June 23, 2009

Series LLCs & Assumed Names

Delaware, § 18-215(a), Illinois, 805 ILCS 180/37‑40(a), and Texas, Tex. Bus. Org Code § 601.101 (added by Section 45 of SB 12442), all allow the operating agreement (however named) to 'establish" one or more series.  Only Illinois conditions asset and liability partitioning on the filing of a certificate of designation, § 37-40(b), that specifies the name of the series, § 37-40(d).  Also, only llinois expressly provides that

But what about assumed name filing requirements?  Presumably, that ought not to be an issue in Illinois--the name is already of record, and would not be an assumed name of the LLC itself.  Or at least, that's the way I'd set it up. 

In Delaware and Texas, not only is establishing an LLC entirely private, but also a series is not formally a separate entity.  The use of a series name would then seem to require a filing under the assumed name statute.  For example, under Tex. Bus. & Commerce Code Section 71.002(2)(H), an LLC's name in its "certificate of formation or comparable document" is not an assumed name. Interestingly, although Section 62 of SB 1442 amended TBCC section 71.002, it did not amend subdivision (2)(H). 

A question for practitioners who are UB readers : how are handling the assumed name issue?

posted by Gary Rosin

June 23, 2009 in Commentary | Permalink | Comments (1) | TrackBack

June 22, 2009

Texas: "Reasonable Compensation" and Limitations on LLC & LP Distributions

Section 101.206 of the Texas Business Organization Code (TBOC) prohibits an LLC from making distributions when the fair value of its assets is, or would become, less than its total liabilities.  Section 41 of Senate Bill 1442 amended TBOC Section 101.206 so as to exclude "reasonable compensation" from the limitations of Section 101.206:

   (f) For purposes of this section, "distribution" does not include an amount constituting reasonable compensation for present or past services or a reasonable payment made in the ordinary course of business under a bona fide retirement plan or other benefits program.

Similar language was included in the limitations of distributions of an LLC series, TBOC § 101.613(h) (Section 43 of SB 1442), andof a limited partnership, TBOC § 153.210(b) (Section 52 of SB 1442).

First, In the context of partnerships, TBOC Section 151.001(2) had already defined "distribution" as a transfer to a partner in the partner's "capacity as a partner". I would think that any amount a limited partnership had agreed to pay a partner as compensation for services would not transfers to the partner as partner. If the legislature wanted to make that clear, the logical place to do that would have been TBOC section 151.001(2). TBOC Chapter 151 is a "mini-hub," its provisions apply to all partnerships, and to all uses of "distribution" in Chapters 151 through 154. Adding the limitation to Section 153.210 limits the scope of the carve out.

Second, Chapter 152 (general partnerships) has no limitations on distributions. Before the advent of the LLC, that made sense; all partners were liable for partnership obligations. With the introduction of the LLP (you can blame, or credit, Texas for that), limitations on distributions seem appropriate. But neither Texas nor the RUPA have any such limitations, leaving creditors to fraudulent transfer law.

posted by Gary Rosin

June 22, 2009 in Commentary, Legislative Developments | Permalink | Comments (0) | TrackBack

March 09, 2009

Client Warning Flags (In Re Keck)

The facts giving rise to a recent Report and Recommendations of the Hearing Board of the Illinois Attorney Registration & Disciplinary Commission in In re Keck, No. 06 CH 90 (March 6, 2009), shows a primary "warning flag" of a client that cannot be unsatisfied:

Catherine ... and William Murphy were married on November 18, 1988 and divorced in February 2003. After the divorce action was filed in 1998, Catherine was represented by several different attorneys. She described herself as a client who was very involved, and "hands-on." In the spring of 2002, when Catherine's divorce proceedings had been ongoing for four years and after the court ruled that a prenuptial agreement was valid, she decided that her current attorney ... was overwhelmed by the case and needed the assistance of another attorney.

Id. at 2.  Four years, and several attorneys on, Catherine wanted the assistance of a new lawyer.  As Gomer Pyle would have said:  "Surprise! Surprise! Surprise!"  Guess who was the subject of a grievance? 

Hat tip to the Legal Profession blog.

posted by Gary Rosin

March 9, 2009 in Commentary | Permalink | Comments (0) | TrackBack

March 08, 2009

Care in Contracting. BASF v. POSM II Properties Partnership LP (Del. Ch. 2009)

BASF Corp. v. POSM II Properties Partnership LP, C.A. No. 3608-VCS, (Del. Ch. March 3, 2009) (for opinion, see Delaware Corporate and Commercial Litigation blog), involved tiered limited partnerships.  BASF was a limited partner in POSM II Properties Partnership, LP formed to build and lease a facility to Lyondell's predecessor-in-interest, ARCO.  The partnership's general partner was POSM II Properties, the initial general partner of which was ARCO (later, Lyondell Chemical Company).  BASF's predecessor-in-interest, Mobil, had negotiated for a right to withdraw from the partnership if ARCO (or, now, Lyondell) or its affiliates no longer operated the facility.  After Basel AF S.C.A.acquired Lyondell, Lyondell became a wholly-owned subsidiary of LyondellBasel.  BASF claimed that, even though Lyondell was still operating the facility, the change in control of Lyondell triggered the withdrawal right.  Slip Op. at 3-4.

Vice Chancellor Strine, noted that the parties' agreement tied the withdrawal right to Lyondell's operation of the facility, and not to a change in control of Lyondell itself.  Id. at 4-7.  He declined to find a de facto change in control:

If the parties t... had reached a bargain to give [BASF] a right to walk away and be bought out upon a change of control of [Lyondell], one would have expected them to use the common technique and do that explicitly. In this regard, it is notable that change of control provisions often detail the precise scenarios that qualify, whereas, under BASF’s approach, the parties would either have to reach an after-the-fact accord on what corporate events qualified as an implied change in the operator or have a court do so. 

Delaware law does not invest judicial officers with the power to creatively rewrite unambiguous contracts in this manner.

Id. at 13  (footnote omitted).

Certainly, it's hard to imagine that major oil companies didn't know about acquisitions and mergers, and the effect of various structures used in acquisitions on the rights of the parties.

Hat tip, Francis G.X. Pileggi.

posted by Gary Rosin

March 8, 2009 in Commentary, Partnership Cases | Permalink | Comments (0) | TrackBack

March 03, 2009

Statute of Frauds and UBE Agreements

Thomas E. Rutledge has posted on SSRN The Statute of Frauds and Partnership/Operating Agreements, J. Passthrough Entities 41 (November-December 2008), in which he discusses a recent holding by Vice Chancellor Lamb in Olsen v. Halverson, C.A. No. 1884-VCL (Del. Ch. Oct. 22, 2008) that the statue of frauds applies to LLC operating agreements. This despite Section 18-101(7) of the Delaware Limited Liability Company Act, includes "written, oral or implied" (emphasis added).

While we might disagree over the importance of signed writings to resolve disputes about the agreement of the parties, how in the world did an Operating Agreement for a hedge fund go unsigned?

posted by Gary Rosin

March 3, 2009 in Commentary, Scholarship | Permalink | Comments (0) | TrackBack

February 20, 2009

Holdover LLCs. Spellman v. Katz (Del. Ch. 2009)

What happens when the practice of the members of an Unincorporated Business Entity (UBE) varies from the terms of the UBE's constitutive documents?  In a recent opinion in Spellman v. Katz, C.A. No. 1838-VCN (Del. Ch. February 9, 2009), Vice Chancellor Noble invoked the Parole Evidence Rule to prohibit the consideration of evidence showing that the members of an LLC had disregarded a provision in the LLC Agreement. 

In Spellman, Doctors Katz, Spellman and Alfieri formed Delaware Bay Surgical Services, P.A. as the vehicle for the joint practice of medicine.  At the same time, the three also formed KSA, L.L.C.  The LLC bought a piece of property, constructed a building, Bayview Medical Center, and leased it (or a portion of it) to the PA.  At some point, Dr. Alfieri withdrew form the LLC (and, presumably, the PA), and bought one of what eventually became three "units" from the LLC.  In February, 2002, after an unsuccessful attempt to force dissolution of the PA, Dr. Spellman withdrew from the practice.  In 2002, presumably after Spellman's departure, another unit in the building was sold.  Dr Katz continues to practice through the PA, and the PA continues to lease a unit in the building.  Slip Op., at 1-2 & nn. 1-4.

In his recent opinion, Chancellor Noble granted Dr. Spellman's request for dissolution of the LLC and the appointment of a liquidating trustee.  Section 5.1 of the LLC Agreement provided for dissolution and winding up of the LLC

as soon as possible after the construction of the building [Bayview Medical Center] has been completed, the condominium documents have been finalized and a certificate of occupancy has been issued with respect to each condominium unit . . .

Id. at 2 (bracketed portion in the opinion's quotation of Section 5.1).   

Although Dr Katz did not cast his argument in terms of mistake, he did argue that the members had intended the LLC to be used as the vehicle to own the facilities used by the PA in order to obtain  tax benefits.  Id. at 5.  He claimed that the members did not know of the language of Section 5.1.  Id. at 6. Chancellor Noble rejected those arguments out-of-hand:

Dr. Katz would have the Court ignore the plain language of Section 5.1 in deference to his recollection of the parties’ intention that KSA would continue as an entity long after the completion of Bayview Medical Center....

Id. at 5. 

The Chancellor also noted that Dr. Katz had not argued waiver, estoppel or acquiescence.  Id. at 6 n.20.  In retrospect, that was a mistake.  Whatever else is true, the LLC did continue doing business for over two years after the completion of the facility.  Dr. Alfieri left the practice, withdrew from the LLC, and then bought his unit (presumably, the space he had already been using).  The practice PA continued to lease the remainder of the building until Dr. Spellman left the practice, at which point the LLC sold a second unit.

How should the law handle a variance between the agreements and the practice of the parties?  Continuation of a business beyond an agreed term or undertaking, and without an express agreement to do so, was common enough that, almost a hundred years ago, the UPA addressed it (Section 23).  RUPA continues to provide for it (Section 406).  ULLCA Section 802(b) does permit the members to waive winding up, but the ULLCA does not address a continuation without a waiver.  Section 18-806 of the Delaware LLC Act does allow "revocation of dissolution," but only by "the affirmative vote or written consent of all remaining members...."

All the LLC statutes need to address the problem of "holdover" LLCs.  The R/UPA approach of falling back on the statutory default may not be the right solution.  For example, under Section 18-801(a)(1) of the Delaware LLC Act, the statutory default is perpetual existence.   One the other hand, the substance of the RUPA statutory default--an "at will" entity--may well be proper to handle holdovers.

In the absence of a legislative solution, UBE documents should address the problem.

Time to get to work.

Hat tip to the Delaware Business Litigation Report.

posted by Gary Rosin

February 20, 2009 in Commentary, LLC Cases | Permalink | Comments (0) | TrackBack

February 19, 2009

Joint Ventures vs. Partnerships. Costa v. Borges (Idaho 2008)

I know that historically--before the Great Depression, perhaps even before the 20th Century--courts considered joint ventures and partnerships to be distinct business forms (for reasons that will become apparent, note my use of "forms" instead of "entities").  To be sure, the two were "similar" and courts usually applied partnership law to joint ventures.  As the Idaho Supreme Court recently put it in its opinion in Costa v. Borges, 2008 Op. No. 23, at 4, 179 P.3d 316 (Idaho February 15, 2008) (citations omitted):

Because of the similarities between partnerships and joint ventures, partnership law generally governs joint ventures.  A partnership is "an association of two (2) or more persons to carry on as co-owners a business for profit." "A joint adventure is generally a relationship analogous to but not identical with a partnership, and is often defined as an association of two or more persons to carry out a single business enterprise with the objective of realizing a profit."

The opinion in Costa v. Borges then took an unexpected turn.  Because RUPA Section 201 declares a partnership to be an entity separate from its partners, the Idaho Supreme Court concluded that partnership and joint venture law have parted company:

Although a partnership is now an entity distinct from its partners, "a joint venture is not an entity separate and apart from the parties composing it." There is no statute providing that a joint venture is an entity distinct from its members. There is no statutory provision allowing for the dissociation of a member from a joint venture and the continuation of the joint venture in business as a separate entity. That portion of RUPA providing for the continuation of a partnership as a separate legal entity after dissociation of a partner has no application to a joint venture.

Slip. Op. at 5 (citations omitted) (emphasis added).  Later, the Court indicated that, even in a three-member joint venture,

However, even if the joint venture had three members it could not continue doing business after the withdrawal of one member. Because "a joint venture is not an entity separate and apart from the parties composing it," a joint venture cannot continue in business as a separate legal entity after one joint venturer withdraws.

Id. at 4-5 (citation omitted). 

The same could have been said of mid-(20th) century partnerships.  Not only does the Costas v. Borges freeze joint-venture law, it also ignores Rights of partners under UP)A Section 38(2).  A joint venture is only a partnership for a particular purpose.  Under UPA Section 38(2), after the early withdrawal of a partner in a partnership for a particular purpose, the remaining partner(s) may

continue the business of the partnership, either by themselves or jointly with others ....

That is, the question is not whether a partnership may continue after the withdrawal of one of two partners, but whether the remaining partners may continue the business without dissolution.  That said, with its emphasis on continuation of the entity, the RUPA does not adequately address continuation of the business of two-partner partnerships after the premature withdrawal of one of the partners.

Hat tip to Marc Ward.

posted by Gary Rosin

February 19, 2009 in Commentary, LLC Cases | Permalink | Comments (0) | TrackBack

February 18, 2009

Reverse Piercing: A Single Member LLC Paradox

Carter G. Bishop (Suffolk) has posted on SSRN "Reverse Piercing: A Single Member LLC Paradox," an article forthcoming in the South Dakota Law Review.  Bishop's focus is on the rise of single member LLCs (SMLLCs) as an asset-protection vehicle, and the resulting difficulties of creditors of the single member under existing LLC law.  He suggests that, in lieu of "ad hoc equitable judicial remedies," id. at 6, the states should take the SMLLC off the table as an asset-protection vehicle:

every state would amend its SMLLC legislation to provide that upon the voluntary or involuntary transfer of the only economic interest in the SMLLC, the transferee will be admitted as a substituted member, with or without the consent of the only member.

Id. at 70.

On the Florida Asset Protection blog, Jonathan Alper notes that, in FTC v. Olmstead, the remedies of creditors of the sole member of an SMLLC are now before the Florida Supreme Court via a certified question. He has a recent post on the oral arguments in FTC v. Olmstead.

There also has been an interesting discussion of this on LNET-LLC.

Hat tip to Paul Caron.

posted by Gary Rosin

February 18, 2009 in Commentary, LLC Cases, Scholarship | Permalink | Comments (1) | TrackBack

February 17, 2009

Allocations vs. Distributions. More on Casavecchia v. Mizrahi

As mentioned in my earlier post on the Casavecchia v. Mizrahi series of cases, the essence of the Casavecchia's claims was that

  1. the LLC had been formed to develop a single real estate development, Hills of the Heartland,
  2. the development had been completed, and all units sold, and
  3. instead of distributing profits, the Mizrahi had instead loaned the LLC's funds to another LLC in which the Casavecchias were not participating.

I have already noted the disconnect between the Casavecchia's understanding of the parties' prior practice--one development at a time, and the formation of a new vehicle for new projects--and the breadth of the purpose provision of the LLC's Operating Agreement. 

But here are other puzzling aspects of the trial court's original order, Cassavecchia v. Mizrahi, No. 008635/2005 (N.Y. Sup. Ct. August 23, 2006) (Warshawsky, J.).  At first, it seemed as though Justice Warshawsky had ordered a defacto dissolution of the LLC.  In this connection, note that Section 701 only allows voluntary dissolution without a vote of the members only when the organizational documents provide for a time for dissolution, or dissolution on the happening of a specified event.  Section 702 of the New York Limited Liability Company Law allows for judicial dissolution at the request of a member "whenever it is not reasonably practicable to carry on the  business in conformity with the articles of  organization or operating agreement."  To the extent Warshawsky found a limited purpose, he could have found a voluntary dissolution under Section 701 or, perhaps that it was "not longer reasonably practicable" a purpose that had been completed.  But that's not what the order said.

On closer reading, Warshawsky casts the issue as

The issue that emerges for determination is whether a reading of  ¶ 8,together with ¶¶ 4, 6 and 9 leads to the conclusion that profits of the Hills of Heartland venture should be allocated and distributed to the shareholders so that they have the right to control their use. See e.g. LLCL § 507, Interim Distributions.

Slip Op., at 3 (emphasis added).  Section 4 of the Operating Agreement set forth a broad, rather than a narrow, purpose of the LLC.  Id. at 2.  Section 6 provides for management by action of a majority in interest, which itself is consistent with the early statement that Mizrahi managed the day-to-day affairs of the LLCId.  Section 9 provides for distributions "at the times and in the amounts determined by a majority in interest".  Id.  Section 507 of the New York LLC Law provides for interim distributions to members

to the extent and at the times or upon the happening of events specified in the operating agreement....

Section 8 of the operating agreement provides for the allocation of profits and losses to the members.  Slip Op., at 3.  Warshawsky then noted the dispute as to the purpose of the LLC, and concluded

While it is conceivable that [LLC] could build homes and lend money out of profits so generated, that plan of operating would have to be approved by all the investors in the venture as they are the lawful beneficiaries of the success of any LLC.

Slip Op., at 4. (emphasis added).

It is clear that, while Warshawsky contemplates interim distributions, the basis for his order of "an inquest ... to determine the profits available for distribution" is not entirely clear.  Does he deem that the Cassavecchias' own a majority of interest, so can decide to make distributions?  Does he instead believe (wrongly) that allocations under Section 8 give the members the right to distributions?  Why else would he suggest that the diversion of profits into a loan would require the approval of all investors?

posted by Gary Rosin

February 17, 2009 in Commentary, LLC Cases | Permalink | Comments (0) | TrackBack

February 11, 2009

Transactional Perspectives on Casavecchia v. Mizrahi

The still on-going litigation arising out of Hills of Heartland LLC can help illuminate the role of a transactional lawyer.  The latest installments are two opinions out of the NY Appellate Court, 2nd department, Casavecchia v. Mizrahi, 2008 NY Slip Op 00938 & 2008 NY Slip Op. 00939 (NY AD [2nd] December 16, 2008).  The appellate opinions grow out of orders by Judge Warshawsky (N.Y. Sup. Ct., Nassau County) on August 23, 2006 and on September 11, 2007.  The point here is not to parse the opinion, but to note the inconsistency between the LLC's operating agreement and the practice of the parties.

Casavecchia and Mizrahi were serial real estate developers who

were in business together for many years constructing and marketing residential housing of which Hills of Heartland is just one. Allegedly, as a development was completed , the profits were used to finance the building of a new development. There came a time when plaintiff was no longer associated with the business.

Order, September 11, 2007, at 2.  One of the key disputes between Casavecchia and Mizrahi related to the role (and purpose) of Hills of Heartland LLC.  In the Order of August 26, 2006, Judge Warshawsky found that the purpose of Hills of Heartland LLC was solely to develop Hills of Heartland: 

Defendant bootstraps section 202(f) & (c) of the LLC on to the Hills of Heartland Operating Agreement to support the claim that the purpose of the Company was to build and to lend money. He unfolds a rather convoluted claim that plaintiff was interested in the Company lending money rather than distributing it when the Company acquired a parcel of land on which it has now completed development....   * * *  His profound ending is that the process of lending retained money rather making a distribution to investors is a sage and efficacious way of doing new business with old money.

* * *  The only dispute in the arguments of the parties ... is whether the Company was formed to lend money. 

Despite thoroughly and carefully searching the record the court can find no evidence that it was.  Defendant's assertion is unsupported by evidentiary proof in admissable form .... He testified that the Company had not made any loan. He admitted in the answer that it was formed to build homes.

Id. at 4. 

Mizrahi's attorney appears to have focused on Section 202(f) of the New York Limited Liability Company Law, which includes in the laundry list of general powers of an LLC the power to "lend  money for any lawful purpose, invest or reinvest its funds...."  Earlier in the opinion, Judge Warshawsky had quoted paragraph 4 of the LLC's Operating Agreement, which included an omnibus purpose clause:

4.  PURPOSE. The Company is formed for the purpose of acquiring, owning, operating, developing, constructing buildings of all kinds or nature and selling real estate and engaging in any lawful act or activity for which limited liability companies may be formed under the LLCL and engaging in any and all activities necessary or incidental to the foregoing.

Order of August 26, 2006, at 2 (emphasis added). 

The point here is not to assess Judge Warshawsky's conclusion, could well have been influenced by the fact that he loaned the LLC's funds to a company in which the Casavecchia's had no ownership interest:

that defendant Mizrahi is the only investor in the Company who is actively involved in Casa Mason, the proposal of being an unsecured, unguaranteed, interest free lender to a Mizrahi entity appears to be a bountiful bonanza to only defendant.

Id. at 5.

Instead, assuming that the parties' prior practice had been to invest in particular development projects via project-related unincorporated business entities (UBEs), why did the purpose clause not only refer to investment in real estate generally, but also include an omnibus purpose clause?  Surely, some transactional dropped the ball here, probably by trying to save drafting time by pulling out a form. 

There is more that I could say, but I'll stop here.

posted by Gary Rosin

February 11, 2009 in Commentary, LLC Cases | Permalink | Comments (0) | TrackBack

February 04, 2009

Creditors and Interests in LLEs: A Rant on Reading Hotel 71 Mezz Lender LLC v. Falor

In Hotel 71 Mezz Lender LLC v. Falor, 2008 NY Slip Op 09848 (NY AD [1st], December 16, 2008), the Court correctly vacated a trial court

pre-judgment order confirming the ex parte attachment of their membership interests in 23 entities, including Delaware, Georgia and Florida limited liability companies and a solely owned Florida corporation, and the subsequent orders conditionally appointing a receiver of those out-of-state interests.

Slip Op at 2. 

The odd thing about the trial court order, and in the appellate opinion, is the absence of recognition of the concept of charging orders.  In most states, including New York, a charging order is the exclusive manner by which a creditor can get at an interest in a limited liability entity (LLE).  One would hope that somewhere among the trial court judge, the four appellate justices, and the eleven (!) lawyers listed in the opinion--and their associates or clerks), someone might have brought that concept to the attention of the court.  Perhaps someone did, but that person's advice was ignored. 

Certainly, that must say something about the state of legal education system and its products (lawyers).  But only about a third of law schools offer a separate course in Agency, Partnerships and LLEs.  Even in those schools, most students do not take both Corporations and A&P.  The usual Business Associations course virtually ignores agency, and only gestures in the direction of partnerships and LLEs; then it's off to talk about public corporations and control transactions.

posted by Gary Rosin

February 4, 2009 in Commentary, LLC Cases, Teaching | Permalink | Comments (0) | TrackBack

January 14, 2009

Authority of Members under RULLCA

I have already noted the article by Contributing Editor Thomas E. Rutledge, & Steve G. Frost, RULLCA Section 301 - The Fortunate Consequences (and Continuing Questions) of Distinguishing Apparent Agency and Decisional Authority, 64 Business Lawyer 37 (2008). In RULLCA's little agency problem, Prof. Larry Ribstein discusses the issue, and the article.

To review the bidding, ULLCA (2006) (aka  RULLCA) § 301 provides:

SECTION 301. AGENCY POWER OF MEMBER AS MEMBER

(a) A member is not an agent of a limited liability company solely by reason of being a member.

(b) A person’s status as a member does not prevent or restrict law other than this [act] from imposing liability on a limited liability company because of the person’s conduct

The Comment on 301(a) gives the thinking of the Drafting Committee:

Subsection (a) – Most LLC statutes, including the original ULLCA, provide for what might be termed “statutory apparent authority” for members in a member-managed limited liability company and managers in a manager-managed limited liability company. This approach codifies the common law notion of apparent authority by position and dates back at least to the original, 1914 Uniform Partnership Act. UPA, § 9 provided that “the act of every partner … for apparently carrying on in the usual way the business of the partnership … binds the partnership,” and that formulation has been essentially followed by RUPA, § 301, ULLCA, § 301, ULPA (2001), § 402, and myriad state LLC statutes.

This Act rejects the statutory apparent authority approach, for reasons summarized in a “Progress Report on the Revised Uniform Limited Liability Company Act,” published in the March 2006 issue of the newsletter of the ABA Committee on Partnerships and Unincorporated Business Organizations:

The concept [of statutory apparent authority] still makes sense both for general and limited partnerships. A third party dealing with either type of partnership can know by the formal name of the entity and by a person’s status as general or limited partner whether the person has the power to bind the entity.

Most LLC statutes have attempted to use the same approach but with a fundamentally important (and problematic) distinction. An LLC’s status as member-managed or manager-managed determines whether members or managers have the statutory power to bind. But an LLC’s status as member- or manager-managed is not apparent from the LLC’s name. A third party must check the public record, which may reveal that the LLC is manager-managed, which in turn means a member as member has no power to bind the LLC. As a result, a provision that originated in 1914 as a protection for third parties can, in the LLC context, easily function as a trap for the unwary. The problem is exacerbated by the almost infinite variety of management structures permissible in and used by LLCs.

The new Act cuts through this problem by simply eliminating statutory apparent authority.

PUBOGRAM, Vol. XXIII, no. 2 at 9-10.

Codifying power to bind according to position makes sense only for organizations that have well-defined, well-known, and almost paradigmatic management structures.

  • flexibility of management structure is a hallmark of the limited liability company; and
  • an LLC’s name gives no signal as to the organization’s structure,

it makes no sense to:

  • require each LLC to publicly select between two statutorily preordained structures (i.e., manager-managed/member-managed); and then
  • link a “statutory power to bind” to each of those two structures.

Under this Act, other law – most especially the law of agency – will handle power-to-bind questions. See the Comment to subsection (b).

In their article, Rutledge & Frost argue that RULLCA Sec. 301(a) eliminates the concept of apparent authority in both member-managed and manager-managed LLCs.  64 Business Lawyer at 47-50.  For example, they argue that "[i]t is noteworthy that RULLCA does not address either the actual or apparent authority of a manager when the LLC ... elects to be member managed.  Id. at 48 & n.63 (emphasis added.  Although footnote 63 quotes a portion of the Comments to Section 407:

The common law of agency will also determine the apparent authority of an LLC’s manager or managers....

(emphasis added), Rutledge and Frost do not examine the effect of Section 407.  Their view seems to be that the only role of Section 407 is to allocate "decisional authority" in member-managed and manager-managed LLCs.  Ribstein seems to concur (noting that the rights granted members in member-managed LLCs under Section 407(b) "apparently [are] not enough to make a member an agent under 301(a). ").

In my view, RULLCA 407(b)(1)-(4) are clearly to the contrary:

(b) In a member-managed limited liability company, the following rules apply:

(1) The management and conduct of the company are vested in the members.

(2) Each member has equal rights in the management and conduct of the company’s activities.

(3)  A difference arising among members as to a matter in the ordinary course of the activities of the company may be decided by a majority of the members.

(4)  An act outside the ordinary course of the activities of the company may be undertaken only with the consent of all members.

RULLCA § 401(b)(1)-(4) (emphasis added).  Under Section 407(b)(2), the rights of each member are not limited to management ("decisional") rights, but also include the right to conduct the business of the LLC.  Both the UPA Section 18(e) and RUPA Section 401(f) include almost identical language.  Cases such as National Biscuit Co. v. Stroud, view UPA 18(e) as giving partners actual authority to conduct ordinary business, unless limited by a majority vote of the partners.  For manager-managed LLCs, RULLCA Section 401(c)(2)& (3), are identical to Section 401(b)(2) & (3).  The Comments indicate that Section 401(c)(2) & (3) are similar to their partnership analogues:

If (i) an LLC’s operating agreement merely states that the LLC is manager-managed and does not further specify the managerial responsibilities, and (ii) the LLC has only one manager, the actual authority analysis is simple. In that situation, this subsection:

  • serves as “gap filler” to the operating agreement; and thereby
  • constitutes the LLC’s manifestation to the manager as to the scope of the manager’s authority; and thereby
  • delimits the manager’s actual authority, subject to whatever subsequent manifestations the LLC may make to the manager (e.g., by a vote of the members, or an amendment of the operating agreement).

If the operating agreement states only that the LLC is manager-managed and the LLC has more than one manager, the question of actual authority has an additional aspect.  It is necessary to determine what actual authority any one manager has to act alone.

Paragraphs (c)(2), (3), and (4) combine to provide the answer.  A single manager of a multi-manager LLC:

  • has no actual authority to commit the LLC to any matter “outside the ordinary course of the activities of the company,” paragraph (c)(4)(C), or any matter encompassed in paragraph (c)(4); and
  • has the actual authority to commit the LLC to any matter “in the ordinary course of the activities of the company,” paragraph (c)(3), unless the manager has reason to know that other managers might disagree or the manager has some other reason to know that consultation with fellow managers is appropriate.

The first point follows self-evidently from the language of paragraphs (c)(3) and (c)(4).  In light of that language, no manager could reasonably believe to the contrary (unless the operating agreement provided otherwise).

The second point follows because:

  • Subsection (c) serves as the gap-filler manifestation from the LLC to its managers, and subsection (c) does not require managers of a multi-manager LLC to act only in concert or after consultation.
  • To the contrary, subject to the operating agreement:
    • paragraph (c)(2) expressly provides that “each manager has equal rights in the management and conduct of the activities of the company,” and
    • paragraph (c)(3) suggests that several (as well as joint) activity is appropriate on ordinary matters, so long as the manager acting in the matter has no reason to believe that the matter will be controversial among the managers and therefore requires a decision under paragraph (c)(3).

RULLCA § 407 cmt. (emphasis added).  Although I might quibble as to whether and when possible disagreement suspends actual authority,

Given that Section 407(c)(1), (2), (3) and (4)(C) are identical in substance as Section 407(b)(1)-(4), the same reasoning applies to member-managed LLCs:  each member has actual authority to act in ordinary matters, unless limited by the other members.

posted by Gary Rosin

January 14, 2009 in Commentary | Permalink | Comments (0) | TrackBack

January 06, 2009

Papers at Section on A, P, LLC & UAs, AALS 2009

The awkwardly, but inclusively, named AALS Section on Agency, Partnerships, LLCs and Unincorporated Associations will meet on Friday, Jan. 9, 2009 in San Diego.  No fewer than six papers will be presented.  For details, go to Prof. Larry Ribstein's blog, AALS Agency/Partnership Section.

posted by Gary Rosin

January 6, 2009 in Commentary | Permalink | Comments (0) | TrackBack

January 02, 2009

Derivative Fiduciary Duties and Fiduciary Waivers (Faulkner)

Revised 01/05/2009

The recent opinion in Faulkner v. Kornman (In re The Heritage Organization, L.L.C.), Adv. Proc. No. 06-3377-BJH (Banker. N.D. Tex. Dec. 12, 2008), raises an interesting question.  The underlying Operating Agreement provided that Heritage's Manager owed no fiduciary duties of any sort to it or to its members.  Slip Op., at 29.  The trustee of the bankruptcy estate of Heritage asserted breach of fiduciary duties against the officers of Heritage's Manager (also an LLC).  Although those officers may also have been officers of Heritage, this post will focus only the duties that they might have owed when acting as officers of the Manager.

Begin with two central principles.  First, an organization is separate from the persons that act on its behalf ("agents").  Although owners of the organization may not be liable for its obligations (assuming a limited liability form was used), the same is not true for its agents.  Agents can avoid liability on contracts entered into by them of behalf of the organization, but only if they fully disclose the the other party the identity of the organization, and that they are acting for it.  Agents remain fully responsible for any torts or crimes in which they participate.  The Nuremberg defense--I was just following orders (or acting for my organization)--does not wash.

The second principle is that organizations act only through human agents.  Those agents owe fiduciary duties to the organization, but generally owe only the usual duties to other persons--the duty to operate a car carefully, the duty not to defraud, or the duty not to murder (although Hollywood seems to think that duty is customary in large corporations!).

As I argued in Car gill & Statutory Preemption, the fiduciary obligations of persons that control a fiduciary derive from the fiduciary obligations of the controlled fiduciary.  To the extent that the controlled fiduciary (the manager of The Heritage Organization, L.L.C.) has procured a waiver of its fiduciary obligations (as in Section 6.03(A) of Heritage's Operating Agreement), it should follow that the controlling fiduciary's (the defendant's in Faulkner) duties should follow that of the controlled fiduciary.  Thus, in Faulkner, a waiver of fiduciary duties of Heritage's Manager should also extend to the managers and officers of that Manager.

Of course, it would be better to address that question in the Operating Agreement itself.  But then litigators would have less to do!

posted by Gary Rosin

January 2, 2009 in Commentary, LLC Cases | Permalink | Comments (0) | TrackBack

December 18, 2008

Rights to Information under RULLCA Sec. 410

In Information Rights Under New Iowa LLC Law, Marc Ward points out that, under Sec. 489.410 of the Iowa RULLCA, members have the right to certain information without demand.  He notes the breadth of Section 489.410.1.b(1)--Section 410(a)(2)(A) of the RULLCA.  That part of Section 410 requires a member-managed LLC to furnish each member

[w]ithout demand, any information concerning the company's activities, financial condition, and other circumstances which the company knows and is material to the proper exercise of the member's rights and duties under the operating agreement or this chapter....

Section 410(a)(3) imposes the same obligation to disclose on members of member-managed LLCs, but only to the extent that they know that information.  Ward argues that this affirmative disclosure obligation should apply on where the LLC is affirmatively communicating with its members.

I would argue that the "member's rights and duties" to which Section 410(a)(2)(A) refers are the rights and obligations relating to management of LLC by a member of a member-managed LLC.  Section 410(b)(1) makes this clear by providing that, in manager=managed LLCs,

[t]he informational rights stated in subsection a and the duty stated in subsection (a)(3) apply to the managers and not the members.

In manager-managed LLCs, the LLC (and its manager) are required to provided information without demand only

[w]henever this [act] or an operating agreement provides for a member to give or withhold consent to a matter, before the consent is given or withheld, the company shall, without demand, provide the member with all information that is known to the company and is material to the member’s decision.

RULLCA § 410(b)(4).

Regardless of whether a manager is a member, the manager's right to relevant information relating to the management of the LLC should be much broader.  Where there is more than one manager, arguably, that should include the right to information about, and relating to, material actions by other managers.

posted by Gary Rosin

December 18, 2008 in Commentary, Legislative Developments | Permalink | Comments (0) | TrackBack

December 10, 2008

Dreir LLP and the the New York LLP provisions

I recently blogged about possible partnership-by estoppel issues in claims against the Dreier law firm non-equity partners. After further reading, the firm appears to be structured as an LLP, so that changes things. An LLP is still a partnership, so that implies more than one partner.  Assuming that the non-equity partners were in fact partners of the LLP, the focus shifts to the variety of LLP used in the New York Statute.

Under Section 26(b), a New York LLP is a "full-shield" LLP, with the usual exception ("cutout") imposing liability for a partner's own torts or those of persons under the partner's "direct supervision and control".  Sec. 26(c)(i).  In addition, Section 26(d) allows a majority of partners, unless otherwise agreed, to agree to liability of "all or specified partners ... for all or specified debts, obligations or liabilities" of the LLP.  Of course, and partner can agree"to act as a guarantor or surety for, provide collateral for or otherwise be liable for, the debts, obligations or liabilities" of the LLP.  Id.

posted by Gary Rosin

December 10, 2008 in Commentary, Unincorporated Business News | Permalink | Comments (0) | TrackBack

Non-Equity Partners in Law Firms

I don't know if you have heard of the "Dreier" law firm and its financial structure.  In an article published in 2007 in the national Law Journal, "How to Find Professional Fulfillment Outside the Equity Partnership Model," Marc S. Dreier touted the advantages of a law-firm structure with only one equity partner.  As described by Dreier, the structure is not particularly unusual.  There is one equity partner. Each of the other members of the firm--which he refers to as "partners"--get a base compensation, plus a bonus based on a share of the gross revenues attributed to business done or generated by that member.  No profit-sharing.

Now there is nothing particularly unusual about this structure; just another variant of "Eat What You Kill." At least in Texas, many small firms are structured in the same manner.  Sometimes there are a few equity partners, rather than just one; everyone else gets a share of gross revenue.  Sometimes the others get "advances"--implying a debt"--against future allocations.  The IRS considers the other members to be employees, and their advances salaries subject to withholding and employment taxes.

What made the Dreier firm different was that he was the only equity partner in a 175-member firm (at the time of the article).

Drier is the news again.  According to the AmLaw Daily Blog ([yesterday and today (Dec. 10, 2008)] on Law.com (here and here), Dreier has been indicted and arrested on charges of securities fraud.

The firm's primary lender, Wachovia, has sued the firm and all the no-equity partners for default on an aggregate of $14.5 million in money loaned to the firm.  In today's article, Zach Lowe of the American Lawyers also raised the possibility of liability to clients should it turn out that client trust funds have been misapplied.

Putting aside the questions of personal responsibility under ethics rules, and possible personal assurances given by a non-equity partner, the answers may turn on partnership-by-estoppel (New York still operates under a UPA-based statute) or the "purported partner" provisions of the RUPA (2001). 

To make matters worse, in some satellite offices, the name of a non-equity partner was added to the firm name to

capitalize[] on the reputation and goodwill of [local] partners, who are widely recognized as leaders in a particular field or region.

See Dreier's 2007 article.

Perhaps we'll get a published estoppel opinion out of this.  And those are hard to find.

Hat-tip to Zach Lowe and Daniel wise (New York Law Journal).

Update:  As noted in my next post, the Drier firm is an LLP, which changes things.  I'm leaving this post up for those small firms that may might not have adopted a limited liability structure.  GSR

posted by Gary Rosin

December 10, 2008 in Commentary, Unincorporated Business News | Permalink | Comments (0) | TrackBack

December 04, 2008

Cargill and Background Fiduciary Duties

The arguments in Cargill  regarding statutory preemption hinged on whether trustees and managers of a Delaware statutory owed fiduciary duties in the absence of an express provision in the governing instruments.  This is the "mere contractual entity" argument that may be gaining traction in Delaware, and which I have criticized at length.  As I argued in, for example, Mere Contractual Entities:  UBEs and Fiduciary Duties:

Fiduciary duties [arise] in relationships in which persons are entrusted with the management of a business; because they are entrusted with the power to manage, they have a fiduciary duty to use that power primarily, if not solely, in the best interests of the business and all its owners.

In Cargill, Section 3809 of the Delaware Statutory Trust Act expressly incorporates "the laws of this State pertaining to trusts...."  Although Vice Chancellor Parsons cited Section 3809 in his opinion in Cargill, Slip Op. at 22-23, he also noted that, in the opinion in In re USA Cafes Litigation, 600 A.2d 43 (Del. Ch. 1991), then Chancellor Allen had "relied almost entirely" on the background fiduciary duties of both trust law and that of other business entities.  Id. at 23-24 & n.59.

posted by Gary Rosin

December 4, 2008 in Commentary, Trusts | Permalink | Comments (0) | TrackBack

December 02, 2008

Cargill and Sale of Control

In Cargill, Inc. v. JWH Special Circumstance LLC, C.A. No. 3234-VCP (Del. Chan. Ct. November 7, 2008) (see facts), all of the claims against Cargill and its subsidiary, Cargill Investment Services (CIS) relate to the sale of control of the Trust.  What makes Cargill different from the usual change-of-control case is that Cargill and CIS used their control of the Trust's Managing Owner, CIS Investments (CISI), to cause it to consent to transfer of the Forex and the cash bullion account agreements to a subsidiary of Refco without regard to the best interests of the Trust.  Slip Op. at 38.

From that perspective, Cargill involves not just a change-of-control, but a use of "corporate office" to facilitate that change-of-control.

     posted by Gary Rosin

December 2, 2008 in Commentary, LLC Cases | Permalink | Comments (0) | TrackBack

Cargill & Statutory Preemption

One of the issues in Cargill, Inc. v. JWH Special Circumstance LLC, C.A. No. 3234-VCP (Del. Chan. Ct. November 7, 2008) is whether the Delaware Statutory Trust Act preempts claims for breaches of fiduciary duty.  This post discusses that portion of the Cargill opinion, Slip Op. at 33-38.

As with most of the recent Delaware unincorporated business entity statutes, the Delaware Statutory Trust Act embodies the principle of party autonomy in the formation of unincorporated business forms. DSTA § 3825(b), (d) & (e).  As might be expected, the question is not so much that principle, but how it plays out in a particular form and its statute.  In the view of the court, the key provision is Sec. 3806(a), which consist of four sentences:

[I] Except to the extent otherwise provided in the governing instrument of a statutory trust, the business and affairs of a statutory trust shall be managed by or under the direction of its trustees.

[II] To the extent provided in the governing instrument of a statutory trust, any person (including a beneficial owner) shall be entitled to direct the trustees or other persons in the management of the statutory trust.

[III] Except to the extent otherwise provided in the governing instrument of a statutory trust, neither the power to give direction to a trustee or other persons nor the exercise thereof by any person (including a beneficial owner) shall cause such person to be a trustee.

[IV] To the extent provided in the governing instrument of a statutory trust, neither the power to give direction to a trustee or other persons nor the exercise thereof by any person (including a beneficial owner) shall cause such person to have duties (including fiduciary duties) or liabilities relating thereto to the statutory trust or to a beneficial owner thereof.

See, Cargill, Slip Op. at 34 n.79.

The key dispute is the different approaches of the 3rd and 4th sentences of Sec. 3806(a), both of which deal with persons having, or exercising, the power to direct a trustee (or managing owner). 

Vice Chancellor Parsons agrees with Balotti & Finkelstein (id. at 37 n.86) that sentence III prevents liability of controlling persons as fiduciaries, but distinguishes conduct by a controlling person that causes the fiduciary to act without regard to the best interests of the Trust.  Id. at 37-38.  I am not comfortable with that reasoning.  In my view, the rationale behind imposing fiduciary duties on controlling persons is that such persons arrogate the power of the statutory managers, so should be subject to the same fiduciary duties as apply to the controlled managers.  Thus, the "USA Cafes" duty is not separate from, but is identical to, the fiduciary duties of the controlled person.

So, how do we reconcile the difference between sentences III and IV?  Here, I must admit to complete befuddlement.  The first puzzle of sentences III and IV is why status as a trustee should be treated separately from duties and liabilities to the trust.  The two seem to go hand-in-hand.  The reason why one would want to avoid being deemed to be a trustee is to avoid the duties and liabilities of a trustee.  So far as I can tell, the only other consequence of trusteeship is the right of a trustee to hold trust property in its own name. 

Given the separation, the second puzzle is why the governing documents should have different roles.  The difference thus becomes a trap for the unwary. Perhaps the legislature meant to distinguish between the traditionally onerous duties of a trustee and the usual fiduciary duties of the managers of businesses.  If that was the intent, surely it could have been more clearly expressed.

posted by Gary Rosin

December 2, 2008 in Commentary, LLC Cases | Permalink | Comments (2) | TrackBack