Tuesday, April 9, 2019
A 2017 opinion related to successor liability just posted to Westlaw. The case is an EEOC claim "against the Hospital of St. Raphael School of Nurse Anesthesia (“HSR School”) and Anesthesia Associates of New Haven (“AANH”), alleging gender discrimination and retaliation in violation of Title VII of the Civil Rights Act of 1964 . . . ." The plaintiff was seeking to join Yale New Haven Hospital (“YNHH”). MARGARITE CONSOLMAGNO v. HOSPITAL OF ST. RAPHAEL SCHOOL OF NURSE ANESTHESIA and ANESTHESIA ASSOCIATES OF NEW HAVEN, P.C., 3:11CV109 (DJS), 2017 WL 10966446, at *1 (D. Conn. Mar. 27, 2017).
There is no evidence that the HSR School had an existence that was independent of AANH. In fact, the HSR School was going to cease operating due to the fact that AANH was going to cease operating. The HSR School was not a limited liability corporation (“LLC”), private corporation (“P.C.”), or other legal entity registered with the Connecticut Secretary of State. (Tr. 141-142). There is no evidence that the HSR School had its own assets, bank account, or tax identification number. There is no evidence that the HSR School itself (as opposed to AANH) ever paid anyone for rendering services to the HSR School. There is no evidence that anyone other than AANH had operated the HSR School. Consequently, the Court finds that the predecessor in interest, for the purpose of assessing successor liability, is AANH.
Tuesday, April 2, 2019
A new case from the Southern District of Texas recently appeared, and it is yet another case in which the entity type descriptions are, well, flawed. The case opens:
Before the Court is the defendant’s, Arnold Development Group, LLC (the “defendant”) motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(2) and (3) (Dkt. No. 5), the plaintiff’s, Conesco Industries, LTD.; d/b/a DOKA USA, LTD. (the “plaintiff”) response to the defendant’s motion to dismiss (Dkt. No. 18) and the defendant’s reply in support of its motion (Dkt. No. 20).
. . . .
The plaintiff is a New Jersey limited partnership doing business in Texas and throughout the United States. The defendant is a Missouri limited liability corporation.
In the case before the Court, the defendant is a Missouri corporation and the plaintiff is a New Jersey corporation.
Thursday, March 28, 2019
According to people with knowledge of the cases, once Nike heard Mr. Avenatti’s claims, it acted to inform federal officials of the allegation that the company’s employees were paying players. The nature of the discussion with Mr. Avenatti raised the possibility that extortion was taking place.
Wednesday, March 20, 2019
Get this, from a March 15 ruling and order on a motion for summary judgment:
Greenwich Hotel Limited Partnership [GHLP] is a limited partnership organized under the laws of Connecticut, and is the owner of the Hyatt Regency Greenwich hotel. Answer to First Amended Complaint, dated Dec. 16, 2016 (“Am. Ans.”), ECF NO. 62, at 8. Hyatt Equities, L.L.C. (“Hyatt Equities”) is a limited liability corporation incorporated in Delaware, and is the general partner of Greenwich Hotel Limited Partnership. Id. at 9. The Hyatt Corporation (“Hyatt Corp.”) is a limited liability corporation incorporated in Delaware, and is the agent of Greenwich Hotel Limited Partnership. Id. at 9.
"Upon information and belief, defendant Hyatt Equities is a limited liability company organized under the laws of the State of Delaware, and is the general partner of GHLP.
. . . .
Upon information and belief, defendant Hyatt Corporation is a corporation organized under the laws of the State of Delaware and is the agent of GHLP."
Benavidez v. Greenwich Hotel LP, 3:16-CV-191, Answer to First Amended Complaint, dated Dec. 16, 2016 (“Am. Ans.”), ECF NO. 62, at 9. This is all properly stated, but somehow it didn't translate to the ruling and order.
Kudos to the filing attorneys on getting it right. I wonder if this is something that can be corrected? One would hope. Okay, at least I hope so.
Tuesday, March 12, 2019
It is Spring Break at WVU, so I am using this time to finish some paper edits and catch up on my email. Last week, I got an email about a recent case from the United States District Court for the Northern District of Illinois. It is a headache-inducing opinion that continues the trend of careless language related to limited liability companies (LLCs).
The opinion is a civil procedure case (at this point) regarding whether service of process was effective for two defendants, one a corporation and the other an LLC. The parties at issue, (collectively, “Defendants”) are: (1) Ditech Financial, LLC f/k/a Green Tree Servicing, LLC (“Ditech Financial”) and (2) Ditech Holding Corporation f/k/a Walter Investment Management Corp.’s (“Ditech Holding”). The court notes that it is unclear whether there is diversity jurisdiction, because
“the documents submitted by Defendants with their motion to dismiss suggest that there may be diversity of citizenship in this case. See [12-1, at 2 (stating Ditech Holding is a Maryland corporation with a principal office in Pennsylvania) ]; [12-1, at 2 (stating Ditech Financial is a Delaware limited liability corporation with a principal office in Pennsylvania) ].”
Clayborn v. Walter Investment Management Corp., No. 18-CV-3452, 2019 WL 1044331, at *8 (N.D. Ill. Mar. 5, 2019) (emphasis added).
Why do courts insist on telling us the state of LLC formation and principal place of business, when that is irrelevant as to jurisdiction for an LLC? Hmm. I supposed that fact that courts keeping calling LLCs “corporations” might have something to do with it. The court does seem to know the rule for LLCs is different than the one for corporations, noting that “Plaintiff has not pled or provided the Court with any information regarding the citizenship of each member of Ditech Financial LLC. “ Id.
Despite this apparent knowledge, the court goes on to say:
Under Illinois law, “a private corporation may be served by (1) leaving a copy of the process with its registered agent or any officer or agent of the corporation found anywhere in the State; or (2) in any other manner now or hereafter permitted by law.” 75 ILCS 5/2-204. At least one court to consider the issue has concluded that Illinois state law does not allow service of a summons on a corporation via certified mail. Ward v. JP Morgan Chase Bank, 2013 WL 5676478, at *2 (S.D. Fla. Oct. 18, 2013); see also 24 Illinois Jurisprudence: Civil Procedure § 2:20; 13 Ill. Law and Prac. Corporations § 381. Plaintiff has not cited, nor has the Court located, any support for the proposition that a summons and complaint sent by certified mail constitutes one of the “other manner[s] now or hereafter permitted by law” to effectuate service. Consequently, the Court concludes that Plaintiff has not properly served Ditech Holding under Illinois law, and therefore cannot have served Ditech Financial.2 [see below]
Id. Now the case gets more confusing. Note that last line above: the court implies that proper service of the corporate parent may have been sufficient to serve the LLC, too. Footnote 2 of the opinion properly clarifies this, though the court then provides another baffling tidbit.
Footnote 2 provides:
Even if Plaintiff had properly served Ditech Holding, it would not have properly effectuated service upon Ditech Financial. Ditech Financial appears to be a limited liability company.; . Under Illinois law, service on a limited liability company is governed by section 1–50 of the Limited Liability Company Act. 805 ILCS 180/1–50; John Isfan Construction, Inc. v. Longwood Towers, LLC, 2 N.E.3d 510, 517–18 (Ill. App. Ct. 2016). Under section 1–50 of the Limited Liability Company Act, a plaintiff may only serve process upon a limited liability company by serving “the registered agent appointed by the limited liability company or upon the Secretary of State.” Pickens v. Aahmes Temple #132, LLC, 104 N.E.3d 507, 514 (Ill. App. Ct. 2018) (quoting 805 ILCS 180/1–50(a)). To properly serve Ditech Financial, Plaintiff would have had to deliver a copy of the summons and complaint to Ditech Financial’s registered agent in Illinois: CT Corporation System. [12, at 5.]
The court had already stated the Ditech Financial was an LLC, though it had called it a “limited liability corporation.” Is the court unclear about the entity type? If entity type is in question, it would seem worthy of note in the body of the opinion. The court properly cites to the LLC Act, but it inconclusive as to whether Ditech Financial is, in fact, an LLC.
To make matters worse, the court repeats, in footnote 3, its earlier mistake as to what an LLC really is:
Service on a limited liability corporation, such as Ditech Financial, must be effectuated in the same manner as service on a corporation such as Ditech Holding. See, e.g., Grieb v. JNP Foods, Inc., 2016 WL 8716262, at *3 (E.D. Pa. May 13, 2016) (evaluating the effectiveness of service of process on a limited liability company under Pa. R. Civ. P. 424).
Tuesday, March 5, 2019
Gregg D. Polsky, University of Georgia Law, recently posted his paper, Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups. It is an interesting read and worth a look. H/T Tax Prof Blog. Following the abstract, I have a few initial thoughts:
Perhaps the most fundamental role of a business lawyer is to recommend the optimal entity choice for nascent business enterprises. Nevertheless, even in 2018, the choice-of-entity analysis remains highly muddled. Most business lawyers across the United States consistently recommend flow-through entities, such as limited liability companies and S corporations, to their clients. In contrast, a discrete group of highly sophisticated business lawyers, those who advise start-ups in Silicon Valley and other hotbeds of start-up activity, prefer C corporations.
Prior commentary has described and tried to explain this paradox without finding an adequate explanation. These commentators have noted a host of superficially plausible explanations, all of which they ultimately conclude are not wholly persuasive. The puzzle therefore remains.
This Article attempts to finally solve the puzzle by examining two factors that have been either vastly underappreciated or completely ignored in the existing literature. First, while previous commentators have briefly noted that flow-through structures are more complex and administratively burdensome, they did not fully appreciate the source, nature, and extent of these problems. In the unique start-up context, the complications of flow-through structures are exponentially more problematic, to the point where widespread adoption of flow-through entities is completely impractical. Second, the literature has not appreciated the effect of perplexing, yet pervasive, tax asset valuation problems in the public company context. The conventional wisdom is that tax assets are ignored or severely undervalued in public company stock valuations. In theory, the most significant benefit of flow-through status for start-ups is that it can result in the creation of valuable tax assets upon exit. However, the conventional wisdom makes this moot when the exit is through an initial public offering or sale to a public company, which are the desired types of exits for start-ups. The result is that the most significant benefit of using a flow- through is eliminated because of the tax asset pricing problem. Accordingly, while the costs of flow-through structures are far higher than have been appreciated, the benefits of these structures are much smaller than they appear.
Before commenting, let me be clear: I am not an expert in tax or in start-up entities, so my take on this falls much more from the perspective of what Polsky calls "main street businesses." I am merely an interested reader, and this is my first take on his interesting paper.
To start, Polsky distinguishes "tax partnerships" from "C Corporations." I know this is the conventional wisdom, but I still dislike the entity dissonance this creates. Polsky explains:
Tax partnerships generally include all state law entities other than corporations. Thus, general and limited partnerships, LLCs, LLPs, and LLLPs are all partnerships for tax purposes. C corporations include state law corporations and other business entities that affirmatively elect corporate status. Typically, a new business will often need to choose between being a state-law LLC taxed as a partnership or a state-law corporation taxed as a C corporation. The state law consequences of each are nearly identical, but the tax distinctions are vast.
As I have written previously, I'd much rather see the state-level entity decoupled from the tax code, such that 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.
As Dinky Bosetti once said, "It's good to want things."
Anyway, as one who focuses on entity choice from (mostly) the non-tax side, I dispute the idea that "[t]he state law consequences of each [entity] are nearly identical, but the tax distinctions are vast." From governance to fiduciary duties to creditor relationships to basic operations, I think there are significant differences (and potential consequences) to entity choice beyond tax implications.
I will also quibble with Polsky's statement that "public companies are taxed as C corporations." He is right, of course, that the default rule is that "a publicly traded partnership shall be treated as a corporation." I.R.C. § 7704(a). But, in addition to Business Organizations, I teach Energy Law, where we encounter Master Limited Partnerships (MLPs), which are publicly traded pass-through entities. See id. § 7704(c)-(d).
Polsky notes that "while an initial choice of entity decision can in theory be changed, it is generally too costly from a tax perspective to convert from a corporation to a partnership after a start-up begins to show promise." This is why those of us not advising VC start-ups generally would choose the LLC, if it's a close call. If the entity needs to be taxed a C corp, we can convert. If it is better served as an LLC, and the entity has appreciated in value, converting from a C corp to an LLC is costly. Nonetheless, Polsky explains for companies planning to go public or be sold to a public entity, the LLC will convert before sale so that the LLC and C Corp end up in roughly the same place:
The differences are (1) the LLC’s pre-IPO losses flowed through to its owners while the corporation’s losses were trapped, but as discussed above this benefit is much smaller than it appears due to the presence of tax-indifferent ownership and the passive activity rules, (2) the LLC resulted in additional administrative, transactional, and compliance complexity (including the utilization of a blocker corporation in the ownership structure), and (3) the LLC required a restructuring on the eve of the IPO. All things considered, it is not surprising that corporate classification was the preferred approach for start-ups.
This is an interesting insight. My understanding is that the ability pass-through pre-IPO losses were significant to at least a notable portion of investors. Polsky's paper suggests this is not as significant as it seems, as many of the benefits are eroded for a variety of reasons in these start ups. In addition, he notes a variety of LLC complexities for the start-up world that are not as prevalent for main street businesses. As a general matter, for traditional businesses, the corporate form comes with more mandatory obligations and rules that make the LLC the less-intensive choice. Not so, it appears, for VC start-ups.
I need to spend some more time with it, and maybe I'll have some more thoughts after I do. If you're interested in this sort of thing, I recommend taking a look.
Tuesday, February 26, 2019
Westlaw recently posted an interesting Massachusetts case at the intersection of criminal law and business law. Massachusetts (the Commonwealth) sought to commit a defendant as a sexually dangerous person. Commonwealth v. Baxter, 94 Mass. App. Ct. 587, 116 N.E.3d 54, 56 (2018). The defendant was (at the time) an inmate because of a probation violation related to offenses of rape of a child and other crimes. The Commonwealth retained Mark Schaefer, Ph.D., for an expert opinion, and Dr. Schaefer concluded that the defendant was, under state law, a sexually dangerous person. The hearing judge found probable cause to think the defendant was a sexually dangerous person and had him temporarily committed for examination by two qualified examiners, as required by law. Dr. Joss determined that the defendant was sexually dangerous, and Dr. Rouse Weir determined he was not.
After the reports of the qualified examiners were submitted to the court, the defendant moved to exclude Dr. Joss from providing evidence at trial, or in the alternative, to appoint a new qualified examiner to evaluate the defendant. As grounds therefor, the defendant alleged that Dr. Joss and Dr. Schaefer were both among six “member/partners in Psychological Consulting Services (‘PCS’), a limited liability corporation [LLC] based in Salem, Massachusetts.” He argued that the members of the LLC have a fiduciary duty of loyalty to the company and are necessarily “dedicated to [its] financial and professional success.” Because Dr. Schaefer and Dr. Joss were “intertwined both professionally and financially,” through their partnership in PCS, the defendant claimed that their relationship “create[d] a conflict of interest and raise[d] a genuine issue of Dr. Joss's impartiality in his role as a [qualified examiner].” The defendant offered no affidavit in support of his motion, and did not request an evidentiary hearing.
Tuesday, February 19, 2019
Conference Announcement -- Artificial Intelligence: Thinking About Law, Law Practice, and Legal Education
Thinking About Law, Law Practice, and Legal Education
Hosted by the Duquesne University School of Law
Friday & Saturday, April 26-27, 2019
Developments in artificial intelligence are changing virtually all aspects of our world, ranging from autonomous vehicles to robotic surgery, and from smartphones to smart speakers. Lawyers, legal educators, and policymakers are already experiencing the effects of computers that aid and, in some cases, replace the often-tedious work done by lawyers and other members of society. Law school graduates will need to understand how intelligent systems can enhance and streamline the work that they do, and how their careers may be changed in the future. Furthermore, artificial intelligence technology will likely call for greater government oversight, result in new laws, and trigger litigation.
This two-day conference will feature presentations by educators, practitioners, policymakers, and computer scientists that will demonstrate how the development of artificial intelligence is affecting society, the law, the legal profession, and legal education. The Duquesne Law Review will dedicate space in its Winter 2019 symposium issue to publishing papers from this conference.
Presenters & Agenda, Day One (Law and Law Practice):
- Dean Alderucci (Carnegie Mellon Univ.): Customized Artificial Intelligence Techniques for the Patent Field
- Kevin Ashley (Univ. of Pittsburgh): Connecting Case Texts and Computational Models of Legal Reasoning
- Kristen Baginski (Lexis): Lexis Advance and the Use of AI and Analytics: A Brief Overview of Recent and Upcoming AI and Analytic Enhancements to the Lexis Advance Platform
- Kishor Dere (Indian Society of International Law): Role of Artificial Intelligence in Predicting the Speed and Results of Judicial Decision-Making
- Tabrez Y. Ebrahim (California Western Univ.): Autonomous Vehicles Ethics & Law: An Artificial Intelligence Trolley Problem
- Brian S. Haney (Martian Technologies): The Optimal Agent: The Future of Autonomous Vehicles & Liability Theory
- Patrick Juola (Duquesne Univ.): Specificity and Sensitivity in Discovery: What Artificial Intelligence Can Offer
- Ganes Kesari (Gramener, Inc.): Smart Contract Risk Identification with AI
- Timothy Lau, Esq. (Federal Judicial Center): Educating Federal Judges on AI
- Oliver Round, Esq., Seema Phekoo, Esq., & Kyle Johnson (BNY Mellon), & Scott Curtis (Deloitte LLP): Practical Applications of Artificial Intelligence and Machine Learning in Corporate Legal Departments
- Emile Loza de Siles, Esq. (Technology & Cybersecurity Law Group): Algorithmic Justice: A New Proposal Toward the Identification and Reduction of Discriminatory Bias in Artificial Intelligence Systems
- Igor Vuletić (Josip Juraj Strossmayer Univ.): Criminal Law Facing Challenges of Autonomous Technology: Who Is Liable for a Traffic Accident Caused by an Autonomous Vehicle?
Presenters & Agenda, Day Two (Legal Education):
- Dionne E. Anthon, Prof. Anna P. Hemingway, & Prof. Amanda Sholtis (Widener Law Commonwealth): Practice-Ready Millennials: Technology Training for Efficient and Effective Communication
- Jamie J. Baker (Texas Tech Univ.): Legal Research and The Duty of Technology Competence: Regulating Algorithms in Law
- Randy J. Diamond (Univ. of Missouri): Technology Skills for Lawyers
- Kristi Gedid (Mylan), Virginia L. Zaccari (Duquesne Univ.), & Kevin Miller (LegalSifter): How Artificial Intelligence is Transforming the Legal Sector
- Emily Janoski-Haehlen & Librarian Sarah Starnes (Univ. of Akron): From AI to IoT: Using Legal Innovations to Teach Legal Technology Competency Across the Curriculum
- Kate Norton (Duquesne Univ.): Artificial Intelligence as a Path to Closing the Justice Gap
- Julie Oseid (Univ. of St. Thomas), Prof. Melissa Love Koenig (Marquette Univ.), & Amy Vorenberg (Univ. of New Hampshire): OK Google, Will Artificial Intelligence Replace Human Lawyering?
- Teresa Godwin Phelps (American Univ.) & Richard B. Phelps (Broadcast Media):“Alexa, Write a Memo”: The Promise and Challenges of AI and Legal Writing
- James B. Schreiber & Prof. Ashley London (Duquesne Univ.): Considerations Surrounding the Data Science World We Are In
- Drew Simshaw (Georgetown Univ.): Teaching Legal Research and Writing in an Era of Artificial Intelligence
Conference Registration Fees:
- Presenters and Duquesne faculty – Free
- Other registrants with a full-time academic or government agency affiliation - $50 per day
- All others, including attorneys seeking CLE credits -- $90 per day (yielding three hours of CLE credit each day)
Duquesne will provide free on-site parking to conference attendees. A continental breakfast, snacks, and lunch will be provided each day, and a conference-closing reception will take place in the Bridget and Alfred Peláez Legal Writing Center, the home of Duquesne’s Legal Research and Writing Program.
Pittsburgh is an easy drive or short flight from many cities. Duquesne has arranged for blocks of discounted rooms at two hotels near to campus, within walking distance of the law school and downtown Pittsburgh. Attendees can enjoy Pittsburgh area attractions, including our architectural treasures, museums, art collections, shopping, and world-class professional sports teams.
For more information, and to complete the online registration for the conference and hotels, please visit https://www.law.duq.edu/news/artificial-intelligence-conference-april-26-27th-2019. Hotel registration will close soon, so please make your reservations now.
Tuesday, February 12, 2019
Sometimes, LLC cases are a mess. It is often hard to tell whether the court is misstating something, whether the LLCs (and their counsel) are just sloppy, or both. My money, most of the time is on "both."
Consider this recent Louisiana opinion (my comments inserted):
The defendant, Riverside Drive Partners, LLC (“Riverside”) appeals the district court judgment denying its motion for a new trial related to its order of January 8, 2018, dismissing all pending claims against three parties in this multiparty litigation: (1) CCNO McDonough 16, LLC (“CCNO”); (2) R4 MCNO Acquisition LLC (“R4”); and (3) Joseph A. Stebbins, II. After review of the record in light of the applicable law and arguments of the parties, the district court judgment is affirmed. . . .
This litigation arises out of a dispute among partners in a real estate development related to the conversion of an existing historic building into an affordable housing complex. Pursuant to the Operating Agreement signed on September 30, 2013, McDonough 16, LLC, was formed to acquire, rehabilitate, and ultimately lease and operate a multi-family apartment project consisting of the historic building and a new construction building. In turn, McDonough 16, LLC had two members, also limited liability entities: (1) the “Managing Member,” CCNO [an LLC] and (2), the “Investor Member,” R4, a Delaware limited liability company with its principal place of business in New York. [Who cares? Jurisdiction of the LLC is based on the citizenship of the LLC member(s).] Likewise, CCNO had two limited liability partnerships as members: (1) CCNO Partners 2, LLC, [thus not an LLP, but and LLC] which was formed by two members who were residents of and domiciled in Orleans Parish: Mr. Stebbins and Michael Mattax; and (2) the appellant, Riverside, a Florida limited liability company [also not an LLP] with its principal place of business in Florida whose sole member, Jack Hammer, is a resident of and domiciled in Georgia. Iberia Bank was lender for the project.
CCNO McDonough 16, LLC v. R4 MCNO Acquisition, LLC, 2018-0490 (La. App. 4 Cir. 11/14/18), 259 So. 3d 1077, 1078 (comments and emphasis added)
The issue was whether Riverside, LLC, as a member of CCNO, was needed to agree for CCNO to enter a settlement agreement. The court noted,
Section 3. 13 of the CCNO Operating Agreement provides:
Overall Management Vested in Members and Managers. Except as expressly provided otherwise in this Operating Agreement or otherwise agreed in writing at a meeting, management of the Company is vested in the Members in proportion to their initial Capital Contributions, and every Member is hereby made a Manager. All powers of the Company are exercised by or under the authority of the Managers and Members and the business and affairs of the Company are managed under the direction of the Members and Managers. The Managers may engage in other activities of any nature. (Emphasis added).
In addition, the CCNO Operating Agreement defines “Majority in Interest” as “any referenced group of Managers, Members or persons who are both, a combination who, in aggregate, own more than fifty percent (50%) of the Membership Interests owned by all of such referenced group of Managers and Members.” Notably, Section 2.05 of the CCNO Operating Agreement specifically provides that any amendment to the agreement requires the approval of the beneficiary of any mortgage lien, i.e., Iberia Bank.
Riverside does not dispute that it owns less than fifty per cent of the CCNO shares or that CCNO Partners 2, of which Mr. Stebbins is a member, owns proportionally more of the membership interest in CCNO. Rather, Riverside asserts that this does not matter because, although the CCNO Operating Agreement clearly established CCNO Partners 2 owned 66.67% of CCNO (and, concomitantly, that Riverside only 33.33%), a subsequent amendment altered the proportion of ownership to 60% (CCNO Partners 2) and 40% (Riverside) and redefined “Majority in Interest” to mean “more than 60%,” thereby making any settlement agreement reached without the appellant's consent invalid.
Two closing thoughts:
- Jack Hammer as an LLC member of a construction-focused entity sounds like one of my exam characters. Awesome.
- Westlaw's synopsis states: "Managing member of limited liability corporation (LLC) brought action against investor member to enjoin removal as manager." No. An LLC is a limited liability company, not a corporation. (Regular readers had to see that coming.)
- LLCs are not limited partnerships, either, even if they are structured similarly or even use the term "partner." An LLC is a separate and unique entity. Really.
Wednesday, February 6, 2019
Tom Rutledge at Kentucky Business Entity Law Blog writes:
As a general proposition, LLC operating agreements may change the default rules provided for in the LLC Act. A recent decision from Pennsylvania found that a general provision as to decision making by majority vote did not alter the statutory default of unanimous approval to amend the operating agreement. Saltzer v. Rolka, No. 702 MDA 2017, 2018 WL 5603050 (Pa. Super. Ct. Oct. 30, 2018).. . . .Under the Pennsylvania LLC Act, the default rule for amendment of the operating agreement is unanimous approval of the members. 15 Pa.C.S.A § 8942(b). That rule may be altered in a written operating agreement. Id. The LLC’s operating agreement provided that it could be amended by the members at a regular or special meeting, but in that section did not address the threshold for the required vote. Another section of the agreement provided “Except as otherwise provided in the [LLCA], or this Agreement, whenever any action is to be taken by vote of the members, it shall be authorized upon receiving the affirmative vote of a majority of the votes cast by all Members entitle to vote upon.” 2018 WL 5603050, *4. The court found that this provision was of itself insufficient to alter the statutory default as to amending the operating agreement. Unfortunately the decision did not detail why it was insufficient or what more it would have needed to be sufficient.
This outcome is consistent with some similar limited partnership cases. Courts tend to look for clear and unambiguous statements of intent when operating agreements and partnership agreements change default rules of voting when it comes to fundamental rights that go to the purpose of the entity, like adding new investors (partners/members), dissolution, etc. For example, in In Re Nantucket Island Associates Ltd., 810 A.2d 351 (Del. Ch. 2002), the court considered whether a General Partner in a limited partnership "had the unilateral authority to: i) issue a new class of preferred units having superior claims to capital and income distributions and ii) amend the partnership agreement to subordinate the contractual distribution rights of the existing limited partners to those new claims." Although" the general partner had the freedom to draft a clear and explicit grant of authority to itself to amend the partnership agreement in these circumstances," Vice Chancellor Strine determined that the general partner failed to do so:
This case therefore stands as yet another example of how important it is to draft limited partnership agreements carefully. Although our law permits a limited partnership agreement to invest far-ranging authority in a general partner, it also requires a clear and unambiguous articulation of that authority so that investors are given fair warning of the deal they are making by buying units. When a general partner drafts an agreement that is susceptible to more than one reasonable interpretation, the one most favorable to the public investors will be given effect.
The lesson: when you want to take broad and far-reaching powers, especially those with a default rule requiring unanimity, be very, very clear.
Tuesday, January 29, 2019
Back in 2011, I wrote, in a Harvard Business Law Review Online article, that the default rule in analyzing all LLC questions should be one taken from CML V, LLC v. Bax, 6 A.3d 238 (Del. Ch. Nov. 3, 2010): “[T]here is nothing absurd about different legal principles applying to corporations and LLCs.” I still believe that. I further argued:
Where legislatures have decided that distinctly corporate concepts should apply to LLCs—such as allowing piercing the veil or derivative lawsuits—those wishes (obviously) should be honored by the courts. And where state LLC laws are silent, the court should carefully consider the legislative context and history, as well as the policy implications of the possible answers to the questions presented. Courts should put forth cogent reasons for their decisions, rather than blindly applying corporate law principles in what are seemingly analogous situations between LLCs and corporations. [footnotes omitted]
In 2014, I discussed a case West Virginia case in a post here at Business Law Prof Blog, More LLC Veil Piercing Forced into State Statutes. In that post, I was critical of a West Virginia Supreme Court of Appeals decision reading veil piercing into the state's LLC statute. My main issue with that case, Kubican v. The Tavern, LLC, 232 W.Va. 268, 752 S.E. 2d 299 (2013), was that" Virginia’s veil-piercing test stated more clearly than other states . . . that corporate formalities are the main issue for the unity of interest test" for veil piercing an LLC. This is problematic because, of course, LLCs don't have many formalities, and none of them are "corporate" (because LLCs are not corporations).
To be fair, the opinion wisely directed that, for LLC veil piercing, courts “disregard of formalities requirement.” But the overlay of corporate formalities and corporate traditions remain in the numerous other factors courts are to consider, and thus analysis of the factors are likely to occur with through a decidedly corporate filter. That's not reasonable or fair for LLCs.
The West Virginia legislature is looking to remedy this, and overrule the Supreme Court of Appeals, has proposed Senate Bill 258:
ARTICLE 3. RELATIONS OF MEMBERS AND MANAGERS TO PERSONS DEALING WITH LIMITED LIABILITY COMPANY.
§31B-3-303. Liability of members and managers.
(a) Except as otherwise provided in §31B-3-303(c) of this code, the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company
solelyby reason of being or acting as a member or manager. It is the intent and policy of the Legislature that for any claim against a limited liability company arising after the effective date of the reenactment of this section during the regular session of the Legislature, 2019, common law corporate “veil piercing” claims may not be used to impose personal liability on a member or manager of a limited liability company, and that the West Virginia Supreme Court of Appeals decision in Joseph Kubican v. The Tavern, LLC, 232 W.Va. 268, 752 S.E. 2d 299 (2013) be nullified.
(b) The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.
(c) All or specified members of a limited liability company are liable in their capacity as members for all or specified debts, obligations, or liabilities of the company if:
(1) A provision to that effect is contained in the articles of organization; and
(2) A member so liable has consented in writing to the adoption of the provision or to be bound by the provision.
As noted above, I have supported legislative action to allow or disallow LLC veil piercing. Where LLC veil piercing is to be allowed, I have advocated for a clearly stated LLC-specific test. And were veil piercing to be eliminated, I have advocated for legislation making that clear, too. This proposal has this last option right.
That said, I have a couple significant objections to the proposed statute, as written. First, and most significant, the statute could be read to eliminate the possibility of personal liability for any company debt for any member of an LLC. The proposed legislation seeks to modify the following: "A member or manager is not personally liable for a debt, obligation, or liability of the company
solely by reason of being or acting as a member or manager." By dropping "solely," this proposal appears to limit other potential sources of liability (that are not veil piercing), which are traditionally considered liability related to the actions or a member. By analogy, the Model Business Corporation Act provides, "(b) A shareholder of a corporation is not personally liable for any liabilities of the corporation (including liabilities arising from acts of the corporation) except (i) to the extent provided in a provision of the articles of incorporation permitted by section 2.02(b)(2)(v), and (ii) that a shareholder may become personally liable by reason of the shareholder’s own acts or conduct." § 6.22 Liability of Shareholders (emphasis added).
Where an individual LLC member acts in a way that should lead to liability (promises to pay individually, seek to deceive, etc.), the possibility for direct liability to the member is proper and is generally recognized by even the most ardent advocates of abolishing veil piercing. For example, the most prominent scholar on this front, Prof. Bainbridge, in his article, Abolishing LLC Veil Piercing, "advocates a regime of direct liability: Did the defendant-members do anything for which they are appropriately held personally liable?" I concur.
[Author's note: the proposed statute was amended today adding "solely" back into the statute. That amendment occured after I wrote this, but before it posted, so someone else was on it.]
It is the intent and policy of the Legislature that for any claim against a limited liability company arising after the effective date of the reenactment of this section during the regular session of the Legislature, 2019, common law corporate “veil piercing” claims may not be used to impose personal liability on a member or manager of a limited liability company, and that the West Virginia Supreme Court of Appeals decision in Joseph Kubican v. The Tavern, LLC, 232 W.Va. 268, 752 S.E. 2d 299 (2013) be nullified.
This is problematic because it applies to all prior negotiated relationships, meaning that contracts would have been negotiated with veil piercing available. This may, in some way, impacted how people negotiated guarantees in contracts. In a prior post, I criticized the Wyoming high court for making LLC veil piercing easy and suggesting that laws should not encourage parties to seek guarantees:
The court cites potential abuse of LLC laws if they were to adopt such a rule that motivates companies to ask for guarantees. instead adopting a rule that could incentivize companies like Western actively avoid ask ingfor guarantees. Why? Because if you ask for a guarantee and are refused, it could be used against you later. But if you don’t ask, you may get to piece the veil and seek a windfall recovery by getting a post hoc guarantee that was not available via negotiation.
This West Virginia proposed legislation would likely lead more parties to seek guarantees, which I see as a good thing. But this is a significant change to the legal landscape, and it seems to me the whole thing should be prospective. Thus, new interactions, new contracts or renewals, etc., should be under the new law, but that there should be at least some look-back period. One could argue that a "claim against a limited liability company arising after the effective date" related to a 2014 contract is a claim that "arose" before the effective date because a "claim" is different from a "lawsuit." For me, I would probably amend it to say something like, for events leading to a lawsuit against a limited liability company arising after the effective date . . . .." This would have the added benefit of preserving claims for events preceding the effective date that were not filed or discovered but are still within the statute of limitations. This seems more equitable to me.
Anyway, I am intrigued by the concept of eliminating LLC veil piercing, but I think this needs more thought.
[Author's note 2: The amended language mentioned above added substantial changes to part (c), which I am inserting below.]
An additional amendment now adjusts part (c) t0 read (my comments inserted in bold):
(c) All or specified members of a limited liability company are liable in their capacity as members for all or specified debts, obligations or liabilities of the company if:
(1) A provision to that effect is contained in the articles of organization; and
(2) A member so liable has consented in writing to the adoption of the provision or to be bound by the provision.
(1) A provision to that effect is contained in the articles of organization, and a member so liable has consented in writing to the adoption of the provision or to be bound by the provision; [This is currently item 12 of the West Virginia Secretary of State Articles of Organization of Limited Liability form.]
(2) The member against whom liability is asserted has personally guaranteed the liability or obligation of the limited liability company in writing; [Good to make this clear, I suppose, though that is a personal obligation that attaches to the indidvudal. This is less necessary with "solely" added back to part (a).]
(3) As to a tax liability of the limited liability company, the law of the state or of the United States imposes liability upon the member; or [Also a personal obligation that attaches to the indidvudal.]
(4) The member commits actual fraud which causes injury to an individual or entity. [True before this law was proposed as a personal obligation that attaches to the indidvudal. The potential problem with this list of items 1-4 is that it may serve to limit or eliminate other forms of personal liablity that existed under prior law. Hopefully, the "solely" langauge keeps all direct liability intact, but sometimes when a list like this is created, it is also read to mean it is the exclusive list of direct liability available.]
(d) Enterprise liability. — In circumstances where the members of a limited liability company are, in whole or in part, corporations, limited liability companies, or other entities which are not human beings, then if a jury shall determine that the liability of a limited liability company sounding in tort arose as part of the activities of a joint enterprise, those entities which are part of the joint enterprise with the limited liability company may be liable for the liability of the limited liability company which arose as part of the business operations of the joint enterprise, not as a piercing of the veil, but instead under the doctrine of joint enterprise liability. [This is an attempt at preserving the concept of enterprise liability as introduced in Walkovsky v. Carlson. I rather like the idea, but I think this language could be more clear. I hope to have time to draft proposed changes soon.]
(e) Member as tortfeasor. — Nothing in this section shall immunize or shield a member of a limited liability company, solely because he or she is a member of a limited liability company, from liability for his or her own tortious conduct that proximately causes injury to another party while the member is acting on behalf of the limited liability company. In such circumstance, the liability of a member is not through veil piercing, but rather primary, as against any tortfeasor. [I like this and think it is critical to make clear. It does run the risk of including things I don't think it always should, such as providing indivdual liablity for a company's business tort claims, such as a toritious interference with contract.]
(f) Clawback authority. — If a member is proved to have committed any of the following acts, then a creditor of the limited liability company whose judgment the limited liability company cannot satisfy may seek clawback from the member under this subsection: Provided, That the limited liability company’s judgment creditor may proceed in the shoes of the limited liability company [like a derivative suit?] to clawback funds from the member in order to reimburse the limited liability company for either the amount of the judgment against the limited liability company or the amount transferred from the limited liability company to the member in bad faith, whichever is less. [This may work for a business that is on going, but lacks funds for a particular creditor. However, where the LLC is in the zone of insolvency, it could be used to prioritize one creditor over another, possibly improperly. That is, it appears this intends for the clawback funds to go to the creditor. Once the funds come back to the LLC, though, it seems to me those funds should still need to be disbursed properly in consideration of all creditors with outstanding claims.]
The wrongful acts which will justify clawback (but not veil piercing) are:
(1) Conflicted exchange;
(2) Insolvency distribution; or
(3) Siphoning of funds.
(g) Definitions. — As used in this section:
“Conflicted exchange” means a transfer of money or other property from a limited liability company to a member of the limited liability company (or to any other organization in which the member has a material financial interest) in exchange for services, goods, or other tangible or intangible property of less than reasonable equivalent value.
“Insolvency distribution” means a transfer of money or other property from a limited liability company to a member of that limited liability company (or to any other organization in which the member has a material financial interest), in respect of the member’s ownership interest, that renders the limited liability company insolvent.
“Insolvent” means, with respect to a limited liability company, that the limited liability company is unable to pay its debts in the ordinary course of business. Claims that are unusual in nature or amount, including tort claims in claims for consequential damages, are not to be considered claims in the ordinary course of business for the purposes of this section.
“Siphoning of funds” means whether the manager or majority member has siphoned funds from the limited liability company in violation of the articles of organization, the operating agreement, or this article. [I would have hoped that all avenues to recover for improper distributions would remain. I am okay with listing them, as long as none are excluded by creation of the list.]
That's all for now. This is a pretty big proposal, and it won't surprise me if it passes. If they are committed to it, I sure hope they take the time to get it right.
Tuesday, January 22, 2019
In Business Organizations, I am in the early part of teaching agency and partnership. In my last class, we discussed Cargill, which is a fairly typical case to open agency discussions. I like Cargill, and I think it is a helpful teaching tool, but I think one needs to go beyond the case and facts to give a full picture of agency.
Of note, the case deals only with "actual agency" -- for whatever reason, the plaintiffs did not argue "apparent agency" or estoppel in the alternative. A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285, 290 n.6 (Minn. 1981) (“At trial, plaintiffs sought to establish actual agency by Cargill's course of dealing between 1973 and 1977 rather than 'apparent' agency or agency by estoppel, so that the only issue in this case is one of actual agency. ”). I think this explains a lot about how the case turns out. That is, the court recognized that to find for the farmer, there had to be an actual agency relationship.
I don't love this outcome because one of the hallmarks of an agency relationship is its reciprocal nature. That is, once we find an agency relationship, the principal is bound to the third party and the third party is bound to the principal. In contrast, in a case of estoppel, the principal may be bound (estopped from claiming there is not an agency relationship), but that finding only runs one way. The principal still cannot bind the third party.
This is a problem for me in Cargill. That is, I don't see a scenario where a court would bind the farmers to Cargill on similar facts. (I know I am not the first to make this observation, but it seemed worth exploring a bit.) As such, I don't think it can rightly be deemed an agency relationship.
Assume the facts from the case to show agency, but suppose instead Cargill was suing the farmers because the grain prices had increased dramatically and that the farmers had a contract with Warren (the purported agent) to deliver grain at $5/bushel. However, spot prices were now $15/bushel. Warren had not paid the farmers for a prior shipment and did not have the ability to pay now. If the contract is with Warren, the farmers should be able to now sell that grain in the market and take the extra $10/bushel for themselves. However, if Cargill were really the principal on that contract, Cargill would have a right to buy it at $5/bushel. I just don't see a court making such a ruling on these facts.
For what it's worth, I do think there is an estoppel argument here, and I think the Cargill court had ample facts to support finding Cargill a guarantor through other actions (promises to pay, name on checks, etc.), some of which might support an apparent authority argument, too. But because I don't see this relationship as an agency relationship as a two-way street, I don't think it can be an "actual agency" relationship.
Incidentally, I see this reciprocal nature test as proper for partnerships, too. That is, unless a court, on similar facts, would be willing to find a partnership where it works to the detriment of the plaintiffs, one cannot find a partnership. Think, for example, of another classic case, Martin v. Peyton, 246 N.Y. 213 (N.Y. 1927). There, creditors of the financial firm KNK sued KNK, as well as Peyton, Perkins, and Freeman (PPF) who had loaned KNK money. The claim was that PPF was not a mere lender, but had instead become partners of KNK because of the amount of control and profit sharing included in the loan arrangement. If PPF were deemed partners of KNK, of course, PPF would be liable to the KNK creditors. Here, the court determines that no partnership exists.
While a reasonably close call, I think this is right. I don't think, based on a similar set of facts, that a court would find for PPF if the dispute were such that finding a partnership between PPF and KNK would reduce the amount KNK would pay its investors. If it can't run both ways, the partnership cannot exist. I appreciate that in some cases, there simply is not a good analog to test the reciprocal nature of the relationship. But where it's possible, I think this is a good test to determine whether there really is an agency or partnership relationship or if, instead, what we really have is a sympathetic plaintiff.
Tuesday, January 15, 2019
I am wading back into a jurisdiction case because when it to LLCs (limited liability companies), I need to. A new case from the United States Court of Appeals for the Sixth Circuit showed up on Westlaw. Here's how the analysis section begins:
Jurisdiction in this case is found under the diversity statute 28 U.S.C. § 1332. John Kendle is a citizen of Ohio; defendant WHIG Enterprises, LLC is a Florida corporation with its principal place of business in Mississippi; defendant Rx Pro Mississippi is a Mississippi corporation with its principal place of business in Mississippi; defendant Mitchell Chad Barrett is a citizen of Mississippi; defendant Jason Rutland is a citizen of Mississippi. R. 114 (Second Am. Compl. at ¶¶ 3, 5) (Page ID #981–82). Kendle is seeking damages in excess of $75,000. Id. at ¶¶ 50, 54, 58, 64, 71 (Page ID #992–95). The district court issued an order under Rule 54(b) of the Federal Rules of Civil Procedure that granted final judgment in favor of Mitchell Chad Barrett, and so appellate jurisdiction is proper. R. 170 (Rule 54(b) Order) (Page ID #3021).
Kendle v. Whig Enterprises, LLC, No. 18-3574, 2019 WL 148420, at *3 (6th Cir. Jan. 9, 2019).
No. No. No. An LLC is not a corporation, for starters. And for purposes of diversity jurisdiction, "a limited liability company is a citizen of any state of which a member of the company is a citizen." Rolling Greens MHP, L.P. v. Comcast SCH Holdings L.L.C., 374 F.3d 1020, 1022 (11th Cir. 2004). As such the where the LLC is formed doesn't matter and the LLC's principal place of business doesn't matter. All that matters is the citizenship of each LLC member.
In this case, I can tell from the opinion that Kendle and Rutland are "co-owners" of WHIG Enterprises. The opinion suggests there may be other owners (i.e., members). The opinion refers to the plaintiff suing "WHIG Enterprises, LLC, two of its co-owners, and another affiliated entity." Kendle v. Whig Enterprises, LLC, No. 18-3574, 2019 WL 148420, at *1. The opinion later refers to Rutland as "another WHIG co-owner." If we want to know whether diversity jurisdiction is proper, though, we'll need to know ALL of WHIG's members.
Now, it may well be that there is diversity among the parties, but we don't know, and neither, apparently, does the court. That may not be an issue in this case, but if people start modeling their bases for jurisdiction on the Kendle excerpt above, things could get ugly. The Eleventh Circuit, as noted above. A more recent case further reminds us to check diversity for all members in an LLC. Thermoset Corporation v. Building Materials Corp. of America et al, 2017 WL 816224 (11th Cir., March 2, 2017).
I figured that I should give a shout out to folks getting right, given all my criticism of those getting it wrong. Come, Sixth Circuit, let's get it together.
Tuesday, January 8, 2019
Not for my purposes, anyway. Back in 2016, I made the argument that the IRS should "stop using state-law designations":
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.
We discussed this issue on Saturday at the 2019 AALS Section on Agency, Partnership, LLCs & Unincorporated Associations Program on LLCs. As I taught my first Business Organizations class of the semester, I talked about this and it occurred to me that maybe the better way to think about this is to simply acknowledge that there are no federal entities.
State law is the origin of all entity types (barring, perhaps, a few minor exceptions), and references to "C Corps" and "S Corps" are not really on target. I concede that the IRS does so, which is a challenge, but it's really unnecessary under today's tax code. That is, with check-the-box options, most entity types can choose whatever tax treatment they wish. An LLC can choose to be taxed under subchapter S, for example, though it has to meet certain requirements (e.g., can only have one class of "stock"), but the LLC can file Form 2553 an make an S election.
As such, as I have argued before, I think we should work to keep entity type and tax treatment separate. Thus, for example, we can have an S-taxed LLC (an LLC that made the S election) and a K-taxed LLC (an LLC that made a K election for pass-through taxation). The tax treatment does not "convert" the LLC to a corporation -- or S corp. It simply provides for certain tax treatment. I really think we'd see some doctrinal improvements if we could get more people to use language that makes clear tax treatment and entity type are separate issues, at least in today's word.
Entities are creatures of state law. How the federal or state government tax such entities does not change that reality. It's time we start using more precise language to make that clear.
Tuesday, January 1, 2019
Tuesday, December 18, 2018
Sometimes I think courts are just trolling me (and the rest of us who care about basic entity concepts). The following quotes (and my commentary) are related to the newly issued case, Estes v. Hayden, No. 2017-CA-001882-MR, 2018 WL 6600225, at *1 (Ky. Ct. App. Dec. 14, 2018):
"Estes and Hayden were business partners in several limited liability corporations, one of which was Success Management Team, LLC (hereinafter “Success”)." Maybe they had some corporations and LLCs, but the case only references were to LLCs (limited liability companies).
But wait, it gets worse: "Hayden was a minority shareholder in, and the parties had no operating agreement regarding, Success." Recall that Success is an LLC. There should not be shareholders in an LLC. Members owning membership interests, yes. Shareholders, no.
Apparently, Success was anything but, with Hayden and Estes being sued multiple times related to residential home construction where fraudulent conduct was alleged. Hayden sued Estes to dissolve and wind down all the parties’ business entities claiming a pattern of fraudulent conduct by Estes. Ultimately, the two entered a settlement agreement related to (among other things) back taxes, including an escrow account, which was (naturally) insufficient to cover the tax liability. This case followed, with Estes seeking contribution from Hayden, while Hayden claimed he had been released.
Estes paid the excess tax liability and filed a complaint against Hayden, "arguing Hayden’s breach of the Success partnership agreement and that Estes never agreed to assume one hundred percent of any remaining tax liabilities of Success." Now there is a partnership agreement? Related to the minority shareholder's obligations to an LLC? [Banging head on desk.]
The entity structures to these business arrangements are a mess, and it makes the opinion kind of a mess, though I would suggest the court could have at least tried to straighten it out a bit. It even appears that the court got a little turned around, as it states, "While Estes may have at one time been liable for a portion of Success’s tax liabilities incurred from 2006 to 2010, once the parties signed the Settlement Agreement, his liability ended pursuant to the release provisions contained therein." I think they meant that Hayden may have been liable but no longer was following the release, especially given that the court affirmed the grant of summary judgment to Hayden.
Tuesday, December 11, 2018
Jack Welch, former GE CEO (1981 to 2001) was revered for his ability to maximize shareholder value. Yet in 2009, he explained that shareholder value was
“the dumbest idea in the world. Shareholder value is a result, not a strategy... your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal… Short-term profits should be allied with an increase in the long-term value of a company.”
This runs contrary to how many people think about the role of the CEO and the board of directors. I think it's spot on, and it is a key reason the business judgment rule, and its role in preserving director primacy, is so critical.
Last week, a Wall Street Journal article about Dick's Sporting Goods made the rounds. The article reported:
Ed Stack, the chairman and chief executive of Dick’s Sporting Goods Inc., arrived at work the Monday after a gunman killed 17 people at a school in Parkland, Fla., nearly certain the outdoor retailer should limit sales of some guns.
. . . .
Dick’s Financial Chief Lee Belitsky asked, “So what’s the financial implication here?” according to Mr. Stack. “I basically said, I don’t really care what the financial implication is, but you’re right, we should look.”
Company executives convened the board via teleconference to explain the proposed plan, took some time to reflect, then gathered again a few days later to vote. “It was unanimous that we should do this and stand up and take a stand,” said Mr. Stack, whose family holds a controlling stake in the retailer.
This revelation led many folks to question whether Stack's statement that he did not "really care" about the financial implications was a breach of fiduciary duty. The concern was buoyed by the reality that store sales had dropped about 3% to 4% for the year, and the drop was linked to the decision to limit certain gun sales.
That said, a drop in sales does not mean there was a breach of any duty any more than an increase in sales means no breach occurred. Results may be evidence, but that's all they are. Part of the story. Incidentally, though it is not proof, either way, it is worth noting that Dick's sales dropped, but profits rose after the decision because the company cut costs by replacing some guns with higher-margin items.
It seems like every time a CEO or board issues a decision that is controversial or chooses to say that he or she supports a certain course of action because they think it is the "right thing to do," the questions begin about whether either the duty of care or loyalty has been breached. I maintain that a statement (or series of statements) like that is not sufficient to overcome the business judgment rule to allow a review of the decision.
This is especially true where, like in the Dick's situation, there is evidence that the company deliberated appropriately. The WSJ article noted that company executives called together the board to explain the proposed plan, "took some time to reflect, then gathered again a few days later to vote." The vote was unanimous to end all assault-style weapons sales and to and stop selling guns or ammunition to those under 21 years of age. Interestingly, Walmart Inc. and other retailers followed Dick's lead later that day. If the deliberative process is a concern, it would seem those following Dick's should be more vulnerable to a fiduciary duty/business judgment rule challenge than Dick's.
For what it's worth, I think Dick's or any store deciding NOT to change their sales practice would also be protected by the business judgment rule, just as I think Chick-Fil-A's decision not to open on Sundays should be protected by the business judgment rule (though if it were a Delaware corporation, I am not sure it would be).
This is not to say I don't believe in fiduciary duties. I very much do. I just also believe in a strong business judgment rule, ideally enforced as an abstention doctrine. (I believe in lots of things.)
I need more than a few public statements before I think anyone should be looking behind an entity's decision making. Recent examples raising entity fiduciary duty questions, like Dick's and Nike's Colin Kaepernick ads, have had positive financial outcomes of the entities, but it shouldn't matter. The business judgment rule is there to protect all the decisions of the board that are not the product of fraud, illegality, or self-dealing, not just correct decisions.
Wednesday, December 5, 2018
In this case, Commerce and Industry served the summons on Southern Construction by serving the wife of the manager of Southern Construction. Doc. No. 10. Because Southern Construction is a limited liability corporation, service is proper under Fla. Stat. § 48.062 . . . .
*2 (1) Process against a limited liability company, domestic or foreign, may be served on the registered agent designated by the limited liability company under chapter 605. A person attempting to serve process pursuant to this subsection may serve the process on any employee of the registered agent during the first attempt at service even if the registered agent is a natural person and is temporarily absent from his or her office.
(2) If service cannot be made on a registered agent of the limited liability company because of failure to comply with chapter 605 or because the limited liability company does not have a registered agent, or if its registered agent cannot with reasonable diligence be served, process against the limited liability company, domestic or foreign, may be served:(a) On a member of a member-managed limited liability company;(b) On a manager of a manager-managed limited liability company; or(c) If a member or manager is not available during regular business hours to accept service on behalf of the limited liability company, he, she, or it may designate an employee of the limited liability company to accept such service. After one attempt to serve a member, manager, or designated employee has been made, process may be served on the person in charge of the limited liability company during regular business hours.(3) If, after reasonable diligence, service of process cannot be completed under subsection (1) or subsection (2), service of process may be effected by service upon the Secretary of State as agent of the limited liability company as provided for in s. 48.181.
In the proof of service, the process server attests that he served Kenneth W. Jordan, the manager of Southern Construction, by serving Kimberly Jordan, Kenneth Jordan’s wife, at an address in Midway, Georgia. Doc. No. 10. Neither the process server nor counsel for Commerce and Industry provided any evidence that Southern Construction did not have a registered agent or, if it did, that service could not be made on the registered agent. There is also no evidence that Kimberly Jordan is a member, a manager or an employee of Southern Construction designated to accept service. Finally, there is no evidence regarding the address at which service was made, i.e., at the office of the registered agent, at the office of Southern Construction or at a residence. Therefore, based on the present record, the Court cannot conclude that service of process has been properly perfected.
Service of unincorporated associations is much more complicated. Service is made
Upon an unincorporated association which is subject to suit under a common name, by delivering a copy of the summons and complaint to any officer, director, or governor thereof, or by delivering or mailing in accordance with paragraph (1) above a copy of the summons and complaint to any agent or attorney in fact authorized by appointment or by statute to receive or accept service in its behalf; or, if no such officer, director, governor, or appointed or statutory agent or attorney in fact be found, then by delivering or mailing in accordance with paragraph (1) above a copy of the summons and complaint to any member of such association and publishing notice of the pendency of such action once a week for two successive weeks in the newspaper of general circulation in the county wherein such action is pending. Proof of publication of such notice is made by filing the publisher’s certificate of publication with the court.
Does a manager count as an officer or director? A quick look at cases did not answer that question, but it would seem to me the answer should be "no." Obviously, the easiest way to do complete service would be to serve an LLC's agent or attorney, if either can be found. But if you have to serve a "member," one must deliver the summons and complaint to the member AND "publish notice of the pendency of such action once a week for two successive weeks in the newspaper of general circulation in the county wherein such action is pending." Old school. Anyway, it seems to me that it is high time for West Virginia to specifically recognize LLCs and other entity forms in the Rules of Civil Procedure.
Tuesday, November 27, 2018
Last week I posted Can LLC Members Be Employees? It Depends (Because of Course It Does), where I concluded that "as far as I am concerned, LLC members can also be LLCs employees, even though the general answer is that they are not. " I thought I would follow up today with an example of an LLC member who is also an employee.
I am not teaching Business Associations until next semester, but it galls me a little that I did not note this case last week, as it is a case that I teach as part of the section on fiduciary duties in Delaware.
Genitrix, LLC, is a Delaware limited liability company formed to develop and market biomedical technology. Dr. Segal founded the Company in 1996 following his postdoctoral fellowship at the Whitehead Institute for Biomedical Research. Originally formed as a Maryland limited liability company, Genitrix was moved in 1997 to Delaware at the behest of Dr. H. Fisk Johnson, who invested heavily.
Equity in Genitrix is divided into three classes of membership. In exchange for the patent rights he obtained from the Whitehead Institute, Segal's capital account was credited with $500,000. This allowed him to retain approximately 55% of the Class A membership interest. . . .Under the [LLC] Agreement, the Board of Member Representatives (the “Board”) manages the business and affairs of the Company. As originally contemplated by the Agreement, the Board consisted of four members: two of whom were appointed by Johnson and two of whom were appointed by Segal. In early 2007, however, the balance of power seemingly shifted. . . .Dr. Andrew Segal, fresh out of residency training, worked for the Whitehead Institute for Biomedical Research . . . [and when he] left the Whitehead Institute and obtained a license to certain patent rights related to his research.
With these patent rights in hand, Dr. Segal formed Genitrix. Intellectual property rights alone, however, could not fund the research, testing, and trials necessary to bring Dr. Segal's ideas to some sort of profitable fruition. Consequently, Segal sought and obtained capital for the Company. Originally, Segal served as both President and Chief Executive Officer, and the terms of his employment were governed by contract (the “Segal Employment Agreement”). Under the Segal Employment Agreement, any intellectual property rights developed by Dr. Segal during his tenure with Genitrix would be assigned to the Company.
Fisk Ventures, LLC v. Segal, No. CIV.A. 3017-CC, 2008 WL 1961156, at *2 (Del. Ch. May 7, 2008) (emphasis added) (footnotes omitted).
Co-blogger Joan Heminway noted in a comment to last week's post that what it means to be an employee can vary, based on statutory and other conditions, which is certainly true. I stand by my prior conclusion that it depends on the case whether a particular member of an LLC is an employee, and even that can vary based on context. Thus, LLC members are not inherently employees, and perhaps most of the time they are not, but it's also true that LLC members can be employees.
Finally, as to the Fisk Ventures case, in case you're curious, the short of it is that Fisk decided not to provide additional financing to Genitirx, and Segal sued claimed that not doing so breached certain fiduciary duties under the LLC agreement and further various acts "tortiously interfered with the Segal Employment Agreement." Ultimately, Chancellor Chandler determined that there was no duty breached, the obligation of good faith and fair dealing did not block certain members from exercising express contractual rights, and the agreement's clause disclaming any fiduciary duties was valid.