September 2006 — Issue 8

Cordier v. Tkach

No B179095, 2006 WL 2407051 (Cal. App. 2 Dist. Aug. 22, 2006)

Limited liability of partner.

Fogarty v. Parker, Poe, Adams, and Bernstein, L.L.P.

__ So.2d __, 1040335, 2006 WL 2383376 (Ala. 2006)

Minority members of an Alabama LLC sued a North Carolina law firm and two of its attorneys based on the attorneys’ role in denying them access to the books and records of the LLC. The plaintiffs alleged that the attorneys threatened legal action against them if they continued to seek access to the LLC’s records, misrepresented Alabama law by stating that Alabama law did not entitle them to access to the LLC’s books and records, and removed the books and records from Alabama to prevent the plaintiffs from having access to them. The court held that the Alabama Legal Services Liability Act (ALSLA) was not the exclusive remedy for the minority members’ claims because the ALSLA applies only to allegations of legal malpractice, i.e., claims against legal services providers that arise from performance of legal services, and thus only applies to claims brought by the one who receives legal services. In arguing that they were not in privity with the plaintiffs, the attorneys expressly stated that they never provided legal services to the plaintiffs. Furthermore, the ALSLA did not apply to the attorneys because they were not licensed to practice law in Alabama, and the ALSLA applies only to attorneys licensed in Alabama. The court next held that Alabama recognizes a private cause of action for the unauthorized practice of law in Alabama and concluded that the plaintiffs stated a claim for relief by alleging that the attorneys were not licensed in Alabama and that the plaintiffs were injured as a result of representations made concerning Alabama law for the majority owners and the LLC itself. The court also found that the plaintiffs had stated a claim against the attorneys based on the statutory inspection provisions of the Alabama Limited Liability Company Act. The court pointed out that the statute provides for personal liability of “any agent, member, or manager” of an LLC who refuses to permit a member to inspect the books and records without reasonable cause. The plaintiffs alleged that the attorneys were acting as the LLC’s agent and that they refused to permit the plaintiffs to inspect certain records without reasonable cause; therefore, the allegations supported a claim for relief under the statute, which provides for a penalty in an amount up to 10% of the fair market value of the membership interest of the member in addition to other damages.

Burkle v. Burkle

141 Cal.App.4th 1029, 46 Cal.Rptr.3d 562, No. B185841 (Cal. App. 2 Dist. 2006)

Carrie Burkle’s father, Ronald Burkle, formed a Delaware LLC when Carrie was 19 years old. Ronald owned 99% of the LLC and provided the funds for Carrie’s 1% interest in the LLC. Carrie filed suit seeking declaratory relief and an accounting after learning of her 1% interest in the LLC. Carrie sought access to the LLC’s books and records through discovery requests and based on California statutory provisions. Ronald sought summary judgment and asserted that the capital contributions he made to the LLC were loans and that he drew down Carrie’s capital account to repay himself for the prior loans plus accrued interest on the loans. The trial court denied Carrie’s request for access to the LLC’s financial records, granted Ronald’s motion for summary judgment, and denied Carrie’s request to amend her complaint to add conversion and breach of fiduciary duty claims based upon her father’s appropriation of her capital account. On appeal, the court reversed the trial court’s summary judgment. The court stated that characterizing a transfer of funds as a gift or a loan often presents questions of fact. The court reviewed the evidence raising a fact question in this case, including the absence of any documentation of a loan and the fact that Ronald was asserting that Carrie owed him over $14,000 after repaying himself with the balance of her capital account. The court stated, “[W]e do not see how a parent can unilaterally determine the terms of a loan to an adult child, and assert his entitlement to unpaid interest, without the knowledge or agreement of the borrower.” The court also addressed Ronald’s argument that the transfer of funds could not have been a gift because a transfer of money does not constitute a gift unless the donor relinquishes control over the money. The court pointed out that Ronald necessarily relinquished control over the funds when he invested them in the LLC because he had no title to or interest in Carrie’s interest. Any control Ronald retained flowed from his position as manager of the LLC, not from his position as provider of the funds. The court next determined that Carrie had inspection rights under Section 17453 of the Corporations Code, which states: “If the members of a foreign limited liability company residing in this state represent 25 percent of more of the voting interests of members of that limited liability company, those members shall be entitled to all information and inspection rights provided in Section 17106.” (Section 17106 provides members of a California LLC access to records for purposes reasonably related to the member’s interest.) Ronald argued that “those members” entitled to inspection rights are only those California members with a 25% or greater interest; however, the court of appeals had no difficulty concluding that once the interest of California residents in an LLC reaches the 25% threshold, any California member is entitled to the benefits of California law on inspection of LLC records. According to the court, “‘those members’ unambiguously refers to California members, and merely distinguishes members residing in California from members residing elsewhere, who are not entitled to inspection rights under California law.” Since all the members of the LLC – Carrie with a 1% interest and Ronald with a 99% interest – resided in California, Carrie was entitled to inspection rights. Finally, the court found that Carrie should be permitted to amend her complaint to seek damages for conversion and breach of fiduciary duty.

In re Bianchini (Bianchini v. Ryan)

346 B.R. 593, No. 05-31506 (LMW) (Bankr. D. Conn. 2006).

In a prior lawsuit against the debtor in New Jersey, a judgment was entered against entities owned by the debtor, including an LLC, based in part on the jury’s findings that the entities were the debtor’s alter egos created to shield assets or for other unjust purposes, and that the assets of any of them should be used to satisfy debts of any other. A judgment lien was recorded on property owned by the LLC, and the property was later conveyed to the debtor subject to the lien. In this bankruptcy proceeding, the debtor sought to treat the LLC’s property as his own at the time the judgement lien was recorded in order to claim his interest in the property as exempt under Section 522(b)(2). The court declined to do so, stating that it did not construe the New Jersey judgment as declaring that the debtor was the owner of the LLC’s property at that time, but rather as permitting the judgment creditor to disregard the state of record title to the extent necessary to satisfy the judgment. The court noted that the debtor was attempting to “reverse pierce” the LLC’s veil to treat the LLC’s assets as his own and observed that many jurisdictions recognize both offensive and defensive reverse piercing. The court stated that equitable principles govern veil piercing in Connecticut and concluded that Connecticut courts would not pierce the veil between the debtor and the LLC to allow the debtor to benefit by disregarding record title to the property when the debtor had placed record title to the property in the LLC for unjust purposes. The court commented in a footnote that if record title to the property were still in the LLC as of the petition date and the trustee sought pierce the LLC’s veil for the benefit of the debtor’s creditors, that would have been a different matter.

Facchina v. Malley

No. Civ.A. 783-N, 2006 WL 2328228 (Del. Ch. Aug. 1, 2006).

The court applied the statutory default rules to resolve a dispute over who was the managing member of a Delaware LLC, concluding that the LLC did not have an LLC agreement and that members constituting more than 50% in interest had authority to remove the defendants as managing members and replace them with another individual who became the managing member. The defendants argued that a shareholder’s agreement in effect for a predecessor corporation constituted the operating agreement of the LLC, but the court rejected that argument. The members of the LLC had begun their business as shareholders of a California corporation but discovered that they could not achieve the S corporation status they desired because one of the shareholders was a foreign national. The corporation then merged into a newly formed Delaware LLC, but the members of the LLC never executed an operating agreement. The defendants argued that the shareholder’s agreement governing the corporation became the operating agreement of the surviving LLC, and the defendants challenged the validity of various actions taken after the merger, including the removal of the defendants and designation of another individual as managing member, on the basis that they were not accomplished in compliance with the shareholder’s agreement. The court stated that the shareholder’s agreement did not automatically take on the role of the operating agreement because the corporation ceased to exist in the merger, and the court concluded that the defendants failed to establish any agreement that the shareholder’s agreement became the LLC’s operating agreement. The defendants relied upon a provision in the merger agreement reciting that the operating agreement of the LLC would be the one “in effect immediately prior to the effective time;” however, the court did not read this provision to constitute an adoption of the shareholder’s agreement as the operating agreement after the merger. The court pointed out that the provision simply established that the LLC’s operating agreement before the merger would be the operating agreement of the surviving LLC after the merger; however, the LLC never had an operating agreement. The defendants claimed that everyone understood the shareholder’s agreement would serve as the operating agreement because the LLC was intended to be a continuation of the enterprise governed by the shareholder’s agreement. The court acknowledged that such an agreement might have made sense, but the defendants failed to prove such an agreement (which the court noted could have been reached orally) by all the members. The testimony only established an understanding by two of the members (the defendants), not an agreement of all the members. The statutory default rules thus applied, and the action taken was effective. The defendants challenged the use of a written consent to appoint the managing member, claiming that a meeting was required under California law. The court rejected the argument that California law governed the internal affairs of a Delaware LLC with its principal (and in this case, only) place of business in California and stated that Delaware law governs the internal affairs of a Delaware LLC regardless of its place of operations. The action was valid under Delaware law, which permits the use of written consents, whether California law permits action by written consent or not.

Martin v. JBS Technologies, LLC

__ F.Supp.2d __, No. 05-CV-920, 2006 WL 2361698 (S.D. Ohio 2006).

The operating agreement of a Delaware LLC provided that “[t]he Company shall indemnify and hold harmless its Members, its Directors, and any other employee or agent of the Company” subject to certain standards. Martin, a former employee, asserted a right of indemnification against the LLC in connection with an earlier lawsuit in which she and the LLC and various other individuals related to the LLC were defendants, and in which all the claims were ultimately dismissed. The LLC sought summary judgment on Martin’s indemnification claim, arguing that the operating agreement was a contract between the LLC and the state and that Martin could not recover because she was not a party. The court noted the broad statutory authority conferred upon Delaware LLCs to provide for indemnification by contract in their operating agreements. The court also mentioned the policy of freedom of contract underlying the Delaware LLC statute and the Delaware policy concerns supporting indemnification coverage under contracts. The court examined the indemnification provision in the operating agreement and found that it unambiguously applied to Martin because she was an “employee or agent” at all relevant times. The court concluded that there was at least an issue of material fact as to whether Martin’s conduct was taken reasonably and in good faith so as to make her eligible for indemnification, and the LLC did not demonstrate that she was ineligible to receive indemnification.

Hamby v. Profile Products, L.L.C.

632 S.E.2d 804, No. COA05-1491 (N.C. App. 2006).

An employee of an LLC brought a personal injury action based on injuries sustained in a workplace accident. The employee sued the LLC employer, a co-employee, and another LLC that was the sole member-manager of the LLC employer. The trial court granted summary judgment in favor of the LLC employer and the co-employee but denied summary judgment as to the member-manager. The member-manager sought an interlocutory appeal on several grounds. In the course of addressing the arguments, the court of appeals concluded that the plaintiff was pursuing an ordinary negligence claim against the member-manager and that the member-manager was not protected by the exclusivity provision of the North Carolina Worker’s Compensation Act. A dissenting judge cited case law holding that the protection of the exclusivity provisions of the Worker’s Compensation Act extends to officers, managers, and directors of a corporate employer and argued this case law applied equally in the LLC context. The dissenting judge also relied upon provisions of the North Carolina LLC Act describing the agent status of a manager; however, the majority relied upon the principle that the Worker’s Compensation Act exclusivity provisions do not bar recovery against a related but separate entity from the employer and concluded that the controlling statute was the provision of the LLC statute providing that members and managers may be liable by reason of their own acts or conduct.

Gomi Investors, LLC v. Schimmell Holdings, Inc.

Civil Action No. 2278-N, 2006 WL 2304035 (Del. Ch. July 27, 2006)

Denial of motion to expedite in suit involving alleged unauthorized formation of Delaware LLC.

Minca v. Kathryn Arnett Studio, LLC

931 So.2d 1126, No. 2005-CA-1174 (La. App. 2006)

Enforceability of LLC member’s oral guaranty.

Pointer v. Castellani

21 Mass. L. Rptr. 199, No. 053003BLS1, 2006 WL 2006127 (Mass. Super. May 11, 2006)

Interpretation of indemnification and advancement obligations under indemnification and exculpation provisions of operating agreement.

611, LLC v. U.S. Lubes, LLC

Civil No. CCB-05-3417, 2006 WL 2038615 (D. Md. July 18, 2006)

Interpretation of operating agreement substitute member provisions.

Solutia Inc. v. FMC Corporation

F.Supp.2d __, No. 04 Civ. 3842(WHP), 2006 WL 2109430 (S.D. N.Y. 2006)

Pre-formation duties in connection with agreement to form “joint venture” LLC.

Trent v. River Place, LLC

632 S.E.2d 529, No. COA05-1051 (N.C. App. 2006)

Operating agreement capital call provisions and transfer restrictions.

Haynes v. B & B Realty Group, LLC

633 S.E.2d 691, No. COA05-1125 (N.C. App. 2006)

Insufficiency of allegations to support liability of member based on member’s own tortious conduct; absence of fiduciary duty to mere assignee or potential assignee.

United States v. Payment Processing Center, LLC

439 F.Supp.2d 435, Civil Action No. 06-0725 (E.D. Pa. 2006)

Statutory power of LLC to indemnify and advance expenses to members, managers, and employees in absence of provisions in operating agreement.

Kira, Inc. v. All Star Maintenance

No. A-03-CA-950 LY, 2006 WL 2193006 (W.D. Tex. July 31, 2006)

Governing law; interpretation of operating agreement provisions requiring action to be “agreed upon by members”and waiving or limiting fiduciary duties.