Stripping Member of Management Rights in LLC After Bankruptcy Violated Automatic Stay

Stripping Member of Management Rights in LLC After Bankruptcy

Violated Automatic Stay

 

In a recent decision, it was held that stripping an LLC’s member of the right to vote in and control an LLC after bankruptcy violated the automatic stay.  This is an important decision as it responds to the question of whether or not the right to participate in management, as contrasted with the right to participate in the economics of the LLC, shall be deemed part of the bankruptcy estate.  Walro v. The Lee Group Holding Co., LLC (In re Lee), Case No. 12-90007-JJG-7A, Adv. Pro. No. 14-59011 (Bankr. S.D. Ind. Dec 18, 2014).

 

Lee held 51 of the 100 voting units in and therefore controlled The Lee Group Holding Company, LLC.  He held, however, no economic rights in the LLC.  After he filed for bankruptcty protection the trustee asserted that Lee’s “non-economic interest [in the voting rights] became property of the estate subject to control by the Trustee on the filing of the petition pursuant to 11 U.S.C. § 541.”  Slip op. at ¶ 9. The other members then executed a Resolution wherein they purported to accept Lee’s withdrawal as a member or the LLC – this removal was identified as being pursuant to section 3.7 of the operating agreement, but its language is not recited in the opinion.  They also purported to remove him as a manager and to elect a replacement manager.

 

The trustee brought this action challenging Lee’s removal as a member and manager of the LLC.

 

Curiously, the members defended their action on the basis that Lee was not really a member in that he did not share in the economics of the LLC, a notion that was quickly rejected by the court, it noting that the operating agreement referred to lee as a member.  The court also found that as Lee held a majority of the voting rights in the LLC it was not possible for the other members to alter the terms of the operating agreement.

 

The opinion did not reference the section of the LLC Act providing, inter alia, that a member is disassociated (and loses their voting rights) upon bankruptcy.  Likely the other members did not rely upon that provision in light of the many decisions that have found such statutes to violate the Bankruptcy Code’s prohibitions on ipso facto clauses.

 

Ultimately, Lee was not removed as a member and he remains the manager of the LLC; the actions of the other members purporting a different outcome violated the automatic stay and were void.

Court of Appeal Affirms Jury Verdict of No Apparent Agency

Court of Appeal Affirms Jury Verdict of No Apparent Agency

 

In a recent decision, the Court of Appeals affirmed a determination by a jury that no apparent agency existed. Jones v. Topf, No. 2012-CA-002007-MR (Ky. App. Dec. 5, 2014).

Marika Jones purchased a multiunit residential property in Louisville that required refurbishing. On May 28, 2008, Jones entered into an agreement with Willie Hill, a licensed electrician, to perform the electrical work that needed to be done as part of the rehabilitation. In connection there with, Jones advanced to Hill a portion of the purchase price. Although there was dispute as to when it was conveyed to Jones, Hill advised her that while he was a licensed electrician, he is not as well  an electrical contractor, and only a licensed contractor has the capacity to pull a permit to perform electrical work. Ultimately, at Hill’s request, Joel Topf, who does business as Topf Ceramic Tile and Electric, pulled the permit on behalf on Jones/Hill.

 

Jones was unhappy with the speed and quality of Hill’s work, and terminated the agreement. Thereafter, Topf withdrew the permit. Ultimately, Jones brought suit against both Hill and Topf As to Topf, she sought to hold him liable for Hill’s breach of contract under an apparent agency /respondeat superior theory.

Topf testified that Hill was not his employee and that he pulled the permit as a favor; that testimony was corroborated by Hill. The claim under respondeat superior/apparent agency went to trial, which held in favor of Topf. From that determination Jones appealed.

 

The jury instruction required a finding for the Topf unless Jones was able to show that Hill was acting on behalf of Topf at the time the contract for the work was signed. Jones argued that the law does not require that the apparent agency have existed at the time the contract was entered into, but may arise at any time during the duration of its performance.

 

Jones argues that the law places no requirement upon the party asserting an apparent-agency theory to prove the existence of the relationship at any specific time. Instead, Jones maintains all that is required is that the harmed party justifiably rely upon the appearance that one causing the harm is the apparent or ostensible agent of the alleged principle (sic) at some point during the period in which the party is harmed. Slip op at 8-9.

The Court of Appeals rejected this suggestion. Rather, it emphasized that the focus must be upon the relationship at the time the contract was entered into.

 

Failure to Pay Rent Not Sufficient to Pierce LLC Veil

Failure to Pay Rent Not Sufficient to Pierce LLC Veil

 

In a recent decision from Ohio, it was held that the failure of a LLC to pay certain rental payments in accordance with the lease was not, but self, conduct sufficient to pierce the LLC’s veil and impose liability on its members.  R.L.R. Investments, LLC v. Wilmington Horsemens Group, LLC, No. CA 2013-09-017, 2014 WL 5422203 (Ohio Ct. App. Oct.. 27, 2014).

 

Wilmington Horsemens Group, LLC was a tenant of RLR Investments. Each of the members of Wilmington guaranteed the obligation to RLR under the lease.    The lease provided that, in the event rent was not paid within 10 days of the due date, a late charge of $500 per day would be assessed.

 

Wilmington fell behind on its lease payments at a time when $302,594 was due and outstanding.  In addition, there was alleged to be owed a further $532 500 of late fees. RLR, in addition to seeking to hold the members liable under their personal guarantees of the lease, sought as well to pierce the veil of the LLC. Presumably, although this is not provided for in the opinion, they sought to do so in order to avoid certain limitations on enforcement that are available to guarantors and other sureties.

 

Ultimately, RLR moved for summary judgment against both Wilmington and its members on the breach of contract claims; in response the members of Wilmington moved for summary judgment on our RLR’s attempt to pierce the LLC’s veil. Ultimately, summary judgment would be granted RLR on its claims against the LLC under the lease, while at the same time summary judgment was granted to the members to the effect that the veil of the LLC would not be pierced. In addition, it was found that the late fee of $500 per day was unconscionable and therefore unenforceable as a penalty. On appeal, RLR challenged the determination that the LLCs veil should not be pierced and that the late fee is unenforceable.

 

As to the effort to pierce the LLC’s veil, the court reviewed Ohio law as to piercing the veil of a corporation; at no point did it raise, much less expand upon, any distinctions to be made when considering the LLC rather than a corporate veil. That said, the court found it was improper for the trial court to require RLR to plead all the elements of fraud in making a claim for piercing. Still, the determination to dismiss the piercing claim was upheld as there was no evidence that the members "managed Wilmington Horsemen so that it committed an illegal act or similarly unlawful act. Instead, the evidence established that Wilmington Horseman simply failed to make timely rent payments since December 2005 and owes RLR $302,594 in unpaid rent. Breach of contract without more is insufficient conduct to pierce the corporate veil.” Slip op. at ¶ 17; 2014 WL 5422203, *4.

 

Even as RLR lost in its effort to pierce the LLC’s veil, it was successful in reversing the trial court's determination that the guarantees were ambiguous and therefore unenforceable. The guarantees themselves contained at expiration date (i.e., they did not run the same term as did the underlying lease). Finding no ambiguity, the Court of Appeals enforced the guarantees for all liabilities incurred prior to the expiration date.  “While the Individuals would not be liable under the Guaranty for any liabilities incurred pursuant to a contract after the Guaranty expired, the Individuals’ liabilities were incurred prior to the expiration of the Lease. Therefore, the Individuals are liable for the entire breach of contract damages.” Slip op at ¶ 26, 2014 WL 5422203, *7.

 

Turning to the late fees, after reciting Ohio law with respect to the excess liquidated damages, they were held to be an unenforceable penalty in part because RLR failed to put forth evidence that the amount of the late fee had any relationship to the additional cost incurred by reason of the failure to timely satisfy the obligations under the lease.

Derivative Action Dismissed for Failure to Make Demand and Adequately Represent Corporate Interests

Derivative Action Dismissed for Failure to Make Demand and Adequately Represent Corporate Interests

 

In a recent decision the Court of Appeals affirmed the dismissal of a derivative action against the Gannett Company, Inc., although the plaintiff would not accept that the action was derivative, on the basis that shareholder had not plead demand made upon the board and failure to adequately represent the “interests of the similarly situated shareholders in representing the rights of the corporation.” Flint v. Jackson, No. 2014-CA-000426-MR (Ky. App. Dec. 19, 2014).

 

            Flint filed suit against several senior executives of the Courier-Journal (owned by Gannett) alleging a variety of claims for failure to report on his efforts to, for example, have several judges impeached by the General Assembly, alleging that persons in the government have promised payments to them if they will not run stories about Flint’s efforts to have these person’s impeached, similar allegations of blackmail, etc.  The trial court dismissed the action under C.R. 12 for failure to state a cause of action for which relief could be granted, this being a derivative action.

 

            On the basis that this is a derivative action, the court considered the elements that must be present for a derivative action to proceed.  The Court applied Kentucky corporate law.  Gannett is a Delaware corporation, and it should have been that law applied.  That said, the outcome would have been the same. Initially it was accepted that Flint was a Gannett shareholder.  Flint’s complaint was dismissed for failure to plead either that he had made demand upon the corporation for action before filing the complaint, or in the alternative pleading futility.  Second, the trail court determined that Flint did not adequately represent the “interests of the similarly situated shareholders in representing the rights of the corporation.” Slip op. at 8.

 

            As to the alleged personal injury, which if existing would remove the action from the requirements of a derivative action, the Court of Appeals affirmed the determination that under the First Amendment there is not “authority to order publication of information against the paper’s editorial discretion.”  Slip op. at 8-9.

 

            As for the failure to adequately represent the interests of the corporation, this decision is consistent with that from earlier this year in Watkins v. Stock Yards Bank & Trust Co., No. 2011-CA-000228-MR, 2012 WL 2470692 (Ky. App. June 29, 2012) (To Be Published), which decision was reviewed HERE IS A LINK.  As an alternative basis for the dismissal of the suit as a derivative action, the Court could have relied upon the requirement that a corporation be represented by counsel, and that Flint as a non-attorney may not represent the interests of the corporation.

 

            A concurring decision from Judge Maze provides a discussion of the limitations that may and in his view should be imposed upon pro se plaintiffs, especially those who like Flint file significant numbers of suits.

Dram Shop Action Barred by Plaintiff’s Settlement with the Drunk Driver

Dram Shop Action Barred by Plaintiff’s Settlement with the Drunk Driver

            A decision rendered last Friday by the Kentucky Court of Appeals upheld a dismissal of a dram shop action on the basis that the plaintiffs’ settlement with the at-fault driver’s insurer eliminated the possibility of a recovery against the club.  Butt v. Independence Club Venture, No. 2013-CA-001400-MR (Ky. App. Dec. 19, 2014).

            Nathan King, after drinking at the Electric Cowboy, was driving a car in which the plaintiffs were passengers.  An accident ensued, and three of the plaintiffs were killed; a fourth passenger was injured.  The plaintiffs settled their respective cases against King and his insurer, expressly reserving the right to bring a dram shop action against Electric Cowboy on the basis that it continued serving King after he was intoxicated, but stating inter alia that they have no further claim against King/the insurer. 

 

            Electric Cowboy sought and was awarded summary judgment, which was upheld by the Court of Appeals, on the basis that (i) Electric Cowboy would have a claim for indemnification from King to the extent that it was responsible to the plaintiffs, (ii) the plaintiffs had released King of any further liability and therefore (iii) the plaintiffs could have no further recovery.  In support of this determination the Court of Appeals relied upon DeStock #14 v. Logsdon, 993 S.W.2d 952 (Ky. 1999) for the proposition that under Kentucky’s dram shop statute “the tortfeasor remains primarily liable for injuries while the dram shop is secondarily liable with a right of indemnity against the tortfeasor. Butt, slip op. at 7, citing DeStock #14, 993 S.W.2d at 957.

 

            In that the release deprived Electric Cowboy of its legal capacity to demand the King make it whole should it have any liability to the plaintiffs, the plaintiffs could not proceed against Electric Cowboy.

Irony

IRONY

      Earlier this year a rare edition of Karl Marx’ Das Kapital sold for $40,000.

Spouses Are Not Fiduciaries

Spouses Are Not Fiduciaries

Last Friday, the Kentucky Court of Appeals issued an opinion in a suit based upon estate planning and alleged a legal malpractice. More important from my perspective is the determination that spouses are not, ab initio, fiduciaries of one another.  Kloiber v. Kloiber Dynasty Trust, Case No. 2013-CA-000436-MR (Ky. App. December 5, 2014). This opinion has been designated “Not to be Published.”

This decision arose out of certain efforts by Beth Ann Kloiber to challenge the terms of the Daniel Kloiber Dynasty Trust, PNC Delaware trust Co., Trustee, all with respect to the substantive terms thereof and related assertions that certain legal counsel either aided and abetted or conspired to deprive her of certain marital rights therein. Those interested in those topics should review the opinion itself.

Much of the allegations with respect to breach of fiduciary duty, as well as the related aiding and abetting claims, were premised on the fact that spouses stand in a fiduciary relationship to one another. The trial court, in dismissing those claims, determined that spouses, as spouses, do not stand in a fiduciary relationship with one another. The Court of Appeals upheld that determination noting in footnote 9 to the opinion:

The parties argue over whether this Court should be persuaded by our sister states to adopt a fiduciary duty upon a spouse simply due to marriage. We decline to do so.

As has been oft referenced here and elsewhere, fiduciary duties are atypical. While the marriage relationship may may and certainly does impose significant limitations upon the spouses vis-a-vis one another, this decision makes clear that, upon the breakdown of the marriage relationship, without more it may not be asserted that one spouse violated a fiduciary duty to the other.

Sale of Natural Gas at a Loss Does Not Support the Claim for Waste by Land Owner

Sale of Natural Gas at a Loss Does Not Support the Claim for Waste by Land Owner

 

A recent decision by the six circuit Court of Appeals has rejected the notion that the sale of natural gas at a loss, resulting in the landowners receiving no proceeds, did not constitute “waste.”  Cornett v. Magnum Hunter Production, Inc., No. 14-5390 (6th Cit. Nov. 25, 2014).

 

The plaintiffs own certain real property for which they had granted a lease to extract and sell natural gas. Under the lease, those owners were to receive 12.5% of the net sale proceeds (after the deduction of certain identified expenses).  With the near collapse of prices for natural gas, the sales price, after the deduction of the expenses, resulted in no net payment to the land owners.  They filed suit against the gas producer, alleging, inter alia, that continuing to extract gas from the property and sell it without any return to the land owners constituted "waste" of that asset. 

 

The trial court disagreed with this assessment and dismissed the complaint. On appeal, the sixth Circuit Court of Appeals would affirm the trial court's decision.

 

The 6^th Circuit’s decision is quite short, and simply rejects the notion that producing at no net gain to the owners was waste.  The Court did not that the right of the producer to “shut in” the well was for the protection of the producer, not the land owner, and that the producer had simply the right (and not the obligation), to shut in the well. 

 

The Court of Appeals as well rejected the plaintiff’s invitation for either the 6^th Circuit or the trial court on remand to discern a claim for some other cause.  This invitation was rejected on the basis that “the complaint is required to state a plausible claim for relief on its face in order to survive a motion to dismiss.”

 

Presumably the land owners could have, in the lease, required minimum royalties irrespective of sales prices or required that depletions cease when prices would not support royalties at a certain level.  Having failed to do so, they will  not be permitted to complain on the basis of waste.