Tuesday, August 6, 2019

LLC Mistakes Closer Than Kevin Bacon

I decided to track the path of "limited liability corporation" (which should be "limited liability company" when referring to an LLC) in a recent court case.  It's my thing.  Anyway, this gem popped up today: 

This Court previously held “although wage, investment, and other economic losses may flow to an individual from discriminatory harm suffered by a corporation, those injuries are not ‘separate and distinct’ from those suffered by that corporation.” Club Xtreme, Inc. v. City of Wayne, 2010 WL 1626415 at *5 (E.D. Mich. Apr. 21, 2010). Under Michigan law, rules with respect to corporations apply equally to limited liability corporations. Hills and Dales General Hosp. v. Pantig, 295 Mich.App. 14, 21 (2011). As such, a limited liability company is its own “person,” separate and distinct from its owners. Id. Here, Darakjian is separate and distinct from his LLC, TIR.

Darakjian v. City of Birmingham, 2019 WL 3412883 (E.D.Mich.) at * 4. 
 
First, "Club Xtreme?"  Yeah, that's my Michigan. 
 

Second, "Under Michigan law, rules with respect to corporations apply equally to limited liability corporations." True as to LLCs, but, um, no, LLCs are not corporations. So where did that come from? 

Well, this part of "bad law" originates here, as noted: "The rules respecting the corporate form apply equally to limited liability corporations." Hills & Dales Gen. Hosp. v. Pantig, 295 Mich. App. 14, 21, 812 N.W.2d 793, 797 (2011). Except that, and good on them, the case Hills and Dales cites is Florence Cement Co. v. Vettraino, 292 Mich. App. 461, 477, 807 N.W.2d 917, 926 (2011), which only talks about a "limited liability company." This one is an easy Kevin Bacon game. It's just two degrees back.  I suppose that's good, right? Still ...

Do these mistakes, in this instance, impact the outcome? No. But that's not the point. There are cases where LLC versus corporation does matter. And these mistakes will provide citations for incorrect outcomes.  

August 6, 2019 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Wednesday, July 24, 2019

LLCs (Still Not Corporations) Win Some, Lose Some in New Opinion

In 2010, an Illinois court reviewed Delaware business law making the following observations:

With respect to a limited liability corporation, Delaware law states that “[u]nless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members....” 6 Del.C. § 18–402. Thus, pursuant to Delaware law, directors are generally provided with authority for managing the corporation and members are generally provided with authority for managing the limited liability company. The bankruptcy court therefore properly found that a member of a LLC would be an analogous position to a director of a corporation under Delaware law.

Longview Aluminum, L.L.C. v. Brandt, 431 B.R. 193, 197 (N.D. Ill. 2010), aff'd sub nom. In re Longview Aluminum, L.L.C., 657 F.3d 507 (7th Cir. 2011).

Well, initially, it must be noted that an LLC is not a corporation at all.  As the quoted Delaware law observes, it is a “limited liability company.” Corporations and LLCs are distinct entities. 

I’ll also take issue with adopting the bankruptcy court’s finding “that a member of an LLC would be an analogous position to a director of a corporation under Delaware law.”  I will concede that a member of an LLCmaybe an analogous position to a director of a corporation under Delaware law, but that is not inherently true. 

The Longview Aluminumcourt had determined that, “under Delaware law, a corporation generally must ‘be managed by or under the direction of a board of directors . . . .’” 8 Del. Code § 141. While that’s technically accurate, it understates that general nature of Delaware directors. Note that the statue is mandatory in nature (“shall”), and then provides limited changes:

The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.

8 Del. Code § 141(a).

Remember, the Longview Aluminumcourt stated that, “[w]ith respect to a limited liability corporation, Delaware law states that ‘[u]nless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members....’ 6 Del.C. § 18–402.”  Id.

But Delaware LLC law provides:

“Unless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members in proportion to the then current percentage or other interest of members in the profits of the limited liability company owned by all of the members, the decision of members owning more than 50 percent of the said percentage or other interest in the profits controlling . . . .” 

6 Del. Code § 18-402.

That’s different in structure than directors. Directors act as a body, usually with one vote per director. This default provision provides for a very different structure, providing that one member with over 50% of the interests is controlling.  That’s not like a board at all.  And furthermore, those members  in charge of the entity may not have any fiduciary duties to the LLC. The Delaware LLC Act states:

“To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement . . . .” 6 Del. C. § 18-1101(c).

Corporate directors have some version of fiduciary duties. Again, a notable difference.  It appears that the Longview Aluminumcourt (affirming the bankruptcy court) may have been right to extend the corporate director concept to the LLC managers in that case because of the structure of the LLC’s operating agreement.  But the court went on to imply that a member of a LLC is“an analogous position to a director of a corporation under Delaware law.” That very much overstates things.

Why discuss this 2010-11 case at length now? Because this section was cited last week:

“[I]n referencing a director, Section 101(31)(B) was intended to refer to the party that “managed” the debtor corporation.” Longview Aluminum, L.L.C. v. Brandt, 431 B.R. 193, 197 (N.D. Ill. 2010) (citing 11 U.S.C. § 101(31)(B)). “With respect to a limited liability corporation, Delaware law states that ‘[u]nless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members ....” Id. (quoting 6 Del.C. § 18–402).

In re Licking River Mining, LLC, No. 14-10201, 2019 WL 2295680, at *41 (Bankr. E.D. Ky. July 19, 2019), as amended (July 19, 2019).

Fortunately, other than failing to correct the mistake of calling an LLC a corporation, the Licking River Miningseems to have gotten the outcome right.  The court determined that a 25% member interest lacked control because all LLC “decisions were to be made either by a majority of the LLC interests or by the entity's managing member.”Id.Good call, and hopefully this case will clarify (and correct) any negative implications from the Longview Aluminum case.  But even if it does, it gives longer life to an incorrect reference to LLCs and increases the likelihood it will be cited repeatedly. 

Win some, lose some, I guess.

 



 

July 24, 2019 in Corporations, Delaware, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Tuesday, July 9, 2019

Tennessee Court Subtly Affirms that LLCs Are Not Corporations

A recent Tennessee court decision subtly notes that limited liability companies (LLCs) are not, in fact corporations. In a recent Tennessee federal court opinion, Judge Richardson twice notes the incorrect listing of an LLC as a "limited liability corporation."  

First, the opinion states:

The [Second Amended Complaint] alleges that Defendant Evans is a resident of Tennessee, Defendant #AE20, LLC is a California limited liability company, and Defendant Gore Capital, LLC is a Delaware limited liability “corporation.”3

Gore Capital is in fact a limited liability company.

FERNANDO CAMPS, Pl., v. GORE CAPITAL, LLC, KARL JAMES, ANGELA EVANS, and #AE20, LLC, Defendants., 3:17-CV-1039, 2019 WL 2763902, at *1 and n.3 (M.D. Tenn. July 2, 2019) (emphasis in original). 

Judge Richardson later notes, in footnote 11:

Plaintiff states that he was sent documents that listed Gore’s (not #AE20’s) principal place of business as being in Chattanooga, Tennessee, although the SAC lists Gore as a “Delaware limited liability corporation (sic)[.]”
Id. 2019 WL 2763902, at *6 n.11 (M.D. Tenn. July 2, 2019). 
 
Given all the times I have complained about courts not correcting such mistakes, I figured I should give this opinion a well-deserved shout out for getting this right.  Thank you. 

July 9, 2019 in Business Associations, Corporations, Current Affairs, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (1)

Tuesday, July 2, 2019

If Sole Ownership of an Entity Means Alter Ego, then Veil Piercing Will Be Inevitable

Veil piercing continues its randomness. Back in April, in Hawai'i Supreme Court decision, Calipjo v. Purdy, 144 Hawai'i 266, 439 P.3d 218 (2019), the court determined that there was evidence to support a trial court jury's decision to pierce the veil of an multiple entities and hold the sole member/shareholder of the entities liable.  (An appellate court had determined that there was insufficient evidence to support veil piercing.)

The decision may be sound, but the evidence for the decision makes the outcome seemingly inevitable. In determining there was evidence to support the jury's decision, the court notes the plaintiff's allegations were that "sole ownership and control is one of many factors that can establish alter ego and, therefore, evidence of Purdy’s ownership and control was pertinent to this claim."  The court then explains, 

In this case, the jury was presented with evidence that Purdy exercised exclusive ownership and control over Regal Corp. and Regal LLC. Purdy testified that he was the sole shareholder, director, and officer of Regal Corp. and the sole member and manager of Regal LLC. This court has held that “sole ownership of all of the stock in a corporation by one individual” is one relevant factor to determine alter ego. Id. (quoting Associated Vendors, 26 Cal. Rptr. at 814). Purdy’s testimony supports the jury’s determination that Purdy exercised exclusive ownership and control over Regal Corp. and Regal LLC; it constitutes evidence that Purdy was the sole owner and manager of either company.

Note, though, that the plaintiff claimed that "sole ownership and control ... can establish alter ego."  The court more accurately  states that ownership and control are a factor.  They are not dispositive or else limited liability for a single-member LLC, corporation, or other limited liability entity would be a fiction.  The jury instructions, though, seem to eliminate the possibility that an entity and a single shareholder or member could be separate.  The jury was told: 

You should consider the following facts in determining whether or not to disregard the legal entity of Regal Capital Corporation and return a verdict in favor of plaintiff against Defendant Jack Purdy, as an individual.

One, whether or not defendant Jack Purdy owned all or substantially all the stock in Regal Capital Corporation; two, whether or not Jack Purdy exercised discretion and control over the management of Defendant Regal Capital Corporation; three, whether or not Defendant Jack Purdy directly or indirectly furnished all or substantially all of the financial investment in Defendant Regal Capital Corporation; four, whether or not Regal Capital Corporation was adequately financed either originally or subsequently for the business in which it was to engage.

Five, whether or not there was actual participation in the affairs of Regal Capital Corporation by its stockholders and whether stock was issued to them. Six, whether or not Regal Capital Corporation observed the [formalities] of doing business as a corporation such as the holding of regular meetings, the issuance of stock, the filing of necessary reports and similar matters. Seven, whether or not Defendant Regal Capital Corporation [dealt] exclusively with Defendant Jack Purdy, directly or indirectly in the real estate sales development activities in this case. Eight, whether or not Defendant Regal Capital Corporation existed merely to do a part of business of Defendant Jack Purdy.

So, here was have an undercapitalization factor, and that could be separate from the shareholder/member, and we have the traditional "corporate formalities" test, but even there, these instructions imply that the entity must have additional shareholders to be "real." For numbers one, two, three, five, seven, and eight, a jury would almost always have to find that those factors would support veil piercing for any sole shareholder corporation or single-member LLC.  I don't think that's either the intent or the substance of current law in most jurisdictions, though the Hawai'i Supreme Court clearly disagrees with me. 

In this case, there seems to be at least some evidence of fraud, and I'm more than willing to defer to a jury if they determined that the defendant had sole control of his entities and he used those entities to commit fraud.  I just object to court's apparent comfort level with the idea having sole control of an entity or entities, and exercising that control, on its own suggests something nefarious.  

I know people use LLCs and corporations to engage in all sorts of bad behavior, and I'd like to see that punished more often than it seems to be.  But relaxing the application of legal standards to get there is not a good way to do it.  If the law should be changed, then legislatures should get to work on that.  If we think single-owner entities are a bad idea (I don't think they are inherently so), let's deal with that through legislation so that at least everyone knows the rules. 

Ultimately, it's not as though current veil piercing jurisprudence has been clear or sound or predictable. There has always been a random nature to it. However, for single-member entities, if the current trends continue, the randomness of veil piercing will not attach not to the outcome of a lawsuit -- it will attach to whether or not someone brings suit at all.  

July 2, 2019 in Contracts, Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Wednesday, June 5, 2019

Call for Papers: AALS Section on Agency, Partnership, LLCs, and Unincorporated Entities

The AALS Section on Agency, Partnership, LLCs, and Unincorporated Entities is pleased to announce a Call for Papers from which up to three presenters will be selected for the section's program to be held during the AALS 2020 Annual Meeting in Washington, DC. The program will explore decisions and strategies for choice of business form. As unincorporated business forms have matured and those who use them have learned their advantages and disadvantages, key decisions about choice of form have changed in important and interesting ways. In addition, accelerating advances in technology promise to play surprising roles in the formation and operation of unincorporated firms. 

Submission Information: 

Please submit an abstract or draft of an unpublished paper to Kelli Alces Williams at kalces@law.fsu.edu before August 5, 2019.  Please remove the author’s name and identifying information from the submission. Please include the author’s name and contact information in the submission email. 

Papers will be selected after review by members of the Executive Committee of the Section. Authors of selected papers will be notified by August 30, 2019. The Call for Paper presenters will be responsible for paying their registration fee, hotel, and travel expenses. 

Any inquiries about the Call for Papers should be submitted to: Kelli Alces Williams, Florida State University College of Law, kalces@law.fsu.edu or (850) 644.5079. 

June 5, 2019 in Call for Papers, Joshua P. Fershee, LLCs, Unincorporated Entities | Permalink | Comments (0)

Tuesday, May 28, 2019

A Summer of Change and a Grading Update

I'll start with the exciting news that my Business Organizations students were 48 for 48 in recognizing that LLCs are not corporations.  In fact, a number of my students specifically referred to "LLCs (NOT corporations) ..." in their exams. It's nice to be heard.  I believe that's at least three years in a row without such a mistake, and maybe longer. I have evidence, at least on this issue, repetition is effective.  

As for this summer, it is going to be an interesting one.  I have now finished grading my last classes as a part of West Virginia Univerity College of Law. As some readers may know, I have accepted the opportunity to join Creighton University School of Law as the next dean.  (For those wondering, my wife Kendra will be joining the Creighton Law faculty, as well, where, as was true at WVU, she will teach family law as a full professor.) After Kendra's run for Congress ended, she told me it was "my turn," and that I should pursue my goals.  I don't think either of us expected such a big change so quickly.  

Long before all of this became a reality, and after the campaign, we planned a family vacation to Europe for a month, so we'll be doing that with the kids -- Bulgaria, Germany, Italy, and Greece.  Buying and selling a house, moving across the country, and starting new jobs (and new schools for the kids) will all be part of the mix, too, but hey, what's life without some adventure?  

The fact that we're willing to leave should tell people just how much we believe in this opportunity. We have an absolutely incredible life already, with dear friends, amazing students, and a community of supportive and caring people.  (Not to mention an absolutely gorgeous location.) And yet we're moving.  I have high hopes and high expectations -- both for me and for my new institution.  It's worth stating clearly that we have loved West Virginia and we have had incredible opportunities to grow both personally and professionally. I want people to know that we are not so much leaving West Virginia as we are going to Creighton, a possibility I wouldn't have without my time here at WVU.

I very much appreciate that, and because of all we have learned and experienced, new adventures await.  

May 28, 2019 in Joshua P. Fershee, Law School, LLCs, Teaching | Permalink | Comments (2)

Wednesday, May 22, 2019

Exam Grading -- No LLCs as Corporations (So Far)

It has been kind of a unique end of the semester, and I am working feverously to get through my Business Organizations exams. I'm getting there.  So far, I have had zero exams reference a "limited liability corporation."  If this holds, it will be at least three years in a row.  

I have had a couple of folks refer to LLC veil piercing as piercing the "corporate" veil (another no-no), and I did have some other "corporate" references to LLCs (e.g., "an LLC's corporate formalities"), so we're not all the way there. But so far, I am seeing improvement, and I appreciate the effort.  

Here's hoping for 48 of 48 describing the LLC (as an entity) correctly.  I hope the rest of my colleagues are holding up well here in the home stretch. Good luck to all. 

May 22, 2019 in Business Associations, Corporations, LLCs, Teaching | Permalink | Comments (0)

Tuesday, May 7, 2019

It Is Best to Be Precise When Asking Others to Be Precise (LLC edition)

A recent report and recommendation from a U.S. magistrate recommends that the referring court find that a plaintiff did not provide the facts needed to support taking diversity jurisdiction.  The magistrate is correct, but the recommendation is a little ironic in that it seems to be chiding the plaintiff for a lack of precision, and well, this: 

Here, Peeples' amended complaint contains the bare assertions that the address for Xlibris Publishing is in Bloomington, Indiana, while his address is in Mobile, Alabama. The bare allegation respecting the Defendant is insufficient as it does not identify whether Xlibris is a corporation or, instead, an unincorporated entity such as a limited liability corporation. Moreover, if Xlibris is a corporation, the complaint does not delineate its state(s) of incorporation and the state where it has its principal place of business. See Flintlock Constr. Servs., LLC v. Well-Come Holdings, LLC, 710 F.3d 1221, 1224 (11th Cir. 2013) (“A corporation is considered a citizen of every state in which it has been incorporated and where it has its principal place of business.”). And, if an unincorporated entity such as a limited liability corporation,3 the amended complaint does not allege every state in which each of its members are citizens. See, e.g., Lewis v. Seneff, supra, at *3 (Without the information concerning the citizenship of each limited liability company's membership, Plaintiffs have not shown that this Court has subject matter jurisdiction.”).

3 It appears to the undersigned that Xlibris Publishing is a limitedliability corporation. See www.xlibris.com (last visited, April 4, 2019, at 3:30 p.m.) (Xlibris website shows that it is an LLC).

MARIO ANDJUAN PEEPLES, Pl., v. XLIBRIS PUBLISHING, Def.., CA 19-0070-JB-C, 2019 WL 1983817, at *5 (S.D. Ala. Apr. 8, 2019), report and recommendation adopted sub nom. Peeples v. Xlibris Publg., CV 19-0070-JB-C, 2019 WL 1983055 (S.D. Ala. May 3, 2019).
 
In two spots in the above excerpt, the recommendation refers to a "limited liability corporation" when it clearly means "limited liability company" (the latter being used in other sentences in the excerpt).  
 
As I said, the analysis seems correct, despite the incorrect language. Mistakes happen, but still, it shouldn't be that hard to get it right (and the incorrect term showed up twice!).  As evidence, I haven't seen "limited liability corporation" in more than two years on one of my Business Organizations exams, and I haven't seen it yet this year, either.
 
This mission continues.  
 

May 7, 2019 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Thursday, May 2, 2019

The Department of Health and Human Services Is Trying to Make Me Sick

Okay, not really. But my daily Westlaw search for "limited liability corporation" recently started delivering contract award announcements from the Department of Health and Human Services (DHHS) related to contract awards. DHHS reconds many "business types" for their records, such as "Minority Owned Business" and "For Profit Organization. And now, apparently, "limited liability coroporation" is one of them.  ARRRRRGHH! LLCs are "limited liability companies" and are not corporations.  An internet search shows that there are at least 78 of these DHHS designations out there (and I'll wager there are more).  

Following is an excerpt of one such announcement.  You'll note that, according to the announcement, Seba Professional Services LLC is both a "Partnership or Limited Liability Partnership" and a "Limited Liability Corporation."  Sigh.  Really, they're making my stomach hurt: 

Department of Health and Human Services awarded contract of IGF::CT::IGF PATIENT MESSENGER AND TRANSPORT SERVICES to SEBA PROFESSIONAL SERVICES LLC

Washington: This contract was awarded to seba professional services llc with a potential award amount of $6,117,056. Of this amount, 100% ($6,117,056) has been obligated.
 
Awarding Agency:
Department of Health and Human Services
 
. . . .
 
Recipient:
SEBA PROFESSIONAL SERVICES LLC
. . . .
 
Business Types
Woman Owned Business
Women Owned Small Business
Economically Disadvantaged Women Owned Small Business
Minority Owned Business
Black American Owned Business
Partnership or Limited Liability Partnership
Limited Liability Corporation
For Profit Organization
DoT Certified Disadvantaged Business Enterprise
Self-Certified Small Disadvantaged Business
8a Program Participant
 
 

May 2, 2019 in Corporations, Current Affairs, Joshua P. Fershee, LLCs | Permalink | Comments (0)

Tuesday, April 9, 2019

Court Says No Successor Liability Attaches When There Was No Entity

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). 

 
 
Apparently, the HSR School trained nurse anesthetists was owned and run by AANH a Connecticut “professional corporation.”  The plaintiff was in the HSR School for about six months before she was dismissed, she claimed, because of " gender discrimination and retaliation for reporting a staff member’s inappropriate sexual conduct." Id. The plaintiff sought to join YNHH because that entity took over running an anesthesia school that had been, in some form, the HSR school.  
 
The successor liability part is rather interesting, though largely devoid of facts from the transaction.  The court ultimately concludes that even though YNHH resumed a similar school, it was not a successor entity and could not be joined.  
 
A challenging part about the case is that entities are described, but often not clearly and with conflicting entity-type language.  For example, although AANH was a "professional corporation," the court explained that " [t]he AANH anesthesiologists, who were also partners in AANH, were responsible for deciding how the HSR School would operate." Id. at *2. One of the doctors was also referred to as an "ownership partner in AANH." Id. at *3. I suspect that anesthesiologists, like lawyers, traditionally created firms that were partnerships, so the principals often call themselves "partners," regardless of their actual entity type. Still, it would be nice for courts to clarify the actual roles of those involved.  
 
Furthermore, in describing the HSR School, the court states, 
 
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.
Id. at *6. Ultimately, it appears the court has determined this was some version of an asset purchase  (even though neither party provided a copy of the asset purchase agreement), so the liability stayed with AANH.  This appears to be correct, but it's hard to know without that document.
 
And it is hard to know what the obligations are when additional relevant possible parties are.  The court further determined that the potential successor entities, "YNHH and Yale University are two separate corporate entities with separate governance structures."  Except there is no statement as to what types of entities they are, where they were formed, or anything else other than a reference to testimony from a witness who said YNHH was a separate entity from Yale University.  It would seem to me that some of the related documentation would be valuable, but the court has spoken.  
 
And fair enough. But I have to correct this: "The HSR School was not a limited liability corporation company (“LLC”), private professional corporation (“P.C.”), or other legal entity."  

April 9, 2019 in Business Associations, Corporations, Joshua P. Fershee, Lawyering, LLCs, M&A, Partnership | Permalink | Comments (0)

Tuesday, April 2, 2019

Still Howling at the Moon: Not All Businesses Are Corporations!

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.
CONESCO INDUSTRIES, LTD. d/b/a DOKA USA, LTD., Pl., v. ARNOLD DEVELOPMENT GROUP, LLC, Def.., 4:18-CV-02851, 2019 WL 1430112, at *1 (S.D. Tex. Mar. 29, 2019) (emphasis added). 
 
Everybody who reads this blog knew that was coming because I am writing about the case. Arnold Development Group, LLC, is not a limited liability corporation. It is a limited liability company.
 
So, fine, this kind of error is not remarkable, given my numerous posts on the subject. But the opinion, in the discussion section, follows with this gem: 
In the case before the Court, the defendant is a Missouri corporation and the plaintiff is a New Jersey corporation
Id. at *2. Nuh-uh.  The opinion had already established that we're dealing with a Missouri LLC and New Jersey limited partnership. Neither entity is a corporation.  
 
Fortunately, entity status here does not seem to have any clear impact on the personal jurisdiction analysis (this about specific jurisdiction), but still. The case was dismissed without prejudice, which means at least some of this language could come to bear in future versions of the litigation.  Here's hoping that the parties, and the next reviewing court (should there be one), are a little more careful with describing the entity types.  

April 2, 2019 in Corporations, Joshua P. Fershee, Lawyering, LLCs, Partnership | Permalink | Comments (0)

Wednesday, March 20, 2019

Clue, LLC Edition: This Time, the Judge (or the Judge's Clerk) Did It

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.

Benavidez v. Greenwich Hotel LP, 3:16-CV-191 (VAB), 2019 WL 1230357, at *1 (D. Conn. Mar. 15, 2019). 
 
Once more, for the people in back: LLCs are "limited liability companies," not "limited liability corporations."As such, LLCs are not "incorporated." LLCs are formed or organized. In addition, corporations are entities that provide shareholders limited liability, but they are generally not referred to as "limited liability corporations" because they might be confused with a separate and distinct entity type, the LLC.  
 
Whenever I read a case with this kind of language, I wonder how it happened.  Sometimes, like today, I go to the docket (thanks, Bloomberg Law) to see if the source of the wrongdoing (evil doing) was the party/lawyer or the judge/judge's clerk.  This time, it's pretty clear the lawyer got it right.  The case made it easy, as the ruling cited to the Answer to First Amended Complaint, which I pulled.  Here's how the lawyer's answer framed these "facts": 

"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. 

March 20, 2019 in Corporations, Joshua P. Fershee, Lawyering, LLCs, Partnership | Permalink | Comments (0)

Tuesday, March 12, 2019

LLCs Are Not Corporations, Spring Break Edition

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.[1]; [12]. Under Illinois law, service on a limited liability company is governed by section 1–50 of the Limited Liability Company Act. 805 ILCS 180/1–50John 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).

The court ultimately dismisses the claim without prejudice, which seems proper.  But the rest of this? Sigh. If you need me, I’ll be the one in back banging his head on the table. image from media.giphy.com

March 12, 2019 in Agency, Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Tuesday, March 5, 2019

Quick Take on Polsky's Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups

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.

March 5, 2019 in Corporate Finance, Corporate Governance, Corporations, Joshua P. Fershee, LLCs, Partnership, Unincorporated Entities, Venture Capital | Permalink | Comments (0)

Tuesday, February 26, 2019

Can You Exclude Experts In Criminal Cases Because They Are "Partners" in the Same LLC?

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.

Here's where the business law part comes in: 

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.

Commonwealth v. Baxter, 94 Mass. App. Ct. 587, 116 N.E.3d 54, 56 (2018) (emphasis added).  A substitute expert was substituted for Dr. Joss, and that expert determined that defendant was not sexually dangerous, and the Commonwealth appealed. 
 
In addition to the obvious error of calling an LLC a corporation (this is an error was in defendants allegations) and LLC members "partners", there is more here.  
 
The court noted that the expert reported was not admitted in the lower court "based on 'the appearance of an inappropriate and avoidable conflict,'” stating further the lower court judge even stated expressly, "This isn't about actual bias."  The court then states that "where a party seeks to disqualify an attorney for a conflict of interest, the mere appearance of impropriety without attendant ethical violations is insufficient to support an order of disqualification." The defendant was arguing that the "partnership" (meaning membership in the LLC) worked to incentivize Dr. Joss to have the same conclusion as Dr. Schaefer so there would be no "public perception" that Dr. Schaefer was “proven wrong.” Id.
 
The court then explains that this is not a situation where the "reliability or validity" of the expert's methods or experience were in question. As such, "In the absence of evidence suggesting that the reliability of the witness's testimony is in doubt or that the witness is under an actual conflict of interest, the remedy for the defendant's concerns is in forceful cross-examination and argument, not in exclusion." Id. at 59. 

This is interesting to me.  It seems to me this is not like traditional attorney conflicts, where we want to impute knowledge of one attorney to another in the same firm because the knowledge of the first attorney could harm the client of the second.  This case is more analogous to getting a second opinion from a doctor in the same practice (or maybe network). It's possible that the second doctor could be influenced by the first, but it's not clearly the case. 
 
That said, I think there is something to the idea that members of a firm might have a bias in favor of the other members of the firm. But I appreciate the court's point that it needs to be more than a mere association of the doctors.  The fiduciary duty claim here fails, in my view, without more because there is no showing that the firm benefits from a particular outcome. That is, in any given case, multiple qualified experts can come to different conclusions (as this case makes clear) and that's plainly acceptable.  
 
Separately, this case also underscores how close a call such things are. Various experts came to different conclusions, and to some degree, at least in this case, the luck of the draw (of experts) is outcome determinative for both the Commonwealth and the defendant. I am sure there are cases where that's less true, in favor of either side, but I suspect it's close a lot of the time.  
 
Ultimately, this seems like the court got the rule right for future cases, though I am also not entirely clear why the order of discharge cannot stand. That is, it seems to me that just because the lower court ordered another expert review, there is no showing that the replacement expert was somehow not qualified or proper in their report. At least to the extent the standard was unclear, I might have been inclined to let the prior decision stand because I'd apply the same standard of review to all the experts in the case before excluding their work.  Perhaps the reviewing court was concerned that the lower court was expert shopping or something similar, but that's not clear.  Regardless, it's usually interesting when entity law works its way into criminal law. 


 

February 26, 2019 in Corporations, Joshua P. Fershee, LLCs, Partnership | Permalink | Comments (0)

Tuesday, February 19, 2019

New Paper: Business Entities as Skeleton Keys

Christopher G. Bradley at University of Kentucky College of Law has posted his paper, Business Entities as Skeleton Keys.  The paper was also selected for the 2019 AALS Section on Agency, Partnership, LLCs and Unincorporated Associations program, Respecting the Entity: The LLC Grows Up.  

Chris notes the use of business entities to accomplish goals not attainable previously and the use of entities "to accomplish customized transactions and evade legal restrictions that would otherwise prevent them."  His observations and insights are good ones, and his paper is definitely worth the read.  I can't help but think that some of this is occurring more because of an increasing comfort with entities and a willingness to engage in creative transactions. We're seeing in beyond the use of entities, too, with the rise of derivatives over the last 20 or so years, not to mention cryptocurrencies.  Anyway,  it's a good paper and I recommend it. 

Here's the abstract:

This Article identifies the increasingly important phenomenon of what I term “skeleton key business entities” and discusses the ramifications of their rise. Modern business entities, such as LLCs, are increasingly created and deployed to accomplish customized transactions and evade legal restrictions that would otherwise prevent them. Rather than acting as traditional businesses, such entities are tools, or “skeleton keys,” used to open “locked doors” presented by existing bodies of law, including contract, property, bankruptcy, copyright, tax, national security, and even election law.

The Article centers on the example of the “Artist’s Contract,” a fascinating 1971 project, in which artists sought to retain rights in artworks they sold—to obtain a percentage of future appreciation in value, to exhibit the work upon request, and so on. As prior scholarship has noted, the transaction contemplated by the Artist’s Contract could not have been accomplished in regular contract form due to rules concerning privity, servitudes on chattels, and the first sale doctrine, among other things. But this no longer remains true. The emergence of modern business entity law provides the tools—i.e., skeleton key business entities—to “solve” all of these legal problems and allow for bespoke transactions such as those desired by the artists.

The rise of skeleton key business entities may unsettle numerous other bodies of law. They may bring efficiencies but may undermine important policies. After providing a range of examples, I suggest that scholars—including those outside the business and commercial law realm—should turn renewed attention to the remarkable capacities of these flexible, inexpensive, and surprisingly potent transactional tools. We should consider if it makes sense to force parties pursuing newly enabled forms of commerce to bear the costs of filtering transactions through business entities; or alternatively, which traditional doctrines should bind modern entities just as they bind parties outside of those forms.

February 19, 2019 in Contracts, Corporations, Joshua P. Fershee, LLCs, Partnership, Unincorporated Entities, Writing | Permalink | Comments (0)

Tuesday, February 12, 2019

Vague Operating Agreement or Not, LLCs are Not Limited Partnerships or Corporations

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).
CCNO McDonough 16, LLC v. R4 MCNO Acquisition, LLC, 2018-0490 (La. App. 4 Cir. 11/14/18), 259 So. 3d 1077, 1079.  One thing not clear from the case is the CCNO is a Louisiana LLC, which I was able to find out via a Louisiana commercial entity search. Louisiana LLC law, by default, provides that members manage the business unless the operating agreement says otherwise.  The operating agreement appears to confirm the members as managers. My read of this provision would be that this provision makes management subject to a vote. That is, I read "management of the Company is vested in the Members in proportion to their initial Capital Contributions" to mean management is decided by a vote in proportion to capital contributions.  It is not intended to mean, I don't think, that actual management is divided by voting rights (e.g., that Member A with 60% voting interest makes 60% of the decisions and Member B with 40% makes 40% of the decisions). If management is by vote, it would appear that CCNO, with at least 60% of the voting interest, could proceed to settlelment without Riverside, LLC. 
 
However, the opinion goes on to explain:
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.
CCNO McDonough 16, LLC v. R4 MCNO Acquisition, LLC, 2018-0490 (La. App. 4 Cir. 11/14/18), 259 So. 3d 1077, 1079–80.
 
Though this lacks some context, it appears that the court is saying that in defining "Majority in Interest," the operating agreement was telling us what vote was needed to "manage" the LLC.  That might make sense, in that initially the agreement gave CCNO the power to manage because it had more than 50% of the voting interest. Then, apparently, there was an amendment to make a majority vote 60%+1, if properly executed, would have required Riverside's consent to settle. However, the operating agreement also required the mortgage lien beneficiary to approve any amendment, which was not apparently done.  
 
This all seems like it is likely the right outcome, but it sure is hard to piece together. Perhaps all LLC cases should require the court to attach the operating agreement to the opinion. After all, LLC decisions are largely driven by the operating agreement, so it would be helpful for all of us trying to learn from the case to have the full context.  

Two closing thoughts:

  1. Jack Hammer as an LLC member of a construction-focused entity sounds like one of my exam characters. Awesome. 
  2. 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.)
  3. 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. 

February 12, 2019 in Corporations, Joshua P. Fershee, Litigation, LLCs, Management | Permalink | Comments (0)

Wednesday, February 6, 2019

Entity Lesson: Be Explicit When Changing Default Voting Rules

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.  

February 6, 2019 in Joshua P. Fershee, LLCs, Partnership | Permalink | Comments (0)

Tuesday, January 29, 2019

WV Proposal to Eliminate LLC Veil Piercing: Reasonable Concept, Needs A Lot of Work

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 solely by 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.]

Next, 

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. 

January 29, 2019 in Joshua P. Fershee, Legislation, LLCs | Permalink | Comments (5)

Tuesday, January 15, 2019

Sixth Circuit, Why Can't You Be More Like Your Sister, Eleventh Circuit? #LLCs

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. 

January 15, 2019 in Corporations, Current Affairs, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (1)