Monday, November 25, 2019
Last Friday, a new opinion from the United States Court of Appeals for the First Circuit tackled a complex application of the Employee Retirement Income Security Act of 1974 (ERISA) law that required an analysis of “federal partnership law,” which assessed whether two entities had created a “partnership-in-fact, as a matter of federal common law.” Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 16-1376, 2019 WL 6243370, at *5 (1st Cir. Nov. 22, 2019). I hate the idea of “federal partnership law,” but I concede it is a thing for determining certain responsibilities under the tax code and ERISA. I still maintain that rather than discussing federal entity law and entity type in these cases, we should instead be discussing liability under certain code sections as they apply to the relevant persons and/or entities. Nonetheless, that’s not the state of the law.
Even though I don’t like the concept of federal partnership law, I can work with it. As such, I think it is fair to ask courts to respect entity types if they are going to insist on using entity types to determine liability. Alas, this is too much to ask. Friday’s opinion explains:
The issue on appeal is whether two private equity funds, Sun Capital Partners III, LP (“Sun Fund III”) and Sun Capital Partners IV, LP (“Sun Fund IV”), are liable for $4,516,539 in pension fund withdrawal liability owed by a brass manufacturing company which was owned by the two Sun Funds when that company went bankrupt. The liability issue is governed by the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”). Under that statute, the issue of liability depends on whether the two Funds had created, despite their express corporate structure, an implied partnership-in-fact which constituted a control group. That question, in the absence of any further formal guidance from the Pension Benefit Guaranty Corporation (“PBGC”), turns on an application of the multifactored partnership test in Luna v. Commissioner, 42 T.C. 1067 (1964).
Id. at *1 (emphasis added). The court continued: “To the extent the Funds argue we cannot apply the Luna factors because they have organized an LLC through which to operate SBI, we reject the argument. Merely using the corporate form of a limited liability corporation cannot alone preclude courts recognizing the existence of a partnership-in-fact.” Id. at *6. (emphasis added).
LLCs are not corporations, and they do not have a corporate form or structure! They are limited liability companies, which are totally different entities from corporations.
It seems I am often saying this, but the court does seem to get to the right conclusion despite the entity errors:
The fact that the entities formally organized themselves as limited liability business organizations under state law at virtually all levels distinguishes this case from Connors and other cases in which courts have found parties to have formed partnerships-in-fact, been under common control, and held both parties responsible for withdrawal liability.
Id. at *8.
That courts tend to get it right, even when using improper entity language, does not mean it’s not a big deal. It simply means that judges (and their clerks) understand the distinctions between entities and entity types, even if their language is not perfect. That seems to be generally okay as applied in the individual cases before each court. However, these cases communicate beyond just the parties involved and could influence poor drafting decisions that could have impacts as between individual members/partners/shareholders down the road. It sure would be great if more courts would take the chance when there is an opportunity to be clear and precise.
Monday, November 18, 2019
It’s been a minute since I took some time to look at whether courts are still treating LLCs as corporations. Spoiler alert: They are. Last week, the Southern District of Florida gave a shining example:
Defendants argue that Vista, a limited liability corporation, is a citizen of any state of which a member of the company is a citizen for diversity purposes. Because the January 26, 2018 written agreement (“Agreement”) granted the PJM Defendants a 10% ownership interest in Vista, Defendants maintain that Vista is a Florida citizen by virtue of the PJM Defendants’ Florida citizenship, thereby destroying complete diversity. . . .
Plaintiffs contend that Vista is a California corporation and complete diversity exists. In support, Plaintiffs proffer Vista’s California LLC records which show that Armen Temurian is the entity’s only member. Defendants argue that these records are self-serving, and that the plain language of the Agreement contradicts these records and establishes the PJM Defendants’ ownership in Vista. . . .
The Agreement expressly recognizes that the PJM Defendants have obtained a 10% ownership of all Vista current and future direct and indirect entities, which contradicts Plaintiffs’ proffered California LLC records on their face. . . . Because Vista is a citizen of every state that any member is a citizen of, Vista is a citizen of Florida, which destroys diversity. The Court therefore does not have diversity jurisdiction over this matter.
ARMEN A. TEMURIAN, et al, Plaintiffs, v. PHILLIP A. PICCOLO, JR., et al, Defendants. Additional Party Names: George Foerst, Joseph Reid, K.F.I. Software, Kevin Dalton Johnson, Paul Morris, Travelada, LLC, Vista Techs. LLC, No. 18-CV-62737, 2019 WL 5963831, at *3-*4 (S.D. Fla. Nov. 13, 2019) (emphasis added).
The court seems to arrive at the correct conclusion, though without clearly and properly identifying the entities involved, it’s hard to be sure. Note that here, according to the court, the defendants claim Vista is an LLC ( a limited liability company.) The Plaintiffs replied, the court says, that the company is a “California corporation.” If Vista is an LLC, as it seems to be, and it had members who were also Florida citizens, the court would be correct to find a lack of diversity jurisdiction. Still, it would be a big help if the court would help lay out the facts in an accurate way so that the facts more clearly lead to the legal outcome.
Sunday, November 10, 2019
I have a new(ish) essay that focuses on the concept of eliminating the fiduciary duty in an LLC, as permitted by Delaware law, and what that could mean for future parties. The paper can be found here (new link). When parties A and B get together to create an LLC, if they negotiate to eliminate their fiduciary agreements as to one another, I’m completely comfortable with that. They are negotiating for what they want; they are entering into that entity and operating agreement together of their own free will. So there may be differences in bargaining power—one may be wealthier than the other or have different kinds of power dynamics—but they are entering into this agreement fully aware of what the obligations are and what the options are for somebody in creating this entity.
My concern with eliminating fiduciary obligations comes down the road. That is, how do we make sure that if people are going to disclaim the fiduciary duty of loyalty, particularly, what happens if this change is made after formation? In such a case, I like to look at our traditional partnership law, which says there are certain kinds of decisions, at least absent an agreement to the contrary, that have to go to the entire group of entity participants. That is, a majority vote is not sufficient; there is essentially a minority veto.
I like the freedom of contract elimination of fiduciary duties provides, but I also am sensitive to the risks such eliminations can provide. Thus, I argue that Delaware (and other states allowing reduction or elimination of the duty of loyalty) should require an express statement about the fiduciary duties (when modified from the default) and an express statement of how those duties can be modified, whether expanding, restricting, or eliminating the duties. To protect against the predatory modification of fiduciary duties, I believe that states should include a statutory requirement that changes to fiduciary duties must be express. Here’s my proposal:
Any limited liability company agreement that provides for a modification of the default rules for what constitutes a breach of duties (including fiduciary duties) of a member, manager or other person to a limited liability company, whether to expand, restrict, or eliminate those duties, must expressly state if the modifications are intended to expand, restrict, or eliminate the duties. Any limited liability company agreement that allows the modification of fiduciary duties must state expressly how those modifications can be made and by whom. Absent such any such statement, fiduciary duties may only be modified by agreement of all the members.
Supporting freedom of contract has value, but I also think we need to account for the fact that we did not traditionally allow for the elimination of fiduciary duties. As such, we should make sure that those participating in LLCs should know both what they signed up for initially, and also if the entity has provided the opportunity for a majority to make a fundamental change to traditional duties. This balance, I think, is essential to protecting investor expectations while still allowing for entities to develop the model that best serves the members’ goals.
Monday, October 28, 2019
The recent Tennessee Court of Appeals decision in Mulloy v. Mulloy has me thinking. Here is the case synopsis:
Two brothers formed a limited liability company to own and lease a commercial property. When the tenant sought to expand, both brothers sought to find a suitable space for the tenant to lease. The younger of the two brothers found a property that would ideally suit the tenant’s needs, a fact that was communicated to his brother. The older brother purchased the property through a newly created limited liability company without his younger sibling’s involvement. The older brother’s new limited liability company then leased the new property to the tenant. The younger brother brought a derivative suit against his brother and the newly formed limited liability company, claiming usurpation of a corporate opportunity belonging to the limited liability company that the brothers had formed together and tortious interference with business relationships. The younger brother also claimed unjust enrichment. Following a trial, the chancery court found in favor of the older brother and his newly formed limited liability company and dismissed the complaint. After our review of the record, we affirm.
The facts are quite a bit more complex than that. But you get the idea.
First, let me make Josh Fershee's point for him: limited liability company (LLC) members cannot usurp "corporate" opportunities, since they are not corporations. Indeed, the court in Mulloy repeatedly refers to the doctrine in that way and cites to corporate law precedent we all know and love. This despite an accurate citation to Tennessee's statutory standard for the usurpation of LLC opportunities: requiring members to hold in trust for the LLC "any property, profit or benefit derived by the member in the conduct . . . of the LLC’s business, or derived from a use by the member of the LLC’s property, including the appropriation of any opportunity of the LLC.” Tenn. Code Ann. § 48-249-403(b)(1).
But the big surprise for me was "we affirm." Why? I just kept thinking of Meinhard v. Salmon. Apart from he fact that this case involves a Tennessee LLC and two brothers, the material facts are substantially similar. Yet, the result is different. The Mulloy court reasons that the property acquisition opportunity at issue was not the LLC's, but rather the older brother's (even though the brothers' jointly owned LLC existed to lease property to a specific tenant--the same tenant to which the older brother rents the new property--property that the younger brother originally identified). The court references facts that do help the older brother here. But something just smells wrong about this. The lack of candor in this situation is particularly disturbing.
So, that set me to wondering if there was a way to get that "punctilio of an honor, the most sensitive" back into the judicial sightline. Immediately, I thought of Anderson v. Wilder--a 2003 Tennessee Court of Appeals case in which the court applies the close corporation shareholder fiduciary duties under Massachusetts corporate law to members in a Tennessee LLC. However, it then occurred to me that Anderson was decided under Tennessee's "old" LLC Act; but the LLC in Mulloy opted into Tennessee's modernized, "new" LLC Act, which became effective on January 1, 2006. The new LLC Act is modeled in part on the Revised Uniform Limited Liability Company Act and provides as follows, in pertinent part (in Tenn. Code Ann. § 48-249-403(a) and (b) (emphasis in italics added)):
- "The only fiduciary duties a member owes to a member-managed LLC and the LLC's other members and holders are the duty of loyalty and the duty of care . . . ."
- "A member's duty of loyalty to a member-managed LLC and the LLC's other members and holders of financial rights is limited to the following: (1) To account to the LLC and to hold as trustee for it any . . . benefit derived by the member in the conduct . . . of the LLC's business, or derived from a use by the member of the LLC's property, including the appropriation of any opportunity of the LLC . . . ."
These statutory provisions would appear to foreclose an argument that members of an LLC organized under the new LLC Act have a fiduciary duty of utmost good faith and loyalty to each other under Anderson (or otherwise at common law). Much as I hate to admit it, that's the way a court should, and likely would, see this.
What do you think? Is my concern about the holding in the appellate court opinion in Mulloy warranted? Or do we treat the Mulloy brothers like "big boys" and agree with the appellate and trial courts? Your views are welcomed. I am looking for some creative arguments here . . . .
Saturday, October 12, 2019
Some of you may remember my post from last year on the American Bar Association's LLC Institute, an annual program at which I have presented and from which I have benefitted. This year's institute is scheduled for November 7 & 8 at the Stetson Tampa Law Center. The registration deadline is October 25. The registration site can be found here.
The program agenda is, as usual, amazing. Baylor Law's Beth Miller will lead off (with others) in presenting updates on relevant decisional law. Additional highlights include panels on "LLC Agreements That Went Wrong, and How to Fix Them: Case Studies and War Stories" and "Re-Imagining the Business Trust as a Sustainable Business Form" (the latter featuring friend and Florida Law prof Lee-Ford Tritt) and an ethics program featuring (among others) Bob Keatinge, who is always illuminating and entertaining. Presentations by other LLC Institute favorites (including Tom Rutledge, whose message to me prompted this post) pepper the program.
On Thursday night, at the annual dinner, Mitchell Hamline School of Law Emeritus Professor Dan Kleinberger will receive the 2019 Martin I. Lubaroff Award. Most business law profs know Dan, who has (among other things) been a tremendous servant of the academy and the bar on unincorporated business entity issues. I have benefitted from that service. I am sad to miss being at the institute this year to see him get that award and congratulate him in person.
The LLC Institute is where the LLC elite meet. If you have not attended this program and research/write in the unincorporated business associations area, I recommend you check it out. Heck, I recommend that you attend anyway. It's a super two days of learning and networking in a lovely part of the country. Continuing legal education credit is available.
Tuesday, August 20, 2019
A recent California court order granting a motion for final settlement in an antitrust class action suit appears to have left LLCs out as "person(s)" in the definitions. Here's the clause, which is repeated a few times in the Settlement Agreement:
(w) “Person(s)” means an individual, corporation, limited liability corporation, professional corporation, limited liability partnership, partnership, limited partnership, association, joint stock company, estate, legal representative, trust, unincorporated association, government or any political subdivision or agency thereof, and any business or legal entity and any spouses, heirs, predecessors, successors, representatives or assignees of any of the foregoing.
IN RE: LITHIUM ION BATTERIES ANTITRUST LITIGATION, 2019 WL 3856413, Slip Copy (N.D.Cal. Aug. 16, 2019) (emphasis added).
A "limited liability corporation" and a "corporation" are the same thing. I am certain the "limited liability corporation" language was intended to cover "limited liability companies" or LLCs. But it doesn't cover LLCs, which are different entities. Of course, the fact that the definition includes all "unincorporated associations," LLCs are included, but this is sloppy and in my humble view, should never have been approved.
California has been know to make this distinction murky (see here) and some California courts like to just plain get it wrong. But this is a settlement that is being reviewed by the court, and I am willing to bet this language is in all sorts of settlement agreements because they are cutting and pasting the definitions from settlement to settlement.
From now on, I say courts should deny these agreements when proposal gets things like this wrong. Or better yet, reduce the legal fees, so it doesn't harm the class, but let's the lawyers know they should be drafting carefully. Sure, it's not a huge deal in this case, but it sure would be nice if more courts would send the message that LLCs are not corporations. Because they're not.
Tuesday, August 6, 2019
I decided to track the path of "limited liability corporation" (which should be "limited liability company" when referring to an LLC) in a recent court case. It's my thing. Anyway, this gem popped up today:
This Court previously held “although wage, investment, and other economic losses may flow to an individual from discriminatory harm suffered by a corporation, those injuries are not ‘separate and distinct’ from those suffered by that corporation.” Club Xtreme, Inc. v. City of Wayne, 2010 WL 1626415 at *5 (E.D. Mich. Apr. 21, 2010). Under Michigan law, rules with respect to corporations apply equally to limited liability corporations. Hills and Dales General Hosp. v. Pantig, 295 Mich.App. 14, 21 (2011). As such, a limited liability company is its own “person,” separate and distinct from its owners. Id. Here, Darakjian is separate and distinct from his LLC, TIR.
Second, "Under Michigan law, rules with respect to corporations apply equally to limited liability corporations." True as to LLCs, but, um, no, LLCs are not corporations. So where did that come from?
Well, this part of "bad law" originates here, as noted: "The rules respecting the corporate form apply equally to limited liability corporations." Hills & Dales Gen. Hosp. v. Pantig, 295 Mich. App. 14, 21, 812 N.W.2d 793, 797 (2011). Except that, and good on them, the case Hills and Dales cites is Florence Cement Co. v. Vettraino, 292 Mich. App. 461, 477, 807 N.W.2d 917, 926 (2011), which only talks about a "limited liability company." This one is an easy Kevin Bacon game. It's just two degrees back. I suppose that's good, right? Still ...
Do these mistakes, in this instance, impact the outcome? No. But that's not the point. There are cases where LLC versus corporation does matter. And these mistakes will provide citations for incorrect outcomes.
Wednesday, July 24, 2019
In 2010, an Illinois court reviewed Delaware business law making the following observations:
With respect to a limited liability corporation, Delaware law states that “[u]nless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members....” 6 Del.C. § 18–402. Thus, pursuant to Delaware law, directors are generally provided with authority for managing the corporation and members are generally provided with authority for managing the limited liability company. The bankruptcy court therefore properly found that a member of a LLC would be an analogous position to a director of a corporation under Delaware law.
Longview Aluminum, L.L.C. v. Brandt, 431 B.R. 193, 197 (N.D. Ill. 2010), aff'd sub nom. In re Longview Aluminum, L.L.C., 657 F.3d 507 (7th Cir. 2011).
Well, initially, it must be noted that an LLC is not a corporation at all. As the quoted Delaware law observes, it is a “limited liability company.” Corporations and LLCs are distinct entities.
I’ll also take issue with adopting the bankruptcy court’s finding “that a member of an LLC would be an analogous position to a director of a corporation under Delaware law.” I will concede that a member of an LLCmaybe an analogous position to a director of a corporation under Delaware law, but that is not inherently true.
The Longview Aluminumcourt had determined that, “under Delaware law, a corporation generally must ‘be managed by or under the direction of a board of directors . . . .’” 8 Del. Code § 141. While that’s technically accurate, it understates that general nature of Delaware directors. Note that the statue is mandatory in nature (“shall”), and then provides limited changes:
The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.
8 Del. Code § 141(a).
Remember, the Longview Aluminumcourt stated that, “[w]ith respect to a limited liability corporation, Delaware law states that ‘[u]nless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members....’ 6 Del.C. § 18–402.” Id.
But Delaware LLC law provides:
“Unless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members in proportion to the then current percentage or other interest of members in the profits of the limited liability company owned by all of the members, the decision of members owning more than 50 percent of the said percentage or other interest in the profits controlling . . . .”
6 Del. Code § 18-402.
That’s different in structure than directors. Directors act as a body, usually with one vote per director. This default provision provides for a very different structure, providing that one member with over 50% of the interests is controlling. That’s not like a board at all. And furthermore, those members in charge of the entity may not have any fiduciary duties to the LLC. The Delaware LLC Act states:
“To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement . . . .” 6 Del. C. § 18-1101(c).
Corporate directors have some version of fiduciary duties. Again, a notable difference. It appears that the Longview Aluminumcourt (affirming the bankruptcy court) may have been right to extend the corporate director concept to the LLC managers in that case because of the structure of the LLC’s operating agreement. But the court went on to imply that a member of a LLC is“an analogous position to a director of a corporation under Delaware law.” That very much overstates things.
Why discuss this 2010-11 case at length now? Because this section was cited last week:
“[I]n referencing a director, Section 101(31)(B) was intended to refer to the party that “managed” the debtor corporation.” Longview Aluminum, L.L.C. v. Brandt, 431 B.R. 193, 197 (N.D. Ill. 2010) (citing 11 U.S.C. § 101(31)(B)). “With respect to a limited liability corporation, Delaware law states that ‘[u]nless otherwise provided in a limited liability company agreement, the management of a limited liability company shall be vested in its members ....” Id. (quoting 6 Del.C. § 18–402).
In re Licking River Mining, LLC, No. 14-10201, 2019 WL 2295680, at *41 (Bankr. E.D. Ky. July 19, 2019), as amended (July 19, 2019).
Fortunately, other than failing to correct the mistake of calling an LLC a corporation, the Licking River Miningseems to have gotten the outcome right. The court determined that a 25% member interest lacked control because all LLC “decisions were to be made either by a majority of the LLC interests or by the entity's managing member.”Id.Good call, and hopefully this case will clarify (and correct) any negative implications from the Longview Aluminum case. But even if it does, it gives longer life to an incorrect reference to LLCs and increases the likelihood it will be cited repeatedly.
Win some, lose some, I guess.
Tuesday, July 9, 2019
A recent Tennessee court decision subtly notes that limited liability companies (LLCs) are not, in fact corporations. In a recent Tennessee federal court opinion, Judge Richardson twice notes the incorrect listing of an LLC as a "limited liability corporation."
First, the opinion states:
The [Second Amended Complaint] alleges that Defendant Evans is a resident of Tennessee, Defendant #AE20, LLC is a California limited liability company, and Defendant Gore Capital, LLC is a Delaware limited liability “corporation.”3
3 Gore Capital is in fact a limited liability company.
Judge Richardson later notes, in footnote 11:
Plaintiff states that he was sent documents that listed Gore’s (not #AE20’s) principal place of business as being in Chattanooga, Tennessee, although the SAC lists Gore as a “Delaware limited liability corporation (sic)[.]”
Tuesday, July 2, 2019
Veil piercing continues its randomness. Back in April, in Hawai'i Supreme Court decision, Calipjo v. Purdy, 144 Hawai'i 266, 439 P.3d 218 (2019), the court determined that there was evidence to support a trial court jury's decision to pierce the veil of an multiple entities and hold the sole member/shareholder of the entities liable. (An appellate court had determined that there was insufficient evidence to support veil piercing.)
The decision may be sound, but the evidence for the decision makes the outcome seemingly inevitable. In determining there was evidence to support the jury's decision, the court notes the plaintiff's allegations were that "sole ownership and control is one of many factors that can establish alter ego and, therefore, evidence of Purdy’s ownership and control was pertinent to this claim." The court then explains,
In this case, the jury was presented with evidence that Purdy exercised exclusive ownership and control over Regal Corp. and Regal LLC. Purdy testified that he was the sole shareholder, director, and officer of Regal Corp. and the sole member and manager of Regal LLC. This court has held that “sole ownership of all of the stock in a corporation by one individual” is one relevant factor to determine alter ego. Id. (quoting Associated Vendors, 26 Cal. Rptr. at 814). Purdy’s testimony supports the jury’s determination that Purdy exercised exclusive ownership and control over Regal Corp. and Regal LLC; it constitutes evidence that Purdy was the sole owner and manager of either company.
Note, though, that the plaintiff claimed that "sole ownership and control ... can establish alter ego." The court more accurately states that ownership and control are a factor. They are not dispositive or else limited liability for a single-member LLC, corporation, or other limited liability entity would be a fiction. The jury instructions, though, seem to eliminate the possibility that an entity and a single shareholder or member could be separate. The jury was told:
You should consider the following facts in determining whether or not to disregard the legal entity of Regal Capital Corporation and return a verdict in favor of plaintiff against Defendant Jack Purdy, as an individual.
One, whether or not defendant Jack Purdy owned all or substantially all the stock in Regal Capital Corporation; two, whether or not Jack Purdy exercised discretion and control over the management of Defendant Regal Capital Corporation; three, whether or not Defendant Jack Purdy directly or indirectly furnished all or substantially all of the financial investment in Defendant Regal Capital Corporation; four, whether or not Regal Capital Corporation was adequately financed either originally or subsequently for the business in which it was to engage.
Five, whether or not there was actual participation in the affairs of Regal Capital Corporation by its stockholders and whether stock was issued to them. Six, whether or not Regal Capital Corporation observed the [formalities] of doing business as a corporation such as the holding of regular meetings, the issuance of stock, the filing of necessary reports and similar matters. Seven, whether or not Defendant Regal Capital Corporation [dealt] exclusively with Defendant Jack Purdy, directly or indirectly in the real estate sales development activities in this case. Eight, whether or not Defendant Regal Capital Corporation existed merely to do a part of business of Defendant Jack Purdy.
So, here was have an undercapitalization factor, and that could be separate from the shareholder/member, and we have the traditional "corporate formalities" test, but even there, these instructions imply that the entity must have additional shareholders to be "real." For numbers one, two, three, five, seven, and eight, a jury would almost always have to find that those factors would support veil piercing for any sole shareholder corporation or single-member LLC. I don't think that's either the intent or the substance of current law in most jurisdictions, though the Hawai'i Supreme Court clearly disagrees with me.
In this case, there seems to be at least some evidence of fraud, and I'm more than willing to defer to a jury if they determined that the defendant had sole control of his entities and he used those entities to commit fraud. I just object to court's apparent comfort level with the idea having sole control of an entity or entities, and exercising that control, on its own suggests something nefarious.
I know people use LLCs and corporations to engage in all sorts of bad behavior, and I'd like to see that punished more often than it seems to be. But relaxing the application of legal standards to get there is not a good way to do it. If the law should be changed, then legislatures should get to work on that. If we think single-owner entities are a bad idea (I don't think they are inherently so), let's deal with that through legislation so that at least everyone knows the rules.
Ultimately, it's not as though current veil piercing jurisprudence has been clear or sound or predictable. There has always been a random nature to it. However, for single-member entities, if the current trends continue, the randomness of veil piercing will not attach not to the outcome of a lawsuit -- it will attach to whether or not someone brings suit at all.
Wednesday, June 5, 2019
The AALS Section on Agency, Partnership, LLCs, and Unincorporated Entities is pleased to announce a Call for Papers from which up to three presenters will be selected for the section's program to be held during the AALS 2020 Annual Meeting in Washington, DC. The program will explore decisions and strategies for choice of business form. As unincorporated business forms have matured and those who use them have learned their advantages and disadvantages, key decisions about choice of form have changed in important and interesting ways. In addition, accelerating advances in technology promise to play surprising roles in the formation and operation of unincorporated firms.
Please submit an abstract or draft of an unpublished paper to Kelli Alces Williams at email@example.com before August 5, 2019. Please remove the author’s name and identifying information from the submission. Please include the author’s name and contact information in the submission email.
Papers will be selected after review by members of the Executive Committee of the Section. Authors of selected papers will be notified by August 30, 2019. The Call for Paper presenters will be responsible for paying their registration fee, hotel, and travel expenses.
Tuesday, May 28, 2019
I'll start with the exciting news that my Business Organizations students were 48 for 48 in recognizing that LLCs are not corporations. In fact, a number of my students specifically referred to "LLCs (NOT corporations) ..." in their exams. It's nice to be heard. I believe that's at least three years in a row without such a mistake, and maybe longer. I have evidence, at least on this issue, repetition is effective.
As for this summer, it is going to be an interesting one. I have now finished grading my last classes as a part of West Virginia Univerity College of Law. As some readers may know, I have accepted the opportunity to join Creighton University School of Law as the next dean. (For those wondering, my wife Kendra will be joining the Creighton Law faculty, as well, where, as was true at WVU, she will teach family law as a full professor.) After Kendra's run for Congress ended, she told me it was "my turn," and that I should pursue my goals. I don't think either of us expected such a big change so quickly.
Long before all of this became a reality, and after the campaign, we planned a family vacation to Europe for a month, so we'll be doing that with the kids -- Bulgaria, Germany, Italy, and Greece. Buying and selling a house, moving across the country, and starting new jobs (and new schools for the kids) will all be part of the mix, too, but hey, what's life without some adventure?
The fact that we're willing to leave should tell people just how much we believe in this opportunity. We have an absolutely incredible life already, with dear friends, amazing students, and a community of supportive and caring people. (Not to mention an absolutely gorgeous location.) And yet we're moving. I have high hopes and high expectations -- both for me and for my new institution. It's worth stating clearly that we have loved West Virginia and we have had incredible opportunities to grow both personally and professionally. I want people to know that we are not so much leaving West Virginia as we are going to Creighton, a possibility I wouldn't have without my time here at WVU.
I very much appreciate that, and because of all we have learned and experienced, new adventures await.
Wednesday, May 22, 2019
It has been kind of a unique end of the semester, and I am working feverously to get through my Business Organizations exams. I'm getting there. So far, I have had zero exams reference a "limited liability corporation." If this holds, it will be at least three years in a row.
I have had a couple of folks refer to LLC veil piercing as piercing the "corporate" veil (another no-no), and I did have some other "corporate" references to LLCs (e.g., "an LLC's corporate formalities"), so we're not all the way there. But so far, I am seeing improvement, and I appreciate the effort.
Here's hoping for 48 of 48 describing the LLC (as an entity) correctly. I hope the rest of my colleagues are holding up well here in the home stretch. Good luck to all.
Tuesday, May 7, 2019
A recent report and recommendation from a U.S. magistrate recommends that the referring court find that a plaintiff did not provide the facts needed to support taking diversity jurisdiction. The magistrate is correct, but the recommendation is a little ironic in that it seems to be chiding the plaintiff for a lack of precision, and well, this:
Here, Peeples' amended complaint contains the bare assertions that the address for Xlibris Publishing is in Bloomington, Indiana, while his address is in Mobile, Alabama. The bare allegation respecting the Defendant is insufficient as it does not identify whether Xlibris is a corporation or, instead, an unincorporated entity such as a limited liability corporation. Moreover, if Xlibris is a corporation, the complaint does not delineate its state(s) of incorporation and the state where it has its principal place of business. See Flintlock Constr. Servs., LLC v. Well-Come Holdings, LLC, 710 F.3d 1221, 1224 (11th Cir. 2013) (“A corporation is considered a citizen of every state in which it has been incorporated and where it has its principal place of business.”). And, if an unincorporated entity such as a limited liability corporation,3 the amended complaint does not allege every state in which each of its members are citizens. See, e.g., Lewis v. Seneff, supra, at *3 (Without the information concerning the citizenship of each limited liability company's membership, Plaintiffs have not shown that this Court has subject matter jurisdiction.”).
3 It appears to the undersigned that Xlibris Publishing is a limitedliability corporation. See www.xlibris.com (last visited, April 4, 2019, at 3:30 p.m.) (Xlibris website shows that it is an LLC).
Thursday, May 2, 2019
Okay, not really. But my daily Westlaw search for "limited liability corporation" recently started delivering contract award announcements from the Department of Health and Human Services (DHHS) related to contract awards. DHHS reconds many "business types" for their records, such as "Minority Owned Business" and "For Profit Organization. And now, apparently, "limited liability coroporation" is one of them. ARRRRRGHH! LLCs are "limited liability companies" and are not corporations. An internet search shows that there are at least 78 of these DHHS designations out there (and I'll wager there are more).
Following is an excerpt of one such announcement. You'll note that, according to the announcement, Seba Professional Services LLC is both a "Partnership or Limited Liability Partnership" and a "Limited Liability Corporation." Sigh. Really, they're making my stomach hurt:
Department of Health and Human Services awarded contract of IGF::CT::IGF PATIENT MESSENGER AND TRANSPORT SERVICES to SEBA PROFESSIONAL SERVICES LLC
Woman Owned Business
Women Owned Small Business
Economically Disadvantaged Women Owned Small Business
Minority Owned Business
Black American Owned Business
Partnership or Limited Liability Partnership
Limited Liability Corporation
For Profit Organization
DoT Certified Disadvantaged Business Enterprise
Self-Certified Small Disadvantaged Business
8a Program Participant
Tuesday, April 9, 2019
A 2017 opinion related to successor liability just posted to Westlaw. The case is an EEOC claim "against the Hospital of St. Raphael School of Nurse Anesthesia (“HSR School”) and Anesthesia Associates of New Haven (“AANH”), alleging gender discrimination and retaliation in violation of Title VII of the Civil Rights Act of 1964 . . . ." The plaintiff was seeking to join Yale New Haven Hospital (“YNHH”). MARGARITE CONSOLMAGNO v. HOSPITAL OF ST. RAPHAEL SCHOOL OF NURSE ANESTHESIA and ANESTHESIA ASSOCIATES OF NEW HAVEN, P.C., 3:11CV109 (DJS), 2017 WL 10966446, at *1 (D. Conn. Mar. 27, 2017).
There is no evidence that the HSR School had an existence that was independent of AANH. In fact, the HSR School was going to cease operating due to the fact that AANH was going to cease operating. The HSR School was not a limited liability corporation (“LLC”), private corporation (“P.C.”), or other legal entity registered with the Connecticut Secretary of State. (Tr. 141-142). There is no evidence that the HSR School had its own assets, bank account, or tax identification number. There is no evidence that the HSR School itself (as opposed to AANH) ever paid anyone for rendering services to the HSR School. There is no evidence that anyone other than AANH had operated the HSR School. Consequently, the Court finds that the predecessor in interest, for the purpose of assessing successor liability, is AANH.
Tuesday, April 2, 2019
A new case from the Southern District of Texas recently appeared, and it is yet another case in which the entity type descriptions are, well, flawed. The case opens:
Before the Court is the defendant’s, Arnold Development Group, LLC (the “defendant”) motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(2) and (3) (Dkt. No. 5), the plaintiff’s, Conesco Industries, LTD.; d/b/a DOKA USA, LTD. (the “plaintiff”) response to the defendant’s motion to dismiss (Dkt. No. 18) and the defendant’s reply in support of its motion (Dkt. No. 20).
. . . .
The plaintiff is a New Jersey limited partnership doing business in Texas and throughout the United States. The defendant is a Missouri limited liability corporation.
In the case before the Court, the defendant is a Missouri corporation and the plaintiff is a New Jersey corporation.
Wednesday, March 20, 2019
Get this, from a March 15 ruling and order on a motion for summary judgment:
Greenwich Hotel Limited Partnership [GHLP] is a limited partnership organized under the laws of Connecticut, and is the owner of the Hyatt Regency Greenwich hotel. Answer to First Amended Complaint, dated Dec. 16, 2016 (“Am. Ans.”), ECF NO. 62, at 8. Hyatt Equities, L.L.C. (“Hyatt Equities”) is a limited liability corporation incorporated in Delaware, and is the general partner of Greenwich Hotel Limited Partnership. Id. at 9. The Hyatt Corporation (“Hyatt Corp.”) is a limited liability corporation incorporated in Delaware, and is the agent of Greenwich Hotel Limited Partnership. Id. at 9.
"Upon information and belief, defendant Hyatt Equities is a limited liability company organized under the laws of the State of Delaware, and is the general partner of GHLP.
. . . .
Upon information and belief, defendant Hyatt Corporation is a corporation organized under the laws of the State of Delaware and is the agent of GHLP."
Benavidez v. Greenwich Hotel LP, 3:16-CV-191, Answer to First Amended Complaint, dated Dec. 16, 2016 (“Am. Ans.”), ECF NO. 62, at 9. This is all properly stated, but somehow it didn't translate to the ruling and order.
Kudos to the filing attorneys on getting it right. I wonder if this is something that can be corrected? One would hope. Okay, at least I hope so.
Tuesday, March 12, 2019
It is Spring Break at WVU, so I am using this time to finish some paper edits and catch up on my email. Last week, I got an email about a recent case from the United States District Court for the Northern District of Illinois. It is a headache-inducing opinion that continues the trend of careless language related to limited liability companies (LLCs).
The opinion is a civil procedure case (at this point) regarding whether service of process was effective for two defendants, one a corporation and the other an LLC. The parties at issue, (collectively, “Defendants”) are: (1) Ditech Financial, LLC f/k/a Green Tree Servicing, LLC (“Ditech Financial”) and (2) Ditech Holding Corporation f/k/a Walter Investment Management Corp.’s (“Ditech Holding”). The court notes that it is unclear whether there is diversity jurisdiction, because
“the documents submitted by Defendants with their motion to dismiss suggest that there may be diversity of citizenship in this case. See [12-1, at 2 (stating Ditech Holding is a Maryland corporation with a principal office in Pennsylvania) ]; [12-1, at 2 (stating Ditech Financial is a Delaware limited liability corporation with a principal office in Pennsylvania) ].”
Clayborn v. Walter Investment Management Corp., No. 18-CV-3452, 2019 WL 1044331, at *8 (N.D. Ill. Mar. 5, 2019) (emphasis added).
Why do courts insist on telling us the state of LLC formation and principal place of business, when that is irrelevant as to jurisdiction for an LLC? Hmm. I supposed that fact that courts keeping calling LLCs “corporations” might have something to do with it. The court does seem to know the rule for LLCs is different than the one for corporations, noting that “Plaintiff has not pled or provided the Court with any information regarding the citizenship of each member of Ditech Financial LLC. “ Id.
Despite this apparent knowledge, the court goes on to say:
Under Illinois law, “a private corporation may be served by (1) leaving a copy of the process with its registered agent or any officer or agent of the corporation found anywhere in the State; or (2) in any other manner now or hereafter permitted by law.” 75 ILCS 5/2-204. At least one court to consider the issue has concluded that Illinois state law does not allow service of a summons on a corporation via certified mail. Ward v. JP Morgan Chase Bank, 2013 WL 5676478, at *2 (S.D. Fla. Oct. 18, 2013); see also 24 Illinois Jurisprudence: Civil Procedure § 2:20; 13 Ill. Law and Prac. Corporations § 381. Plaintiff has not cited, nor has the Court located, any support for the proposition that a summons and complaint sent by certified mail constitutes one of the “other manner[s] now or hereafter permitted by law” to effectuate service. Consequently, the Court concludes that Plaintiff has not properly served Ditech Holding under Illinois law, and therefore cannot have served Ditech Financial.2 [see below]
Id. Now the case gets more confusing. Note that last line above: the court implies that proper service of the corporate parent may have been sufficient to serve the LLC, too. Footnote 2 of the opinion properly clarifies this, though the court then provides another baffling tidbit.
Footnote 2 provides:
Even if Plaintiff had properly served Ditech Holding, it would not have properly effectuated service upon Ditech Financial. Ditech Financial appears to be a limited liability company.; . Under Illinois law, service on a limited liability company is governed by section 1–50 of the Limited Liability Company Act. 805 ILCS 180/1–50; John Isfan Construction, Inc. v. Longwood Towers, LLC, 2 N.E.3d 510, 517–18 (Ill. App. Ct. 2016). Under section 1–50 of the Limited Liability Company Act, a plaintiff may only serve process upon a limited liability company by serving “the registered agent appointed by the limited liability company or upon the Secretary of State.” Pickens v. Aahmes Temple #132, LLC, 104 N.E.3d 507, 514 (Ill. App. Ct. 2018) (quoting 805 ILCS 180/1–50(a)). To properly serve Ditech Financial, Plaintiff would have had to deliver a copy of the summons and complaint to Ditech Financial’s registered agent in Illinois: CT Corporation System. [12, at 5.]
The court had already stated the Ditech Financial was an LLC, though it had called it a “limited liability corporation.” Is the court unclear about the entity type? If entity type is in question, it would seem worthy of note in the body of the opinion. The court properly cites to the LLC Act, but it inconclusive as to whether Ditech Financial is, in fact, an LLC.
To make matters worse, the court repeats, in footnote 3, its earlier mistake as to what an LLC really is:
Service on a limited liability corporation, such as Ditech Financial, must be effectuated in the same manner as service on a corporation such as Ditech Holding. See, e.g., Grieb v. JNP Foods, Inc., 2016 WL 8716262, at *3 (E.D. Pa. May 13, 2016) (evaluating the effectiveness of service of process on a limited liability company under Pa. R. Civ. P. 424).
Tuesday, March 5, 2019
Gregg D. Polsky, University of Georgia Law, recently posted his paper, Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups. It is an interesting read and worth a look. H/T Tax Prof Blog. Following the abstract, I have a few initial thoughts:
Perhaps the most fundamental role of a business lawyer is to recommend the optimal entity choice for nascent business enterprises. Nevertheless, even in 2018, the choice-of-entity analysis remains highly muddled. Most business lawyers across the United States consistently recommend flow-through entities, such as limited liability companies and S corporations, to their clients. In contrast, a discrete group of highly sophisticated business lawyers, those who advise start-ups in Silicon Valley and other hotbeds of start-up activity, prefer C corporations.
Prior commentary has described and tried to explain this paradox without finding an adequate explanation. These commentators have noted a host of superficially plausible explanations, all of which they ultimately conclude are not wholly persuasive. The puzzle therefore remains.
This Article attempts to finally solve the puzzle by examining two factors that have been either vastly underappreciated or completely ignored in the existing literature. First, while previous commentators have briefly noted that flow-through structures are more complex and administratively burdensome, they did not fully appreciate the source, nature, and extent of these problems. In the unique start-up context, the complications of flow-through structures are exponentially more problematic, to the point where widespread adoption of flow-through entities is completely impractical. Second, the literature has not appreciated the effect of perplexing, yet pervasive, tax asset valuation problems in the public company context. The conventional wisdom is that tax assets are ignored or severely undervalued in public company stock valuations. In theory, the most significant benefit of flow-through status for start-ups is that it can result in the creation of valuable tax assets upon exit. However, the conventional wisdom makes this moot when the exit is through an initial public offering or sale to a public company, which are the desired types of exits for start-ups. The result is that the most significant benefit of using a flow- through is eliminated because of the tax asset pricing problem. Accordingly, while the costs of flow-through structures are far higher than have been appreciated, the benefits of these structures are much smaller than they appear.
Before commenting, let me be clear: I am not an expert in tax or in start-up entities, so my take on this falls much more from the perspective of what Polsky calls "main street businesses." I am merely an interested reader, and this is my first take on his interesting paper.
To start, Polsky distinguishes "tax partnerships" from "C Corporations." I know this is the conventional wisdom, but I still dislike the entity dissonance this creates. Polsky explains:
Tax partnerships generally include all state law entities other than corporations. Thus, general and limited partnerships, LLCs, LLPs, and LLLPs are all partnerships for tax purposes. C corporations include state law corporations and other business entities that affirmatively elect corporate status. Typically, a new business will often need to choose between being a state-law LLC taxed as a partnership or a state-law corporation taxed as a C corporation. The state law consequences of each are nearly identical, but the tax distinctions are vast.
As I have written previously, I'd much rather see the state-level entity decoupled from the tax code, such that we would
have (1) entity taxation, called C Tax, where an entity chooses to pay tax at the entity level, which would be typical C Corp taxation; (2) pass-through taxation, called K Tax, which is what we usually think of as partnership tax; and (3) we get rid of S corps, which can now be LLCs, anyway, which would allow an entity to choose S Tax.
As Dinky Bosetti once said, "It's good to want things."
Anyway, as one who focuses on entity choice from (mostly) the non-tax side, I dispute the idea that "[t]he state law consequences of each [entity] are nearly identical, but the tax distinctions are vast." From governance to fiduciary duties to creditor relationships to basic operations, I think there are significant differences (and potential consequences) to entity choice beyond tax implications.
I will also quibble with Polsky's statement that "public companies are taxed as C corporations." He is right, of course, that the default rule is that "a publicly traded partnership shall be treated as a corporation." I.R.C. § 7704(a). But, in addition to Business Organizations, I teach Energy Law, where we encounter Master Limited Partnerships (MLPs), which are publicly traded pass-through entities. See id. § 7704(c)-(d).
Polsky notes that "while an initial choice of entity decision can in theory be changed, it is generally too costly from a tax perspective to convert from a corporation to a partnership after a start-up begins to show promise." This is why those of us not advising VC start-ups generally would choose the LLC, if it's a close call. If the entity needs to be taxed a C corp, we can convert. If it is better served as an LLC, and the entity has appreciated in value, converting from a C corp to an LLC is costly. Nonetheless, Polsky explains for companies planning to go public or be sold to a public entity, the LLC will convert before sale so that the LLC and C Corp end up in roughly the same place:
The differences are (1) the LLC’s pre-IPO losses flowed through to its owners while the corporation’s losses were trapped, but as discussed above this benefit is much smaller than it appears due to the presence of tax-indifferent ownership and the passive activity rules, (2) the LLC resulted in additional administrative, transactional, and compliance complexity (including the utilization of a blocker corporation in the ownership structure), and (3) the LLC required a restructuring on the eve of the IPO. All things considered, it is not surprising that corporate classification was the preferred approach for start-ups.
This is an interesting insight. My understanding is that the ability pass-through pre-IPO losses were significant to at least a notable portion of investors. Polsky's paper suggests this is not as significant as it seems, as many of the benefits are eroded for a variety of reasons in these start ups. In addition, he notes a variety of LLC complexities for the start-up world that are not as prevalent for main street businesses. As a general matter, for traditional businesses, the corporate form comes with more mandatory obligations and rules that make the LLC the less-intensive choice. Not so, it appears, for VC start-ups.
I need to spend some more time with it, and maybe I'll have some more thoughts after I do. If you're interested in this sort of thing, I recommend taking a look.