Tuesday, March 20, 2018

At Least Mass. Court Knows LLCs Are Not Partnerships

My goodness. In a recent case, a Massachusetts court deals with issues related to Bling Entertainment, LLC, which is, as you would expect, a limited liability company.  It is NOT a partnership (as the court correctly notes), but ...

Yiming alleges Bling Defendants—as “managers, controlling members, and fellow members of Bling”—owed a duty of utmost good faith and loyalty to Yiming that they breached through their actions of fraud, self-dealing, embezzlement, and mismanagement. D. 16 ¶¶ 70-71. “It is well settled that partners owe each other a fiduciary duty of the utmost good faith and loyalty.” Karter v. Pleasant View Gardens, Inc., No. 16-11080-RWZ, 2017 U.S. Dist. LEXIS 50462, at *13 (D. Mass. Mar. 31, 2017) (quoting Meehan v. Shaughnessy, 404 Mass. 419, 433 (1989)). Bling is not a partnership, however, but is rather a limited liability corporation. D. 16 ¶ 10.
YIMING WANG, Plaintiff, v. XINYI LIU, YUANLONG HUANG, ZHAONAN WANG, BLING ENTERTAINMENT, LLC, SHENGXI TINA TIAN & MT LAW, LLC, Defendants., No. 16-CV-12581, 2018 WL 1320704, at *6 (D. Mass. Mar. 13, 2018).
Negative.  Well, the first part is right.  Bling is an LLC, not a partnership. But it is not a corporation.  This is where some readers are probably thinking, "there he goes again being overly formalistic."  I am, of course, in the realm, anyway, but here, it at least matters a little. Or could, and that's all that concerns me.  The court continued: 
Nevertheless, Yiming argues the same duty applies, which is correct if Bling were a closely held corporation. See, e.g., Demoulas v. Demoulas Super Mkts., 424 Mass. 501, 528-29 (1997) (explaining that in Massachusetts, close corporations shareholders owe one another the duty of utmost good faith and loyalty); Zimmerman v. Bogoff, 402 Mass. 650, 657 (1988). In Massachusetts, a closely held corporation is “typified by: (1) a small number of stockholders; (2) no ready market for corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation.”Demoulas, 424 Mass. at 529 n.34 (quoting Donahue v. Rodd Electrotype Co. of New Eng., Inc., 367 Mass. 578, 586 (1975)).
Id. You know what an LLC doesn't have?  Stockholders.  Or corporate stock. Or any stock for the matter.  The court had more to say: 
In this context, the duty of “utmost good faith and loyalty” applies to majority and minority shareholders alike. See Zimmerman, 402 Mass. at 657-58. Although Yiming did not affirmatively plead that Bling is a close corporation, he did plead that this duty applied to Bling Defendants. D. 16 ¶ 70. Bling Defendants did not contest that they owed a fiduciary duty to Yiming. See D. 26 at 8-9. Accordingly, the Court declines to dismiss this claim.
Id. But we have never established that an LLC owes fiduciary duties to anyone.  In Massachusetts, fiduciary duties apply for LLCs as we expect in all states, and the ability to modify or abrogate those duties are, unlike Delaware, limited (and perhaps very limited).  Nonetheless, it would be worth exploring that and explain the source of the duty.  The court never explores whether such duties apply to LLCs, and apparently the plaintiffs never even asserted that was the case.  
A quick look at Massachusetts law suggests the outcome here would likely be the same for LLCs, but still, can we please establish that?  If an issue warrants two paragraphs about partnerships and closely held corporations, one can spend a little time on the entity actually involved in the case.  I really don't feel like that's too much to expect. And yet my blog history very much suggests otherwise.  More work to do.  

March 20, 2018 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Tuesday, March 13, 2018

LLCs Are Not Corporations. Be Vigilant. Respect the Entity.

A recent Georgia case highlights a whole host of things that frustrate me with litigation related to limited liability companies (LLCs).  This one features an LLC making incorrect arguments and a court sanctioning that silliness. For example

Baja Properties argues that it is exempted from the rule set out in OCGA § 43-41-17 (b) by a provision in OCGA § 43-41-17 (h). Subsection (h) states, in part:
Nothing in this chapter shall preclude any person from constructing a building or structure on real property owned by such person which is intended upon completion for use or occupancy solely by that person and his or her family, firm, or corporation and its employees, and not for use by the general public and not offered for sale or lease. In so doing, such person may act as his or her own contractor personally providing direct supervision and management of all work not performed by licensed contractors.
Baja Properties, LLC v. Mattera, No. A17A1875, 2018 WL 1247432, at *2 (Ga. Ct. App. Mar. 9, 2018) (emphasis added).  Baja Properties is, naturally, an LLC, not a corporation.  
The Goldens, who are the members of the Baja LLC, go on to: 
contend that the trial court erred by denying their motion for summary judgment as to negligence claims asserted against them personally. They assert that corporate law insulates them from liability and that, while a member of an limited liability corporation [sic] may be liable for torts in which he individually participated, Ugo Mattera has pointed to no evidence that the Goldens specifically directed a particular negligent act or participated or cooperated therein. We agree with the Goldens that they were entitled to summary judgment on Ugo Mattera's negligence claim.
An officer of a corporation who takes part in the commission of a tort by the corporation is personally liable therefor, and an officer of a corporation who takes no part in the commission of a tort committed by the corporation is not personally liable unless he specifically directed the particular act to be done or participated or cooperated therein.
Jennings v. Smith, 226 Ga. App. 765, 766 (1), 487 S.E.2d 362 (1997) (citation omitted). Thus, if Baja Properties was negligent in constructing the house, an officer of the corporation could be held personally liable for the negligent construction if he specifically directed the manner in which the house was constructed or participated or cooperated in its negligent construction. See Cherry v. Ward, 204 Ga. App. 833, 834 (1) (a), 420 S.E.2d 763 (1992).
There is NO corporation involved in the dispute! 
It may be that Georgia law applies provides that "corporation" includes all entity types and that "officers" includes any person with some level of entity control.  I don't know.  And I don't need to look it up.  But the lawyers in the case and the court should because without explaining that is the case, the opinion is applying law that is not clearly relevant.  
It's time for courts to get this right, and it is time for lawyers to start noticing their mistakes and those of opposing counsel. Every time you reference an entity, look to see if you have it right.  When you see "corporation" make sure there is a corporation involved.  When you see LLC think "company," and make sure the term are consistent.  It requires vigilance,  but we can do this.  We just have to want to.  Let's do this! 

March 13, 2018 in Corporations, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (0)

Tuesday, February 27, 2018

State Laws Committed to Confusing Business Entities, Courts Happy to Help

Another unforced error on the LLC front, again with a limited liability company being called a corporation.   

This time, it is a recent Texas appellate court case where the court states: “In its pleadings, AMV contends that it is presently a limited liability corporation known as ArcelorMittal Vinton LLC.”  Wallace v. ArcelorMittal Vinton, Inc., 536 S.W.3d 19, 21 n.1 (Tex. App. 2016), review denied (Mar. 31, 2017).  As is so often the case, that is not accurate. 

In its brief, the entity AMV simply stated, that it was a Defendant-Appellee as named in the suit, ArcelorMittal Vinton, Inc., was “n/k/a [now known as] ArcelorMittal Vinton LLC.” Carla WALLACE, Plaintiff-Appellant, v. ARCELORMITTAL VINTON, INC., Defendant-Appellee., 2015 WL 7687420 (Tex.App.-El Paso), 1.  AMV’s counsel never said it was a corporation.  The court did that on its own.

Sigh.  Even in Texas, LLCs are not corporations. I swear!  I looked at the statute.

And yet, a close look at the statute shows why this gets confusing for some people.  The Texas statute provides specific cross-references to certain business provisions (emphasis added):


(a)  Subject to Section 101.114, Sections 21.223, 21.224, 21.225, and 21.226 apply to a limited liability company and the company's members, owners, assignees, affiliates, and subscribers.

(b)  For purposes of the application of Subsection (a):

(1)  a reference to "shares" includes "membership interests";

(2)  a reference to "holder," "owner," or "shareholder" includes a "member" and an "assignee";

(3)  a reference to "corporation" or "corporate" includes a "limited liability company";

(4)  a reference to "directors" includes "managers" of a manager-managed limited liability company and "members" of a member-managed limited liability company;

(5)  a reference to "bylaws" includes "company agreement"; and

(6)  the reference to "Sections 21.157-21.162" in Section 21.223(a)(1) refers to the provisions of Subchapter D of this chapter.

Added by Acts 2011, 82nd Leg., R.S., Ch. 25 (S.B. 323), Sec. 1, eff. September 1, 2011.

As Ham Porter would say, "You're killing me, Smalls." 

February 27, 2018 in Corporations, Joshua P. Fershee, Legislation, LLCs | Permalink | Comments (0)

Tuesday, February 13, 2018

These Reasons Social Benefit Entities Hurt Business and Philanthropy Will Blow Your Mind

I suspect click-bait headline tactics don't work for business law topics, but I guess now we will see. This post is really just to announce that I have a new paper out in Transactions: The Tennessee Journal of Business Law related to our First Annual (I hope) Business Law Prof Blog Conference co-blogger Joan Heminway discussed here. The paper, The End of Responsible Growth and Governance?: The Risks Posed by Social Enterprise Enabling Statutes and the Demise of Director Primacy, is now available here.

To be clear, my argument is not that I don't like social enterprise. My argument is that as well-intentioned as social enterprise entity types are, they are not likely to facilitate social enterprise, and they may actually get in the way of social-enterprise goals.  I have been blogging about this specifically since at least 2014 (and more generally before that), and last year I made this very argument on a much smaller scale.  Anyway, I hope you'll forgive the self-promotion and give the paper a look.  Here's the abstract: 

Social benefit entities, such as benefit corporations and low-profit limited liability companies (or L3Cs) were designed to support and encourage socially responsible business. Unfortunately, instead of helping, the emergence of social enterprise enabling statutes and the demise of director primacy run the risk of derailing large-scale socially responsible business decisions. This could have the parallel impacts of limiting business leader creativity and risk taking. In addition to reducing socially responsible business activities, this could also serve to limit economic growth. Now that many states have alternative social enterprise entity structures, there is an increased risk that traditional entities will be viewed (by both courts and directors) as pure profit vehicles, eliminating directors’ ability to make choices with the public benefit in mind, even where the public benefit is also good for business (at least in the long term). Narrowing directors’ decision making in this way limits the options for innovation, building goodwill, and maintaining an engaged workforce, all to the detriment of employees, society, and, yes, shareholders.

The potential harm from social benefit entities and eroding director primacy is not inevitable, and the challenges are not insurmountable. This essay is designed to highlight and explain these risks with the hope that identifying and explaining the risks will help courts avoid them. This essay first discusses the role and purpose of limited liability entities and explains the foundational concept of director primacy and the risks associated with eroding that norm. Next, the essay describes the emergence of social benefit entities and describes how the mere existence of such entities can serve to further erode director primacy and limit business leader discretion, leading to lost social benefit and reduced profit making. Finally, the essay makes a recommendation about how courts can help avoid these harms.

February 13, 2018 in Business Associations, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Delaware, Joshua P. Fershee, Law and Economics, Lawyering, Legislation, LLCs, Management, Research/Scholarhip, Shareholders, Social Enterprise, Unincorporated Entities | Permalink | Comments (0)

Tuesday, February 6, 2018

LLCs Still Not Corporations, But What Are Managers?

A brand new Arizona case continues the trend of incorrectly discussing limited liability companies (LLCs) as limited liability corporations, but it does allow for an interesting look at how entities are sometimes treated (or not) in laws and regulations. Here’s the opening paragraph of the case:

Noah Sensibar appeals from the superior court's ruling affirming the Tucson City Court's finding that he had violated the Tucson City Code (TCC). He argues that the municipal ordinance in question is facially invalid because it conflicts with a state statute shielding members or agents of a limited liability corporation from personal liability. 

City of Tucson v. Noah Sensibar, No. 2 CA-CV 2017-0087, 2018 WL 703319 (Ariz. Ct. App. Feb. 5, 2018).

About three years ago, the City of Tucson alleged that Sensibar, as “the managing member and statutory agent of Blue Jay Real Estate LLC, an Arizona corporation, was responsible for building code violations.” Id. (emphasis added). Notwithstanding the incorrect characterization of the entity type, it looks like the court at least reasonable (though not clearly correct) to hold Sensibar individually liable.  Here’s why:

The Tuscon City Code states that “Any owner or responsible party who commits, causes, permits, facilitates or aids or abets any violation of any provision of this chapter . . . is responsible for a civil infraction and is subject to a civil sanction of not less than one hundred dollars ($100.00) nor more than two thousand five hundred dollars ($2,500.00).” Tucson Code Sec. 16-48(2) (Violations and penalties).

The Code Definitions in Sec. 16-3 provide the following:

Owner means, as applied to a building, structure, or land, any part owner, joint owner, tenant in common, joint tenant or tenant by the entirety of the whole or a part of such building, structure or land.

. . . .

Person means any natural person, firm, partnership, association, corporation, company or organization of any kind, but not the federal government, state, county, city or political subdivision of the state.

. . .  .

Responsible party means an occupant, lessor, lessee, manager, licensee, or person having control over a structure or parcel of land; and in any case where the demolition of a structure is proposed as a means of abatement, any lienholder whose lien is recorded in the official records of the Pima County Recorder's Office.

As such, the Code seems to contemplate holding both entities and individuals liable. Still, Sensibar had an argument. The use of the term “manager” here causes some potential confusion because one can be a manager of an LLC, while the LLC might serve as the manager of the property. Thus, it could be that only the LLC should be liable.  Another plausible reading, though, is that “manager” meant the natural person doing the managing as is common in property situations.  Manager, like occupant, lessee, and lessor, is not defined in the Code, so it would seem the intended source of the definitions should be from a property perspective, not an entity perspective.

Similarly, the Code could mean a natural “person having control over a structure” can be liable.  If that’s the case, and the court seems to have gone down this road, the argument would be that Sensibar was being held liable directly for his role as manager or person in control of the property and not vicariously for violations of the LLC.  Given that occupants, lessors, and lessees, among others, can be held liable, it does appear that the Code could have intended to impose liability directly on multiple parties, including both individuals and entities. This would be sensible, in many contexts, though it would also be sensible to say explicitly, especially given that the term “person” clearly includes entities. 

A simple improvement might be to update the definition of “responsible party,” as follows:

Responsible party means an, whether as an individual or entity, any occupant, lessor, lessee, manager, licensee, or person having control over a structure or parcel of land and in any case where the demolition of a structure is proposed as a means of abatement, any lienholder whose lien is recorded in the official records of the Pima County Recorder's Office.

That would, at least, be consistent with the decision. Because if the court is holding Sensibar liable for merely being the manager of the LLC, and not as the manager of the property, the case is wrongly decided.  Too bad the notice of appeal was not timely filed – maybe we could have found out. 

UPDATE: Based on a good comment from Tom N., I did a little more research. As of an LLC filing in 2009, Noah Sensibar owned at least a 20% interest. (It may be 50% because there were two listed members, but it was at least 20%.) As such, this suggests that the LLC does not have funding to cover the fines or that express indemnification is lacking and the other member(s) won't agree to cover the costs from LLC funds. 

I will also note that a 2016 decision denying Sensibar's appeal stated, "The court also heard evidence that Sensibar, the managing partner of the LLC, was 'the person in charge' of the property."  City of Tucson v. Sensibar, No. 2 CA-CV 2016-0051, 2016 WL 5899737, at *1 (Ariz. Ct. App. Oct. 11, 2016). Seriously? He's an LLC manager.  That's all.  LLCs are not corporations OR partnerships. THEY ARE LLCS! 

February 6, 2018 in Corporations, Joshua P. Fershee, LLCs, Management | Permalink | Comments (3)

Tuesday, January 23, 2018

The Value of Careful Language in Assessing Businesses: A New Paper from Shu-Yi Oei

As regular readers know, I am particular about language and meaning, especially in the business-entity space related to limited liability companies (LLCs).  I think because of that, I was drawn to a new paper from Shu-Yi Oei (Boston College), The Trouble with Gig Talk: Choice of Narrative and the Worker Classification Fights, 81 Law & Contemp. Probs. ___ (2018).  The abstract: 

The term “sharing economy” is flawed, but are the alternatives any better? This Essay evaluates the uses of competing narratives to describe the business model employed by firms like Uber, Lyft, TaskRabbit, and GrubHub. It argues that while the term “sharing economy” may be a misnomer, terms such as “gig economy,” “1099 economy,” “peer-to- peer economy” or “platform economy” are just as problematic, possibly even more so. These latter terms are more effective in exploiting existing legal rules and ambiguities to generate desired regulatory outcomes, in particular the classification of workers as independent contractors. This is because they are plausible, speak to important regulatory grey areas, and find support in existing laws and ambiguities. They can therefore be deployed to tilt outcomes in directions desired by firms in this sector.

This Essay’s analysis suggests that narratives that are at least somewhat supportable under existing law may be potent in underappreciated ways. In contrast, clearly erroneous claims may sometimes turn out to be hyperbolic yet harmless. Thus, in evaluating the role of narrative in affecting regulatory outcomes, it is not only the obviously wrong framings that should concern us but also the less obviously wrong ones.

There are several interesting points in the piece, and find this part of the conclusion especially compelling: 

I cannot prove that the deployment of gig characterization is the only reason certain legal treatments and outcomes (such as independent contractor classification for workers) seem to be sticking, at least for the moment. My narrower point is that while gig and related characterizations appear innocuous and accurate relative to the sharing characterization, this set of descriptors may actually be doing more work in terms of advancing a desired regulatory outcome. The reasons they are able to do more work are that (1) gig characterization speaks to an important and material legal ambiguity, (2) the gig characterization is plausibly accurate, even if deeply contested, and (3) the proponents of gig characterization have been able to use procedural and other tools to shore up gig characterization and defeat its competitors. These observations may be generalized beyond the gig context: While the temptation is to focus on narratives and characterizations that are clearly wrong, this Essay suggests that we should also pay attention to more subtle narratives that are less clearly wrong, because such narratives may be doing more work by virtue of being “almost right.”

This last point is one that resonates with me on the LLC front, where people insist on comparing or analogizing LLCs to corporations.  There are times when such a comparison or analogy is "almost right," and it is in these circumstances that the perils of careless language can cause the most trouble because the same comparison or analogy can get made later when doing so is clearly wrong. 

January 23, 2018 in Employment Law, Jobs, Joshua P. Fershee, LLCs, Research/Scholarhip | Permalink | Comments (0)

Tuesday, January 16, 2018

A Look Back on LLCs: Ribstein Had It Right

I have had reason to look back on some foundational scholarship in LLCs recently, and one article really stood out for me. Larry Ribstein's The Deregulation of Limited Liability and the Death of Partnership. It's another snow day with kids, so I haven't had a lot of time to delve into the thoughts this raised for me, so I'll let Larry's words speak for themselves.  Keep in mind this is from 1992:  

The popularity of the partnership form of business1 indicates that an organizational form in which some owners can be held personally liable for the firm's debts is efficient for many firms. This could be because, for many firms, individual liability reduces the firm's credit costs more than it increases owners' risk-bearing, monitoring, or other costs. This Article, however, suggests an alternative explanation: the partnership form is attractive for many firms on the margin only because of the regulatory costs of limited liability, including double corporate taxation and limitations on organizational form.

Recent developments provide a valuable opportunity to test this explanation. Many lawyers and legislators have become interested in a new limited liability business form, the "limited liability company" (LLC), that lets firms adopt limited liability without many of the tax and other costs that once attended limited liability. If this Article's regulatory explanation of partnership is correct, the partnership form of business will greatly diminish in importance. After a transitional period, partnership will survive, if at all, as a residual form for firms that have no customized agreement.

January 16, 2018 in Joshua P. Fershee, LLCs | Permalink | Comments (0)

Tuesday, December 26, 2017

Feeling Like Charlie Brown at Christmas: More LLCs as a Corporations

No one will  be shocked that my last post of the year is about a court referring to a limited liability company (LLC) as a "limited liability corporation."  It's wrong to do so, and it's my thing to point out when it happens.  This case is especially striking (and perhaps upsetting) because of the context of the reference.  In this 2015 case that just showed up on Westlaw (or at least, in my alerts), "Plaintiff argues that because Defendants are all limited liability corporations they must identify and prove the citizenship of their various members and that they have failed to do so." Skywark v. Healthbridge Mgmt., LLC, No. 15-00058-BJR, 2015 WL 13621058, at *1 (W.D. Pa. July 22, 2015).  They mean LLCs, not corporations.  Okay, so far this is a pretty typical mistake.  But wait! 

In this case, the defendants did not allege the citizenship of the members of the defendants' LLCs in their initial Notice of Removal, so the plaintiffs claimed that a filed  amendment was more than “technically defective.” In claiming the amendment was "minor, the defendants rely cited  O'Boyle v. Braverman, No. 08-553, 2008 U.S. Dist. LEXIS 62180 (D.N.J. Aug. 12, 2008), which found that when a party mistakenly alleged the citizenship of an LLC as a corporation, the party could still amend the allegations to properly allege the citizenship of its LLC members. 2008 U.S. Dist. LEXIS 62180, at *7. O'Boyle, like the present court on Skywark found the proposed amendment to be technical in nature. 
On the one hand, this is probably correct in terms of justice seeking. On the other hand, if a court were to find that such a mistake was more than minor, perhaps lawyers would get this right in the first place, which they should do.
In assessing the situation, the court states: 
Plaintiff is correct that the citizenship of a limited liability corporation is determined by the citizenship of its members. Zambelli Fireworks Mfg. Co. v. Wood, 592 F.3d 412, 420 (3d Cir. 2010). Defendants have sought to fix any errors that may affect diversity jurisdiction by filing a declaration that identifies the members of their limited liability corporations and allegations of their citizenship. Plaintiff raises several arguments in response to Defendants' declaration and alleges that it is insufficient to prove diversity of citizenship.
Skywark v. Healthbridge Mgmt., LLC, No. 15-00058-BJR, 2015 WL 13621058, at *3 (W.D. Pa. July 22, 2015) (emphasis added). 
To quote Charlie Brown, AAUGH! 
Didn't the court just establish that the entire issue was the distinction between corporations and LLCs?  Sigh. The mistakes are frustrating, but to add to that such a clear lack of internal consistency when the issue has been identified is darn right irritating.  
As I often do, I feel I must acknowledge that we're all human and we make mistakes.  Goodness knows I have made (and continue to make) more than my fair share.  I don't mean to say anyone is a bad person for making such mistakes.  But I sure would appreciate it if they were a lot less common, too.  

If you celebrated, I hope you had a great Christmas. We sure did. Wishing you and yours peace, warmth, and love in this holiday season.  

December 26, 2017 in Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Tuesday, December 19, 2017

Washington Marijuana Law Has Entity Type Quirks (And LLCs Are Still Not Corporations)

A recent case in Washington state introduced me to some interesting facets of Washington's recreational marijuana law.  The case came to my attention because it is part of my daily search for cases (incorrectly) referring to limited liability companies (LLCs) as "limited liability corporations."  The case opens: 

In 2012, Washington voters approved Initiative Measure 502. LAWS OF 2013, ch. 3, codified as part of chapter 69.50 RCW. Initiative 502 legalizes the possession and sale of marijuana and creates a system for the distribution and sale of recreational marijuana. Under RCW 69.50.325(3)(a), a retail marijuana license shall be issued only in the name of the applicant. No retail marijuana license shall be issued to a limited liability corporation unless all members are qualified to obtain a license. RCW 69.50.331(1)(b)(iii). The true party of interest of a limited liability company is “[a]ll members and their spouses.”1 Under RCW 69.50.331(1)(a), the Washington State Liquor and Cannabis Board (WSLCB) considers prior criminal conduct of the applicant.2

LIBBY HAINES-MARCHEL & ROCK ISLAND CHRONICS, LLC, Dba CHRONICS, Appellants, v. WASHINGTON STATE LIQUOR & CANNABIS BOARD, an Agency of the State of Washington, Respondent., No. 75669-9-I, 2017 WL 6427358, at *1 (Wash. Ct. App. Dec. 18, 2017) (emphasis added).  
The reference to a limited liability corporation appears simply to be a misstatement, as the statute properly references limited liability companies as distinct from corporations. The legal regime does, though, have some interesting requirements from an entity law perspective. First, the law provides:
(b) No license of any kind may be issued to:
. . . .
(iii) A partnership, employee cooperative, association, nonprofit corporation, or corporation unless formed under the laws of this state, and unless all of the members thereof are qualified to obtain a license as provided in this section;
Wash. Rev. Code § 69.50.331 (b)(iii) (West). It makes some sense to restrict the business to in-state entities given the licensing restrictions that state has, although it is not clear to me that the state could not engage in the same level of oversight if an entity were, say, a California corporation or a West Virginia LLC. 
The state's licensing requirements, as stated in Washington Administrative Code 314-55-035 ("What persons or entities have to qualify for a marijuana license?") provide: "A marijuana license must be issued in the name(s) of the true party(ies) of interest." The code then lists what it means to be a  “true party of interest” for a variety of entities. 
True party of interest: Persons to be qualified
Sole proprietorship: Sole proprietor and spouse.
General partnership: All partners and spouses.
Limited partnership, limited liability partnership, or limited liability limited partnership: All general partners and their spouses and all limited partners and spouses.
Limited liability company: All members and their spouses and all managers and their spouses.
Privately held corporation: All corporate officers (or persons with equivalent title) and their spouses and all stockholders and their spouses.
Publicly held corporation: All corporate officers (or persons with equivalent title) and their spouses and all stockholders and their spouses.
Multilevel ownership structures: All persons and entities that make up the ownership structure (and their spouses).
Wash. Admin. Code 314-55-035. 

This is a pretty comprehensive list, but I note that the corporation requirements are missing some noticeable parties: directors. The code states, for both privately and publicly held corporations, that all "corporate officers (or persons with equivalent title)" and their spouses and all stockholders and their spouses must be qualified. Directors are not "equivalent" in title to officers. Officers, under Washington law, are described as follows:
(1) A corporation has the officers described in its bylaws or appointed by the board of directors in accordance with the bylaws.
(2) A duly appointed officer may appoint one or more officers or assistant officers if authorized by the bylaws or the board of directors.
(3) The bylaws or the board of directors shall delegate to one of the officers responsibility for preparing minutes of the directors' and shareholders' meetings and for authenticating records of the corporation.
(4) The same individual may simultaneously hold more than one office in a corporation.
Wash. Rev. Code § 23B.08.400. Directors have a different role. The statute provides:

Requirement for and duties of board of directors.

(1) Each corporation must have a board of directors, except that a corporation may dispense with or limit the authority of its board of directors by describing in its articles of incorporation, or in a shareholders' agreement authorized by RCW 23B.07.320, who will perform some or all of the duties of the board of directors.
(2) Subject to any limitation set forth in this title, the articles of incorporation, or a shareholders' agreement authorized by RCW 23B.07.320:
(a) All corporate powers shall be exercised by or under the authority of the corporation's board of directors; and
(b) The business and affairs of the corporation shall be managed under the direction of its board of directors, which shall have exclusive authority as to substantive decisions concerning management of the corporation's business.
Wash. Rev. Code § RCW 23B.08.010.
The Code, then, seems to provide that directors are, as a group, exempt from the spousal connection. The code separately provides:
(4) Persons who exercise control of business - The WSLCB will conduct an investigation of any person or entity who exercises any control over the applicant's business operations. This may include both a financial investigation and/or a criminal history background. 
Wash. Admin. Code 314-55-035.  This provision would clearly include directors, but also clearly excludes spouses. That distinction is fine, I suppose, but it is not at all clear to me why one would want to treat directors differently than LLC managers (and their spouses).  To the extent there is concern about spousal influence--to the level that the state would want to require qualification of spouses of shareholders in a publicly held entity--leaving this gap open for all corporate directors seems to be a rather big miss (or a deliberate exception).  Either way, it's an interesting quirk of an interesting new statute.   

December 19, 2017 in Corporations, Current Affairs, Entrepreneurship, Family Business, Joshua P. Fershee, Legislation, Licensing, LLCs, Management, Nonprofits, Partnership, Shareholders, Unincorporated Entities | Permalink | Comments (0)

Tuesday, December 12, 2017

Getting LLC Definitions Wrong: It's Not Always the Judge's Fault

As I have noted in the past, it is not just judges that make the mistake of calling limited liability companies (LLCs), "limited liability corporations."  Today, I got a notice of a Texas case using the later definition.  Here's the excerpt:

The statute defines a “licensed or registered professional” to mean “a licensed architect, licensed professional engineer, registered professional land surveyor, registered landscape architect, or any firm in which such licensed or registered professional practices, including but not limited to a corporation, professional corporation, limited liability corporation, partnership, limited liability partnership, sole proprietorship, joint venture, or any other business entity.” Tex. Civ. Prac. & Rem. Code Ann. § 150.001(1-a) (emphasis added).

CH2M Hill Engineers, Inc., v. Springer, No. 09-16-00479-CV, 2017 WL 6210837, at *2 (Tex. App. Dec. 7, 2017). 
My first thought was, "Doesn't everyone cut and paste statutory language these days?  How could they get that wrong?"  I went to look up the code, and even before the code section had loaded, it dawned on me:  Of course, they cut and pasted it.  It's the code that's wrong.  Sure enough, it is.
Another recent example comes from a Westlaw source: Business Transactions Solutions § 60:358. I am going to tread lightly here because my mission is not to be a snarky jerk (I can be one sometimes, but that is not my goal).  The source provides what appears to be a model letter to an LLC client that has some very useful information, but I am going to be critical of a couple parts.  The letter opens: "[T]he following is a summary of our discussion concerning business responsibilities that must be met to maintain your LLC status."  Good start.  And then: "Failure to comply with LLC formalities can result in individual liability to the members if the 'corporate veil is pierced.'" I know this is colloquial talk, but couldn't it just say "if the limited liability veil is pierced?"
The draft letter continues:
You can also be liable for the company's debts by implied actions or negligent conduct. If you disregard LLC formalities or commingle your personal interests with the company's assets or interests, you can open the door for an adverse party to “pierce the corporate veil” and render you personally liable for the LLC's debts. To avoid such consequences, you should never refer to your company as “my” business or “our” business. Such a statement could later be used against you as being a material representation that the business was a proprietorship or a partnership rather than a corporation.
There's a lot here with which I disagree. For example, LLCs don't, in my view, have formalities. And an LLC is not a corporation.  The letter also explains that "[m]anagers control the policy of the LLC, (this is similar to a director in a corporation)" and refers to the LLC's "corporate name " and "corporate records." Some of this is accurate colloquially, but don't you hire a lawyer for precision?  I appreciate the idea that lawyers should share a lot of this kind of information with clients, and a lot of this is useful, but this really can be better. The LLC letter should be different than the corporation letter.  

Anyway, this is another example where a lot of my complaints are simply nits, and they probably impact nothing.  But it's not all nits.  Some of this is substance that matters.  So, I keep picking nits. 


December 12, 2017 in Joshua P. Fershee, LLCs | Permalink | Comments (0)

Tuesday, December 5, 2017

Waterhouse Wilson in DePaul Law Review: Cooperatives: The First Social Enterprise

The DePaul Law Review recently posted the article, Cooperatives: The First Social Enterprise, written by my friend and colleague Elaine Waterhouse Wilson (West Virginia Univ. College of Law). I recommend checking it out. Here is an overview: 

As the cooperative and social enterprise movements merge, it is necessary to examine the legal and tax structures governing the entities to see if they help or hinder growth. If the ultimate decision is to support the growth of cooperatives as social enterprise, then those legal and tax structures that might impede this progress need to be re-examined.

This Article considers some of the issues that may impede the charitable sector in supporting the growth of the cooperative business model as a potential solution to issues of income inequality. To do so, the Article first defines a “cooperative.” Part II examines the definition of a cooperative from three different viewpoints: cooperative as social movement, cooperative as economic arrangement, and cooperative as legal construct. From these definitions, it is possible to identify those elements inherent in the cooperative model that might qualify as a tax-exempt purpose under the Internal Revenue Code (the Code) §501(c)(3). Part III reviews the definition of “charitable” for § 501(c)(3) purposes, specifically in the context of economic development and the support of workers. This Part demonstrates that many of the values inherent in the cooperative model are, in fact, charitable as that term is understood for federal tax purposes.

If a cooperative has charitable elements, however, then it should be possible for the charitable sector to support the cooperative move- ment. Part IV analyzes the possibilities and limitations of direct support by the charitable sector, including mission-related investing by charities and program-related investing by private foundations. In this regard, the cooperative can be viewed in many respects as an ex- isting analog to the new social enterprise forms, such as the benefit corporation or the L3C. Finally, Part V provides recommendations for changing both federal and state law to further support the cooperatibe movement in the charitable sector.


December 5, 2017 in CSR, Family Business, Joan Heminway, Joshua P. Fershee, LLCs | Permalink | Comments (1)

Tuesday, November 28, 2017

LLCs Are Still Not Corporations, And At Least One Judge (In Dissent) Knows It

A recent Pennsylvania opinion makes all sorts of mistakes with regard to a single-member limited liability company (LLC), but in dissent, at least some of the key issues are correctly framed. In an unreported opinion, the court considered whether a company (WIT Strategy) that required an individual to form an LLC as a predicate to payment was an employee eligible for unemployment compensation. WIT Strategy v. Unemployment Compensation Board of Review, 2017 WL 5661148, at *1 (Pa. Cmwlth. 2017).  The majority explained the test for whether the worker was an employee as follows:

The burden to overcome the ‘strong presumption’ that a worker is an employee rests with the employer. To prevail, an employer must prove: (i) the worker performed his job free from the employer's control and direction, and (ii) the worker, operating as an independent tradesman, professional or businessman, did or could perform the work for others, not just the employer.

Id. at *3. (quoting Quality Care Options v. Unemployment Comp. Bd. of Review, 57 A.3d 655, 659-60 (Pa. Cmwlth. 2012) (citations omitted; emphasis added)).

As to the first prong, the Unemployment Compensation Board of Review (UCBR) determined, and the court confirmed, that WIT Strategy had retained control over the claimant consistent with the type of control one exerts over an employee.  I might disagree with the assessment, but the test is correct, and the analysis reasonable, if not clearly correct.  Assessment of the second prong, though, is flawed.  

The court quotes the UCBR's conclusions:

The [UCBR] does not find that [C]laimant was operating a trade or business, customarily or otherwise. The only reason [C]laimant formed the LLC was because WIT required it, claiming that it needed to pay [C]laimant through the LLC. WIT also claimed that doing so was a ‘common agency model’ for its kind of agency. The [UCBR] does not credit WIT's testimony. Rather, although [C]laimant did perform two projects for other entities, each for under $600 [.00], there is no evidence that [C]laimant solicited business through her LLC since its inception in 2013 through her termination in 2015. [C]laimant worked for WIT 40 hours per week and did not have employees of the LLC to solicit business for her. Further, although WIT claimed that all its team members were required to have additional clients through their LLCs to share with it, WIT did not prove that [C]laimant had such clients. As [C]laimant did not operate a trade or business, but rather the LLC was formed as a type of shell corporation, the fact that [C]laimant was the single-member owner is not dispositive. [C]laimant was not customarily engaged in a trade, occupation, profession or business.

Id. at *4 (emphasis and modification in original).
Enter President Judge Mary Hannah Leavitt.  In dissent, Judge Leavitt writes what should be the majority opinion.  First, she notes that "quality control" is not the same thing as control by an employer.  I think her analysis of the control prong is the better one, but again, reasonable minds can assess these facts differently. As the second prong, Judge Leavitt also quote the UCBR, then proceeds to assess it correctly. She explains: 
The legal form by which Claimant provided public relations and communications services to WIT-provided clients and to her own clients is irrelevant. A sole proprietor may establish a single-member LLC for many reasons, the obvious being a desire to limit individual liability. It is not known what the Board meant by a “shell corporation,” and there is no evidence on this point. A limited liability company is not even a corporation. The Pennsylvania Associations Code provides as follows:
One or more persons may act as organizers to form a limited liability company ....
15 Pa. C.S. § 8821. A single-member LLC, such as Jilletante Creative, is a perfectly lawful and valid alternative to a sole proprietorship.
Claimant continued to operate as an LLC even after her separation from WIT. The record includes Claimant's two-page detailed proposal to a potential client on “Jilletante Creative, LLC” letterhead, signed as “Jilletante Creative, LLC; By: Jillian Ivey, sole member.” R.R. 10a-11a. Jilletante Creative is not a sham or “shell” corporation, and characterizing it as such is a red herring in the analysis of whether Claimant worked for WIT clients as an employee of WIT or as an independent contractor.
Id. at *12 (Leavitt, Pres. J, dissenting). Yes!   "It is not known what the Board meant by a 'shell corporation,' and there is no evidence on this point. A limited liability company is not even a corporation." This is exactly right. Further, there is nothing wrong with an LLC serving one client. Whether its because it is a requirements contract (e.g., I will do as much work for you as you require) or simply that the LLC's owner is comfortable with the revenue coming from a single client, having only one client does not make you an employee.  
As a side note, as someone who has worked both for a law firm and a public relations agency, it is not at all uncommon for people in each profession to work as independent contractors.  A lawyer can be a solo and work for one client, or that lawyer can be hired an brought into the firm or in-house.  Same with PR professionals.  They may work as employees, but it is not uncommon to work as an independent contractor, in part to maintain the flexibility of work location, hours, and manner in which the work is completed.  
In the unemployment compensation context, what constitutes an employee can often be different than what one might deem an employee in the agency context. And that's okay. Sometimes we craft different definitions for different purposes or policy goals.  But disregarding an entity as a "shell" merely because there is only one member is wrong because the law says it is wrong.  If a state wants to outlaw single-member entities, they can (they'd be wrong to do so, but that's a different discussion).  But as long as the law allows it, the courts should respect it.  
Furthermore, when a person creates an LLC, they are actively engaging in the process of defining their relationship with others. I can come up with scenarios where maybe the existence of an LLC should be disregarded in the employment analysis, but more often than not the use of an LLC in the relationship should be compelling evidence of the type of relationship the parties have.  
Although this opinion still gets it wrong, there is hope. The dissent has set forth a proper path, and I can only hope others will follow. 

November 28, 2017 in Case Law, Corporations, Employment Law, Joshua P. Fershee, LLCs | Permalink | Comments (3)

Tuesday, November 14, 2017

No Need to Veil Pierce an LLC When Direct Liability Is Available (and LLCs Are Still Not Corps)

A new Maryland case deals with claims against a limited liability company that the plaintiff claimed was "registered as a limited liability corporation ('LLC')." Farm Fresh Direct Direct By a Cut Above LLC v. Downey, 2017 WL 4865481, at *2 (D. Md., 2017).  The court repeats the mistake, but the complaint is the original source, as it incorrectly identifies the LLC as a "corporation" and not a company.  The court then explains some of the allegations as follows: 
Plaintiff alleges that Sinsky violated 15 U.S.C. § 1125(a)(1)(A) and engaged in unfair and deceptive trade practices, in violation of Maryland common law. ECF 1, ¶¶ 17-22, 23-26. At its core, plaintiff's contention is that “Sinsky is the resident agent and incorporator” of Farm Fresh Home (ECF 1, ¶¶ 12-13), and in that capacity she “filed” the articles of organization for Farm Fresh Home, creating a name for the “competing company” that is “intentionally confusing” because of its similarity to Farm Fresh Direct. ECF 1, ¶ 12.
. . . .
*4 Farm Fresh Home is a limited liability company. As a threshold matter, I must determine whether Sinsky is subject to suit in light of Farm Fresh Home's status as a limited liability company.
Id. at *3–4. 
That is not quite right. The complaint alleges that Sinsky, by helping to form the LLC, violated the Lanham Act and Maryland common law (the court repeats the complaint's "incorporator" language, but presumably this is meant to refer to the formation of the LLC).  The question, at least initially, should not be whether Sinksy is subject to suit as a member of the LLC.  The question, then, is whether there is a direct claim against Sinsky for creating the competing entity.
The court seems to understand this is at least part of the analysis because the opinion discusses veil piercing (in the corporate context, of course) as well as the concept of direct liability.  As to direct liability, the opinion correctly explained: “An LLC member is liable for torts he or she personally commits, inspires, or participates in because he or she personally committed a wrong, not ‘solely’ because he or she is a member of the LLC.” Id. at *5 (quoting Allen v. Dackman, 413 Md. 132, 158, 991 A.2d 1216, 1228 (2010)). The opinion further states that there can be direct liability under the Lanham Act and for unfair trade practices, even when an entity is involved.  This is (at least conceptually) correct.  Despite this, the opinion ultimately misses the mark: 
The question here is not whether plaintiff will ultimately prevail. Its allegations as to Sinsky border on thin. But, for purposes of the Motion, plaintiff adequately alleges sufficient facts and inferences that Sinsky participated in the creation of Farm Fresh Home for the purpose of using a confusingly similar name to compete with Farm Fresh Direct. See A Society Without a Name, 655 F.3d at 346. Therefore, plaintiff is not entitled to the protection of the corporate shield at this juncture.
Id. at *7 (emphasis added). No and no. First, LLCs do not have corporate shields. They have LLC or limited liability shields, but You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One!  Second, there is no need to consider veil piercing at this point. The court has found sufficient claims as to Sinsky's participation to support direct liability. The inquiry should end there. And even if there were value in discussing both direct liability and veil piercing (there is not), the court's own citation to Allen v. Dackman should indicate that this section is not solely related to entity-derived liability.  
I don't mean to be too hard on anyone here.  This is not personal -- it simply about identifying and trying to correct errors related to entity status. I know that not all courts or practicing attorneys spend the amount of time I do with entities and their nuances.  And this case involves a pro se party, which can make things even more challenging.
I just still maintain that this is something we can correct. Apparently, one blog post at a time. 

November 14, 2017 in Accounting, Corporate Personality, Corporations, Intellectual Property, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (5)

Monday, November 6, 2017

2017 American Bar Association LLC Institute

I had the privilege of being invited again this year to present at the 2017 LLC Institute, an annual program produced by the LLC, Partnership and Unincorporated Entities Committee of the American Bar Association's Business Law Section.  As part of a panel discussion on LLC fiduciary duties (with friend-of-the-BLPB Mohsen Manesh and others), I sang a few bars of Rocky Top (!) and talked about the fiduciary duty waiver issue that we faced in Tennessee in revamping our limited partnership law this past year.  But that was far from the highlight of the program!  

Luckily, friend-of-the-BLPB Tom Rutledge--a leader in (and former chair of) the LLC, Partnership and Unincorporated Entities Committee--has captured the essence of the two-day event in blog posts here and here.  He notes in sum:

Over the last two days we have . . . , by means exceptional panels, considered and informed the participants on the broadest range of issues materially important to our shared area of interest and practice.  That is the mission of the LLC Institute, and hopefully it has again delivered on its objective.  The materials are posted and available for anyone, and in a few weeks the audio recordings will as well be posted.  While we recommend them to you, if you did not attend you missed out on the opportunity to ask questions as the programs were in progress and perhaps even more importantly the opportunity to meet new and liaison with old friends.  Those relationships are one of the great values of our Committee, the means by which we lean on and assist one another. 

This is so true.  The relationships--built through banter between and among panelists and audience members before, during, between, and after the sessions are what make this event special.  Of course, the subject matter also is phenomenally interesting.  

Co-blogger Josh Fershee also presented at the Institute this year.  Other BLPB readers and friends who attended (some of whom also presented) included:

  • Suffolk Law's Carter Bishop (who moderated and led our panel);
  • Colorado's infamous consummate practitioners and thought-leaders Bill Callison (who gave an amazing luncheon talk on Thursday regarding his work in establishing a model entity law statute for use in developing countries*) and Bob Keatinge;
  • Glommer and BYU Law Associate Dean Christine Hurt; and
  • Baylor Law's Beth Miller (a/k/a the walking, talking guru of Texas business associations law and Queen of LLC caselaw--who, it was announced, will soon have a Committee content award named after her).

I am sure that I am missing someone . . . .  Needless to say, a good time was had by all.  And let me know if you'd like to be part of the program next year.  I know that the folks who organize the event like to have new presenters come every year, to keep the banter going.  I am happy to pass your name along.


*Specifically, as noted in his firm biography: "He is the American Bar Association's delegate to the United Nations Commission on International Trade Law Working Group I (Micro, Small and Medium Enterprises), which is focusing on law reforms enabling adoption of simplified business entity structures by micro-, small- and medium-sized businesses in developing countries. He serves on the UNCITRAL Secretariat's expert group in this process."

November 6, 2017 in Conferences, Joan Heminway, LLCs | Permalink | Comments (2)

Tuesday, October 31, 2017

Mistake Number Two in Mueller's Indictment: Manafort's LLCs Are Not Corporations

The distinction between limited liability companies (LLCs) and corporations is one that remains important to me. Despite their similarities, they are distinct entities and should be treated as such.

When the indictment for Paul Manafort and Richard Gates was released yesterday, I decided to take a look, in part because I read that the charges included claims that the defendants "laundered money through scores of United States and foreign corporations, partnerships, and bank accounts."  (Manafort Indictment ¶ 1.)

It did not take long for people to note an initial mistake in the indictment.  The indictment states that Yulia Tymoshenko was the president of the Ukraine prior to Viktor Yanukovych. (Id. ¶ 22.) But, Dan Abrams' Law Newz notes, "Tymoshenko has never been the president of the Ukraine. She ran in the Ukrainian presidential election against Yanukoych in 2010 and came in second. Tymoshenko ran again in 2014 and came in second then, too." Abrams continues: 

The Tymoshenko flub is a massive error of fact, but it doesn’t impinge much–if any–on the narrative contained in the indictment itself. The error doesn’t really bear upon the background facts related to Manafort’s and Gates’ alleged crimes. The error also doesn’t bear whatsoever upon the laws Manafort and Gates are accused of breaking. Rather, it’s an error which bears upon the credibility of the team now seeking to prosecute the men named in the indictment.

Perhaps. It is a high-profile mistake, but it doesn't go to the core of the charges, so I think this may overstate it a bit.  Still, it is hardly ideal, and it's definitely an unforced error.  And unfortunately, there is a second such error.  

Paragraph 12 of the indictment provides a chart of entities that were "owned or controlled" by the defendants. The chart headings provide "Entity Name," "Date Created," and "Incorporation Location." But a number of the entities are not corporations. They are LLCs,  and you do not "incorporate" an LLC.  You form an LLC.  (Also, just to be clear, LLCs are not "partnerships," either. They are LLCs.)

Similar to the Tymoshenko error, the type of entity does not appear to impact the underlying narrative or charges.  For example, entity type does not appear to impact the "conspiracy to launder money" count. And other jurisdictions, such as Cyprus, do tend to merge the corporate concept with the company concepts in a way that might make the chart headings less wrong than it is for U.S. entities.  Nonetheless, it would not have been that hard to go with "Entity Origin" or "Formation Location."  

Okay, so all of this is rather nitpicky, and I get that.  The underlying charges are serious, and I hope and expect that the charges and the surrounding facts (not these mistakes) will be the focus of the legal process as it runs its course. But, it is also proper, I think, to work toward getting the entire document right. Details matter, and at some point could mean the difference between winning and losing, even if that does not appear to be the case this time around.   

October 31, 2017 in Corporations, Current Affairs, Joshua P. Fershee, Lawyering, LLCs, Partnership, White Collar Crime | Permalink | Comments (1)

Tuesday, October 24, 2017

Hawaii Courts Take Note: LLCs Are Not Corporations

A recent magistrate judge's recommendation on a motion to strike in Hawaii alerted me to a problem with the Hawaii Local Rules of Practice for the United States District Court for the District of Hawaii.  The mistake is not the judge's; it is in the rules.  The recommendation explains: 

[An] LLC must be represented by an attorney. See Local Rule 83.11 (“[b]usiness entities, including but not limited to ... limited liability corporations ... cannot appear before this court pro se and must be represented by an attorney”) . . . .

THE BANK OF NEW YORK MELLON FKA THE BANK OF NEW YORK, AS TRUSTEE FOR THE CERTIFICATE HOLDERS OF THE CWMBS INC., CHL MORTGAGE PASS-THROUGH TRUST 2006-OA5, MORTGAGE PASS THROUGH CERTIFICATES, SERIES 2006-OA5, a Delaware corporation, Plaintiffs, v. LEN C. PERRY JR.; NATHAN JON LEWIS; 3925 KAMEHAMEHA RD PRINCEVILLE, HI 96722, LLC, Defendants., No. CV 17-00297 DKW-RLP, 2017 WL 4768271, at *1 (D. Haw. Oct. 2, 2017), report and recommendation adopted sub nom. THE BANK OF NEW YORK MELLON fka THE BANK OF NEW YORK, AS TRUSTEE FOR THE CERTIFICATE HOLDERS OF CWMBS INC.; CHL MORTGAGE PASS-THROUGH TRUST 2006-OA5, MORTGAGE PASS THROUGH CERTIFICATES, SERIES 2006-OA5, a Delaware corporation, Plaintiff(s), v. LEN C. PERRY, JR.; NATHAN JON LEWIS; 3925 KAMEHAMEHA RD PRINCEVILLE, HI 96722, LLC Defendant(s)., No. CV 17-00297 DKW-RLP, 2017 WL 4767667 (D. Haw. Oct. 20, 2017).  (I know this could be cited more succinctly, but I thought this was pretty great so I went with the whole enchilada.)

The local rules, available here, state, as quoted, 

LR83.11.  Business Entities.

Business entities, including but not limited to corporations, partnerships, limited liability partnerships, limited liability corporations, and community associations, cannot appear before this court pro se and must be represented by an attorney. (emphasis added)

LLCs (limited liability companies) are still not corporations, and too often courts and local rules insist on saying they are. But help is available.  I made my first trip this summer to Hawaii with my family, and it was amazing. So I put this offer out there: if anyone in Hawaii would like some help cleaning up local rules (and other business-entity related laws, rules, and regulations) count me in.  This rule is wrong, but there is a whole lot right about Hawaii. 

October 24, 2017 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Tuesday, September 26, 2017

Courts Determined to Confuse Everyone about LLCs

The United States District Court for the Northern District of Mississippi seems to understand that LLCs are different than corporations, but they don't really want to keep them separate. See this passage, to which I have added notes: 

Regarding complete diversity, the citizenship of a limited liability corporation [no, limited liability company]  is determined by the citizenship of all its members. Tewari De-Ox Sys., Inc. v. Mtn. States/Rosen, Ltd. Liab. Corp., 757 F.3d 481, 483 (5th Cir. 2014). The “citizenship of an unincorporated [yes!] association must be traced through each layer of the association, however many there may be.” Deep Marine Tech., Inc. v. Conmaco/Rector, L.P., 515 F.Supp.2d 760, 766 (S.D. Tex. 2007). Further, “§ 1332(c)(1), which deems a corporation [wait, what?] of ‘every State and foreign state’ in which it is incorporated and the ‘State or foreign state’ where it has its principal place of business, applies to alien corporations.” Vantage Drilling Co. v. Hsin-Chi Su, 741 F.3d 535, 537 (5th Cir. 2014). The defendants submitted an upstream analysis of their organizational structure, tracing through each layer of association, to properly allege the citizenship of each member, ultimately establishing that they and Tubwell are citizens of different states.

JOE TUBWELL PLAINTIFF v. SPECIALIZED LOAN SERVICE LLC (SLS), Agents and Successors, Loan No. 1012441108; MORGAN STANLEY MORTGAGE CAPITAL HOLDINGS LLC, Agents and Successors DEFENDANTS, 3:17-CV-15-DMB-RP, 2017 WL 4228760, at *2 n.2 (N.D. Miss. Sept. 22, 2017). 
The court seems to have gotten to the right answer (I think), but this is hardly helping clarify anything.  It appears maybe they have left some of the key facts out. This is a time where a diagram might be helpful.  And properly identifying the entity types would definitely be.  

September 26, 2017 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Tuesday, September 19, 2017

The Magical LLC, Part 1

A recent New Republic article states: 

The Community Law Center, a local legal services group, launched an investigation into 1906 Boone and hundreds of other vacant properties around Baltimore. The hunt took more than a year. In many cases, the identity of a property owner was hidden behind a maze of shell companies; an operation called Baltimore Return Fund LLC, for example, had purchased 1906 Boone at a city tax sale for $5,452. Eventually, the investigation revealed a Texas-based web of nearly a dozen LLCs—limited liability corporations, a form of legal tax shelter—that controlled more than 300 properties in Baltimore. Nearly all had been purchased at tax sales, often online, between 2001 and 2010. Most sold for less than $5,000. Many were vacant and in bad shape.

Okay, so we all know LLCs are not limited liability corporations (right?). But the entity form is a "legal tax shelter?"  As a pass-through entity?  What does this word salad mean?  Would this be less of a scourge if some guy owned them instead of the magical LLC?  I don't understand what the entity form has to do with any such concerns at all.  

Suppose they did the research and found out Benefit Corporation, Inc., owned all of them. Would they have breathed a sigh of relief?  

So many questions, so few answers. 

H/T to our astute and helpful reader Gregory J. Corcoran.

September 19, 2017 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (1)

Tuesday, August 29, 2017

More Corporate LLCs and Phantom Veil Piercing

And so it continues:

In a recent case in the United States District Court, District of Columbia, a court messes up the entity (referring to one of the parties as “Howard Town Center Developer, LLC, is a limited liability corporation (‘LLC’)") and also does a fine job of improperly stating (or really, failing to state) the law for veil piercing. 

I took the initiative to pull the initial complaint and the answer to see if either of the parties were responsible for calling the LLC a corporation. Both sides properly referred to the LLC as a “limited liability company,” so it appears the corporation reference is a court-created issue.

In the case, a property developer brought action to require a university landowner to reinstate a ground lease and development agreement between developer and university, after the university sent notices of termination. The University counterclaimed to recover unpaid rent. The court determined, among other things, that the university was entitled to the damages it sought of $1,475,000 for unpaid rents and to attorney fees related to the developer's breach of a ground lease and development agreement. But the opinion doesn’t stop there.

It is quite clear that the developer LLC does not have the funds to pay the judgment, so the question of whether the LLC’s veil could be pierced was also raised.  The court, I think properly, determined that “a targeted asset or individual must be named before veil-piercing may be considered.” Howard Town Ctr. Developer, LLC v. Howard U., CV 1075 (BAH), 2017 WL 3493081, at *56 (D.D.C. Aug. 14, 2017). The court continued: “The University should not lament, nor the Developer celebrate, that conclusion, however, on the erroneous assumption that the University has waived its right to veil-piercing in this matter.” Id.  

The court then determined that, because of “considerations of justice and equity,” the university could later seek a veil-piercing action if it were unable to satisfy its judgment. “Any such action will be fairly straightforward given the instant decision, including the Court's observations regarding the inadequacy of the Developer's capitalization . . . and the University may then be entitled to the additional discovery it presently seeks.” Id.

 Wow.  That’s some heavy dicta.  First, the court never states what the rule is for veil piercing an LLC, so it is a pretty bold assertion to say veil-piercing will be “straightforward.” Is the sole test adequate capitalization? What does that mean?  And what is that test? Well, the court gives us an explanation in footnote 22:

The Developer's status as an inadequately capitalized shell company is an ongoing demonstration of bad faith. LLCs are a legitimate corporate form, and the societal benefits of such entities are significant. Dickson testified that the use of such entities in transactions like this one is “typical[ ],” explaining that “single-asset entities are established as borrowers” so that “the borrower[ ] contains one asset,” the advantage from a “liability standpoint” being that “on a transaction of this size, the asset couldn't be pulled into bankruptcy.” Trial Tr. Day 7 AM at 49:25–50:7. Yet, even a single-asset entity must be capitalized to the extent necessary to satisfy its obligations to the project it was created to support. See Lawlor v. District of Columbia, 758 A.2d 964, 975 (D.C. 2000) (noting inadequate capitalization as factor in determining whether a given entity's corporate form should be respected). Consequently, abuse of the corporate form to render a company judgment-proof is impermissible and reflects bad faith.

Um, no.  First, the LLC is not a corporate form. And an entity not being able to pay its debts is not, in and of itself, a showing of bad faith.  Otherwise, what’s the point of limited liability? The court seems to think that being judgment proof because of a lack of funds is not allowed. But it is specifically allowed. If there is fraud or deception, that is not allowed. But an inability to pay the bills is not, alone, at all improper.  It is unfortunate, and perhaps awful, but it is not improper. 

Ultimately, it may be that veil piercing could be justified under DC law, but first, we’d need to know what that law is.  And it should be clear that it is LLC-veil-piercing law that is to be applied, and not the “corporate” veil piercing this court has apparently relied upon.  Once again, I will repeat my call for courts to state specifically the law (and the test) they are applying in LLC-veil-piercing cases, explain why the factors of the test are appropriate in the LLC setting, and then apply that test. 

Instead, the court suggests that veil piercing is essentially inevitable, which could have a strong role in forcing a settlement. This language amounts to phantom veil piercing.  The court never stated a veil-piercing test, never ran the test, and yet, there it is: the specter of a pierced limited liability veil. 

The court seemed frustrated with the developer, and that may be well founded.  Maybe the developer committed fraud. Maybe the developer and other representatives made binding promises that should make them all guarantors. The case also suggests that there may be an argument for enterprise liability among some of the entities mentioned.  And those are all issues that should have been considered.  But none of them are veil piercing claims, and if the court is going to go down that road, the court needs to be more precise to ensure justice and equity prevail.  

August 29, 2017 in Corporations, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (1)

Tuesday, August 15, 2017

Poor LLC Language Leads to Poor LLC Doctrine (And Unnecessary Veil Piercing)

Earlier this week, Professor Bainbridge posted California court completely bollixes up business law nomenclature, discussing Keith Paul Bishop's post on Curci Investments, LLC v. Baldwin, Cal. Ct. App. Case No. G052764 (Aug. 10, 2017).  The good professor, noting (with approval) what he calls my possibly "Ahabian" obsession with courts and their LLC references, says that "misusing terminology leads to misapplied doctrine."  Darn right.

To illustrate his point, let's discuss a 2016 Colorado case that manages to highlight how both Colorado and Utah have it wrong. As is so often the case, the decision turns on incorrectly merging doctrine from one entity type (the corporation) into another (the LLC) without acknowledging or explaining why that makes sense.  To the court's credit, they got the choice of law right, applying the internal affairs doctrine to use Utah law for veil piercing a Utah LLC, even though the case was in a Colorado court. 

After correctly deciding to use Utah law, the court then went down a doctrinally weak path.  Here we go:

Marquis is a Utah LLC. (ECF No. 1 ¶ 7.) Utah courts apply traditional corporate veil-piercing principles to LLCs. See, e.g., Lodges at Bear Hollow Condo. Homeowners Ass'n, Inc. v. Bear Hollow Restoration, LLC, 344 P.3d 145, 150 (Utah Ct. App. 2015). The basic veil-piercing analysis requires two steps:
The first part of the test, often called the formalities requirement, requires the movant to show such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist. The second part of the test, often called the fairness requirement, requires the movant to show that observance of the corporate form would sanction a fraud, promote injustice, or condone an inequitable result.
Jones v. Marquis Properties, LLC, 212 F. Supp. 3d 1010, 1021 (D. Colo. 2016). 
First, say it with me: You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One.  Second, the so-called "the formalities requirement" is a problem for Utah LLCs if one looks at the Utah LLC Act. The Colorado court does not do that, and neither does the Utah court that decided Bear Hollow Restoration, upon which Colorado relied.  They should have. You see, Utah has adopted the Revised Uniform Limited Liability Act, and the Utah version states expressly: 
The failure of a limited liability company to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground for imposing liability on a member or manager of the limited liability company for a debt, obligation, or other liability of the limited liability company.
Utah Code Ann. § 48-3a-304(b). So, that is at least potentially a problem, because the Utah test for the formalities requirement is supposed to be determined by looking at seven factors:
(1) undercapitalization of a one-[person] corporation; (2) failure to observe corporate formalities; (3) nonpayment of dividends; (4) siphoning of corporate funds by the dominant stockholder; (5) nonfunctioning of other officers or directors; (6) absence of corporate records; [and] (7) the use of the corporation as a facade for operations of the dominant stockholder or stockholders....
Lodges at Bear Hollow Condo. Homeowners Ass'n, Inc. v. Bear Hollow Restoration, LLC, 344 P.3d 145, 150 (Utah App. 2015).
I know some will argue I am being overly formalistic in highlighting how corporate focused these factors are, but this is problematic.  Virtually all of these factors must, at a minimum, be contorted to apply to LLCs.  If the test is going to be applied, the least a court should do is to rewrite the test so it refers LLCs specifically.  Why? Well, primarily because in doing so, it would make clear just how silly these factors are when trying to do so.  (For example, LLCs don't have stockholders, corporate funds, dividends, and generally don't have an obligation to have officers or directors.) 

 The Marquis Properties court skips actually applying the test saying simply that an SEC investigation report was sufficient to allow veil piercing. The court determined that an SEC report establishes that sole member of the LLC used the entity "to create the illusion of profitable investments and thereby to enrich himself, with no ability or intent to honor" the LLC's obligations. "Given this, strictly respecting [the LLC's] corporate form [ed. note: UGH] would sanction [the member's] fraud."  The Court then found that veil-piercing was appropriate to hold the member "jointly and severally liable for the amounts owed by" the LLC to the plaintiffs.

But veil piercing is both neither appropriate nor necessary in this case.  In discussing the SEC report earlier in the case, the court found that "all elements of mail and wire fraud are present." I see nothing that would absolve either the LLC as an entity of liability for the fraud and I see no reason why the member of the LLC would not be personally liable for the fraud he committed purportedly on behalf of the LLC and for his own benefit.  

This case illustrates another problem with veil piercing: both courts and lawyers are too willing to jump to veil piercing when simple fraud will do. This case illustrates clearly that fraud was evident, and fraud should be sufficient grounds for the plaintiffs to recover from the individual committing fraud. That means the entire veil piercing discussion should be treated as dicta. The entity form did not create this problem, and the entity form does not need to be disregarded, at least as far as I can tell, to allow plaintiffs to recover fully.  Before even considering veil piercing, a court should be able to state clearly why veil piercing is necessary to make the plaintiff whole. Otherwise, you end up with bad case law that can lead to bad doctrine, which leads to inefficient courts and markets.  

Oh, and while I'm at it, Westlaw needs to get their act together, too.  The Westlaw summary and headnotes say "limited liability corporation (LLC)" five times in connection with this case.  Come on, y'all.  


August 15, 2017 in Business Associations, Corporations, Joshua P. Fershee, Lawyering, LLCs, Shareholders, Unincorporated Entities | Permalink | Comments (0)