September 2009 — Issue 43

Securities and Exchange Commission v. Lowery

633 F.Supp.2d 466 (W.D. Mich. 2009)

The SEC brought an action for violation of anti-fraud and registration provisions of the federal securities laws based on the sale of unregistered units in Colorado LLPs engaged in the online casino business. After the death of one of the two individual promoters of the venture, the SEC sought summary judgment against the other individual, a 77-year-old retired lawyer whose role was to develop and manage the online casinos. The court concluded that the LLP units were investment contracts, and thus securities, as a matter of law. The court noted the decision of the Eleventh Circuit Court of Appeals in SEC v. Merchant Capital that interests in a Colorado LLP were investment contracts, and thus securities, whenever any one of the following criteria is met: (1) the LLP is similar in structure to a limited partnership, meaning that the partners had to vote for a particular managing partner and had no practical ability to conduct the LLP’s business; (2) the partners had little or no experience in the business affairs of the LLP; or (3) the partners were so dependent on the unique entrepreneurial or managerial skill of the seller or promoter that they could not realistically replace him or exercise meaningful partnership powers. The court found all three criteria were satisfied in this case. The court discussed and relied upon the opinion of the government’s expert, who concluded that the investor/partners became passive investors in the LLPs by necessity and choice because the investors lacked the experience, interest, or ability to manage the partnership and, in any event, designated the deceased promoter as the managing partner. The expert also stated that, due to the partners’ limited liability, the partners had less of an incentive to be active in the business and affairs of the partnership than partners in a traditional partnership. Thus, the expert concluded that the presumption that partners have both the right and incentive to manage is not appropriate in an LLP. The expert further concluded that, even if the investors did not cede control to the deceased promoter, the investments would still be securities because the LLPs themselves were passive. The internet gambling sites, which were the ultimate source of any return, were owned and operated by the defendant and entities controlled by or affiliated with him, and the LLPs thus relied upon the defendant and his affiliates to realize a profit. After concluding that the LLP investments were securities as a matter of law, the court addressed the other elements of the registration and fraud counts and found that the defendant, who was proceeding pro se, failed to show a genuine issue of material fact as to any element.


U.S. Claims, Inc. v. Saffren & Weinberg, LLP

Civil Action No. 07-0543, 2009 WL 2179738 (E.D. Pa. 2009)

The court discussed the Pennsylvania LLP provisions and their application to claims against an LLP law firm partner, Weinberg, who argued he could not be held individually liable for any contracts or misrepresentations made by his partner, Saffern. The court examined the statutory provisions addressing liability in a Pennsylvania LLP and concluded that a partner in an LLP is liable for the partnership’s breach of contract executed by another partner and not the result of any error, omission, negligence, incompetence, or malfeasance by that partner. The complaint alleged that Saffern entered into acknowledgments of various purchase agreements, and the court concluded that it could not determine at this juncture of the litigation whether the breach of contract claims against Weinberg rested solely on wrongful acts of Saffern, with no involvement of Weinberg or the firm, or whether the claims were attributable to the partnership as a whole, making both partners individually liable. The court concluded that fraud claims against Weinberg sufficiently alleged that Weinberg committed or participated in the alleged fraudulent misrepresentations, noting that the LLP statute states that it does not affect the liability of a partner for any negligent or wrongful acts or misconduct committed by the partner or any person under the partner’s direct supervision or control.


Credit Suisse Securities (USA) LLC v. West Coast Opportunity Fund, LLC

C.A. No. 4380-VCN, 2009 WL 2356881 (Del. Ch. July 30, 2009)

Evans, an individual who was the sole member and manager of an LLC, signed a lock-up agreement in which he agreed not to pledge or transfer certain stock owned by the LLC for a specified period of time. The agreement was signed by the individual and did not refer to the LLC. Below the individual’s name, the title “Chief Executive Officer” appeared, but no company name was provided. The plaintiff sought a declaration that the lock-up agreement did not prohibit a pledge of the shares to the plaintiff. The defendant sought to avoid the pledge of the shares to the plaintiff based on the lock-up agreement. The court found that Evans executed the lock-up agreement in his personal capacity and that the agreement did not bind the LLC. The parties agreed that Evans signed the agreement in his personal capacity, and the court commented that the inclusion of the title “Chief Executive Officer” did not change the result because there was nothing on the face of the agreement to indicate an intent on the part of Evans to act in that capacity. The stock in question was the property of the LLC rather than Evans because a member has no interest in specific LLC property. Evans could not encumber property he did not own. The court addressed in a footnote the defendant’s argument that the LLC should be viewed as the alter ego of Evans and that the LLC should be estopped from pledging its shares in violation of the agreement. The court appeared to acknowledge the possibility that an LLC’s veil could be pierced, but stated that the defendant did not plead facts necessary to put the alter ego and equitable estoppel arguments at issue. The court stated that it was not the plaintiff’s burden to plead a negative, i.e., that the LLC was not inadequately capitalized. The court acknowledged that the defendant and Evans may have intended that the lock-up agreement prohibit the very conduct in which Evans engaged, but the court concluded the agreement did not indicate any intent to bind anyone other than Evans. The defendant argued that the agreement prohibited Evans from pledging shares regardless of who owned them by virtue of the phrase prohibiting transfers “directly or indirectly.” The court stated that it did not need to reach that question because its task was complete in determining that the LLC was not bound by the agreement and the defendant thus could not prevent the LLC’s transfer of its shares to the plaintiff. The court noted that it might well be that Evans violated the lock-up agreement by pledging the LLC’s shares, but Evans was not before the court, and determining whether he violated the agreement was not necessary.


Mickman v. American International Processing, LLC

Civil Action No. 3869-VCP, 2009 WL 2244608 (Del. Ch. July 28, 2009)

A member sought photocopies of the general ledgers of two LLCs under the Delaware LLC statute and LLC operating agreements. The court analyzed the provision in the LLC operating agreements, which provided members “access to all books and records” upon one day’s written notice. The court looked to the corporate context for guidance and concluded that “access to all books and records” includes the right to obtain photocopies of general ledgers. The court first concluded that the broad term “all books and records” includes general ledgers, noting that courts have construed the narrower terms “books and records” and “books of accounts” to include general ledgers. The court next discussed whether “access” included the right to obtain photocopies. Relying on cases in the corporate context, the court construed “access” to have its ordinary meaning, which includes the right to make photocopies. The court noted that the plaintiff satisfied the demand requirement under the operating agreements and that the operating agreements did not contain a proper purpose requirement. The court also commented that the plaintiff’s offer to enter a confidentiality agreement should minimize any genuine concern about an improper purpose. Because the LLC agreement provided the plaintiff with a contractual right to copies of the LLCs’ general ledgers, it was not necessary for the court to address the plaintiff’s additional arguments for inspection rights under the LLC statute. The court denied the plaintiff’s request for attorney’s fees and costs, finding that the LLCs did not act in bad faith or vexatiously in resisting the plaintiff’s demand because the LLCs had at least a colorable basis for denying that the plaintiff was a member.


In re LaHood (Heartland Bank and Trust Company v. Covey)

Bankruptcy No. 07-81727, Adversary No. 07-8156, 2009 WL 2169879 (Bankr. C.D. Ill. July 16, 2009)

In a prior opinion, the bankruptcy court determined that a lender’s judgment lien against an LLC member’s distributional interest was not valid because the charging order remedy in the Illinois LLC statute operates to the exclusion of all other remedies. The lender had obtained a pre-petition judgment against the debtor, and the lender served the debtor with a citation that impressed a lien upon the debtor’s personal property under Illinois judgment collection provisions. In this opinion, the court addressed the lender’s argument that the charging order provision of the LLC statute applies only to a distributional interest and that the lender’s judgment lien obtained under the general judgment collection provisions applied to the debtor’s membership interest. The lender emphasized the statutory distinction between a membership interest and a distributional interest and argued that, although it did not obtain a charging order so as to obtain a lien on the distributional interest, it nevertheless obtained a citation lien on the membership interest. The court stated that the lender’s implied argument that it somehow had the right to enforce its lien against the distributional interest, the only interest that mattered at this point, directly contradicted the plain language of the charging order provision. The lender’s argument implied that a creditor could bypass the exclusive procedure of the charging order provision and obtain a lien on a member’s distributional interest by obtaining a lien on the entire membership interest, which includes the distributional interest. Applying the rule of statutory construction that a specific provision controls over a more general one, the court concluded that the exclusive charging order provision in the LLC statute necessarily controlled over the more general statute providing for a citation lien on personal property. The court stated that the lender mischaracterized the court’s prior opinion as holding that the charging order provision operates to preclude a citation lien from attaching to a member’s non-economic rights, saying the issue was not presented on the facts of this case. The court said that non-economic rights were not at issue given the LLC’s dissolution, and the court questioned what good it would do the lender to have a lien on the debtor’s non-economic rights when it was his distributional interest that the trustee proposed to administer. The court commented that, even assuming a judgment creditor may obtain a lien on a member’s non-economic rights, lienor status does not entitle the creditor to exercise those rights. The court discussed the Illinios LLC charging order provisions and stood by its prior opinion that the “exclusive remedy” language of the statute must be interpreted as meaning “to the exclusion of all other remedies.” The court discussed two other Illinois cases addressed in its previous opinion, Dowling v. Chicago Options Associates, Inc. and Bobak Sausage Co. v. Bobak Orland Park, Inc., and stood by its view that Dowling did not speak to the issues before the court and that Bobak recognized that a broad reading of Dowling could not be reconciled with the charging order provisions. The court sated that if Dowling had any validity at all regarding LLC interests, it was valid only as it might apply to the forced sale of a member’s non-economic rights in an LLC. Even to that extent, the court pointed out that the court in Bobak was critical of Dowling, since the Bobak court did not view a public sheriff’s sale as the most appropriate way to sell a judgment debtor’s non-economic interest in an LLC.


JPMorgan Chase Bank, N.A. v. KB Home

632 F.Supp.2d 1013 (D. Nev. 2009)

Eight real estate companies formed an LLC for the purpose of acquiring and developing real estate, and the LLC entered a credit agreement. The LLC executed various collateral documents including an agreement under which it granted a security interest in acquisition agreements between the LLC and its members under which each member agreed to purchase specified portions of the land. The lender alleged that it had filed a financing statement perfecting its security interest in personal property, such as the acquisition agreements and the LLC operating agreement. The members allegedly refused to purchase the land as required under the acquisition and operating agreements, and the LLC defaulted under the credit agreement and collateral documents. The lender filed suit alleging causes of action for breach of contract against the members and their parent companies, breach of fiduciary duty against the members and their parent companies, intentional interference with contractual relationships against the parent companies, and constructive trust. The defendants claimed that the lender lacked standing to enforce the operating agreement and that the breach of contract claim against the members thus failed as to the operating agreement. The defendants argued that the operating agreement precluded enforcement of its provisions by a creditor and that none of the collateral documents contained an assignment of the operating agreement. Further, the defendants argued that the LLC could not pledge rights in the operating agreement because it was not a party. The court noted that the plain language of the operating agreement provided that no creditor could enforce its provisions, but the lender alleged that the collateral documents granted the lender a security interest in the operating agreement and that the lender could thus enforce any rights of the LLC under the operating agreement. (The lender argued that Sections 9406(4) and 9408(1) of the Nevada UCC rendered ineffective the provision of the operating agreement denying a creditor the right to enforce the operating agreement, but the court noted that, assuming this argument was correct, the lender had a security interest only if it was granted that right.) The lender relied upon language in the deed of trust, under which the LLC conveyed “all contract rights...relating to the Real Property.” Although the LLC was not a party to the operating agreement, the court stated that a provision granting the LLC a right to recover in the event of a default by a member or the general manager could be enforced by the lender if the LLC conveyed a security interest in those rights. The court thus analyzed whether the rights under the operating agreement related to the real property and concluded that the provision was ambiguous. Because it was not clear whether the parties intended to convey a security interest in the operating agreement, the lender’s claim for breach of the operating agreement survived the motion to dismiss. The court dismissed a portion of the breach of contract claim against the parent companies of the members of the LLC, finding that the lender’s claim for breach of contract failed insofar as it alleged a claim under contracts to which the parents were not parties and insofar as it alleged a tortious claim for breach of the implied covenant of good faith and fair dealing. The court stated that a tortious claim for breach of the implied covenant of good faith and fair dealing arises only in rare circumstances where there is a special element of reliance or fiduciary duty. Because the parties in this case were all sophisticated real estate developers and lenders who entered heavily negotiated documents, the court found such element lacking. The court denied the motion to dismiss insofar as it related to breach of contract claims against the parent companies under agreements the parent companies had signed as “guarantors.” The language of those agreements suggested that the parent companies signed only to acknowledge the members had rights and obligations, but use of the label “guarantor” suggested a guaranty of such obligations. Because the parties’ intent was not clear, the court refused to dismiss the claims based on these agreements. The court dismissed claims that the members breached fiduciary duties to the LLC because the operating agreement contained a provision that “neither the Members nor their respective Managers shall have any fiduciary duties to any other Member or Managers or [the LLC] or the General Manager.” The court noted that the Nevada legislature restricted the elimination of fiduciary duties for partnership agreements but not for LLC operating agreements and pointed out that Nevada had not adopted the provision of the Revised Uniform Limited Liability Company Act stating that an operating agreement may not eliminate the duties of loyalty or care or any other fiduciary duty. The court stated that an amendment of the Nevada LLC statute allowing an operating agreement to limit or eliminate any and all liabilities for breach of contract and breach of duties of a member, manager, or other person suggested that the Nevada legislature’s intent was to allow parties to an operating agreement to limit or eliminate fiduciary duties even though the provision did not take effect until October 1, 2009 (after the events in this case and after the court’s opinion). Because no allegation or contract demonstrated that the parent companies of the members were bound to act for the benefit of the LLC, the court also dismissed the breach of fiduciary duty claims against the parent companies. The court stated that directors of an insolvent corporation owe a fiduciary duty to the company’s creditors under the corporate case law of many states and concluded that “the Nevada Supreme Court would extend the insolvency exception to limited liability companies.” Based on allegations regarding the LLC’s insolvency and the management and control of the LLC, the court stated that it was possible that the defendant members and their parent companies caused the managers of the LLC to breach fiduciary duties, and the lender had stated a claim as it related to an alleged breach of fiduciary duty owed to the LLC’s lenders. With respect to claims for intentional interference with contractual relations against the parent companies of the members, the court noted that courts around the country have held that a parent corporation is privileged to interfere with contracts of its wholly-owned subsidiary if the contract threatens a present economic interest of the subsidiary unless there is clear evidence the parent employed wrongful means or acted with an improper purpose. The court stated that, even assuming the Nevada Supreme Court would adopt this privilege, dismissal of the claim for intentional interference with contractual relations was not appropriate because it was not clear from the complaint whether the parent companies intended to interfere solely based on their own self-interest or the interest of the members, or for some improper purpose or another reason.


Thompson v. United States

87 Fed.Cl. 728, 104 A.F.T.R.2d 2009-5381 (Ct. Cl. 2009)

(discussion of application of passive activity rules to LLC members and differentiation of LLC member from limited partner).


Bacarella Transportation Services, Inc. v. Right Way Logistics, LLC

639 F.Supp.2d 249 (D. Conn. 2009)

(inapplicability of statutory liability of member for assets distributed where there was no actual or de facto dissolution of LLC under Connecticut or Ohio law).


In re Aldape Telford Glazier, Inc.

410 B.R. 60 (Bankr. D. Idaho 2009)

(impropriety of sole member’s treating assets of dissolved LLCs as member’s own assets prior to completion of winding up under Idaho LLC statute; dismissal of member’s bankruptcy petition based on impermissible combining of financial affairs of separate entities).


Kerrigan v. Bourgeois

16 So.3d 612 (La. App. 2009)

(limited liability of LLC member under Louisiana law in absence of fraud, negligence, or wrongful conduct on part of member).


T.W. Herring Investments, LLC v. Atlantic Builders Group, Inc.

975 A.2d 264 (Md. App. 2009)

(actual and apparent authority of manager and person to whom authority is delegated by manager under North Carolina Limited Liability Company Act).


Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC

881 N.Y.S.2d 270 (App. Div. 4th Dept. 2009)

(member’s standing to seek dissolution of LLC notwithstanding member’s letter of resignation where lawyer purporting to represent LLC lacked authority to accept resignation and letter did not indicate whether it concerned member’s membership or employment).


Arfa v. Zamir

880 N.Y.S.2d 635 (App. Div. 1st Dept. 2009)

(interpretation of put provision in LLC operating agreement).


Roemmich v. Eagle Eye Development, LLC

633 F.Supp.2d 747 (D.N.D. 2009)

(admissibility of lay testimony regarding likelihood of collecting judgment against LLC member; inadmissibility of law professor expert testimony on efficacy and permissibility of foreclosure of charging order under North Dakota law).


Alvarez v. 9ER’s Grill @ Blackhawk, L.L.C.

Civil Action No. H-08-2905, 2009 WL 2252243 (S.D. Tex. July 28, 2009)

(application and effect of “enterprise” definition with respect to related LLCs under Fair Labor Standards Act).