November 2009 — Issue 45

Julian v. Julian

Civil Action No. 4137-VCP, 2009 WL 2937121 (Del. Ch. Sept. 9, 2009)

Three brothers owned and operated several LLCs together, and the plaintiff (“Gene”) sued his brothers (“Francis” and “Richard”) after he resigned as a member of several of the LLCs. The case involved two different versions of Section 18-603 of the Delaware Limited Liability Company Act. For LLC agreements entered into before July 31, 1996, the statute permitted a member to resign with six months’ notice. For LLC agreements entered into after July 31, 1996, the statute prohibits resignation before dissolution and winding up unless the LLC agreement states otherwise. Gene sought an award of fair value for his interest in the four pre-1996 LLCs and an award of fair value for Gene’s interest in the three post-1996 LLCs, but Gene ultimately conceded that the claims for fair value of the interests in the post-1996 LLCs should be pursued in arbitration. Gene also asserted derivative claims for damages on behalf of two LLCs for recovery of excess management fees that were charged by the management company owned by Francis and Richard. The defendants moved to dismiss the fair value claims against one LLC on the basis that the claims were not ripe and against the remaining three LLCs on the basis that they were subject to arbitration. The defendants also moved to stay the derivative claims. With respect to ripeness, the defendants relied upon the fact that Gene filed his fair value claim only two days after his resignation from the LLC. The Delaware LLC statute provides an LLC a “reasonable” time after resignation of a member to determine and distribute the resigning member’s LLC interest. The court denied the defendants’ motion to dismiss for lack of ripeness because it was reasonable to infer that the members would not have agreed on the value of the business regardless of how long the plaintiff waited to file suit in view of the fact that the family members were engaged in litigation regarding valuation and other business issues. Also, the court noted that the timing of the commencement of the suit was not critical when the valuation was based on facts as they existed at the time of the member’s resignation. Finally, the court noted that dismissing the claim would be inefficient because Gene could simply re-file the action the next day. With respect to the arbitration issue, the court ultimately granted the defendants’ motion to dismiss the fair value claims against the remaining three pre-1996 LLCs because arbitration was appropriate. The court divided the arbitrability question into “procedural” and “substantive” arbitrability relying on James & Jackson, LLC v. Willie Gary, LLC. The procedural arbitrability question revolved around whether or not the parties complied with the arbitration provisions of the LLC agreement. A presumption exists that procedural arbitrability questions are answered by arbitrators, not by the courts. The court noted that substantive arbitrability was less clear-cut and included a determination of both the scope of an arbitration provision and the broader issues of whether the contract and/or the arbitration clause were valid and enforceable. The court relied upon a recent chancery court opinion for the proposition that the court must first address the question of who decides whether the parties agreed to submit a particular dispute to arbitration or to a court. According to that decision, courts presume the parties did not intend to arbitrate arbitrability unless there is clear and unmistakable evidence to the contrary. Clear and unmistakable evidence that the parties intended to arbitrate arbitrability exists if the arbitration clause: (1) generally refers all disputes to arbitration, and (2) references a set of arbitral rules that empowers arbitrators to decide arbitrability. The arbitration clause in the present case stated that any controversy “arising out of or relating to” the agreement shall be settled by arbitration. The court interpreted “arising out of or relating to” broadly, and found the arbitration clause sufficient to satisfy the first prong of the test by generally referring all disputes to arbitration. The provision also satisfied the second prong by requiring that the arbitration be conducted in accordance with the rules of the American Arbitration Association. Gene argued that his request for an award of fair value was based on Section 18-604 of the LLC statute and not the LLC agreement. He further argued that the breach of fiduciary duty claims did not arise out of the LLC agreements because the agreements were “bare bones.” Gene relied on Parfi Holding AB v. Mirror Image Internet, Inc. for the proposition that “actions do not touch matters implicated in a contract if the independent cause of action could be brought had the parties not signed a contract.” Essentially, Gene asked the court to decide whether his claims arose out of, or related to, the LLC agreements. The court found that if it answered that question, it would undermine the Willie Gary test. Although the court admitted that common sense required some minor inquiry into whether the arbitration clause covered the underlying dispute, it said that, if there was a colorable basis that the dispute is covered by the arbitration clause and the clause satisfies the Willie Gary test, then the question of substantive arbitrability should be answered by the arbitrator rather than the court. The court decided that since LLCs were creatures of contract, Gene’s request for fair value of his interest was, to some degree, related to the existence of the agreement and its terms. Finally, the court noted that the policy of the court was to defer to arbitration when in doubt. With respect to the defendants’ motion to stay Gene’s prosecution of the derivative claims, the court stated that it would consider any preclusive effects of a pending arbitration elsewhere on the action before the court as well as any burden imposed by both litigating and arbitrating at the same time in different forums. The LLCs subject to the derivative claims did not have arbitration clauses in their agreements. Ultimately, the court denied the defendants’ motion to stay on the basis that the LLCs, the LLC agreements, and the claims involved in the derivative claims were sufficiently different and distinct from those that were being arbitrated. The court did not find that a significant risk of inconsistent judgments would be caused by allowing the litigation on the derivative claims to continue while arbitration began on the other claims. The defendants argued that Gene failed to state a claim for aiding and abetting a breach of fiduciary duty against Richard because the claim failed to state a breach of fiduciary duty by Francis. The court noted that aiding and abetting a breach of fiduciary duty requires (1) knowledge of the breach of a duty, and (2) participation in the wrongful conduct. In this case, Gene alleged a breach of fiduciary duty because the defendants’ management company suddenly increased the fees it charged to a few of the LLCs by 400%. The court denied the defendants’ motion to dismiss, stating that the allegations that Richard consented to the increase in fees (which benefitted a company controlled by Richard and Francis) were sufficient to support a reasonable inference that Richard participated in the alleged wrongdoing. Finally, the court noted that the fact that one of the defendants could have increased the fees on his own did not negate a reasonable inference that the other may have been involved in the decision.

Otero v. Vito

Civil Action No. 5:07-cv-405(CAR), 2009 WL 3063426 (M.D. Ga. Sept. 22, 2009)

Although the undisputed evidence showed that various entities, including numerous LLCs, were used to defeat justice and evade contractual or tort responsibilities, the court was precluded from exercising the equitable power of piercing the veil on behalf of a creditor seeking recovery from the entities to satisfy the debt of the individual who created and controlled the entities because the Georgia Supreme Court has held that reverse veil piercing is not permitted under Georgia law. The court, however, used the alter ego finding in connection with a finding that transfers of money, real property, and personal property from the individual to the entities were fraudulent under the Georgia Uniform Fraudulent Transfer Act. Proof of actual intent to hinder, delay, or defraud his creditors was established by the debtor’s affidavit in which he explained that he used layered corporations, LLCs, and trusts as part of a coordinated strategy to protect personal assets from attachment by creditors. Even in the absence of the admissions of the debtor, the court reviewed evidence of five of eleven factors indicating actual fraudulent intent under the Georgia Uniform Fraudulent Transfer Act. Although the court stated that the complex web of trusts, corporations, and LLCs had not yet been completely untangled, and all of the hurdles set up by the debtor had not been completely removed, the court concluded that enough was known to warrant summary judgment in favor of the creditor.

Abdalla v. Qadorh-Zidan

913 N.E.2d 280 (Ind. App. 2009)

The Abdallas and Zidans formed five LLCs and a corporation. Each family owned 50% of each LLC, and the two families were also the sole directors and shareholders of the corporation. After a dispute developed, the Zidans sold their membership interests to the Abdallas. After receiving K-1 Schedules for the year ending on the date they sold their interests, the Zidans asked to see the books of the LLCs and corporation for the period during which they were members and shareholders. Eventually, the Zidans filed a complaint alleging breach of fiduciary duty, negligence, and declaratory relief to inspect the books and records of the LLCs and corporation for the period during which they were members of the LLCs and shareholders of the corporation. They also sought discovery of the information used to prepare the K-1 Schedules. The Abdallas filed a motion for summary judgment arguing that they did not owe the Zidans any duties in connection with the preparation of the tax data and that the Zidans were not entitled to inspect the companies’ books. The trial court denied the motion for summary judgment, and the Abdallas filed an interlocutory appeal. The parties’ main argument focused on whether a fiduciary duty existed between the companies and the former members and shareholders. The Abdallas relied upon the LLC operating agreements, which provided that a member who assigns all of his interest in the LLCs no longer has any rights or privileges of a member. In addition, the Zidans acknowledged in various agreements that they were relinquishing all of their rights, title and interest as members and shareholders. The Abdallas also argued that the fiduciary relationship of the Zidans with the companies terminated when they sold their interests, regardless of the contractual language, in the absence of a dissolution of the companies because there was no winding up phase which would continue the existence of the duties. The Zidans acknowledged that fiduciary duties generally terminate when a member of an LLC or shareholder of a close corporation transfers his interest, but argued that fiduciary duties remain intact with respect to resolution of pre-separation business. They claimed that a fiduciary relationship covered the preparation of the tax return completed after the Zidans’ involvement in the companies ended because the tax return addressed the period during which they were members and shareholders. The court noted that it had determined in a prior case that “common law fiduciary duties, similar to ones imposed on partnerships and closely-held corporations, are applicable to Indiana LLCs” and that the Indiana Supreme Court had held that shareholders in closely-held corporations owe each other fiduciary duties. The court characterized the question in this case as one of first impression, i.e., “whether a company owes a continuing fiduciary duty to a former shareholder or member to fairly and accurately report the company’s financial results to the IRS for a year in which the former shareholder held stock in the corporation or was a member of the LLC.” The court reviewed case law in the partnership and corporate context and concluded that the Abdallas owed the Zidans a fiduciary duty with respect to the period during which the Zidans were members of the LLC and shareholders of the corporation. To hold otherwise, said the court, would give the Abdallas the freedom to allocate tax burdens to the Zidans and retain tax benefits for themselves without allowing the Zidans any recourse. The court next addressed the Abdallas’ contention that the Zidans had no right of access to the companies’ books because they were no longer members or shareholders of the companies. The court acknowledged that the statutes provided “members” and “shareholders” access to the books and records, but emphasized that the Zidans were not seeking access to current financial information. The court concluded that the Zidans had the right to inspect the records of the companies for the tax year 2006, when the Zidans were still members and shareholders, in order to ensure the correctness of the K-1 Schedules. Finally, the court affirmed the trial court’s denial of the Abdallas’ motion for summary judgment on the Zidans’ negligence claim. The Abdallas argued that the claim sounded in ordinary negligence and that corporate directors and members can only be held liable in the case of willful misconduct or gross negligence. Because the Abdallas failed to proffer any summary judgment evidence that they did not commit willful misconduct or gross negligence other than a self-serving affidavit; therefore, the trial court’s denial of their motion was proper.

In re Hecker

414 B.R. 499 (Bankr. D. Minn. 2009)

The court determined that the debtor could not use reverse veil piercing to claim a homestead exemption in property occupied by the debtor but owned by an LLC that was wholly owned by another LLC in which the debtor held a majority interest. The debtor asked the court to disregard the formalities and exercise the court’s equitable power to “reverse pierce” the veil of the entities in order to deem the debtor the owner of the property so that he could claim an exemption under the Minnesota statute. The court noted that Minnesota extends the doctrine of corporate veil piercing to LLCs under the Minnesota LLC statute, and the court examined two prominent Minnesota reverse piercing homestead exemption cases. The court distinguished the debtor’s situation in this case from the other cases in which reverse piercing was permitted to allow a homestead exemption because the companies created by the debtor were part of a large web of interconnected businesses whereas the two other cases examined by the court involved family farmers whose only business was farming. The parent LLC was an investment business owning over 50 properties. There was no allegation of undercapitalization, failure to observe corporate formalities, nonpayment of dividends, siphoning of funds, nonfunctioning officers and directors, or absence of corporate records. The subsidiary LLC that owned the debtor’s residence was formed to acquire properties, including properties for future commercial development, without the debtor’s wife gaining an interest in the properties. The court concluded that the facts did not support the conclusion that either of these LLCs was the debtor’s alter ego. Furthermore, the court found that the debtor did not meet his burden of demonstrating that reverse piercing the veils of the LLCs would not adversely affect shareholders and creditors. There were five other owners of the parent LLC. These owners, consisting of trusts for the benefit of the debtor’s children and a corporation owned by the debtor, were characterized by the court as separate legal entities whose interests would be diminished in value by recognizing a homestead exemption. Furthermore, the creditors of the LLCs and the corporate member of the parent LLC would be adversely affected. The court discussed the fact that creditors of the corporation and the LLCs would not have expected that the property might be exempt as a homestead since the property was owned by an LLC owned by another LLC owned by four trusts and another corporate entity. Furthermore, the property was recreational property until the eve of bankruptcy when the debtor tried to make it his homestead. Finally, the court concluded that the debtor failed to demonstrate that it would be unfair and unjust not to pierce the veil. In the other cases examined by the court, the parties seeking the homestead exemption would have been entitled to the exemption prior to incorporating, and the question was whether the debtors lost their homestead exemption by incorporating. In this case, the property was not the debtor’s homestead prior to formation of the LLCs, and it was only on the eve of bankruptcy that the debtor decided to move into the home and claim it as his homestead.

BankPlus v. Kinwood Capital Group, L.L.C.

Civil Action No. 3:08cv498 DPJ-JCS, 2009 WL 3062457 (S.D. Miss. Sept. 18, 2009)

The court interpreted the Mississippi LLC statute and concluded that a conveyance of real property by an LLC member who lacked authority to do so was void and did not pass title to a subsequent bona fide purchaser for value. Under the Mississippi LLC statute, every member is an agent of the LLC for the purpose of conducting its business, and the act of a member for apparently carrying on in the usual way the business of the LLC binds the LLC unless the member lacks authority and the person with whom the member is dealing knows that the member has no authority. The statute further provides that no act of a manager or member in contravention of a restriction on authority binds the LLC to persons with knowledge of the restriction. The member in this case was not authorized to convey title to the LLC’s property, and he conveyed the property to another LLC owned by him. Thus, the grantee knew the member lacked authority. The question, however, was whether a subsequent bona fide purchase obtained clear title. The court stated that this was a question of first impression in Mississippi, and the court looked to forgery cases and LLC cases outside of Mississippi for guidance. The court concluded that the legislature intended to protect LLCs from unauthorized acts by the members and that the conveyance by the unauthorized member was void ab initio. The court acknowledged that its conclusion was a close call and stated that it would be tempted to certify the question to the Mississippi Supreme Court if it had authority to do so. The court further noted that the issue was well-defined and would receive de novo review at the next stage of appeal.

Saunders v. Firtel

978 A.2d 487 (Conn. 2009)

(judicial dissolution of LLC where not reasonably practicable to carry on).

ZRII, LLC v. Wellness Acquisition Group, Inc.

Civil Action No. 4374-VCP, 2009 WL 2998169 (Del. Ch. Sept. 21, 2009)

(fiduciary duties of LLC officers).

831 Bartholomew Investments-A, L.L.C. v. Margulis

20 So.3d 532 (La. App. 2009)

(limited liability of LLC members).

Blue Star Corporation v. CFK Properties, LLC

980 A.2d 1270 (Me. 2009)

(veil piercing and liability of individual for own participation in wrongful acts).

Dearborn Street Building Associates LLC v. D & T Land Holdings, LLC

No. 1:07-cv-1056, 2009 WL 3011245 (W.D. Mich. Sept. 16, 2009)

(interpretation of LLC “insider” under Michigan Uniform Fraudulent Transfer Act).

In re Goreham

No. BK-09-80917-TLS, 2009 WL 3018648 (Bankr. D. Neb. Sept. 16, 2009)

(distinction between LLC property and interest of debtor member in LLC and inapplicability of preferential transfer provision to transfer by LLC of its property).

911 Management, LLC v. United States

657 F.Supp.2d 1186 (D. Ore. 2009)

(application of alter ego and nominee doctrines to permit IRS levy against LLC’s bank account with respect to tax liability of members).

Jongebloed v. Texas Lottery Commission

No. 03-08-00154-CV, 2009 WL 2837698 (Tex. App. Aug. 31, 2009)

(interpretation of lottery statute provisions regarding liability of LLC member for sales proceeds owed Lottery Commission by LLC).

In re Supplement Spot, LLC (Floyd v. Option One Mortgage Corporation)

409 B.R. 187 (Bankr. S. D. Tex. 2009)

(veil piercing to treat bank account of LLC president as property of LLC; fiduciary duty of LLC president to creditors of insolvent LLC).

Domestic Construction, LLC v. Bank of America, N.A.

No. CV07-5357BHS, 2009 WL 2853255 (W.D. Wash. Sept. 1, 2009)

(exceptions to limited liability of LLC members; evidence of practices showing disregard of LLC form as potential basis for personal liability and duty to co-venturer of LLC).