merely provides that members and managers are not personally liable because they happen to be members or managers. The court stated that many courts have applied corporate veil piercing to LLCs and that the defendants did not cite “a single case that has ever differentiated an LLC from a corporation for purposes of veil piercing.” The court found “no reason to believe that Ohio would reach a unique result.” The court analyzed each prong of Ohio’s three-prong corporate veil piercing test and concluded that the plaintiff’s pleadings were sufficient as to each prong. With respect to the first prong, that the shareholders or another legal entity exercised such complete control that the corporation had no separate mind, will, or existence of its own, the court commented that it will only be in rare and extreme cases that one sister corporation can truly control another; however, the plaintiff had alleged sufficient facts to proceed to discovery. The defendants did not contest that the plaintiff had sufficiently pled the second and third prongs, i.e., that their control was used to commit fraud, an illegal act, or a similarly unlawful result, and that the plaintiff suffered injury or unjust loss as a result of the control and wrong. The court made a point of stating that the plaintiff’s pleadings were sufficient to satisfy these requirements based on specific allegations that the plaintiff was always paid by the sister LLC rather than the LLC with whom he contracted, that the LLC with whom he contracted was not “real,” and that various aspects of the contract appeared to be fraudulent to the extent the LLC with whom the plaintiff contracted had no assets, liabilities, products, or employees other than the plaintiff.

Ficus Investments, Inc. v. Private Capital Management, LLC

61 A.D.3d 1, 872 N.Y.S.2d 93 (N.Y. App. 1st Dept 2009).

The operating agreement of a Florida LLC contained an advancement of expenses provision that required the LLC to advance funds to pay for or reimburse expenses of a member, manager, or officer if such person delivered a written affirmation of the person’s good faith belief that his or her conduct did not constitute certain types of wrongdoing that were not indemnifiable and a written undertaking to repay any advances if it was ultimately determined that the person was not entitled to indemnification. The indemnification provision of the operating agreement relieved the LLC of the obligation to indemnify a member, manager, or officer who "is adjudged liable to the Company or is subjected to injunctive relief in favor of the Company" for intentional misconduct or a knowing violation of law or for any transaction for which the individual received an unauthorized personal benefit. The action arose out of allegations that the LLC’s CEO and other named defendants misappropriated millions of dollars in funds and assets of the LLC. During the course of the proceeding, the CEO sought reimbursement and advancement of his litigation fees and expenses. The trial court had already issued multiple temporary restraining orders and preliminary injunctions against the CEO, and the plaintiffs argued that the issue of advancement was academic if he would not be entitled to indemnification. The appellate court relied upon Delaware case law and concluded that the provision referring to injunctive relief pertained solely to indemnification and was separate and distinct from the advancement provision. Advancement was contingent only upon the submission of a written affirmation that he or she had not engaged in the specified misconduct and an undertaking to repay any funds disbursed. Two other individuals whose status as “officers” the plaintiffs contested, but who had been held out as officers of the LLC, were also entitled to advancement according to the court.

Remora Investments, L.L.C. v. Orr

673 S.E.2d 845 (Va. 2009)

Remora Investments, L.L.C. (“Remora”), a 50% member of a Virginia LLC, sued the other 50% member, who was also the manager, for breach of fiduciary duty. The trial court held that an LLC manager does not owe the members fiduciary duties and that an LLC member does not have a direct right of action against another member or manager for breach of fiduciary duty. Remora appealed, arguing that it had standing to sue the managing member for breach of fiduciary duty. The Virginia Supreme Court agreed with the trial court based on the Virginia LLC statute and analogous corporate law. The supreme court pointed out that it has analogized LLCs and managers to corporations and directors in previous cases and that the Virginia LLC statute contains provisions setting forth standards of conduct for LLC managers in terms almost identical to provisions regarding directors in the Virginia corporate statute. The Virginia LLC statute requires an LLC manager to discharge the manager’s duties in accordance with the manager’s good faith business judgment, and the corporate statute requires a director to discharge his duties in accordance with the director’s good faith business judgment. The LLC and corporate statutes do not purport to impose duties between members of an LLC, between members and managers of an LLC, between shareholders of a corporation, or between individual shareholders and officers and directors. In contrast, the court pointed out, the Virginia general partnership statute provides that a partner owes the partnership and the other partners the duties of loyalty and care. The court agreed with the trial court that an LLC member does not have standing to bring a breach of fiduciary duty claim directly against another member or manager because the General Assembly would have explicitly provided for such fiduciary duties, as it had done in the partnership context, if it had intended to impose such duties. Remora argued that LLC managers owe members fiduciary duties by analogous application of corporate case law, but the court rejected this argument. The court stated that its holdings in the cases relied upon by Remora did not support Remora’s contention that the court had approved direct causes of action by individual shareholders against directors. Remora also relied upon the Delaware case of Tooley v. Donaldson, Lufkin, & Jenrette, Inc. in support of Remora’s argument that its claim was direct rather than derivative, but the court did not decide whether to adopt the analysis employed by the Delaware Supreme Court in Tooley because the court concluded that all the injuries alleged by Remora were injuries to the LLC even if it followed the approach employed in Tooley. The court concluded by pointing out that the LLC’s operating agreement set forth numerous rights, powers, and duties of managers, but did not establish fiduciary duties between members or between a member and a manager. The court noted that such provisions can be included in an LLC operating agreement just as a corporation and its shareholders are free to vary the commercial rules by contract in the corporate context.

Kwok v. Transnation Title Insurance Company

170 CalApp.4th 1562, 89 Cal.Rptr.3d 141 (Cal. App. 2 Dist. 2009)

(termination of title policy upon transfer of LLC property to members as trustee of family trust).

Stuart v. Stuart

962 A.2d 842 (Conn. App. 2009)

(statutory liability protection of LLC members and managers in absence of veil piercing allegations).

Connors v. Howe Elegant, LLC

47 Conn. L. Rptr. 107, 2009 WL 242324 (Conn. Super. 2009)

(fiduciary duties pending dissolution and propriety of members’ preparations to compete; standard for judicial dissolution).

In re Louis J. Pearlman Enterprises, Inc. (Kapila v. Deutsche Bank A.G.)

398 B.R. 59 (M.D. Fla. 2008)

(ineffectiveness of transfer of LLC interest in absence of compliance with operating agreement; rights of debtor members as property of bankruptcy estates).

Leblanc v. Capital Fulfillment Group, Inc.

No. WOCV200700177, 2008 WL 5505490 (Mass. Super. Dec. 10, 2008)

(sufficiency of pleadings to support liability under veil piercing principles).

Gottlieb v. Northriver Trading Company LLC

872 N.Y.S.2d 46 (N.Y. App. Div. 1st Dept. 2009)

(non-exclusivity of statutory remedies and availability of accounting to LLC member).

Securities and Exchange Commission v. Byers

No. 08 Civ. 7104(DC), 2009 WL 212928 (S.D.N.Y. Jan. 30, 2009)

(inability of investors to exercise rights under operating agreement to replace federal receiver as manager).

Fuiaxis v. 111 Huron Street, LLC

872 N.Y.S.2d 184 (N.Y. App. Div. 2d Dept. 2009)

(enforcement of capital call provision against member seeking judicial dissolution in order to fund LLC’s defense to dissolution action).

Haire v. Bonnelli

870 N.Y.S.2d 591 (N.Y. App. Div. 3d Dept. 2008)

(potential liability of officers and members for participation in tort in furtherance of business).

Law Offices of Squire & Pierre-Louis, LLC v. Fahey Bank

No. 08AP-647, 2009 WL 311441 (Ohio App. Feb. 10, 2009)

(actual and apparent authority to execute guaranty on behalf of LLC).