This blog, written by Thomas E. Rutledge, focuses primarily on business entity law in Kentucky. Postings on contract law, contractual and statutory construction, and the entity law of other jurisdictions appear as well. There may as well be some random discussions of classical, medieval and renaissance history.
Friday, June 27, 2014
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.
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
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
The Court could not have been
more express about the continuity of a member’s limited liability after
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 §
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
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
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
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.
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
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
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
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.”