Sunday, November 18, 2018

ICYMI: #corpgov Weekend Roundup (Nov. 18, 2018)

November 18, 2018 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, November 17, 2018

SEC Roundtable and Proxy Advisory Firms

The SEC held its Roundtable on the Proxy Process on Thursday, and I was able to watch the live webcast of the last panel on proxy advisory firms.  (In a prior post, I discussed how, in advance of the Roundtable, the SEC withdrew two no-action letters that facilitated investment advisors’ reliance on proxy advisory services.) 

One thing I’ll note about the Roundtable is that it felt a lot like oral argument in an appellate court, in that everyone had fun expounding their positions but it’s not where the real policymaking gets done; that’s going to take place in back offices based on private meetings and written submissions, not in a public theater.

Still, I was interested in what everyone had to say.  The webcast just went online here, but I’ll offer a summary of what stood out to me. 

(More under the jump)

Continue reading

November 17, 2018 in Ann Lipton | Permalink | Comments (0)

Friday, November 16, 2018

Will blockchain make voting more or less secure?

     Greetings from Florida, the land of the endless voting snafus. As I continue my research on blockchain use cases, I’m particularly fascinated with the potential to make voting more streamlined and secure. West Virgina just used blockchain-protected voting in a general election for 144 voters in 30 different countries who were able to cast their ballots anonymously using a blockchain-enabled  app. Military personnel and overseas voters from 24 of the state’s 55 counties used the app from Voatz.. Under  the Uniformed and Overseas Citizens Act, personnel verify their identities by providing a photo of their driver’s license, state ID or passport that is matched to a selfie. After confirmation of the identity, the voter receives a mobile ballot based on the one that s/hewould receive in the local precinct. 

     Although the technology is supposed to be tamper proof, some argue that blockchain voting can’t protect against server problems, internet outages, or hacks on the mobile devices. Nonetheless, many governments are exploring the technology for voting and other citizen services. The tiny nation of Estonia has led the way in using digital ledger technology for citizen services since 2008. Through its E-Estonia initiative, the government facilitates voting, education, the justice system, legislation and other services. Not to be outdone, Dubai plans to become the first blockchain-powered government by 2020. Visas, permits, licenses, and bill payments require 100 million documents annually, and  the government believes that it can save 1.5 billion dollars through a paperless system.

     Of course, blockchain isn’t a cure all for our voting woes, but as a Floridian who is still waiting to find out who actually won our gubernatorial and senatorial races, I’m willing to try anything. 

November 16, 2018 | Permalink | Comments (0)

Thursday, November 15, 2018

New Jersey Fiduciary Regulation

Facing looming retirement crises, some states have begun to do more.  Notably, Nevada recently passed a state fiduciary statute.  I cheered the legislation's passage because it mostly puts in place the legal protections that most savers now mistakenly believe that they already have.  New Jersey also recently began to solicit comments on the issue as well.  For the New Jersey process, written comments are due on December 14th.

As it moves forward, New Jersey will likely have to contend with the financial services industry doggedly lobbying to protect a stockbroker's right to sell clients the wrong products.  Much of the campaign will likely be led by the Securities Industry and Financial Markets Association (SIFMA).  SIFMA touts itself as "the voice of the nation's securities industry."  It came up with some creative concerns about the Nevada fiduciary statute and will likely raise similar concerns with New Jersey. 

One SIFMA argument struck me as particularly interesting in its implications:

We remain concerned that any new fiduciary duties under the Nevada law would impose additional recordkeeping requirements that would violate the National Securities Markets Improvement Act of 1996 (“NSMIA). As you well know, NSMIA precludes states from enacting regulations relating to the making and keeping of records “that differ from, or are in addition to, the requirements in those areas established under [the Exchange Act].” We are hard pressed to envision a scenario in which new duties do not require the creation of a new record.

For example, under the new law, broker-dealers and their agents are subject to NRS 628A.020. This provision states:

“A financial planner has the duty of a fiduciary toward a client. A financial planner shall disclose to a client, at the time advice is given, any gain the financial planner may receive, such as profit or commission, if the advice is followed. A financial planner shall make diligent inquiry of each client to ascertain initially, and keep currently informed concerning the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.” 

Both the disclosure and information collection requirements would need to be done in writing, or verbally followed by the creation of a written record to document compliance with and ensure adequate supervision of these obligations. In our view, even if the Division does not require that a new form be filled out, the broker-dealer would still have to create a new record to demonstrate compliance, which violates NSMIA. We encourage you to continue to explore options that do not create additional books and records issues.

In essence, SIFMA appears to be arguing that states cannot regulate conduct within state borders if it would require incidental paperwork.  Curiously, SIFMA's testimony omitted the statute's next sentence which says that the "[SEC] shall consult periodically the securities commissions (or any agency or office performing like functions) of the States concerning the adequacy of such requirements as established under this chapter."  If Congress intended to strip the states of the power to regulate conduct, it seems odd that the statute would direct the SEC to check with the states to make sure that its books and records rules were adequate.  If a court read the statute the way SIFMA seems to, it would mean that a state could not require a financial adviser to inform the client about how much money she would make off selling a particular product.  It would also mean that the states could not regulate conduct if it might ever require anyone to write something down.

The argument also seems to stretch too far because it would interfere with state authority to prohibit fraud.  When Congress passed the NSMIA, it took pains to explicitly preserve the states' power to enforce their anti-fraud laws.  If state law creates a disclosure duty to inform the customer about a conflict, it would likely be a fraudulent omission for a broker-dealer to make sales without disclosing the conflict.  

It'll be interesting to watch this issue to see what happens.


November 15, 2018 | Permalink | Comments (0)

Wednesday, November 14, 2018

ICYMI: #corpgov Midweek Roundup (Nov. 14, 2018)

November 14, 2018 in Stefan J. Padfield | Permalink | Comments (0)

Tuesday, November 13, 2018

LLCs are Not Corporations, But That Does Not Mean LLC Diversity Rules Make Sense

Back in May, I noted my dislike of the LLC diversity jurisdiction rule, which determines an LLC's citizenship “by the citizenship of each of its members” I noted, 

I still hate this rule for diversity jurisdiction of LLCs.  I know I am not the first to have issues with this rule. 

I get the idea that diversity jurisdiction was extended to LLCs in the same way that it was for partnerships, but in today's world, it's dumb. Under traditional general partnership law, partners were all fully liable for the partnership, so it makes sense to have all partners be used to determine diversity jurisdiction.  But where any partner has limited liabilty, like members do for LLCs, it seems to me the entity should be the only consideration in determing citizenship for jurisdiction purposes. It works for corporations, even where a shareholder is also a manger (or CEO), so why not have the same for LLCs.  If there are individuals whose control of the entity is an issue, treat and LLC just like a corporation. Name individuals, too, if you think there is direct liability, just as you would with a corporation. For a corporation, if there is a shareholder, director, or officer (or any other invididual) who is a guarantor or is otherwise personally liable, jurisdiction arises from that potential liability. 
I am reminded of this dislike, once again, by a recently available case in which an LLC is referred to as a "limited liability corporation" (not company).  
Dever v. Family Dollar Stores of Georgia, LLC, No. 18-10129, 2018 WL 5778189, at *1 (11th Cir. Nov. 2, 2018). This is so annoying. 
The LLC in question is Family Dollar Stores of Georgia, LLC, which involved a slip-and-fall injury in which the plaintiff was hurt in a Family Dollar Store. Apparently, that store was located in Georgia. The opinion notes, though, that the LLC in question was "organized under Virginia law with one member, a corporation that was organized under Delaware law with its principal place of business in North Carolina." Id. 
It seems entirely absurd to me that one could create an entity to operate stores in a state, even using the state in the name of the entity, yet have a jurisdictional rule that would provide that for diversity jurisdiction in the state where the entity did business (in a brick and mortar store, no less) where someone was injured.  (Side note: It does not upset me that Family Dollar Stores of Georgia, LLC, would be formed in another state -- that choice of law deals with inter se issue between members of the LLC. )  
I'll also note that I see cases dealing with LLC diversity jurisdiction incorrectly referring to LLCs as "limited liability corporations." For example, these other cases also appeared on Westlaw within the last week or so: 
  • Util Auditors, LLC v. Honeywell Int'l Inc., No. 17 CIV. 4673 (JFK), 2018 WL 5830977, at *1 (S.D.N.Y. Nov. 7, 2018) ("Plaintiff ... is a limited liability corporation with its principal place of business in Florida, where both of its members are domiciled.").

  • Thermoset Corp. v. Bldg. Materials Corp. of Am., No. 17-14887, 2018 WL 5733042, at *2 (11th Cir. Oct. 31, 2018) ("Well before Thermoset filed its amended complaint, this court ruled that the citizenship of a limited liability corporation depended in turn on the citizenship of its members.").
    ALLENBY & ASSOCIATES, INC. v. CROWN "ST. VINCENT" LTD., No. 07-61364-CIV, 2007 WL 9710726, at *2 (S.D. Fla. Dec. 3, 2007) ("[A] limited liability corporation is a citizen of every state in which a partner resides.").
Coincidence? Maybe, but it's still frustrating. 

November 13, 2018 in Corporations, Delaware, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Monday, November 12, 2018

Blessings to All Veterans

Today, in honor of my Dad, my father-in-law, my cousin, my administrative assistant, many friends, and others who have honored us with their military service, I am posting a link to a recent episode of The Home Team with Jared Allen's Homes for Wounded Warriors.  The episode features an interview by my former student, Betty Rhoades, of one of my new military buddies, Captain Chris Davis, USMC.  Chris is a 3L at UT Law and a super guy.  He founded a nonprofit last year, Vols for Vets, of which I (and others) are very proud.

Thanks to all who have served in our armed forces for helping to protect us from enemies far and near.  Your service is to be honored and cherished.  We thank you for our lives and our freedom.

November 12, 2018 in Joan Heminway | Permalink | Comments (1)

ComplianceNet2 Conference Invitation Announcement & Call for Papers


Friend of the BLPB Josephine Nelson informs us of the following:

The second-annual ComplianceNet conference will take place on June 3-4, 2019. Villanova University Charles Widger School of Law and its Girard-diCarlo Center for Ethics, Integrity and Compliance will host the conference. Like the highly successful inaugural conference at UC Irvine in 2018, this conference will allow scholars from across disciplines and different legal and regulatory topics to exchange research and explore connections for collaboration.

The timing of this year’s conference is designed to follow on the heels of the Law & Society meeting in nearby Washington, D.C. If you are already headed to Law & Society, Villanova is a short train-ride away and easily accessible by public transportation. Regardless of whether you will be attending Law & Society, Villanova is in a beautiful location right outside Philadelphia, easily serviced by major international airports (Philadelphia (PHL), Newark (EWR), Baltimore (BWI), two more in NYC, and two more in DC); 90 minutes from NYC; and two hours from D.C.

The theme of this year's conference is Business Ethics, although we welcome additional papers discussing compliance across diverse settings. This year’s theme seeks to engage the question of how to run ethical companies, and how to encourage ethical behavior within organizations. The conference welcomes attempts to explore the strengths and limitations of various approaches, to identify how measurement strategies have shaped practices, and to understand how we can improve outcomes, for instance through new technology and combining methods. Submissions do not need to align with the meeting theme, but we encourage you to consider relating to it. The conference is also open to scholars and other experts who want to attend without presenting a paper.

The conference will host a business meeting of ComplianceNet, during which members may discuss future activities.

To register for the conference either as a presenter or attendee, please fill out the form by following this link. The URL is

For individual papers, please submit the paper title and abstract (up to about 200 words). For panels (3 papers minimum with a maximum of 5 per panel), please submit an integrative statement explaining the panel (approximately 200 words), the titles of each paper and their authors, and an abstract for each paper (approximately 200 words). At our website,, there is also a form to nominate papers for awards. Papers may be considered for awards whether they come through the nomination link or are presented at the conference.

The early registration discount deadline to submit papers and panels is January 25, 2019. The regular registration deadline for papers and panels is February 22, 2019. The registration deadline to attend without a paper or panel (as space available) is March 29, 2019. Registration for the conference includes the yearly membership in ComplianceNet. If you have questions regarding the call for proposals or about the conference, please contact Benjamin van Rooij (

 . . . 

---For conference updates, please refer to the ComplianceNet website at 

Sounds like a great event.  I note (and informed Josephine) that this conference overlaps with the Impact Investing Legal Working Group (IILWG)/Grunin Center for Law and Social Entrepreneurship’s 2019 Conference on “Legal Issues in Social Entrepreneurship and Impact Investing – in the US and Beyond,” scheduled for June 4-5 at the NYU Schools of Law in NYC.  More on that conference later.  In any event, it looks like there is a lot to do up North after the Law and Society Association conference!  One could spend the whole week away presenting papers. . . .

November 12, 2018 in Compliance, Conferences, Ethics, Joan Heminway | Permalink | Comments (0)

Sunday, November 11, 2018

ICYMI: #corpgov Weekend Roundup (Nov. 11, 2018)

November 11, 2018 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, November 10, 2018

Appraisal and Market Efficiency

Jonathan Macey and Joshua Mitts have just posted an intriguing new article, Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets, regarding calculation of value for the purposes of an appraisal action.

As I’ve posted about previously (here and here), Delaware is in the midst of a judicial reinterpretation of its appraisal statute, placing new emphasis on market pricing for determining the value of publicly traded stock.  Currently, one open question is whether “market” pricing refers to the deal price, assuming the process was relatively clean, or the unaffected trading price of the stock. 

Macey & Mitts begin by agreeing with VC Laster’s opinion in Verition Partners Master Fund, Ltd., et al. v. Aruba Networks, Inc., that valuation should be based on the trading price, and not the deal price, and their discussion after is where things get interesting.

First, they point out that apparently, Delaware courts only will consider trading price relevant to an appraisal action if price is efficient.  But they argue that even prices of stock that trades inefficiently would serve as a better indicator of value than more traditional calculations like discounted cash flow, in part because there are many different types of “inefficient” markets and some will process the most important information about the company and produce a reasonably accurate price – perhaps with the judge adjusting for any information that was not assimilated.  The test for market efficiency in an appraisal action is, in their view, too demanding.

Part of the reason I find this argument so interesting is that it mirrors the same kind of arguments we’ve been having in the fraud on the market space for over a decade, namely, how efficiently must the stock trade before plaintiffs are entitled to the fraud on the market presumption?  In that context, just like Mitts and Macey, Donald Langevoort (among others) has argued that courts have demanded too high a standard of efficiency when a lesser one would do for the purposes of the inquiry – a point that the Supreme Court seems to have found persuasive.  Of course, in the Section 10(b) context, we’re talking about informational efficiency; Mitts and Macey's argument depends on markets being efficient for fundamental value, or at least more accurate than other types of analysis.

The second argument that Macey and Mitts make is that the stock price reaction of the acquirer may indicate whether the deal price was too high, in which case, any appraised value should be lower.  I.e., if the acquirer’s stock price drops in response to announcement of the deal, that would suggest that the market believes the target was overvalued.  That’s a really clever suggestion, though I do wonder about their argument that the analysis holds even for private targets – we might legitimately ask whether the market knows enough about private targets to make an informed assessment of the appropriateness of the deal price and the target’s effect on the acquirer’s value.

Of course, overall, their argument would push Delaware’s law even further toward eliminating appraisal for all but the most egregious cases; in recent years, many scholars have argued that appraisal can be used as a kind of substitute for a broken system of fiduciary duty litigation.  Macey and Mitts believe that if fiduciary litigation is broken, it should be fixed, rather than substituting in a different cause of action to do that work.

November 10, 2018 in Ann Lipton | Permalink | Comments (0)

Friday, November 9, 2018

The Cambridge Handbook of Social Enterprise Law

The Cambridge Handbook of Social Enterprise Law, edited by Ben Means (South Carolina) and Joe Yockey (Iowa) is at the printers and should be ready for orders in early 2019. 

My fellow BLPB editor Joan Heminway and I both have chapters in the book, along with many others. 

The introduction is posted on SSRN, for those who are interested. Also, editor Ben Means has many talents, as he did the cover artwork below as well.

The Cambridge Handbook of Social Enterprise Law_Cover

November 9, 2018 in Business Associations, Corporate Governance, Haskell Murray, Joan Heminway, Research/Scholarhip, Social Enterprise | Permalink | Comments (0)

Thursday, November 8, 2018

Bias and Investing Mistakes: A Risk Management Issue

The Theranos collapse and Elizabeth Holmes' indictment makes me wonder about what investor biases may have played a role in allowing Theranos to operate as long as it did.  In an op-ed in The Hill, Ann McGinley and I point out that it might have been her seemingly deliberate projection of an idealized masculinity:  

Presenting the right identity may unlock millions in funding and bypass close, critical reviews. Consider Elizabeth Holmes, the recently indicted founder of Theranos. Flanked by a board sporting retired military officers, she presented herself as a masculinized take on the Steve Jobsian ideal — aping his wardrobe choices with a black turtleneck sweater.

Her costume was often complimented by a blazer’s broad shoulders, and she spoke with a startlingly deep voice.  The presentation exuded a hard-charging masculinity, allowing backers to see her as a Jungian fantasy of Jobs’ second coming. 

The op-ed ties back to the bigger law review article discussing the ways in which a bias toward favored identities causes founders to perform their and their entities' identities to please sources of capital. 

Gender bias (and other forms of implicit bias) likely does more than just raise capital costs for founders.  It also seems to saddle venture capital funds with risks.  The same techniques legitimate founders may embrace to raise capital might also be used by fraudsters looking to increase their odds on a con.  In essence, uncorrected implicit biases may make it easier to dupe VCs into buying into frauds.

There may be ways to mitigate this risk. Implementing some blind or purely paper-based screening process to vet initial ideas without in-person presentations may provide a check similar to the techniques used in orchestral auditions. After all, research has led Cass Sunstein and others to conclude that job interviews do more harm than good.  Getting a diverse committee to consider and approve investments might also also provide another check because a diverse group might not share the same biases.  Of course, some biases are strong and widely shared.  For example, investors generally tend to prefer investments pitched by masculine voices.  

Ultimately, I don't know how to perfectly solve the problem.  At the least, being aware of it and proceeding deliberately may allow some funds to reduce the role bias plays in their decisions.


November 8, 2018 | Permalink | Comments (0)

Wednesday, November 7, 2018

ICYMI: #corpgov Midweek Roundup (Nov. 7, 2018)

November 7, 2018 in Stefan J. Padfield | Permalink | Comments (0)

Tuesday, November 6, 2018

Vote. Please.

With just a few hours left to vote, I am taking this opportunity to ask you, if you have not already, to vote.  Please. It is our opportunity to be heard.

So often people complain about money in politics, and I agree that raises concerns. But we always have the power to choose. We, the voters, always have the final say. We can impose term limits any time we want, by voting people out.  If it is really a concern for us, we can overcome money in politics by choosing those who reject corporate interests. Either way, it is up to us. So, if you haven't already, please, please vote. 

And if you already voted, thank you.  Good work.  

November 6, 2018 in Current Affairs, Joshua P. Fershee | Permalink | Comments (0)

Monday, November 5, 2018

Elections of the Political and Corporate Kind

By the time many of you read this, Election Day 2018 will be upon us (or even over).  I have had elections on my mind for some time now--elections of the political and corporate kind.  As a result of an invitation to participate in last week's symposium on women and corporate governance hosted by the George Washington Law Review ("Women and Corporate Governance: A Conference Exploring the Role and Impact of Women in the Governance of Public Corporations"), my election-oriented thoughts somehow became infused with gender reflections . . . .

1992 was dubbed the political “Year of the Woman.” The appointment of Clarence Thomas to the U.S. Supreme Court in 1991 after hearings focused on sexual harassment allegations and revelations of Bill Clinton’s extramarital sexual conduct during his first campaign for election as U.S. President were and are credited with the record number of women elected to federal legislative positions in 1992. “When the ballots were counted, America had elected a record-breaking four women as senators and 24 women as representatives to Congress.” Li Zhou, The striking parallels between 1992’s “Year of the Woman” and 2018, explained by a historian, VOX, Nov 2, 2018, (interview with Georgetown University professor Michele Swers).

2018 has again been a hallmark year for women in politics—and in the public company boardroom. The #MeToo movement (and along with it yet another U.S. Supreme Court appointment tinged with allegations of sexual misconduct and a U.S President with a history of philandering and lechery) undoubtedly has been a factor in both the record-breaking number of women seeking political office in 2018 and a simultaneous renewed interest in gender diversity on corporate boards of directors. Perhaps this is not surprising. #MeToo largely emanates from the abuse of gendered power in government and business firms (which together are responsible for the fundamental regulation of our economic and social lives).

Given these parallels, there may be some value to looking at both the political and business management reactions to #MeToo.  Specifically, I am interested in comparing, contrasting, and reflecting on the gender effects of the #MeToo movement on public company board composition in relation to the gender effects of the #MeToo movement on the composition of legislative bodies. I have determined to write a symposium essay along those lines for the George Washington Law Review.  Your reflections and ideas on content are welcomed.

November 5, 2018 in Corporate Governance, Joan Heminway | Permalink | Comments (0)

Sunday, November 4, 2018

ICYMI: #corpgov Weekend Roundup (Nov. 4, 2018)

November 4, 2018 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, November 3, 2018

What I Did on My Friday in Cleveland

Yesterday, I had the pleasure of participating in Case Western Reserve Law Review Conference and Leet Symposium, Fiduciary Duty, Corporate Goals, and Shareholder Activism.  It was a fun and lively set of discussions with some interesting themes that hit right in my sweet spot of interests, so I had a wonderful time.  I’ll give a brief synopsis of the topics under the cut, but the entire thing will soon be available as a webcast online at the above link, and next year the law review will publish a special symposium issue.

Also, I just apologize in advance if I misdescribe anyone’s remarks – if you see this post and want to correct me, feel free to send an email.

[More under the jump]

Continue reading

November 3, 2018 in Ann Lipton | Permalink | Comments (2)

Friday, November 2, 2018

New Recommendations from Investor Advisory Committee

The SEC's influential Investor Advisory Committee has just released new recommendations for the SEC as it continues to move forward with its effort to raise the standard for investment advice given to retail customers.  Although the entire recommendation is worth reading, it highlights the special importance of making sure that account-type recommendations fall within the rule.  As it currently stands, the proposed regulation does not apply to initial recommendations about what kind of account a customer should select.

The Committee described the issue's critical importance:

Some of the most important decisions investors make arise at the outset of the relationship, before they receive recommendations regarding specific transactions. These include decisions about whether to roll money out of a retirement account and into an IRA, what type of account to open (where the firm has more than one account type available), and the scope of services to be provided. Those central decisions, generally made at the beginning of a brokerage or advisory relationship, set up the contours of the relationship. They will often have a far greater impact on the investor than subsequent recommendations regarding which specific securities to invest in.

Rollover recommendations, for example, are frequently provided at a critical juncture in an investor’s life – retirement – and are often irrevocable decisions. Similarly, while some investors (including those who trade frequently) may be best served by paying an asset-based fee, others (including buy-and-hold investors who rarely trade) may be better served by paying transaction fees. Decisions about which type of account to open have the potential to greatly affect their costs. Moreover, both rollover and account type recommendations are recommendations of an “investment strategy involving securities” that can have substantial potential long-term impacts on investors. And both types of recommendations inherently involve potential conflicts of interest, making it critical that advisers and brokers put their clients’ interests ahead of their own in making such recommendations.

Early account-type decisions will likely have significant impacts on the range of options available later.  The risk is that advisers eager to gather assets to manage will cause investors to pay higher fees and experience lower returns by drawing them into the wrong account type for their situation.  Consider a choice facing a retiree with a buyout offer for a defined-benefit pension.  If the retiree asks a financial adviser for advice, the advice should be in the best interest of the retiree--not the financial adviser.  The right advice might be for the retiree to keep the pension and not move assets to the financial adviser.  It's hardly acting in a person's best interest to draw them into a decision that isn't in their best interest and then act in their best interest once bad advice has caused them to surrender a stable pension.   


November 2, 2018 | Permalink | Comments (0)

Wednesday, October 31, 2018

ICYMI: #corpgov Midweek Roundup (Oct. 31, 2018)

October 31, 2018 in Stefan J. Padfield | Permalink | Comments (0)

Tuesday, October 30, 2018

Should You Ever Pierce the LLC Veil to Let a Member Recover? Probably Not.

Tom Rutledge, at Kentucky Business Entity Law Blog, writes about a curious recent decision in which the Kentucky Court of Appeals overrule a trial court, holding that the law of piercing the veil required the LLC veil to be pierced. Tavadia v. Mitchell, No. 2017-CA-001358-MR, 2018 WL 5091048 (Ky. App. Oct. 19, 2018).

Here are the basics (Tom provides an even more detailed description):

Sheri Mitchell formed One Sustainable Method Recycling, LLC (OSM) in 2013. Mitchell initially a 99% owner and the acting CEO with one other member holding 1%. Mitchell soon asked Behram Tavadia to invest in the company, which he did.

He loaned OSM $40K at 6% interest from his business Tavadia Enterprises, Inc. (to be repaid $1,000 per month, plus 5% of annual OSM profits).  There was no personal guarantee from Mitchell.  OSM then received a $150,000 a business development from METCO, which Tavadia personally guaranteed and pledged certain bonds as security.

Two years (and no loan payments) later under the original $40,000 loan, Tavadia agreed to delay repayment. OSM and Tavadia the created a second loan for $250,000, refinancing the original $40,000 and a subsequent Tavadia $12,000 loan.  This loan provided Tavadia a 25% ownership interest in OSM, but there was still no personal guarantee on the loan. Mitchell claimed this loan was needed to purchase essential equipment (no equipment was purchased). OSM then received a $20,000 loan from Fundworks, LLC, which was secured by Mitchell, who signed Tavadia’s name for OSM and she signed a personal guarantee in Tavadia’s name (both without permission).

Not surprisingly, in October 2015, OSM stopped operations, the equipment was sold, and more than half of the sale proceeds were deposited in Mitchell’s personal bank account, with the rest going to OSM’s account. OSM (naturally) defaulted on the Fundworks’ loan, which Tavadia learned about when Fundworks demanded repayment. The METCO loan also defaulted, and Tavadia was asked to provide funds from the bonds he provided as collateral.

Okay, so it sounds like Mitchell took advantage of Tavadia and engaged in some elements of fraud. What I can’t figure out from this case is why we’re talking about veil piercing.

First, the court states: “The evidence presented at trial demonstrated that Mitchell diverted OSM assets into her own account.” Tavadia v. Mitchell, No. 2017-CA-001358-MR, 2018 WL 5091048, at *5 (Ky. Ct. App. Oct. 19, 2018). So that money Mitchell owes to OSM, which owes money to Tavadia.  The court noted that at least half the funds from the sale of OSM equipment went into Mitchell’s personal account. That needs to go back to OSM, and if veil piercing has value, then a simple order of repayment should be, too. 

Second, the Fundworks loan, which Mitchell signed for, is really her loan, not Tavadia’s. He did not know about it until they sought payment, so it wasn’t ratified, and there is no other indication she has authority to enter into the contract. 

At a minimum, these funds are owed Tavadia (or OSM) and should be itemized as such.  Presumably, that is not enough money to make Tavadia whole. And I don’t know he should be. To the extent there were legitimate (if poorly executed) business attempts, he is on the hook for those losses. As such, I don’t see this as a veil-piercing case.

Instead, Tavadia should be able to sue Mitchell for her fraudulent actions that harmed him directly. And Tavadia should be able to make OSM sue Mitchell for improper transfers and fraud. 

Maybe there are other theories for recovery, too, but veil piercing should not be one. Mitchell did not use the entity to commit fraud. She committed fraud directly. Just because there is an entity, plus an unpaid loan, it does not make this a veil-piercing case. In fact, because Tavadia is a member of the LLC, I think there is a reasonable argument that (absent truly unique circumstances) veil piercing cannot apply. 

I am sympathetic that Tavadia was taken advantage of, and I think that Mitchell should have a significant repayment obligation to him, but I just don’t think this claim should be rooted in veil piercing.  At a minimum, like in administrative law, one should have to exhaust his or her remedies before proceeding to a veil-piercing theory. 

October 30, 2018 in Contracts, Entrepreneurship, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (1)