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)

Tuesday, January 8, 2019

I Don't Care What the IRS Says, There Are No Federal Entities

Not for my purposes, anyway. Back in 2016, I made the argument that the IRS should "stop using state-law designations": 

My proposal is not abolishing corporate tax – that’s a much longer post and one I am not sure I’d agree with.  Instead, the proposal is to have entities choose from options that are linked the Internal Revenue Code, and not to a particular entity. Thus, we would have (1) entity taxation, called C Tax, where an entity chooses to pay tax at the entity level, which would be typical C Corp taxation; (2) pass-through taxation, called K Tax, which is what we usually think of as partnership tax; and (3) we get rid of S corps, which can now be LLCs, anyway, which would allow an entity to choose S Tax

This post deals with the tax code, which means I am in over my head, and because this is tax related, it means the solution is a lot more complicated than this proposal.  But now that the code provisions are not really linked to the state law entity, I think we should try refer to state entities as state entities, and federal tax status with regard to federal tax status.  Under such a code, it would be a little easier for people to understand the concept behind state entity status, and it would make more sense to people that a “C Corp” does mean “publicly traded corporation” (a far-too common misunderstanding).  Thus, we could have C Tax corporations, S Tax LLCs, K Tax LLCs, for example.  We'd know tax status and state-entity status quite simply and we'd separate the concepts. 

We discussed this issue on Saturday at the 2019 AALS Section on Agency, Partnership, LLCs & Unincorporated Associations Program on LLCs. As I taught my first Business Organizations class of the semester, I talked about this and it occurred to me that maybe the better way to think about this is to simply acknowledge that there are no federal entities.  

State law is the origin of all entity types (barring, perhaps, a few minor exceptions), and references to "C Corps" and "S Corps" are not really on target. I concede that the IRS does so, which is a challenge, but it's really unnecessary under today's tax code. That is, with check-the-box options, most entity types can choose whatever tax treatment they wish.  An LLC can choose to be taxed under subchapter S, for example, though it has to meet certain requirements (e.g., can only have one class of "stock"), but the LLC can file Form 2553 an make an S election.  

As such, as I have argued before, I think we should work to keep entity type and tax treatment separate.  Thus, for example, we can have an S-taxed LLC (an LLC that made the S election)  and a K-taxed LLC (an LLC that made a K election for pass-through taxation).  The tax treatment does not "convert" the LLC to a corporation -- or S corp. It simply provides for certain tax treatment.  I really think we'd see some doctrinal improvements if we could get more people to use language that makes clear tax treatment and entity type are separate issues, at least in today's word.   

Entities are creatures of state law. How the federal or state government tax such entities does not change that reality.  It's time we start using more precise language to make that clear.  

January 8, 2019 in Corporate Personality, Joshua P. Fershee, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (1)

Tuesday, December 18, 2018

There Once was an LLC with a Partnership Agreement Governing the Minority Shareholder's Interest

Sometimes I think courts are just trolling me (and the rest of us who care about basic entity concepts). The following quotes (and my commentary) are related to the newly issued case, Estes v. Hayden, No. 2017-CA-001882-MR, 2018 WL 6600225, at *1 (Ky. Ct. App. Dec. 14, 2018): 

"Estes and Hayden were business partners in several limited liability corporations, one of which was Success Management Team, LLC (hereinafter “Success”)." Maybe they had some corporations and LLCs, but the case only references were to LLCs (limited liability companies).

But wait, it gets worse:  "Hayden was a minority shareholder in, and the parties had no operating agreement regarding, Success."  Recall that Success is an LLC. There should not be shareholders in an LLC. Members owning membership interests, yes. Shareholders, no. 

Apparently, Success was anything but, with Hayden and Estes being sued multiple times related to residential home construction where fraudulent conduct was alleged. Hayden sued Estes to dissolve and wind down all the parties’ business entities claiming a pattern of fraudulent conduct by Estes. Ultimately, the two entered a settlement agreement related to (among other things) back taxes, including an escrow account, which was (naturally) insufficient to cover the tax liability.  This case followed, with Estes seeking contribution from Hayden, while Hayden claimed he had been released. 

Estes paid the excess tax liability and filed a complaint against Hayden, "arguing Hayden’s breach of the Success partnership agreement and that Estes never agreed to assume one hundred percent of any remaining tax liabilities of Success." Now there is a partnership agreement?  Related to the minority shareholder's obligations to an LLC?  [Banging head on desk.] 

The entity structures to these business arrangements are a mess, and it makes the opinion kind of a mess, though I would suggest the court could have at least tried to straighten it out a bit.  It even appears that the court got a little turned around, as it states, "While Estes may have at one time been liable for a portion of Success’s tax liabilities incurred from 2006 to 2010, once the parties signed the Settlement Agreement, his liability ended pursuant to the release provisions contained therein."  I think they meant that Hayden may have been liable but no longer was following the release, especially given that the court affirmed the grant of summary judgment to Hayden.  

For what it's worth, it appears that the court analyzed the release correctly, so the resolution on the merits is likely proper. Still, blindly adopting the careless entity-related language of the litigants is frustrating, at a minimum.  But it does give me something else to write about. As long as these case keeping showing up, and they will keep showing up, Prof. Bainbridge need not wonder, "Is legal blogging dead?"  Not for me, and I don't think for those of us here at BLPB, anyway. 
 



 

December 18, 2018 in Contracts, Corporations, Joshua P. Fershee, Lawyering, Litigation, LLCs, Partnership | Permalink | Comments (0)

Wednesday, December 5, 2018

Service of Process for LLCs (Which Are Still Not Corporations)

I just don't get the fascination that courts have with calling LLCs (limited liability companies) limited liability corporations. Yes, at this point, I can no longer claim to be surprised, but I can remain appalled/disappointed/frustrated/etc. Today I happened upon a U.S. District Court case from Florida that made just such an error.  This one bugs me, in part, because the court's reference immediately precedes a quotation of the related LLC statute, which repeatedly refers to the "limited liability company."  It's right there! 
 
That said, the court assesses the situation appropriately, and (I think) gets the law and outcome right.  The court explains: 
In this case, Commerce and Industry served the summons on Southern Construction by serving the wife of the manager of Southern Construction. Doc. No. 10. Because Southern Construction is a limited liability corporation, service is proper under Fla. Stat. § 48.062 . . . .
*2 (1) Process against a limited liability company, domestic or foreign, may be served on the registered agent designated by the limited liability company under chapter 605. A person attempting to serve process pursuant to this subsection may serve the process on any employee of the registered agent during the first attempt at service even if the registered agent is a natural person and is temporarily absent from his or her office.
(2) If service cannot be made on a registered agent of the limited liability company because of failure to comply with chapter 605 or because the limited liability company does not have a registered agent, or if its registered agent cannot with reasonable diligence be served, process against the limited liability company, domestic or foreign, may be served:
 
(a) On a member of a member-managed limited liability company;
(b) On a manager of a manager-managed limited liability company; or
(c) If a member or manager is not available during regular business hours to accept service on behalf of the limited liability company, he, she, or it may designate an employee of the limited liability company to accept such service. After one attempt to serve a member, manager, or designated employee has been made, process may be served on the person in charge of the limited liability company during regular business hours.
 
(3) If, after reasonable diligence, service of process cannot be completed under subsection (1) or subsection (2), service of process may be effected by service upon the Secretary of State as agent of the limited liability company as provided for in s. 48.181.
In the proof of service, the process server attests that he served Kenneth W. Jordan, the manager of Southern Construction, by serving Kimberly Jordan, Kenneth Jordan’s wife, at an address in Midway, Georgia. Doc. No. 10. Neither the process server nor counsel for Commerce and Industry provided any evidence that Southern Construction did not have a registered agent or, if it did, that service could not be made on the registered agent. There is also no evidence that Kimberly Jordan is a member, a manager or an employee of Southern Construction designated to accept service. Finally, there is no evidence regarding the address at which service was made, i.e., at the office of the registered agent, at the office of Southern Construction or at a residence. Therefore, based on the present record, the Court cannot conclude that service of process has been properly perfected.
COMMERCE & INDUSTRY INSURANCE COMPANY, Plaintiff, v. SOUTHERN CONSTRUCTION LABOR SERVICES, LLC, Defendant., No. 617CV965ORL31KRS, 2017 WL 10058577, at *1–2 (M.D. Fla. July 26, 2017) (emphasis added). 
 
The court here gets this right by both following the procedures (e.g., the presumption is to serve the LLC's agent) and the also does not make any assumptions that a spouse is a member or employee, so that's a good one.  This case led me to take a look at my home state's process rules for LLCs. 
 
West Virginia's process is less clear.  For example, West Virginia's rules for service of process do not include a mention of LLCs specifically. The rules provide for service to a "domestic private corporations" and "unincorporated associations" (among others). For a domestic private corporation, service can be completed by serving "an officer, director, or trustee thereof; or, if no such officer, director, or trustee be found, by delivering a copy thereof to any agent of the corporation . . . ." or by serving an authorized agent or attorney.  

Service of unincorporated associations is much more complicated.  Service is made 

Upon an unincorporated association which is subject to suit under a common name, by delivering a copy of the summons and complaint to any officer, director, or governor thereof, or by delivering or mailing in accordance with paragraph (1) above a copy of the summons and complaint to any agent or attorney in fact authorized by appointment or by statute to receive or accept service in its behalf; or, if no such officer, director, governor, or appointed or statutory agent or attorney in fact be found, then by delivering or mailing in accordance with paragraph (1) above a copy of the summons and complaint to any member of such association and publishing notice of the pendency of such action once a week for two successive weeks in the newspaper of general circulation in the county wherein such action is pending. Proof of publication of such notice is made by filing the publisher’s certificate of publication with the court.

Does a manager count as an officer or director? A quick look at cases did not answer that question, but it would seem to me the answer should be "no." Obviously, the easiest way to do complete service would be to serve an LLC's agent or attorney, if either can be found.  But if you have to serve a "member," one must deliver the summons and complaint to the member AND "publish[] notice of the pendency of such action once a week for two successive weeks in the newspaper of general circulation in the county wherein such action is pending." Old school. Anyway, it seems to me that it is high time for West Virginia to specifically recognize LLCs and other entity forms in the Rules of Civil Procedure.   

December 5, 2018 in Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Tuesday, November 27, 2018

Not the Default Rule, But LLC Members Definitely Can Be Employees

Last week I posted Can LLC Members Be Employees? It Depends (Because of Course It Does), where I concluded that "as far as I am concerned, LLC members can also be LLCs employees, even though the general answer is that they are not. " I thought I would follow up today with an example of an LLC member who is also an employee.  

I am not teaching Business Associations until next semester, but it galls me a little that I did not note this case last week, as it is a case that I teach as part of the section on fiduciary duties in Delaware.  

The case is Fisk Ventures, LLC v. Segal and the relevant facts excerpted from the case are as follows: 
Genitrix, LLC, is a Delaware limited liability company formed to develop and market biomedical technology. Dr. Segal founded the Company in 1996 following his postdoctoral fellowship at the Whitehead Institute for Biomedical Research. Originally formed as a Maryland limited liability company, Genitrix was moved in 1997 to Delaware at the behest of Dr. H. Fisk Johnson, who invested heavily. 
Equity in Genitrix is divided into three classes of membership. In exchange for the patent rights he obtained from the Whitehead Institute, Segal's capital account was credited with $500,000. This allowed him to retain approximately 55% of the Class A membership interest. . . . 
 
Under the [LLC] Agreement, the Board of Member Representatives (the “Board”) manages the business and affairs of the Company. As originally contemplated by the Agreement, the Board consisted of four members: two of whom were appointed by Johnson and two of whom were appointed by Segal. In early 2007, however, the balance of power seemingly shifted. . . . 
 
Dr. Andrew Segal, fresh out of residency training, worked for the Whitehead Institute for Biomedical Research . . . [and when he] left the Whitehead Institute and obtained a license to certain patent rights related to his research.
With these patent rights in hand, Dr. Segal formed Genitrix. Intellectual property rights alone, however, could not fund the research, testing, and trials necessary to bring Dr. Segal's ideas to some sort of profitable fruition. Consequently, Segal sought and obtained capital for the Company. Originally, Segal served as both President and Chief Executive Officer, and the terms of his employment were governed by contract (the “Segal Employment Agreement”). Under the Segal Employment Agreement, any intellectual property rights developed by Dr. Segal during his tenure with Genitrix would be assigned to the Company.

Fisk Ventures, LLC v. Segal, No. CIV.A. 3017-CC, 2008 WL 1961156, at *2 (Del. Ch. May 7, 2008) (emphasis added) (footnotes omitted).  

So, for my purposes, that's a solid example of an LLC member who is also an employee, and it is from a case featured in more than one casebook, I might add.  

Co-blogger Joan Heminway noted in a comment to last week's post that what it means to be an employee can vary, based on statutory and other conditions, which is certainly true. I stand by my prior conclusion that it depends on the case whether a particular member of an LLC is an employee, and even that can vary based on context.  Thus, LLC members are not inherently employees, and perhaps most of the time they are not, but it's also true that LLC members can be employees. 

Finally, as to the Fisk Ventures case, in case you're curious, the short of it is that Fisk decided not to provide additional financing to Genitirx, and Segal sued claimed that not doing so breached certain fiduciary duties under the LLC agreement and further various acts "tortiously interfered with the Segal Employment Agreement."  Ultimately, Chancellor Chandler determined that there was no duty breached, the obligation of good faith and fair dealing did not block certain members from exercising express contractual rights, and the agreement's clause disclaming any fiduciary duties was valid.  

 

November 27, 2018 in Contracts, Delaware, Joshua P. Fershee, LLCs | Permalink | Comments (3)

Tuesday, November 20, 2018

Can LLC Members Be Employees? It Depends (Because of Course It Does)

Tom Rutledge posts the following over at the Kentucky Business Entity Law Blog:

LLC Members Are Not the LLC’s Employees

There is now pending before the Eighth Circuit Court of Appeals of a suit that may turn on whether the relevant question, namely whether an LLC member is an employee of the LLC, has already been determined by a state court. In that underlying judgment, the Circuit Court of Cole County, Missouri, issued a judgment dated October 9 18, 2017 in the case Joseph S. Vaughn Kaenel v. Warren, Case No.: 15 AC-CC 00472. That judgment provided in part:

As an equity partner of Armstrong Teasdale, LLP, [Kaenel] is not a covered employee protected by the Missouri Human Rights Act.

I am curious as to which case this is that is pending.  Tom knows his stuff and knows (and respects) the differences between entities, so I assume there is more to than appears here.  

For example, the fact that a state court determined that an LLP equity partner is not an employee does not inherently answer the question of whether an LLC member is an employee. It could, but it does not have to do so.  

In addition, I'd want to know more about the relationship between the LLC member and the entity.  I am inclined to agree that an LLC member is not generally an employee merely by virtue of being a member.  But I am also of the mind that an LLC member could also be an employee.  In fact, there are times when counsel would be wise to advise a client who is an LLC member to also get an employment contract is she wishes to get paid.  I am assuming there is not an employment contract here for the Eighth Circuit case. 

However, suppose in the operating agreement all the members agree to pay one member for certain services. Or perhaps the compensated member gets priority payouts because of her agreement to do certain work for the entity.  That would, as far as I am concerned, at least muddy the waters.

I'll be interested to see where this one goes (and, perhaps, what I have missed). But as far as I am concerned, LLC members can also be LLCs employees, even though the general answer is that they are not.  

November 20, 2018 in Employment Law, Joshua P. Fershee, LLCs, Partnership | Permalink | Comments (2)

Tuesday, November 13, 2018

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

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

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

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

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

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

Tuesday, October 30, 2018

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tuesday, October 9, 2018

Bang Head Here: California and the LLC as a "Corporation"

California drives me nuts with lazy references to LLCs -- "limited liability companies" -- as" limited liability corporations." See, e.g., Dear California: LLCs are Not Corporations. Or Are They?

A 2010 case recently posted to Westlaw provides another example, this time from the local rules for the United States District Court for the Central District of California.  The case deals with an attorney withdrawing as counsel for an LLC, which requires the withdrawing attorney to provide notice to soon-to-be former client YPA, that as

a limited liability company that cannot proceed pro se, its failure to have new counsel file a timely notice of appearance will result in the dismissal of its complaint for failure to prosecute and of the entry of its default on the cross-complaint.

YOUR PERSONAL ASSISTANT, LLC, a Nevada limited liability company, Plaintiff, v. T-MOBILE USA, INC., a Delaware Corp., & DOES 1-100, inclusive. Defendants., No. CV1000783MMMRCX, 2010 WL 11598037, at *3 (C.D. Cal. Apr. 23, 2010)

This is fairly typical, as entities are generally not allowed to appear pro se -- that is reserved as an option for natural persons. However, because of poor drafting, the local rules keep open the possibility that an LLC could appear pro se.  As the court notes in footnote 9, the rules provide:

9. See CA CD L.R. 83-2.10.1 (“[a] corporation including a limited liability corporation, a partnership including a limited liability partnership, an unincorporated association, or a trust may not appear in any action or proceeding pro se.”)

Id. at *3 n.9 (C.D. Cal. Apr. 23, 2010).  The language here refers to an LLC a type of corporation, which, as a general matter, it is not.  A limited liability partnership is a type of partnership (with gaps often filled by partnership law), but corporations and LLCs are, most of the time, separate and distinct entities.
 
image from www.thefrugalhumanist.com
None of this is new, coming from me.  But I'm not giving up, even if I that tree I keep banging my head on is a Redwood. 

October 9, 2018 in Corporations, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (0)

Tuesday, September 4, 2018

Sports Agents, LLCs, and LLPs: You Can't Believe Everything You Read on the Internet

I am teaching Sports Law this semester, which is always fun.  I like to highlight other areas of the law for my students so that they can see that Sports Law is really an amalgamation of other areas: contract law, labor law, antitrust law, and yes, business organizations.  I sometimes cruise the internet for examples to make my point that they really need to have a firm grounding the basics of many areas of law to be a good sports lawyer.  Today, I found a solid example, and not in a good way.  

I found a site providing advice about "How to Start a Sports Agency" at the site https://www.managerskills.org.  This is site is new to me.  Anyway, it starts off okay: 

Ask any successful sports agent: education is the foundation upon which you will build your business. The first step is to earn your bachelor’s degree from an appropriately accredited institution.

. . . .

Once you have obtained your bachelor’s degree, the next step will be to pursue your master’s degree. Alternately, you may choose to pursue a law degree.

While a law degree is not required, the skills you acquire during your studies will be particularly beneficial when it comes to negotiating contracts for your clients. Most major leagues, including the NFL and the NBA, requires their sports agents to possess a master’s degree.

All true. A law degree should also help when it comes to figuring out your entity choice.  The site's advice continues: 

The next step is to choose a professional name for your business and to create a limited liability corporation (LLC). If you have one or more business partners, then you will need to create a limited liability partnership (LLP).

Yikes.  I mean, yikes.  First, an LLC is a limited liability company!

Second,  I believe that after Massachusetts allowed single-member LLCs in 2003, all states allowed the creation of single-member LLCs, so an LLC is an option. An LLP might be an option, and some professional entities for certain lawyers might be an option (or requirement), such as the PLLC or PC.  But the idea that one needs to choose an LLP if there is more than one person participating in the business is flawed. It is correct that to be an LLP, there would need to be more than one person, but this is not transitive.  

Anyway, while not great advice, this gives me some good material for class tomorrow.  I will probably start with, "Don't believe everything you read on the Internet." 

September 4, 2018 in Contracts, Corporations, Joshua P. Fershee, LLCs, Sports | Permalink | Comments (0)

Saturday, September 1, 2018

Should Corporate Lawyers and Business Law Professors Be Talking About DAOs?

Did I lose you with the title to this post? Do you have no idea what a DAO is? In its simplest terms, a DAO is a decentralized autonomous organization, whose decisions are made electronically by a written computer code or through the vote of its members. In theory, it eliminates the need for traditional documentation and people for governance. This post won't explain any more about DAOs or the infamous hack of the Slock.it DAO in 2016. I chose this provocative title to inspire you to read an article entitled Legal Education in the Blockchain Revolution.

The authors Mark Fenwick, Wulf A. Kaal, and Erik P. M. Vermeulen discuss how technological innovations, including artificial intelligence and blockchain will change how we teach and practice law related to real property, IP, privacy, contracts, and employment law. If you're a practicing lawyer, you have a duty of competence. You need to know what you don't know so that you avoid advising on areas outside of your level of expertise. It may be exciting to advise a company on tax, IP, securities law or other legal issues related to cryptocurrency or blockchain, but you could subject yourself to discipline for doing so without the requisite background. If you teach law, you will have students clamoring for information on innovative technology and how the law applies. Cornell University now offers 28 courses on blockchain, and a professor at NYU's Stern School of Business has 235 people in his class. Other schools are scrambling to find professors qualified to teach on the subject. 

To understand the hype, read the article on the future of legal education. The abstract is below:

The legal profession is one of the most disrupted sectors of the consulting industry today. The rise of Legal Tech, artificial intelligence, big data, machine learning, and, most importantly, blockchain technology is changing the practice of law. The sharing economy and platform companies challenge many of the traditional assumptions, doctrines, and concepts of law and governance, requiring litigators, judges, and regulators to adapt. Lawyers need to be equipped with the necessary skillsets to operate effectively in the new world of disruptive innovation in law. A more creative and innovative approach to educating lawyers for the 21st century is needed.

For more on how blockchain is changing business and corporate governance, come by my talk at the University of Tennessee on September 14th where you will also hear from my co-bloggers. In case you have no interest in my topic, it's worth the drive/flight to hear from the others. The descriptions of the sessions are below:

Session 1: Breach of Fiduciary Duty and the Defense of Reliance on Experts

Many corporate statutes expressly provide that directors in discharging their duties may rely in good faith upon information, opinions, reports, or statements from officers, board committees, employees, or other experts (such as accountants or lawyers). Such statutes often come into play when directors have been charged with breaching their procedural duty of care by making an inadequately informed decision, but they can be applicable in other contexts as well. In effect, the statutes provide a defense to directors charged with breach of fiduciary duty when their allegedly uninformed or wrongful decisions were based on credible information provided by others with appropriate expertise. Professor Douglas Moll will examine these “reliance on experts” statutes and explore a number of questions associated with them.

Session 2: Fact or Fiction: Flawed Approaches to Evaluating Market Behavior in Securities Litigation

Private fraud actions brought under Section 10(b) of the Securities Exchange Act require courts to make a variety of determinations regarding market functioning and the economic effects of the alleged misconduct. Over the years, courts have developed a variety of doctrines to guide how these inquiries are to be conducted. For example, courts look to a series of specific, pre-defined factors to determine whether a market is “efficient” and thus responsive to new information. Courts also rely on a variety of doctrines to determine whether and for how long publicly-available information has exerted an influence on security prices. Courts’ judgments on these matters dictate whether cases will proceed to summary judgment and trial, whether classes will be certified and the scope of such classes, and the damages that investors are entitled to collect. Professor Ann M. Lipton will discuss how these doctrines operate in such an artificial manner that they no longer shed light on the underlying factual inquiry, namely, the actual effect of the alleged fraud on investors.

Session 3: Lawyering for Social Enterprise

Professor Joan Heminway will focus on salient components of professional responsibility operative in delivering advisory legal services to social enterprises. Social enterprises—businesses that exist to generate financial and social or environmental benefits—have received significant positive public attention in recent years. However, social enterprise and the related concepts of social entrepreneurship and impact investing are neither well defined nor well understood. As a result, entrepreneurs, investors, intermediaries, and agents, as well as their respective advisors, may be operating under different impressions or assumptions about what social enterprise is and have different ideas about how to best build and manage a sustainable social enterprise business. Professor Heminway will discuss how these legal uncertainties have the capacity to generate transaction costs around entity formation and management decision making and the pertinent professional responsibilities implicated in an attorney’s representation of such social enterprises.

Session 4: Beyond Bitcoin: Leveraging Blockchain for Corporate Governance, Corporate Social Responsibility, and Enterprise Risk Management

Although many people equate blockchain with bitcoin, cryptocurrency, and smart contracts, Professor Marcia Narine Weldon will discuss how the technology also has the potential to transform the way companies look at governance and enterprise risk management. Companies and stock exchanges are using blockchain for shareholder communications, managing supply chains, internal audit, and cybersecurity. Professor Weldon will focus on eliminating barriers to transparency in the human rights arena. Professor Weldon’s discussion will provide an overview of blockchain technology and how state and nonstate actors use the technology outside of the realm of cryptocurrency.

Session 5: Crafting State Corporate Law for Research and Review

Professor Benjamin Edwards will discuss how states can implement changes in state corporate law with an eye toward putting in place provisions and measures to make it easier for policymakers to retrospectively review changes to state law to discern whether legislation accomplished its stated goals. State legislatures often enact and amend their business corporation laws without considering how to review and evaluate their effectiveness and impact. This inattention means that state legislatures quickly lose sight of whether the changes actually generate the benefits desired at the time off passage. It also means that state legislatures may not observe stock price reactions or other market reactions to legislation. Our federal system allows states to serve as the laboratories of democracy. The controversy over fee-shifting bylaws and corporate charter provisions offers an opportunity for state legislatures to intelligently design changes in corporate law to achieve multiple state and regulatory objectives. Professor Edwards will discuss how well-crafted legislation would: (i) allow states to compete effectively in the market for corporate charters; and (ii) generate useful information for evaluating whether particular bylaws or charter provisions enhance shareholder wealth.

Session 6: An Overt Disclosure Requirement for Eliminating the Duty of Loyalty

When Delaware law allowed parties to eliminate the duty of loyalty for LLCs, more than a few people were appalled. Concerns about eliminating the duty of loyalty are not surprising given traditional business law fiduciary duty doctrine. However, as business agreements evolved, and became more sophisticated, freedom of contract has become more common, and attractive. How to reconcile this tradition with the emerging trend? Professor Joshua Fershée will discuss why we need to bring a partnership principle to LLCs to help. In partnerships, the default rule is that changes to the partnership agreement or acts outside the ordinary course of business require a unanimous vote. See UPA § 18(h) & RUPA § 401(j). As such, the duty of loyalty should have the same requirement, and perhaps that even the rule should be mandatory, not just default. The duty of loyalty norm is sufficiently ingrained that more active notice (and more explicit consent) is necessary, and eliminating the duty of loyalty is sufficiently unique that it warrants unique treatment if it is to be eliminated.

Session 7: Does Corporate Personhood Matter? A Review of We the Corporations

Professor Stefan Padfield will discuss a book written by UCLA Law Professor Adam Winkler, “We the Corporations: How American Businesses Won Their Civil Rights.” The highly-praised book “reveals the secret history of one of America’s most successful yet least-known ‘civil rights movements’ – the centuries-long struggle for equal rights for corporations.” However, the book is not without its controversial assertions, particularly when it comes to its characterizations of some of the key components of corporate personhood and corporate personality theory. This discussion will unpack some of these assertions, hopefully ensuring that advocates who rely on the book will be informed as to alternative approaches to key issues.

 

September 1, 2018 in Ann Lipton, Compliance, Conferences, Contracts, Corporate Governance, Corporate Personality, Corporations, Current Affairs, Employment Law, Human Rights, Intellectual Property, International Business, Joan Heminway, Joshua P. Fershee, Law School, Lawyering, LLCs, Marcia Narine Weldon, Real Property, Shareholders, Social Enterprise, Stefan J. Padfield, Teaching, Technology, Web/Tech | Permalink | Comments (0)

Wednesday, August 29, 2018

California Court Misplays Smackdown: LLCs Are Still Not Corporations

In a recent California appellate opinion disposing of the second appeal of an earlier judgment seems to have the court irritated.  It does appear the appellant was trying to relitigate a decided issue, so perhaps that's right.  But the court makes its own goof.  After referring repeatedly to the "limited liability company" at issue, the court then goes down a familiar, and disappointing, path.  The court explains: 

In any event, the Supreme Court opinion which Foster contends we disregarded, Essex Ins. Co. v. Five Star Dye House, Inc. (2006) 38 Cal.4th 1252, 1259, has no relevance here. Essex decided whether an assignee of a bad faith claim could also recover attorney fees. (Ibid.) This holding has nothing to do with whether a limited liability corporation may assign its appellate rights in an improper attempt to circumvent the rules requiring corporations to be represented by attorneys.

JENNITA FOSTER, Plaintiff & Appellant, v. OLD REPUBLIC DEFAULT MANAGEMENT SERVICES, Defendant & Respondent., No. B280006, 2018 WL 4075910, at *2 (Cal. Ct. App. Aug. 27, 2018) (emphasis added).  
 
It's not clear whether Essex Insurance Company is an LLC or a corporation, though it's a strong bet it is a corporation. (A search of California entities and a quick look at the docket were inconclusive.) Regardless, I know that case does not discuss LLCs and that the instant case definitely deals with a "limited liability company."  It is "unpublished/noncitable," according to Westlaw, so I guess that's good, but it is still out there. 
 
Ultimately, the court's apparent frustration seems warranted, but it is a little ironic (and a bit amusing) that the court misstates the entity type in the smackdown.  

August 29, 2018 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (2)

Tuesday, August 21, 2018

ABA LLC Institute - It's Almost That Time Again . . . . Yay!

This post notifies/reminds everyone that the American Bar Association's LLCs, Partnerships and Unincorporated Entities Committee will be hosting its annual LLC (that's limited liability company, Josh!) Institute on October 11 and 12, 2018 in Washington, D.C.  The 2018 program is being held at the Westin Washington, D.C. City Center.  Registration can be accomplished here.

For those of you who have not been to this unique ABA program, to consists of a enticing, manageable, substantive programs.  The audience is very participatory; lots of questions are raised and comments are freely given.  Presenting in front of this group is pure joy, unless you have insufficient knowledge or are unprepared.  I try to put this into my fall schedule every few years.  I always learn something there.

This year's agenda includes sessions on tax and choice of entity, recent tax law changes, beneficial ownership reporting, derivative actions, ethical compliance, and charging orders, as well as the two traditional annual favorites, the non-Delaware, Delaware, and bankruptcy case summaries offered by Baylor Law's Beth Miller.  In addition to Beth, from the academic side of the aisle, Duke Law's Deborah DeMott is participating in the session on derivative actions, and B.U. Law's  Nancy Moore will be addressing issues relating to ethical compliance.  (The compliance session comes with a particularly attractive title--at least in the version of the schedule sent to me: Ethics: The Top 15 Things Your Ethics Counsel-Risk Manager Hope You Know (and Hopefully Remember.)

Also, a little birdie (named Tom Rutledge, one of the leaders in organizing the LLC Institute) told me that plans already are in process for the 2019 LLC Institute.  So, if you have ideas for topics that might be covered or speakers that might be appropriate for that program, let me or Tom know.  The program for the LLC Institute always seems so full . . . .  But I know that Tom--one of the nicest and smartest guys around--is receptive to topic and speaker suggestions.

August 21, 2018 in Conferences, Joan Heminway, LLCs | Permalink | Comments (0)

Everyone Wants to Make Non-Corporate Things Corporate: It's Sen. Warren's Turn

Senator Elizabeth Warren last week released her Accountable Capitalism Act. My co-blogger Haskell Murray wrote about that here, as have a number of others, including Professor Bainbridge, who has written at least seven posts on his blogCountless others have weighed in, as well.

There are fans of the idea, others who are agnostic, and still other who thinks it’s a terrible idea. I am not taking a position on any of that, because I am too busy working through all the flaws with regard to entity law itself to even think about the overall Act.

As a critic of how most people view entities, my expectations were low. On the plus side, the bill does not say “limited liability corporation” one time.  So that’s a win. Still, there are a number of entity law flaws that make the bill problematic before you even get to what it’s supposed to do.  The problem: the bill uses “corporation” too often where it means “entity” or “business.”

Let’s start with the Section 2. DEFINITIONS.  This section provides:

 (2) LARGE ENTITY.—

(A) IN GENERAL.—The term ‘‘large entity’’ means an entity that—

(i) is organized under the laws of a State as a corporation, body corporate, body politic, joint stock company, or limited liability company;

(ii) engages in interstate commerce; and

(iii) in a taxable year, according to in- formation provided by the entity to the Internal Revenue Service, has more than $1,000,000,000 in gross receipts.

Okay, so it does list LLCs, correctly, but it does not list partnerships.  This would seem to exclude Master Limited Partnerships (MLPs). The Alerian MLP Indexlist about 40 MLPs with at least a $1 billion market cap.  It also leaves our publicly traded partnerships(PTPs). So, that’s a miss, to say the least. 

Section 2 goes on to define a  

(6) UNITED STATES CORPORATION.—The term “United States corporation’’ means a large entity with respect to which the Office has granted a charter under section 3.

The bill also creates an “Office of United States Corporations,” in Section 3, even though the definitions section clear says a “large entity” includes more than just corporations. 

Next is Section 4, which provides the “Requirement for Large Entities to Obtain Charters.”

LARGE ENTITIES.—

(1) IN GENERAL.— An entity that is organized as a corporation, body corporate, body politic, joint stock company, or limited liability company in a State shall obtain a charter from the Office . . . .”

So, again, the definition does not include MLPs (or any other partnership forms, or coops for that matter) as large entities.  I am not at all clear why the Act would refer to and define “Large Entities,” then go back to using “corporations.”  Odd. 

Later in section 4, we get the repercussions for the failure to obtain a charter: 

An entity to which paragraph (1) applies and that fails to obtain a charter from the Office as required under that paragraph shall not be treated as a corporation, body corporate, body politic, joint-stock company, or limited liability company, as applicable, for the purposes of Federal law during the period beginning on the date on which the entity is required to obtain a charter under that paragraph and ending on the date on which the entity obtains the charter.

Here, the section chooses not to use the large entity definition or the corporation definition and instead repeats the entity list from the definitions section. As a side note, does this section mean that, for “purposes of Federal law,” any statutory “large entity” without a charter is a general partnership or sole proprietorship? I would hope not for the LLC, which isn’t a corporation, anyway.

Finally, in Section 5, the Act provides:

(e) APPLICATION.—

(1) RULE OF CONSTRUCTION REGARDING GENERAL CORPORATE LAW.—Nothing in this section may be construed to affect any provision of law that is applicable to a corporation, body corporate, body politic, joint stock company, or limited liability company, as applicable, that is not a United States corporation.

Again, I will note that “general corporate law” should not apply to anything but corporations, anyway. LLCs, in particular. 

The Act further contemplates a standard of conduct for directors and officers.  LLCs do not have to have either, at least not in the way corporations do, nor do MLPs/PTPs, which admittedly do not appear covered, anyway. The Act also contemplates shareholders and shareholder suits, which are not a thing for LLCs/MLPs/PTPs because they don’t have shareholders.

This is not an exhaustive list, but I think it’s a pretty good start. I will concede that some of my critiques could be argued another way.  Obviously, I'd disagree, but maybe some of this is not as egregious as I see it. Still, there are flaws, and if this thing is going to move beyond even the release, I sure hope they take the time to get the entity issues figured out. I’d be happy to help.

August 21, 2018 in Corporate Governance, Corporate Personality, Corporations, CSR, Joshua P. Fershee, Legislation, LLCs, Management, Partnership, Shareholders, Unincorporated Entities | Permalink | Comments (0)

Tuesday, August 14, 2018

The SEC Needs to Crack Down on Incorrect Entity Types

According to its website,

The U. S. Securities and Exchange Commission (SEC) has a three-part mission:

  • Protect investors
  • Maintain fair, orderly, and efficient markets
  • Facilitate capital formation

I think it needs to add: "Ensure proper entity identification." 

Examples abound. Take this recent 10-Q:

On June 27, 2018, the Company formed a joint venture with Downtown Television, Inc., for the purpose of developing, producing and marketing entertainment content relating to deep-sea exploration, historical shipwreck search, artifact recovery, and expounding upon the history of these shipwrecks.  The joint venture is being formed as a new limited liability corporation that will be 50% owned each by EXPL and Downtown, and has been named Megalodon Entertainment, LLC. (“Megalodon”), as is further described in Note B. 

Endurance Exploration Group, Inc., SEC 10-Q, for the quarterly period ended: June 30, 2018 (emphasis added). 

Side note: That 10-Q, I will note, raised some other questionable decisionmaking, as it goes on to report: 

NOTE B – JOINT VENTURE

EXPL Swordfish, LLC

Effective January 9, 2017, the Company, through a newly formed, wholly owned subsidiary, EXPL Swordfish, LLC (“EXPL Swordfish”), entered into a joint-venture agreement (“Agreement”) with Deep Blue Exploration, LLC, d/b/a Marex (“Marex”).  The joint venture between EXPL Swordfish and Marex is referred to as Swordfish Partners.

As near as I can tell, Swordfish Partners is what it says it is, a partnership formed as a joint venture for a unique purpose.  This is fascinating to me.  Why would a company filing quarterly reports with the SEC not choose to take the time to create an LLC for the joint venture? I'm not a maritime expert, though I did participate in Tulane Law School's program with the Aegean Institute of the Law of the Sea and Maritime Law many years ago. I simply cannot come up with a good reason not to create a limited liability entity for the joint venture.  I know there are times when it makes sense (or is not a concern), but this doesn't seem like one of those times. 

I did a quick look for some other entity issues in SEC filings. There are many more, but this is what the Google machine provided in a quick search:

  • From Core Moldings Technologies, Inc. Schedule 13D (Aug. 8, S018): "GGCP Holdings is a Delaware limited liability corporation having its principal business office at 140 Greenwich Avenue, Greenwich, CT 06830."   
  • From Financial Engines, Inc. Form 8-K, Jan. 28, 2016: "On February 1, 2016, Financial Engines, Inc. (“Financial Engines”) completed the previously announced acquisition of Kansas City 727 Acquisition LLC, a Delaware limited liability corporation ...."
  • Limited Liability Company Agreement of Artist Arena International, LLC, Exhibit 3.206"This Limited Liability Company Agreement (this “Agreement”) of Artist Arena International, LLC, a New York limited liability company (the “Company”), dated as of January 4, 2011, is adopted and entered into by Artist Arena LLC., a New York limited liability corporation (the “Member” or “AA”), pursuant to and in accordance with the Limited Liability Company Law of the State of New York, Article 2, §§ 201-214, et seq., as amended from time to time (the “Act”)."
  • CloudCommerce, Inc., Form 8-K, October 1, 2015: "Certificate of Merger of Domestic Corporation and Foreign Limited Liability Corporation between Warp 9, Inc., a Delaware corporation, and Indaba Group, LLC, a Colorado limited liability company."

I swear we can do better.  Really.  

August 14, 2018 in Corporations, Joshua P. Fershee, LLCs, Securities Regulation | Permalink | Comments (0)

Tuesday, August 7, 2018

A Missed "sic", A Big Bank, and LLCs Are Still Not Corporations

It's not just judges and lawyers. Big banks, too, are apparently not committed to clear and accurate language when it comes to LLCs (limited liability companies).  A recent antitrust case provides an excerpt from a Barclays Settlement Agreement that states:

Paragraph 2(cc) of the Barclays Settlement Agreement defines “Person” as: “An individual, corporation, limited liability corporation, professional corporation, limited liability partnership, partnership, limited partnership, association, joint stock company, estate, legal representative, trust, unincorporated association, municipality, state, state agency, any entity that is a creature of any state, any government or any political subdivision, authority, office, bureau or agency of any government, and any business or legal entity, and any spouses, heirs, predecessors, successors, representatives, or assignees of the foregoing.” Barclays Settlement Agreement ¶ 2(cc).

In re LIBOR-Based Fin. Instruments Antitrust Litig., No. 11 CIV. 5450, 2018 WL 3677875, at *20 (S.D.N.Y. Aug. 1, 2018) (emphasis added). 
 
I checked to see if this was the court's error, but I found a link to what appears to be the settlement agreement, and it, too, includes "limited liability corporation" in paragraph (cc)'s definition.  Given that it is an error in the original, the judge, or at least the judge's clerks, missed an opportunity for an appropriately placed "[sic]," which more than a few lawyers in my experience have relished the opportunity to insert. 
 
I did a little poking around and found that some Barclays' divisions know and honor the distinction.  For example, a 2014 settlement agreement between  Federal Housing Finance Agency and "Barclays Bank PLC, Barclays Capital Inc. ('Barclays Capital'), and Securitized Asset Backed Receivables LLC (collectively, the Barclays Corporate Defendants')" (as well as some other defendants) provides (emphasis added): 

(h) “Person” means an individual, corporate entity, partnership, association, joint stock company, limited liability company, estate, trust, government entity (or any political subdivision or agency thereof) and any other type of business or legal entity . . . .

I guess beyond judges and lawyers, I should extend my An LLC Checklist Proposal to bankers, as well.  We can get this right, I swear.  It's just going to take some work. 
 

August 7, 2018 in Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Tuesday, July 24, 2018

Avengers Take Note: Hydra Is an LLC, But Not a Corporation

An Illinois appellate court decision that was just made available on Westlaw provides some revealing insight into Hydra, the longtime source of evil that many recognize from Captain America: The First Avenger

Hydra stated that Hydra's manager is Ahuva Horowitz, defendant's wife, and that she owns 100% of the membership interests of Hydra a limited liability corporation.

Xcel Supply LLC v. Horowitz, 2018 IL App (1st) 162986, ¶ 14, 100 N.E.3d 557, 561, reh'g denied (Mar. 9, 2018) (emphasis added). 

First, let's correct the record: Hydra is listed as an LLC, a limited liability company. It is not a corporation.  

Second, I should also note, after further review, it's not really THAT Hydra. It is apparently not this one:

In a prehuman time, a cabal of cold-blooded alien reptiles arrived on Earth, planning to start a legacy of evil. They planted the seed that would later gave birth to future evil empires. 

So, instead, the instant Hydra is Hydra Properties, LLC, which came into existence in 2009. That makes more sense, but it's a lot less interesting.  

Still, either way, and for either Hydra, if it's Hydra LLC, it's not a corporation.  

July 24, 2018 in Corporations, Film, Joshua P. Fershee, LLCs, Unincorporated Entities | Permalink | Comments (0)

Tuesday, June 26, 2018

Call for Papers: Respecting the Entity: The LLC Grows Up (AALS 2019)

Call for Papers for

Section on Agency, Partnership, LLCs and Unincorporated Associations on

Respecting the Entity: The LLC Grows Up

at the 2019 AALS Annual Meeting

The AALS Section on Agency, Partnership, LLCs and Unincorporated Associations is pleased to announce a Call for Papers from which up to two additional presenters will be selected for the section’s program to be held during the AALS 2019 Annual Meeting in New Orleans on Respecting the Entity: The LLC Grows Up.  The program will explore the evolution of the limited liability company (LLC), including subjects such as the LLCs rise to prominence as a leading entity choice (including public LLCs and PLLCs), the role and impact of series LLCs, and differences in various LLC state law rights and obligations. The program will also consider ethics and professional responsibility and governance raised by the LLC. The Section is particularly seeking papers that discuss the role of the LLC as a unique entity (or why it is not).

The program is tentatively scheduled to feature:

  • Beth Miller, M. Stephen and Alyce A. Beard Professor of Business and Transactional Law, Baylor Law
  • Tom Rutledge, Member, Stoll Keenon Ogden PLLC, Louisville, KY

Our Section is proud to partner with the following co-sponsoring sections:

  • AALS Section on Business Associations
  • AALS Section on Transactional Law and Skills

Submission Information:

Please submit an abstract or draft of an unpublished paper to Joshua Fershee,Joshua.Fershee@mail.wvu.edu on or before August 1, 2018. Please remove the author’s name and identifying information from the paper that is submitted. 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 25, 2018. 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: Joshua Fershee, West Virginia University College of Law, Joshua.Fershee@mail.wvu.edu or (304) 293-2868.

June 26, 2018 in Agency, Call for Papers, Conferences, Joshua P. Fershee, LLCs, Writing | Permalink | Comments (0)

Tuesday, June 12, 2018

A Private Ordering and Dual Class Share Structures in IPOs (and Beyond)

Bernie Sharfman's paper, A Private Ordering Defense of a Company's Right to Use Dual Class Share Structures in IPOs, was just published, and I think he has a point. In fact, as I read his argument, I think it is consistent with arguments I have made about the difference between restrictions or unconventional terms or practices that exist at purchase versus such changes that are added after one becomes a member or shareholder.  Here's the abstract: 

The shareholder empowerment movement (movement) has renewed its effort to eliminate, restrict or at the very least discourage the use of dual class share structures in initial public offerings (IPOs). This renewed effort was triggered by the recent Snap Inc. IPO that utilized non-voting stock. Such advocacy, if successful, would not be trivial, as many of our most valuable and dynamic companies, including Alphabet (Google) and Facebook, have gone public by offering shares with unequal voting rights.

Unless there are significant sunset provisions, a dual class share structure allows insiders to maintain voting control over a company even when, over time, there is both an ebbing of superior leadership skills and a significant decline in the insiders’ ownership of the company’s common stock. Yet, investors are willing to take that risk even to the point of investing in dual class shares where the shares have no voting rights and barely any sunset provisions, such as in the recent Snap Inc. IPO. Why they are willing to do so is a result of the wealth maximizing efficiency that results from the private ordering of corporate governance arrangements and the understanding that agency costs are not the only costs of governance that need to be minimized.

In this essay, Zohar Goshen and Richard Squire’s newly proposed “principal-cost theory,” “each firm’s optimal governance structure minimizes the sum of principal costs, produced when investors exercise control, and agent costs, produced when managers exercise control,” is used to argue that the use of dual class shares in IPOs is a value enhancing result of private ordering, making the movement’s renewed advocacy unwarranted.

The recommended citation is Bernard S. Sharfman, A Private Ordering Defense of a Company's Right to Use Dual Class Share Structures in IPOs, 63 Vill. L. Rev. 1 (2018).

I find his argument compelling, as I lean toward allowing contracting parties to enter into agreements as they so choose. I find this especially compelling at start-up or the IPO stage.  I might take a more skeptical view of changes made after start-up. That is, if dual-class shares are voted created after an IPO by the majority insiders, there is a stronger bait-and-switch argument. Even in that case, if the ability to create dual-class shares by majority vote was allowed by the charter/bylaws, it might be reasonable to allow such a change, but I also see a self-dealing argument to do such a thing post-IPO. At the outset, though, if insiders make clear that, to the extent that a dual-class share structure is self-dealing, the offer to potential purchasers is, essentially, "if you want in on this company, these are our terms." I can work with that. 

This is consistent with my view of other types of disclosure. For example, in my post: Embracing Freedom of Contract in the LLC: Linking the Lack of Duty of Loyalty to a Duty of Disclosure, I discussed the ability to waive the duty of loyalty in Delaware LLCs:

At formation . . . those creating an LLC would be allowed to do whatever they want to set their fiduciary duties, up to and including eliminating the consequences for breaches of the duty of loyalty.  This is part of the bargain, and any member who does not agree to the terms need not become a member.  Any member who joins the LLC after formation is then on notice (perhaps even with an affirmative disclosure requirement) that the duty of loyalty has been modified or eliminated.

It was my view, and remains my view, that there some concerns about such changes after one becomes a member that warrant either restrictions or at least some level of clear disclosures of the possibility of such a change after the fact, though even in that case, perhaps self-dealing protections in the form of the obligations of good faith and fair dealing would be sufficient. 

Similarly, in my 2010 post, Philanthropy as a Business Model: Comparing Ford to craigslist, I explained: 

I see the problem for Henry Ford to say, in essence, that his shareholders should be happy with what they get and that workers and others are more his important to him than the shareholders. However, it would have been quite another thing for Ford to say, “I, along with my board, run this company the way I always have: with an eye toward long-term growth and stability. That means we reinvest many of our profits and take a cautious approach to dividends because the health of the company comes first. It is our belief that is in the best interest of Ford and of Ford’s shareholders.”

For Ford, there seemed to be something of a change in the business model (and how the business was operated with regard to dividends) once the Dodge Brothers started thinking about competing. All of a sudden, Ford became concerned about community first. For craigslist, at least with regard to the concept of serving the community, the company changed nothing. And, in fact, it seems apparent that craiglist’s view of community is one reason, if not the reason, it still has its “perch atop the pile.”

Thus, while it is true craigslist never needed to accept eBay’s money, eBay also knew exactly how craigslist was operated when they invested. If they wanted to ensure they could change that, it seems to me they should have made sure they bought a majority share.  

I understand some of the concern about dual-class shares and other mechanisms that facilitate insider control, but as long as the structure of the company is clear when the buyer is making the purchase decision, I'm okay with letting the market decide whether the structure is acceptable.  

June 12, 2018 in Corporate Finance, Corporate Governance, Corporations, Joshua P. Fershee, LLCs, Securities Regulation | Permalink | Comments (1)

Tuesday, June 5, 2018

An LLC By Any Other Name, Is Still Not a Corporation

Earlier this week, Keith Paul Bishop observed on his blog, "Professor Joshua Fershee has been fighting the good fight on limited liability company nomenclature, but I fear that he is losing."   I am not willing to concede that I am losing (yet), but I have to concede that I am winning less often than I'd hoped.  

Bishop noted my "helpful checklist" from last week for those writing about LLCs, but he argues, "it may be time to give up the fight and bestow an entirely new name on LLCs that is less likely to be confused with corporations. I am still not ready to give up the fight, but it is an interesting thought, and there are some options.

One path I have proposed before that I think would help: Let Corps Be Corps: Follow-Up on Entity Tax Status.  In that post, I suggested that the IRS should just stop using state-law entity designations, and thus stop having “corporate” tax treatment. I explained:

My proposal is not abolishing corporate tax . . . .  Instead, the proposal is to have entities choose from options that are linked the Internal Revenue Code, and not to a particular entity. Thus, we would have (1) entity taxation, called C Tax, where an entity chooses to pay tax at the entity level, which would be typical C Corp taxation; (2) pass-through taxation, called K Tax, which is what we usually think of as partnership tax; and (3) we get rid of S corps, which can now be LLCs, anyway, which would allow an entity to choose S Tax

Federal requirements to be eligible for the various tax status options would remain, but the entity type itself would cease to be a consideration. And we'd have to change our language to reflect that. 

But maybe LLCs could be something else. A current problem is that "company" is a synonym for "corporation" in common usage. Thus, it is easy to see why a layperson would think a "limited liability company" is the same thing as a "limited liability corporation."  Of course, there are lots of words that have a broad meaning in common parlance, but a narrower meaning in the legal sense, so it is not inherently problematic to expect lawyers to be able to draw such a distinction. (For example, as a 1L, we learn that assault does not include physical contact, but in general usage, there would be the assumption of contact.) 

Still, what else could we use?  To start, if a change were in the works, I think the "c" needs to go. Otherwise, the assumption will remain that the "c" means "corporation."   Here's an initial list: 

  • LLA: Limited Liability Association
  • LLB: Limited Liability Business
  • LLE: Limited Liability Entity
  • LLG: Limited Liability Group
  • LLO: Limited Liability Operation
  • LLV: Limited Liability Vehicle

It would not need to be, necessarily, something that says "limited liability" as long as that is conveyed.  So perhaps:

  • EOA: Entity Assets Only
  • CLB: Capped Liability Business
  • NIL: No Individual Liability
  • LCI: Losses Capped (at) Investment 
  • ILL: Investment Limited Losses
  • WYSIWYG: What You See Is What You Get
  • AMY or TED:  Just a name. You can assign a name to anything. We could name our entity AMY or TED.  (I considered SUE, but that already has a legal meaning)

I remain committed to trying to educate people so we can keep the current regime and just get it right, but it is good to have options. I welcome alternative ideas or critiques of any of these.  

Long live the LLC! 

June 5, 2018 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (3)