Tuesday, August 25, 2015
I know I am Johnny One Note on this, but while researching another project, I decided to check again if litigators (and courts) are still referring to veil piercing of LLCs as "corporate veil piercing." As I have noted before, for LLCs, it should be "piercing the LLC veil" or, more generally, "piercing the limited liability veil." Or "PLLV," as I like to call it. (Not as catchy is "PCV," but it is far more universally accurate.)
Sure enough, last week, a New York court refused to denied the defendants' motion to dismiss the plaintiff's third amended complaint, deciding that "Plaintiff has adequately pled facts sufficient to defeat the Individual Defendant's motion to dismiss Plaintiff's claim for piercing the corporate veil." Capital Inv. Funding, LLC v. Lancaster Grp. LLC, No. CIV.A. 8-4714 JLL, 2015 WL 4915464, at *7 (D.N.J. Aug. 18, 2015). But Plaintiff is seeking to piercing the veil of an LLC. As such, I think they need a fourth amended complaint.
Also last week, in an unpublished opinion, a Minnesota court upheld a decision to pierce the limited liability veil of Alpha Law Firm, LLC. The court found the court below "did not abuse its discretion by piercing Alpha's corporate veil." Guava LLC v. Merkel, No. A15-0254, 2015 WL 4877851, at *8 (Minn. Ct. App. Aug. 17, 2015). Again, though, the LLC did not have such a veil because it was not a corporation.
This should be easier to keep straight in Minnesota than most places. Minnesota has a statute the specifically allows for LLC veil piercing, and states that the corporate law concept applies to the LLC. But it also calls it "piercing the veil" in the LLC statute, which means the veil is an LLC veil, and not a corporate one. The statute:
. . . .
Subd. 2.Piercing the veil. The case law that states the conditions and circumstances under which the corporate veil of a corporation may be pierced under Minnesota law also applies to limited liability companies.
I am sympathetic (to a point). As Guava points out, when a statute brings corporate veil piercing into the LLC world, it can be awkward. Another excerpt from Guava makes that obvious:
Hansmeier next challenges the district court's decision to pierce on the merits. “In certain circumstances, it is possible to ‘pierce the corporate veil’ and hold a shareholder personally liable .” Gunderson v. Harrington, 632 N.W.2d 695, 705 (Minn.2001) (Gilbert, J., dissenting) (citing Victoria Elevator Co. of Minneapolis v. Meriden Grain Co., 283 N.W.2d 509, 512 (Minn.1979)). Veil piercing applies to LLCs as well as corporations. Minn.Stat. § 322B.303, subd. 2 (2014). A court may pierce a corporate veil when there is fraud or when the shareholder is the “alter ego” of the corporation. Gunderson, 632 N.W.2d at 705.
Hansmeier next challenges the district court's decision to pierce on the merits. “In certain circumstances, it is possible to ‘pierce the corporate veil’ and hold a shareholder personally liable .” Gunderson v. Harrington, 632 N.W.2d 695, 705 (Minn.2001) (Gilbert, J., dissenting) (citing Victoria Elevator Co. of Minneapolis v. Meriden Grain Co., 283 N.W.2d 509, 512 (Minn.1979)). A court may pierce a corporate veil when there is fraud or when the shareholder is the “alter ego” of the corporation. Id. at 705. Veil piercing applies to LLCs as well as corporations. Minn.Stat. § 322B.303, subd. 2 (2014). Thus, a court may pierce the veil of an LLC when there is fraud or when the member is the “alter ego” of the LLC. See Minn.Stat. § 322B.303, subd. 2 (2014); Gunderson, 632 N.W.2d at 705.
Tuesday, August 18, 2015
Over at the Kentucky Business Entity law blog, Thomas Rutledge discusses a recent decision from the United States District Court for the Southern District of Indiana, affirming a Bankruptcy Court decision that finding that when a member of an LLC with voting control personally files bankruptcy, that right to control the LLC became a vested in the trustee because the right was part of the bankruptcy estate. The case is In re Lester L. Lee, No. 4-15-cv-00009-RLY-WGH, Adv. Proc. No. 14-59011 (S.D. Ind. August 10, 2015) (PDF here).
A key issue was that the bankruptcy filer (Lester Lee) had 51% of the vote, but no shares. The court then explains:
7. . . . [t]he Operating Agreement states . . .
(D) Each member shall have the voting power and a share of the Principal and income and profits and losses of the company as follows:
Member’s Name (Share) (Votes)
Debra Jo Brown (20%) (10)
Brenda R. Lee (40%) (20)
Larry L. Lee (20%) (10)
Melinda Gabbard (20%) (10)
Lester L. Lee (0%) (51)
. . . .
8. . . . Trustee’s counsel became aware of the Debtor’s 51% voting rights as a member, and that pursuant to applicable law, “this noneconomic interest became property of the estate subject to control of the Trustee on the filing of the petition pursuant to 11 U.S.C. § 541.”
Here's Rutledge's take:
On appeal, the Court’s primary focus was upon whether the right to vote in an LLC constitutes “property of the estate,” defined by section 541(a)(1) of the Bankruptcy Code as “all legal or equitable interest of the Debtor in property as of the commencement of the case. After finding that Lee could be a “member” of the LLC notwithstanding the absence of any share in the company’s profits and losses or the distributions it should make, the Court was able to determine that Lee was a member. In a belt and suspenders analysis, the Court determined also that the voting rights themselves could constitute “economic rights in the company” affording him the opportunity to, for example, “ensure his continued employment as manager” thereof.
In a response to Rutledge's blog, Prof. Carter Bishop notes,
The court did not state the trustee could exercise those voting rights. The next step is crucial. If the operating agreement is an executory contract of a multi-member LLC, BRC 365 will normally respect LLC state law restrictions as “applicable law” and deny the trustee the right to exercise the debtor’s voting rights (similar outcome to a non-delegable personal service contract).This was a managing member of a multi-member LLC, so I assume BRC 365 blocks the trustee’s exercise.
Rutledge notes that could be the case, but it's also possible the Lee court was saying we already decided that -- voting rights are part of the estate.
I find all of this interesting and important to think about, especially given my limited bankruptcy knowledge. My main interest, though, is how might we plan around such a situation? Many LLC statutes provide some options.
For example, some states allow those forming an LLC to adopt a provision in the Operating Agreement that makes bankruptcy an event that triggers "an event of dissociation,” which would make the filer (or his or her successor in interest) no longer a member. See, e.g., Indiana Code sec. 23-18-6-5(b) ("A written operating agreement may provide for other events that result in a person ceasing to be a member of the limited liability company, including insolvency, bankruptcy, and adjudicated incompetency."). This raises the question, then, of whether the bankruptcy code trumps this LLC code such that the bankruptcy filing creates an estate that makes it so the state LLC law cannot operate to eliminate the filer as a member.
The answer is no, the state law doesn't trump the bankruptcy code, but the state provision can still have effect. A recent Washington state decision (petition for review granted), relying on Virginia law, determined that where state law dissociates a member upon a bankruptcy filing, the trustee cannot be a member, and thus the trustee cannot exercise membership rights:
[I]nstead of dissociating the debtor, Virginia law operated to dissociate the bankruptcy estate itself. The court concluded, “Consequently, unless precluded by § 365(c) or (e), his bankruptcy estate has only the rights of an assignee.
Given the similarities between Virginia's and Washington's treatment of LLC members who file for bankruptcy, we adopt the reasoning of Garrison–Ashburn [253 B.R. 700 (Bankr. E.D. Va. 2000)]. By applying Washington law, we conclude that RCW 25.15.130 dissociates a bankruptcy estate such that it retained the rights of an assignee under RCW 25.15.250(2), but not membership or management rights, despite the provisions of 11 U.S.C. § 541(c)(1).
The court then needed to decided whether § 365 allows a member to retain his or her membership. Under Washington partnership law, as applied to the bankruptcy code, the court explained:
under § 365, the other partners are not obligated to accept an assumption of the partnership agreement. Partnerships are voluntary associations, and partners are not obligated to accept a substitution for their choice of partner. The restraint on assumability also makes the deemed rejection provision of § 365 inapplicable to the partnership agreement. Therefore, § 365(e)'s invalidation of ipso facto provisions does not apply, and state partnership law is not superseded. The debtor-partner's economic interest is protected by other sections of the bankruptcy code, but he no longer is entitled to membership.
Wednesday, August 12, 2015
This weekend I will be in Panama filling in at the last minute for the corporate law session for an executive LLM progam. My students are practicing lawyers from Nicaragua, El Salvador, Costa Rica and Paraguay and have a variety of legal backgrounds. My challenge is to fit key corporate topics (other than corporate governance, compliance, M & A, finance, and accounting) into twelve hours over two days for people with different knowledge levels and experiences. The other faculty members hail from law schools here and abroad as well as BigLaw partners from the United States and other countries.
Prior to joining academia I spent several weeks a year training/teaching my internal clients about legal and compliance matters for my corporation. This required an understanding of US and host country concepts. I have also taught in executive MBA programs and I really enjoyed the rich discussion that comes from students with real-world practical experience. I know that I will have that experience again this weekend even though I will probably come back too brain dead to be coherent for my civil procedure and business associations classes on Tuesday.
I have put together a draft list of topics with the help of my co-bloggers and based in part on conversations with some of our LLM and international students who have practiced law elsewhere but who now seek a US degree:
Agency- What are the different kinds of authority and how does that affect liability?
Key issues for entity selection
- ease of formation
- ownership and control
- tax issues
- asset protection/liability to third parties for obligations of the business /piercing the veil of limited liability
- attractiveness to investors
- continuity and transferability
Main types of business forms in the United States
-Partnership/General and Limited
- C Corporation
- S Corporation
- Limited Liability Company
Fiduciary Duties/The Business Judgment Rule
Basic Securities Regulation/Key issues for Initial Public Offering/Basic Disclosures (students will examine the filings for an annual report and an IPO)
The Legal System in the United States
-how do companies defend themselves in lawsuits brought in the United States?
-key Clauses to Consider when drafting dispute resolution clauses in cross border contracts
Corporate Social Responsibility- Business and Human Rights
Enterprise Risk Management/What are executives of multinationals worried about?
Yes, this is an ambitious (crazy) list but the goal of the program is to help these experienced lawyers become better business advisors. Throughout the sessions we will have interactive exercises to apply what they have learned (and to keep them awake). So what am I missing? I would love your thoughts on what you think international lawyers need to know about corporate law in the US. Feel free to comment below or to email me at email@example.com. Adios!
August 12, 2015 in Business Associations, Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Human Rights, International Business, International Law, Lawyering, Litigation, LLCs, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (0)
Thursday, July 30, 2015
Last week I attended a panel discussion with angel investors and venture capitalists hosted by Refresh Miami. Almost two hundred entrepreneurs and tech professionals attended the summer startup series to learn the inside scoop on fundraising from panelists Ed Boland, Principal Scout Ventures; Stony Baptiste, Co-Founder & Principal, Urban.Us, Venture Fund; Brad Liff, Founder & CEO, Fitting Room Social, Private Equity Expert; and (the smartest person under 30 I have ever met) Herwig Konings, Co-Founder & CEO of Accredify, Crowd Funding Expert. Because I was typing so fast on my iPhone, I didn’t have time to attribute my notes to the speakers. Therefore, in no particular order, here are the nuggets I managed to glean from the panel.
1) In the seed stage, it’s more than an idea but less than a business. If it’s before true market validation you are in the seed round. At the early stage, there has been some form of validation, but the business is not yet sustainable. Everything else beyond that is the growth stage.
2) The friend and family round is typically the first $50-75,000. Angels come in the early stage and typically invest up to $500,000.
3) The seed rounds often overlap with angels and businesses can raise from $500,000 to $1,000,000. If you have a validated part of a business model but are not self funding then you are at Series A investment stage. You still need outside capital despite validation. The Series A round often nets between $3-5 million and then there are subsequent rounds for growth until the liquidity event which is either the IPO or acquisition.
4) Venture capitalists are investing their LPs' money and often the LP will co-invest with the VC. Their ultimate goal is for the company to get acquired or go public.
5) At the early stages some VCs will show a deal to other investors if it looks good. Later stage VCs will become more competitive and will keep the information and good deals to themselves.
6) It’s important to find a lead investor or lead angel to champion your idea.
7) Not all funding is helpful. Some panelists discussed the concepts of “fallen angels” or “devils,” which were once helpful but now are not providing value but still take up time and energy that could be better spent focusing on building the business. “False angels” are those who could never have been helpful in the first place.
8) You don’t want to be the first or the last check the angel is writing. You want to get references on the angel investor and see where they have invested and what their plan is for you.
9) There is smart money and dumb money. Smart money gives money and additional resources or value. Dumb money just gives money and nothing else. It’s passive and doesn’t jump into the business (note the panelists disagreed as to whether this was a good or bad thing). Another panelist noted the distinction between helpful and harmful money. Harmful people think they are helpful and give advice when they don’t have a lot to add but take up a lot of time. Sometimes helpful money just gives a check and then gets out of the way. It’s the people in between that can cause the problems.
10) VCs and angels invest in teams as well as ideas. They look for the right fit and a mix of veteran entrepreneurs, a team/product fit, a mix of technical and nontechnical people, professionals whose reputations and resumes can be verified. They want to know whether the people they are investing in have been in a competitive environment and have learned from success or failure.
11) Crowdfunding can be complicated because investors don’t meet the entrepreneurs. They see everything on the web so the reputation and the need for a good team is even more important.
12) Convertible notes are the “gold standard” according to one speaker and it’s the workhorse for funding. There was some discussion of safe notes, but most panelists didn't have a lot of experience with them and that was echoed this week by attorney David Salmon, who advises small businesses and holds his own monthly meetups. One panelist said that the sole purpose of safe notes was to avoid landmines that can blow up the company. Another panelist indicated that from an investor standpoint it’s like a blackhole because it’s so new and people don’t know what happens if something goes wrong.
13) The panelists indicated that businesses need to watch out for: the maturity date for their debt (how long is the runway); when can the investors call the note and possibly bankrupt the company; how will quirky covenants affect the next round of financing and where later investors will fall in line; and covenants that are easy to violate.
14) There was very little discussion of Regulation A+ but it did raise some interest and the possibility to raise even more funds from non-accredited investors. Only 3% of the eight million who can invest through crowdfunding actually do, so Reg A+ may help with that.
16) All of the panelists agreed that entities may start out as LLCs but they will have to convert to a C Corp to get any VC funding.
There was a lot more discussion but this post is already too long. Because I've never been an angel nor sought such funding, I don’t plan to provide any analysis on what I’ve typed above. My goal in attending this and the other monthly events like this was to learn from the questions that entrepreneurs ask and how the investors answer. Admittedly, most of my students won’t be dealing with these kind of issues, but I still introduce them to these concepts so they are at least familiar with the parlance if not all of the nuances.
July 30, 2015 in Business Associations, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Entrepreneurship, Financial Markets, International Business, Law School, Legislation, LLCs, Securities Regulation, Teaching | Permalink | Comments (0)
Wednesday, July 22, 2015
For a number of years now, I have been using group (3-person teams) oral midterm examinations in my Business Associations course. I have found these examinations to be an effective and rewarding assessment tool based on my teaching and learning objectives for this course. At the invitation of the Saint Louis University Law Journal, as part of a featured edition of the journal on teaching business associations law, I prepared a short article giving folks the "why, how, and what" of my experience in taking this approach to midterm assessment. The article was recently published, and I have posted it to SSRN. The abstract reads as follows:
I focus in this Article on a particular way to assess student learning in a Business Associations course. Those of us involved in legal education for the past few years know that “assessment” has been a buzzword . . . or a bugaboo . . . or both. The American Bar Association (ABA) has focused law schools on assessment (institutional and pedagogical), and that focus is not, in my view, misplaced. Until relatively recently, much of student assessment in law school doctrinal courses was rote behavior, seemingly driven by heuristics and resulting in something constituting (or at least resembling) information cascades or other herding behaviors.
In the fall of 2011, I began offering an oral midterm examination to students in my Business Associations course as an additional assessment tool. This Article explains why I started (and have continued) down that path, how I designed that examination, and what I have learned by using this assessment method for three years. Although some (probably most) will not want to do in their Business Associations courses exactly what I have done in mine (as to the midterm examination or any other aspects of the course described in this Article), I am providing this information to give readers ideas for, or courage to make positive changes in, their own teaching (for a course on business associations or anything else).
You may think I am crazy (even--or especially--after reading this article). Regardless, I do hope the article sparks something positive in you regarding your teaching in Business Associations or some other course. Since I am working on finishing a long-overdue book on teaching business associations for Aspen this summer, I would welcome your honest reactions to the article and your additional thoughts on assessment or other aspects of teaching Business Associations.
Friday, July 10, 2015
I’ve always been eager to do pro bono work. I went to law school with the intent of helping the indigent upon graduation, but then with a six-figure debt load, I went to BigLaw in New York and Miami, and then corporate America so that I could pay that debt off. But even as an associate and as in house counsel, I dutifully accepted pro bono cases. As a relatively new academic, I paid my way out of pro bono for the first couple of years as Florida allows and assuaged my guilt with the knowledge that my payments were going to fund the local legal aid office.
This year, as a condition of attending a family law CLE for free, I volunteered to take a case. I’ve devoted over 70 hours to it thus far, and we still aren’t finished even after today’s marathon 6.5 hour hearing dealing with a motion for contempt and enforcement, modification of alimony and child support, a QDRO (qualified domestic relations order), and a house in foreclosure. The case was complicated even according to my seasoned family law practitioner friends.
As a former litigator and current BA professor, I found that my skills helped to make up for my lack of family law expertise. The techniques for cross examining witnesses, preparing for hearing, and introducing exhibits came flooding back. From a BA perspective, knowing to ask questions about the structure of the petitioner’s LLC, inquiring about charging orders, and dissecting the financial statements and corporate tax returns put me in a much better position to protect my client’s interests. I always tell my students on the first day of BA that they never know where they will end up as practitioners, and that in today’s market many of them will be in small firms taking on a number of kind of clients. I try to make them understand how BA can help them in practice areas that don’t seem directly related to business. Now, thanks to this pro bono case I can back that up with proof from my own experience.
Wednesday, July 8, 2015
Last September, I authored a post here on the BLPB on judicial opinions and related statutes regarding LLCs as non-signatories to LLC operating agreements (simply termed "LLC agreements" in Delaware and a number of other states). I recently posted a draft of an essay to SSRN that includes commentary on that same issue as part of a preliminary exploration of the law on LLC operating agreements as contracts. (Readers may recall that I mentioned this work in a post last month on the Law and Society Association conference.) I am seeking comments on this draft, which is under editorial review at the SMU Law Review as part of a symposium issue of essays in honor of our departed business law colleague, Alan R. Bromberg, who had been an SMU Dedman School of Law faculty member for many years before his death in March 2014. My SSRN abstract for the essay, entitled "The Ties That Bind: LLC Operating Agreements as Binding Commitments," reads as follows:
This essay, written in honor and memory of Professor Alan R. Bromberg as part of a symposium issue of the Southern Methodist University Law Review, is designed to provide preliminary answers to two questions. First: is a limited liability company (“LLC”) operating agreement (now known under Delaware law and in certain other circles as a limited liability company agreement) a contract? And second: should we care either way? These questions arise out of, among other things, a recent bankruptcy court case, In re Denman, 513 B.R. 720, 725 (Bankr. W.D. Tenn. 2014).
The bottom line? An operating agreement may or may not be a common law contract. But that legal categorization may not matter for purposes of simple legal conclusions regarding the force and effect of operating agreements. A state’s LLC law may provide that LLCs are contracts or are to be treated as contracts in general or for specific purposes and may establish the circumstances in which operating agreements are valid, binding, and enforceable. However, in the absence of an applicable statute, the legal conclusion that an operating agreement is or is not a common law contract may matter in legal contexts that depend on the common law of contracts for their rules. In either case, the bar may want to participate in clarifying the status of operating agreements as binding commitments.
Any and all comments on the essay are welcomed. Comments that decrease the length of the essay are especially appreciated, since I am admittedly over the allotted word limit. (These essays are meant to be very short pieces so that many of us can contribute to honoring Alan.) Of course, there's always time to write another, lengthier piece on this topic later, if there's enough more to be said . . . .
Also, I will note that the Association of American Law Schools Section on Agency, Partnership, LLC's and Unincorporated Associations is planning a program on the role of contract in LLCs at the 2016 annual meeting in January. I have been asked to participate, and the panel promises to have some additional members that will attack the embedded issues from a number of interesting angles. Stay tuned for more on that.
Tuesday, July 7, 2015
Note to U.K. Supreme Court: LLCs Don't Have Places of Incorporation (But You're Right on Pass-Through Taxation)
A recent unanimous decision from the Supreme Court of the United Kingdom, Anson v. Commissioners for Her Majesty’s Revenue and Customs  UKSC 44, determined that a U.S. limited liability company (LLC) formed in Delaware will be treated for U.K. tax purposes as a partnership, and not a corporation. This is a good thing, as it provides the LLC members the ability to reap more completely the benefits of the entity's choice of form.
What is not so good is that the court left unaddressed a lower court determination as follows, was quoted in para. 47:
“Delaware law governs the rights of the members of [the LLC] as the law of the place of its incorporation, and the LLC agreement is expressly made subject to that law. However, the question whether those rights mean that the income of [the LLC] is the income of the members is a question of domestic law which falls to be determined for the purposes of domestic tax law applying the requirements of domestic tax law ….” (para 71) (emphasis added)
An LLC does not have a place of incorporation! It has a place of formation. Here is the link to Delaware's Certificate of Formation, which is to be filed in accordance with the Limited Liability Company Act of the State of Delaware: https://corp.delaware.gov/llcform09.pdf. In contrast, you can find the Certificate of Incorporation, which is to be filed in accordance with the General Corporation Law of the State of Delaware, here: http://www.corp.delaware.gov/incstk.pdf.
I'm glad the high U.K. court recognized that partnership taxation status can be proper for a U.S. LLC. But, just as You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One, I wish they'd made clear that you can't incorporate an LLC.
Tuesday, May 19, 2015
Vice Chancellor Laster recently issued an opinion in In re Carlisle Etcetera, LLC (available here), that has the potential to encourage (or at least fail to punish) sloppy practices and unnecessarily expands equitable standing for judicial dissolution. In doing so, the case increases litigation risk for LLCs.
The case involves an LLC made up of two member parties that formed Carlisle Etcetera, LLC. (Carlisle): WU Parent and Tom James Co. (James). The LLC agreement called for a manager-managed board, that would serve as sole manager. WU Parent appointed two board designees, as did James. Board decisions required "unanimous approval." At some point, for tax reasons, WU Parent assigned its membership interest to WU Sub. Thereafter, Carlisle identified WU Sub as a 50% member interest in tax filings and the LLC's accountants referred to WU Sub as "an equal member" of the LLC. The parties discussed an updated LLC agreement that would have made clear that an initial member of the LLC could transfer ownership to a wholly owned affiliate that would retain membership status, though that agreement was never finalized.
[Please click below to read more.]
Thursday, April 2, 2015
Earlier this week I went to a really useful workshop conducted by the Venture Law Project and David Salmon entitled "Key Legal Docs Every Entrepreneur Needs." I decided to attend because I wanted to make sure that I’m on target with what I am teaching in Business Associations, and because I am on the pro bono list to assist small businesses. I am sure that the entrepreneurs learned quite a bit because I surely did, especially from the questions that the audience members asked. My best moment, though was when a speaker asked who knew the term "right of first refusal" and the only two people who raised their hands were yours truly and my former law student, who turned to me and gave me the thumbs up.
Their list of the “key” documents is below:
1) Operating Agreement (for an LLC)- the checklist included identity, economics, capital structure, management, transfer restrictions, consent for approval of amendments, and miscellaneous.
2) NDA- Salmon advised that asking for an NDA was often considered a “rookie mistake” and that venture capitalists will often refuse to sign them. I have heard this from a number of legal advisors over the past few years, and Ycombinator specifically says they won't sign one.
3) Term Sheets- the seminar used an example for a Series AA Preferred Stock Financing, which addressed capitalization, proposed private placement, etc.
4) Independent Contractor Agreement- the seminar creators also provided an IRS checklist.
6) Employment Agreement- as a former employment lawyer, I would likely make a lot of tweaks to the document, and vey few people have employment contracts in any event. But it did have good information about equity grants.
7) Convertible Promissory Note Purchase Agreement- here's where the audience members probably all said, "I need an attorney" and can't do this from some online form generator or service like Legal Zoom or Rocket Lawyer.
8) Stock Purchase Agreement- the sample dealt with Series AA preferred stock.
9) IRS 83(b) form- for those who worry that they may have to pay taxes on "phantom income" if the value of their stock rises.
10) A detailed checklist dealing with basic incorporation, personnel/employee matters, intellectual property, and tax/finance/administration with a list of whether the responsible party should be the founders, attorney, officers, insurance agent, accountant, or other outside personnel.
What’s missing in your view? The speakers warned repeatedly that business people should not cut and paste from these forms, but we know that many will. So my final question- how do we train future lawyers so that these form generators and workshops don't make attorneys obsolete to potential business clients?
Thursday, March 19, 2015
Contrary to widespread belief, corporate directors generally are not under a legal obligation to maximise profits for their shareholders. This is reflected in the acceptance in nearly all jurisdictions of some version of the business judgment rule, under which disinterested and informed directors have the discretion to act in what they believe to be in the best long term interests of the company as a separate entity, even if this does not entail seeking to maximise short-term shareholder value. Where directors pursue the latter goal, it is usually a product not of legal obligation, but of the pressures imposed on them by financial markets, activist shareholders, the threat of a hostile takeover and/or stock-based compensation schemes.
Prof. Bainbridge is with Delaware Chief Justice Strine in that profit maximization is the only role (or at least only filter) for board members. As he asserts, “The relationship between the shareholder wealth maximization norm and the business judgment rule, . . . explains why the business judgment rule is consistent with the director's "legal obligation to maximise profits for their shareholders."
Chief Justice Strine has noted that the eBay decision, which I have written about a lot, says that "the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders." I think this is right, but I remain convinced that absent self-dealing or a “pet project,” directors get to decide that what is in the shareholders' best interests.
I have been criticized in some sectors for being too pro-business for my views on corporate governance, veil piercing law, and energy policy. In contrast, I have also been said to be a “leftist commentator,” in some contexts, and I have been cited by none other than Chief Justice Strine as supporting a “liberal” view of corporate norms for my views on the freedom of director choice.
When it comes to the Business Judgment Rule, I think it might be just that I believe in a more hands-off view of director primacy more than many of both my “liberal” and “conservative” colleagues. Frankly, I don’t get too exercised by many of the corporate decisions that seem to agitate one side or the other. I thought I’d try to reconcile my views on this in a short statement. I decided to use the model from This I Believe, based on the 1950s Edward R. Murrow radio show. (Using the Crash Davis model I started with was a lot less family friendly.) Here’s what I came up with [Author's note, I have since fixed a typo that was noted by Prof. Bainbridge]:
I believe in the theory of Director Primacy. I believe in the Business Judgment Rule as an abstention doctrine, and I believe that Corporate Social Responsibility is choice, not a mandate. I believe in long-term planning over short-term profits, but I believe that directors get to choose either one to be the focus of their companies. I believe that directors can choose to pursue profit through corporate philanthropy and good works in the community or through mergers and acquisitions with a plan to slash worker benefits and sell-off a business in pieces. I believe that a corporation can make religious-based decisions—such as closing on Sundays—and that a corporation can make worker-based decisions—such as providing top-quality health care and parental leave—but I believe both such bases for decisions must be rooted in the directors’ judgment such decisions will maximize the value of the business for shareholders for the decision to get the benefit of business judgment rule protection. I believe that directors, and not shareholders or judges, should make decisions about how a company should pursue profit and stability. I believe that public companies should be able to plan like private companies, and I believe the decision to expand or change a business model is the decision of the directors and only the directors. I believe that respect for directors’ business judgment allows for coexistence of companies of multiple views—from CVS Caremark and craigslist to Wal-Mart and Hobby Lobby—without necessarily violating any shareholder wealth maximization norms. Finally, I believe that the exercise of business judgment should not be run through a liberal or conservative filter because liberal and conservative business leaders have both been responsible for massive long-term wealth creation. This, I believe.
Thursday, February 12, 2015
My seventy business associations students work in law firms on group projects. Law students, unlike business students, don’t particularly like group work at first, even though it requires them to use the skills they will need most as lawyers—the abilities to negotiate, influence, listen, and compromise. Today, as they were doing their group work on buy-sell agreements for an LLC, I started drafting today’s blog post in which I intended to comment on co-blogger Joan Heminway’s post earlier this week about our presentation at Emory on teaching transactional law.
While I was drafting the post, I saw, ironically, an article featuring Professor Michelle Harner, the author of the very exercise that my students were working on. The article discussed various law school programs that were attempting to instill business skills in today’s law students. Most of the schools were training “practice ready” lawyers for big law firms and corporations. I have a different goal. My students will be like most US law school graduates and will work in firms of ten lawyers or less. If they do transactional work, it will likely be for small businesses. Accordingly, despite my BigLaw and in-house background, I try to focus a lot of the class discussion and group work on what they will see in their real world.
I realized midway through the time allotted in today’s class that the students were spending so much time parsing through the Delaware LLC statute and arguing about proposed changes to the operating agreement in the exercise that they would never finish in time. I announced to the class that they could leave 10 minutes early because they would need to spend at least another hour over the next day finishing their work. Instead most of the class stayed well past the end of class time arguing about provisions, thinking about negotiation tactics with the various members of the LLC, and figuring out which rules were mandatory and which were default. When I told them that they actually needed to vacate the room so another class could enter, a student said, “we just can’t get enough of business associations.” While this comment was meant to be a joke, I couldn’t help but be gratified by the passion that the students displayed while doing this in-class project. I have always believed that students learn best by doing something related to the statutes rather than reading the dry words crafted by legislators. My civil procedure students have told me that they feel “advanced” now that they have drafted complaints, answers, and client memos about Rule 15 amendments.
I am certainly no expert on how to engage law students, but I do recommend reading the article that Joan posted, and indeed the whole journal (15 Transactions: Tenn. J. Bus. L. 547 (2014). Finally, please share any ideas you have on keeping students interested in the classroom and prepared for the clients that await them.
February 12, 2015 in Business Associations, Business School, Conferences, Corporations, Delaware, Joan Heminway, Law School, LLCs, Marcia Narine, Negotiation, Teaching, Unincorporated Entities | Permalink | Comments (1)
Wednesday, January 7, 2015
I had very limited time at AALS this year (unfortunately) but I still walked away with some great ideas (and a chance to say hello to a few, but not enough, friendly faces). I am borrowing from many ideas shared in the panel cited below, as well as a few of my own. As many of you prepare to teach BA/Corporations for the spring (or making notes on how to do it next time), here are a few fun new resources to help illustrate common concepts:
- HBO's The Newsroom. A hostile takeover, negotiations with a white knight-- all sorts of corporate drama unfolded on HBO's Season 3 of The Newsroom. I couldn't find clips on youtube, but episode recaps (like this) are available and provide a good reference point/story line/hypo/exam problem for class.
- Related, for those of you who teach or encourage the use of Bloomberg services, the Bloomberg terminal was even featured prominently in the season.
- This American Life-- Wake Up Now Act 2 (Dec. 26, 2014). This brief radio segment/podcast tells the story of two investors trying to reduce the pay of a company CEO. The segment discusses board of director elections, board duties, board functions and set up some large questions about whether or not shareholders are the owners of the corporation and their profit maximization is the ultimate goal for a company. This could be followed with Lynn Stout's 2012 NYT Dealbook article proposing the opposite view.
- HBO's Silicon Valley. For all things tech, start up, entrepreneurship and basic corporate formation, clips (you will want to find something without all of the swears, I suspect) and episode recaps from this popular show illustrate concepts and connect with students. Again, great for discussion, hypos, and exam fact patterns.
- The Shark Tank!. I have to thank Christyne Vachon at UD for this idea. There are tons of clips on youtube and most offer the opportunity to talk about investors bringing different things to the table, how to apportion control, etc. Here is an episode involving patent issues. I think that I am going to open my experiential Unincorporated/Drafting class with a Shark Tank clip on Monday.
- Start Up Podcasts. These 30-minute episodes cover a wide range of topics. Here is one podcast on how to value a small business. At a minimum, I will post some of these to my course website this spring. (Thank you Andrew Haile at Elon for this recommendation.).
- Planet Money. The podcasts are a great resource, but what I love is the Planet Money Twitter page because it is a great way to digest daily news, current events and topical developments that may be incorporated into your class.
- Wall Street Journal--TWEETS. (that felt like an oxymoron to write). Aside from the obvious, I find the Twitter feed to be the most useful way to use/monitor the WSJ. I will admit it, I don't "read" it every day, but this is my proxy.
Special thanks to the participants in the Agency, Partnership & the Law's panel on Bringing Numbers into Basic and Advanced Business Associations Courses: How and Why to Teach Accounting, Finance, and Tax
Moderator: Jeffrey M. Lipshaw, Suffolk University Law School
Lawrence A. Cunningham, The George Washington University Law School
Andrew J. Haile, Elon University School of Law
Usha R. Rodrigues, University of Georgia School of Law
Christyne Vachon, University of North Dakota School of Law
Eric C. Chaffee, University of Toledo College of Law
Franklin A. Gevurtz, University of the Pacific, McGeorge School of Law
And Happy New Year BLPB Readers!
Tuesday, January 6, 2015
Over at The Conglomerate, Usha Rodrigues says, "Larry Ribstein was wrong." Usha argues that she's right to teach LLCs at the end of the course, and Larry was of the mind that LLCs should play a more prominent role in the business entities course.
For my teaching, I'm with Larry on this, though I am also of the mind that Usha (and other teachers) may have different goals, so taking another tack is not wrong. I'm pretty sure we're all better teachers when we are true to ourselves and our thinking. For me, anyway, I am, without a doubt, at my worst in the classroom (and probably out) when I try to mimic someone else.
So here's how Usha explains her thinking:
I don't leave LLCs til the end of the semester because I think they're unimportant. It's because the cases are so damn thin. It's still such a new form, I just don't see much there there. Most of them wind up being trial courts who read the statute in completely stupid ways. Blech.
So I teach corporations and partnerships emphasizing fiduciary duty, default vs. mandatory rules, and the importance of the code. In fact, one semester I confess that I would ask a question and then intone, "Look to the code!" so often I felt like a Tolkien refugee. By the time I get to the LLCs cases, which are pretty basic, the class is ready for my message: the LLC is a new form. When dealing with something new, judges look both to the organizational statutes and to the organizational forms they know as they shape the law. Plus the LLC is such an interesting mix between the corporate and partnership form, it just makes sense to get through them both before diving in.
It's hard to argue with Usha's rationale. Like Larry, she's smart, and this is a reasonable take. For me, though, it doesn't work toward my goals, so I have a different point of view. I think it's more in line with where Larry was coming from, though I admit I don't know.
Here's why: I want students (and lawyers and courts) to treat LLCs as unique entities. Leaving them to the end of the course reinforces the idea that LLCs are hybrid entities the combine partnerships and corporations. I just don't think that's the right way to think about LLCs.
Certainly, it is true that LLCs share characteristics of partnerships and corporations. But partnerships and corporations can have similarities, too. We can, for example, refer back to the partnership case of Meinhard v. Salmon when discussing corporate fiduciary duties and corporate opportunity.
In my experience, teaching LLCs at the end of the course seemed to frame the LLC as an entity that is just pulling from partnership or corporate law. As such, it seemed the students were thinking that the real challenge for LLCs was figuring out whether to pull from partnership law or corporate law for an analogy. Part of the reason for that, I think, is that so many of the LLCs cases seem to think so, too. See, e.g., Flahive. As Usha would say, "Blech."
The LLC is prominent enough in today's world that I think it warrants a more prominent role in the introductory business organizations course. If we don't bring the LLCs more to the fore, we allow courts to continue to misconstrue the entity form, in part because we aren't giving students the tools they need to ensure courts understand the unique nature of the LLC.
I figure Usha can get students where she needs to on this regardless of how she teaches business associations. She is a lot smarter than I am. Given my goals and how I think about the LLC, though, I'll keep starting my class with an introduction to LLC formation, and I'll keep teaching LLC cases and issues throughout the semester.
Tuesday, December 30, 2014
I continue to document how courts (and lawyers) continue to conflate (and thus confuse) LLCs and corporations, so I did a quick look at some recent cases to see if anything of interest was recently filed. Sure enough, there are more than few references to "limited liability corporations" (when the court meant "limited liability companies." That's annoying, but not especially interesting at this point.
One case did grab my eye, though, because because of the way the court lays out and resolves the plaintiffs' claim. The case is McKee v. Whitman & Meyers, LLC, 13-CV-793-JTC, 2014 WL 7272748 (W.D.N.Y. Dec. 18, 2014). In McKee, theplaintiff filed a complaint claiming several violations of the Fair Debt Collection Practices Act against defendants Whitman & Meyers, LLC and Joseph M. Goho, who failed to appear and defend this action, leading to a default judgment. After the default judgment was entered, defense counsel finally responded.
This case has all sorts of good lessons. Lesson 1: don't forget that all named parties matter. Get this:
Defense counsel admits that he was under the mistaken assumption that default was to be taken against the corporate entity only. See Item 17. However, default was entered as to both the corporate and individual defendants on July 3, 2014 (Item 9). Defense counsel did not move to vacate the default and in fact did not respond in any way until the default judgment was entered on September 17, 2014. Item 12. Even then, the defense motion was framed as one for an extension of time in which to file an answer (Item 14), rather than a motion to vacate the default or default judgment. Inexplicably, in his papers, defense counsel states that a default judgment has not been entered. See Item 17. Since good cause is to be construed generously and doubts resolved in favor of the defaulting party, see Enron Oil Corp., 10 F.3d at 96, the court will accept the explanation of defense counsel as evidence of a careless lack of attention to procedural detail rather than an egregious and willful default on the part of defendant Goho [the individual and apparent owner of the LLC].
Tuesday, December 9, 2014
The New York Times reports that LLCs have the ability to do things in New York politics that corporations cannot do:
For powerful politicians and the big businesses they court, getting around New York’s campaign donation limits is easy.
. . .
Corporations like Glenwood are permitted to make a total of no more than $5,000 a year in political donations. But New York’s “LLC loophole” treats limited-liability companies as people, not corporations, allowing them to donate up to $60,800 to a statewide candidate per election cycle. So when Mr. Cuomo’s campaign wanted to nail down what became a $1 million multiyear commitment — and suggested “breaking it down into biannual installments” — the company complied by dividing each payment into permissible amounts and contributing those through some of the many opaquely named limited-liability companies it controlled, like Tribeca North End LLC.
It may appear unseemly to allow LLCs to do things corporations cannot do, but (as usual) I bristle at the implication that LLCs should be treated like corporations just because they are limited-liability entities. Perhaps LLCs and corporations should be treated the same for campaign purposes (and I am inclined to think they should be), but there are lots of reasons to treat LLCs differently than corporations, and it is not inherently "a loophole" when they are treated differently.
A loophole is an ambiguity or inadequacy in the law. Here, the different treatment is not an ambiguity, though it is inadequate to limit funding in campaigns. However, it is not at all clear that the intent was to limit funding through LLCs. The law was likely passed so that the legislature could say it did something to reform finance. It did -- it closed the door for corporations and opened the door for LLCs. Playing entity favorites is permissible, even if it's not sensible.
LLCs and corporations are different entities, and different rules for different entities often makes a whole lot of sense. And even when it doesn't make sense, the idea that different entities should have different rules still does. Let's not conflate the two concepts, even when decrying the impact.
Tuesday, December 2, 2014
Okay, so limited liability is probably not going away, though it appears that some would have it that way. "Eroding" is probably a better term, but that's less provocative.
In a piece at Forbes.com Jay Adkisson has posted his take on the Greenhunter case (pdf here), which I wrote about here. Mr. Adiksson is a knowledgeable person, and he knows his stuff, but he seems okay with the recent development of LLC veil piercing law in a way that I am not. For me, many recent cases similar to Greenhunter are off the mark, philosophically, economically, and equitably, in part because they run contrary to the legislation that created things like single-member LLCs.
One of my continuing problems with this case (as is often my problem with veil piercing cases), is that there are often other grounds for seeking payment other than veil piercing. Conflating veil piercing with other theories makes veil piercing and other doctrines murkier. More important, they make planning hard. Neither of these outcomes is productive.
In Greehunter, Adkisson notes the court’s determination of the “circumstances favoring veil piercing.” To begin:
+ There was a considerable overlap of the LLC’s and Greenhunter’s ownership, membership (which is really the same thing), and management. Plus, they used the same mailing address for invoices, and their accounting departments were the same folks.
Okay, first, a shared mailing address is a ridiculous test if we're going to allow subisidiaries at all. Sharing an address or even sharing an accounting department shouldn't really matter for veil piercing. This is really more of an enterprise liability-type issue, though the vertical nature of the entity relationship admittedly makes that harder. However, because an LLC doesn't have to follow formalities this is an absurd test. These facts also don’t, in any way, harm the plaintiffs. Make an agency claim or some other type of guarantor/reliance argument if there is one.
+ The LLC didn’t have any employees of its own, but instead relied upon Greenhunter’s employees to actually do things, including to pay creditors.
So what? Would this be true of a joint venture between partnerships? How about if there were just two LLC members – two people who never worked as employees the entity? Should veil piercing be okay then? No. If there is an agency claim, make that. If there is a guarantor claim, make that one. But this is not enough.
+ The LLC really didn’t have any revenue separate from Greenhunter, since the LLC simply passed through all the revenue to Greenhunter, and Greenhunter only kicked back enough money to the LLC to pay particular bills.
So the LLC would not have any money at all but for that which was put into it by the corporation. This was the structure at the time of deal and the set up at all times. If the creditor plaintiff were concerned, they should have raised that issue (and taken appropriate measures) earlier.
+ Although the LLC contracted with Western to procure services for the benefit of the wind farm, it was Greenhunter that claimed a $884,092 deduction for that project on its tax return.
This is how pass-through tax entities work. If pass-through taxation should not be allowed or single-member LLCs should not be allowed, then fine, but that’s a policy question to be raised with the legislature.
+ Greenhunter manipulated the assets and liabilities of the LLC so that Greenhunter got all the rewards and benefits (including tax breaks), but the LLC was stuck with the losses and liabilities.
This implies something was improperly taken from the LLC, but that's not really explained. If there was an improper transfer of value out of the LLC that should have available for the creditors, then the corporation should have to put those funds (that value) back into the LLC for purposes of creditors. That’s not veil piercing. If there’s not some kind of value that could be transferred back, then the claim doesn’t make sense.
Mr. Adkisson continues:
If one looks a veil piercing law as fundamentally comprising two elements: (1) unity of ownership, and (2) the entity was used as a vehicle to commit some wrong, then the single-member LLC (and the sole shareholder corporation) starts out with one foot in the veil piercing grave.
This is exactly why single-member LLCs are fundamentally lousy asset protection vehicles, despite the gazillion ads appearing in sports pages and classifieds advertising “Form an LLC for Asset Protection!”
This doesn’t mean that single-member LLCs should never be used; to the contrary, they are frequently and properly used in a number of situations for reasons other than liability protection.
First, I suppose this would be right if the premise were accurate, but I don’t see it this way. I don't think a “unity of ownership” is the first element for veil piercing. The above explanation is thus incomplete, and if a court follows it, the court would be wrong because it would be skipping the actual first part of the veil-piercing test. The Greenhunter case explains the proper test:
The veil of a limited liability company may be pierced under exceptional circumstances when: (1) the limited liability company is not only owned, influenced and governed by its members, but the required separateness has ceased to exist due to misuse of the limited liability company; and (2) the facts are such that an adherence to the fiction of its separate existence would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity.
The Greenhunter court even quotes another recent Wyoming case in explaining the rule:
Before a corporation’s acts and obligations can be legally recognized as those of a particular person, and vice versa, it must be made to appear that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of such person and corporation has ceased, and that the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice.
Ridgerunner, LLC v. Meisinger, 2013 WY 31, ¶ 14, 297 P.3d 110, 115 (Wyo. 2013) (quotation marks and citations omitted).
Thus, it is more than a unity of ownership. There needs to be no separate or individual nature for the entity to satisfy the first prong. It’s not in any way a simple ownership test.
Second, I agree that LLCs are hardly perfect for asset protection and I agree that LLCs or other separate entities can be useful for reasons other than liability protection. Still, I find the idea that an LLC – a limited liability company – should be used for something other than “liability protection” to be an odd assertion. One can more easily set up a general partnership or simply a division of an existing entity to accomplish goals of separateness, if that’s the only point. Thus, one may choose an LLC for more than just limited liability purposes, but there’s no reason limited-liability protection wouldn't be a reason to choose an LLC.
The outcome of this case is, frankly, far less concerning to me than the rationale being put forth both in the case and some of the following analysis. I have to admit much of Mr. Adkisson’s analysis is consistent with how many courts see it. I just continue to believe we can do better in the development of veil piercing doctrine, and if we did, we'd see less need for it.
Creditors working with limited liability entities need to treat those entities as such. Ask the parent entity (or an owner) for a guarantee, get a statement of guaranteed funding, or seek some other type of reassurance.
As for courts, if you plan to pierce the veil of an LLC, fine, but please justify the veil piercing using specific reasons through specific application of the facts to the law. It’s more than unity of ownership, and it’s more than an inability to pay. Steve Bainbridge once noted (citing Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519, 524 (7th Cir. 1991):
As one court opined, “some ‘wrong’ beyond a creditor’s inability to collect” must be shown before the veil will be pierced.
At least, that’s supposed to be the rule. I hope it still is.
Tuesday, November 18, 2014
I’m starting to think that courts are playing the role of Lucy to my Charlie Brown, and proper description of LLCs is the football. In follow up to my post last Friday, I went looking for a case that makes clear that an LLC’s status as a disregarded entity for IRS tax purposes is insufficient to support veil piercing. And I found one. The case explains:
Plaintiff . . . failed to provide any case law supporting his theory of attributing liability to Aegis LLC because of the existence of a pass-through tax structure of a disregarded entity. Pl.'s Opp'n. . Between 2006 and 2008, when 100% of Aegis LLC's shares were owned by Aegis UK, Aegis LLC was treated as a disregarded entity by the IRS and the taxable income earned by Aegis LLC was reflected in federal and District of Columbia tax returns filed by Aegis UK. Day Decl. Oct. 2012 [48–1] at ¶ 37. In the case of a limited liability corporation with only one owner, the limited liability corporation must be classified as a disregarded entity. 26 C.F.R. § 301.7701–2(c)(2). Instead of filing a separate tax return for the limited liability corporation, the owner would report the income of the disregarded entity directly on the owner's tax return. Id. Moreover, determining whether corporate formalities have been disregarded requires more than just recognizing the tax arrangements between a corporation and its shareholders. See United States v. Acambaro Mexican Restaurant, Inc., 631 F.3d 880, 883 (8th Cir.2011). Given the above analysis, the undersigned finds that there is no unity of ownership and interest between Aegis UK and Aegis LLC.
As Charlie Brown would say, "Aaugh!"
So the case makes clear, as I was hoping, that it is not appropriate to use pass-through tax status to find a unity of interest and ownership in a way that will support veil piercing. But the court then screws up the description of the very nature of LLCs. This is not a “case of a limited liability corporation!” It's a case of a limited liability company, which is a not a corporation.
Moreover, to use the court’s language, while it is true that “determining whether corporate formalities have been disregarded requires more than just recognizing the tax arrangements between a corporation and its shareholders,” the premise of the case has to do with an LLC’s status. Thus, the court should, at a minimum, make clear it knows the difference. The statement, then, would go something like this: "Determining whether LLC formalities have been disregarded requires more than just recognizing the tax arrangements between an LLC and its members.”
It’s worth noting the entity formalities for LLCs are significantly less that those of corporations, so the formalities portion of LLC veil piecing test should be minimal, but that's a different issue.
Anyway, like Charlie Brown, I will keep kicking at that football, expecting, despite substantial evidence to the contrary, that one day it will be there for me to kick. At least I don't have to go it alone.
Friday, November 14, 2014
The Supreme Court of Wyoming recently decided to pierce the limited liability veil of a single-member LLC. Green Hunter Wind Energy, LLC (LLC), had a single member: Green Hunter Energy, Inc. (Corp). LLC entered into a services contract with Western Ecosystems Technology, Inc. (Western). The court determined that veil piercing – thus allowing Western to recover LLC’s debts from Corp – was appropriate for several reasons. I think the court got this wrong. The case can be accessed here (pdf).
The court provides the following rule for piercing the veil of a limited liability company, providing three basic factors 1) fraud; 2) undercapitalization; and 3) “intermingling the business and finances of the company and the member to such an extent that there is no distinction between them.” The court noted that the failure to following company formalities was recently dropped as a factor by changes to the state LLC statute.
Here’s where the court goes wrong:
(1) As to undercapitalization, the court completely ignores the fact that Western freely contracted with the LLC with little to no cash. If Western wanted the parent Corp to be a guarantor, it could have required that. If Western thought LLC was acting as an agent for Corp, Western should have claimed that. It seems to me this is directly analogous to an actual parent-child relationship. Western contracted with adult (but penniless) child. Child didn't have money when the contract was signed or when the bill was submitted. Western then calls parent and says, "Pay up." Western is free to call, but parent can say, “No. You dealt with my kid, not me, and I didn't agree to this debt.”
(2) There is a better argument this should be different if this were a tort suit where Western did not choose to engage with the LLC, but that's not the case here. I don't see how Western can claim undercapitalization now when they had the opportunity to ask before the contract was formed. Western is the least cost avoider here and assumed the risk of dealing with a lightly capitalized company. It seems to me that should be part of the assessment. Undercapitalization is, as the court notes, “a relative concept.” The court cites potential abuse of LLC laws if they were to adopt such a rule that motivates companies to ask for guarantees. instead adopting a rule that could incentivize companies like Western actively avoid ask ingfor guarantees. Why? Because if you ask for a guarantee and are refused, it could be used against you later. But if you don’t ask, you may get to piece the veil and seek a windfall recovery by getting a post hoc guarantee that was not available via negotiation.
The court’s rationale is as follows:
It makes good business sense for a contract creditor to try to obtain a guarantee from the member or retainer from the limited liability company itself. But we are mindful of the reality of the marketplace that many businesses are not in a position—competitively or economically—to insist on guarantees. For that reason, we decline Appellant’s invitation to find piercing inappropriate in this case because Western did not protect itself from Appellant’s misuse of the LLC by attempting to obtain a guarantee or other form of security. To do so would invite abuse of entities, as is the case here.
No way. If you can’t “competitively or economically” secure a guarantee, then too bad. If the legislature wants to create guarantees or minimum capitalization requirements for all entities, fine. Otherwise, this is absurd.
(3) Further, Court state that "the district court correctly concluded that the LLC 'failed to adequately capitalize the LLC, that LLC was undercapitalized at all times relevant to this suit and the LLC lacks corporate assets." Wrong. Again, if Western knew the finances of LLC at the time of contracting (as it could and should have), then it wasn’t undercapitalized. LLC simply existed and Western did not seek to avoid the risk of dealing with such an entity.
More important, though LLCs cannot have “corporate assets.” It’s a limited liability company, not a corporation. Sheesh. I’ll add this one to my list of courts getting LLC distinctions wrong. (See, e.g., here, here, here, and here.) I would have loved to see the Supreme Court correct the district court on that, at least.
(4) The court incorrectly suggests that the tax filings of the parent corporation and a subsidiary LLC can be a factor in the veil piercing analysis. Sorry, but no. For a single-member LLC, for federal tax purposes, the LLC will probably be a disregarded entity. As such, the LLC will usually (if not always) look like part of the parent corporation. To even consider the tax filing necessarily makes one factor weigh toward piercing. That’s wrong.
Early in the opinion, the court notes, “Piercing seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled.” (quoting Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89 (1985) (internal quotation marks omitted)). In this case the court seems to be trying to make veil-piercing law in LLCs more predictable. I’m concerned they are – they are making is more likely the veil piecing will occur, at least in the single-member LLC context. To the extent we’re going to allow single-member LLCs, that’s unfortunate.
Thursday, November 13, 2014
1) Difference between LLCs, corporations and partnerships
2) Del. and ULLCA coverage of fiduciary duties, and especially the issue of contractual waiver and default
19) No right to distributions, and no right to vote for distributions if manager-managed
20) No right to salary or employment
21) Taxable liability for LLC membership
22) Exit rights—voluntary withdrawals vs. restricted withdrawals, and whether or not that comes with the ability to force the return of an investment or a new status as a creditor of the LLC
23) Liability for improper distributions
24) Veil piercing, particularly given the lack of corporate formalities
I would love some feedback from practitioners as well. What do law students and practicing lawyers need to know about LLCs? What's missing from this list? What should I get rid of? Please feel free to comment below or to email your thoughts to firstname.lastname@example.org.
November 13, 2014 in Business Associations, C. Steven Bradford, Corporate Personality, Corporations, Delaware, Law School, LLCs, Marcia Narine, Partnership, Teaching, Unincorporated Entities | Permalink | Comments (1)