Pannell v. Shannon – A Cornicopia of Guidance on Contract Law, Statutory Interpretation and the Place of LLCs in the Law

Pannell v. Shannon – A Cornicopia of Guidance on Contract
Law, Statutory Interpretation and the Place of LLCs in the Law

      The Kentucky Supreme Court’s decision in Pannell v. Shannon is of great utility on a variety of fronts including identifying a test for when an agreement is executed by an agent versus by a principal, the effect of administrative dissolution/reinstatement upon an agent’s liability, rules for interpreting statutory amendments, and the importance on focusing upon the LLC Act over the common law in assessing LLCs.  Pannell v. Shannon, 425 S.W.3d 58 (Ky. March 20, 2014).

      The dispute arose out of a defaulted lease.  Shannon’s LLC was the tenant – that LLC was during the term of the lease administratively dissolved.  A replacement lease was entered into in the period between the administrative dissolution and the LLC’s reinstatement.  When the LLC ultimately defaulted the landlord sought to hold Shannon liable on the obligation.

Was the Lease with Shannon or the LLC?

      The lease agreement entered into during the period of the LLC’s administrative dissolution described the tenant as being the LLC, but the signature line did not specify that Shannon signed it in a representational capacity (e.g., “Ann Shannon, Sole Member, on behalf of Elegant Interiors, LLC”).  The Court held that level of specificity to not be necessary.  Rather, noting that it indicated “By:” and in reliance upon Fletchers Cyceopedia, the Court found this format, combined with the fact that the body of the lease identified the LLC as the tenant, to be sufficient to indicate she was not signing in an individual capacity.

[T]he simple fact is that Shannon did not have to list her title, although clearly the better practice is to include it.  425 S.W.3d at 64.

Scrivener Error?

      Pannell sought to argue that the identification of the LLC as the tenant was a “scrivener error” and that it was always intended that Shannon as an individual be the tenant.  This argument was rejected on the basis that “full, clear, and decisive evidence” of a mutual mistake was not presented.  425 S.W.3d at 67.

The Effect of Administrative Dissolution/Reinstatement

      The real crux of the decision is the impact of administrative dissolution and subsequent reinstatement upon each of (i) a member’s limited liability and (ii) the liability of an agent on a contract entered into after dissolution and before reinstatement.  425 S.W.3d at 68.  The Court recognized that these are distinct questions based upon distinct legal principles:

“[T]he liability of a director, officer, employee or agent of a limited liability entity during a period of administrative dissolution is technically a separate question from the liability of the owners of the entity.”  425 S.W.3d at 77.  

Member Limited Liability After Administrative Dissolution

      The Court could not have been more express about the continuity of a member’s limited liability after reinstatement:

This Court concludes that a member of an [LLC] enjoys statutory immunity from liability under KRS 275.150 for actions taken during a period of administrative dissolution so long as the company is reinstated before a final judgment is rendered against the member.  425 S.W.3d at 67.

      Distancing LLCs from the common law of corporations (more on that below), the Court looked to the statutes addressing a member’s limited liability (KRS § 275.150) and the retroactive effect of reinstatement (KRS § 275.295(3)(c); now KRS § 14A.7-030(3)) and determined that reinstatement wiped the slate clean.

The plain meaning of the relate-back language is that the company is deemed viable on reinstatement from the point of administrative dissolution onward, which necessarily includes the time of suspension between the date of administrative dissolution and reinstatement.

Reinstatement under the statute literally undoes the dissolution. This is why the Secretary of State was required to “cancel” the certificate of dissolution and issue a certificate of existence. See KRS 275.295(3)(a). And that certificate of existence took effect, by statute, retroactively on the date of dissolution.  425 S.W.3d at 68.

Hence Pannell’s argument that a member’s limited liability is suspended during the period between administrative dissolution and reinstatement was rejected.

Agent Limited Liability After Administrative Dissolution

      Turning to the question of Shannon’s liability as an agent for the LLC’s obligation undertaken while the LLC was administratively dissolved, the Court noted that the question divides into a pair of inquiries, namely:

First, can Shannon under the circumstances of this case be personally liable by reason of her merely being an agent?  Second, can she be personally liable because she acted as an agent without authority?

       In response to the first question, the Court referred to KRS § 275.175(1) and noted that its rule of limited liability extends to the LLC’s agent.  As the LLC’s existence had been reinstated and:

reinstatement is retroactive to the date of dissolution, and it is as if the dissolution never occurred, giving the company a seamless existence.  The limitation on the agent’s liability simply for being an agent is likewise seamless.  425 S.W.3d at 78.

      In that the LLC in question was subsequently reinstated, the Court found there to be no opportunity for imposing liability on an agent.  Rather, as the LLC Act protects agents from liability on the LLC’s debts (KRS § 275.150(1)), then: 

To the extent that any liability is claimed solely because Shannon was a manager or agent of the LLC, the analysis above for why she cannot be liable as a member applies.  The reinstatement is retroactive to the date of dissolution, and it is as if the dissolution never occurred, giving the company a seamless existence.  The limitation on the agent’s liability simply for being an agent is likewise seamless.  425 S.W.3d at 78. 

     Providing an appropriate critical eye to the question before it, the Court observed:

The immunity provided by KRS 275.150 extends only to liability by reason of her being an agent.  By alleging that Shannon acted without authority, Pannell is not claiming she is liable solely because of her status as an agent, but because she had no authority to act as an agent.  425 S.W.3d at 81. 

In reliance upon the statutory statement that a dissolved LLC continues to exist after its dissolution, the Court found that when combined with reinstatement, Shannon never lost the capacity of being the LLC’s agent.

In response to the argument that giving such a broad affect to the effect of reinstatement is improper, the Court observed:

The simple fact is that Kentucky’s corporation law and other business entity laws differ from those in other states ….  The existence of a majority rule can only be persuasive if the rule is based on statutes like those in Kentucky.  425 S.W.3d at 79, 80.

The Nature of LLCs

No end of confusion has resulted from efforts to force LLCs into the prior models of partnerships and LLCs and to them impose the supposed common law of these organizational forms onto the LLC.  The first decision of the Kentucky Court of Appeals in Patmon v. Hobbs, 280 S.W.3d 589 (Ky. App. 2009) is a classic example of a court trying to do so.  Why that does not work was been extensively reviewed.  See, e.g., Rutledge and Geu, The Analytic Protocol for the Duty of Loyalty Under the Prototype LLC Act, 63 Arkansas Law Review 473 (2010). 

      In Pannell, the Supreme Court, building upon prior decisions, made the rule express – LLCs are creatures of statute divorced from the common law.

[The] common law of business entities has largely been abrogated by the adoption of the various statutes like the Kentucky Business Corporation Act and the Kentucky Limited Liability Company Act.  In fact, “limited liability companies are creatures of statute controlled by Kentucky Revised Statutes (KRS) Chapter 275,” not primarily by the common law. To the extent that common law doctrines could arguably govern limited liability companies, the Kentucky Limited Liability Company Act “is in derogation of common law,” KRS 275.003(1), and the traditional rule of statutory construction that “require[s] strict construction of statutes which are in derogation of common law shall not apply to its provisions.” Id. Thus, to the extent the statutes conflict with common law, the common law is displaced.

This Court must therefore first look at the controlling statutory law.  425 S.W.3d at 67-68.  (citations omitted).

      Consequently, in assessing matters involving LLCs the court needs to focus upon the LLC Act and the operating agreement of that particular LLC.  Whether, for example, LLC members are more like partners or more like shareholders is irrelevant to the question of whether the members have fiduciary duties and what those duties are – the LLC Act expressly addresses whether the members owe fiduciary duties, what those duties are and to whom they are owed.  See KRS §§ 275.170(1), (2), (4).  At the risk of redundancy:

[F]irst look to the controlling statutory law.

Continuity in Statutory Construction

      The Kentucky LLC Act provides that a LLC’s dissolution will not “abate or suspend” the rule of limited liability set forth in KRS § 275.150.  KRS § 275.300(4)(e).  Accord KRS § 271B.14-050(2)(i).  While this statute was adopted only in 2007, the Kentucky Supreme Court found this provision was not an alteration of the law but rather “clarified the intent of the legislature as to the effect of dissolution on the liability of … corporate shareholders.”  425 S.W.3d at 72.  This application of in pari mataria, which requires a nuanced consideration as to whether the General Assembly sought to alter versus clarify the meaning of a prior enactment, stands in contrast to the far more clumsy, and typically inapplicable, rule to the effect that by each amendment the legislature seeks to alter and depart from the prior rule.  In the area of business entity law, based as it is upon typically comprehensive statutory schemes, tweaking the words employed for the purposes of providing greater clarity and precision is far more typical than is a reversal or abandonment of a principle.  That is not to say it never happens, but it is relatively rare.

Subsequent Statutes Address Liability Absent Reinstatement

      While Pannell v. Shannon limits its application to the treatment of member and agent liability after there has been reinstatement, it does not follow that member and agent liability absent reinstatement remains unresolved.  Rather, questions of member limited liability have been addressed in statutory amendments enacted subsequent to the time the Pannell v. Shannon dispute arose. 

      First, KRS § 275.300, it addressing the effects of dissolution, now provides that dissolution does not “abate or suspend” the rule of limited liability.  In consequence, it cannot be argued that a member’s/manager’s/agent’s limited liability is lost upon dissolution.  In this respect it is important to note an important distinction between the corporate and LLC Acts.  The Business Corporation Act, at KRS § 271B.6-220, affords the shareholders limited liability from the corporation’s debts and obligations.  Hence, KRS § 271B.14-050(2)(i), in preserving limited liability upon dissolution, preserves it only for the shareholders.  Put another way, KRS § 271B.14-050(2)(i) does not speak to the liability of corporate directors, officer and agents for a corporate liability undertaken post-dissolution and absent reinstatement.  In contrast, the grant of limited liability in the LLC Act, KRS § 275.150(1), applies not only to members but also managers and agents.  Hence the preservation of limited liability after dissolution as affected by KRS § 275.300(4)(e) is broader than is the equivalent provision in the Business Corporation Act.  Now, whether after dissolution and before reinstatement one was an “agent” may be in dispute, but that is resolved under other law.

      Second, it has been made express that upon reinstatement following administrative dissolution, the liability of an agent for actions undertaken during the period of dissolution “shall be determined as of the administrative dissolution or revocation had never occurred.”  KRS § 14A.7-030(3)(b).  See also 425 S.W.3d at 81, note 20.

      Third and last, in response to Martin v. Pack, the acts now provide that an agent may after dissolution enter into contracts appropriate for the entity’s winding up and liquidation.  See KRS § 275.300(2)(a); id. § 271B.14-050(1)(c).

More on Member Limited Liability

      Building upon the earlier decision in Racing Investment Fund 2000, LLC, the Court highlighted the centrality of limited liability to the LLC and imposed a high bar for setting it aside.  425 S.W.3d at 66.  As such, where it is questionable whether an agent enjoys limited liability, the presumption will be that it is available.  It remains to be seen whether and how this attitude will impact upon whether and how is developed a distinct theory for piercing LLCs.

More on the Nature of Administrative Dissolution

      In Pannell, the Kentucky Supreme Court considered the purpose of administrative dissolution and rejected an effort by a third-party to impose liability upon a dissolved LLC’s agent for an LLC obligation based upon “the temporary faltering of the relationship between the LLC and the state to [the third-parties’] advantage when [the third-party] has no interest in that relationship.”  425 S.W.3d at 84.  Administration dissolution to be little more than a speed-bump in the bilateral relationship between the Commonwealth and an entity created under the laws thereof.

More on the Source of Duties in LLCs

      The Supreme Court has directed that the first source of LLC law is the LLC Act and recognized that LLCs are strangers to the common law.  In Patmon v. Hobbs, the Court of Appeals imposed fiduciary obligations upon the “officers and members” of an LLC based upon the determination that LLCs are “similar to Kentucky partnerships and corporations.” 280 S.W.3d at 594-95.  The Pannell decision significantly undercuts (if not more) this analytic path, and directs that rather than relying upon analogy to other organizational forms the focus needs to be upon the language of the LLC Act.  In that the LLC Act defines who owes fiduciary duties, to whom they are owed and what are those duties (KRS § 275.170), there the question should end.

A Small Footfault on Member – versus – Manager-Managed

      It bears noting that the Court made a small misstep in its consideration of agency and the application of KRS § 275.135.  This statute provides, inter alia, that in a member-managed LLC each member as a member is an agent of the LLC while if the LLC is manager-managed the managers are agents and the members are not by reason of that status agents.  The Court suggested that the determination of whether the LLC is member or manager managed is determined by a factual assessment of the management employed.  See 425 S.W.3d at 76, fn. 17.  In fact, whether an LLC is member or managed is a positive law question determined by reference to the election made in the articles of organization.  See also KRS § 275.025(1)(d).  As set forth in the comment to Prototype section 401, “Irrespective of the provisions in the operating agreement, whether a LLC is ‘manager managed,’ as that phrase is used in the Act, depends on whether the articles of organization so provide.”

 

A Pair of Recent Equine Dispute Decisions Illuminate Principles of Contract, Agency and Fiduciary Duty Law

A Pair of Recent Equine Dispute Decisions Illuminate Principles
of Contract,  Agency and Fiduciary Duty Law

      A pair of May, 2014 decisions, while themselves not inter-related, provide a litany of useful direction on numerous points of contract, agency and fiduciary duty law.  Crestwood Farm Bloodstock v. Everest Stables, Inc., __ F.3d __, 2014 WL 1856697 (6^th Cir. May 9, 2014); James T. Scatuorchio Racing Stable, LLC v. Walmac Stud Management, LLC, 2014 WL 2116096 (E.D. Ky. May 20, 2014).  As a concession to the brevity of life, this review will focus upon the legal rules explicated in the decisions and skip their tortured factual background.

The Covenant of Good Faith and Fair Dealing

      Every contract includes an implied covenant of good faith and fair dealing, it imposing an affirmative obligation “to do everything necessary to carry [the agreement] out.”, Ranier v. Mt. Sterling Nat. Bank, 812 S.W.2d 154, 156 (Ky. 1991); Ram Eng’g & Constr., Inc. v. Uni. of Louisville, 127 S.W.3d 579, 585 (Ky. 2003), and a negative burden to not act to “prevent [ ] the creation of the condition under which payment would be due.”  Oden Realty Co. v. Dyer, 45 S.W.2d 838, 840 (Ky. 1932). Crestwood Farm, 2014 WL 1856697, *8; Scatuorchio, 2014 WL 2113096, *8.

      In the Crestwood case, Everest directed Crestwood to sell certain horses at auction with no reserve.  Crestwood did so.  Everest “planted a separate agent at the auction (without Crestwood’s knowledge)” who sought to raise the price by bidding against the unrelated bidders.  Effectively, Everest set a reserve on the auction.  Crestwood 2014 WL 1856697, *1.  Everest argued that it did not violate the agreement in that it was Crestwood who was barred from setting a reserve.  Id. at *8.  The Court found this conduct to violate the obligation of good faith and fair dealing, consequent to which Crestwood was entitled to $219,513.89, that being what would have been its share of the sale proceeds of the failed high bid.

      At the same time the implied covenant will not supersede the express terms of the agreement.

But the “implied covenant of good faith and fair dealing does not prevent a party from exercising its contractual rights.”  Farmers Bank & Trust Co. v. Willmott Hardwoods, Inc., 171 S.W.3d 4, 11 (Ky. 2005); see also Hunt Enters. v. John Deere Indus. Equip. Co., 18 F.Supp.2d 697, 700 (W.D. Ky. 1997) (the covenant of good faith and fair dealing, “does not preclude a party from enforcing the terms of the contract….  It is not ‘inequitable’ or a breach of good faith and fair dealing in a commercial setting for one party to act according to the express terms of a contract for which it bargained”).  Put another way, “a party’s acting according to the express terms of a contract cannot be considered a breach of the duties of good faith and fair dealing.”  Big Yank Corp. v. Liberty Mut. Fire Ins. Co., 125 F.3d 308, 313 (6^th Cir. 1997). 

Scatuorchio, 2014 WL 21113096, *8.

      On that basis, the claim that a fee determined in accordance with a formula in the subject agreement could not be challenged a violating the implied covenant.  Rather, “the plaintiffs may not at this time re-write the unambiguous, agreed-upon language of the SHLA under the guise of the implied covenant of good faith and fair dealing.”  Scatuorchio, 2014 WL 211096, *9.

      Another important point is that the implied covenant does not serve to preclude self-dealing conduct, but rather only police it at the margins by protecting the express contracted terms.

As to allegations that “constitute self dealing,” a party may act in its own interest and not breach the covenant of good faith and fair dealing, as long as its discretion is not used in a way that is contrary to the spirit of the agreement. 

Scaturochio, 2014 WL 2113096, *9.

      Where, as in this case, the plaintiff was unable to show the defendant “acted in bad faith, or in an arbitrary, capricious, or unreasonable manner,” the use of contractually afforded discretion would not be second-guessed. 

Fiduciary Relationships

      Both Courts highlighted the necessary and high thresholds for the creation of a fiduciary relationship, essentially the agreement by the fiduciary to act for the benefit of the other even if doing so is to the detriment of the fiduciaries’ interest.  In Crestwood the plaintiffs sought to leverage facts including the principal’s failing health and a long course of business into a fiduciary relationship.  The Court disagreed, holding that: 

That the two were friends, even close friends, may well explain why they did business together.  But that does not establish a fiduciary relationship – that Crestwood was charged with putting Everest’s interests above its own.  Many friends do business together.  But not all friends are fiduciaries, and in the world of arms-length commercial negotiations few are.  See, e.g., Sallee, 286 F.3d at 891-92 (“[T]he fact that the relationship has been a cordial one, of long duration, [is not] evidence of a [fiduciary] relationship.”  (internal quotation marks omitted)); 90 C.J.S. Trusts § 197 (“The mere existence of mutual respect and confidence does not make a business relationship fiduciary.”)

Crestwood, 2014 WL 1856697, *5. 

      Setting forth a tour-de-force recitation of the elements of a fiduciary relationship, the Scatuorchio Court, at 2014 WL 2113096, *12, wrote:

            Under Kentucky law, to establish the existence of a fiduciary duty, a party must demonstrate that: (i) the parties’ relationship existed prior to the transaction that is subject of the claim; (ii) the reliance was not merely subjective but reasonable; and (iii) the nature of the relationship imposed a duty upon the fiduciary to act in the principal’s interest, even if such action were to the detriment of the fiduriary.  In re Salle, 286 F.3d at 892; Ballard v. 1400 Willow Council of Co-Owners, Inc., No. 2010-SC-533-DG, 2013 Ky. LEXIS 579, at *33-35 (Ky. Nov. 21, 2013).  A fiduciary duty requires more than the generalized business obligation of good faith and fair dealing.  See In re Salle, 286 F.3d at 891; see also Gresh v. Waste Servs. of Am., 311 F. App’x 766, 771 (6^th Cir. 2009); Quadrille Bus. Sys. v. Ky. Cattlemen’s Ass’n, 242 S.W.3d 359, 365 (Ky. Ct. App. 2007) (“An ordinary business relationship or an agreement reached through arm’s length transactions cannot be turned into a fiduciary one absent factors of mutual knowledge of confidentiality or the undue exercise of power or influence.”  (quotation marks and citation omitted)).  “Only in rare commercial cases is it reasonable to believe the other party will put your interests ahead of their own.”  In re Salle, 286 F.3d at 892.  Rather, “extraordinary facts are necessary” to support such a believe.  Id.; see also Crestwood Farm Bloodstock v. Everest Stables, Nos. 13-5688/13-5689, 2014 U.S. App. LEXIS 8751, at * 14-15 (6^th Cir. May 9, 2014). 

      Where “commercially sophisticated parties enter into arm’s-length business agreements” that do not “expressly or impliedly contain any provision supporting the creation of a fiduciary relationship” or indicate that one party has agreed to act primarily in the interest of others to its own detriment,” no fiduciary relationship will be found. 

The Principal-Agent Contract Controls

            Everest alleged that Crestwood had violated certain duties imposed by agency law by not maximizing the value of the horses sold, including by not setting reserves.  In that Crestwood was barred by the written agreement from setting reserves, the Court found Everest’s objection to be without merit. 

            Where a contract exists defining the scope of the principal-agent relationship ...  the existence and extent of the agent’s duties are determined by the agreement between the parties.”  Monumental Life Ins. Co. v. Nationwide Retirement Solutions, Inc., 242 F.Supp.2d 438, 449 (W.D.Ky.2003) (applying Kentucky law); Restatement (Second) of Agency § 376. 

Crestwood, 2014 WL 1856697, *6. 

Takeaways

            A few takeaways:

·         the implied covenant of good faith and fair dealing with not alter express contractual obligations;

·         the obligations of an agent to a principal are determined first by reference to their express agreement and only thereafter by reference to general agency law; and

·         commercial relationships will almost never be fiduciary in nature.  

West Virginia Considers When Interest Begins to Accrue on the Redemption of an LLC Member

West Virginia Considers When Interest Begins to Accrue
on the Redemption of an LLC Member

      In a decision earlier this year from the West Virginia Supreme Court, it considered when statutory interest would begin to accrue on the liquidating distribution due a withdrawing member.  The West Virginia Court found that the interest began to accrue from the withdrawal even though the amount of the liquidating distribution was not determined until a subsequent court action.  Marrara v. Ripley Associates, LLC, 755 S.E.2d 120 (W. Va. 2014).

      Marrara was the co-trustee of a trust that was in turn a member of Ripley Associates, LLC, owning a 25% share thereof.  The LLC was organized under the original West Virginia LLC Act, it being based upon the original Uniform Limited Liability Company Act, and was “at will,” meaning a member could withdraw and receive a liquidating distribution.  The trust decided to withdraw from the Ripley LLC.  In that Operating Agreement did not specify how the interest of the dissociating member would be valued, that was left to the LLC Act.  The LLC tendered an offer to purchase the trust interest for $413,727.35, which offer the trust rejected.  Thereafter, an action was filed in state court to determine the value of the interest.

      In a questionable feat to evaluation, the Court would determine that the LLC as a whole was worth $2,000,000 and that the “fair market value” of the trust’s interest therein was $500,000.  The trial court as well ordered that interest, at the rate of 7%, would begin to run from January 15, 2013, the date the valuation determination was made.  The trust appealed, arguing that interest should run from November 4, 2011, the date it tendered its notice of dissociation and as well the “as of” the company’s valuation.

      After reviewing the statutory language, including departures in the West Virginia LLC Act from the Uniform Act, the Court determined that:

When a member dissociates from at-will limited liability company, the interest provided by § 702(e) is to be calculated from the date of dissociation determined under § 701(a)(1).

Consequently, the Supreme Court held that the trial court improperly limited the payment of interest from the time the value of the trust’s interest in the LLC was determined, rather than going back to the effective date of dissociation.

LLC’s Member Held Personally Liable for the LLC’s Copyright Violations

LLC’s Member Held Personally Liable for the LLC’s Copyright Violations

 

            A recent decision out of Ohio has addressed the personal liability of an LLC’s member for copyright violations that occurred at the LLC’s restaurant.  The takeaway is that the LLC’s liability shield will not protect the member from vicarious liability for the copyright violations.  Broadcast Music, Inc. v. Meadowlake, Ltd., ___ F.3d ___, 2014 WL 2535384 (6^th Cir. June 6, 2014).

 

            Meadowlake  owned a restaurant at which recorded and live music was commonly played. The LLC was owned 5% by Philip Barr and 95% by Philip’s father Roy.  While Philip was the on-site manager, all “significant decision” required Roy’s consent. Notwithstanding a score of letters sent over several years insisting that Meadowlake, no license was acquired.  Finally BMI sued the LLC, Philip and Roy.  The LLC and Philip extricated themselves from the suit by seeking bankruptcy protection, leaving only Roy to answer the suit.  A magistrate judge awarded BMI summary judgment.

            On appeal, Roy (it appears he was proceeding pro se) argued that he was not liable for copyright infringement in that it was not he who played the songs.  If there was infringement, “The bands that played at the restaurant and the people who turned on the recording did that.”

           The court was having none of that.  Rather, citing Gordon v. Nextel Commc’ns, 345 F.3d 922 (6^th Cir. 2003),  it held that Roy “becomes vicariously liable for a direct infringement of a copyright ‘by profiting from [the] infringement while declining to exercise a right to stop or limit it.’”

            Turning to the fact that the restaurant was owned by an LLC was of no import. Roy had the right to stop or limit the infringement – he was the 95% owner. 

 

"Once a defendant meets the test for vicarious liability, the classification of his business does not (at least in general) exempt him from liability." 

Sixth Circuit Affirms Dismissal of Claim for Piercing the Corporate Veil

Sixth Circuit Affirms Dismissal of Claim for Piercing the Corporate Veil

 

       Last Friday the Sixth Circuit issued its decision in CNH Capital America LLC v. Hunt Tractor, Inc., affirming the trial court’s summary judgment in favor of the defendants on a claim for piercing the corporate veil.  The Court also discussed an interesting point on the interface of claims for piercing the veil and claims for fraudulent conveyance.   CNH Capital America LLC v. Hunt Tractor, Inc., ___ Fed. Appx.  ___, 2014 WL 2619814 (6^th Cir. June 13, 2014). 

        The decision of Judge Simpson, CNH Capital America LLC v. Hunt Tractor, Inc., 2013 WL 1310878 (W.D. Ky. Mar. 26, 2013), was previously reviewed HERE. 

       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.  Scott Hunt was personally liable on that debt consequent to a guarantee thereof, which guarantee was upheld by Judge Simpson.  The validity of the guarantee was not appealed to the Sixth Circuit.

        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, Judge Simpson dismissed both consequent to the plaintiff’s failure to name Commonwealth Bank, the transferee of the funds realized from 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, Judge Simpson 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, Judge Simpson 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.”  Neither of those determinations was appealed.

       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, Judge Simpson 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 district 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.”).

      The Sixth Circuit affirmed the summary judgment on the piercing claim.  Cutting to the chase, the Sixth Circuit found:

Because CNH does not present an injustice beyond the mere inability to collect a debt, the Court will affirm the district court’s grant of summary judgment.  2014 WL 2619814, *6. 

The Court went on to observe that while the funds received from the Kentucky Department of Transportation were transmitted to Commonwealth rather than, as required by contract, to CNH, still “Hunt Tractor paid off a legitimate business debt with the funds it received.” 

 

            The Sixth Circuit, in reliance upon Waste Conversion Techs., Inc. v. Warren Recycling, Inc., 191 Fed. App’x 429, 434-35 (6^th Cir. 2006), agreed with the determination that piercing is the wrong remedy when the alleged claim may be addressed through the law of fraudulent conveyance.  It bears noting that the reference to fraudulent conveyance law does not mean the claim needs to be successful.  Rather, the Sixth Circuit upheld the grant of summary judgment made on CNH’s fraudulent conveyance claim.

Another Challenge to the Accommodation to the Affordable Care Act’s Contraceptive Mandate Fails

Another Challenge to the Accommodation to the Affordable Care Act’s

Contraceptive Mandate Fails

 

The Affordable Care Act (the “ACA”) and it's implementing regulations require, inter alia, that insurance plans cover, without a deductible, all FDA approved contraceptives (the “Mandate”).  Certain for-profit organizations led by Hobby Lobby have challenged this requirement. Various lower courts that have come to a variety of conclusions to whether or not Hobby Lobby and other companies making similar arguments must comply with this aspect of the ACA.  My criticism of their arguments appears HERE.  The cases now pending before the United States Supreme Court, and a ruling is expected any day now

 

There is another series of challenges to the ACA’s Mandate now moving through the courts.  Under the implementing regulations, certain obviously religious organizations (e.g., churches) are exempt from the Mandate.  Another class of religiously affiliated organizations (e.g., Catholic colleges) are not exempt from the Mandate, but may be exempted from it.  In order to take advantage of this exemption, those religious organizations are required to sign and submit a Form 700 that certifies that they are a qualifying religious organization.  When the religious organization exempts itself from the requirements of the Mandate, either the plan’s third-party administrator or insurer is obligated to directly make available the coverage for contraceptives. 

Certain religious organizations that of themselves qualify for this exemption from the Mandate, it being referred to as the "Accommodation," have objected to the obligation to submit the Form 700 on the basis that it will then prompt coverage of the contraceptives that go against their religious beliefs.

While there are decisions to the contrary, the most notable being one in favor of the Little Sisters of the Poor, the clear trend in these decisions is that the Accommodation does not violate the religious rights of the subject religious organizations.  For example, in a decision out of the Seventh Circuit Court of Appeals written by Judge Posner, the reasoning of which has recently been adopted by the US District Court for the Southern District of Alabama (Eternal World Television Network v. Burwell, 1:13-cv-00521-CG-C (June 17, 2014):

Federal law, not the religious organizations signing and mailing of the form, requires health-care insurers, along with third-party administrators of self-insured health plans, to cover contraceptive services.  By refusing to fill out the form Notre Dame would subject itself to penalties, but [it's third-party administrator] would still be required by federal law to provide the services to the university's students and employees unless and until their contractual relation with Notre Dame terminated.

University of Notre Dame v. Sibelius, 743 F.3d 547, 554 (7th Cir. 2014).

Continuing on that same point, as observed by the Eternal World Court:

Legally (if not morally) speaking, there is a world of difference between a law that compels EWTN to provide contraceptive coverage directly and one in which the government places the burden on someone else after EWTN ops out.  Because EWTN's only religious objection to the mandate hinges upon the effect it will have on other parties after ETWN signs Form 700 rather than anything inherent to the act of signing and delivering Form 700 itself, the court  finds that the mandate does not impose a substantial burden on EWTN's religious practice within the meaning of the [Religious Freedom Restoration Act].

In a similar vein, in the Notre Dame decision, Judge Posner had observed that, while a conscientious objector may for himself avoid military service, he cannot then object that someone else be drafted in his place.

 

No doubt this controversy will  be headed to the Supreme Court for resolution.

Utah Court Considers Limitations on Actual Authority of LLC Manager, Reverses Summary Judgment as to Ratification

Utah Court Considers Limitations on Actual Authority of LLC Manager,

Reverses Summary Judgment as to Ratification

     
      A recent decision from Utah considered the statutory limits on actual and apparent authority to bind an LLC.  Zions Gate R.V. Resort, LLC v. Oliphant, __ P.3d __, 2014 WL 1717026 (Utah App. May 1, 2014).

      Purportedly on behalf of the LLC, Darcy Sorpold, one of its managers, executed a 99-year lease for a RV pad in favor of Oliphant, the lease purportedly being delivered in compensation for certain services rendered the LLC by Oliphant.  The LLC brought a forcible detainer action against Oliphant, alleging his rights under the purported lease to be invalid.  Oliphant, in turn, brought a quiet title action, and the trial court granted summary judgment in his favor.  This appeal followed.

      Initially, the LLC challenged the trial court’s determination that the lease was valid, noting that the LLC’s articles required the actions of both managers (the second manager being Jones) in order to bind the LLC.  Under the then applicable LLC Act (Utah adopted a new LLC act effective January 1, 2014), a manager had authority to bind the company in the ordinary course of business “unless the manager had no authority to act for the company in the particular matter and the lack of authority was expressly described in the articles of organization.”  Utah Code Ann. § 48-2-c-802(2)(c).  The LLC’s articles, in addition to providing that it would be manager-managed, expressly provided that “It shall require the agreement, approval or consent of both Managers to act on behalf of or to constitute the act of [Zions Gate].”  Based thereon, the Court of Appeals determined that Sorpold did not have actual authority to bind the LLC to the lease with Oliphant. 

      Having lost the argument that Sorpold had actual authority to enter into the lease and thereby bind the LLC, Oliphant argued that he had apparent authority to bind the LLC.  The Court noted, however, that under Utah law, it being based on § 166 on the Restatement (Second) of Agency, a third party’s knowledge that the agent lacks authority defeats a claim for apparent authority.  Horrocks v. Westfalia Systemat, 892 P.2d 14, 16 n.1 (Utah Ct. App. 1995).  Atypically, the Utah LLC Act provides that any provision set forth in the LLC’s articles of organization is notice to third parties.  Utah Code Ann. § 48-2c-121(1).  In that the limitation on Sorpold’s authority to act unilaterally on behalf of the LLC was prescribed by the articles of organization, and in that Oliphant was deemed on notice of the limitations on Sorpold’s actual authority, he could not rely upon apparent authority.  In response to Oliphant’s argument:

that it is unreasonable and unrealistic to expect individuals or companies entering into an agreement with an LLC to acquire the articles of organization for that LLC to determine if the signatory to an agreement is authorized to enter into that agreement on behalf of the LLC

, the Court noted the rule that it is the responsibility of the third party to ascertain the agent’s actual authority and further that while:

Oliphant may believe the law imposes an unrealistic burden on those doing business with LLCs, it is not the prerogative of this Court to question the wisdom of the statutory scheme enacted by the legislature.  2014 WL 1717026, *3.

       Having determined that Sorpold lacked either apparent or actual authority to enter into the lease binding the LLC to Oliphant, the Court turned its attention to the argument that the LLC had ratified the lease.  Remanding the matter to the trial court, the Court of Appeals found there to be significant factual questions involved in the question of whether or not ratification (or repudiation) had taken place.  Perhaps, however, signaling to the trial court the proper outcome once the factual record is determined, the Court noted that Utah statute of frauds “requires that any agent executing an agreement conveying an interest in land on behalf of his principal must be authorized in writing” and that “w[here] the law requires the authority to be given in writing, the ratification must also generally be in writing,” citing Bradshaw v. McBride, 649 P.2d 74, 78, 79 (Utah 1982).

      It bears noting that under the Kentucky LLC Act the outcome of this case might be different.  Initially, as to the last point, the Kentucky Statute of Frauds, while certainly requiring that conveyance of an interest in real property be in writing, does not require that any delegation of authority to execute an instrument involving real property likewise be in writing.  Such may be typically required as a matter of good practice, but the failure to do so does not implicate the Statute of Frauds.  Second and of greater import, the Kentucky LLC Act contains a different rule than that of Utah with respect to the notice effect of the articles of organization.  Rather, under Kentucky law, the articles of organization are of themselves only notice that the LLC exists, of the four primary components set forth in KRS § 275.025(1) (i.e., the LLC’s name, registered office and agent, mailing address and the statement as to whether it is member- or manager-managed), if it is a professional LLC what professions are being practiced and, if it is a nonprofit LLC, that fact.  Hence, while it is possible in the articles of organization to recite limitations upon the actual authority of the members or managers, those limitations will not be deemed to be notice to and binding upon third parties merely by being filed with the Secretary of State and available on its website.

Retired Member of LLC Failed to Receive the Benefit of the Bargain He Thought He Had but He Did Get Everything to Which He was Entitled

Retired Member of LLC Failed to Receive the Benefit of the Bargain

He Thought He Had but He Did Get Everything to Which He was Entitled

 

      A recent case out of Maryland highlights the importance of appreciating the effect of withdrawal from an LLC prior to the time the interest therein is liquidated.  In this instance, a retired member realized substantially less than he thought he was entitled to.  In addition, the Court upheld amendments to the economic deal after the withdrawal, including a related party sale of the LLC’s sole asset, were valid.  Thomas v. Bozick, __ A.3d __, 2014 WL 2208394 (M.D. App. May 28, 2014).

      Thomas was a member of the architectural firm George, Miles & Buhr, LLC and as well a member of GMB Plaza, LLC, which limited liability company owned the building out of which the architectural firm operated.  Under GMB Plaza’s operating agreement, resignation from the professional practice was an event of involuntary termination, giving rise in the LLC a right (but not an obligation) to redeem the dissociated member’s interest on the terms set forth in the operating agreement.  After Thomas’ resignation, the purchase price as set forth in the operating agreement was calculated, and it was determined that it was well in excess of the fair market value of the related property.  On that basis, the LLC elected not to redeem Thomas’s interest.  The LLC did proceed, however, to reduce the rent being charged the professional firm, the reduced rental rate being based upon independent appraisals.  Thomas was not consulted with respect to this reduction in rent.  Thereafter, GMB Plaza’s property was again appraised, that appraisal for purposes of cash flow valuation being based upon the now reduced rental rate.  With those now updated appraisals in hand, a new LLC was formed amongst the then incumbent members of GMB Plaza and one third party.  Without consultation with Thomas, the real property was sold to that new LLC.  GMB Plaza proceeded to wind up and liquidate its affairs, sending Thomas a check for his prorata portion of the sales proceeds.  Thomas then brought suit challenging these various transactions.

      Initially, Thomas argued that he did not cease to be a member of GMB Plaza upon his resignation from the professional firm or that, in the alternative, to the extent he ceased to be a member, he came back into membership status upon the LLC’s election to not acquire his interest in the company.  On the basis of both the operating agreement and the Maryland LLC Act, the court rejected these suggestions.  Rather, it was clear that the company had only a right, and not an obligation, to acquire the interest, and it would be illogical to suggest that one could cease being a member and then return to membership status without compliance with the provisions of the act required for the admission of a new member.  Rather, the Maryland LLC Act provided, inter alia, that upon dissociation, a now former member becomes the assignee of their own membership interest.  Hence, from the time of his resignation from the professional firm, Thomas ceased to have any right to participate as a member in the management of GMB Plaza.

In sum, appellant’s membership in GMB Plaza ended upon his retirement, and only his economic interest in GMB Plaza, of which he was an assignee, remained.  As an assignee, appellant could not partake in the management of GMB Plaza or vote company matters.  He was not entitled to notice of meetings of GMB Plaza, nor could he participate in the decision to sell the Property or decide on the Property’s fair market value.  2014 WL 2208394, *8.

      In response to Thomas’s assertion that the reduction in rental rate was a breach of the operating agreement or effected to “obtain an artificially low price” for his interest in the company, the Court of Appeals affirmed the trial court’s dismissal.  Essentially, Thomas had not come forward with evidence demonstrating that the reduced rate was other than appropriate in light of prevailing conditions.  In addition, the reduction in rate did not implicate the operating agreement, it appearing that the lease agreement was an independent document (as one would assume it would be), and the managing member of GMB Plaza was permitted to set the rental rate.

      Turning then to the ultimate sale of the property from GMB Plaza, Thomas argued that, in being allowed to reset the rental rate and the valuation mechanism for the property, the then remaining members of GMB Plaza “could set any price for the Property without [Thomas’s] input, which clearly would violate the operating agreement and the fiduciaries duties appellants owed to [Thomas].  [Thomas] concludes that the lowered Property value “defraud[ed] [him] out of his fair share of the value of the [Property].”  2014 WL 2208394, *9.

      With respect to the departure from the valuation mechanism described in the operating agreement of GMB Plaza, the Court noted that it was to be utilized if the LLC determined to exercise its option to acquire Thomas’s interest therein.  In that GMB waived its right to exercise that option, the agreed-upon valuation formula was inapplicable.  From there, in that the sale price was determined by averaging two independent appraisals, and Thomas not having presented any evidence that those appraisals were not reliable, the grant of summary judgment to the defendants as to this point was affirmed.

      Essentially, Thomas’s objection was that GMB Plaza was not required to redeem his interest in the LLC at a valuation formula fixed as of the date of his retirement.  Unfortunately for him, that is not the deal he had negotiated.  Having granted only a call option, he was left to only passively receive the fruits of the transaction as subsequently negotiated without his input.

Master Limited Partnership’s Effort to be Treated as a Corporation for Purposes of Diversity Jurisdiction Rejected

Master Limited Partnership’s Effort to be Treated as a Corporation

for Purposes of Diversity Jurisdiction Rejected

      In a decision earlier this year, a master limited partnership sought to have itself characterized as a corporation for purposes of determining diversity jurisdiction in contrast to the usual rule that with respect to a limited partnership, citizenship is based upon that of each general and limited partner.  Had this effort been successful, the master limited partnership would have been ascribed the citizenship of only its principal place of business and its jurisdiction of organization.  That effort was, however, rejected.  Trafigura AG v. Enterprise Products Operating, LLC, No. H-13-2712, ___ F.Supp.2d __, 2014 WL 501962 (S.D. Tex. Jan. 21, 2014). 

       Suit was brought by Trafigura against Enterprise Products Operating, LLC (“Enterprise”) arising out of certain asserted indemnification obligations from Enterprise in favor of Trafigura.  Enterprise sought dismissal for lack of subject matter jurisdiction.  Trafigura is organized in Switzerland and is therefore a foreign citizen.  Enterprise was organized and had its principal place of business in Texas.  However, Enterprise, as a master limited partnership whose units were publicly traded, had owners in a number of foreign countries.  In response to Enterprise’s efforts to have the case dismissed for lack of diversity, Trafigura argued that Enterprise’s citizenship should be determined utilizing the corporate jurisdiction of organization/jurisdiction of principal business test rather than an unincorporated organization’s citizenship of all members test, reasoning:

Trafigura contends that because a master limited partnership is publicly traded it is more like a corporation than a partnership, and it should therefore get corporate treatment for jurisdictional purposes, such that its citizenship is determined solely by reference to its state of incorporation and its principal place of business.  2014 WL 501962, *2.

      In support of this reasoning, Trafiguro pointed to the Supreme Court’s decision in Puerto Rico v. Russell & Co., 228 U.S. 476, 482 (1933) in which it held that a Puerto Rican sociedad en comandita would, based upon its similarity to a corporation, be similarly treated for purposes of diversity jurisdiction.

      On the basis that these “similarity” arguments were rejected by the Supreme Court in Carden, this Court was not willing to find an exception for a master limited partnership.  Rather, it wrote that:

Nevertheless, despite the practical similarities between certain types of unincorporated entities and corporations, as well as concerns with basic fairness and substance over form, the Supreme Court identified Congress as the appropriate source, rather than the Courts, for aligning the law of federal diversity jurisdiction with the changing realties of commercial organizations.

      Diversity jurisdiction being lacking, the suit was dismissed.