November 2008 — Issue 33

LLCs: Harvey v. Grey Wolf Drilling Company

542 F.3d 1077, No. 07-31106 (5th Cir. (La.) 2008)

As a matter of first impression in that circuit, the Fifth Circuit Court of Appeals determined that the citizenship of an LLC for diversity jurisdiction purposes is determined by the citizenship of all of its members. Noting that the United States Supreme Court has not specifically addressed the citizenship of an LLC, the court joined other circuits in applying the Supreme Court’s decision in Carden v. Arkoma Associates (which held that the citizenship of an unincorporated association, such as a limited partnership, is based on the citizenship of all of its members) to LLCs. The court pointed out that Congress has created a statutory exception to the Carden rule of citizenship for unincorporated associations in the limited context of class actions, but has made no similar exception in any other part of the general diversity jurisdiction statute. The court also noted that the Louisiana LLC statute explicitly provides that an LLC is an “unincorporated association” and that no LLC “shall be deemed, described as, or referred to as ... [a] corporation.”

EBG Holdings LLC v. Vredezicht’s Gravenhage

109 B.V., Civil Action No. 3184-VCP, 2008 WL 4057745 (Del. Ch. Sept. 2, 2008).

A Delaware LLC sued one of its members, a Dutch LLC (“VG 109"), and the member’s parent corporation (“NIBC”), seeking a declaration that VG 109 was NIBC’s alter ego, specific performance of provisions of the LLC agreement regarding the reimbursement of tax withholding payments made on VG 109’s behalf, and a declaration that VG 109’s attempted transfer of its economic interest was invalid. The LLC asserted four bases for the court’s exercise of personal jurisdiction over NIBC: (1) Delaware’s long-arm statute; (2) the terms of the LLC agreement; (3) alter ego or veil piercing theories of jurisdiction; and (4) agency theory of personal jurisdiction. The court rejected the argument that NIBC’s single act of participating in the formation of the LLC in Delaware was sufficient to confer personal jurisdiction under the long-arm statute. Personal jurisdiction over VG 109, which consented to jurisdiction in the LLC agreement, was not challenged, and the court acknowledged that ownership of a Delaware subsidiary may constitute the transaction of business in Delaware. The court concluded, however, that the only business the LLC claimed NIBC conducted in Delaware was participating in the formation of the LLC, a participation too attenuated to subject it to personal jurisdiction, especially since the LLC failed to demonstrate that the LLC was NIBC’s or VG 109’s subsidiary, as the term is commonly understood, as opposed to a company in which VG 109 held only a minority interest. The record did not show that NIBC formed the LLC, or participated in the formation, in a meaningful fashion. NIBC was one of eighteen lenders that agreed to the formation of the LLC as part of a debt restructuring plan, and the complaint did not allege that NIBC had a dominant or controlling position in the lender group. The record did not suggest that NIBC or VG 109 caused the LLC to be formed as a Delaware LLC, as opposed to some other type of entity. The court stated that it was not persuaded that a minority member of an LLC with as small and indirect an ownership interest as that of NIBC (VG 109 was listed at various times as owning approximately 4.5% and 2.5% of the equity interest in the LLC) would be subject to personal jurisdiction in Delaware in the absence of facts suggesting NIBC participated in selecting Delaware as the state of formation or otherwise actively participated in the formation beyond taking an indirect minority membership interest. The court next rejected the argument that the consent to jurisdiction provision in the LLC agreement applied to NIBC. Though the term “party” in the consent to jurisdiction provision was not defined, the court found nothing to suggest that the term would include NIBC, which was neither a signatory nor a member as to the original or amended LLC agreement. Though NIBC was an affiliate covered by the indemnification provisions of the LLC agreement, the court stated that the LLC failed to explain how the application of the indemnification provisions to NIBC supported its contention that NIBC consented to jurisdiction. In fact, the court found that the parties manifested an intent not to include affiliates in the consent to jurisdiction provision by expressly including affiliates in the indemnification provisions while referring only to parties in the consent to jurisdiction provision. The court next discussed the agency and alter ego theories of personal jurisdiction. The court identified certain common factors but explained that the scope of the alter ego theory was broader in that only the precise conduct instigated by the parent is attributable to the parent under the agency theory whereas all of the activities of the subsidiary are attributable to the parent under the alter ego theory. Drawing all inferences in favor of the LLC, the court found for purposes of determining NIBC’s amenability to suit in Delaware that VG 109 acted as NIBC’s agent, but the court found that the actions of VG 109 did not provide a sufficient basis for the exercise of jurisdiction under the long-arm statute. In other words, apart from its consent to jurisdiction, VG 109 would not have been subject to jurisdiction in Delaware. The court concluded that a minority, passive investor in a Delaware LLC who allegedly breaches the LLC agreement in a manner that affects the rights of the LLC and its members inter se is not subject to jurisdiction under Delaware’s long-arm statute for the breach without a showing that the LLC investor took some additional action from which the cause of action arose to consciously take advantage of the laws of Delaware. The court refused to impute VG 109’s consent to jurisdiction under the agency theory because sophisticated parties had negotiated an agreement that included a consent to jurisdiction by the parties, and not their affiliates, and circumventing the parties’ intention under the guise of an agency argument would “sanction bootstrapping and defeat the careful drafting of the consent provision.” The court also rejected the argument that NIBC was subject to personal jurisdiction under the alter ego theory. Because the court found that there were insufficient acts of VG 109 to satisfy the long-arm statute, the court stated that it need not decide the question of whether VG 109 was the alter ego of NIBC. However, the court discussed the LLC’s arguments for disregarding the separate existence of VG 109 and its parent corporation and concluded that the LLC had not made a sufficient showing of fraud or other inequity to disregard the corporate form. The court pointed out that the fraud or injustice must stem from an inequitable use of the corporate form itself, not merely from the underlying cause of action for breach of contract. A conclusory statement in the complaint that NIBC knowingly used VG 109 as an instrument to shield itself from liability for tax obligations related to ownership in the LLC was insufficient to support a reasonable inference that NIBC’s use of VG 109’s limited liability status was fraudulent or inequitable. There also was no showing that VG 109’s capitalization was so minimal as to prove it was a sham entity. The court also stated that the LLC’s inability to sue NIBC in Delaware for taxes due from VG 109 did not create the requisite inequity.

In re Seneca Investments, LLC

Civil Action No. 3624-CC, 2008 WL 4329230 (Del. Ch. Sept. 23, 2008)

An LLC member sought judicial dissolution of the LLC. The court analyzed the claim under the judicial dissolution provisions of the Delaware LLC statute and the Delaware corporation statute because the members contractually agreed that the LLC would be governed as a corporation and that the Delaware General Corporation Law would apply. The LLC had two organizational documents: an operating agreement and a charter. The purpose clause in the charter stated that the purpose of the LLC was “to engage in any lawful act or activity for which corporations may be organized under the Delaware General Corporation Law.” The petition for dissolution alleged that the LLC had abandoned its business and should thus be dissolved. Specifically, the petition alleged that the LLC had not for several years had a business plan, sought or received capital, had shareholder or director meetings, or sought to hire anyone who could conduct business on its behalf. The LLC’s only assets were approximately $2.2 million in cash, shares of stock of a publicly held company, and a minority interest in a private internet marketing company. The LLC sought judgment on the pleadings, and the court concluded that the petitioner alleged no facts that would compel the court to grant the petition for dissolution. In the absence of extensive LLC case law interpreting the LLC judicial dissolution statute, and given the similarity of the LLC and limited partnership judicial dissolution statutes (authorizing the court to decree dissolution whenever it is not reasonably practicable to carry on the business in conformity with the LLC/limited partnership agreement), the court considered limited partnership case law in this context as well as LLC case law. In the absence of an allegation of deadlock, the court focused on whether it was impracticable for the LLC to fulfill its business purpose. Because the LLC’s charter stated that its purpose was to engage in any lawful act or activity for which corporations may be organized, and a corporation may function as a passive instrumentality to hold title to assets, the court concluded the allegations were insufficient to support a claim that it was not reasonably practicable to carry on in conformity with the operating agreement. The court stated that allegations that the LLC had failed to comply with certain provisions of the operating agreement (such as making distributions, providing reports, and continuing to allow the petitioner to serve as director) were not grounds for dissolution, and the court would not attempt to police violations of operating agreements by dissolving LLCs. The court rejected the petitioner’s argument that the operating agreement prohibited any business activity by the LLC other than liquidating assets and distributing cash. Turning to the provision of the Delaware General Corporation Law that allows the court of chancery to appoint a custodian or receiver when the corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets, the court analyzed whether the LLC had abandoned its business by looking to the LLC’s purpose clause. In view of the broad purpose clause, and because a corporation can lawfully function as a passive holding company, the court concluded that the facts alleged in the petition showed that the LLC was performing a valid corporate function by passively investing in other businesses. Furthermore, the court pointed out that the LLC was pursuing counterclaims, and pursuing legal claims is an acceptable and common corporate function. The court stated that it was aware of the possibility that a company facing a petition for dissolution would file non-meritorious counterclaims to avoid dissolution, but the court did not see any indication of abuse in the instant case.

Andrews v. Ford

990 So.2d 820, No. 2007-CA-00497-COA (Miss. App. 2008)

After one of the members of an LLC died, the deceased member’s administratrix brought suit against the remaining member for breach of contract and specific performance of a buy-sell agreement. The court construed the LLC operating agreement and buy-sell agreement between the members as part of the same transaction because the agreements were executed on the same date and the buy-sell agreement was referred to in the operating agreement. The court concluded, however, that the dispute between the deceased member’s estate and remaining member was not within the scope of the arbitration clause in the operating agreement because the deceased member’s estate was not a “member” under the operating agreement and the arbitration clause only encompassed disputes among members.

M.C. Multi-Family Development, L.L.C. v. Crestdale Associates, Ltd.

193 P.3d 536, No. 48347 (Nev. 2008).

The operating agreement of a residential real estate development LLC contained the following provision permitting members to engage in competition: "This Operating Agreement shall not preclude or limit in any respect the right of any Member or Administrative Committee Member to engage in or invest in any business activity of any nature or description, including those which may be the same or similar to the Company’s business and in direct competition therewith. Any such activity may be engaged in independently or with other Members or Administrative Committee Members. No Member shall have the right, by virtue of the Articles of Organization, this Operating Agreement or the relationship created hereby, to any interest in such other ventures or activities, or to the income or proceeds derived therefrom. The pursuit of such ventures, even if competitive with the business of the Company, shall not be deemed wrongful or improper and any Member or Administrative Committee Member shall have the right to participate in or to recommend to others any investment opportunity." Although the minority member had the right to develop other projects, the LLC and its majority member sued the minority member and the minority member’s company alleging, inter alia, that the minority member and his company converted the LLC’s contractor’s license for their own purposes when they used the LLC’s license to develop competing properties rather than obtain a separate contractor’s license. The trial court entered a directed verdict in favor of the minority member on the conversion claim, and the supreme court reversed the trial court’s judgment and remanded for a trial on that issue. The court first determined that intangible property, such as a license, can be converted under Nevada law. The court then determined that the plaintiffs had offered sufficient evidence on the issue of whether the minority member’s use of the license constituted “wrongful dominion” over the license to overcome the motion for directed verdict. There was testimony that the majority member and manager did not grant the minority member permission to use the LLC’s license and that the operating agreement did not authorize the use of the LLC’s license on the other projects even though it permitted members to engage in other projects. Although there was testimony that other members of the LLC used the license on individual projects, the court stated that the evidence was not so overwhelming that a verdict against the minority member would be contrary to law, and the probative value of any prior course of conduct concerning the license was undermined by the fact that the use of the license by other members occurred prior to the current majority member’s acquisition of its interest in the LLC. The court noted that the fact that the jury found in favor of the minority member on the other claims of wrongful conduct (which included breach of fiduciary duty claims) did not mean there could be no “wrongful dominion” with respect to the conversion claim. The court viewed the element of “wrongful dominion” as distinct from the “wrongfulness” element of other torts, and it was for the jury to determine whether the specific elements of conversion existed. The court rejected the majority member’s argument that the trial court erred in admitting parol evidence on the meaning of the operating agreement in connection with the majority member’s breach of contract claim against the minority member for breach of the general covenant of good faith and fair dealing. The majority member argued that the operating agreement (which included a provision that the articles of organization and operating agreement contained the entire understanding of the parties and superseded prior understandings and agreements) was clear and unambiguous in that, while it unambiguously allowed members to pursue other projects, it did not provide them authority to use the LLC’s contractor’s license in pursuit of those projects. The court found that the admission of parol evidence did not violate the parol evidence rule because the agreement was silent on the ability of members to use the license on other projects, and parol evidence was admissible on this point to prove a subsequent oral modification or to resolve a latent ambiguity in the agreement.

Kandi v. United States

295 Fed.Appx. 873, No. 06-35209, 2008 WL 4429296 (9th Cir. 2008)

(validity of check-the-box regulations).

Sports Imaging of Arizona, L.L.C. v. 1993 CKC Trust

No. 1 CA-CV 05-0205, 2008 WL 4448063 (Ariz. App. Sept. 30, 2008)

(fiduciary duties of manager, controlling member, and those in control of manager and controlling member; personal liability of individuals for participation in torts or breaches of duty of entity manager of LLC)

Delgadillo v. White

No. 1 CA-CV 07-0042, 2008 WL 4095494 (Ariz. App. April 22, 2008)

(fiduciary duty of managers; fairness of sale of LLC asset)

IH Riverdale, LLC v. McChesney Capital Partners, LLC

292 Ga.App. 841, 666 S.E.2d 8, No. A08A0369 (Ga. App. 2008)

(validity of amendment of operating agreement to eliminate minority member’s distribution right)

Alexander Building, LLC v. Queen & Crescent Hotel, LLC

Civil Action No. 08-1513, 2008 WL 4373033 (E.D. La. Sept. 23, 2008)

(personal liability of managing member who acts without authority or signs agreement without accurately identifying LLC)

Interphase Garment Solutions, LLC v. Fox Television Stations, Inc.

566 F.Supp.2d 460 (D. Md. 2008)

(LLC’s inability to assert claim for intentional infliction of emotional distress or invasion of privacy)

Billings v. Bridgepoint Partners, LLC

21 Misc.3d 535, 863 N.Y.S.2d 591 (N.Y. Sup. 2008)

(application of contemporaneous ownership and demand requirements in New York LLC derivative litigation)

In re DePaulis (Holland v. DePaulis)

Civil No. 3:07cv75, 2008 WL 4446999 (W.D.N.C. Sept. 26, 2008)

(analogy to corporate “instrumentality rule” for LLC veil piercing in absence of North Carolina case law on LLC piercing; insufficiency of evidence to pierce LLC veil)

Durina v. Filtroil

No. 07 CO 24, 2008 WL 4307892 (Ohio App. Sept. 18, 2008)

(lack of jurisdiction to dissolve LLC formed in jurisdiction other than forum state)

Virginia Cellular LLC v. Virginia Department of Taxation

276 Va. 486, 666 S.E.2d 374 (Va. 2008)

(exemption of LLCs from telecommunications company tax applicable in lieu of corporate income tax)