September 2008 — Issue 31

LLPs: In re Rambo Imaging, L.L.P.

No. 07-11190-FRM, 2008 WL 2778846 (Bankr. W.D. Tex. July 15, 2008).

The issue in this case was whether an individual who was a partner of a Texas LLP was a general partner with standing to be a petitioner in an involuntary bankruptcy case. The partnership was a general partnership registered under the Texas full-shield LLP statute. The court stated that it had been unable to find any case law addressing the ability of a partner in an LLP to file an involuntary action, and the court relied upon Collier on Bankruptcy in concluding that the petitioning general partner should be treated as a shareholder of a corporation under the Bankruptcy Code and thus ineligible to be a petitioning partner under Section 303(b)(3). Collier on Bankruptcy takes the position that a full-shield LLP should be treated as a corporation because the definition of a “corporation” under the Bankruptcy Code broadly encompasses a “partnership association organized under a law that makes only the capital subscribed responsible for the debts of the association” and because, in view of the purpose of Section 303(b)(3), which is to protect general partners who are exposed to personal liability for partnership obligations, Section 303(b)(3) should not be available to LLP partners. The court went on to conclude that, even if the petitioning individual was a general partner, he should be estopped to make that claim because it was clearly inconsistent with the individual’s position in prior litigation in which he claimed to be a limited partner. The court stated that the individual’s view of what type of partner he was seemed to change as his perceived interest changed, and that is precisely the situation judicial estoppel was designed to address.

LLCs: ULQ, LLC v. Meder

666 S.E.2d 713, No. A08A1205 (Ga. App. 2008)

Four individuals formed an LLC, and the operating agreement designated the majority member as the sole manager. The operating agreement provided that an officer could be removed by the manager with or without cause whenever in the manager’s judgment the best interest of the LLC would be served. Removal was a dissociating event requiring the member to sell his interest to the other members or the LLC at a designated value. The manager appointed Meder, a 10% member, as vice president and later terminated him, claiming that he had abused other employees and that his termination was thus in the best interests of the LLC. The LLC exercised its right to purchase Meder’s interest. The value in effect under the operating agreement at that time was the value of a member’s capital account, and Meder’s capital account was zero due to LLC losses. Meder sued the LLC, alleging that his termination and buy out breached the operating agreement, breached fiduciary duties owed to him by the LLC, and wrongfully converted the value of his capital investment and interest. The LLC counterclaimed alleging various causes of action based on Meder’s contacting LLC clients, after his termination as an officer and before the purchase of his membership interest, to persuade them to withhold their business from the LLC. The LLC sought summary judgment on Meder’s breach of contract claim on the basis that the operating agreement permitted his termination with or without cause, but the court of appeals held that the trial court did not err in denying summary judgment because there was a fact issue with respect to the duty of good faith and fair dealing implied in all contracts. The court stated that the exercise of discretion by a party to a contract is subject to the implied duty of good faith unless the contract states that the discretion is “absolute” or within the “sole” judgment of the party. Because the operating agreement did not vest the manager with absolute discretion in terminating an officer, but rather required the manager to conclude that termination was in the best interest of the LLC, the manager was required to exercise good faith in terminating Meder. Meder presented evidence that he was not abusing other employees and that the true motive for terminating him was to allow the LLC to purchase his interest for nothing at a time when the LLC was about to take off financially, thereby raising an issue regarding the exercise of good faith by the manager. The LLC prevailed on its argument that it did not owe Meder a fiduciary duty. The court acknowledged that the majority owner as the sole manager owed a fiduciary duty to the LLC and its members, but concluded that it would make no sense to hold the LLC responsible for a manager’s breach of a fiduciary duty to the LLC and its members. The court cited case law from other jurisdictions holding that a corporation owes no fiduciary duty to its shareholders and held that an LLC owes no fiduciary duty to its members, either directly or vicariously for actions taken by its manager. The trial court thus erred in denying summary judgment in favor of the LLC on Meder’s breach of fiduciary duty claim. The court held that Meder breached the operating agreement by convincing a customer to withhold its business from the LLC by falsely informing the customer that the LLC was experiencing severe financial difficulties that had resulted in Meder’s termination. So long as Meder was a member or owner of the LLC, he was obligated under a provision of the operating agreement not to interfere with customer relationships of the LLC. The court held that the same conduct could not form the basis of a tortious interference claim, however, because Meder was an owner of the LLC rather than a stranger to the contract or business relationship. Finally, relying on the Georgia LLC statute, the court rejected the LLC’s argument that Meder breached a fiduciary duty to the LLC when he convinced the LLC’s customer to withhold business from the LLC. The LLC statute requires a member or manager, when managing the affairs of the LLC, to act in a manner the member or manager believes in good faith to be in the best interest of the LLC, but the statute also specifies that a non-manager member of a manager-managed LLC has no duties to the LLC or the other members solely by reason of acting as a member unless otherwise provided by the articles of organization or a written operating agreement. Based on this statutory provision, the court held that a non-managing member in a manager-managed LLC owes no duties to the LLC or other members. The court stated that such duties may be imposed in the operating agreement or articles of organization, but neither the operating agreement nor the articles of organization in this case did so. Thus, the trial court did not err in granting Meder summary judgment on the breach of fiduciary duty claim.

Blair v. McDonagh

177 Ohio App.3d 262, 894 N.E.2d 377, No. C-070238 (Ohio App. 2008)

Blair and McDonagh formed an LLC to operate Irish pub restaurants. Disputes developed, and litigation between the members ensued. The members asserted against each other various claims, including claims for breach of contract and breach of fiduciary duty. The jury returned a verdict in favor of McDonagh on all claims. On appeal, Blair argued that McDonagh’s breach of fiduciary duty claim was actually the LLC’s and could only be raised by the LLC. The court stated that there are circumstances under which a shareholder in a close corporation may bring an individual action, but the court found it unnecessary to reach that issue because Blair never raised the issue until he filed his motion for JNOV. Further, Blair asserted his own claim for breach of fiduciary duty; therefore, under his logic he, too, should have brought the claim in the name of the LLC. Instead, he named the LLC as a defendant. He requested and relied upon the instructions on breach of fiduciary duty and related damages, and the court held that any error was invited error. The court also rejected Blair’s argument that the evidence established that McDonagh breached his duty of good faith and fair dealing by refusing to consent to a line of credit that Blair had negotiated for the LLC and that was necessary for the good of the LLC. The court stated that an LLC, like a partnership, involves a fiduciary relationship that imposes on the members a duty to exercise the utmost good faith and honesty in all dealings and transactions with the LLC. Similarly, the court said that the parties to a contract owe each other a duty of good faith and fair dealing. The court found that McDonagh presented substantial evidence that he had acted in good faith and that he had withheld his consent for legitimate reasons, the most important of which was that Blair had refused to provide necessary financial information to evaluate the business and the necessity for the loan. Additionally, McDonagh’s loans to the LLC would have been subordinated to the line of credit loan. The court stated that McDonagh was not acting in bad faith when he failed to consent to the line of credit loan under these circumstances. Finally, the court held that the trial court did not err in ruling that $20 million in advances by McDonagh to the LLC were loans rather than capital contributions. The operating agreement provided that the members contemplated that additional requirements of the LLC would be met by a bank loan and/or capital contribution of McDonagh and that the LLC was authorized to accept additional capital contributions from McDonagh in such amount as the members deemed appropriate or necessary. Blair argued that these provisions showed the parties contemplated that McDonagh’s advances would be treated as capital contributions rather than loans. However, the operating agreement also provided that no member was required to make any further capital contribution or loan to the LLC. Thus, under the plain language of the agreement, McDonagh was permitted, but not required, to provide loans or capital, and the operating agreement did not show that McDonagh’s advances were necessarily capital contributions. The court concluded that there was evidence to support the trial court’s decision that McDonagh’s advances were intended by the parties to be loans based on evidence of how Blair treated the advances on the LLC’s tax returns, language on the memo line of the checks, and testimony of one of Blair’s accountants.

Todd v. Sullivan Construction LLC

191 P.3d 196, No. 33954 (Idaho 2008)

Todd and Sullivan formed an LLC to engage in masonry and concrete construction work, and Sullivan discovered that Todd and an employee of the LLC were planning to go into business together and that the employee used the LLC’s equipment and employees to do concrete jobs on the side for a corporation whom the LLC sought as a customer. The employee resigned, and Sullivan purchased Todd’s interest in the LLC. Todd and the former employee of the LLC then formed their own concrete construction company. The former LLC employee billed for the concrete work performed for the corporation whose business the LLC had sought, and the payments for that work were deposited in the account of the new company formed by Todd and the former LLC employee. Among the claims asserted by the LLC in ensuing litigation among the parties was a claim against Todd for willful misconduct. The trial court dismissed this claim, and the LLC appealed. The LLC alleged that Todd solicited business away from the LLC or otherwise usurped opportunities of the LLC for his personal benefit while still a member of the LLC and that this conduct was “willful misconduct” under the Idaho LLC statute because it was a breach of fiduciary duty to the LLC. The Idaho LLC statute provides that a member or manager shall not be liable to the LLC or the members for any action or failure to act on behalf of the LLC unless the act or omission constitutes gross negligence or willful misconduct. The court stated that the statute does not create a cause of action but rather sets forth a burden of proof for an LLC or its members to hold another member or manager liable for acts or omissions on behalf of the LLC. Both the LLC and Todd assumed that the statute applied to the LLC’s willful misconduct claim, though the court noted that it could certainly be argued that the conduct in issue was not taken on behalf of the LLC. The court analyzed whether the evidence that Todd had breached his fiduciary duty by soliciting business away from the LLC was sufficient to amount to willful misconduct. The trial court concluded that there was no proof that Todd engaged in “active” willful misconduct, but the court of appeals stated that the statute does not require proof of active willful misconduct – it only requires proof of willful misconduct. The court of appeals concluded that the trial court’s holding that there was sufficient evidence to support submission of the LLC’s tortious interference claim (which was based on the same alleged misconduct as the willful misconduct claim), and Todd’s failure to challenge the jury’s finding that Todd committed that tort, was inconsistent with the trial court’s directed verdict on the willful misconduct claim. The court stated that intentionally interfering with the LLC’s prospective business was willful misconduct, and, if there was sufficient evidence to show that Todd and the LLC’s employee were acting in concert to interfere with the LLC’s prospective business with respect to the jobs in issue, there was sufficient evidence that Todd himself usurped those business opportunities.

Kirksey v. Grohmann

754 N.W.2d 825, No. 24600 (S.D. 2008)

Four sisters inherited equal ownership in their family’s land and conveyed their ownership in the land to an LLC in exchange for equal ownership in the LLC. The LLC was formed to avoid paying certain estate taxes by employing a special use valuation, to keep the land in the family, and to keep ownership in the real property in the sisters and not their spouses. One sister, Grohmann, lived on the land and managed the LLC. Initially, the land was leased to Grohmann and two other sisters for livestock grazing, but one of the sisters sold her livestock to the other two, and Grohmann and Randell continued to lease the land from the LLC to graze livestock owned by them and preserve the special use valuation. Relations between the sisters became strained, and Kirksey and Ruby sought to terminate the grazing lease and dissolve the LLC after receiving an appraisal of the real estate indicating that it was worth over $3.2 million. At a meeting of the LLC members, Grohmann and Randell opposed motions to terminate the lease and dissolve the LLC. Major actions taken by the LLC required a majority vote of the members, and the parties were deadlocked. Kirksey and Ruby filed a suit for judicial dissolution on the basis that the LLC’s economic purpose was unreasonably frustrated and that it was not reasonably practicable to carry on the LLC’s business in conformity with the articles of organization or operating agreement. Kirksey argued that the strained relations made any major decisionmaking impossible. Kirksey further claimed that Grohmann and Randell had a personal financial interest in continuing the lease and preventing dissolution to the detriment of Kirksey and Ruby. The court examined the judicial dissolution provisions in the South Dakota LLC statute and discussed partnership and LLC case law in other jurisdictions addressing circumstances under which judicial dissolution was sought. The court examined the language of the operating agreement regarding the purpose of the LLC and stated that it was clear that the intended business was a livestock and farming operation. While there was no dispute that the ranching and livestock operation could continue despite the sisters’ dissension, the court stated that the question was whether it was reasonably practicable for the LLC continue in accordance with the operating agreement. Kirksey and Ruby argued that the livestock lease was no longer beneficial to the LLC because the rental rate was set when the land was worth considerably less. Grohmann and Randell argued that Kirksey and Ruby were aware of the nominal profit margin when the LLC was formed and that nothing had changed to make it impracticable for the LLC to continue. The court stated that the sisters formed the LLC with the understanding that they would have relatively equal say in the management and operation, but the court concluded that equality in decision making no longer existed because Grohmann and Randell had all the power with no reason to change the terms of a lease extremely favorable to them. Leaving half the owners with all the power in the operation of the LLC was not a reasonable and practicable operation of the business according to the court. The court said the deadlock impeded the continued function of the business in conformity with the operating agreement because there was no procedure to break a tie and protect the LLC in the event of changed conditions. As long as the LLC was under the control of and favorable only to half its members, the court found it could not be said to be reasonably practicable for it to continue in accordance with its operating agreement. The court also concluded that the economic purpose of the LLC was likely to be unreasonably frustrated, recognizing that there is little case law addressing this standard. The court acknowledged that forced dissolution is a drastic remedy but found that the deadlocked condition of the LLC and the inability of the sisters to communicate other than through their lawyers was unreasonably frustrating the economic purpose of the LLC. The court thus remanded for an order of judicial dissolution and winding up of the LLC.

Pravak v. Meyer Eye Group, PLC

No. 07-2433-JPM-dkv, 2008 WL 2951101 (W.D. Tenn. July 25, 2008)

Three ophthalmologists agreed to form an ophthalmology practice, and Dr. Pravak signed a letter of intent in which he agreed to become a member in a newly formed LLC. The three doctors signed the LLC’s lease agreement, a membership consent form, and a loan agreement, and Dr. Pravak was paid a “draw” by the LLC until the other two doctors began characterizing themselves as the only partners and ceased to characterize Dr. Pravak’s compensation as a “draw.” The LLC’s accountant indicated that she wished to recode all Dr. Pravak’s checks as contract labor, and the other two doctors asserted that the LLC did not have formal members without an operating agreement. Dr. Pravak filed suit alleging various causes of action, including breach of contract, tortious interference with contract, breach of fiduciary duty, civil RICO violations, and injunctive and declaratory relief. The court held that the letter of intent was a binding agreement between the parties and was not subject to a condition precedent. The essential terms and the parties’ subsequent conduct were sufficient to create a binding agreement. Thus, Dr. Pravak’s breach of contract claims were claims upon which relief could be granted, and the court declined to dismiss them. Dr. Pravak’s claim that the other two doctors interfered with the LLC’s obligations under the letter of intent failed because the other two doctors were also parties to the letter of intent. The court discussed fiduciary duties under the Tennessee LLC statute and case law and stated that Tennessee courts have interpreted the statutory language to mean that members owe fiduciary duties to a member-managed LLC but not to each other. The court stated that an exception to this general rule imposes a fiduciary relationship upon a majority owner of an LLC in his relationship to the minority owner, but that this case involved uncomplicated contractual duties and not a factual situation involving oppression by the majority of the minority. The court stated that the general rule that members of a member-managed LLC do not owe one another fiduciary duties applied in this case because the case did not stem from the expulsion of a minority member through the exploitation of the majority’s status as was the case in Anderson v. Wilder, the only Tennessee LLC case to impose a fiduciary duty based on oppression of the minority by the majority. The court thus dismissed the breach of fiduciary duty claims. The court dismissed Dr. Pravak’s RICO claim because the LLC could not be both the “person” and the “enterprise” in the alleged RICO violations. The court declined to dismiss the claims for declaratory and injunctive relief, which the defendants alleged could only be brought derivatively, because the allegations appeared to comply with the procedural requirements for derivative actions.

Connecticut Light and Power Company v. Westview Carlton Group, LLC

108 Conn. App. 633, 950 A.2d 522 (Conn. App. 2008)

(application of instrumentality veil piercing test to pierce veil of single member LLC).

Pharmalytica Services, LLC v. Agno Pharmaceuticals, LLC

C.A. No. 3343-VCN, 2008 WL 2721742 (Del. Ch. July 9, 2008)

(preliminary injunctive relief precluding member from acting on LLC’s behalf under rationale similar to issuance of status quo order).

Urban Hotel Development Company v. President Development Group, L.C.

535 F.3d 874, Nos. 07-2228, 07-2320 (8th Cir. (Mo.) 2008)

(removal of member under redemption provision of operating agreement; exercise of redemption/removal of member as not in violation of fiduciary duties; interpretation of provision specifying valuation of membership interest as member’s “actual tax basis”).

Mission Primary Care Clinic, PLLC v. Director, Internal Revenue Service

Civil Action No. 5:07cv162-DCB-JMR, 2008 WL 2789504, 102 A.F.T.R.2d 2008-5256 (S.D. Miss. July 17, 2008)

(analysis of payments by LLC to member as“wages or salary”of member acting as independent contractor for purposes of continuous levy provision of Section 6331(e) of Internal Revenue Code).

Ross v. Nelson

54 A.D.3d 258, 861 N.Y.S.2d 670 (N.Y. A.D. 1st Dept. 2008)

(propriety of removal of member-manager under operating agreement containing no specific removal provision).

Miceli v. KBRG of Statesville, LLC

No. 5:05CV265-V, 2008 WL 2945451 (W.D.N.C. July 24, 2008)

(dissolved LLC’s ability to defend lawsuit as part of winding up process).

Morris v. Hennon & Brown Properties, LLC

No. 1:07CV780, 2008 WL 2704292 (M.D.N.C. July 3, 2008)

(discussion of fiduciary duty principles under North Carolina law; lack of standing of LLC investor to assert claims in direct action).

Daines v. Vincent

190 P.3d 1269, No. 20060838 (Utah 2008)

(limited liability of LLC member).

Cosmopolitan Imports, LLC v. Pacific Funds, LLC

No. 59896-1-I, 2008 WL 2791983 (Wash. App. July 21, 2008)

(interpretation of agreement between members and analysis of member’s dealings with co-member as not in breach of fiduciary duties).

Hartford Insurance Company v. Ohio Casualty Insurance Company

189 P.3d 195, Nos. 57943-6-I, 58345-0-I (Wash. App. 2008)

(ability of administratively cancelled LLC’s insurer to pursue equitable contribution/subrogation claim for payment made on cancelled LLC’s behalf).