November 2006 — Issue 10

In re Weddle (Elsaesser v.Cougar Crest Lodge, LLC)

__ B.R. __, Bankruptcy No. 05-21089-TLM, Adversary No. 06-7015-TLM, 2006 WL 2848042 (Bankr. D. Idaho 2006).

The plaintiff in this adversarial proceeding alleged that the defendant LLC received a preferential transfer when it recorded judgments it recovered against the debtors and obtained a lien on the debtors’ real property. The debtors were members of the transferee LLC, each holding a 5% interest in the LLC. The only other member (Manning) was the father of Terri Weddle, one of the debtors. The LLC operated a lodge, and the debtors were employees of the LLC and managed the daily operations until their employment was terminated by Manning, who was designated in the operating agreement and articles of organizations as the sole manager of the LLC. The LLC obtained a judgment on a note executed by the debtors and a separate judgment for fees and costs. The LLC recorded the judgments, and the debtors filed bankruptcy several months later. Since the judgments were recorded more than 90 days prior to the bankruptcy petition, the plaintiff had to prove the LLC was an insider to prevail on the preference claim. The court rejected the plaintiff’s claim that the debtors were statutory insiders as defined under Section 101(31)(A) of the Bankruptcy Code because the definition does not specifically address membership, management, or control of an LLC; the definition only mentions an individual’s relationship to a partnership or corporation. The plaintiff argued in the alternative that the LLC was an insider on the basis that the LLC and Manning were alter egos. Since Manning was the father of Terri Weddle and was a per se insider, the plaintiff argued that the LLC, as Manning’s alter ego, was an insider. The court concluded that Idaho courts would apply corporate veil piercing principles to LLCs, but the court granted the LLC summary judgment on this claim. The court concluded that the plaintiff’s slim showing of unity of interest, which was based on Manning’s alleged operation of the LLC without regard to formalities, might be sufficient to raise a disputed issue of material fact, although the court pointed out that the type of total control exercised by Manning was allowed by law. The court granted summary judgment for the LLC, however, because the plaintiff provided no support for the allegation that failure to treat Manning and the LLC as alter egos would lead to inequitable results. The fact that general unsecured creditors would receive a smaller distribution was insufficient to support this prong of the alter ego analysis. Finally, the court rejected the plaintiff’s argument that the LLC was a non-statutory insider. The court found no indication that the LLC exercised any control or influence over the debtors at the time of the transfers in question.

Puleo v. Topel

__ N.E.2d __, No. 1-05-0367, 2006 WL 2796456 (Ill. App. 2006).

The plaintiffs sought to hold the sole member and manager of an LLC personally liable for a debt incurred by the LLC after the LLC was involuntarily dissolved and before it was reinstated. The plaintiffs argued that the managing member should be liable just as an officer or director of an Illinois corporation would be liable for a debt incurred by a dissolved corporation. The court examined the provisions of the Illinois LLC statute and found that they differed from the corporate statute. The court pointed out that the LLC statute expressly provides that a member or manager is not liable for debts of the LLC unless the articles of organization provide for personal liability and the member has consented in writing to the provision. Additionally, the LLC statute only addresses liability to the LLC for unauthorized acts during winding up and does not contain a provision like that in the corporate statute which imposes liability on a person who assumes to exercise corporate powers without authority. Finally, the court found it significant that the legislature removed from the LLC statute a provision that provided for personal liability of members and managers to the extent a shareholder or director in an Illinois corporation would be personally liable under analogous circumstances.

DIRECTV Group, Inc. v. Darlene Investments, LLC

No. 05 CIV. 5819(WHP), 2006 WL 2773024 (S.D. N.Y. Sept. 27, 2006).

The two members of an LLC which filed Chapter 11 bankruptcy executed a mutual release and covenant not to sue as part of the LLC’s reorganization. One of the members asserted a claim for fraudulent inducement of the mutual release. Applying New York law as specified in the choice of law provision of the mutual release, the court held that the mutual release barred the fraudulent inducement claim. The member argued in the alternative that its fraudulent inducement claim was actionable based on the other member’s breach of a fiduciary duty arising from the parties’ amended LLC agreement. The court found, however, that a second amended LLC agreement executed at the time of the mutual release eliminated fiduciary duties. The court stated that the second amended LLC agreement omitted the fiduciary duty provision contained in the amended LLC agreement and that the mutual release and second amended LLC agreement superseded all previous agreements. The court applied Delaware law to the interpretation of the LLC agreement pursuant to the choice of law clause in the second amended LLC agreement. Citing Delaware case law, the court stated that “[c]ontracting parties are free to eliminate fiduciary duties in a limited liability company agreement” and that LLC members “can be virtually certain” that their agreements will be enforced in accordance with their terms. The court went on to state that, even if a fiduciary relationship could be established, it would not be a means to avoid the preclusive impact of the mutual release because a party that releases a fraud claim may not subsequently assert that its fraudulent inducement claim is actionable based on an independent duty to disclose fraud.

In re Midpoint Development, L.L.C. (Holliman v. Midpoint Development, L.L.C.)

466 F.3d 1201, No. 05-6046 (10th Cir. 2006).

The court dismissed the bankruptcy of an Oklahoma LLC because the LLC filed articles of dissolution prior to the bankruptcy filing and ceased to exist under Oklahoma law when the articles of dissolution were filed. On November 14, 2003, the LLC’s sole member executed and filed articles of dissolution with an effective date of November 14, 2003. On the same day, the member filed a petition for appointment of a receiver to complete the winding up of the LLC’s affairs. On June 22, 2004, the LLC filed a petition for bankruptcy relief. Two creditors filed a motion to dismiss the bankruptcy on the basis that the debtor no longer existed and was ineligible to be a debtor. The bankruptcy court determined that the LLC was empowered to wind up its affairs after dissolution, including filing bankruptcy. The district court determined that the LLC ceased to exist on the effective date of its articles of dissolution and reversed the bankruptcy court’s order. The court of appeals analyzed the relevant provisions of the Oklahoma LLC statute at length and affirmed the district court’s dismissal of the bankruptcy on the basis that the LLC ceased to exist on the effective date of its articles of dissolution. The court relied upon provisions of the Oklahoma LLC Act specifying that the LLC comes into existence when the articles of organization are filed and that the articles of organization are canceled upon the filing of articles of dissolution. The court also noted that a subsequent amendment to the statute clarifies that the existence of an LLC continues until cancellation of the articles of organization. The court also examined other provisions of the statute and found that, read together, they indicated that dissolution and the winding up period should precede the effective date of the articles of dissolution. The court stated that the LLC should have wound up its affairs prior to filing articles of dissolution or should have specified an effective date in the future if it desired to have a significant period of time to wind up, including filing for bankruptcy.

D’Elia v. Rice Development, Inc.

__ P.3d __, No. 20050247-CA, 2006 WL 2934091 (Utah App. 2006).

A limited partner sued the corporate and LLC general partners of two limited partnerships and sought to hold the individual owner of the entities personally liable for breaches of fiduciary duty of the general partners. The court first addressed the argument that the individual owner of the corporation and LLC was liable for the entities’ actions under the alter ego theory. The court noted that California veil piercing principles applied to the corporation and Utah veil piercing principles applied to the LLC based on the conflict of laws rule that the law of the state of formation governs the liability of the owners of the entity. The court stated, however, that the law of the two states differed little in this area and presented no need to bifurcate the analysis. The court concluded that it was appropriate for the trial court to consider the fact that the plaintiff voluntarily contracted with the entities and noted that courts are more reluctant to pierce the veil in such cases. The court affirmed the trial court’s determination that the evidence did not support piercing the veil of the entities because the plaintiff encouraged many of the informal and lax practices that the plaintiff claimed justified piercing the veils. While there was evidence of certain clearly inappropriate actions, such as failing to account for missing monies, overcharging for work performed by the LLC, and misuse of certain funds, the court agreed with the trial court that such wrongs were more appropriately remedied as breaches of fiduciary duty. The court went on to conclude that the LLC’s member participated in the activities that were a breach of fiduciary duty on the part of the LLC and that the member could be held personally liable on the basis of such participation. Though the Utah LLC statute states that members and managers do not have personal liability for the debts and liabilities of the LLC, the plaintiff relied upon Utah case law holding that an officer or director of a corporation may be held personally liable for participating in wrongful activity of the corporation. The court noted that several state courts have imposed personal liability on LLC members or managers on the basis that the LLC statutes expressly provided for liability where the member or manager participates in the LLC’s tortious conduct. Utah’s statute is silent in such respect, but the court was persuaded by case law in other states in which LLC statutes are similarly silent and the courts nevertheless concluded that LLC members or managers can be personally liable for participating in torts of the LLC under the same principles that apply to corporate officers who participate in tortious conduct. Because the LLC’s member exercised total control over the LLC and participated in the LLC’s breaches of fiduciary duty and acts of constructive fraud, the member was personally liable for the breaches of duty and acts of constructive fraud.

Systrends, Inc. v. Group 8760, LLC

__ So.2d __, Nos. 1041548, 1041795, 1041569, and 1050058, 2006 WL 2925323 (Ala. 2006).

Discussion of statutory duties of LLC members and managers and common law duties of LLC agents.

Goldberg v. Winogradow

No. CV000093186S, 2006 WL 3041979 (Conn. Super. Oct. 12, 2006).

Charging order.

Citrin v. International Airport Centers LLC

C.A. No. 2005-N, 2006 WL 2576977 (Del. Ch. Sept. 7, 2006).

Mandatory advancement provisions of LLC operating agreement.

In re Teknek, LLC (Levey v. Hamilton)

__ B.R. __, Bankruptcy No. 05 B 27545, Adversary No. 06 A 00412, 2006 WL 2959506 (Bankr. N.D. Ill. 2006).

Exercise of personal jurisdiction over foreign members of Illinois LLC; LLC veil piercing; breach of fiduciary duty; wrongful distributions.

Troutwine Estates Development Company, LLC v. Comsub Design and Engineering, Inc.

854 N.E.2d 890, No. 45A05-0509-CV-562 (Ind. App. 2006).

LLC veil piercing.

Waun v. Universal Coin Laundry Machine, LLC

No. 267954, 2006 WL 2742007 (Mich. App. Sept 26, 2006).

Personal liability of LLC members with respect to tortious acts committed in capacity as LLC agent.

Cognex Corporation v. VCode Holdings, Inc.

Civ. No. 06-1040 (JNE/JJG), 2006 WL 3043129 (D. Minn. Oct. 24, 2006).

LLC veil piercing.

Quebecor World (USA), Inc. v. Harsha Associates, L.L.C.

__ F.Supp.2d __, No. 06-CV-6002L, 2006 WL 2918797 (W.D. N.Y. 2006).

Limited liability of member notwithstanding variance in name of LLC in contract; LLC veil piercing; successor liability.

In re Orchard at Hansen Park, LLC

347 B.R. 822, No. 06-32016 HDH-11 (Bankr. N.D. Tex. 2006)

Creditor’s standing as “party in interest” to challenge bankruptcy of LLC; dismissal of bankruptcy filed without consent of all members as required under Washington law and operating agreement.