The 2012 Amendments to Kentucky’s Business Entity Statutes

The 2012 Amendments to Kentucky’s Business Entity Statutes

            The Kentucky Law Journal Online has released The 2012 Amendments to Kentucky’s Business Entity Statutes.  This article reviews the various statutory updates set forth in 2012 H.B. 341.  The article can be accessed through the KLJ’s website – here is a LINK to the article.

Director Fiduciary Duties

Forthcoming from the Kentucky Supreme Court – Director Fiduciary Duties

      On August 15 the Kentucky Supreme Court will hear oral arguments in 1400 Willow Council of Co-Owners, Inc. v Ballard.  As previously reviewed (see posting on September 29, 2011), one issue in the case is whether the statutory formula in the statute as to a director’s fiduciary obligations, including the determination of the beneficiary of the obligations (namely the corporation), is exclusive of any conflicting common law or simply cumulative to it. 

      My views on the matter are set forth in Is the Statutory Fiduciary Duty of Corporate Directors Exclusive?, available on SSRN, abstract 20644923.  Here is a link to the piece.  LINK

      The Court of Appeals’ decision can be found at 2010 WL 2010521, 2010 Ky. App. LEXIS 94, No. 2008-CA-001155-MR (Ky. App. 2010).

Interest Adverse to the LLC

Connecticut’s Supreme Court Addresses “Adverse” Interest Against LLC

      Under the Connecticut Limited Liability Company Act (Conn. Gen. Stat. § 34-187(b)), “The vote of any member of manager who has an interest in the outcome of the suit that is adverse to the interest of the [LLC] shall be excluded” from any vote as to whether the LLC should bring suit, with the authorization to bring suit generally being made by a majority of interest of the members.  Kentucky has a similar provision in its LLC Act, specifically KRS § 275.335.  The statutes do not, however, identify the standards to apply to determining whether there is such an “adverse” interest.  That is the issue recently addressed by the Connecticut Supreme Court in 418 Meadow Street Associates, LLC v. Clean Air Partners, LLC, SC 18699 (Conn. May 22, 2012).

      418 Meadow Street Associates, LLC (“Meadow”) was, at the time relevant to this action, owned 50% by Barbara Levine, 33.33% by Michael Weinshel and 16.67% by Mark Wynnick.  Meadow owned a building that was in part leased to Clean Air Partners, LLC (“Clean Air”).  While Barbara Levine had no direct ownership interest in Clean Air, her husband Steven was a 20% owner thereof.  A dispute arose between Meadow and Clean Air regarding the lease.  Weinshel and Wynnick proposed that Meadow bring suit against Clean Air.  Barbara Levine, on the other hand, expressly objected to bringing the suit.

      And there arose the conflict.  If Barbara Levine’s interest in Meadow was to be counted, on the basis that she did not have an interest adverse to that of the LLC, Meadow would not have the necessary majority approval to bring suit.  Alternatively, if Barbara’s interest in the LLC were excluded from the calculation, that exclusion being based upon her having an interest adverse to that of the LLC, majority approval was in place.  Both the trial court and the intermediate court of appeals determined that Barbara Levine’s interest was not adverse to that of Meadow, finding she lacked a “proprietary interest” in the defendant.  In turn, the case was appealed to the Supreme Court, which would ultimately reverse both the trial court and the Court of Appeals.

      The Supreme Court characterized the determinations below as follows:

According the trial court, “Barbara Levine is not a party to the action, and she does not have a proprietary interest in [the defendant].  She cannot be assigned an interest in the case simply because she is the wife of a co-owner of the defendant.”  In upholding the trial court’s conclusion, the Appellate Court stated that “the record support[ed] the [trial] court’s finding that … [Barbara Levine’s] husband’s ownership interest was not significant enough to assign her with an interest adverse to the outcome of the action based on their personal relationship alone.”  418 Meadow Street Associates, LLC v. Clean Air Partners, LLC, supra, 123 Conn. App. 422.  Thus, the Appellate Court’s conclusion is slightly different from the conclusion that the trial court reached.  The trial court’s decision suggests that, under the facts of this case, § 34-187(b) would not have excluded Barbara Levine’s vote because she did not have a direct, proprietary interest in the defendant.  Furthermore, the trial court stated that the spousal relationship alone was not enough to support a claim that a member has an interest adverse to the interest of the limited liability company.  The Appellate Court’s decision, on the other hand, suggests that a spousal relationship may be sufficient to support an adverse interest claim in some circumstances, depending on the extend of the spouse’s interest in the defendant company.  In other words, the Appellate Court apparently accepted the proposition that a member’s interest could be considered adverse by virtue of his or her spouse’s interest but that, in the present case, Steven Levine’s interest in the defendant was too minor to Barbara Levine.  We need not address the differences between the trial court’s and the Appellate Court’s decision, however, because our decision turns solely on a matter of statutory interpretation.

Looking to several dictionary entries for “adverse,” the Court found that:

The term “adverse” in § 34-187(b) encompasses any interest of a member that in contrary or opposed to the [LLC’s] interest in the outcome of the litigation ….

We also conclude that when a spouse of a [LLC] member holds an interest or maintains a position of control in a defendant company, as in the present case, that member’s interest properly is considered adverse to the outcome of a lawsuit that the [LLC] brings against the defendant company ….  Simply put, under § 34-187(b), the sweeping scope of the term “adverse” requires that the interests of a member’s spouse be imputed to the member. 

      The Court went on to note that this bright line rule is effective to preclude subsequent recourse to litigation based upon issues such as the magnitude of the spouse’s interest and as well provide clarity against which a contrary rule may, in the operating agreement, be adopted.

Delaware's Anonymity? A Response to The New York Times

Delaware's Anonymity? A Response to The New York Times

The Triumph of Hope Over Experience

A second marriage has been described as the triumph of hope over experience. On that basis Henry VIII must have been among the most hopeful of men known to history. Today is the anniversary of his SIXTH wedding, that to Katherine Parr in 1543. She, along with fourth wife Ann of Cleve's, would outlive Henry. Katherine was a pretty positive person herself. Henry was her third husband, the first two having predeceased her. She would ultimately marry again, that to Thomas Seymour (uncle to Edward VI and brother of Edward Seymour, protector of the realm during Edward's minority).

Shareholder Lacked Standing to Pursue Derivative Action

Shareholder Held Not To Fairly and Adequately Represent

Corporation in Derivative Action

      On June 29, the Court of Appeals issued an important decision regarding standing to bring a derivative action, there affirming the trial court’s summary judgment and order of dismissal in favor of the various defendants.  Watkins v. Stock Yards Bank & Trust Co., No. 2011-CA-000228-MR, 2012 WL 2470692 (Ky. App. June 29, 2012) (To Be Published).

      Under the law governing business corporations, it is the board of directors that is charged to oversee the corporation’s management and affairs.  KRS § 271B.8-010(2).  In exceptional circumstances, where the board of directors  is not pursuing the interests of the corporation, a shareholder may bring a derivative action pursuant to which, on the corporation’s behalf, the shareholder litigates in its name.  There exist, however, substantive requirements for bringing a derivative action including, in most instances, that the shareholder may a demand upon the board of directors that it act, that the shareholder have been in that status at the time of the actions complained of, and that they remain a shareholder throughout the pendency of the action.  In addition, KRS § 271B.7-400(1), provides that:

A derivative proceeding shall not be maintained if it appears that the person commencing the proceeding does not fairly and adequately represent the interests of the shareholders in enforcing the right of the corporation.

            Watkins, an individual, was one of the four living beneficiaries of  the NIB Trust, it being in turn a 40% shareholder of Beargrass, a Kentucky corporation that had been the owner of the Oxmoor Shopping Center.  In 2003, Oxmoor had been sold by Beargrass for $72.4 million, which sale received the unanimous approval of Beargrass’ directors and shareholders.  Seventeen months after that sale, the purchasers from Beargrass sold Oxmoor for $123 million.  After that second sale, Watkins requested that the trustee of the trust commence a shareholder derivative action challenging the initial sale.  Being apparently unsatisfied with the investigation made at that time and the determination, concurred in by the other beneficiaries of the trust, to not proceed with the derivative action, Watkins, on behalf of Beargrass, filed a combined derivative and individual action asserting breaches of fiduciary duty in the recommendation of the sale of the Oxmoor property for an inadequate price.  An additional derivative action was subsequently filed against the prior managers of the Oxmoor property, they having been the acquirer from Beargrass.

       Ultimately, the appellees moved for summary judgment, which was granted by the trial court, whereupon all of Watkins claims (both individual and derivative) were dismissed.  He appealed.  Certain of the defendants filed motions for attorney fees against Watkins, which motions were denied by the trial court, and they filed a cross-appeal.

       The court relied primarily upon Davis v. Comed, Inc., 619 F.3d 585, 593-94 (6^th Cir. 1980), a decision interpreting the analogous FRCP 23.01, in assessing whether Watkins did or did not fairly and adequately represent the interests of the shareholders.  Applying its analysis, the court noted that all of the other shareholders of Beargrass had filed affidavits opposing the lawsuit and as well had voted to indemnify Osborn and Maynard, respectively the chairman and president of Beargrass, from any liability incurred in the lawsuit:

In this case, there are similarly situated shareholders, and Watkins is opposed by them all.  Further, all of the beneficiaries of the NIB and TWB Trusts, except Watkins, opposed this action.  Watkins has no support from any of the shareholders or beneficiaries he purports to represent.  Accordingly, we conclude that Watkins does not fairly and adequately represent the interests of the shareholders as required by KRS 271B.7-400(1).  Slip op. at 11.

In addition, there was evidence that Watkins sought to personally gain from the action notwithstanding the fact that it was brought as a derivative action for which any recovery would be a corporate asset:

As correctly noted by the trial court, a month after Watkins filed this suit, Watkins’s counsel sent a letter to [the trustee of the NIB Trust] and counsel for Osborn, Maynard and Stock Yards Bank, offering to dismiss all claims, including the derivative ones, in exchange for a payment $2.2 million to Watkins personally.

Watkins argues that the settlement letter was proper because it was a settlement of only his individual claims and that the parties knew the trial court would have to approve the settlement.  However, we note that Watkins’s settlement letter clearly states that he is willing to dismiss all claims, including the derivative ones, if he personally received $2.2 million.  We believe that Watkins’s willingness to settle all claims at the expense of the shareholders and beneficiaries reflects that his self-interests were in conflict with the interests of those he purports to represent.  Slip op. at 9-10.

      As for Watkins’s individual claims, they were dismissed on the basis that he asserted no individual injury, distinct from that suffered by the other shareholders of Beargrass, and further that the asserted injury was nothing more than the loss of the value of his stock:

We note that the violations of duties Watkins claimed Stock Yards Bank owed directly to him and the NIB Trust are the same duties he claims Stock Yards Bank owed to the other shareholders.  Moreover, Watkins failed to demonstrate a specific injury to himself outside the diminution in the value of the corporate assets and his stock.  Therefore, we conclude that the trial court did not err in dismissing his direct claims.  See Sahni v. Hock, ___ S.W.3d __, 2007-CA-001785-MR (Ky. App. 2010) (concluding that depreciation and the value of the shareholder’s stock was not a sufficient type of direct personal injury necessary to sustain a direct cause of action).  Slip op. at 13.

      As for the denial of award of attorney fees against the plaintiff (see KRS § 271B.-400(4)), the court noted that the statute is discretionary with the trial court, and that there existed no basis for setting aside that determination on an abuse of discretion standard.

      No word yet as to any appeal to the Kentucky Supreme Court.

       This decision is important for a variety of reasons.  First, we have here the affirmance of a determination, on summary judgment, that a shareholder does not adequately represent the interests of the corporation.  This ruling should go a long way to support the dismissal, on similar bases, of other unjustified derivative actions.  Second, the court has here confirmed that opposition from other similarly situated shareholders is a basis for denying standing and as well confirmed that a plaintiff shareholder who seeks to appropriate to themselves the benefit of the action is not an adequate shareholder representative.  Similar claims were brought in the Sahni v. Hock action; in that case, the plaintiff, Hock, offered to settle all actions, including the derivative claims, for a payment to herself as an individual, but no dismissal resulted.  Third, there has again been confirmed the rule that diminution in value of stock is a derivative and not an individual claim.

        With respect to the issue of attorney fees, while the court’s ruling may be consistent with the statute as it currently exists, the question must be raised as to whether reform is needed in this area, especially in light of the prior direction from the Court of Appeals in Sahni v. Hock to the effect that an award of attorney fees is not appropriate if the plaintiff prevails even slightly in the action.  It needs to be recognized that a derivative action imposes significant costs and expenses upon the corporation in violation of the general applicable rule that it is the board of directors that has control of the corporation’s management and affairs.  When a plaintiff shareholder seeks to act in place of the directors, there exist a significant policy basis for requiring that they proceed in a reasoned and informed manner.  For example, the bringing, on an individual basis, of claims that are clearly derivative would seem to be, of itself and to the extent thereof, a basis of the award of attorney fees.  Second, bringing a derivative action on behalf of a corporation and then, for individual benefit, seeking to appropriate the fruits thereof should of itself be a basis for the award attorney fees.  Third and last, the statute should be amended to provide for proportionate analysis, on a claim by claim basis, of the award of attorney fees, in effect overruling that portion of Sahni v. Hock that held that recovery on even a minor point by the plaintiff protected them from an award of attorney fees to the corporation and the defendants.  While there is an obvious policy basis for the derivative action, the exceptional costs they incur justify constraints upon those who might bring them without due investigation of both the facts and the applicable law.

Chancery Decides: Not Per Se Breach of Fiduciary Duty for a Board to Fail to have a Succession Plan.

Chancery Decides: Not Per Se Breach of Fiduciary Duty for a Board to Fail to have a Succession Plan.


I really must question the reasoning of the Delaware court as to there not being a fiduciary obligation to have in place a succession plan.  I see that as one of the primary obligations of the Board, especially in light of the actuarial certainty that every CEO will die and all are at any time at risk of death by accident.  In the same manner as does the British Monarchy, "an heir and a spare" should be at all times on hand.  A board that does not do so risks gaps in oversight.

ABA Business Law Section Actively Opposes Low-Profit LLCs

ABA Business Law Section Actively Opposes Low-Profit LLCs


Rather than repeat what has already been well said, see this post from Doug Batey regarding opposition to the L3C.

Delaware Does Not Impose Fiduciary Duty, Per Se, to Minimize Corporate Taxes

Delaware Does Not Impose Fiduciary Duty, Per Se, to Minimize Corporate Taxes

This is an interesting decision, especially its holding a to the absence of an obligation to minimize taxes; it may have some bearing on the Sullivan v. Sullivan case that is currently brewing here in Louisville.

Fractured Kentucky Supreme Court Addresses Dog Bite Liability

Fractured Kentucky Supreme Court Addresses Dog Bite Liability

 

      In a remarkably fractured decision, the Kentucky Supreme Court has recently addressed the law as to when a landlord can be liable for dog bite liability.  Benningfield v. Zinsmeister, 2009-SC-000660-DG (Ky. June 21, 2012).

      Brandon Benningfield, an eight year old boy, was approached by a Rottweiler owned by Dominic Harrison.  Brandon ran, at which point the dog gave chase and attacked him, resulting in numerous injuries to Brandon.  The dog in question had been kept in the fenced pen of the yard of Dominic’s parents.  His parents in turn leased their residence from the Zinsmeisters.  As recounted by the Kentucky Supreme Court, “The attack occurred on the sidewalk across the street from the rented property after the dog somehow escaped from the back yard.”  Slip op. at 2.  Brandon’s mother, Laurie Benningfield, filed suit against the Harrisons, as the owner of the dog, and against the Zinsmeisters, asserting that they bore strict liability for the dog attack.  Ultimately, the Harrisons settled, and suit proceeded against the Zinsmeisters under KRS § 258.095(5), which defines the owner of a dog as including “every person who keeps or harbors the dog, or has it in his care, or permits it to remain on or about premises owned or occupied by him.”  The trial court granted summary judgment and the Court of Appeals affirmed on the basis that liability did not extend to the landlord when the attack does not take place on the leased premises.

      The Supreme Court would hold that, while the landlord may be treated as a statutory owner of the dog, focusing on the statutory reference to the dog being “on or about” the leased premises:

We read this to mean that a landlord is only an owner when the dog is within the landlord’s permission that is, when it remains on or about the premises.  Because liability depends on ownership, which under the statute depends on permission, then a landlord’s liability is limited by the scope of the permission so that it exists only when the attack occurs “on or about” the premises.  Slip op. at 12.

Ultimately, the court determined that “on or about” requires that the attack take place “on the property or so close to it as to be within the immediate physical reach.  Thus, it would include an attack that occurs immediately adjacent to the property – for example, on the sidewalk or just off the curb – but nothing further away.”  Slip op. at 12.  On that basis, the court determined that an attack taking place across the street was not “on or about” and, for that reason, the Zinsmeisters, as landlords, were not liable under the dog bite statute.

      This decision led to no less than four separate opinions from the seven members of the court.

      For the perspective of business law, it is important for all landlords to appreciate that Kentucky law does provide that, in least in certain circumstances, a landlord can be held responsible for dog bites that take place “on or about” their property if they have consented (which consent may be either explicit or implicit) to permitting dogs to be maintained at the property.  Landlords would be well advised to confirm the availability of insurance coverage in these events and to as well mandate that tenants maintain appropriate insurance coverage for which the landlord is identified as an additional insured.

Administrative Dissolution + Reinstatement = No Personal Liability of Officers

Administrative Dissolution + Reinstatement = No Personal Liability of Officers

      The wisdom of the 2012 amendments to the Kentucky statutes providing that, upon reinstatement after administrative dissolution, the liability of any agents of the entity will be determined as if the dissolution had never taken place, has been confirmed by a  recent decision of the Kentucky Court of Appeals.  Harshman Construction & Electric, Inc. v. Witte, No. 2011-CA-000609-MR, 2012 WL 2471445 (Ky. App. June 29, 2012) (Not To Be Published).

      The Wittes contracted with Harshman Construction & Electric, Inc. to build a home.  They ultimately had a falling out over failures by Harshman to conform the construction to the plans and excessive delays in construction, and the decision reviews the measure of damages available to them.  In addition, the Wittes asserted that certain of the officers and Harshman’s sole shareholder should be held personally liable on the basis that, during part of the construction phase, Harshman Construction was administratively dissolved.  Specifically, while the contract was entered into in March 2007 and construction began in May 2007, Harshman Construction was administratively dissolved in November 2007, one month before the final break in their relationship leading to the Complaint being filed in February 2008.  Harshman was reinstated in March 2010.  In January 2011, three years after the filing of the Complaint, the individual defendants moved to dismiss the claims against them.

The trial court denied the motion to dismiss stating that:  (1) the corporation was dissolved at the time work was being performed; therefore, the Wittes were dealing with individuals at that time and not agents of the corporation; (2) dismissing [the individual defendants] could be prejudicial because the motion to dismiss was filed nearly three years after the action was commenced; and (3) the [individual defendants] actively engaged in litigation and individually raised counterclaims against the Wittes.  Slip Op. at 4.

Ultimately, two of the individual defendants were found liable on the Witte’s claims.  Needless to say, that decision was appealed.

      Reversing the determination that the individuals were personally liable, the Court parsed KRS 271B.14-22(3), the predecessor to now applicable KRS § 14A.7-030, both of which provide that upon the reinstatement of a dissolved entity, the reinstatement shall “related back to and take effect as of the effective date of the administrative dissolution or revocation” and the organization shall proceed forward as if the administrative dissolution “had never occurred.”  Slip Op. at 5.  Noting that the statute does not impose a time limitation for seeking reinstatement after administrative dissolution, it relied upon the 2005 ruling of the Court of Appeals in Fairbanks Arctic Blind Co. v. Prather & Associates, Inc., the Harshman Court writing that:

As reinstatement of a corporation relates back to the effective date of dissolution and operates as if dissolution never occurred, it naturally follows that the shareholders and officers of such corporation are not individually liable for actions undertaken on behalf of the corporation during its dissolution.  Slip Op. at 6.

      The Court of Appeals did remand to the trial court the argument, not previously addressed, that the corporate veil of Harshman Construction should be pierced.

      As to the effect of the reinstatement, this ruling of the Court of Appeals is normatively accurate for the reasons previously reviewed in section 9.5 of Dissolution of a Limited Liability Company, that being Chapter 9 of Limited Liability Companies in Kentucky (UK/CLE 2011).   The holding is as well consistent with both eServices, L.L.C. v. Energy Purchasing, Inc., 2012 WL 404957 (E.D. Ky. Feb. 6, 2012) and Pannell v. Shannon, No. 2010-CA-001172-MR (Ky. App. Aug. 26, 2011).  Further, it is consistent with the statutory amendments approved by the 2012 Kentucky General Assembly.  By means of that amendment, it creating KRS § 14A.7-030(3)(c), it is now express that upon reinstatement:

The liability of any agent shall be determined as if the administrative dissolution or revocation had never been heard.

KRS § 14A.7-030 as amended by 2012 Ky. Acts, ch. 81, § 83.

New York Times Article Bashes Delaware as Corporate Haven

New York Times Article Bashes Delaware as Corporate Haven

This is an interesting, and in my mind not entirely even-handed, article.  The function of the registered agent is not explained, and neither is the fact that the law does not even suggest that a company is located at/doing business from its registered office.  In addition, there is no consideration given to the immense transactional costs that would be imposed upon everyday businesses were the Levin proposal to be enacted.  Some of those issues I reviewed in Requiring Disclosure of Business Entity Ownership: Proposed New Laws are Burdensome, But With the Benefit of Being Ineffective, 13 J. Passthrough Entities 47 (July/Aug., 2010).

Here is a link to that article LINK