Monday, April 29, 2013
Kentucky Supreme Court Not to Review Enforcement of Arbitration Agreement Against Affiliates and Their Employees
Kentucky Supreme Court Not to Review Enforcement of
Arbitration Agreement Against Affiliates and Their Employees
There was previously here discussed (August 23, 2012) a decision of the Kentucky Court of Appeals rendered in Palazzo v. Fifth Third Bank, 2012 WL 3552633 (Ky. App. Aug. 17, 2012) (Not to be Published). Therein, the Court held that an agreement to arbitrate disputes would be applicable as well with respect to claims against certain affiliates of the party directly named in the arbitration agreement.
By order dated April 17, 2013, the Kentucky Supreme Court denied discretionary review of this decision.
Friday, April 26, 2013
Smith v. Bear, Inc. Returns to Court of Appeals for Application
of the Trust Fund Doctrine Against Smith
The case of Bear, Inc. v. Smith has returned to the Court of Appeals for consideration of challenges to the trial court’s determination of Smith and Smith Services, Inc.’s liability on an account that has grown from $26,000 to $90,863.22. Smith v. Bear, Inc., __ S.W.3d ___, 2013 WL 1352148, No. 2010-CA-001803-MR (April 5, 2013).
Smith Services, Inc., a Kentucky corporation of which Smith was the sole shareholder, had an account with Bear, Inc. for the purchase of fuel. Smith did not personally guarantee the corporation’s debt. The account grew to $25,000, at which point Bear required that all purchases be satisfied on a monthly basis. The outstanding account was not, however, satisfied. Smith closed Smith Services, Inc. in 2003, but did not either file articles of dissolution or notify its creditors of its dissolution. Bear Inc. filed suit on the open account.
On the first appeal, while holding that the statutory mechanism for giving notice to creditors is optional rather than mandatory, the Court as well held that Bear, Inc. could have a claim against Smith individually on either a theory of piercing the veil or on the basis that Smith held corporate assets in trust for the corporation’s creditors. At the time the corporation ceased its activities there were “shareholder loans” of $173,000 due from Smith. Bear, Inc. v. Smith, 303 S.W.3d 137 (Ky. App. 2010).
On remand Smith proceeded pro se on his own behalf and on behalf of the (long dissolved) corporation. The trial court granted summary judgment as to the liability of both Smith and the corporation on the account; Smith did not attend the hearing on that issue and he filed no opposition to the request for summary judgment. The determination of liability was to the extent of the un-repaid shareholder loans.
At a bench trial Bear Inc.’s president testified as to the amount of the open account, it having with interest grown from the initial $28,000 to $90,863.22, and legal costs and expenses in the amount of $42,330.38. Smith offered no contrary evidence, called no witnesses and introduced no exhibits. Judgment was entered against Smith and the corporation, and this appeal followed.
On appeal, in an amazing demonstration of chutzpah, Smith objected that the trial court permitted him to proceed pro se. As for Smith individually, the Court of Appeals, while reciting all the problems involved in pro se representation, held that he could not avoid the consequences of his decision to so proceed. However, as to the corporation, it was held that it could not proceed pro se, it requiring a legal representation, and that it could not be represented by one who, like Smith, is not an attorney. On that basis the Court of Appeals reversed the judgment against Smith Services, Inc.
From there the court proceeded to consider the substance of the determination that Smith is personally liable on Smith Services, Inc.’s debt to Bear, Inc. Sadly, the decision is muddled. It begins by reciting facts as to the lack of corporate formalities (annual meeting minutes, reasonable salary, dividends), all of this could support an equitable remedy of piercing the veil. Then the Court pivoted, describing the “shareholder loans,” a corporate asset, and described how the trust fund doctrine imposes a constructive trust on those assets:
Generally, when a shareholder receives assets of a corporation that dissolves, such assets are hold in trust for the corporation’s creditors, and the shareholder remains personally responsible for the corporate debt to the extent of the value of the corporate property received.
Applying this principle (more on that below), the summary judgment granted by the trial court as to liability was affirmed. 2013 WL 1352148, *6.
Finding that the trial court was proceeding in equity, rather than law, the Court of Appeals affirmed the decision to proceed without a jury. Further, applying the rules of equity governing restitution, the award of attorney fees was affirmed.That of itself is an interesting topic, one to which I will return to in a future post.
While the outcome of this case is clearly correct, I do feel it fair to observe that the Court of Appeals’ decision is far less clear than it could have been. That lack of specificity may in future disputes lead to arguments for an over-broad application. That would be unfortunate.
Initially, it is important to appreciate what this case is not about. First, this is not a piercing decision. While the Court initiated a piercing analysis in addressing the absence of corporate formalities in Smith Services, Inc., it never completed the analysis. Notably, it did not make the injustice finding required by Inter-Tel Technologies.
Second, while discussed in terms of the shareholder receiving corporate property before dissolution, I’m not sure that is the crux of the matter. First, KRS § 271B.6-400, it addressing limits on dividends, and KRS § 271B.8-330, it addressing the liability of directors for declaring an improper dividend and the limited right of indemnification from the recipient shareholders, are not at issue in this case – the funds at issue were treated as loans to the shareholder and not dividends.
Smith Services, Inc. held an account receivable from Smith. At the time of the corporation’s dissolution, irrespective of giving notice to creditors, the corporation, it is to collect its assets and discharge its liabilities. KRS § 271B.14-050(1). As such it had an obligation to convert that account receivable into cash. Although it does not appear that a Kentucky court has directly addressed the point, it may be credibly argued that the obligation to pay creditors, especially if the corporation’s liabilities exceed its assets, imposes fiduciary obligations upon the board of directors to harvest those assets. Were, as here, the director(s) entirely fail to pursue collection of the debt due the corporation, a claim for breach of duty (perhaps a fiduciary duty) exists.
The imposition of a constructive trust upon the funds in Smith’s possession, the proceeds of these “shareholder loans,” is somewhat problematic. Now in this case, due to the unity of Smith as the sole shareholder (the debtor) and the sole director, the imposition of a constructive trust is unassailable. The Court did not, however, condition the imposition of the trust upon that unity. Rather, it broadly stated that corporate assets received prior to dissolution “are held in trust for the corporation’s creditors.” 2013 WL 1352148, *6.
This likely is an overstatement of the law. Slightly altering the facts, imagine that the debtor was an independent business venture to which the corporation had extended various loans. Would the creditor’s dissolution, of itself, convert the proceeds of those loans into a trust fund for the corporation’s creditors? I can’t believe that is the case, but I’m sure the argument will soon be made.
Regardless, this decision and that previously rendered by the Court of Appeals provide important guidance on dissolution of business organizations, especially when creditors are left unsatisfied. Clearly directors will (as they should be) be held to account for not taking necessary steps to the greatest possible resolutions of those claims.
The Pazzi Conspiracy
For those of you who enjoyed the movie “Hannibal,” aspects of the first half are built around the contest between Hannibal Lector and an Italian detective surnamed Pazzi. Hannibal Lector identified the detective as a descendant of the Florentine Pazzi family that had been involved in a plot against the de’ Medici family, then rulers of Florence. One of the Pazzi conspirators was hanged from the side of a palazzo; that same fate that would befall Inspector Pazzi at Lector’s hands.
Today is the anniversary of the attack upon the de’ Medicis in 1478.
The drawing of the hanged Pazzi shown in the movie as part of the slide show is a drawing by Leonardo DaVinci. The Pazzi was not, however, disemboweled.
For those who may be watching the Showtime “Borgias” show, the Pazzi conspiracy is less than a generation before the events being recounted of the papacy of Alexander VI; he was elected Pope in August, 1492.
Wednesday, April 24, 2013
Beware Greeks Bearing Gifts
Today marks the anniversary of the traditional Fall of Troy in 1184 B.C., thereby bringing to its culmination the Trojan War.
The Fall of Troy is not recounted in Homer’s Iliad, the iconic epic, it rather covering only a period of ten days to two weeks within the supposed ten-year span of the war. The Fall of Troy through the subterfuge of the Trojan Horse is briefly mentioned in the Odyssey and is referenced in several other Greek sources. The story would not find, however, its full development until Virgil’s Aeneid.
Some modern historians have attempted to explain the story as an analogy, suggesting actually that an earthquake – Poseidon, whose portfolio included horses, was as well the god of earthquakes. I, for one, would rather retain the literal interpretation.
Regardless it is a great story, especially the fall of Achilles to Paris after the former killed Hector. Speaking of which, the movie Troy misstated the story, likely because they wanted to keep Brad Pitt on the screen. Achilles was killed before the fall of Troy; he never entered the city.
Coyle v. Schwartz Returns to the Court of Appeals
for Quick Disposal of Remaining Claims
Coyle v. Schwartz has returned to the Kentucky Court of Appeals, Schwartz continuing to assert a variety of wrongs purportedly done to him by Coyle, his former co-owner of a Kentucky corporation. The Court of Appeals has quickly disposed of the those remaining claims. Schwartz v. Coyle, No. 2011-CA-002335-MR, 2013 WL 1701824 (Ky. App. April 19, 2013) (Not to be Published).
Schwartz and Coyle were the co-shareholders of American Scale Corporation, a Kentucky corporation, each initially being an equal shareholder. After an automobile accident involving Schwartz and his passenger, an incident that led to the passenger bringing suit against American Scale, Coyle insisted that Schwartz convey to him a 1% in the corporation’s shares, thereby constituting Coyle the 51% shareholder while leaving Schwartz with 49% of the shares. Documents to effect that transfer were subsequently executed. Some two years thereafter, Schwartz and Coyle executed a buy-sell agreement that provided, in part, that the majority shareholder would have a call option on the minority shareholder’s shares at a price determined by the shareholders from time to time. They initially agreed that the shares would have a value of $250 each; they never subsequently updated that determination. Twelve years thereafter, Coyle exercised his call option, indicating he would pay to Schwartz the $250 per share agreed to twelve years previously. Schwartz filed suit, challenging the validity of that buy-sell agreement and the $250 per-price share. While the trial court held that the $250 per share price was an unenforceable penalty, directing that the shares be re-valued before Schwartz would be compelled to sell, it found the agreement itself enforceable.
In a prior review by the Court of Appeals, the determination as to the binding nature of the agreed upon price was reversed to the effect that the valuation mechanism set forth in the buy-sell agreement would be enforced as written. The Kentucky Supreme Court denied discretionary review of that decision, but as well ordered that the decision of the Court of Appeals not be published. Coyle v. Schwartz, Nos. 2002-CA-001287-MR, 2002 CA-001574-MR (Ky. App. March 26, 2004).
On remand to the trial court, there remained a number of claims by Schwartz, namely:
• Wrongful discharge of Schwartz by American Scale;
• Shareholder derivative claim by Schwartz for breach of fiduciary duty;
• A claim by Schwartz against Coyle for breach of fiduciary duty; and
• Schwartz’s claim against Coyle for intentional infliction of emotional distress.
These claims were dismissed by the trail court on a pair of motions for summary judgment.
On the basis that Schwartz was no longer a shareholder of the corporation, it was determined he lacked standing to pursue the shareholder derivative claim. In reliance upon Bacigalupo v. Kohlhepp, 240 S.W.3d 155 (Ky. App. 2007), the Court held that one who lost their shareholder status during the pendency of a derivative action lost their standing to pursue that action. Schwartz’s effort to distinguish that case on the basis that it involved a cash-out merger where his situation involved the sale of his shares to another shareholder was unavailing; the Court focused upon the plaintiff’s status as a shareholder and not the mechanism by which they ceased to be a shareholders.
Second, in a somewhat confusing passage, the Court held, inter alia, that a shareholder does not, in his or her individual capacity, have a personal cause of action arising out of injuries alleged to be suffered by the corporation.
With respect to the claim for wrongful discharge, Schwartz argued that his termination was consequent to his effort to inspect company records under KRS § 271B.16-040, arguing, it would appear, that it was a violation of public policy for him to be discharged for exercising his statutory right. This argument the Court of Appeals rejected, noting that the corporate document inspection statute contains its own remedy, namely a court order of inspection with the recovery of costs and attorney fees, citing in support thereof Grzyb v. Evans, 700 S.W.2d 399 (Ky. 1985). On that basis, the wrongful discharge claim was rejected.
As for the remaining charge, namely one of intentional infliction of emotional distress, while there was some confusion as to whether this had been actually dismissed by the trial court on summary judgment, it was determined that the matter was not preserved for appeal, and therefore could be easily set aside.
At this juncture, it is not known whether Schwartz will seek discretionary review with the Kentucky Supreme Court.
As to the claim of wrongful discharge from employment, it needs to be remembered that the shareholder and employment relationships are distinct from one another and as defined by distinct documents, agreements and law. As noted in Releford v. T. Clay Stuart, P.S.C., 2006 WL 1949819 (Ky. App. Nov. 15, 2006), it quoting Shrout v. The TFE Group, 161 S.W.3d 351, 354 (Ky. App. 2005), “[I]mportant to a finding of wrongful discharge is the requirement that the public policy must be defined by statute and directed at providing statutory protection to the worker in his employment situation."
No appeal of the Court of Appeal's decision was made to the Kentucky Court of Appeals, and this decision became final on June 3, 2013.
No appeal of the Court of Appeal's decision was made to the Kentucky Court of Appeals, and this decision became final on June 3, 2013.
Tuesday, April 23, 2013
The Court of Appeals Once Again Considers and Invalidates
Arbitration Clause on the Basis of Insufficient Authority
Yet again, the Court of Appeals has determined that a particular agreement to arbitrate was not enforceable on the basis that the agents executing the agreement on behalf of the principal lacked actual authority to so bind the principal. There being no effective agreement to arbitration, the matter could proceed in court. Kindred Nursing Centers Limited Partnership v. Leffew, No. 2011-CA-002067-MR, 2013 WL 1688361 (Ky. App. April 19, 2013).
Louis Leffew, on the basis he was mentally incapable of handling his daily needs, had appointed for him as an emergency custodians Jerry Leffew, his son, and Yvonne Leffew, his wife. The District Court, in appointing Jerry and Yvonne Louis’ emergency custodians, completed an AOC Form 748, “Order for Emergency Appointment of Fiduciary,” indicating thereon by checking certain boxes that they had the “authority to conduct Lewis’ affairs as follows: to determine his living arrangement, consent to medical procedures, and to handle his financial responsibilities. The District Court did not check boxes that would have given them power to dispose of Louis’ property, to execute instruments on his behalf, or to enter into contractual relationships.”
There was as well an additional power of attorney given by Louis to Jerry giving him “power of attorney rights to get all papers and statements written papers concerning charges”; this was provided at the time that Louis was apparently incarcerated.
Within two months of being appointed his emergency custodians, Jerry and Yvonne admitted Louis to the Harrodsburg Health Care Center, a facility operated by Kindred. On his behalf, they signed admission documents including an agreement to arbitrate disputes arising in connection with his treatment at the facility. Ultimately the Cabinet for Health and Family Services was appointed Louis’ permanent guardian, and it executed and delivered several documents for his re-admission to the Harrodsburg Health Care Center, each indicating that it was pursuant to the terms of the original admission. Ultimately Louis passed away, and Jerry filed suit alleging the nursing home had negligently caused Louis’ death. Kindred sought dismissal or a stay and that the matter be referred to arbitration.
On appeal, Kindred argued that:
(1) although Jerry and Yvonne did not have authority to enter into the arbitration agreement, the Cabinet’s subsequent execution of re-admission documents, after having been named Louis’s permanent guardian, constituted ratification of Jerry’s and Yvonne’s action upon admission, thereby binding Louis;
(2) Jerry should be estopped, in accordance with Kentucky law, from asserting he had no authority to act, because the nursing home relied to it detriment on Louis’s 2007 hand-written power of attorney document; and
(3) even if Kentucky law does not permit Jerry’s estoppel, the Federal Arbitration Act (FAA) permits estoppel of the estate even though Louis did not sign the arbitration agreement. 2013 WL 1688361, *2.
With respect to the argument that the Cabinet for Health and Family Services had in effect ratified the ADR agreement entered into at the time of admission, the Court of Appeals noted that while ratification was certainly possible, the ratification must be by the principal and not by the agent. As the Cabinet was always Louis’ agent, it never had the capacity as principal to ratify the prior act:
Only Louis could subsequently ratify [the arbitration agreement]. Because he never regained competence, it was impossible for him to do so…. The Cabinet could not ratify the arbitration agreement because the Cabinet was not a principal; rather, it was a judicially appointed agent of Louis which possessed limited authority to act on his behalf. 2013 WL 1688361, *3.
As to the argument that Jerry should be estopped from relying upon his lack of authority to bind Louis, the court found that the elements of estoppel were not met. Rather, Kindred had been presented a copy of the handwritten power of attorney and thereby had the means to know of its limited scope. “Even a cursory examination of this document would alert nursing home administrators that it did not confer upon Jerry the authority to enter into the arbitration agreement.” Id.
Turning to the argument that the Federal Arbitration Act should in some manner mandate a successful estoppel argument, the Court made short shift of the argument, noting that principles of contract creation that exist at state law are not preempted by the FAA.
Consequently, the determination of the trial court denying the motion to compel arbitration was affirmed.
This decision is another in a long string of recent holdings in which arbitration agreements, purportedly entered into at the time of a hospital or healthcare facility admission, were ultimately found unenforceable against the admittee’s estate. This case is curious in that Louis presented the handwritten power of attorney at the time of his admission, thereby putting Kindred on notice of its (very limited) terms. It was because Kindred was aware of those limited terms that the estoppel argument, at least in part, was ultimately unsuccessful. In this instance, from Kindred’s perspective, too much knowledge was a bad thing. One wonders if Kindred might have been successful having not seen the actual document and rather relied on an express statement from the purported agent of their capacity to bind the principal.
Court of Appeals Addresses Partnership by Estoppel
A recent decision by the Court of Appeals has considered the application of partnership by estoppel principles to hold an actor personally liable on a third-party debt. Gibson v. Ready Mix Concrete, No. 2012-CA-000962-MR, 2013 WL 1385012 (Ky. App. April 5, 2013) (Not to be Published).
Lanham was the owner of Somerset Motor Sports, Inc. As the corporation was not succeeding, Lanham entered into negotiations with Gibson. They agreed to form a new venture, intending to expand Somerset Motor Sports physical facility and hopefully its product mix. Organizational documents for an LLC were prepared (the opinion does not detail whether those documents were the articles and an operating agreement or only one but not the other), and states that articles of organization were ever filed with the Secretary of State (later the opinion contradicts itself on that point). The agreement between Lanham and Gibson was that Lanham would contribute to the new venture the existing business of Somerset Motor Sports while Gibson would bear the cost of the improvements to the physical plant. At part of the expansion, Gibson contacted Ready Mix Concrete, explaining what was needed for the expansion and explaining further that he and Lanham were working in partnership with Gibson being the 51% partner. While Ready Mix would be paid $12,558.53 for the work done, the remaining outstanding balance of $59,279.45 for work performed through October, 2008 was never satisfied. In December, 2008, both Somerset Motor Sports, Inc. and Lanham filed for bankruptcy protection. Ready Mix then brought suit against Gibson for the outstanding balance.
Gibson’s initial argument was that no partnership ever came into existence because he and Lanham never entered into a formal partnership agreement and no filings with respect to that partnership were ever made with the Kentucky Secretary of State. The trial court, however, determined that in fact a partnership came into existence. In addition, the trial court, citing KRS § 362.1-308(1), determined that Gibson was as well a partner by estoppel and therefore liable on the partnership’s obligations.
On appeal, Gibson argued that a determination that he was a partner by estoppel was erroneous and further that certain statements that he purported to have made to Ready Mix put it on notice that he would not be responsible on the partnership’s debt.
The opinion is confusing with respect to the status of the venture to be formed between Gibson and Lanham. While the opinion states at one point that “The new entity was to be called Somerset Motor Sports Complex, LLC, but was never incorporated,” the opinion later states “that Gibson’s name appears as an ‘organizer’ on the articles of organization filed with the Kentucky Secretary of State.” In fact, articles of organization for an LLC under that name were filed with the Kentucky of State on November 7, 2008. As such it was organized subsequent to the partnership incurring the debt to Ready Mix. The LLC was administratively dissolved on November 3, 2009 for failure to file its annual report.
The Court of Appeals, acknowledging that the trial court seemed to have treated interchangeably the principles of partnership and partnership by estoppel, determined that it had correctly concluded that Gibson was liable on the open account to Ready Mix. Not drawing many distinctions to correct that blurring, the Court of Appeals found that Gibson was liable both as an actual partner and as well as a partner by estoppel.
That said, we don’t know much more about the principal after this case than we did before. Also, the court’s apparent confusion with respect to the organization of an LLC is curious.
Kentucky’s Earliest Decision on Corporate Law?
In tracing back from the current time certain aspects of Kentucky’s history of corporate laws, I decided to jump backwards to find the earliest decision I could locate on substantive corporate law. At least for now, that earliest decision appears to be The Former Trustees of Paris v. The Trustees of Paris, 3. Ky. Rep. (Hardin) 464 (Ky. 1808). Therein, the then current board of the City of Paris brought an action in assumpsit against the former trustees in connection with certain town records that the former trustees retained. The Court of Appeals held that an action in assumpsit was insufficient. Rather:
For the delivery of those records and papers specifically, some appropriate and compulsive remedy must be sought, such as a bill in equity, a mandamus or (if they can be sufficiently described and identified) an action in detinue.
Admittedly this may be best characterized as a decision on appropriate remedies, but tellingly the Court treated the records of the (municipal) corporation as property of the corporation rather than of its prior board.
Ergo, the corporation had “its” property, and those entitled to the possession of same were being denied that right. That assumption goes to the root of what is a corporation, namely a legal construct that may hold title to property irrespective of alterations in its constituent ownership and management.
Monday, April 22, 2013
An Early Decision on the Liability of Managerial Employees versus Owners
Greenup and Innes v. Barbee’s executor, 4 Ky. Rep. (1 Bib) 320 (1809), is an interesting early decision addressing the distinction between the liability of owners versus the liability of non-owner managers.
A company, not incorporated and not identified by name, was organized in Danville in 1789. Greenup, Innes and Barbee were appointed the managers of the venture. Barbee was not an owner in the venture. It contracted with John Brown in Philadelphia to construct the necessary machinery, an undertaking that exhausted the initial payment made – still Brown completed the task of manufacturing the equipment. Innes and Barbee, on behalf of the venture, delivered a note to Brown for the amount due. The venture failed and its few assets were sold by the sheriff – most of the debt to Brown remained outstanding. He then brought suit against Barbee, on which he prevailed by default (the opinion is not clear – Barbee may at this point have already been deceased). The trial court then ordered Greenup and Innes, the other two managers, to pay one-third of the debt to Brown, Barbee’s estate being one-third liable thereon.
On appeal the judgment against Barbee was reversed. As to the liability on the note to Brown:
It is evident that the company are liable to the defendant for the amount he has been, or may be compelled to pay on their account. As the company was not an incorporated body, the total exhaustion of the property put into common stock in the payment of demands upon the company does not exonerate the members of it from further responsibility. They continue responsible in their individual capacities to the full amount of every debt justly due from the association.
But as to the managers not owners of the venture, a set including Barbee:
But it does not appear that the plaintiffs in this case were members of the association, or that they were any otherwise concerned than as managers or agents for the company. In that capacity they could make themselves personally liable only by acting fraudulently, or exceeding their authority, or by receiving money belonging to the association which they had not accounted for; but none of these charges are alleged by the defendant, nor does there appear anything in the cause by which such charges could be supported.
Hence Barbee was not responsible in whole or in part for the debt to Brown.
Today the same rule is recited in the Restatement (3rd) of Agency as to the liability of an agent on a contract entered into on behalf of a disclosed principal.
Tuesday, April 16, 2013
New York Court of Appeals Addresses What is a Partnership for a Particular Term or for a Particular Undertaking
New York Court of Appeals Addresses What is a Partnership for a
Particular Term or for a Particular Undertaking
Recently the New York Court of Appeals, that being the highest appellate state in that jurisdiction, addressed the assertion that a particular partnership was not one for either a particular term or for a particular undertaking. Such categorization is an important aspect of partnership law; while New York retains its enactment of the 1914 Uniform Partnership Act, and has not adopted the 1997 Revised Uniform Partnership Act, it is in effect interpreting language that continues to exist in Kentucky’s adoption of the Uniform Partnership Act. Further, partnerships for a particular term or for a particular undertaking continue to exist under RUPA. Gelman v. Buehler, 2013 N.Y. slip op. 01991 (N.Y. Ct. App. Mar. 26, 2013).
Gelman and Buehler entered into an oral partnership agreement pursuant to which they would (a) raise capital with which to identify a potential acquisition target, (b) identify that target, (c) raise additional funds, (d) acquire the acquisition target, (e) manage the acquisition target to greater profitability and (f) sell the acquisition for a profit for both the investors and themselves. However, within months of the creation of this oral partnership agreement (neither party contested its contents), the relationship broke down and Buehler announced he was leaving the partnership. The outcome of the dispute would turn upon whether the partnership is one either at will or, in the alternative, for a particular term or for a particular undertaking.
Under partnership law, any partner may, at any time, withdraw from a partnership at will and in so doing initiate its dissolution. No damages flow from a partner so acting. In contrast, if a partnership is for a particular term or for a particular undertaking, while each individual partner retains the power to withdraw from the partnership, damages may be awarded to compensate the partnership for the consequences of that withdrawal.
At the trial level, Buehler prevailed in his argument that the partnership was one at will, there being neither a definite term nor a definite undertaking. That decision was, however, reversed by the intermediate Court of Appeals which, on a 3-2 vote, determined that the partnership did have a definite term, running through the expected liquidity event as to the acquired business. Further, it found that the partnership was one for a particular undertaking, namely that of “acquiring a business and expanding it until the investors would receive a return on their capital investments.”
The Court of Appeals would agree with the trial court’s decision, overturning the ruling of the Appellate Division. Citing a number of cases as to what is a “particular undertaking” including the decision of the Kentucky Court of Appeals rendered in Fischer v. Fischer, 197 S.W.3d 98 (Ky. 2006), it found that the partnership was not one for a term in that there had been no agreement as to its duration; a term partnership requiring some sort of identifiable termination date.
As to the argument that the partnership was for a particular undertaking, the Court of Appeals determined that the partnership lacked a “specific objective or project” that may be accomplished at some future time; its plan for acquisition and resale was “too amorphous” to satisfy the statutory requirements.
The partnership having, ultimately, been one at will, no damages flowed from its termination.
A curious point in the complaint (hat tip to Peter Mahler for posting it on his blog) is that a LLC (identified as a corporation) was organized in Delaware as, apparently, the vehicle through which funds would be solicited. Still, it was asserted that “The LLC was not intended to take the place of the partnership agreement between the parties.” Complaint ¶ 20. The relationship between the LLC and the partnership is not further explained in the Complaint, and the LLC is not addressed in the Court of Appeals’ decision. Was the partnership the LLC’s member? One of the plaintiff’s claims was for damages flowing from the potential investors’ decisions to not invest in the LLC. The alleged damages resulting from the prospective investors withdrawing their commitments from the LLC gave rise to claims in favor of the LLC and not of Gelman individually.
Saturday, April 13, 2013
Here is a link to Doug Batey's review of a recent Maryland decision on piercing the veil of an LLC:
Batey on Piercing in Maryland
Batey on Piercing in Maryland
Wednesday, April 10, 2013
2013 General Assembly Adopts Technical Amendments to Various
Business Entity Statutes, Other References to Business Entities
The 2013 General Assembly did not take up any new business entity statutes similar to the 2012 Kentucky Uniform Statutory Trust Act or the 2012 Kentucky Uniform Limited Cooperative Association Act. Rather, it focused upon a pair of small bills that enacted technical amendments.
The first of these bills was H.B. 343 (Ky. 2013 Acts, ch. 65), it requiring that various states agencies adopt a single identification number for business entities. Currently, corporations, LLCs and other forms of business organizations are assigned numerous identification numbers by numerous state agencies. For example, a business entity has an organizational number assigned by the Secretary of State while the Department of Revenue assigns an entirely independent Kentucky taxpayer identification number. An additional number is assigned for purposes of worker’s compensation coverage, and additional numbers may be assigned for particular regulatory purposes.
Under H.B. 343, and as part of the One-Stop system being implemented by the Secretary of State, each business will be assigned a single identification number to be used across numerous state agencies, namely the Secretary of State, the Finance and Administration Cabinet, the Cabinet for Economic Development, the Commonwealth Office of Technology, and the Education and Workforce Development Cabinet. The various affected Cabinets have until December 31, 2013 to recommend a timeline for applying the new common identifiers to newly formed organizations, and there is an up to five year timeline for full implementation.
The second bill at issue was S.B. 69 (2013 Ky. Acts, ch. 106), sponsored by Senator Sarah Beth Gregory. This legislation contained a number of distinct updates to either business entity statutes or other statutes referencing business entity law.
Initially, in several instances this statute corrects references to the “limited liability corporation,” references that had accreted in a number of individual statutes. Of course, a “limited liability corporation” does not exist; there exist corporations - limited liability companies, but those are distinct organizational forms. For example, the secondary recycling “stolen copper” bill passed by the 2012 Kentucky General Assembly impose limitations upon “limited liability corporations.” See KRS §§ 433.900(1) and 433.902(1)(d) as enacted by 2012 Ky. Acts, ch. 91, §§ 1, 2. Another example appeared in the statutes governing the Executive Branch Ethics Commission. See KRS § 11A.201(13) (prior to amendment by 2013 Ky. Acts, ch. 106, § 2). Should, under the bill as enacted, an enforcement action be brought against a limited liability company, it could be argued that the statute does not extend to that organizational form. With the changes made in S.B. 69, that opportunity is no longer available. See 2013 Ky. Acts, ch. 106, §§ 2, 8, 12 and 13. Also, several of these statutes referred to “partnerships, limited liability partnerships”; they did not, in turn, reference “limited partnerships.” See, e.g., KRS § 11A.201(13); id. § 433.900(1), prior to amendment by 2013 Ky. Acts, ch. 106. In that every limited liability partnership is first a general partnership, a redundancy was created. Also, absent reference to additional statutory authority (see KRS § 446.010(30)), limited partnerships are arguably exempt from the statutory requirements. Again, the amendments address these deficiencies.
A technical change made in the LLC Act addresses to whom a member’s request to inspect company books and records is to be addressed. While the statute did require previously that the member tender a request to inspect the company books and records, it did not specify to whom that request should be made. As such, ambiguity existed as to whether he should go to any or all managers, all other members, or only the entity itself. With the change made, the request is to be tendered to the limited liability company. See KRS § 275.185(2) as amended by 2013 Ky. Acts, ch. 106, § 7. Where the operating agreement in question does not specify how notice or request is to be tendered to the LLC by a member, such may be done through the registered agent. KRS § 14A.4-040(1).
Another change to the LLC Act expressly authorizes a written operating agreement to impose reasonable limitations on the inspection of LLC books and records. See KRS § 275.185(5) as amended by 2013 Ky. acts, ch. 106, § 7. Previously the LLC Act expressly sanctioned limitations upon the use of company records and information, but was silent as to limiting access ab initio. While likely limits on access would have been enforced (see KRS § 275.003(1)) absent this amendment, it removes any question.
Last on the LLC Act, a revision has been made as to the amendment of the articles of organization. Under KRS § 275.175(2)(c), the approval of a majority-in-interest of the members was required to effect an amendment reversing the manager-managed or member-managed election. The LLC Act was silent as to the required consent threshold for other amendments. The substance of the amendment is to delete the reference as to the manager-managed versus member-managed election; now all amendments to the articles of organization will require the approval of a majority-in-interest of the members. See KRS § 275.175(2)(c) as amended by 2013 Ky. Acts, ch. 106, § 6.
A global change made with respect to the names of business organizations makes express that the identifier (e.g., “Inc.,” “LLC,” “PSC”) must appear at the end of the name. See KRS § 14A.3-010 as amended by 2013 Ky. Acts, ch. 160, § 3. This change is consistent with the filing procedures that have traditionally been employed by the Secretary of State’s office. To the extent the existing company name is inconsistent with these rules, it will be functionally grandfathered. Under the rule as now codified, “Widgets Incorporated of Lexington” will not be an acceptable name, but “Widgets of Lexington, Incorporated” will be acceptable. These requirements apply only to “real names”; an assumed name may set forth the identifier, if used in the assumed name, other than at the end.
A technical change made in the Kentucky Uniform Statutory Trust Act moves a single sentence between two adjacent sections of the act; it had been misplaced in the prior enactment. See KRS §§ 386A.6-030, 386A.6-040 as amended by 2013 Ky. Acts, ch. 160, §§ 10-11. No substantive change is effected. A statement has been added to the Statutory Trust Act to make express that a statutory trust has continuity of life. See KRS § 386A.3-050(6) as created by 2013 Ky. Acts, ch. 160, § 9.
It has long been the rule that the qualification of a foreign entity to transact business is not a basis for Kentucky to regulate the foreign entities’ internal affairs. See, e.g., KRS § 14A.9-050(3). The issue left unresolved is the ability to regulate the internal affairs of either (i) foreign entities transacting business while exempt from the requirement to qualify or (ii) foreign entities in default of an obligation to qualify to transact business. Might Kentucky regulate the internal affairs of either? Obviously not, and a 2013 amendment makes that clear. See KRS § 14A.9-050(3) as amended by 2013 Ky. Acts, ch. 160, § 4.
All of these amendments are effective June 25, 2013. See OAG 13-005 (April 5, 2013).
Tuesday, April 9, 2013
Did Texas Court Botch Diversity of Citizenship Analysis?
It may be that a Texas Circuit Court applied the wrong rule in its analysis of the citizenship of a limited liability company. Ruelas v. Wal-Mart, 2013 WL 949344 (E.D. Tex. Jan. 30, 2013).
In this Report and Recommendation by Magistrate Judge Mazzant, he was called upon to parse the ownership and therefore the citizenship of several Wal-Mart entities. The plaintiff in this slip-and-fall action named Wal-Mart Stores, Texas, L.P., Wal-Mart Stores, Inc. and Wal-Mart Stores Texas, LLC as defendants.
The Court dismissed consideration of Wal-Mart Stores Texas, L.P. on the basis that before the filing of the complaint this limited partnership had been merged with and into Wal-Mart Stores Texas, LLC, with the LLC being the surviving entity. Ergo, the LP no longer existed at the time the action was filed.
Applying Hertz v. Friend, 559 U.S. 77 (2010), Wal-Mart Stores, Inc. had the citizenship of its jurisdiction of organization (Delaware) and that of its principal place of business under the ‘nerve center’ test (Arkansas).
That left for consideration Wal-Mart Stores Texas, LLC. While noting its jurisdiction of organization (Delaware) and its principal place of business (Arkansas), the Court repeated the rule that an LLC’s citizenship is determined by that of its members.
It was asserted that the LLC’s sole member is Wal-Mart Real Estate Business Trust, a Delaware statutory trust with its principal place of business in Arkansas. It is then stated that Wal-Mart Property Co., a Delaware corporation with its principal place of business in Arkansas, is the sole “owner” of the statutory trust. “Owner” is not further explained – is it the same as trustee, beneficial owner, or something else?
Here may be the first failure in the analysis. To this point ownership of the initial LLC has been traced back to a single corporation. Why, at this juncture, was Wal-Mart Stores Texas, LLC not ascribed the corporation’s citizenships (Delaware and Arkansas) and that be the end of the story? Based on the facts presented that should have been the conclusion.
The Court, however, continued its analysis, stating that Wal-Mart Stores East, LP is the sole “owner” (shareholder?) of Wal-Mart Property Co. Wal-Mart Stores East, LP has as its general partner WSE Management, LLC and as its limited partner WSE Investments, LLC. The sole member of each of WSE Management and WSE Investments is Wal-Mart Stores East, LLC.
Here is where the analysis again seems to fail. The Court wrote:
Wal-Mart Stores East, LLC is a limited liability company organized under the laws of the State of Arkansas with its principal place of business in Arkansas. Wal-Mart Stores East, LLC’s corporate office, financial records, and corporate books and records are located in Arkansas. Therefore, Defendants offer the evidence that conclusively demonstrated Wal-Mart Store East, LLC is a citizen of Arkansas.
But that is not the test. An LLC is not a citizen of a particular jurisdiction by virtue of being organized or maintaining its principal place of business in that jurisdiction. See, e.g., JMTR Enterprises, LLC v. Duchin, 42 F.Supp.2d 87 (D. Mass. 1999) (LLC not deemed a citizen of a state by virtue of being organized therein); Muhlenbeck v. KI, LLC, 304 F.Supp. 797 (E.D. Va. 2004) (“[T]he citizenship of a [LLC] depends not on the state in which it is organized or the state in which it does most of its business, but rather on the citizenship of the entities that own the LLC.”). Rather, citizenship is determined by reference to that of the ultimate owners. This decision did not address the members of Wal-Mart Stores East, LLC, applying rather (so it would seem) the test applied to corporations.
Based on the information ultimately available, this decision, after a Herculean traipse through a Byzantine structure, the Court both continued past the point at which a determination could and should have been made and then stopped too soon and applied the wrong test to the assessment of citizenship. The analytic path, it would seem, should have stopped at Wal-Mart Property Co., a corporation. In continuing on to Wal-Mart Stores East, LLC, the Court then applied the wrong test. By then, a conclusion as to citizenship would have been possible only by the further investigation of the citizenship of the members in Wal-Mart Stores East, LLC.
The Magistrate’s Recommendation was adopted by the Circuit Court in an order dated March 8, 2013. While the analysis appears to have been flawed, the outcome is not impacted in that Wal-Mart is not shown to be a Texas citizen and diversity does exist.