Saturday, February 17, 2018

More on Purpose


More on Purpose


Last  year, in the Journal of Passthrough Entities, I published a short article on the importance of the “purpose” clause in LLC operating agreement and  similar business entity documents. HERE IS A LINK to that article.  Just before that article was released Peter Mahler, in his blog New York Business Divorce, wrote about the Mace v. Tunick decision; HERE IS A LINK to that posting.  Thanks to Peter’s lead, I was able to incorporation Mace v. Tunick into my article.
 
There have been further developments in the Mace case, and Peter has written about them in a posting titled The Purposeless Purpose Clause Makes a Comeback – Or Does It?; HERE IS A LINK to that posting.
 
Essentially, the LLC at question had a generic purpose clause, allowing it to engage in any activity in which an LLC may engage.  It was created to own the real estate from which a particular business operated.  The minority owner in the operating business eventually retired and was redeemed.  The operating business was then relocated out of state.   The majority owner of the LLC wanted it to remain in business, and he had the LLC lease the property to a third-party, but at a substantially lower rate than it had been receiving.  The minority owner wanted to liquidate the property and receive a liquidating distribution.
 
The plaintiff argued that the facts and circumstances, namely that the LLC’s purpose was to hold and lease property to the operating business, was no longer possible and that judicial dissolution of the LLC should follow.  That position was rejected as the purpose clause in the LLC’s documents was clear an unambiguous and therefore not subject to modification by parol evidence.
 
On that basis the minority member’s petition for judicial dissolution failed. Peter Mahler’s posting provides numerous insights as to the application of this decision.

Friday, February 16, 2018

No Partnership When Written Agreement Said No Partnership


No Partnership When Written Agreement Said No Partnership

       In a summary order issued by the United States Court of Appeals for the Second Circuit, it affirmed the determination that a particular business relationship was not a partnership because the purported partners, in writing, stated that it was an independent contractor relationship. Galvastar Holdings, LLC v. Harvard Seel Sales, LLC, No. 17-1571 (2nd Cir. Jan. 16, 2018).
      In this case, one of the two parties to a business relationship asserted that it was a joint venture with, consequently, fiduciary obligations between the two parties. The trial court rejected this assertion, that conclusion was affirmed by the Second Circuit. After reciting the elements of a joint venture, the court pointed to the terms of a pair of agreements that provided:
The relationship of Galvstar and Harvard under this agreement shall be solely that of independent contractors. Nothing contained herein or any other documents comprising a part hereof shall be deemed to constitute or create a relationship of agency, joint venture, partnership or any relationship other than that as herein specified.
      In that the two participants were not partners/joint ventures, no fiduciary duties arose.

Thursday, February 15, 2018

Questions on Bankruptcy Remoteness Certified to Fifth Circuit


Questions on Bankruptcy Remoteness Certified to Fifth Circuit

      Earlier this year, the United States Bankruptcy Court for the Southern District of Mississippi certified certain questions to the Fifth Circuit Court of Appeals, all relating to the ability to organize a venture as “bankruptcy remote.” In re: Franchise Services of North America, Inc., Case No. 1702316EE (Bankr. S.D. Miss. Jan. 17, 2018).
      For a number of years, there has existed a question of whether a particular business entity can structure itself as being “bankruptcy remote” with the effect that those remoteness provisions will be upheld. This reflects the tension between the law generally holding that it is against public policy to contract away the right to receive bankruptcy protections in contrast to the ability of participants in a business venture to, by contract, structure their relationship as they see fit. In a pair of 2016 decisions, In Re: Lake Michigan Beach Pottawattamie Resort, LLC and In Re: Intervention Energy Holdings, various bankruptcy remote structures were struck down. HERE is a link to my review of the In Re: Lake Michigan decision and HERE is a link to my review of the In Re: Intervention Energy Holdings decision. Most recently, Judge Schaff, in  In Re Lexington Hospitality Group, LLC, 2017 WL 4118117 (Bankr. E.D. Ky. Sept. 15, 2017) held that another bankruptcy remote structure was unenforceable.
      In this case, the bankruptcy court is asking the Court of Appeals to pass upon a certain bankruptcy remoteness structure referred to as a “Golden Share.” In the Golden Share structure, the right to veto a bankruptcy filing is held by an equity owner. This is in contrast to many of the other structures in which case the right to limit bankruptcy was vested in a creditor.

Wednesday, February 14, 2018

The “Nerve Center” of a Newly Formed Corporation


The “Nerve Center” of a Newly Formed Corporation

      An LLC, for purposes of federal diversity jurisdiction (28 U.S.C. § 1332) has the citizenship of each of its members. Where a member is a business corporation, the LLC will be attributed with both the corporation’s jurisdiction of organization and that in which it maintains its principal place of business, determined under the US Supreme Court’s “nerve center” test. What is the jurisdiction of incorporation is a straightforward question of positive law. For a corporation that has a significant operating history, determining where is the “nerve center,” the place at which the executive decisions are made, can be determined from that history. A recent case, however, faced the question of what would be the nerve center of a corporation that was newly organized. 3123 SMB LLC v. Horn, No. 16-55304, 2018 WL 445479 (9th Cir. Jan. 17, 2018).
      In this instance, a California LLC had been operating for some period of time. Embroiled in litigation, and shortly before filing a lawsuit against the LLC’s former attorney, the ownership of the LLC was restructured. As restructured, the sole member in the LLC was a business corporation incorporated in Missouri. In turn, its directors and officers were domiciled in California. The new corporation’s organizational documents provided that the annual meeting of the Board of Directors would be held in Missouri.
      The challenge before the court was whether the nerve center of the corporation would be Missouri, as set forth in the organizational documents, or California.
      The court would ultimately determine that the statement in the organizational documents that the principal executive activities would be discharged in Missouri would be given effect. The outcome of that determination was that the LLC was a citizen of Missouri with the capacity to bring its malpractice suit against its California attorney in federal court.

Monday, February 12, 2018

No Breach of Fiduciary Duty in Fraudulent Stock Transfer Agreement, But There Was a Breach of Contract and a Violation of the Implied Covenant of Good Faith and Fair Dealing


No Breach of Fiduciary Duty in Fraudulent Stock Transfer Agreement, But There Was a Breach of Contract and a Violation of the Implied Covenant of Good Faith and Fair Dealing

      In a recent decision by a US District Court in Arkansas, it was held that, where a shareholder engaged in a fraudulent share transfer agreement, there was no breach of fiduciary duty. However, on the same facts, there was a breach of the implied covenant of good faith and fair dealing. Morrison v MC Express LLC, Case No. 3:17-CV-00144 BSM (E.D. Ark. Jan. 9, 2018).
      Mitchell started a trucking business, MC Express, Inc. He enlisted Morrison for assistance in obtaining customers. Morrison agreed to do so in return for both commissions and stock in the MC Express. In 2002, Morrison and Mitchell executed an agreement providing that there would be transferred to Morrison 10% of Mitchell’s stock in the MC Express upon “the removal of Chuck Mitchell’s personal liability by the holders of the debts owed by MC Express, Inc.” Morrison, with Mitchell’s knowledge and consent, held himself out as a “minority member” in the corporation.
      For over 10 years, no stock was transferred to Morrison pursuant to the March 29, 2002 agreement. In November, 2012, Mitchell, without Morrison’s knowledge, changed the name of the company to “MC Express Leasing” and formed a new LLC under the name “MC Express.” He then began to transfer many of the assets of the corporation to the LLC with the effect that the corporation was left undercapitalized. Then, December 2016, Mitchell told Morrison, inter alia, that Mitchell had never been personally liable on the debts of MC Express and for that reason Morrison would never be entitled to the 10% of the stock.
       Initially, the court found that there had been a breach of contract. Mitchell never guaranteed any of the bank debt or other obligations of MC Express, so the condition precedent to the transfer of the shares to Morrison had always been satisfied. In addition, by having transferred assets from MC Express to the newly organized LLC, in which Morrison had no and would have no ownership interest, Mitchell violated the implied covenant of good faith and fair dealing. “Morrison, however, presumably did not enter into an agreement to receive stock in an undercapitalized and pilfered corporation.”
       With respect to the claim for fiduciary duty, it was rejected on what may be a somewhat questionable basis. The court found that, while fiduciary obligations are owed to shareholders, Morrison never became a shareholder, and therefore cannot claim the benefit of those obligations. Understandable, but there exist a lingering question as to whether Mitchell, by having violated the stock transfer agreement and in so doing deprived Morrison of the rights to formally acquire the shares and thereby become a shareholder, should be able to hide behind his improper actions to deprive Morrison of the breach of fiduciary claim.

Sunday, February 11, 2018

Effort to Reverse Pierce P.S.C. Rejected


Effort to Reverse Pierce P.S.C. Rejected

      In a typical case seeking to pierce the veil, a judgment-creditor seeks to hold the shareholders the corporation or the members in an LLC, the corporation or LLC being the judgment-debtor, liable for the obligations of the business entity. More rarely, we see efforts to hold a business entity liable for the debts of its owners. In certain instances, a judgment-creditor of a member or shareholder will seek to access the assets of the corporation or LLC in order to satisfy the judgment. This is referred to as outsider reverse piercing. Occasionally, we will see efforts by shareholder or a member to have a corporation or LLC ignored so as, intentionally, to make the assets of the business organization directly accessible by the owner. This is referred to as “insider reverse piercing.” In a case decided just last week by the Kentucky Court of Appeals, it rejected an effort by a shareholder in a professional service corporation (“P.S.C.”) to effect an insider reverse pierce and thereby claim coverage under an insurance policy. Isaacs v Sentinel Insurance Company, Limited, No. 2017-CA-000204-MR, 2018 WL 663001 (Ky. App. Feb. 2, 2018).
      Darrell Isaacs, a well-known personal injury plaintiff’s attorney in Louisville (a/k/a “Hammer”), was on January 19, 2015 injured while riding his bicycle on River Road, having been struck by Michael Baumann. Isaacs sued not only Baumann but also Sentinel Insurance, the firm that had written a policy to Isaacs’ firm, Isaacs & Isaacs P.S.C., of which he was the sole shareholder. Essentially (at least as I understand it), on the basis that Baumann did not have sufficient insurance, Isaacs was making a claim against Sentinel under the policies issued to the PSC. It bears noting that there is no suggestion that Isaac’s bicycle (which I understand to have been a Pinarello Dogma) was an insured vehicle under the Sentinel policy.

      Initially, the Court of Appeals dismissed the suggestion that the Sentinel policy covered Isaacs at the time of the accident.
So, an individual is entitled to UIM coverage if occupying a covered motor vehicle at the time of the accident. In short, the terms of UIM coverage set forth in the insurance policy are clear and unambiguous.
In this case, Isaacs was riding a bicycle at the time of the accident and was not occupying a covered auto. Under the clear and unambiguous terms of the insurance policy, Isaacs is not an insured entitled to recover UIM benefits. 2018 WL 663001, *3.
       The Court of Appeals as well rejected an effort by Isaacs to treat him and his PSC as “synonymous,” rejecting as well the argument “that the P.S.C. is nothing more than a ‘legal fiction’ for tax purposes only.” Rather, the court found:
In Kentucky, a professional service corporation (P.S.C.) is a corporate entity as set out in Kentucky Revised Statutes (KRS) 274.015. The corporation must provide professional service to the public of the type which requires as a condition precedent thereto, the obtaining of a license or other required legal authorization to perform the service.  This, licensed attorneys like Isaacs, are “qualified” persons under the statute who may form a P.S.C. to conduct their legal practice.  More importantly, a P.S.C. formed under KRS Chapter 274 has the “same powers, authority, duties and liabilities as a corporation formed under KRS Chapter 271B.”
Thus, a professional service corporation is a distinct legal entity under Kentucky law.  The formation of a P.S.C. under Kentucky law does not involve tax issues.  Rather, those issues look to an election under various federal tax laws by management as to whether the newly formed corporation will elect to be a C-Corporation or S-Corporation for tax purposes.  Isaacs’ argument that he is one and the same as his P.S.C. for insurance purposes because of a tax election is totally without legal merit under Kentucky law, as the record reflects he is a shareholder of the corporation.  Similarly, Isaacs’ argument that he is the named insured of the corporation’s automobile insurance policy by virtue of his stock in the P.S.C. is also without merit (citations omitted).
      And so ended the effort to reverse pierce the P.S.C.

Wednesday, February 7, 2018

The Bonfire of the Vanities


The Bonfire of the Vanities

      Today, February 7, marks the anniversary of the Bonfire of the Vanities, an event which took place in Florence Italy in 1497.
      Savonarola, a Dominican Friar, had been preaching against the material and artistic excesses present in Florence, arguing in contrast for a life of austerity. On February 7 was held the Bonfire of the Vanities, with “Vanities” including everything from ancient secular manuscripts to make up to mirrors to secular (as contrasted with religious) paintings. As recited in Ivan Cloulas (trans. Gilda Roberts), The Borgias at 134, “His hold over the Florentines was such that on February 7, 1497, on the Piazza della Signoria, he set up the famous ‘bonfire of the vanities,’ on which lascivious paintings, obscene books, lutes, pomades, perfumes, mirrors, dolls, playing cards, gaming tables, and scores of other articles were confined to the flames.” Exactly what was lost cannot be known.
      Savonarola would ultimately be excommunicated by Pope Alexander VI and suffered death by hanging in 1498; his body was burnt and the ashes cast into the river.