The Fifth Circuit Court of Appeals Confirms What We All Feared, Namely That We Do Not Understand Series

The Fifth Circuit Court of Appeals Confirms What We All Feared,

Namely That We Do Not Understand Series

A recent decision of the Fifth Circuit Court of Appeals considered and largely remanded to the trial court a dispute turning in part on the characteristics of the series of a limited liability company.  In doing so the Fifth Circuit confirmed that many important questions with respect to series remain unresolved.  That lack of clarity cautions against the use of the series structure in all but the most highly-lawyered environments.  Alphonse v. Arch Bay Holdings, L.L.C., No. 13-30154, 2013 WL 6490229 (5^th Cir. Dec. 11, 2013). 

The suit began simply enough, a “plain vanilla” foreclosure action.  Alphonse’s home was foreclosed upon pursuant to a “confession of judgment” clause that was enforceable under Louisiana law.  Arch Bay Holdings, L.L.C. – Series 2010B, the holder of the mortgage note, filed a petition to enforce under the confession of judgment clause.  Ultimately, Alphonse’s house was sold at a sheriff’s auction.  Alphonse did not participate in or otherwise challenge the foreclosure action.  He did, however, after the completion of the foreclosure, bring this action in federal court against Arch Bay Holdings, L.L.C., of which Series 2010B was a component, and Specialized Loan Servicing, LLC (“SLS”), the mortgage servicing agent, charging violations under the Louisiana Unfair Trade Practices Act and the federal Fair Debt Collection Practices Act, those suits being based upon alleged irregularities arising out of “robo-signing.”  In response, Arch Bay Holdings and SLS moved to dismiss on the basis of the Rooker-Feldman doctrine and res judicata.  Alphonse argued that his claims were separate from an objection to the foreclosure itself and that the res judicata effect thereof did not bar his claims.

The trial court granted that motion to dismiss on the basis that the Rooker-Feldman doctrine precluded the federal court from reviewing the state court foreclosure action.  Alternatively, the district court also found that res judicata barred the claims against Arch Bay.  Last, the district court determined as well that the claims against Arch Bay based upon the Louisiana Unfair Trade Practices Act should be dismissed on the basis that Delaware law determines the liability for Arch Bay for the activities of Series 2010B, the latter being the real party in interest and the separate juridical entity from Arch Bay.  With respect to this analytic path, in the words of the Court of Appeals, “Alfonse sued the wrong defendant.”  This appeal followed.

With respect to the District Court’s reasoning as to res judicata, an intervening decision of the Fifth Circuit, Truong v. Bank of America, NA, 717 F.3d 377, 381 (5^th Cir. 2013), directed that res judicata should not attach, and for that reason this panel of the Firth Circuit reversed that of the trial court as to  Rooker-Feldman abstention.  Still, Arch Bay and SLS asserted that the trial court’s dismissal should be upheld on additional grounds of res judicata and the separate legal status of Series 2010B from Arch Bay.

Those arguments would ultimately be unavailing.

The District Court had found, without any apparent factual investigation, that Arch Bay and Series 2010B had a similar identity of interest.  Distinguishing another Fifth Circuit case in which a subsidiary and parent were found, for purposes of res judicata, to effectively be alter egos of one another, the Fifth Circuit wrote:

The court’s analysis in Zatarain [v. WDSU-Television, Inc., 1995 WL 295317, at *3 (E.D. L.A. May 8, 1995), aff’d on other grounds, 70 F.3d 1143 (5^th Cir. 1996)] turned on facts such as the common CEO/President, which were particularly pertinent to the plaintiff’s discrimination claim.  In contrast, here the court dismissed Alphonse’s claims and found an identity of interest without any factual development.  2013 WL 6490229, *4.

Further, the Court noted that the legally distinct status of Series 2010B from Arch Bay requires additional investigation.  To that end:

However, as discussed below, the separate juridical status of a Series LLC with respect to third-party plaintiffs remains an open question.  We remand because there are insufficient facts in the record to determine whether the Series LLC in this case is truly separate.  The important question is that the res judicata identity of parties questioned – whether a Series 2010B and its parent Arch Bay have identical interests – ought in fairness be considered together of whether the question of whether Series 2010B is in fact a distinct juridical entity.  Id.

Before returning to the question of analyzing a series, the Court also dismissed the assertion that res judicata should attach to bar any claim against SLS on the basis that SLS, even while an agent of Series 2010B, may not have shared the same interest as it did. 

Returning to the question of the legal relationship between Arch Bay and Series 2010B, the Court first reviewed Delaware’s law of LLCs (incorrectly stating that it was reviewing “the Delaware Corporate Code”, specifically § 215 of the Delaware LLC Act and there emphasizing the fact that a series “shall have the power and capacity to, in its own name … sue and be sued.”  While noting that Louisiana law provides that “the laws of the state or other jurisdiction under which a foreign [LLC] is organized shall govern its organization, its internal affairs, the liability of its managers and members that arose solely out of their positions as manager and members.”  [La. Rev Stat. Ann. § 12:1342], the Court noted that the District Court failed to consider:

The possibility that liability to a third party like Alphonse constitutes external rather than internal affairs.  2013 WL 6490229, *6.

From there, the Court of Appeals wrote:

In light of the fact that the district court failed to consider the external-internal affairs conflict-of-law question under Louisiana law, dismissal under Federal Rule of Civil Procedure 12 without leave to amend what is error.  We remand to the district court to consider this question, perhaps with the benefit of factual development.

I have otherwise written (Again, For the Want of a Theory: The Challenge of the “Series” to Business Organization Law, 46 American Business Law Journal 311 (2009); The Man Who Tells You He Understands Series Will Lie To You About Other Things As Well, 16 J. Passthrough Entities 53 (Mar./Apr. 2013))  that the number of issues involving LLCs that are not yet understood is significant.  As has been repeatedly stated, whether the limited liability shield afforded in a state of organization will be respected in a state that does not similarly provide for series remains to be resolved and how that analysis should be undertaken is open to dispute.  The Alphonse case expands upon that caution, reminding us that irrespective of the structuring of the relationship between a series and the parent organization and the rights between them vis-à-vis those members and managers associated with the series, there is the additional question of how a third party to that relationship should be treated.  While, all things being equal, the application of res judicata as applied to business entities in a group would be expected, it remains to be seen whether a more loose or more strict variant thereof will be applied.  Essentially, this is the “Wild Wild West” of business organization laws, and almost every conceivable question remains still to be addressed.