Business Law Prof Blog

AALS 2025 - Section on Agency, Etc. - Calls for Papers

AALS Section on Agency, Partnerships, LLCs, and Unincorporated Associations

Calls for Papers

The AALS Section on Agency, Partnerships, LLCs, and Unincorporated Associations is pleased to announce two calls for papers, one for a panel presentation and one for a works-in progress session geared to workshopping the research and writing of junior faculty.

Panel Presentation:

Up to three paper presenters will be selected for the section's principal panel to be held during the AALS 2025 Annual Meeting in San Francisco, CA. The program is entitled Technology's Intersection with Agency, Partnerships, and Unincorporated Associations. Co-Sponsored by the Sections on Technology, Law and Legal Education and Transactional Law and Skills, the session is designed to explore research and teaching involving the interactions of principal/agent relationships, partnerships, and unincorporated business associations with artificial intelligence, blockchains, cybersecurity, and other technological developments.

Works-in-Progress Session:

The section seeks paper proposals from junior scholars for a works-in-progress program.  Submissions for this session may relate to any topic within the scope of the law governing agency, partnerships, LLCs, or unincorporated associations.

Submission Information: 

To respond to either or both calls for papers, please submit a substantial abstract (five or more pages) or draft of an unpublished paper to Joan Heminway at [email protected] before September 6, 2024.  Please remove the author's name and identifying information from the submission. Please include in the submission email your institution, your tenure status, and the number of years you have been in your current position, as well as a statement indicating whether the paper has been accepted for publication and, if not, when you anticipate submitting the article for publication. The subject line of the email should read: "Submission – Panel" or "Submission – WIP Program," as applicable.  Authors of selected papers will be notified in September. Presenters are responsible for paying their registration fee, hotel, and travel expenses.  Inquiries about the section's programs also should be directed to Joan Heminway at [email protected] or (865) 974-3813.

New Paper: An LLC By Any Other Name Is Still Not A Corporation

It's been little while since I posted here, but long-time readers of theis blog will not be surprised by the topic.  I am happy to say that, after a lot of work with an exceptional co-author who shares my concerns, Professor Samantha Prince from Penn State Dickinson Law, we have an article documenting the problems with mislabeling LLCs and providing a variety of solutions.  I have been writing on this for nearly 15 years, and unfortunately, not a lot has changed. 

The article, An LLC By Any Other Name Is Still Not A Corporation, is now available on SSRN, here, and has been submitted for publication. In the meantime, we welcome thoughts and comments.  

Here is the abstract: 

Business entities have their own unique characteristics. Entrepreneurs and lawyers who represent them select an entity structure based on the business’s current and projected needs. The differing needs of each business span across myriad topics such as capital requirements, taxation, employee benefits, and personal liability protection. These choices present advantages and disadvantages many of which are built into the type of entity chosen.

It is critically important that people, especially lawyers, recognize the difference between entities such as corporations and limited liability companies (LLCs). It is an egregious, nearly unforgivable, error in our view to call an LLC a “limited liability corporation.” In part, this is because lawyers should try to get things right, but it is also because conflating the two entity types can lead to unpredictable outcomes. Perhaps more important, it could lead to incorrect and unjust outcomes. A prime example lies within the veil piercing context.

Lest you think that this is not a prevalent occurrence, there are nearly 9,000 references to the phrase “limited liability corporation” in court cases. Practicing attorneys are not the only people messing this up. Judges, legislators, federal and state agency officials, and media pundits are also getting it wrong. Most recently, Justice Samuel Alito scribed an op-ed that was published in the Wall Street Journal where he misused the term. Even the TV show Jeopardy! allowed as correct the answer, “What is a limited liability corporation?,” during one episode.

Enter artificial intelligence. AI relies on information it can find, and therefore AI generators, like ChatGPT, replicate the incorrect term. With a proliferation of users and programs using ChatGPT and other AI, the use of incorrect terminology will balloon and exacerbate the problem. Perhaps one day, AI can be used to correct this problem, but that cannot happen until there is widespread understanding of the distinct nature of LLCs and a commitment to precise language when talking about them.

This article informs of the looming harms of misidentifying and conflating LLCs with corporations. Additionally, it presents a warning together with ideas on how to assist with correcting the use of incorrect terminology in all contexts surrounding LLCs.

How to Contract Conference- February 16-17 in Miami

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

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

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

It is not about the mega deals.

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

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

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

It is not a summary of recent case law.

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

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

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

It is not going to put you to sleep.

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

Why not combine learning about contracts with having fun?

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

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

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

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

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

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

 

 

 

 

 

 

The Wit and Wisdom of Tom N.

It was so wonderful to be able to host an in-person version of our "Connecting the Threads" Business Law Prof Blog symposium on Friday.  Connecting the Threads VI was, for me, a major victory in the continuing battle against COVID-19--five healthy bloggers and a live audience!  Being in the same room with fellow bloggers John Anderson, Colleen Baker, Doug Moll (presenting with South Carolina Law friend-of-the-BLPB Ben Means), and Stefan Padfield was truly joyful.  And the topics on which they presented--shadow insider trading, exchange trading in the cloud, family business succession, and anti-ESG legislation--were all so salient.  (I offered the abstract for my own talk on fiduciary duties in unincorporated business associations in last week's post.)  For a number of us, the topic of our presentations arose from work we have done here on the BLPB.

This year, as I noted in my post last week, we had a special guest as our luncheon speaker.  That guest would be known to many of you who are regular readers as "Tom N."  Tom has commented on our blog posts here on the BLPB for at least eight years.  (I rooted around and found a comment from him as far back as 2014.)  And Tom lives right here in Tennessee--in middle Tennessee, to be exact (closer to Haskell Murray than to me).  You can check out his bio here.  I am delighted that we were able to coerce Tom to give up a day of law practice to come join us at the symposium.

The title/topic for Tom's talk was "A Country Boy Busines Lawyer's View from Down in the Weeds."  The talk was, by design, a series of reflections on Tom's wide-ranging business law practice here in the state of Tennessee.  He tries to stay out of the courtroom, but by his own recounting, he has been in court in every county in the state--and Tennessee has 95 counties!  

In the end, Tom ended up offering a bunch of tips for law students and lawyers (both of whom were in attendance at the symposium).  I took notes during Tom's talk.  I have assembled them into a list below.  The key points are almost in the order in which they were delivered.  The stories that led to a number of these snippets of practical advice were priceless.  You had to be there.  Anyway, here is my list, together with a few editorial comments of my own.  Tom can feel free to add, correct, or dispute my notes in the comments!

• Take tax courses; if you fear they may hurt your GPA, audit them.
• Use all available resources to get more knowledge.  (Tom indicated that he bought Westlaw/used Practical Law as a solo practitioner for many years but recently gave it up.  he also noted that he regularly reads a number of the law prof blogs.)
• Be a bar association member and access the resources bar associations provide.  (Tom noted the excellent written materials published by the American Bar Association and the superior continuing legal education programs produced by the Tennessee Bar Association.)
• “You are going to learn to write in law school.”  (Tom advised focusing on clear, efficient writing—something I just emphasized with my Business Associations students last week.)
• Publish in the law.  (Tom shared his view that writing in the law improves both knowledge and analysis.)
• Expect the unexpected, especially in court (e.g., confronting in court transactions in pot-bellied pigs involving a Tennessee nonprofit).  And as a Corollary: "You can't make this stuff up."  The truth often is stranger than anything you could make up . . . .)
• In business disputes, never assume that an attorney was there on the front end.  (And yes, there was mention of the use by many unknowledgeable consumers of online entity formation services.)
• As a lawyer, be careful not to insert your own business judgment.  The business decision is the client's to make.
• Relatedly, let the business people hand you the framework of the deal.
• Along the same lines: "I am not paying people to tell me I can’t do it; I am paying people to tell me how to do it.”  (As heard by Tom from his father, a business owner-manager.  I think many of us have heard this or learned this—sometimes the hard way . . . .  I do try to prevent my students from learning that lesson the hard way by telling them outright.)
• And further: “You want to screw up a deal, put the lawyers in the center of it.”
• As a courtroom lawyer, know the judges and—perhaps more importantly—court clerks!
• Introduce yourself to everyone; they may be in a position to help you now or later (referencing the time he introduced himself, unknowingly, to John Wilder, the former Lt. Governor of Tennessee, who proceeded to introduce him to the local judges).
• Preparation for the bar exam is a curriculum of its own.  (That's close to a quote.)
• “A lot of things go more smoothly of you can get people talking.”  (Tom is more of a fan of mediation than arbitration.)
• Local rules of court may not be even published; sometimes, you just need to pick up the phone and call the court clerk.  (Another reason to get to know local court clerks!)
• Developing rapport with a judge is incredibly important to successful courtroom lawyering.
• Saying "I don’t know" does not hurt anything; in fact, it may help judges/others develop confidence in you and your integrity.
• Your law school grades will not matter after your first or second job.  Employers will be looking at you and your professional record, not your grades.

I am sure I missed something along the way.  Maybe my fellow bloggers in attendance will have something to add.  But this list alone is, imv, pure gold for students and starting lawyers.

Ten Ethical Traps for Business Lawyers

I'm so excited to present later this morning at the University of Tennessee College of Law Connecting the Threads Conference today at 10:45 EST. Here's the abstract from my presentation. In future posts, I will dive more deeply into some of these issues. These aren't the only ethical traps, of course, but there's only so many things you can talk about in a 45-minute slot. 

All lawyers strive to be ethical, but they don’t always know what they don’t know, and this ignorance can lead to ethical lapses or violations. This presentation will discuss ethical pitfalls related to conflicts of interest with individual and organizational clients; investing with clients; dealing with unsophisticated clients and opposing counsel; competence and new technologies; the ever-changing social media landscape; confidentiality; privilege issues for in-house counsel; and cross-border issues. Although any of the topics listed above could constitute an entire CLE session, this program will provide a high-level overview and review of the ethical issues that business lawyers face.

Specifically, this interactive session will discuss issues related to ABA Model Rules 1.5 (fees), 1.6 (confidentiality), 1.7 (conflicts of interest), 1.8 (prohibited transactions with a client), 1.10 (imputed conflicts of interest), 1.13 (organizational clients), 4.3 (dealing with an unrepresented person), 7.1 (communications about a lawyer’s services), 8.3 (reporting professional misconduct); and 8.4 (dishonesty, fraud, deceit).  

Discussion topics will include:

1. Do lawyers have an ethical duty to take care of their wellbeing? Can a person with a substance use disorder or major mental health issue ethically represent their client? When can and should an impaired lawyer withdraw? When should a lawyer report a colleague?
2. What ethical obligations arise when serving on a nonprofit board of directors? Can a board member draft organizational documents or advise the organization? What potential conflicts of interest can occur?
3. What level of technology competence does an attorney need? What level of competence do attorneys need to advise on technology or emerging legal issues such as SPACs and cryptocurrencies? Is attending a CLE or law school course enough?
4. What duties do lawyers have to educate themselves and advise clients on controversial issues such as business and human rights or ESG? Is every business lawyer now an ESG lawyer?
5. What ethical rules apply when an in-house lawyer plays both a legal role and a business role in the same matter or organization? When can a lawyer representing a company provide legal advice to an employee?
6. With remote investigations, due diligence, hearings, and mediations here to stay, how have professional duties changed in the virtual world? What guidance can we get from ABA Formal Opinion 498 issued in March 2021? How do you protect confidential information and also supervise others remotely?
7. What social media practices run afoul of ethical rules and why? How have things changed with the explosion of lawyers on Instagram and TikTok?
8. What can and should a lawyer do when dealing with a businessperson on the other side of the deal who is not represented by counsel or who is represented by unsophisticated counsel?
9. When should lawyers barter with or take an equity stake in a client? How does a lawyer properly disclose potential conflicts?
10. What are potential gaps in attorney-client privilege protection when dealing with cross-border issues? 

If you need some ethics CLE, please join in me and my co-bloggers, who will be discussing their scholarship. In case Joan Heminway's post from yesterday wasn't enough to entice you...

Professor Anderson’s topic is “Insider Trading in Response to Expressive Trading”, based upon his upcoming article for Transactions. He will also address the need for business lawyers to understand the rise in social-media-driven trading (SMD trading) and options available to issuers and their insiders when their stock is targeted by expressive traders.

Professor Baker’s topic is “Paying for Energy Peaks: Learning from Texas' February 2021 Power Crisis.” Professor Baker will provide an overview of the regulation of Texas’ electric power system and the severe outages in February 2021, explaining why Texas is on the forefront of challenges that will grow more prominent as the world transitions to cleaner energy. Next, it explains competing electric power business models and their regulation, including why many had long viewed Texas’ approach as commendable, and why the revealed problems will only grow more pressing. It concludes by suggesting benefits and challenges of these competing approaches and their accompanying regulation.

Professor Heminway’s topic is “Choice of Entity: The Fiscal Sponsorship Alternative to Nonprofit Incorporation.” Professor Heminway will discuss how for many small business projects that qualify for federal income tax treatment under Section 501(a) of the U.S. Internal Revenue Code of 1986, as amended, the time and expense of organizing, qualifying, and maintaining a tax-exempt nonprofit corporation may be daunting (or even prohibitive). Yet there would be advantages to entity formation and federal tax qualification that are not available (or not easily available) to unincorporated business projects. Professor Heminway addresses this conundrum by positing a third option—fiscal sponsorship—and articulating its contextual advantages.

Professor Moll’s topic is “An Empirical Analysis of Shareholder Oppression Disputes.” This panel will discuss how the doctrine of shareholder oppression protects minority shareholders in closely held corporations from the improper exercise of majority control, what factors motivate a court to find oppression liability, and what factors motivate a court to reject an oppression claim. Professor Moll will also examine how “oppression” has evolved from a statutory ground for involuntary dissolution to a statutory ground for a wide variety of relief.

Professor Murray’s topic is “Enforcing Benefit Corporation Reporting.” Professor Murray will begin his discussion by focusing on the increasing number of states that have included express punishments in their benefit corporation statutes for reporting failures. Part I summarizes and compares the statutory provisions adopted by various states regarding benefit reporting enforcement. Part II shares original compliance data for states with enforcement provisions and compares their rates to the states in the previous benefit reporting studies. Finally, Part III discusses the substance of the benefit reports and provides law and governance suggestions for improving social benefit.

All of this and more from the comfort of your own home. Hope to see you on Zoom today and next year in person at the beautiful UT campus.

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

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

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

LLCs: The Uncola (Bankruptcy Edition)

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

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

(31)The term “insider” includes—

. . . . 

(B)if the debtor is a corporation—

(i)

director of the debtor;

(ii)

officer of the debtor;

(iii)

person in control of the debtor;

(iv)

partnership in which the debtor is a general partner;

(v)

general partner of the debtor; or

(vi)

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

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

 

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

 

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

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

11 USC § 101(9). 

 

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

 

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

 

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

Law Firms Should Not Have Corporate Practice Groups

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

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

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

 

 

 

Dear Florida: LLCs Are Still Not Corporations

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.

New Essay: An Overt Disclosure Requirement for Eliminating the Fiduciary Duty of Loyalty

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.   

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

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

Submission Information: 

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

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

Any inquiries about the Call for Papers should be submitted to: Kelli Alces Williams, Florida State University College of Law, k[email protected] or (850) 644.5079. 

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

Gregg D. Polsky, University of  Georgia Law, recently posted his paper, Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups. It is an interesting read and worth a look. H/T Tax Prof Blog.  Following the abstract, I have a few initial thoughts:

Perhaps the most fundamental role of a business lawyer is to recommend the optimal entity choice for nascent business enterprises. Nevertheless, even in 2018, the choice-of-entity analysis remains highly muddled. Most business lawyers across the United States consistently recommend flow-through entities, such as limited liability companies and S corporations, to their clients. In contrast, a discrete group of highly sophisticated business lawyers, those who advise start-ups in Silicon Valley and other hotbeds of start-up activity, prefer C corporations.

Prior commentary has described and tried to explain this paradox without finding an adequate explanation. These commentators have noted a host of superficially plausible explanations, all of which they ultimately conclude are not wholly persuasive. The puzzle therefore remains.

This Article attempts to finally solve the puzzle by examining two factors that have been either vastly underappreciated or completely ignored in the existing literature. First, while previous commentators have briefly noted that flow-through structures are more complex and administratively burdensome, they did not fully appreciate the source, nature, and extent of these problems. In the unique start-up context, the complications of flow-through structures are exponentially more problematic, to the point where widespread adoption of flow-through entities is completely impractical. Second, the literature has not appreciated the effect of perplexing, yet pervasive, tax asset valuation problems in the public company context. The conventional wisdom is that tax assets are ignored or severely undervalued in public company stock valuations. In theory, the most significant benefit of flow-through status for start-ups is that it can result in the creation of valuable tax assets upon exit. However, the conventional wisdom makes this moot when the exit is through an initial public offering or sale to a public company, which are the desired types of exits for start-ups. The result is that the most significant benefit of using a flow- through is eliminated because of the tax asset pricing problem. Accordingly, while the costs of flow-through structures are far higher than have been appreciated, the benefits of these structures are much smaller than they appear.

Before commenting, let me be clear: I am not an expert in tax or in start-up entities, so my take on this falls much more from the perspective of what Polsky calls "main street businesses." I am merely an interested reader, and this is my first take on his interesting paper. 

To start, Polsky distinguishes "tax partnerships" from "C Corporations."  I know this is the conventional wisdom, but I still dislike the entity dissonance this creates.  Polsky explains: 

Tax partnerships generally include all state law entities other than corporations. Thus, general and limited partnerships, LLCs, LLPs, and LLLPs are all partnerships for tax purposes. C corporations include state law corporations and other business entities that affirmatively elect corporate status. Typically, a new business will often need to choose between being a state-law LLC taxed as a partnership or a state-law corporation taxed as a C corporation. The state law consequences of each are nearly identical, but the tax distinctions are vast.

 As I have written previously, I'd much rather see the state-level entity decoupled from the tax code, such that we would 

have (1) entity taxation, called C Tax, where an entity chooses to pay tax at the entity level, which would be typical C Corp taxation; (2) pass-through taxation, called K Tax, which is what we usually think of as partnership tax; and (3) we get rid of S corps, which can now be LLCs, anyway, which would allow an entity to choose S Tax. 

As Dinky Bosetti once said, "It's good to want things." 

Anyway, as one who focuses on entity choice from (mostly) the non-tax side, I dispute the idea that "[t]he state law consequences of each [entity] are nearly identical, but the tax distinctions are vast."  From governance to fiduciary duties to creditor relationships to basic operations, I think there are significant differences (and potential consequences) to entity choice beyond tax implications. 

 I will also quibble with Polsky's statement that "public companies are taxed as C corporations."  He is right, of course, that the default rule is that "a publicly traded partnership shall be treated as a corporation." I.R.C. § 7704(a). But, in addition to Business Organizations, I teach Energy Law, where we encounter Master Limited Partnerships (MLPs), which are publicly traded pass-through entities. See id. § 7704(c)-(d).

Polsky notes that "while an initial choice of entity decision can in theory be changed, it is generally too costly from a tax perspective to convert from a corporation to a partnership after a start-up begins to show promise."  This is why those of us not advising VC start-ups generally would choose the LLC, if it's a close call. If the entity needs to be taxed a C corp, we can convert.  If it is better served as an LLC, and the entity has appreciated in value, converting from a C corp to an LLC is costly.  Nonetheless, Polsky explains for companies planning to go public or be sold to a public entity, the LLC will convert before sale so that the LLC and  C Corp end up in roughly the same place:  

The differences are (1) the LLC’s pre-IPO losses flowed through to its owners while the corporation’s losses were trapped, but as discussed above this benefit is much smaller than it appears due to the presence of tax-indifferent ownership and the passive activity rules, (2) the LLC resulted in additional administrative, transactional, and compliance complexity (including the utilization of a blocker corporation in the ownership structure), and (3) the LLC required a restructuring on the eve of the IPO. All things considered, it is not surprising that corporate classification was the preferred approach for start-ups.

This is an interesting insight. My understanding is that the ability pass-through pre-IPO losses were significant to at least a notable portion of investors. Polsky's paper suggests this is not as significant as it seems, as many of the benefits are eroded for a variety of reasons in these start ups.  In addition, he notes a variety of LLC complexities for the start-up world that are not as prevalent for main street businesses. As a general matter, for traditional businesses, the corporate form comes with more mandatory obligations and rules that make the LLC the less-intensive choice.  Not so, it appears, for VC start-ups.  

 I need to spend some more time with it, and maybe I'll have some more thoughts after I do.  If you're interested in this sort of thing, I recommend taking a look.

New Paper: Business Entities as Skeleton Keys

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

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

Here's the abstract:

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

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

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

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.  

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 blog. Countless 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.

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.  

Professional Responsibility in an Age of Alternative Entities, Alternative Finance, and Alternative Facts

Like my fellow editors here at the BLPB, I enjoyed the first Business Law Prof Blog conference hosted by The University of Tennessee College of Law back in the fall.  They have begun to post their recently published work presented at that event over the past few weeks.  See, e.g., here and here (one of several newly posted Padfield pieces) and here. I am adding mine to the pile: Professional Responsibility in an Age of Alternative Entities, Alternative Finance, and Alternative Facts.  The SSRN abstract reads as follows:

Business lawyers in the United States find little in the way of robust, tailored guidance in most applicable bodies of rules governing their professional conduct. The relative lack of professional responsibility and ethics guidance for these lawyers is particularly troubling in light of two formidable challenges in business law: legal change and complexity. Change and complexity arise from exciting developments in the industry that invite—even entice—the participation of business lawyers.

This essay offers current examples from three different areas of business law practice that involve change and complexity. They are labeled: “Alternative Entities,” “Alternative Finance,” and “Alternative Facts.” Each area is described, together with significant attendant professional responsibility and ethics challenges. The essay concludes by offering general prescriptions for addressing these and other professional responsibility and ethics challenges faced by business lawyers in an age of legal change and complexity.

I do not often write on professional responsibility issues.  However, I do feel an obligation every once in a while to add to the literature in that area addressing issues arising in transactional business law.  In essence, it's service through scholarship.  

I hope you read the essay and, if you do, I hope you enjoy it.  I also can recommend the commentary on it published by my UT Law faculty colleague George Kuney and my student Claire Tuley.  Both comments will be available electronically in the coming months.  I will try to remember to post links . . . .

These Reasons Social Benefit Entities Hurt Business and Philanthropy Will Blow Your Mind

I suspect click-bait headline tactics don't work for business law topics, but I guess now we will see. This post is really just to announce that I have a new paper out in Transactions: The Tennessee Journal of Business Law related to our First Annual (I hope) Business Law Prof Blog Conference co-blogger Joan Heminway discussed here. The paper, The End of Responsible Growth and Governance?: The Risks Posed by Social Enterprise Enabling Statutes and the Demise of Director Primacy, is now available here.

To be clear, my argument is not that I don't like social enterprise. My argument is that as well-intentioned as social enterprise entity types are, they are not likely to facilitate social enterprise, and they may actually get in the way of social-enterprise goals.  I have been blogging about this specifically since at least 2014 (and more generally before that), and last year I made this very argument on a much smaller scale.  Anyway, I hope you'll forgive the self-promotion and give the paper a look.  Here's the abstract: 

Social benefit entities, such as benefit corporations and low-profit limited liability companies (or L3Cs) were designed to support and encourage socially responsible business. Unfortunately, instead of helping, the emergence of social enterprise enabling statutes and the demise of director primacy run the risk of derailing large-scale socially responsible business decisions. This could have the parallel impacts of limiting business leader creativity and risk taking. In addition to reducing socially responsible business activities, this could also serve to limit economic growth. Now that many states have alternative social enterprise entity structures, there is an increased risk that traditional entities will be viewed (by both courts and directors) as pure profit vehicles, eliminating directors’ ability to make choices with the public benefit in mind, even where the public benefit is also good for business (at least in the long term). Narrowing directors’ decision making in this way limits the options for innovation, building goodwill, and maintaining an engaged workforce, all to the detriment of employees, society, and, yes, shareholders.

The potential harm from social benefit entities and eroding director primacy is not inevitable, and the challenges are not insurmountable. This essay is designed to highlight and explain these risks with the hope that identifying and explaining the risks will help courts avoid them. This essay first discusses the role and purpose of limited liability entities and explains the foundational concept of director primacy and the risks associated with eroding that norm. Next, the essay describes the emergence of social benefit entities and describes how the mere existence of such entities can serve to further erode director primacy and limit business leader discretion, leading to lost social benefit and reduced profit making. Finally, the essay makes a recommendation about how courts can help avoid these harms.

Washington Marijuana Law Has Entity Type Quirks (And LLCs Are Still Not Corporations)

A recent case in Washington state introduced me to some interesting facets of Washington's recreational marijuana law.  The case came to my attention because it is part of my daily search for cases (incorrectly) referring to limited liability companies (LLCs) as "limited liability corporations."  The case opens: 

In 2012, Washington voters approved Initiative Measure 502. LAWS OF 2013, ch. 3, codified as part of chapter 69.50 RCW. Initiative 502 legalizes the possession and sale of marijuana and creates a system for the distribution and sale of recreational marijuana. Under RCW 69.50.325(3)(a), a retail marijuana license shall be issued only in the name of the applicant. No retail marijuana license shall be issued to a limited liability corporation unless all members are qualified to obtain a license. RCW 69.50.331(1)(b)(iii). The true party of interest of a limited liability company is “[a]ll members and their spouses.”¹ Under RCW 69.50.331(1)(a), the Washington State Liquor and Cannabis Board (WSLCB) considers prior criminal conduct of the applicant.²

LIBBY HAINES-MARCHEL & ROCK ISLAND CHRONICS, LLC, Dba CHRONICS, Appellants, v. WASHINGTON STATE LIQUOR & CANNABIS BOARD, an Agency of the State of Washington, Respondent., No. 75669-9-I, 2017 WL 6427358, at *1 (Wash. Ct. App. Dec. 18, 2017) (emphasis added).  

 

The reference to a limited liability corporation appears simply to be a misstatement, as the statute properly references limited liability companies as distinct from corporations. The legal regime does, though, have some interesting requirements from an entity law perspective. First, the law provides:

 

(b) No license of any kind may be issued to:

 

. . . .

 

(iii) A partnership, employee cooperative, association, nonprofit corporation, or corporation unless formed under the laws of this state, and unless all of the members thereof are qualified to obtain a license as provided in this section;

Wash. Rev. Code § 69.50.331 (b)(iii) (West). It makes some sense to restrict the business to in-state entities given the licensing restrictions that state has, although it is not clear to me that the state could not engage in the same level of oversight if an entity were, say, a California corporation or a West Virginia LLC. 

 

The state's licensing requirements, as stated in Washington Administrative Code 314-55-035 ("What persons or entities have to qualify for a marijuana license?") provide: "A marijuana license must be issued in the name(s) of the true party(ies) of interest." The code then lists what it means to be a  “true party of interest” for a variety of entities. 

True party of interest: Persons to be qualified

 

Sole proprietorship: Sole proprietor and spouse.

 

General partnership: All partners and spouses.

 

Limited partnership, limited liability partnership, or limited liability limited partnership: All general partners and their spouses and all limited partners and spouses.

 

Limited liability company: All members and their spouses and all managers and their spouses.

 

Privately held corporation: All corporate officers (or persons with equivalent title) and their spouses and all stockholders and their spouses.

 

Publicly held corporation: All corporate officers (or persons with equivalent title) and their spouses and all stockholders and their spouses.

Multilevel ownership structures: All persons and entities that make up the ownership structure (and their spouses).

Wash. Admin. Code 314-55-035. 

This is a pretty comprehensive list, but I note that the corporation requirements are missing some noticeable parties: directors. The code states, for both privately and publicly held corporations, that all "corporate officers (or persons with equivalent title)" and their spouses and all stockholders and their spouses must be qualified. Directors are not "equivalent" in title to officers. Officers, under Washington law, are described as follows:

 

(1) A corporation has the officers described in its bylaws or appointed by the board of directors in accordance with the bylaws.

(2) A duly appointed officer may appoint one or more officers or assistant officers if authorized by the bylaws or the board of directors.

(3) The bylaws or the board of directors shall delegate to one of the officers responsibility for preparing minutes of the directors' and shareholders' meetings and for authenticating records of the corporation.

(4) The same individual may simultaneously hold more than one office in a corporation.

Wash. Rev. Code § 23B.08.400. Directors have a different role. The statute provides:

Requirement for and duties of board of directors.

(1) Each corporation must have a board of directors, except that a corporation may dispense with or limit the authority of its board of directors by describing in its articles of incorporation, or in a shareholders' agreement authorized by RCW 23B.07.320, who will perform some or all of the duties of the board of directors.

(2) Subject to any limitation set forth in this title, the articles of incorporation, or a shareholders' agreement authorized by RCW 23B.07.320:

(a) All corporate powers shall be exercised by or under the authority of the corporation's board of directors; and

(b) The business and affairs of the corporation shall be managed under the direction of its board of directors, which shall have exclusive authority as to substantive decisions concerning management of the corporation's business.

Wash. Rev. Code § RCW 23B.08.010.

 

The Code, then, seems to provide that directors are, as a group, exempt from the spousal connection. The code separately provides:

 

(4) Persons who exercise control of business - The WSLCB will conduct an investigation of any person or entity who exercises any control over the applicant's business operations. This may include both a financial investigation and/or a criminal history background. 

Wash. Admin. Code 314-55-035.  This provision would clearly include directors, but also clearly excludes spouses. That distinction is fine, I suppose, but it is not at all clear to me why one would want to treat directors differently than LLC managers (and their spouses).  To the extent there is concern about spousal influence--to the level that the state would want to require qualification of spouses of shareholders in a publicly held entity--leaving this gap open for all corporate directors seems to be a rather big miss (or a deliberate exception).  Either way, it's an interesting quirk of an interesting new statute.   

 

 

 

 

 

 

Poor LLC Language Leads to Poor LLC Doctrine (And Unnecessary Veil Piercing)

Earlier this week, Professor Bainbridge posted California court completely bollixes up business law nomenclature, discussing Keith Paul Bishop's post on Curci Investments, LLC v. Baldwin, Cal. Ct. App. Case No. G052764 (Aug. 10, 2017).  The good professor, noting (with approval) what he calls my possibly "Ahabian" obsession with courts and their LLC references, says that "misusing terminology leads to misapplied doctrine."  Darn right.

To illustrate his point, let's discuss a 2016 Colorado case that manages to highlight how both Colorado and Utah have it wrong. As is so often the case, the decision turns on incorrectly merging doctrine from one entity type (the corporation) into another (the LLC) without acknowledging or explaining why that makes sense.  To the court's credit, they got the choice of law right, applying the internal affairs doctrine to use Utah law for veil piercing a Utah LLC, even though the case was in a Colorado court. 

After correctly deciding to use Utah law, the court then went down a doctrinally weak path.  Here we go:

Marquis is a Utah LLC. (ECF No. 1 ¶ 7.) Utah courts apply traditional corporate veil-piercing principles to LLCs. See, e.g., Lodges at Bear Hollow Condo. Homeowners Ass'n, Inc. v. Bear Hollow Restoration, LLC, 344 P.3d 145, 150 (Utah Ct. App. 2015). The basic veil-piercing analysis requires two steps:

The first part of the test, often called the formalities requirement, requires the movant to show such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist. The second part of the test, often called the fairness requirement, requires the movant to show that observance of the corporate form would sanction a fraud, promote injustice, or condone an inequitable result.

Jones v. Marquis Properties, LLC, 212 F. Supp. 3d 1010, 1021 (D. Colo. 2016). 

 

First, say it with me: You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One.  Second, the so-called "the formalities requirement" is a problem for Utah LLCs if one looks at the Utah LLC Act. The Colorado court does not do that, and neither does the Utah court that decided Bear Hollow Restoration, upon which Colorado relied.  They should have. You see, Utah has adopted the Revised Uniform Limited Liability Act, and the Utah version states expressly: 

The failure of a limited liability company to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground for imposing liability on a member or manager of the limited liability company for a debt, obligation, or other liability of the limited liability company.

Utah Code Ann. § 48-3a-304(b). So, that is at least potentially a problem, because the Utah test for the formalities requirement is supposed to be determined by looking at seven factors:

(1) undercapitalization of a one-[person] corporation; (2) failure to observe corporate formalities; (3) nonpayment of dividends; (4) siphoning of corporate funds by the dominant stockholder; (5) nonfunctioning of other officers or directors; (6) absence of corporate records; [and] (7) the use of the corporation as a facade for operations of the dominant stockholder or stockholders....

Lodges at Bear Hollow Condo. Homeowners Ass'n, Inc. v. Bear Hollow Restoration, LLC, 344 P.3d 145, 150 (Utah App. 2015).

 

I know some will argue I am being overly formalistic in highlighting how corporate focused these factors are, but this is problematic.  Virtually all of these factors must, at a minimum, be contorted to apply to LLCs.  If the test is going to be applied, the least a court should do is to rewrite the test so it refers LLCs specifically.  Why? Well, primarily because in doing so, it would make clear just how silly these factors are when trying to do so.  (For example, LLCs don't have stockholders, corporate funds, dividends, and generally don't have an obligation to have officers or directors.) 

 The Marquis Properties court skips actually applying the test saying simply that an SEC investigation report was sufficient to allow veil piercing. The court determined that an SEC report establishes that sole member of the LLC used the entity "to create the illusion of profitable investments and thereby to enrich himself, with no ability or intent to honor" the LLC's obligations. "Given this, strictly respecting [the LLC's] corporate form [ed. note: UGH] would sanction [the member's] fraud."  The Court then found that veil-piercing was appropriate to hold the member "jointly and severally liable for the amounts owed by" the LLC to the plaintiffs.

But veil piercing is both neither appropriate nor necessary in this case.  In discussing the SEC report earlier in the case, the court found that "all elements of mail and wire fraud are present." I see nothing that would absolve either the LLC as an entity of liability for the fraud and I see no reason why the member of the LLC would not be personally liable for the fraud he committed purportedly on behalf of the LLC and for his own benefit.  

This case illustrates another problem with veil piercing: both courts and lawyers are too willing to jump to veil piercing when simple fraud will do. This case illustrates clearly that fraud was evident, and fraud should be sufficient grounds for the plaintiffs to recover from the individual committing fraud. That means the entire veil piercing discussion should be treated as dicta. The entity form did not create this problem, and the entity form does not need to be disregarded, at least as far as I can tell, to allow plaintiffs to recover fully.  Before even considering veil piercing, a court should be able to state clearly why veil piercing is necessary to make the plaintiff whole. Otherwise, you end up with bad case law that can lead to bad doctrine, which leads to inefficient courts and markets.  

Oh, and while I'm at it, Westlaw needs to get their act together, too.  The Westlaw summary and headnotes say "limited liability corporation (LLC)" five times in connection with this case.  Come on, y'all.