Thursday, June 27, 2013
Seventh Circuit Considers Relationship of Contractual Liability Cap, Economic Loss Rule and Contractual Indemnification
Seventh Circuit Considers Relationship of Contractual Liability Cap,
Economic Loss Rule and Contractual Indemnification
In a recent decision of the United States Seventh Circuit Court of Appeals, it considered how to apply a contractual provision limiting one party to a contract maximum liability against both the economic loss doctrine and state law limiting contractual indemnification terms. In this case, the Court found that the contractual limit on maximum liability would be enforced, and that a failure to do so would, in effect, undercut the economic loss rule. SAMS Hotel Group, LLC v. Environs, Inc., __ F.3d __, 2013 WL 2402824 (7th Cir. May 31, 2013).
SAMS Hotel Group, LLC entered into an architectural agreement with Environs for the design of a hotel. That contract provided for a fee of $70,000 and as well contained a provision providing, inter alia, that the maximum damages that could be available to the land owner would be that $70,000 fee. The building was constructed, nearly completely, when it was discovered that numerous defects existed such that it had to be demolished. The owner brought suit against the architect claiming $4 million in damages.
Sitting in diversity, the District Court struck the owner’s claims for negligence, finding them to be barred by the economic loss rule, i.e., the plaintiff cannot recover for economic damages asserted in tort where a contract governs the relationship of the parties. 2011 WL 809048. Having dismissed that count, there was a bench trial on the breach of contract claim, in which the owner prevailed. However, having prevailed, he was limited to recovering the $70,000 fee and, consequent to that cap, nothing beyond that. 2012 WL 3139765. He then appealed to the Seventh Circuit.
Applying Indiana law, the Seventh Circuit wrote:
The general rule of freedom of contract includes the freedom to make a bad bargain. 2013 WL 2402824, *6.
Based upon the fact that the contract was entered into between sophisticated commercial entities with equal bargaining power (i.e., it did not involve a consumer contract or a contract of adhesion), the Court of Appeals enforced the maximum liability provision of the agreement. The Court reasoned that ignoring the contractually agreed to maximum liability would permit an end-run around the economic loss rule. With respect to the effort to recharacterize the liability cap as a contractual indemnification, the plaintiff’s theory being that contractual indemnification must “clearly and unequivocally” shift liability for another party’s simple negligence, the Court found that the liability cap would not be so interpreted. Rather, while liability caps “serve to establish a contractual ceiling” on the damages that may be awarded, indemnification works to insure a party against his own negligence. 2013 WL 2402824, *3. Ergo, the two would not be treated as distinguishable, and the heightened standard applied to indemnification clauses will not be applied to liability caps.
LLC Member Held Liable on What He Thought Was Company Credit Card
In a recent decision of the Kentucky Court of Appeals, it was held that the member of an LLC would be personally liable for charges incurred in connection with an American Express card. The Court considered and dismissed arguments that the suit was improperly brought in that American Express is not qualified to transact business in Kentucky and under the Statute of Frauds. Williams v. American Express Bank, FSE, No. 2012 CA-000855-MR (Ky. App. June 14, 2013) (Not to be Published).
Williams was one of the three members of Wheel Play, LLC, a Kentucky LLC. The company ceased operations in 2012, leaving an open balance of $36,814.71 on the American Express obligation. American Express relied primarily upon its card holder agreement, which provided, inter alia, that by using the card, one agrees to the terms of that agreement. Williams, treated as the “authorizing officer” of the LLC, was obligated “to pay all Charges, including Charges incurred by Additional Cardmembers” on the account. Further, that same Cardmember Agreement provided:
The Company and the Basic Cardholder are responsible under this Agreement for all use of the Card Account by the Basic Cardmember and Additional Cardmembers, by anyone the Basic Cardmember or an Additional Cardmember lets use the Card, and the charges they incur will be billed to the Basic Cardmember.
Williams relied, in turn, on the limited liability provision (KRS § 275.150) of the LLC Act. Williams also asserted that he should be treated as a guarantor of the company debt, and that the Cardmember Agreement did not satisfy the terms of the KRS § 371.065, the guaranty should be held unenforceable.
In reviewing the Cardmember Agreement, the Court of Appeals found that Williams and the LLC jointly applied for and received the line of credit from AmEx, which was conditioned upon the terms of the Agreement with AmEx. Ergo, Williams undertook direct liability on the debt.
As to the argument that his personal liability should be barred by the Kentucky statute covering personal guarantees, the Court found that Williams was an original obligator under the Agreement and not a guarantor.
With respect to the assertion that AmEx could not bring suit because it was not qualified to do business, that claim was initially dismissed for its failure to be brought as an affirmative defense. In addition, the Court found that American Express is exempt from the requirement to qualify to transact business in that it is a savings association regulated by the Office of the Comptroller of the Currency for which, inter alia, qualification is not required. On this point, the Court cited the 2012 decision rendered in Williams v. Chase Bank USA, N.A., it relating to a national chartered bank regulated by the Office of the Comptroller of the Currency.
Last, with respect to Williams’ assertion that enforcement of the debt against him would violate the Statute of Frauds, the Court found that Williams was bound the Cardmember Agreement and, irrespective thereof, KRS § 371.010(9) exempts from the scope of the Statute of Frauds “agreements pursuant to which credit is extended by means of a credit card or similar device.”
Needless to say, many small businesses that are, in effect, debt financing their operations through credit card draws need to carefully scrutinize those agreements if they believe that the members or other owners making the draws on those cards will in some manner be protected from liability when the business fails.
Wednesday, June 19, 2013
Yeah, That Never Happened
Fictional portrayals of historical events can be entertaining, but as well they can be misleading. The historic timeline is sometimes altered for the benefit of the story, while at other times anachronisms are introduced.
Today is the anniversary of the death of Piers Gaveston, the friend and confident (their remains debate as to whether they were as well lovers) of Edward of Caernarfon, the son of Edward I of England.
Now in the movie Braveheart Piers is thrown from a window to his death by Edward I. Edward I died in 1307. Piers died in 1312. Quite a trick throwing someone from a window five years after your death.
It never happened. Piers outlived Edward I, and received considerable royal favor from Edward II. He was in turn exiled from England at the insistence of nobles who thought their place as counselors to the king were being undermined by the overly close relationship between Edward II and Piers. Upon his return to England he was attacked and killed.
Sorry, no riveting scene of the king throwing someone from a window to prove a point about leadership.
The other day I was watching some back episodes of The Borgias. FYI, the supposed incestuous relationship between Cesare and Lucrezia is unconfirmed, and Juan's servant was killed at the same time he was.
But I digress. There was an episode in while Catarina Sforza erects a fake shroud to attract pilgrims, it being identified as the Shroud of Constantinople. Anyone seeing it today would identify it as a replica of the Shroud of Turin, right down to the regular triangular holes. A few may know those holes are from fire damage.
Now the fake relic exhibited in The Borgias is shown in 1500 - Sforza is trying to divert pilgrims from that year's Jubilee celebration. So why does her fake relic display the results of fire damage that was not suffered by the real Shroud until 1532?
Tuesday, June 18, 2013
Court Addresses Kitchen Sink Complaint, Largely Dismisses
Claims Against Corporation’s Shareholder
Judge Simpson of the Western District of Kentucky has recently addressed and largely dismissed a kitchen sink complaint a corporate shareholder, it being apparent that he was the only “deep pocket” from which a secured creditor might be made whole. While the Court upheld the liability of the corporate debtor and the guarantor of that debt, it dismissed in toto this effort to hold a shareholder personally liable on those obligations. CNH Capital America LLC v. Hunt Tractor, Inc., 2013 WL 1310878 (W.D. Ky. Mar. 26, 2013).
Briefly, Hunt Tractor was a dealer for Case Equipment, with equipment financing provided by CNH Capital America, LLC (“CNH”). At the times relevant to this dispute, Scott Hunt was the President and majority shareholder of Hunt Tractor. His father-in-law, Pagano, was a minority shareholder. Scott Hunt had personally guaranteed the corporation’s obligation to CNH. Pagano had guaranteed certain obligations of Hunt Tractor to Commonwealth Bank, which provided Hunt Tractor with a term loan and a line-of-credit.
Skipping over a variety of financial transactions and problems that Hunt Tractors was having in meeting various obligations (not, undoubtedly, occasioned by the credit crisis that began in 2008), Hunt Tractors liquidated a significant block of inventory to the Kentucky Department of Transportation. Those funds were in turn tendered to Commonwealth Bank in order to close out the existing term loan and line-of-credit. Hunt Tractor then defaulted on the balance of his obligations to CNH. CNH sold the collateral, leaving a $2 million deficiency. Suit was then brought against Hunt Tractors, Steve Hunt, individually, and Pagano.
Initially, the Court found that Hunt Tractor was liable on the indebtedness, and that Scott Hunt was liable thereon pursuant to his guaranty of the company’s obligation. Two defenses had been raised to this liability. First, it was asserted that CNH did not undertake a commercially reasonable sale of the collateral. The Court found that an assertion that the collateral had not been sold on a commercially reasonable basis constituted an affirmative defense under the Federal Rules of Civil Procedures, and as that defense had not been adequately pled, it was barred. As to the Scott Hunt’s guaranty of the company’s obligations, it of itself did not comply with the Kentucky guaranty statute, KRS § 371.065(1), but the guaranty agreement itself provided it would be governed by Wisconsin law. Undertaking an extensive review of Kentucky law as to choice of law, the Court found that the doctrine set forth in Wallace Hardware would in this case be applied. Scott Hunt was deemed to be a sophisticated business man, and he either would have appreciated or had opportunity to come to appreciation of the impact of the choice of law provision. The parties having contractually agreed that the validity of the guaranty would be determined under the law of Wisconsin, and as the guaranty was viable under that law, it was enforced against Scott Hunt.
No doubt believing that both Hunt Tractors and Scott Hunt would have insufficient assets to satisfy its claim, CNH brought a variety of claims against Pagano seeking to hold him personally liable on the open amount. With respect to a pair of assertions based upon preferential conveyance and fraudulent conveyance, both were dismissed consequent to the plaintiff’s failure to name Commonwealth Bank, the transferee of the funds realized from the asset sale to the Kentucky Department of Transportation, as a party. Noting that Kentucky’s fraudulent conveyance law is different in several respects from the Uniform Fraudulent Transfer Act, the Court found that a fraudulent or preferential conveyance claim must name the transferee of the assets in that the claim is essentially one for rescission of the transfer. Having not named Commonwealth Bank, those claims failed. With respect to an assertion that Pagano breached a fiduciary duty to CNH, the Court was able to easily dismiss same, finding there was no fiduciary duty of Pagano to CNH, a fiduciary duty that would have required Pagano to put the interests of CNH “ahead of his own.”
CNH also brought a claim against Pagano based upon the theory of piercing the veil, a claim that the Court disposed of on interesting grounds. After reciting the test for piercing set forth by the Kentucky Supreme Court in Inter-Tel Technologies, the Court focused upon the fact that CNH could have achieved the same result of a successful piercing claim by a successful action for fraudulent conveyance. Essentially, the availability for a claim for fraudulent conveyance eliminates the possibility of the “injustice” element of piercing. The Court wrote that:
In light of the fact that Hunt Tractor [sic CNH] had an available remedy for the supposedly improper conveyance from Hunt Tractor to Commonwealth Bank, there would be no injustice in declining to pierce the corporation veil in this case. See 1 William Mead Fletcher, Fletcher Cyclopedia on the Law of Private Corporations, § 41.34 (1999) (“Where attempted transfers of corporate assets may be avoided as fraudulent conveyances, disregarding the corporate entity is unnecessary.”).
Sixth Circuit Court of Appeals Holds LLC to be a Nominal Party to
Dispute Between LLC Members as to Ownership Thereof
The Sixth Circuit Court of Appeals has set forth the analysis of when, in a dispute between the members, the LLC will itself be treated as an nominal party whose citizenship will not impact upon the diversity analysis. Mortenson Family Dental Center, Inc. v. Heartland Dental Care, Inc., 2013 WL 1942849 (6th Cir. May 13, 2013).
Mortenson Family Dental Center, Inc. and Heartland Dental Care, Inc. were the two members of Morheart Dental Management Services, LLC. A dispute arose as to the management of that LLC, and Mortenson asserted that Heartland’s interest therein had been diluted for failure to satisfy a capital call. Mortenson and the LLC then brought a declaratory judgment action in Kentucky to determine Heartland’s ownership interest in Morheart. Heartland removed that action to federal court and filed a motion seeking dismissal in favor of litigation already pending in Illinois. Mortenson moved for remand on the basis that diversity jurisdiction was lacking. The Court held to the contrary and granted the motion to dismiss in favor of the Illinois litigation.
Morheart, originally organized as a Kentucky LLC, in January, 2009, merged with and into a Delaware LLC of the same name. If the citizenship of the LLC were at issue, diversity would be lacking, it having the citizenship of its two members. The Court found, however, that the LLC was only a nominal party to the action in that it did not itself seek to enforce any duty owed by either of the members. In doing so, the Court explained that, for example, the fact that the LLC needs to make distributions in accordance with the ownership ratios did not itself cause the LLC to be a real party in interest as to the dispute.
In summation, the Court wrote:
The real dispute in this case is between Mortenson and Heartland. The LLC is only a spectator on the sideline. That it will give a trophy to the winner does not make it a player in the game.
My only quibble with this decision (and nominal party/real party in interest analysis is not my forte) is the statement by the Court:
Indeed, the LLC is not even a party to the operating agreement,
noting that this is essentially a dispute between Mortenson and Heartland as to “their ownership percentages in the LLC under the operating agreement.” My only problem with this statement is that it is diametrically opposed to the statute. Morheart had been, over the period of its existence, both a Kentucky and a Delaware LLC. Under the Kentucky LLC Act, and specifically KRS § 275.003(4):
Except to the extent set forth in a written operating agreement, a limited liability company is bound by and a party to the operating agreement.
The Delaware LLC Act contains similar language at Del. Code Ann. tit. 6, § 18-101(7). As such the statement by the Court of Appeals that the LLC is not a party to the operating agreement is, at minimum, open to dispute (e.g., was there a provision in the operating agreement expressing providing that the company is not a part thereto) or simply inaccurate.
Today marks the anniversary of the death, in 1536 of Henry Fitzroy, the illegitimate son of King Henry VIII and Elizabeth Blount. Notwithstanding his illegitimacy, Henry may have considered Fitzroy a possible male heir. As a child he had been raised to the nobility, being both an Earl and a double Duke. While passing on the throne to an illegitimate heir would have been extraordinary (it had never been done since the Conquest), Howard, the Duke of Norfolk and an astute (although not always effective) student of Tudor politics, must have thought it possible in that he arranged for the marriage of his daughter to Fitzroy. This is the same Howard who promoted Henry’s marriages to Anne Boleyn and Catherine Howard, both his nieces.
Likely Fitzroy died of tuberculosis (and not the sweating sickness that was suggested in the HBO show “The Tudors”), the same malady that would likely claim his half-brother, the future Edward VI.