Business Law Prof Blog

How to Contract Conference- February 16-17 in Miami

I had originally planned to post Pt. 2 of the blog post I did a couple of weeks ago, but this announcement is time sensitive.

I'm thrilled to announce that the Transactional Skills Program at the University of Miami School of Law is partnering with Laura Frederick for the second How to Contract conference. It's time sensitive because we are considering holding a side event with a contract drafting and negotiation competition for law students if there's enough interest. If you think you would be interested, please email me at mweldon@law.miami.edu.

For lawyers, there are virtual and live options for the contract conference. I've cut and pasted from the website so you can see why you should come to sunny Miami (and it won't be hurricane season):

It is not about the mega deals.

ContractsCon is about the contracts you work on EVERY DAY. We want to help you learn how to draft and negotiate the deals you see all the time.

Because for every 100-page specialized contract sent to outside counsel, there are thousands of smaller but important ones that in-house counsel and professionals do day in and day out.

ContractsCon focuses on how we manage risk and make the tough decisions with less time and information than we need.

It is not a summary of recent case law.

ContractsCon is about providing actionable advice to help you do the work that you have sitting in your inbox RIGHT NOW.

It's not about case names or citations and we don't get into academic explanations.

ContractsCon focuses on the real-world expertise from experienced practitioners that you need to improve your contract skills and expertise and become better at drafting and negotiating in the real world.

It is not going to put you to sleep.

ContractsCon is about the fun and awesomeness of contracts. We are organizing it to be a true lovefest for everything contracts.  

Why not combine learning about contracts with having fun?

You'll meet other lawyers and professionals passionate about contract drafting and negotiating. Our sessions and workshops feature contracting superstars who love what they do and will share their excitement with you. Plus we're planning a ton of activities on-site and online to keep you engaged. 

ContractsCon is designed for in-house lawyers and professionals who want to learn:

• the insights and techniques needed to handle the commercial contracts filling their inbox every day,
• how experienced lawyers manage risk, work efficiently, and make the hard decisions in challenging circumstances,
• WHAT to say, WHY to say it that way, and HOW to reach the best-negotiated deal you can with your contract counterparties.

Virtual ticket holders get access to 6 HOURS of no-fluff practical contract training by experienced practicing lawyers.

People who attend in person in Miami get 12 HOURS of training, including 6 hours of interactive skills workshops.

I hope to see you in Miami in a few months. Don't forget to follow Laura Frederick on LinkedIn for great contract drafting tips and to let me know whether you and your students might be interested in participating in a contract drafting competition. 

 

 

 

 

 

 

Practical Tips for Teaching or Training Adult Learners

Millions of law school graduates around the US just took the bar exam. Others are preparing to enter colleges and graduates schools in a few weeks. How will these respective groups do? While a lot depends on how much and how well they study, a large part of their success or failure may depend on how they've been taught. I recently posted about how adults learn and what the research says we should do differently. In this post, I'll show how I used some of the best practices in the last ten days when I taught forty foreign lawyers from around the world  and thirty college students in separate summer courses offered by the University of Miami as well as nine Latin American lawyers who were taking courses in business law from a Panamanian school. I taught these disparate groups about ESG, disclosures, and human rights. With each of the cohorts, I conducted a simulation where I divided them into groups to prioritize issues based on whether they were a CEO, an investor, a consumer, the head of an NGO, and for the US college students, I added the roles of a member of Congress or influencer. In a future post, I will discuss how the groups prioritized the issues based on their demographics. Fascinating stuff. 

Depending on what you read, there are six key principles related to adult learning:

1. It seems obvious, but adults need to know why they should learn something. Children learn because they are primed to listen to authority figures. Too often in law school or corporate training, there's no correlation to what they learn and what they actually do. When I taught the two groups of foreign lawyers, I talked about the reality and the hype about ESG and how the topic could arise in their practices with specific examples. When I spoke to the college students who were considering law school, I focused on their roles and responsibilities as current consumers and as the future investors, legislators, and heads of NGOs. Same powerpoint but different emphasis.

2. Adults are self-directed. Under one definition, "self-directed learning describes a process by which individuals take the initiative, with or without the assistance of others, in diagnosing their learning needs, formulating learning goals, identifying human and material resources for learning, choosing and implementing appropriate learning strategies, and evaluating learning outcomes." This may seem radical because many of my colleagues complain that today's students need a lot of hand holding and spoon feeding, and I agree to some extent. But I also think that we don't give students enough credit and we underestimate them. I developed my curriculum for the practicing lawyers but I also asked what they wanted to learn and what would be most useful for them. I only had a few hours with them, so I wasn't able to explore this much as I would have. But in some of my traditional courses at the law school and when I train adults in other contexts, I often give a choice of the exam type and topic. This ensures that they will submit a work product that they are passionate about. At the end of my traditional classes at the law school, I also ask them to evaluate themselves and me based on the learning outcomes I established at the beginning of the semester. They tend to be brutally honest about whether they've taken responsibility for their own learning.

3. Adults filter what we tell them through their life experiences. In my traditional classes, I send out a survey to every student before the semester starts so that I understand their backgrounds, perspectives, and what's important to them. I often pick hypotheticals in class that directly address what I've learned about them through the surveys so it resonates much more clearly for them. With my three groups this week, I didn't have the chance to survey them but I knew where they were all from and used examples from their countries of origin, when I could. When the college students entered the Zoom room, I asked them to tell me why they picked this class. This helped me understand their perspectives. I also picked up on some of their comments during discussion and used those data points to pivot quickly when needed. It would have been easy to focus on my prepared lecture. But what does ESG mean to a lawyer in Bolivia, when that's not a priority? College students quickly grasped the context of socially responsible investing, so I spent more time there than on the Equator Principles, for example. The cultural and generational differences were particularly relevant when talking about the responsibility of tech companies from a human rights perspective. The lawyers and students from authoritarian regimes looked at social media and the power to influence the masses in one way, while the college students saw the issues differently, and focused more on the mental health issues affecting their peers. Stay tuned for a future post on this, including interesting discussion on whether Congress should repeal Section 230.

4. Adults become ready to learn only when they see how what they are learning applies to what they need to do at work and at home. With the foreign lawyers, I focused on how their clients could have to participate in due diligence or disclosure as part of a request from a company higher up in the supply chain. I focused on reputational issues with the lawyers who worked at larger companies. College students don't deal with supply chains on a regular basis so I spent more time focusing on their role as consumers and their participation in boycotts at their universities and their activism on campus and how that does or does not affect what companies do. 

5. Adults need a task-centered or problem-focused approach to learning. I had to lecture to impart the information, but with each group, they learned by doing. I had 12 hours with the Latin American lawyers so to test them on their understanding of US business entities, instead of having them complete a multiple choice quiz, I asked them to interview me as a prospective client and develop a memo to me related providing the advice, which is what they would do  in practice. They, with the other groups, also prioritized the issues discussed above from their assigned roles as CEO, NGO head, institutional investor, or consumer. When I teach my compliance course to law students, they draft policies, hold simulated board meetings, and present (fake) CLEs or trainings. My business and human rights students  have the option to draft national action plans, write case studies on companies that they love or hate, or write develop recommendations for governments for their home country. Students are much more likely to engage with the material and remember it when they feel like they are solving a real problem rather than a hypothetical.

6. Adults need extrinsic and intrinsic rewards. Everyone I taught this week will get some sort of certificate of completion. But they all chose to take these courses and those who weren't part of the UM program either self paid or were reimbursed by their employers. None of them were required to attend the classes, unlike those in elementary and high school. When students choose a course of study and learn something relevant, that's even more important than the certificate or diploma. 

I hope this helps some of you getting ready for the upcoming semester. Enjoy what's left of the summer, and if you try any of these suggestions or have some of your own, please leave a comment.

 

Business Associations & Relationships on the Future Bar Exam: A Virtual Symposium (Part V)

It's been one week since I announced and started posting in this virtual symposium on the NextGen Bar Exam. Thanks to Josh, Ben, and John for joining me in commenting on the proposed content scope outline relating to Business Associations and Relationships.  You can find their posts here, here, and here, respectively. 

We have raised issues about terminology.  And there are a few areas that are lacking in clarity or specificity.  In addition, two important overarching points have emerged to date in our posts.  One is that it is important to indicate the source of the law being tested, since the default rules operative in various areas of LLC and corporate law are not the same in the dominant national statutory frameworks.  (I offer another example of how this may matter in the discussion of corporate director and officer fiduciary duties, below.)  The other is that the default rules in business associations law tell only part of the story.   Constitutional issues, authorized private ordering, and decisional law that both supplements and interprets state legislative enactments can all play roles.

In this post, I offer a few more points that illustrate or add to these observations.

Partnership Nomenclature

The outline notes that distinctions between or among partnerships (denominated "general partnerships" in the outline), limited liability partnerships, and limited partnerships will be tested.  That seems appropriate.  But the next few prompt all refer to "general partners."  Neither partnerships nor limited liability partnerships have general partners.  They just have partners.  Only limited partnerships distinguish general partners from limited partners.

Partnership Governance

Only the duty of loyalty between and among partners and the partnership is proposed to be tested as a matter of partnership fiduciary duties.  Why not care?  And what about the obligation of good faith and fair dealing?  These governance rules are all equally important.  And duties of care and loyalty exist in agency law, unincorporated business associations law, and corporate law.

Moreover, the outline notes under "Duty of loyalty": "This topic includes the consequences of a partner acting outside the scope of the partner’s authority to bind the partnership."  This annotation is perplexing to me.  I have two principal substantive comments about it.

First, a partner's authority to bind the partnership is a matter of agency authority--the authority to transact with third parties.  A partner's fiduciary duties are a matter of internal governance (as the relevant outline topic, "Rights of . . . partners among themselves" indicates).  Two separate parts of the Revised Uniform Partnership Act (the "RUPA") address relations with third parties and internal governance--Articles 3 and 4, respectively.  So, the annotation introduces an apples-and-oranges problem--the illumination of an internal governance rule by reference to a third-party relations rule.

Second, the duty of loyalty of partners in a RUPA partnership is relatively specific.  It consists of three exclusive components: 

(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;

(2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and

(3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.

It is hard for me to see how a partner acting outside of their agency authority would implicate any of the three components of the duty of loyalty.  That conduct does not, of itself, result in the partner: deriving or taking any property, profit, or benefit of or belonging to the partnership; having conflicting interests, or competing with the partnership.

Corporations and LLCs, Generally

I agree with John that LLCs and corporations should each have their own category.  The doctrinal rules (structure, governance, and finance) are simply too different.  The general categories under each (and under partnerships, for that matter)--formation, management and control, fiduciary duties, agency, third-party liability, etc.--can be almost exactly the same.   Topics like veil piercing, pre-organizational contracting, and shareholder/member litigation that apply to both corporations and LLCs in similar ways can be noted in the outline for each with a cross-reference to the other or can be called out separately in the outline (with any unique corporate or LLC nuances addressed in that broader context).

Corporate Director (and Officer) Fiduciary Duties

While Josh and Ben have focused some pointed and valuable comments on jurisdictional differences in limited liability company fiduciary duties (comments that I endorse), I am at least as troubled by jurisdictional differences in corporate fiduciary duties.  I have written in the past in this space (here, here, and here) about the challenges in teaching corporate fiduciary duty law.  Delaware's classification of Caremark oversight duties as good faith questions actionable as breaches of the duty of loyalty runs counter to decisional law in other jurisdictions that characterizes oversight failures as breaches of the duty of care.  In sum, the relative narrowness of the fiduciary duty of care in Delaware, the capaciousness of Delaware's duty of loyalty, and the Delaware judiciary's reinterpretation of a director's obligation of good faith as a component of the duty of loyalty distinguish the law of director fiduciary duties in Delaware from the law of fiduciary duties elsewhere. 

Generally

Like others, I have doubts about the fairness and efficacy of bar exams as meaningful gatekeepers for the profession.  But I assume good faith in constructing the NextGen Bar Exam.  With that in mind, any bar exam should assess the law that licensed practitioners should know.  And it should use normative terms in signaling the law to be tested and recognize the use of normative terms in evaluating performance.  In this regard, it is important to note that there are parallel types of legal rules in agency, unincorporated business associations law, and corporate law.  There are recognized, well-worn labels for describing these component legal rules in agency and business associations law.  Why reinvent the wheel?  If parallel legal doctrine from business associations and relationships laws is to be tested, the content scope outline should use the acknowledged customary descriptors for those rules.

These comments round out my thoughts on the "Business Associations and Relationships" portion of the proposed Content Scope Outlines for the NextGen Bar Exam of the Future.  I welcome additional posts and any responses here on the BLPB, and as I noted in my initial post, comments can be filed with the National Conference of Bar Examiners here.  The comment period closes on April 18, 2022. 

Business Associations & Relationships on the Future Bar Exam: A Virtual Symposium (Part IV) - Guest Post from John Rice

The following symposium post comes to us from John Rice at Duquesne Law.

*     *     *

I’m pleased to add my voice among those commenting as part of this virtual symposium on the recently-released Content Scope Outline for the “Business Associations & Relationships” for the NextGen Bar Exam. Despite my general skepticism of the efficacy of any bar examination, I tend to view the draft outlines as an improvement above the current exam outline. I join with my colleagues Joan, Joshua, and Benjamin in stressing how imperative it is that the NCBE specify the specific sources of law from which these topics are drawn.

In terms of substance, I favor separating LLCs into their own category rather than merely being a sub-set of corporation law. Additionally, the business litigator in me feels compelled to note that the draft outline’s description of “Shareholder and member litigation: direct and derivative litigation” is underdeveloped. I want my students to recognize litigation as a form of shareholder control over the corporation and to evaluate the standing prerequisites and demand requirement. Likewise, I would prefer more attention be paid to the specific remedies available in business disputes, including declaratory judgment, injunctive relief, and the appointment of receivers and custodians.

In this post, however, I wish to briefly move our conversation of the “Business Associations & Relationships” coverage to consider the “Foundational Skill and Associated Lawyering Task” of legal research. The NCBE has identified two “skills” under the umbrella of legal research: First, the ability to engage in statutory interpretation, and second, legal issue spotting in a “client file.” In doing so, the NCBE under-comprehends the skills associated with legal research and overlooks what I consider to be one of the most fundamental legal research skills, and that skill is one particularly well-situated to be tested in the context of business law; that is, synthesis of separate legal authorities into one analysis.

Of all the subjects identified to be tested on the NextGen Bar Exam, Business Associations is the only subject that would require a test candidate to consider the interplay of separate legal authorities: the constitutional delegations of authority, the default rules created by the applicable statutory scheme, the private ordering agreed to by contract between the parties, the case law from the jurisdiction interpreting the statute and contract, and the underlying principles of equity and fairness. For example, a question about fiduciary duty in the context of a Delaware corporation would require a candidate to draw from multiple sources of law: the line of case law recognizing the existence of fiduciary duty; the statutory limits that may be impose on fiduciary duty by the chartering documents and bylaws; and the contractual limits actually agreed to by the parties.

Joshua implicitly recognized this opportunity in his post when he discussed the significance of looking to corporate documents to understand the applicable rules for quorum. But this sort of analysis should be the goal of the bar examination’s testing of the law of business associations—not merely an incidental consequence. A minimally competent attorney—whatever that may mean—should be able to articulate the legal research and factual investigation they would need to undertake to answer a question.

In my view, the NCBE would be wise to revise the content outlines to account for how candidates may evaluate different sources of applicable law in light of one another, and to express what information—legal and factual—they would to engage in a complete analysis of the questions presented.

Business Associations & Relationships on the Future Bar Exam: A Virtual Symposium (Part II)

Thanks to Joan Heminway for kicking off our virtual symposium, here, where some of us will take a look at the recently released National Conference of Bar Examiners (NCBE) content summaries of the material planned for future bar exams in the Content Scope Outlines .  These comments relate to the "Business Associations & Relationships” portion. 

As a general matter, I have been growing increasingly skeptical of the bar exam and its role and purpose for the profession.  I very much believe we need to facilitate a process to help ensure clients are served by competent lawyers who have the skills necessary to serve clients.  However, I am more and more convinced that bar exam does an incomplete job of testing readiness for practice, potentially ingrains some bad practices, and continues to inappropriately limit access to the profession for women and minorities. Those issues, though, are for another time.   

Following are my initial thoughts on the Business Associations and Relationships portion of the Outlines:

In the area of “Partnerships,” under “Nature of general partnerships” and “Formation, the outline states: “This topic includes the de facto treatment of improperly created incorporated entities as general partnerships.”  Here, in place of “incorporated entities” I would recommend replacing it with “corporations” or “limited liability entities.”  If they intend to limit the review to corporations, which would not be surprising given the way the “de facto corporation doctrine” is often taught, then say that. If it means improperly formed limited liability entities (intending to include LLCs, LPs or LLPs) then say that.  An “incorporated entity” is necessarily a corporation.

For the section on “Corporations and Limited Liability Companies,” I agree with Joan that the corporation concept of “articles of incorporation” is too narrow, unless they intend to pick a state or model law that uses that phrase (and if so, please tell us!).  Adding “formation document” or “creation document” could work, though most casebooks include something “charter or articles or certificate of incorporation.” 

For LLCs, I think it should say “Operating or member agreements” (not members, though maybe “members’ agreements”). 

Items “IX. Piercing the Corporate Veil” should say, “Piercing the Entity Veil” given that this section does not say whether it’s just corporations (the general section is corporations and LLCs).  A literal reading of this would suggest they only intend to test it as to corporations, but given the way courts and other commentators treat this concept, such an assumption would be (unfortunately) flawed. There is an “asterisk” by this area, which means exam takers will be expected” to know the details of the relevant doctrine without consulting legal resources.”  Here, too, it would be important to know the jurisdiction because veil piercing law is not uniform state to state, and this is even more true of LLCs than it is of corporations. The basics are similar, but states vary.  Texas, for example, requires “actual fraud” for contract-type veil piecing claims.  And veil piercing is different for LLCs, too. Compare, for example, Minnesota law and the ULLCA. 

Under “management and control” of corporations, I don’t love that they test quorum, because it’s my understanding that, in years past, they have tested on some default rules of quorum (though I have not been able to verify that). Quorum should always be checked by looking at the articles/certificate/charter and bylaws AND buy checking the state statute to make sure that the chosen path is permissible under the statute.  There is no “asterisk” by this area, which means exam takers should “have generality familiarity with the topics.” So, it’s possible the bar examiners are approaching this by testing quorum where they would provide the relevant statute and or corporate documents (or specifics would not matter for the call of the question).  If so, great, but I think it’s worth raising to ensure that’s the case.

Finally, fiduciary duties may be tested for corporations and LLC.  These, too, are general, so hopefully exam takers will be able to respond with general knowledge and supplemental information in the exam. Given the divergent nature of Delaware LLC law in this area, it would seem worthwhile to give some guidance as to the source of law, exam takers should be using in their responses.  I will, again, second Joan’s point: “I favor letting examinees know which sets of rules and norms apply to their exam responses.”

 

Short Paper: The Benefits and Burdens of Limited Liability

I recently received the final version of my short article, "The Benefits and Burdens of Limited Liability," in Transactions: The Tennessee Journal of Business Law.  The article is based on some of my prior blog posts, as well as my presentation as part of the fourth annual Business Law Prof Blog symposium, Connecting the Threads. It was great event, as always, thanks to Joan and the whole crew at Tennessee Law, and it was my pleasure to be part of it.  

Here's the abstract: 

Law students in business associations and people starting businesses often think the only choice for forming a business entity is a limited liability entity like a corporation or a limited liability company (LLC). Although seeking a limited liability entity is usually justifiable, and usually wise, this Article addresses some of the burdens that come from making that decision. We often focus only on the benefits. This Article ponders limited liability as a default rule for contracts with a named business and considers circumstances when choosing a limited liability entity might not communicate what a business owner intends. The Article notes also that when choosing an entity, you get benefits, like limited liability, but burdens (such as need for counsel or tax consequences) also attach. It's not a one-way street. The Article closes by urging courts to consider both the benefits and burdens of an entity choice, especially in considering whether to uphold or disregard an entity, to help parties achieve some measure of certainty and equity.

The journal also has thoughtful and insightful commentary from Professor George Kuney (available here) and student Tyler Ring (here). 

 

 

Court (Eventually) Gets Law Right -- The Entity? Not So Much

A recent federal court order gets the basics of entity law representation right, but it's pretty murky on exactly what entity is involved.  The case involves a claim of trademark infringement in which the plaintiff, International Watchman, Inc., sued OnceWill, LLC.  The order explains: 

In OnceWill's Motion, OnceWill indicated that it “is a sole proprietorship consisting of proprietor Ryan Sood.” (Id.) OnceWill's Motion also showed that it was filed by Ryan Sood, acting pro se. (Id.) The Court granted OnceWill's Motion that same day.

Subsequently, also on November 12, 2020, Plaintiff filed its Motion, requesting that the Court strike OnceWill's Motion and reconsider its order granting the requested extension of time for OnceWill to respond to Plaintiff's Complaint. (Doc. No. 13.) Plaintiff asserts that OnceWill is a limited liability company (“LLC”), not a sole proprietorship as OnceWill represented. (Id. at 2.) In support of this assertion, Plaintiff provided a printout from the Washington Secretary of State's website showing that OnceWill is listed as an LLC. (Id.; Doc. No. 13-1.) As a result of OnceWill's status as an LLC, Plaintiff argues that OnceWill only can maintain litigation or appear in court through an attorney and cannot file pleadings or motions in Court on its own behalf pro se as it has attempted to do here.

INTERNATIONAL WATCHMAN, INC., Plaintiff, v. ONCEWILL LLC, et al., Defendants., No. 1:20-CV-02290, 2020 WL 7138650, at *1 (N.D. Ohio Dec. 7, 2020).

 

As I have noted previously, though some people don't like the idea, the need for an entity to be represented by counsel is generally understood to be required.  The court corrects the initial misstep of allowing the LLC's apparently sole member to appear pro se for what he claimed was a sole proprietorship. If it's a properly created LLC, it is an LLC.  

 

So, what, again is an LLC? I am glad I asked.  An LLC is a "limited liability company," which is an entity distinct from a corporation.  At least, that's what state law tells us. Some courts like to merge the two, as evidenced in this case.:

“The law is well-settled that a corporation may appear in federal courts only through licensed counsel and not through the pro se representation of an officer, agent, or shareholder.” Nat'l Labor Relations Bd. v. Consol. Food Servs., Inc., 81 F. App'x 13, 14 n.1 (6th Cir. 2003). “This rule also applies to limited liability corporations.” Barrette Outdoor Living, Inc. v. Michigan Resin Representatives, LLC, No. 11-13335, 2013 WL 1799858, at *7 (E.D. Mich. Apr. 5, 2013), report and recommendation adopted, 2013 WL 1800356 (E.D. Mich. Apr. 29, 2013); accord Perry v. Krieger Beard Servs., LLC, No. 3:17-cv-161, 2019 U.S. Dist. LEXIS 27311, at *2 (S.D. Ohio Feb. 21, 2019) (“[L]imited liability companies may not appear in this Court pro se and, thus, may only appear through a licensed attorney admitted to practice in this Court.”); Hilton I. Hale & Associates, LLC v. Gaebler, No. 2:10–CV–920, 2011 WL 308275, at *1 (S.D. Ohio Jan. 28, 2011) (“[A] limited liability corporation is another example of an artificial entity that should retain legal counsel before appearing in federal court.”).

Id. (emphasis added). In this instance, it is accurate that the representation rule that applies is the same for LLCs and corporations, but that does not make LLCs and corporations the same.  Really! 

 

It really does seem proper to me not to allow pro se representation of entities, even when they are owned and operated by a single person (though I have noted elsewhere that I would be okay with pro se representation for administrative matters, as long as allowed for by statute or rule).  Note that here, Mr. Sood almost certainly does not want to be a "sole proprietorship" because if he were, he could be held personally liable for OnceWill's trademark infringement. (Of course, it is possible he might be, anyway, but one certainly would not want to make it easier to be held personally liable.)  In fact, the plaintiffs here might have be wise to request amend their complaint to also name Mr. Sood, individually, to the lawsuit, in case the court did allow the pro se appearance. Appearing pro se, it seems to me, suggests personal liability.  

 

Lastly, a comment on the last citation from the excerpted part of the order:  What is an artificial entity?  Are certain entities real?  Like maybe general partnerships? But even those partners can be corporations and LLCs.  Or are is this distinguishing natural persons from "artificial" entities?  I imagine this is intended to be similar to the "fictional person" concept for the corporation, thus further justifying the requirement that an entity must be represented by an attorney. But if so, it would be good to be clear about that.   

 

Oh well.  Such is life. 

 

Jeopardy Doesn't Know LLCs Are Not Corporations, But Courts Are Improving

In September of 2015, I did a Westlaw search, which returned 4575 cases referring to a "limited liability corporation," rather than the proper "limited liability company" or LLC.   That search followed one that I had done on May 2011, and the 2015 search showed a jump of 1802 new cases.  Today's search returned 5,211 such cases, an increase of 636 cases in five and a half years. That's still more than 100 cases per year, but it's a reduction of about half the rate we were seeing between 2011 and 2015.  (I concede this is not especially scientific, but it's still instructive.) 

It appears, then, that we're making progress, but two steps forward, one step back. Even Jeopardy -- Jeopardy! -- recently got this wrong.  I thank Professor Samantha Prince at Penn State Dickinson Law for bringing this to my attention, upsetting as it is.   

LLCs make it to Jeopardy this evening but ughhh at the answer they permitted!! @jfershee pic.twitter.com/faLFwOyQRc

— Samantha Prince (@ProfSJPrince) November 28, 2020

In addition, a recent tax court opinion followed suit: "All limited liability corporations, or LLCs, mentioned in this opinion are entities treated as partnerships for federal tax purposes." Padda v. Comm'r of Internal Revenue, T.C.M. (RIA) 2020-154, at n.3 (T.C. 2020) (emphasis added).  

So, there's clearly a lot of work left to do, but I remain hopeful that we're trending in the right direction. LLCs are still not corporations, and we need to keep reminding folks. Stay vigilant, good people! 

 

2020 American Bar Association LLC Institute - Free for Law Students!

I have written about the American Bar Association Limited Liability Institute in this space before.  See, e.g., here, here, here, here, and here.  The 2020 LLC Institute is being hosted virtually and begins next Friday--something to look forward to at the end of election week!  This ABA program is always a premier event, and it is the only national annual program that focuses in exclusively on LLCs and unincorporated business associations.

Importantly, this year's institute is free to law students.  I have recommended registration and attendance to mine.  Click here for more information, including the agenda, list of speakers (including yours truly!), and registration.

Is an LLC Member Labeled as a Partner Personally Liable for LLC Debts?

If one is going to ignore entity distinctions, I supposed one may as well go all in.  Following is from an opinion issued last week that involves Christeyns Laundry Technology, LLC (“Christeyns”), which is a limited liability company.  The opinion, though, asserts: 

Selective is a New Jersey corporation with its principal place of business in New Jersey. [Docket No. 1-1, ¶ 2.] Christeyns is a Limited Liability Corporation with two partners: Christeyns Holding, Inc., and Rudi Moors. [Docket No. 25, at 14, ¶ 7.] Christeyns Holding, Inc., is a Delaware corporation with its principal place of business in East Bridgewater, Massachusetts. [Id. at 14, ¶ 8.] Rudi Moors is a resident of South-Easton, Massachusetts. [Id. at 14, ¶ 9.] The remaining parties’ claims arise out of a common nucleus of operative fact.

SELECTIVE INSURANCE COMPANY OF AMERICA, Plaintiff, v. CHRISTEYNS LAUNDRY TECHNOLOGY, LLC, et al., Defendants. Additional Party Names: Clean Green Textile Servs., LLC, Lavatec Laundry Tech., Inc., Single Source Laundry Sol., No. CV1911723RMBAMD, 2020 WL 6194015, at *3 n.2 (D.N.J. Oct. 22, 2020) (emphasis added).

We have already established that an LLC is a limited liability company, and not a corporation. And while the opinion seems to track the diversity requirements of corporation and an LLC correctly, LLCs are not partnerships, and thus do not have partners, either.  LLCs are made up of members. Referring to them as members clearly connotes limited liability protections that are generally provide to members of an LLC, while the generic "partner" could imply that each "partner" faces unlimited liability for the debts and obligations of a "partnership." 

Similarly, another case from last week made the following observation about a witness:

"Ernest Thompson is listed as "GEN. PART" of M Nadlan LLC per DHPD records. The court takes this to mean General Partner of the Limited Liability Corporation."

 Yolanda Martinez, Petitioner, M Nadlan LLC, Respondent., No. 41219/2019, 2020 WL 6166864, at *3 n.3 (N.Y. Civ. Ct. Oct. 21, 2020) (emphasis added).

Again with the mixing of entities.  In fairness, the court did not label Mr. Thompson as "GEN. PART." Someone else did.  But the court did refer to the LLC as a corporation.  Once again, although I know LLCs sometimes adopt partnership terms, they should not.  And yet again, here, "general partner" could imply personal liability for entity debts on the part of Mr. Thompson, evening though it is more likely he is a managing member of the LLC.  If you are listed as a general partner, that holding out could be deemed to be a form or personal guarantee, at least where one could plausibly claim reliance.  Moreover, it's just bad form.  

Anyway, it's possible, and maybe even likely, that courts would uphold limited liability protections for these LLC members who are listed as partners. But why take the risk of having to find out?  

More Misidentified LLCs, Plus Lagniappe

I was today years old when I learned that the California courts have a group of cases captioned the "Franchise Tax Board Limited Liability Corporation Tax Refund Cases."  This is distressing.  

In that case, the court explains: "This coordinated litigation involves the remedies available to certain limited liability companies (LLCs) that paid a levy pursuant to section 17942 of the Revenue and Taxation Code which was later determined by this District to be unconstitutional."  Fran. Tax Bd. Ltd. Liab. Corp. Tax Refund Cases, 235 Cal. Rptr. 3d 692, 697 (Cal. App. 1st Dist. 2018), reh'g denied (Aug. 6, 2018), review denied (Oct. 31, 2018) (emphasis added).  We can see clearly that rhe courts knows these are limited liability companies, and not limited liability corporations. Nonetheless, for eternity, when citied, these cases will refer to limited liability corporations. See, e..g, Union Band Wage & Hour Case v. Union Bank, B295835, 2020 WL 6018545, at *18 (Cal. App. 2d Dist. Oct. 9, 2020) ("Their reliance on Franchise Tax Board Limited Liability Corp. Tax Refund Cases (2018) 25 Cal.App.5th 369, 395-396 does not support their position."). 

Another recent case makes a similar mistake, thought it seems to have gotten a lot of other things right.  A Louisiana court explained: 

Robinson argues that, pursuant to La. R.S. 12:1320(B), as the manager of HLN, a limited liability corporation, Robinson is not liable, in solido, with HLN. Moreover, Robinson argues that Appellant mischaracterized the claim in an attempt to “resurrect” a prescribed tort claim. This Court, in Streiffer v. Deltatech Constr., LLC, explained that “[a] limited liability company is a business entity separate from its members and its members’ liability is governed solely and exclusively by the law of limited liability companies. ‘The fact that a person is the managing member of a limited liability company and/or has a significant ownership interest therein does not in itself make that person liable for its debts.’ ” 2018-0155, pp. 7-8 (La. App. 4 Cir. 10/10/18), ––– So.3d ––––, 2018 WL 4923559, writ denied, 2018-2107 (La. 2/18/19), 263 So.3d 1154 (internal citations omitted). Pursuant to La. C.C. Art. 24, limited liability companies, such as HLN, and its members, such as Robinson, are considered wholly separate entities. Ogea v. Merritt, 2013-1085, p. 6 (La. 12/10/13), 130 So.3d 888, 894-95. Further, pursuant to La. R.S. 12:1320(B), “no **11 member, manager, employee, or agent of a limited liability company is liable in such capacity for a debt, obligation, or liability of the limited liability company.” Further, pursuant to La. R.S. 12:1320(C), “[a] member, manager, employee, or agent of a limited liability company is not a proper party to a proceeding by or against a limited liability company, except when the object is to enforce such a person's rights against or liability to the limited liability company.” Based on the record before us, Robinson, as a manager of the limited liability company, cannot be liable, in solido; Appellant offered no evidence to rebut the general rule of limited liability.

Thomas v. Hous. Louisiana Now, L.L.C., 2020-0183 (La. App. 4 Cir. 9/30/20) (emphasis added). Other than the limited liability corporation thing, this is about right.  An individual who is a member of an LLC may have some independent liability (respondent inferior) by his or her actions in tort or through veil piercing, but they are not liable for the torts of the entity merely by being a member or manager.  Here the court notes that no evidence was offered to suggest otherwise.  Thus, the rest of the assessment is spot on.  

One other interesting note for those not familiar with Louisiana's civil law origins: the reference to a "prescribed tort claim" is a reference to an attempt to a cause of action for which the statute of limitations had run.  My first job as a law clerk was with a New Orleans law firm, and while I had went to Tulane, I took the common law curriculum. My first assignment was related to a "prescription issue," which sounded like a property law claim to me. Fortunately, the assigning attorney quickly clarified that for me. 

 

 I figured I'd add a little some extra -- lagniappe -- beyond a mere rant about people not accurately describing LLCs. 

The Limited Liability Corporation Returns (And It Isn't Pretty)

The dreaded "limited liability corporation" strikes again.  In today's find, the United States District Court for the North District California makes a boo boo. In assessing whether a court had jurisdiction over an LLC (limited liability company), the court proceeded through the following:

 

As to the first element, the Court agrees that the Eastern District of Michigan would have subject matter jurisdiction pursuant to the Class Action Fairness Act, 28 U.S.C. § 1332(d)(2). The Class Action Fairness Act vests federal courts with original jurisdiction over class actions that meet the following prerequisites: (1) “the matter in controversy exceeds the sum or value of $5,000,000, exclusive of interest and costs”; (2) the parties meet minimal requirements for diversity such that “any member of a class of plaintiffs is a citizen of a State different from any defendant”; and (3) the class equals to or exceeds 100 individuals in the aggregate. 28 U.S.C. § 1332(d). Those requirements are satisfied here. ... [A]t least one class member is a citizen of a different state from Defendant: Plaintiff Esquer is a citizen of California, id. ¶ 17, whereas Defendant is a Michigan limited liability company with its principal place of business in Michigan, id. ¶ 26; Rollins Decl. ¶ 11. Accordingly, the Eastern District of Michigan would have subject matter jurisdiction under the Class Action Fairness Act.

As to the second element, Defendant StockX, LLC would be subject to personal jurisdiction in Michigan as a Michigan limited liability corporation with its principal place of business in Michigan, as set forth above.

 

Esquer v. StockX, LLC, 19-CV-05933-LHK, 2020 WL 3487821, at *3 (N.D. Cal. June 26, 2020) (emphasis added).

 

Except that, unlike corporations, "the citizenship of an LLC is determined by the citizenship of its members." Zambelli Fireworks Mfg. Co., Inc. v. Wood, 592 F.3d 412, 420 (3d Cir. 2010). The principal place of business and the state of formation matter for corporations, not LLCs, in jurisdictional determinations.  Perhaps that slip -- calling the LLC a "limited liability corporation," instead of correctly using "limited liability company" (as the court had done previously) -- led to this mistake.  

 

This decision may be correct, if any of the LLC's members are also Michigan citizens. But the rationale is unquestionably wrong.   

 

2021 AALS Annual Meeting - Section on Agency, Etc. Call for Papers

Call for Papers
AALS Section on Agency, Partnership, LLCs & Unincorporated Associations 

Entrepreneurship and the Entity 

January 5-9, 2021, AALS Annual Meeting 

The AALS Section on Agency, Partnership, LLCs & Unincorporated Associations will sponsor a panel on “Entrepreneurship and the Entity” at the 2021 AALS Annual Meeting in San Francisco, California. This panel will showcase scholarship on subjects relating to business law and entrepreneurship, including entity choice throughout a company’s evolution, financing alternatives, and how legal rules promote and discourage different kinds of entrepreneurship. Scholars are encouraged to interpret the subject of the Call for Papers broadly and creatively. 

SUBMISSION PROCEDURE: Scholars should send a summary of a work or a work-in-progress of no more than 600 words to Professor Sarah C. Haan at haans@wlu.edu on or before Friday, August 21, 2020. The summary should be a pdf or Word document that has been stripped of information identifying the author; only the cover email should connect the author to the submission. The subject line of the email should read: “Submission—[author name & title].” Papers will be selected through an anonymous review by the Section’s Executive Committee. 

SPECIAL NOTE: Interested parties are encouraged to submit even if they are not certain at this time that they will attend the AALS Annual Meeting in person. 

ELIGIBILITY: Scholars at AALS member law schools are eligible to submit. Pursuant to AALS rules, faculty at fee-paid non-member law schools, foreign faculty, adjunct and visiting faculty (without a full-time position at an AALS member law school), graduate students, fellows, and non-law school faculty are not eligible to submit. Please note that all program presenters are responsible for paying their own annual meeting registration fees and, for those attending the AALS Annual Meeting in person, travel expenses. 

Any inquiries about the Call for Papers should be submitted to: Professor Sarah C. Haan at haans@wlu.edu. 

Teaching Moment: LLCs Don't Have "Corporate" Name Endings

I am teaching Business Associations this summer, and I am excited to get back in the classroom. Well, I was. Instead, I am teaching in virtual class room via Zoom.  I am still glad to be interacting with students in a teaching capacity, but I sure miss the classroom setting. I am glad, though, to have this experience so I am closer to what this has been like for our students and faculty.  I still have the benefit of my colleagues experiences, students who have been in the online learning environment, and a little time to plan, so it's better for me than it was for everyone in March. Still, there is quite a learning curve on all of this. 

Over the past several years, I have asked students to create a fictional limited liability company (LLC) for our first class.  It does a number of things. To begin, it connects them with a whole host of decisions businesses must make in choosing their entity form.  It also introduces them to the use of forms and how that works.  I always give them an old version of the form. This year, I used 2017 Articles of Organization for a West Virginia Limited Liability Company. It does a couple of things.  There is an updated form (2019), so it gives me a chance to talk about the dangers of using precedent forms and accepting what others provide you without checking for yourself.  (Side note: I used West Virginia even though I an in Nebraska, because Nebraska doesn't have a form. I use this one to compare and contrast.) 

In addition, I like my students to see how most businesses start with entity choice and formation -- by starting one.  It leads to some great conversations about limited liability, default rules, member/manager management choices, etc. Each year, I have had at least one person opt-in for personal liability, for example, for all members.

I also, which will shock no one, use the form to discuss the distinct nature of LLCs and how they are NOT corporations.  And yet, the West Virginia LLC form tries to under cut me at each turn.  For example, the form requires that the LLC name choose a "corporate name ending."  From the instructions: 

Enter the exact name of the company and be sure to include one of the required corporate name endings: “limited liability company,” “limited company,” or the abbreviations “L.L.C.,” “LLC,” “L.C.,” or “LC.” “Limited” may be abbreviated as “Ltd.” and “Company” may be abbreviated as “Co.” [WV Code §31B-1-105] Professional companies must use “professional limited liability company,” “professional L.L.C.,” “professional LLC,” “P.L.L.C.,” or “PLLC.” [WV Code §31B-13-1303] 

Seriously, people.  LLC are not corporate.  In fact, choosing a corporate name ending would be contrary to the statute.  

The form continues: 

13. a. The purpose(s) for which this limited liability company is formed is as follows (required): [Describe the type(s) of business activity which will be conducted, for example, “real estate,” “construction of residential and commercial buildings,” “commercial painting,” “professional practice of law" (see Section 2. for acceptable "professional" business activities). Purpose may conclude with words “…including the transaction of any or all lawful business for which corporations may be incorporated in West Virginia.”] (final emphasis added)

Finally, the instructions state that

[t]he principal office address need not be in WV, but is the principal place of business for the company. This is generally the address where all corporate documents (records) are maintained.(final emphasis added)

My students know from day one this matters to me, and it's not just semantics. My (over) zealousness helps underscore the importance of entity decisions, and the unique opportunities entities can provide, within the default rules and as modified. My first day, I always make sure students see this at least twice: "A thing you have to know. LLCs are not Corporations!" 

Is it overkill? Perhaps, we all have our things.

Oh, and it's time for West Virginia to add a 2020 update to the LLC form.  

It's Not Cool to Skip Completely the LLC Law. Not Cool.

Plain Bay alleges that it is a citizen of Florida for diversity purposes as it is a Florida limited liability company incorporated in Florida with its principal place of business in Florida and that Yates is a citizen of California for diversity purposes as he “is a citizen of the United States and a resident of the State of California[.]” . . . In order for this Court to properly exercise jurisdiction over a case, “the action must be between ‘citizens of different States.’ ” 28 U.S.C. § 1332(a)(1).

Plain Bay Sales, LLC v. Gallaher, 9:18-CV-80581-WM, 2020 WL 961847, at *2 (S.D. Fla. Feb. 28, 2020) (emphasis added). 

 

Yates, though, was a UK citizen, who lived in Florida, and thus, "the Court concludes that, for diversity purposes, Yates should be considered a citizen of Florida." Id. The court eventually determines that Yates would destroy diversity, but Plain Bay removed him as a defendant, and as a dispensable party, diversity was restored. 

 

Okay, but there is a problem here. Two really. First, Plain Bay was not "incorporated" anywhere. It was formed. It is an LLC, not a corporation.  But more important, Plain Bay's citizenship has not been determined.  The state of formation and principal place of business is irrelevant to LLC citizenship. “[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). Here, the court determined that the plaintiff LLC is an citizen of Florida without ever looking at the citizenship of any members. They may all be Florida residents, but WE DON'T KNOW. 

 

Anyway, not even stating the law for determining citizenship of an LLC is not cool. Not cool at all. 

LLCs Are Not Corporations: A New Hero Emerges

The Honorable Aida M. Delgado-Colón made me smile today.  As BLPB readers know, An LLC By Any Other Name, Is Still Not a Corporation. Finally, I received a notice of a court acknowledging this fact and requiring a party to refer to their legal entity correctly. Judge Delgado-Colón writes: 

Pursuant to this Court’s sua sponte obligation to inquire into its own subject matter jurisdiction and noticing the unprecedented increase in foreclosure litigation in this District, the Court ordered plaintiff to clarify whether it is a corporation or a limited liability company (“LLC”).

REVERSE MORTGAGE FUNDING, LLC, Pl., v. THE ESTATE OF ANGEL RAFAEL ANTONINI-NAZARIO, et al, Defendants., CV 16-3092 (ADC), 2020 WL 881019, at *1 (D.P.R. Feb. 20, 2020).  

 

The opinion continues:

Here, the Court cannot ascertain that diversity exists among the parties. Rule 11(b) of the Federal Rules of Civil Procedure holds attorneys responsible for “assur[ing] that all pleadings, motions and papers filed with the court are factually well-grounded, legally tenable and not interposed for any improper purpose.” Mariani v. Doctors Associates, Inc., 983 F.2d 5, 7 (1st Cir. 1993) (citing Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 393 (1990). Despite Rule 11’s mandate, the Court finds significant inconsistencies among plaintiff’s representations, which to this date remain unclear. As noted at ECF No. 53, plaintiff has repeatedly failed to explain why its alleged principal place of business is in New Jersey instead of Michigan. To make matters worse, plaintiff now claims to be a “limited liability corporation”¹ under Delaware law.

Id. at *2.

 

Because the court was "unable to determine that complete diversity exists between the parties," the Court dismissed "without prejudice the amended complaint for lack of subject matter jurisdiction." Id.  

 

I might quibble with some parts of the opinion (mostly that I think it could make what the plaintiff should have done even more clear), but that's just quibbling.  I am thrilled to see an opinion that held the responsible party accountable for their entity descriptions.  

 

Thank you, Judge Delgado-Colón. 

LLCs: The Uncola (Bankruptcy Edition)

The United States Bankruptcy Court for the Western District of Kentucky has opened my eyes to some bankruptcy law issues I hadn't previously seen. The court also committed what I consider to be a cardinal sin: the court refers to an LLC as a "limited liability corporation."  An LLC is a "limited liability company," which is a statutorily different entity than a corporation. 

The court states: "Sunnyview and TR are limited liability corporations. They are not individuals and do not meet the definition of insiders under 11U.S.C.§ 101(31)(B)[sic]." In re: Bullitt Utilities, Inc., No. 15-34000(1)(7), 2020 WL 547278, at *6 (Bankr. W.D. Ky. Jan. 24, 2020) (emphasis added). Other than being LLCs, and not corporations, this appears to be correct. The statute, 11 U.S.C.§ 101(31), provides: 

(31)The term “insider” includes—

. . . . 

(B)if the debtor is a corporation—

(i)

director of the debtor;

(ii)

officer of the debtor;

(iii)

person in control of the debtor;

(iv)

partnership in which the debtor is a general partner;

(v)

general partner of the debtor; or

(vi)

relative of a general partner, director, officer, or person in control of the debtor;

The court continues, "If considered to be corporations, none of the entities meet the definition of a [sic] 'insider'”. Id. The LLCs at issue are creditors, without any express control, so it is correct that they could not be insiders on their own. The court also determined there was "no evidence" that the individual in control of the two LLCs had used his power in a manner that resulted in "inequitable conduct," so the LLCs under his control could not be held liable under any theory of vicariously liability (e.g., entity veil piercing). 

 

Based on the court's factual determinations, this all appears to come out correctly, notwithstanding the mischaracterization of the LLC. 

 

More frustrating, for me, is my discovery that bankruptcy law does, in fact, characterize a "corporation" as follows: 

(9) The term “corporation”— (A) includes— (i) association having a power or privilege that a private corporation, but not an individual or a partnership, possesses; (ii) partnership association organized under a law that makes only the capital subscribed responsible for the debts of such association; (iii) joint-stock company; (iv) unincorporated company or association; or (v) business trust; but (B) does not include limited partnership.

11 USC § 101(9). 

 

So, while I acknowledge the statute, I strenuously object. (We all know how effective that is.) Corporations are just not partnerships and they are really, really not unincorporated companies or associations. That would be like saying Coca-Cola or Pepsi are an "Uncola. (Yes, I am dating myself with that reference.) 

 

Couldn't we just use something like "Covered Entity" for the definition?  

 

Anyway, in closing, I will once again note that cases like this run the risk of creating bad law where an LLC is in control of a corporation. The court here states that the LLC is not and individual, but an LLC (I think) is a "person" under the definitions. The statute provides that "[t]he term 'person' includes individual, partnership, and corporation ...." 11 USC § 101(41). And as per 11 USC § 101(9), "corporation" includes unincorporated companies. Thus, I hope that the fact that LLCs in this case were not individuals, does not lead a potential future court to miss that they also need to consider whether an LLC might be a "person in control of the debtor."

Weidner: LLC Default Rules Are Hazardous to Member Liquidity

Although I had to miss the American Bar Association's LLC Institute this past year, it looks like I can still get the benefit of some of the wisdom shared there in written form.  FSU Law Dean Emeritus and Alumni Centennial Professor Don Weidner has posted an article, LLC Default Rules Are Hazardous to Member Liquidity, based on the thoughts he shared as the keynote speaker at that annual event.  The SSRN abstract follows:

This article is based on the author’s Keynote Address at the 2019 LLC Institute sponsored by the American Bar Association’s Business Law Section. It traces and critiques the shift in the default rules in LLC law away from partnership law and toward corporate law, using the Uniform LLC Acts of 1996 and 2006 as exemplars of the national trend. It focuses on two key issues: the removal of liquidity rights, both the right to dissolve and the right to be bought out, and the removal of easy access to member remedies. It argues that, on both key issues, the default rules have moved away from enforcing the presumed intent of small groups of entrepreneurs who form businesses without the benefit of counsel. By forming LLCs, entrepreneurs across the country are now unwittingly locking themselves in to perpetual entities that offer them no liquidity and present them with costly procedural obstacles to enforcing both their rights under the operating agreement and their statutory rights.

I look forward to reading this.  SSRN: it's the next best thing to being there--at least in this case.  I am grateful to Don for writing up his thoughts on the migration of limited liability company default rules (away from partnership norms and toward corporate norms) and for mentioning this work to me in a recent conversation and email message.

Law Firms Should Not Have Corporate Practice Groups

As a new dean in a new city, I have had the opportunity to meet hundreds of impressive lawyers in Omaha.  I have been incredibly impressed by the sophisticated practices at the very law firms I have visited. For "midsized" firms, there are lawyers doing incredible work here that is the same work being done on the coasts, including some amazing M & A work. 

But here in Omaha, just like every city around the country, law firms have "corporate" practices.  But really, those are business law practices or transactional practices.  Almost every corporation of significant size also owns some LLCs (limited liability companies) and perhaps other entities. And certainly these firms, especially those working with real estate companies, will work with LLCs and other pass through entities.  

So, consistent with my prior posts on this subject, I urge lawyers and firms to acknowledge the full scope of what we do.  It's not just corporate.  It's so much more. And that's a good thing. I just ask that we embrace business practice or transactional practice to try to include all we do.   

 

 

 

The Implied Covenant of Good Faith Means The Contract Makes Some Sense (If Only A Little)

Prof. Bainbridge recently posted, Here's the thing I don't understand about the implied covenant of good faith and fair dealing. He explains: 

In Bandera Master Funds LP v. Boardwalk Pipeline Partners, LP, C.A. No. 2018-0372-JTL (Del. Ch. Oct. 7, 2019), the court reviews the Delaware law of the implied covenant:

“In order to plead successfully a breach of an implied covenant of good faith and fair dealing, the plaintiff must allege a specific implied contractual obligation, a breach of that obligation by the defendant, and resulting damage to the plaintiff.” Fitzgerald v. Cantor, 1998 WL 842316, at *1 (Del. Ch. Nov. 10, 1998). In describing the implied contractual obligation, the plaintiffs must allege facts suggesting “from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of . . . had they thought to negotiate with respect to that matter.” Katz v. Oak Indus. Inc., 508 A.2d 873, 880 (Del. Ch. 1986). That is because “[t]he implied covenant seeks to enforce the parties’ contractual bargain by implying only those terms that the parties would have agreed to during their original negotiations if they had thought to address them.” El Paso, 113 A.3d at 184. Accordingly, “[t]he implied covenant is well-suited to imply contractual terms that are so obvious . . . that the drafter would not have needed to include the conditions as express terms in the agreement.” Dieckman, 155 A.3d at 361.

My question is simple: How do you know that the provision was left out because it was obvious? After all, if it was obvious, shouldn't the parties have put it in the contract? Put another way, how do you know the parties did think about it and decide to leave it out?

Agreed.  And I think this concept of the implied covenant matters more than ever, now that Delaware allows the elimination of the duty of loyalty in LLCs (my thoughts on that here). Even in allowing parties to eliminate the duty of loyalty in an LLC, such agreements always retain the duty of good faith and fair dealing. The Delaware LLC Act provides (emphasis added): 

§ 18-1101 Construction and application of chapter and limited liability company agreement.

. . .

(c) 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; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.

So what does that mean? I am of the mind that the implied covenant of good faith and fair dealing means that: (1) you get the express terms of the agreement, and (2) the agreement cannot take away all possible reasons for the deal in the first place.  As to the latter point, it means, quite simply, even without a duty of loyalty, there must be some reason for the contract to exist at all.  So, you may not be entitled to a fair share of proceeds from the agreement, or even a significant share.  But there must always be some value (or potential value) to have been gained by entering the agreement. At a minimum, it can't be an agreement to get nothing, no matter what. 

As one example, a Delaware court explained that a plaintiff's claim was lacking when the 

the incentive [gained by the defendant] complained of is obvious on the face of the OA [operating agreement]. The members, despite creating this incentive, eschewed fiduciary duties, and gave the Board sole discretion to approve the manner of the sale, subject to a single protection for the minority, that the sale be to an unaffiliated third party. . . . [T]he parties to the OA [thus considered] the conditions under which a contractually permissible sale could take place. They avoided the possibility of a self-dealing transaction but otherwise left to the [defendant] the ability to structure a deal favorable to their interests. Viewed in this way, there is no gap in the parties’ agreement to which the implied covenant may apply. The implied covenant, like the rest of our contracts jurisprudence, is meant to enforce the intent of the parties, and not to modify that expressed intent where remorse has set in.

Miller v HCP & Co., C.A. No. 2017-0291-SG (Del. Ch. Feb. 1, 2018). (More commentary on this case here.)

Furthermore, the implied covenant

does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand. Even where the contract is silent, an interpreting court cannot use an implied covenant to re-write the agreement between the parties, and should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.

Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, 202 A.3d 482, 507 (Del. 2019) (footnotes omitted). For more on this case see the Delaware Corporate &Commercial Litigation Blog. 

 

Parties have a lot of latitude, but I think the covenant of good faith and fair dealing means that there must be a reasonable effort to honor the express terms of the agreement and there must have been some reason to enter the contract. That's it.  It's not a lot, but it still has teeth where someone takes all of the things.