Tuesday, July 24, 2018
An Illinois appellate court decision that was just made available on Westlaw provides some revealing insight into Hydra, the longtime source of evil that many recognize from Captain America: The First Avenger.
Hydra stated that Hydra's manager is Ahuva Horowitz, defendant's wife, and that she owns 100% of the membership interests of Hydra a limited liability corporation.
Xcel Supply LLC v. Horowitz, 2018 IL App (1st) 162986, ¶ 14, 100 N.E.3d 557, 561, reh'g denied (Mar. 9, 2018) (emphasis added).
First, let's correct the record: Hydra is listed as an LLC, a limited liability company. It is not a corporation.
Second, I should also note, after further review, it's not really THAT Hydra. It is apparently not this one:
So, instead, the instant Hydra is Hydra Properties, LLC, which came into existence in 2009. That makes more sense, but it's a lot less interesting.
Still, either way, and for either Hydra, if it's Hydra LLC, it's not a corporation.
Monday, February 26, 2018
Professional Responsibility in an Age of Alternative Entities, Alternative Finance, and Alternative Facts
Like my fellow editors here at the BLPB, I enjoyed the first Business Law Prof Blog conference hosted by The University of Tennessee College of Law back in the fall. They have begun to post their recently published work presented at that event over the past few weeks. See, e.g., here and here (one of several newly posted Padfield pieces) and here. I am adding mine to the pile: Professional Responsibility in an Age of Alternative Entities, Alternative Finance, and Alternative Facts. The SSRN abstract reads as follows:
Business lawyers in the United States find little in the way of robust, tailored guidance in most applicable bodies of rules governing their professional conduct. The relative lack of professional responsibility and ethics guidance for these lawyers is particularly troubling in light of two formidable challenges in business law: legal change and complexity. Change and complexity arise from exciting developments in the industry that invite—even entice—the participation of business lawyers.
This essay offers current examples from three different areas of business law practice that involve change and complexity. They are labeled: “Alternative Entities,” “Alternative Finance,” and “Alternative Facts.” Each area is described, together with significant attendant professional responsibility and ethics challenges. The essay concludes by offering general prescriptions for addressing these and other professional responsibility and ethics challenges faced by business lawyers in an age of legal change and complexity.
I do not often write on professional responsibility issues. However, I do feel an obligation every once in a while to add to the literature in that area addressing issues arising in transactional business law. In essence, it's service through scholarship.
I hope you read the essay and, if you do, I hope you enjoy it. I also can recommend the commentary on it published by my UT Law faculty colleague George Kuney and my student Claire Tuley. Both comments will be available electronically in the coming months. I will try to remember to post links . . . .
Tuesday, February 13, 2018
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, December 19, 2017
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
(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;
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).
(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.
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.
(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.
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, August 15, 2017
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.
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.
(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....
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.
Tuesday, April 11, 2017
The Uniform Law Commission is in the process of considering the Limited Liability Company Protected Series Act (f/k/a Series of Unincorporated Business Entities Act), and the final reading is schedule to take place in July 2017. (Draft is here.) I have been discussing the challenges of Series LLCs with a variety of folks, and it strikes me that a consistent theme about the Series LLC is a concern about asset protection between each LLC in there Series. That is, there is concern that some courts may disregard the separateness of each LLC in the Series and treat the entire Series as a single entity. I share this concern, but it strikes me that it is a rather outlandish concern that a court would do so without some significant level of fraud or other injustice to warrant whatever the state version of veil piercing would mandate.
One source goes so far as to state:
Case law has not been developed on Series LLCs yet, and there is much fear in the professional world that the assets may not be as protected as when the entity is formed. What is clear is that the “corporate formalities” must be carefully followed, such that:
Separate books and records should be maintained for each series;
Creditors need to be made specifically aware of the separate existence of each series; and
The assets of each must be unambiguously identified as belonging to that series.
I don't consider these corporate formalities as at all, given that we're talking about an LLC, but it's true that any Series LLC would be well served to follow the entity formalities we'd expect of any entity seeking to protect limited liability. Perhaps because the Series LLC as an entity is new, there is a need for heightened vigilance, but I am of the mind these kinds of measures are proper for all entities, if one wants to reduce the likelihood of veil piercing, enterprise liability, or other agency/guarantor concerns.
Another source warns of the risks of the Series LLC:
The biggest problem with series LLCs is that many states (including California) don’t have series legislation and may choose to ignore the laws of the state where the series was created. That’s because you’re subject to their rules when doing business in their state. The example of the attitude of the California Franchise Tax Board applies to fees, but liability protection is also an issue. Since series LLCs are so new they’ve never been tested by courts, even in the states that permit them. That means there’s no guarantee that limited liability protection will be extended to each series until every state rules on the subject. It’s hard to see how a court would choose to grant this kind of protection inside one entity, and only time will tell if courts will do this. But do you want this type of uncertainty when you are trying to protect your assets?
Again, perhaps valid, but the idea that a state would simply ignore a properly created entity formed in another state is an outrageous proposition, in my mind. If a state sees fit to define an entity, and such an entity is properly formed, that should be sufficient to follow the entity rules. That might be different if a state were to write a law that specifically disallows certain kinds of entity structures. (I'd likely have a problem with that, too, but on the merits of such a law.) And some laws clearly change the analysis, like bankruptcy. But to simply disregard another state's entity structure if the business is properly operating? That's not right.
Anyway, I agree with those who are cautious about the relative limited liability protections of the Series LLC, especially outside of the eight(?) states that have such laws (Delaware, Nevada, Illinois, Iowa, Oklahoma, Tennessee, Texas and Utah). But I do find it disturbing that so many people are comfortable with the idea that courts would (and perhaps should) be so inherently skeptical of a structure chosen by a state legislature that the court would disregard the concept completely. I am all for requiring entities to be clear which entity is to bound (and I think those doing business with those entities should seek guarantees, co-signers, or other assurances where they want them). Courts allowing plaintiffs to expand limited liability beyond a Series entity to include other entities, based only on the use of the Series structure, is different. Like haphazard veil piercing, such decisions run the risk of incentivizing careless or ambiguous drafting and give creditors a chance to pursue a windfall in the form of an un-negotiated guarantee.
As I often remind my students, to argue against the concept of limited liability is a very different thing than arguing that the current law allows one to disregard an entity in a particular circumstance. One asks, "What should be?," while the other asks, "What is?" And to dislike the idea of a Series LLC is very different than suggesting a Series LLC law is invalid. There, the former says what the law should be," while the latter says that what is, is not.
Tuesday, February 14, 2017
I hope this Valentine's Day is a good one for you, dear readers. Mine started with a random (minor) dog bite on my morning run, followed by some time with some very nice health care professionals and quite a few less pleasant needles.
A friend alerted me to the law-related Twitter hashtag #AppellateValentines. Some of them are quite funny. See, e.g.,
Your wish is my mandamus. #AppellateValentines— Emil J. Kiehne (@EmilKiehne) February 14, 2017
There is also a #BusinessValentines hashtag, which is less creative, but has its moments. Of course, there was no #BusinessLawValentines, but there should be and there is now. I went first. Join in, if you're so inclined.
Even if we lived in Delaware, I'd never disclaim my duty of loyalty to you #BusinessLawValentines— Joshua Fershee (@jfershee) February 14, 2017
If you loved me back, we could be Citizens United #BusinessLawValentines— Joshua Fershee (@jfershee) February 14, 2017
And, of course, I could not resist:
Tuesday, January 17, 2017
Here we go again. The Oregon Federal District Court has a rule with an incorrect reference to LLCs on the books:
In diversity actions, any party that is a limited liability corporation (L.L.C.), a limited liability partnership (L.L.P.), or a partnership must, in the disclosure statement required by Fed. R. Civ. P. 7.1, list those states from which the owners/members/partners of the L.L.C., L.L.P., or partnership are citizens. If any owner/member/partner of the L.L.C., L.L.P., or partnership is another L.L.C., L.L.P., or partnership, then the disclosure statement must also list those states from which the owners/members/partners of the L.L.C., L.L.P., or partnership are citizens.
The certification requirements of LR 7.1-1 are broader than those established in Fed. R. Civ. P. 7.1. The Ninth Circuit has held that, “[L]ike a partnership, an LLC is a citizen of every state of which its owners/members/partners are citizens.” Johnson v. Columbia Properties Anchorage, LP, 437 F.3d 894, 899 (9th Cir. 2006). Early state citizenship disclosure will help address jurisdictional issues. Therefore, the disclosure must identify each and every state for which any owner/member/partner is a citizen. The disclosure does not need to include names of any owner/member/partner, nor does it need to indicate the number of owners/members/partners from any particular state.
For federal law purposes, it appears that the rule has excluded LLCs, despite the intent (and likely specific purpose) of the rule. Interestingly, Oregon law, has extended "unless context requires otherwise" the concept of LLCs to apply to partnership and corporate law. Oregon law provides:
Unless the context otherwise requires, throughout Oregon Revised Statutes:
(1) Wherever the term “person” is defined to include both a corporation and a partnership, the term “person” shall also include a limited liability company.(2) Wherever a section of Oregon Revised Statutes applies to both “partners” and “directors,” the section shall also apply:(a) In a limited liability company with one or more managers, to the managers of the limited liability company.(b) In a limited liability company without managers, to the members of the limited liability company.(3) Wherever a section of Oregon Revised Statutes applies to both “partners” and “shareholders,” the section shall also apply to members of a limited liability company.
Wednesday, September 14, 2016
Last spring, in the wake of Justice Scalia's passing, I blogged about Justice Scalia's final business law case: Americold Realty Trust v. ConAgra Ltd. The oral argument signaled that the Court's preference for a formalistic, bright line test that asked whether the entity involved was an unincorporated entity, in which case the citizenship of its members controlled the question of diversity, or whether it was formed as an corporation, in which a different test would apply. The Supreme Court issued its unanimous (8-0) opinion in March, 2016 holding that the citizenship of an unincorporated entity depends on the citizenship of all of its members. Because Americold was organized as a real estate investment trust under Maryland law, its shareholders are its members and determine (in this case, preclude) diversity jurisdiction.
S.I. Strong, the Manley O. Hudson Professor of Law at the University of Missouri, has a forthcoming article, Congress and Commercial Trusts: Dealing with Diversity Jurisdiction Post-Americold, forthcoming in Florida Law Review. The article addresses the corporate constitutional jurisprudential questions of how can and should the Supreme Court treat business entities. What is the appropriate role of substance and form in business law? Her article offers a decisive reply:
Commercial trusts are one of the United States’ most important types of business organizations, holding trillions of dollars of assets and operating nationally and internationally as a “mirror image” of the corporation. However, commercial trusts remain underappreciated and undertheorized in comparison to corporations, often as a result of the mistaken perception that commercial trusts are analogous to traditional intergenerational trusts or that corporations reflect the primary or paradigmatic form of business association.
The treatment of commercial trusts reached its nadir in early 2016, when the U.S. Supreme Court held in Americold Realty Trust v. ConAgra Foods, Inc. that the citizenship of a commercial trust should be equated with that of its shareholder-beneficiaries for purposes of diversity jurisdiction. Unfortunately, the sheer number of shareholder-beneficiaries in most commercial trusts (often amounting to hundreds if not thousands of individuals) typically precludes the parties’ ability to establish complete diversity and thus eliminates the possibility of federal jurisdiction over most commercial trust disputes. As a result, virtually all commercial trust disputes will now be heard in state court, despite their complexity, their impact on matters of national public policy and their effect on the domestic and global economies.
Americold will also result in differential treatment of commercial trusts and corporations for purposes of federal jurisdiction, even though courts and commentators have long recognized the functional equivalence of the two types of business associations. Furthermore, as this research shows, there is no theoretical justification for this type of unequal treatment.
This Article therefore suggests, as a normative proposition, that Congress override Americold and provide commercial trusts with access to federal courts in a manner similar to that enjoyed by corporations. This recommendation is the result of a rigorous interdisciplinary analysis of both the jurisprudential and practical problems created by Americold as a matter of trust law, procedural law and the law of incorporated and unincorporated business associations. The Article identifies two possible Congressional responses to Americold, one involving reliance on minimal diversity, as in cases falling under 28 U.S.C. §§1332(d) and 1369, and the other involving a statutory definition of the citizenship of commercial trusts similar to that used for corporations under 28 U.S.C. §1332(c). In so doing, this Article hopes to place commercial trusts and corporations on an equal footing and avoid the numerous negative externalities generated by the Supreme Court’s decision in Americold.
A special thanks to Professor Strong who read the blog's coverage of Americold and shared her scholarship with me.
Tuesday, September 6, 2016
Private Ordering in the Uncorporation: Modified and Eliminated Fiduciary Duties Are Often the Same Thing
What does it mean to opt out of fiduciary duties? In follow-up to my co-blogger Joan Heminway's post, Limited Partnership Law: Should Tennessee Follow Delaware's Lead On Fiduciary Duty Private Ordering?, I will go a step further and say all states should follow Delaware's lead on private ordering for non-publicly traded unincorporated business associations.
Here's why: At formation, I think all duties between promoters of an unincorporated business association (i.e., not a corporation) are always, to some degree, defined at formation. This is different than the majority of other agency relationships where the expectations of the relationship are more ingrained and less negotiated (think employee-employer relationship).
As such, I'd make fiduciary duties a fundamental right by statute that can be dropped (expressly) by those forming the entity. I'd put an additional limit on the ability to drop fiduciary duties: the duties can only be dropped after formation if expressly stated in formation documents (or agreed unanimously later). That is, if you didn't opt out at formation, tell all those who could potentially join the entity how you can change fiduciary duties later. This helps limit some (though not all) freeze-out options, and I think it would encourage investors to check the entity documents closely (as they should).
At formation, the concerns we might have of, for example, an employee without fiduciary duties, are not the same as they are for co-venturers. Those starting an entity have long negotiated what is a breach of the duty of loyalty, for example. In contrast, I think fiduciary duties in most employer-employee (and similar) relationships reflect the majoritarian default and they facilitate the relationship existing at all. For LLCs and partnership entities, I think that's less clear. Entity formation is relatively rare compared to how often we enter other agency relationships, and they almost always involve significant negotiation (if not planning). And if they don't, the rules we expect traditionally should be the default. But where the parties talk about it, and they usually do, allowing a more robust sense of freedom of contract has value.
Even in Delaware, where one can negotiate out of fiduciary duties, there remains the duty of good faith and fair dealing. I think of that as meaning that the parties still have a right to the essence of the contract. That is, the contract has to mean something. It has to have had a purpose and potential value at formation, and no party can eliminate that. But, the parties only have a right to what was bargained for. As such, what we might traditionally consider a breach of the duty of loyalty could also breach the duty of good faith and fair dealing, but a traditional breach of the duty of loyalty might not be sufficient to find liability where there is expressly no duty of loyalty. Instead, the act must so contradict the purpose of the contract that it rises to the level of a breach the duty of good faith and fair dealing.
Part of the reason I support this option is that I think case law has already validated it, but in such an inartful manner that it confuses existing doctrine. See, e.g., McConnell v. Hunt Sports Enterprises, 132 Ohio App. 3d 657, 725 N.E.2d 1193 (Ct. App. 1999) (“An LLC, like a partnership, involves a fiduciary relationship. Normally, the presence of such a relationship would preclude direct competition between members of the company. However, here we have an operating agreement that by its very terms allows members to compete with the business of the company.”).
In closing, I will note that I am all for express provisions that require investors to pay attention at the outset. I don't believe in helping cheaters hide the ball. I just think law that encourages investors and others joining new ventures to pay attention is useful and will provide long-term value to entities. I don't think that eliminated fiduciary duties at formation raise any more of a risk than we already have with limited or modified fiduciary duties at formation. With the more limited protections described above, freedom of contract should reign.
Wednesday, July 27, 2016
Just in case you haven't gotten the message yet: Delaware law means fiduciary duty freedom of contract for alternative entities. In May 2016, the Delaware Chancery Court upheld a waiver of fiduciary duties in a master limited partnership. In Employees Retirement System of the City of St. Louis v. TC Pipelines GP, Inc., Vice Chancellor Glasscock upheld challenges to an interested transaction (sale of a pipeline asset to an affiliated entity) that was reviewed, according to the partnership agreement, by a special committee and found to be fair and reasonable. The waiver has been described as "ironclad" to give you a sense of how straight forward this decision was. No close call here.
Vice Chancellor Glasscock's letter opinion starts:
Delaware alternative entity law is explicitly contractual;1 it allows parties to eschew a corporate-style suite of fiduciary duties and rights, and instead to provide for modified versions of such duties and rights—or none at all—by contract. This custom approach can be value enhancing, but only if the parties are held to their bargain. Where equity holders in such entities have provided for such a custom menu of rights and duties by unambiguous contract language, that language must control judicial review of entity transactions, subject only to the cautious application of the implied covenant of good faith and fair dealing. Such is the case in the instant matter, which involves a master limited partnership (“MLP”) created with interested transactions involving the general partner as part of its business model.....
The Defendants point out that the [transaction] was approved by a special committee (the “Conflicts Committee”), which approval, in accordance with the partnership agreement, creates a conclusive presumption that the transaction is fair and reasonable to the Partnership. I find that the Conflicts Committee’s approval, in these circumstances, precludes judicial scrutiny of the substance of the transaction and grant the Defendants’ Motion.
Importantly, the contractual safe harbor for interested transactions established a process which, if followed, created a fair and reasonable transaction outside of judicial scrutiny and without recourse by the other partners. The court found that the partnership agreement precluded a good faith analysis of the Conflicts Committee's review and limited the court's review purely to matters of process.
The relevant portions of the Special Approval provision, importantly, are silent as to good faith.....According to the contractual language, the Special Approval of a duly constituted and fully informed Conflicts Committee is conclusive evidence that such transaction is fair and reasonable, and such approval is, therefore, preclusive of further judicial review. The Plaintiff does not allege that the Conflicts Committee was not duly constituted—that is, directors who are neither security holders nor employees or officers of the General Partner or its affiliates. Nor does the Plaintiff allege that the Conflicts Committee was not fully informed. Thus, the approval here is conclusive that the [transaction] is “fair and reasonable” to TCP. According to the explicit language of the LPA, when a conflicted transaction is deemed “fair and reasonable” by the terms of the agreement, such conflicted transaction is incapable of breaching the LPA.
Get the message? LOUD and CLEAR!
The opinion contains more analysis and excerpts of the relevant portions of partnership agreement. Look for an excerpt on this case in my ChartaCourse (electronic platform) Business Organizations casebook.
Wednesday, July 13, 2016
This is just me musing a bit, but in following up my post on how LLCs can choose to “be corporations” for federal tax purposes, meaning they get C corp tax treatment, I was thinking that maybe the IRS could just stop using state-law designations at all. That is, stop having “corporate” tax treatment at all.
My proposal is not abolishing corporate tax – that’s a much longer post and one I am not sure I’d agree with. Instead, the proposal is to have entities choose from options that are linked the Internal Revenue Code, and not to a particular entity. Thus, we would have (1) entity taxation, called C Tax, where an entity chooses to pay tax at the entity level, which would be typical C Corp taxation; (2) pass-through taxation, called K Tax, which is what we usually think of as partnership tax; and (3) we get rid of S corps, which can now be LLCs, anyway, which would allow an entity to choose S Tax.
This post deals with the tax code, which means I am in over my head, and because this is tax related, it means the solution is a lot more complicated than this proposal. But now that the code provisions are not really linked to the state law entity, I think we should try refer to state entities as state entities, and federal tax status with regard to federal tax status. Under such a code, it would be a little easier for people to understand the concept behind state entity status, and it would make more sense to people that a “C Corp” does mean “publicly traded corporation” (a far-too common misunderstanding). Thus, we could have C Tax corporations, S Tax LLCs, K Tax LLCs, for example. We'd know tax status and state-entity status quite simply and we'd separate the concepts.
A guy can dream, right?
Tuesday, June 21, 2016
Last week, a federal court determined that an insurance disclosure that asked about an "applicant's" criminal history did not apply to an LLC member's individual criminal past. In Jeb Stuart Auction Servs., LLC v. W. Am. Ins. Co., No. 4:14-CV-00047, 2016 WL 3365495, at *1 (W.D. Va. June 16, 2016), the court explained:
“Question Eight” on the [insurance] application asked, “DURING THE LAST FIVE YEARS (TEN IN RI), HAS ANY APPLICANT BEEN INDICTED FOR OR CONVICTED OF ANY DEGREE OF THE CRIME OF FRAUD, BRIBERY, ARSON OR ANY OTHER ARSON-RELATED CRIME IN CONNECTION WITH THIS OR ANY OTHER PROPERTY?” Hiatt, on behalf of Jeb Stuart (who [sic] was the sole [LLC] applicant for the insurance policy), answered, “No.” Hiatt signed the application and left.
As you might imagine, Hiatt had been convicted of "hiring individuals to wreck cars so that he could receive the proceeds from the applicable insurance policies," and, yep, about a month later, the building burned down. Id. at *2.
The insurance company cancelled the policy because it claimed Hiatt had lied on the application, and Hiatt sued for the improper cancellation of the policy because he did not lie (he prevailed) and for attorneys fees claiming “the insurer, not acting in good faith, has either denied coverage or failed or refused to make payment to the insured under the policy.” Id. at *3. Judge Kiser determined that not attorneys' fees were warranted:
Neither party was able to rely on a case on point regarding the issue of whether questions on an LLC's insurance application asking about criminal history applied to the members of the LLC, to the corporate entity, or to both. Although I believe the answer to that question is clear, I am not aware of any other court being called upon to answer it. Therefore, although it was unsuccessful in asserting its defense to Jeb Stuart's claim, West American's position did present a novel legal question. As such, the final Norman factor weighs in favor of a finding of good faith.
Monday, June 13, 2016
This past week, I completed the second leg of my June Scholarship and Teaching Tour. My time at "Method in the Madness: The Art and Science of Teaching Transactional Law and Skills" at Emory University School of Law last week was two days well spent. I had a great time talking to attendees about my bylaw drafting module for our transaction simulation course, Representing Enterprises, and listening to others talk about their transactional law and skills teaching. Great stuff.
This week's portion of my academic tour begins with a teaching whistle-stop at the Nashville School of Law on Friday, continues with attendance (with my husband) at a former student's wedding in Nashville on Saturday evening, and ends (my husband and I hope) with Sunday brunch out with our son (and his girlfriend if she is available). Specifically, on Friday, I teach BARBRI for four hours in a live lecture. The topics? Well, I drew a short straw on that. I teach agency, unincorporated business associations (including a bit about both extant limited liability statutes in Tennessee), and personal property--all in four hours. Ugh. Although I am paid for the lecture and my expenses are covered, I would not have taken (and would not continue to take) this gig if I didn't believe that I could be of some help to students. These topics--especially agency and partnership law, but also personal property--often are tested on the bar exam. So, on I press.
I also am completing work this week on the draft article that I will present in Chicago and Seattle on the last two stops of my tour. I will say more about that article in next week's post. In the mean time, let me know if you have any suggestions (or good jokes) on the law of agency, partnerships, LLCs, or personal property (e.g., tenancies, gifts, bailments, adverse possession, replevin) for my lecture on Friday . . . . It's so hard to make these speed-lectures somewhat engaging for the students. [sigh]
Wednesday, May 18, 2016
California is the back on my short list for the state's inability to successfully differentiate between corporations and limited liability companies (LLCs). Last week, an "unpublished/noncitable" decision that was published on Westlaw provided a good example.
The opinion states:
A corporation—including a limited liability corporation—may be served by effecting service on its agent for service of process. (Code Civ. Proc., § 416.10, subd. (a); see also Corp.Code, § 17701.16, subd. (a) [allowing service on limited liability corporations under Code Civ. Proc., § 413.10 et seq.].)7
*12 One of the ways a limited liability corporation can be served is by substituted service. (1 Weil & Brown, Cal. Practice Guide: Civil Procedure Before Trial (The Rutter Group 2015) ¶ 4:172, p. 4–26.) This requires that a copy of the summons and complaint be left at the office of the person to be served (or, in some cases, at the mailing address of the person to be served), in the presence of a person who is apparently in charge, “and by thereafter mailing a copy of the summons and complaint by first-class mail, postage prepaid to the person to be served at the place where a copy of the summons and complaint were left.” (Code Civ. Proc., § 415.20, subd. (a).)
No, no, no. First, even in California, an LLC is a "limited liability company." It says so right in the act. Cal. Corp. Code § 17701.01 (West) ("This title may be cited as the California Revised Uniform Limited Liability Company Act.").
And, yet, I have to admit, if you note the cite to the LLC act, California lawmakers have made this less clear than in other states. Yes, that's right. In California, the LLC Act is part of the California Corporations Code. Cal. Corp. Code §§ 17701.16 - 17713.13 (West). For that matter, so are partnerships, under Title 2. Sigh.
Would it be so terrible if the Corporations Code were called what it is: the Business Entities Code? As currently structured, LLCs and partnerships are arguably types of corporations under California law, as the above cases suggests. One could argue the headings don't change the meaning or intent of the laws. See Cal. Corp. Code § 6 (West) ("Title, division, part, chapter, article, and section headings contained herein do not in any manner affect the scope, meaning, or intent of the provisions of this code."). The problem with that is that the code text says otherwise: "This act shall be known as the Corporations Code." Cal. Corp. Code § 1 (West).
To reinforce that notion, the Code Commission notes from the 2014 main volume explain:
This code was listed in the appendices of Code Commission reports showing code classification as the “Corporations, Partnerships, and Associations Code.” The 14 syllables of that title appear to make it impractical, but no shorter phrase indicative of the full subject-scope has been found. Therefore, resort has been had to the rhetorical device of synecdoche, and the entire code designated by the name of longest part.
I admit I had to look up synecdoche to be sure I was on the right track, but the term supports, I think, my point that California is treating LLCs and partnerships as corporations (or some subset thereof). See, for example, this explanation:
Synecdoche is a literary device in which a part of something represents the whole or it may use a whole to represent a part.
Synecdoche may also use larger groups to refer to smaller groups or vice versa. It may also call a thing by the name of the material it is made of or it may refer to a thing in a container or packing by the name of that container or packing.
Still, even if it were accurate to says LLCs and partnerships are "types" of corporations under the California code, one thing is still clear: an LLC is a limited liability company, which is, at a minimum, a specific type of "limited liability corporation."
I suppose I can see how "14 syllables" might be deemed "impractical," but not at the cost of imprecision. The "Business Entities" -- or even just "Entities" or "Associations" -- Code would seem like a better, more accurate, option.
Oh well. At least the court cited the part of the California code for service of an LLC. That much, they got right.
Tuesday, May 10, 2016
This is just to give everyone a "heads up" on a symposium being held this fall (Friday, October 21 and Saturday, October 22) to honor Lyman Johnson and David Millon. The symposium is being sponsored by the Washington & Lee Law Review (which will publish the papers presented), and I am thrilled to be among the invited speakers. I will have more news on the symposium and my paper for it as the date draws nearer. But I wanted everyone to know about this event so that folks could plan accordingly if they want to attend. I understand Lexington, Virginia is lovely in late October . . . . Actually, it's always been lovely when I have been up there! And the honorees and contributors are a stellar group (present company notwithstanding). I hope to see some of you there.
At the 2017 AALS annual meeting, January 3-7 in San Francisco, the AALS Sections on Agency, Partnerships LLCs, and Unincorporated Associations & Nonprofit and Philanthropy Law will hold a joint session on LLCs, New Charitable Forms, and the Rise of Philanthrocapitalism.
In December 2015, Facebook founder Mark Zuckerberg and his wife, Dr. Priscilla Chan, pledged their personal fortune—then valued at $45 billion—to the Chan-Zuckerberg Initiative (CZI), a philanthropic effort aimed at “advancing human potential and promoting equality.” But instead of organizing CZI using a traditional charitable structure, the couple organized CZI as a for-profit Delaware LLC. CZI is perhaps the most notable example, but not the only example, of Silicon Valley billionaires exploiting the LLC form to advance philanthropic efforts. But are LLCs and other for-profit business structures compatible with philanthropy? What are the tax, governance, and other policy implications of this new tool of philanthrocapitalism? What happens when LLCs, rather than traditional charitable forms, are used for “philanthropic” purposes?
From the heart of Silicon Valley, the AALS Section on Agency, Partnerships LLCs, and Unincorporated Associations and Section on Nonprofit and Philanthropy Law will host a joint program tackling these timely issues. In addition to featuring invited speakers, we seek speakers (and papers) selected from this call.
Any full-time faculty of an AALS member or fee-paid school who has written an unpublished paper, is working on a paper, or who is interested in writing a paper in this area is invited to submit a 1- or 2-page proposal by June 1, 2016. The Executive Committees of the Sections will review all submissions and select two papers by July 1, 2016. If selected, a very polished draft must be submitted by November 30, 2016. All submissions and inquiries should be directed to the Chairs of the Sections at the email addresses below:
University of Oregon School of Law
Garry W. Jenkins
Associate Dean for Academic Affairs
John C. Elam/Vorys Sater Professor of Law
Moritz College of Law,State University
Tuesday, May 3, 2016
A recent Vanity Fair article discussing Citizens United is making the rounds. (I saw it on Facebook!) The article notes:
It had already been established, in Buckley v. Valeo (1976), that anyone has a First Amendment right to spend his or her own money advancing his or her own cause, including a candidacy for political office. Citizens United extended this right to legally created “persons” such as corporations and unions.
I have been giving some more thought to whole “personhood” discussion of late, and my thoughts have taken me back to both Hobby Lobby and Citizens United. What follows is a long blog post that pulls together my thoughts on these two cases in an admittedly not well developed way. But it's a start (though I really should be grading).
Tuesday, March 22, 2016
March has provided a slate of mistakes as to entity form, focusing (as it almost always does) on limited liability companies (LLCs) and various outlets calling such entities "corporations." These are not in any particular order, but lists are neat. Enjoy!
(1 ) Politifact Checks Trump Facts, Forgets to Check Entity Law Facts
In an article on Politifact.com, Donald Trump incorrectly says Virginia winery is the largest on East Coast, which determines that Trump's claims about the size of a winery that his son runs to be false and notes some statements are incorrect. Ironically, the article also claims:
A legal disclaimer on the winery website says the GOP presidential candidate doesn’t own the winery. The venture is a limited liability corporation, and its owners are not a matter of public record.
Wrong. The winery site says, "Trump Winery is a registered trade name of Eric Trump Wine Manufacturing LLC, which is not owned, managed or affiliated with Donald J. Trump, The Trump Organization or any of their affiliates." An LLC is still not a corporation.
(2) Big Bang Theory: Big Brains Don't Know Entity Law
I don't watch the Big Bang Theory, but my colleague at Valparaiso University, Professor Rebecca J. Huss, is a reader of this blog who also cares about precise language with regard to LLCs alerted me to this one. The story line of the March 10 show (the show can be found here) related to a the creation of a partnership agreement for some of the characters. One thing that is realistic is that the folks think it's a good idea to form an entity and draft contract language without a lawyer. One character says he has some concerns about the partnership, and another replies with this "joke": "Are you suggesting a limited liability corporation, because I did not LLC that coming." (The offending segment is roughly 14 minutes into the show.) (This was also covered at Kentucky Business Entity Law Blog, here, which noted, "Ughhhh. LLC ≠ limited liability corporation. Rather, LLC = limited liability company.")
(3) Ghost LLCs Masquerading as Corporations
The Washington Post last week ran a story, How ‘ghost corporations’ are funding the 2016 election. The article discusses how entities can be used to shield those backing political candidates. The article states:
Advocates for stronger campaign-finance enforcement fear there will be even more pop-up limited liability corporations (LLCs) funneling money into independent groups, making it difficult to discern the identities of wealthy players seeking to influence this year’s presidential and congressional contests.
. . . .
Many corporate givers this cycle are well-established hedge funds, energy companies and real estate firms. But a significant share of the money is coming from newly formed LLCs with cryptic names that offer few clues about their backers.
(4) Pass-Through Tax Law Isn't Really About Corporations (mostly)
The Topeka Capital-Journal Editorial Board wrote on March 20: LLC loophole needs plugging: Even some small business owners think the tax exemption should be eliminated. The editorial is related to a 2012 Kansas law, HB 2117, which eliminated taxes on pass-though entities like LLCs, S corps, partnerships, farms, and sole proprietorships. (So, I admit, S corps are corporation, but they are essentially partnerships for federal tax purposes.) Even though I agree with some their concerns, the board makes a couple mistakes here when they assert that the bill "was simply an unconditional gift from the state for anyone who has created an entity called a limited liability corporation (LLC)."
First, it assumes that just LLCs get the benefit, which is not true. All pass-though entities benefit. Second, of course, the "limited liability corporation" is a corporation, not an LLC, and the corporation (other than one chosen to be an S corp) does not get the benefit of the law.
(5) Court Gets Entity Right, Regulations Not Quite
I'm not one to leave the courts out of this. Judge Robert M. Dow, Jr., of the United States District Court, Northern Illinois has an incredible resume. A member of Phi Beta Kappa and a Rhodes Scholar, his credentials are impressive. In a recent decision, though, his opinion refers to a defendant LLC correctly, but then goes on to say that Treasury Regulations are silent on treatment of "limited liability corporations." Alas, that's not accurate. Here's the passage:
It is undisputed that, as of the date of Anderson Bros.' withdrawal from the fund, Anderson Bros. (an Illinois corporation) was 100% owned by Anderson. Anderson therefore had a “controlling interest” in Anderson Bros. 29 U.S.C. § 1.414(c)-2(b)(2)(A). At the same time, Defendant (an Illinois limited liability company) was also solely owned by Anderson. Section 1.414(c)-2 of the Treasury Regulations does not address specifically the treatment of limited liability corporations, and the Board does not address this issue in its brief. According to the Internal Revenue Service (“IRS”), “an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes * * *, unless it files Form 8832 and affirmatively elects to be treated as a corporation.” IRS, Single Member Limited Liability Companies, https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Single-Member-Limited-Liability-Companies (last visited Mar. 16, 2016).
Bd. of Trustees of the Auto. Mechanics' Local No. 701 Union & Inustry Pension Fund v. 6516 Ogden Ave., LLC, No. 14-CV-3531, 2016 WL 1043422, at *4 (N.D. Ill. Mar. 16, 2016) (emphasis added).
Tuesday, March 15, 2016
In my Energy Business: Law & Strategy course, I use Larry A. DiMatteo's article, Strategic Contracting: Contract Law as a Source of Competitive Advantage, 47 Am. Bus. L.J. 727 (2010). I have been using the article in the class since 2012 (this is the third time I have taught it), and I think it does a great job of providing a theoretical backdrop for practical application. I teach the article in combination with a one-sided proposed Memorandum of Understanding to help students think about the contracting process and and the long-term implications of what might seem like a small-scale negotiation. I highly recommend the piece.
In reading the article this time around, though, I was struck by how differently the piece treats limited liability companies (LLCs) and corporations and the way concerns about opportunistic behavior are raised in the context of the latter. In one portion of the article, DiMatteo notes:
Corporate strategy that fails to take account of the strategic use of law is likely to waste opportunities for competitive advantages. A corporate legal strategy can be used to gain competitive advantages both internally and externally.
I wholeheartedly agree, and this is part of the reason I teach my course. Although I don't think this is true of just "corporate" strategy, because the same applies to other entities, such as educational institutions, environmental organizations, LLCs, and even governments. Regular readers will not be surprised that I would choose to start the sentence "entity strategy" instead of "corporate strategy, " but his point is still well taken.
Later in the piece, Prof. DiMatteo takes the following position with regard to LLCs:
The freedom of contract paradigm that underlies LLCs allows for broad flexibility in strategically drafting the operating agreement. I will make a distinction here between proper and improper strategic drafting, because a distinction based on legality is insufficient. That is, improper terms may be perfectly legal under some states’ LLC statutes. The argument here is that the freedom of contract construct can lead to contractual abuse, albeit a legally sanctioned abuse. For example, a combination of clauses could be inserted into the operating agreement that strips nonmanager members of all power and protections, such as removal of fiduciary duties relating to the managing member, an indemnification clause to protect the managing member from liability for malfeasance, and a clause providing that the nonmember managers have no right to withdraw or to seek dissolution. These types of provisions may be legal under some statutory schemes, but strict enforcement of these clauses by the managing member would be abusive.
I fail to see why strategic use of law in this context is more problematic than the strategic use of law in other contexts. I do understand and validate concerns about on-going expectations of fiduciary protections related to entities, and that is why, as I have suggested previously, that the lack of fiduciary duties and post-formation changes to fiduciary duties (especially loyalty) should include disclosure and perhaps other structural protections. (I am less concerned about those forming the entity agreeing to limit or eliminate fiduciary duties because they are agreeing to the option at formation when they can object or walk away.) Still, I don't see any reason that freedom of contract in LLCs is fundamentally different from freedom of contract in any other setting, at least as along as you account for a potential knowledge gap about fiduciary duties. In contrast, I liked how Larry Ribstein framed the question of possible promoter liability for LLCs in New York, where he argued that one could make a complaint that "alleged a misrepresentation which would be actionable without implying a fiduciary duty."
I do agree with Prof. DiMatteo when he says, "In the end, contracts can be a strategic tool in obtaining a competitive advantage, or they can be a tool to support collaboration by minimizing the opportunities for advantage taking." Freedom of contract in LLC formation embraces both of these concepts, too. I just think that those forming the entity should be the ones to determine which path they will take.