November 2007 — Issue 21

United States v. Lu

No. 06-16438, 2007 WL 2753030 (9th Cir. (Ariz.) Sept. 20, 2007).

The court held that single member LLCs are not protected by the Fifth Amendment privilege against self-incrimination and that the district court properly denied a member’s motion to quash a subpoena ordering production of business records of her single member LLCs. Though the Fifth Amendment privilege is available to sole proprietorships, it is not available to collective entities because they are separate legal entities from their owners. The Supreme Court left open in Braswell v. U.S. whether Fifth Amendment protection applies to production of business records when a corporation, which would generally be a collective entity, has only a single employee who also serves as the sole officer. The sole owner of the LLCs in this case argued that the LLCs were not collective units because she was the sole owner and operator and there were no employees. She attempted to bolster the argument that her single member LLCs were analogous to sole proprietorships by noting that she was subject to tax as an individual. The court stated that the single member LLCs were hybrids of both corporations and sole proprietorships, but the crucial distinction was that the individual member was acting in a representative capacity. The state law requirement that an LLC have a statutory agent indicates an agency relationship. The court pointed out that the member served as statutory agent and was free to add other members, which would implicate other aspects of collective entities. The court stated that the member intentionally took advantage of corporate characteristics of the LLC structure to obtain asset-protection benefits, and the business documents were not personal to her because she clearly intended the business to be separate in the event of a lawsuit. Having chosen to organize her businesses as LLCs and obtain the benefits, the member was not free to disregard the creation of separate entities to obtain Fifth Amendment protection for the LLCs’ records. The member argued that production of the subpoenaed documents would incriminate her because she was the sole owner and employee and the jury would reasonably conclude she created the documents. The Supreme Court left open the possibility of Fifth Amendment protection in such a situation in Braswell, but the court said the jury in this case could reasonably conclude other persons produced the business documents because it appeared highly unlikely a person could own and operate multiple massage parlors without employees.

Rudney v. International Offshore Services, LLC

Civil Action No. 07-3908, 2007 WL 2900230 (E.D. La. Oct. 1, 2007).

An LLC member sued for a TRO or preliminary injunction, pending arbitration, against the LLC’s expulsion and buyout of the member and the LLC’s obtaining a loan to fund disproportionate distributions to the majority member. The other members had signed a consent to obtain the loan for the disproportionate distributions and had voted to expel the member after previously amending the operating agreement to add a provision providing for termination of a member upon the vote of 75% in interest of the members and specifying a method of valuing a terminated member’s interest. The court noted provisions of the Louisiana LLC statute protecting members and managers from liability unless they act in a grossly negligent manner, providing for distributions to be allocated in accordance with a written operating agreement, providing that incurrence of indebtedness other than in the ordinary course of business requires the vote of a majority of the members, and providing that amendment of the operating agreement requires the vote of a majority of the members. The Louisiana statute is silent, however, on terminations or expulsions of members. The court concluded that the member was not likely to prevail on the argument that the LLC could not take out a loan since the operating agreement in this case specifically provided that management had the power to incur indebtedness, and there was no evidence that the loan itself would be a breach of duty. The plaintiff, however, was substantially likely to prevail on the merits of his claim challenging disproportionate distributions because the operating agreement provided for proportionate distributions. In the event of a disproportionate distribution, the court ordered that the LLC must set aside ten percent to protect the plaintiff’s interest. The court stated that the LLC was free to make proportionate distributions and otherwise carry on its affairs; it was merely enjoined from making distributions prohibited by the agreement. The court stated that it did not find that distributing funds that would act as debits to capital accounts may not be deemed necessary pursuant to the good faith business judgment of the managers. With respect to the plaintiff’s argument that Louisiana law does not permit expulsions or terminations of members, the court acknowledged that Louisiana law does not address expulsions or terminations, but noted that courts have upheld expulsion or termination clauses in operating agreements. In this case, an amendment to the operating agreement was passed in accordance with the agreement and Louisiana law. Though members are limited by their obligation to discharge their fiduciary duties in good faith, the plaintiff did not meet his burden of demonstrating that he was substantially likely to succeed on this breach of duty claim. Additionally, the member did not meet his burden of showing that the other members breached their fiduciary duty by undervaluing his interest.

Anderson v. Wilder

No. E2006–2647-COA-R3-CV, 2007 WL 2700068 (Tenn. Ct. App. Sept. 17, 2007).

The plaintiffs were expelled as members of an LLC and bought out at $150 per unit, and the defendants shortly thereafter sold the units to a third party for $250 per unit. The plaintiffs sued alleging, inter alia, breach of fiduciary duty and breach of the duty of good faith. The plaintiffs prevailed at trial, and the defendants appealed. The court stated that the defendants’ arguments primarily rested on their belief that a prior opinion of the court of appeals in this case was incorrect in determining that the majority member of an LLC owes a fiduciary obligation to a minority member and that each LLC member is obligated to discharge his or her duty in good faith. The court reviewed the testimony of various members regarding differences in opinion that developed between the majority and minority as to whether cash should be distributed and how to handle various offers for the sale of the company or interests in the company. The evidence also included testimony from an attorney who reviewed the operating agreement and advised the majority that they could expel the minority members under the terms of the operating agreement which provided that a member could be expelled by a majority vote of the members. The court found that the evidence supported the jury’s verdict in favor of the plaintiffs against the defendants who voted their interests to expel the plaintiffs. The court stated that the trial court did not err in refusing to submit the following instruction requested by the defendants: “If you find that the understanding of the parties to the Operating Agreement was that the members who hold a majority of the units could expel any other member, or members, with or without cause, then you must find in favor of the Defendants.” The defendants argued that this instruction tracked the Tennessee statute on modification of standards of conduct in the operating agreement (which states that the operating agreement may define the standard of conduct in a manner to reflect the understanding of the parties provided such definition is not manifestly unreasonable). The court stated that the instruction did not track the statute and was an attempt to circumvent its prior holding regarding fiduciary duties and good faith.

White Family Harmony Investment, Ltd. v. Transwestern West Valley, LLC

No. 2:05CV495DAK, 2007 WL 2821798 (D. Utah Sept. 27, 2007).

An LLC lessee was liable to the plaintiff lessor for unpaid rent and other payments due under the lease, and the plaintiff, relying on the alter ego doctrine, sought to pierce the veil of the LLC under Utah law and hold liable its parent LLC and a commonly owned LLC that held fee title to the property. The defendants filed a motion for summary judgment, and the plaintiff filed a cross-motion for summary judgment against the parent. The court stated that Utah law required proof of two elements to succeed on an alter ego claim: (1) that there is such unity of interest and ownership between the entities that the separate personalities of the different entities no longer exist (referred to by the court as the “formalities element”), and (2) that the observance of the corporate form would sanction a fraud, promote injustice, and cause an inequitable result (referred to by the court as the “fairness element”). The court discussed each of these elements and the summary judgment evidence and concluded that the plaintiff had established both elements as a matter of law with regard to the parent and was entitled to summary judgment on its alter ego claim against the parent. The LLC that owned fee title to the property was not entitled to summary judgment because the plaintiff demonstrated that it shared a unity of interest with the LLC lessee and parent and played a role in the injustice to the plaintiff. The court discussed the formalities element at length. The court first pointed to the fact that the parent was the sole member of the LLC and that the two entities had the same managers. Further, there was a substantial overlap in the individuals who participated in the two entities and other related entities that participated in the management of the LLC. The LLC was initially capitalized by its parent not with cash, but entirely with the leasehold, and all available excess cash was distributed to the parent without regard to requirements contained in the lease or prospective liabilities in connection with the lease. Eventually the LLC began to incur operating losses which the parent covered until the LLC ceased making rent payments. The court concluded that this state of affairs constituted a state of “gross undercapitalization” as defined by Utah law. The parent argued that the fact that the parent made contributions to the LLC to enable it to cover the lease payments when it began operating at a loss was evidence that the parent acted properly, but the court stated that this was evidence that it was the alter ego of the LLC because payment of a subsidiary’s expenses by a parent is a relevant factor in the alter ego analysis. The court also pointed out that the parent paid hundreds of thousands of dollars to a related entity that served as asset manager for the parent and its subsidiaries, including the LLC lessee. The asset manager, as agent of the parent, controlled every aspect of the LLC’s business and ensured that the LLC hired only affiliates, including an affiliate that acted as property manager for the leasehold. The court also attached significance to the fact that the parent generated consolidated financial statements and as a consequence reflected the LLC’s property as its own. The court noted that the LLC had never filed a tax return and did not have its own tax identification number. The court described various other transactions and accounting practices and observed that the LLC did not have the appearance of an independent personality. Additional concerns raised by the court were the LLC’s failure to maintain its registration with the state of Utah and failure to follow corporate formalities. The leasehold was assigned to the LLC prior to its registration with the state, and the LLC at one point allowed its registration to expire, leaving the impression that its managers were unconcerned with formalities. The court stated that the LLC failed to comply with basic record keeping requirements and demonstrated a failure to follow corporate formalities. The LLC’s managers failed to hold any meetings and could produce only two unanimous consents when asked to produce all meeting minutes, resolutions, annual reports, and corporate filings. Decisions to make distributions, execute lease agreements with subtenants, stop making lease payments, and surrender the leasehold were not documented. Another indicator of “unity of interest and ownership” was the fact that the property manager repeatedly confused the LLC with its affiliate that owned fee title to the property. The defendants relied heavily on public policy arguments favoring the liability protection afforded by corporations and LLCs, but the court concluded that such public policy does not trump other public concerns and that the evidence overwhelmingly satisfied the plaintiff’s burden as to the formalities element of its alter ego claim. The court then examined the fairness element and noted that the plaintiff need not show actual fraud, only that a failure to pierce would result in injustice. The court found that the plaintiff satisfied its burden on the fairness element with respect to the parent because it not only played a role in the LLC’s breach of the lease, but was the primary cause of the breach and the party responsible for the LLC’s inability to make the plaintiff whole. The parent decided that the LLC would cease making its lease payments and received the LLC’s cash reserves and kept it undercapitalized. The court concluded that the related LLC that owned fee title to the property was not entitled to summary judgment because it also played a role in the unfairness.

NII-JII Entertainment, LLC v. Troha

No. 2006AP2204, 2007 WL 1695176 (Wis. App. June 13, 2007).

An individual who was a direct and indirect owner of a member of an LLC formed for the purpose of developing a casino for the Menominee Indian Tribe allegedly secretly made a deal with the Tribe to develop the casino independently of the LLC. The court concluded that the individual was not bound by a non-competition provision in the LLC’s operating agreement because the individual did not execute the operating agreement. Noting that the Wisconsin LLC statute calls for common law corporate veil piercing principles to apply to LLCs, the court stated that no allegations supported piercing the veil to disregard the separate existence of the two LLCs that were direct and indirect owners of the LLC. The allegations did not support the claim that the entities were acting as an agent of the individual because the complaint did not allege conduct by the principal that gave the agent reason to believe it was authorized to act on the principal’s behalf or that gave a third person reason to believe the agent was so authorized. The allegations did not support a claim that the individual was bound as a successor of the dissolved LLCs that were the direct and indirect owners of the LLC because the allegations did not establish that the membership interest in the LLC was distributed to the individual. Since the individual was not bound by the operating agreement, the claims for breach of contract and breach of the implied duty of good faith and fair dealing failed.

Burnett v. Rowzee

No. SACV07641DOCANX, 2007 WL 2809769 (C.D. Cal. Sept. 26, 2007).

LLC interests as securities under federal securities law.

Roz Trading Ltd. v. Zeromax Group, Inc.

__ F.Supp.2d __, 2007 WL 2812760, Civil Action No. 06-1040 (CKK) (D. D.C. 2007).

Lack of personal jurisdiction over dissolved Delaware LLC because winding up did not amount to “doing business” or continuing presence in D.C.

In the Matter of Strug-Division, LLC

375 B.R. 445, Bankruptcy No. 07 B 09165, Adversary No. 07 B 09166 (Bankr. N.D. Ill. 2007).

Dismissal of bad faith bankruptcies of single member, single purpose, single asset LLCs that were sole members of single asset real estate LLCs based on infeasibility of reorganization plans calling for sale of property of non-debtor LLCs.

Sudamax Industria E Comercio De Cigarros, Ltda v.Buttes & Ashes, Inc.

__ F.Supp.2d __, 2007 WL 2812915, Civil Action No. 1:05CV-60-M (WD. Ky. 2007).

Limited liability of LLC president contracting for disclosed principal; insufficiency of evidence to support piercing LLC veil under corporate veil piercing principles where LLC maintained formalities and fraud or injustice was not shown.

Miller v. Ross

841 N.Y.S.2d 586, 2007 N.Y. Slip Op. 06803 (N.Y. A.D. 1 Dept. Sept. 20, 2007).

Application of New York rather than Delaware law in suit seeking to unwind conversion of New York limited partnership into Delaware LLC; ineffectiveness of conversion where sole owner of entire class of ownership interest voted against conversion.

Multiquest, P.L.L.C. v. Allstate Insurance Company

__ N.Y.S.2d __, 2007 N.Y. Slip Op. 27366, 2007 WL 2682879 (N.Y. Sup. App. Term 2007).

Ineligibility of psychological services PLLC for reimbursement under New York insurance law based on failure to meet requirements of New York LLC statute by inaccurately identifying psychologist as member and manager.

Siva v. 1138 LLC

No. 06AP-959, 2007 WL 2634007 (Ohio App. Sept. 11, 2007).

Failure to preserve argument that legislature did not intend for corporate veil piercing principles to apply to LLCs; insufficiency of evidence to justify piercing LLC veil under corporate veil piercing principles.

In re Wheland Foundry, LLC (Reese v. Livingston Company)

Bankruptcy No. 06-10904, Adversary No. 07-1044, 2007 WL 2934869 (Bankr. E.D. Tenn. Oct. 5, 2007).

Members’ inability to bring breach of fiduciary duty, usurpation of company opportunity, and fraud claims directly under Georgia law where special injury lacking; inapplicability of exception allowing direct actions in context of close corporation or small LLC under Georgia law where LLC has unpaid creditors; sufficiency of allegations of special injury in connection with misrepresentation and tortious interference claims.

Wierbicki v. Advatech, LLC

No. 1:06-CV-269, 2007 WL 2725944 (E.D. Tenn. Sept. 17, 2007).

Statutory liability protection of non-managing member of Delaware LLC with respect to retaliatory discharge claim where no evidence to support presence of employment relationship between plaintiff and non-managing member and no basis to impose vicarious liability.

In re JNS Aviation, LLC (Nick Corp. v. JNS Aviation, Inc.)

__ B.R. __, 2007 WL 2826138, Bankruptcy No. 04-21055-RLJ-7, Adversary No. 04-2028 (Bankr. N.D. Tex. Sept. 26, 2007).

Application of corporate veil piercing principles to Texas LLC and discussion of facts as satisfying “sham to perpetrate a fraud” doctrine.