New Jersey Court Considers Effect of Law Firm Not Maintaining Required Malpractice Insurance

New Jersey Court Considers Effect of Law Firm Not Maintaining

Required Malpractice Insurance

 

In a recent case from New Jersey, that was considered the effect of a dissolving law firm not maintaining tail malpractice insurance coverage and the impact of that failure on the part nurse personal responsibility for claims against the partnership.  In this instance, based particular on the wording of the New Jersey statute, it was determined that the partners did not lose the limited liability afforded by LLP status.  Mortgage Grader, Inc. v. Ward & Olivo, LLP, Docket No. A-3777-13T3 (NJ App. Div. Nov. 14, 2014).

 

Ward and Olivo organized Ward & Olivo, LLP with themselves as the only partners.  In July, 2009, plaintiff Mortgage Grader, Inc. retained W & O and specifically Olivo to represent it in some patent infringement litigation. The litigation was ultimately settled in return for certain one-time payments to Mortgage Grader for which the defendants received licenses of the intellectual property.

 

On June 30, 2011, Ward and Olivo ceased actively practicing through W & O; thereafter it had no activities except collecting outstanding fees.  The firm’s professional malpractice policy expired on August 8, 2011, and no tail coverage was acquired.

 

In October, 2012, Mortgage Grader filed a lawsuit against the W & O partnership, Oliva and Ward, it being alleged that Oliva’s representation of it in the litigation was deficient.  Ward had never been involved in the representation of Mortgage Grader.

 

While Ward sought to be dismissed from the lawsuit on the basis that he has no liability for the activities of the partnership, it being an LLP, Mortgage Grader asserted that LLP status had been lost where the partnership ceased to maintain malpractice insurance coverage, that being a condition precedent under the New Jersey statute for law firms organized as LLPs.

 

The trial court held that, inter alia, as W&O no longer maintained liability insurance it lost its LLP status and would be treated as a traditional general partnership in which Ward would be responsible for Olivo’s malpractice.  The appellate court disagreed.  Referring to the language of the controlling Supreme Court rule, there were defined consequences for a firm not maintaining the required insurance including termination or suspension of the firm’s ability to practice law or to otherwise discipline it.  N.J. S. Ct. Rule 1:21-1C.    As treatment of an LLP as a general partnership was not a defined consequence of the failure to maintain required insurance, the trial court’s effort to do so was reversed.  As such Ward was practicing with Olivo as partners in an LLP, and Ward was properly dismissed from the suit against W&O and Olivo alleging Olivo’s malpractice.

 

The Court alluded to, but did not base its decision upon, the question of whether a firm is required to maintain tail coverage. 

 

The Kentucky LLP statute was amended in 2012 in response to Evanston Ins. Co. v. Dillard Department Stores, Inc., 602 F.3d 610 (5th Cir. 2010), to provide, inter alia, that the question of LLP status will be determined as of the time of the operative facts giving rise to the claim versus when the claim is filed.  See also Rutledge, The 2012 Amendments to Kentucky’s Business Entity Statutes, 101 Kentucky Law Journal Online 1, 2-3 (2012).  For that reason the question presented in Mortgage Grader, Inc. v. Ward & Olivo, LLP has in Kentucky already been resolved.

No Exculpation for Those Who Aid & Abet a Breach of the Duty of Care

No Exculpation for Those Who Aid & Abet a Breach of the Duty of Care

 

            A recent decision from the Delaware Court of Chancery has highlighted a curious consequence of a 102(b)(7) exculpation of director liability for breach of the duty of care, namely that there can still be aiding and abetting liability.  In re Nine Systems Corporation Shareholders Litigation, C.A. No. 3940-VCN (Del. Ch. Sept. 4, 2014).

 

            In the course of the opinion the court noted that directors may be held liable for breach of the duty of loyalty, but:

 

Directors whose unfair conduct implicated solely the duty of care may be exculpated from liability for monetary damages if the corporation’s certificate of incorporative includes an exculpatory provision pursuant to 8 De. C. § 102(b)(7).

 

Exculpation under 102(b)(7) is not the same as there was no violation of the duty of care; it is only a statement that the directors involved are not personally liable for the breach.

 

For that reason, persons who may be charged with having aided and abetted the director’s breach of duty may still be held liable for the consequences thereof.

 

That statute [102(b)(7)] does not exculpate those who aided and abetted a breach of fiduciary duty, even if the underlying breach is of solely the duty of care.

 

            And there stands the dichotomy: the director who violated the duty of care is not responsible for having done so, but the advisor who aided and abetted that failure may be held liable.

In Fiduciary Duty Cases, the Language of the Statute Matters

In Fiduciary Duty Cases, the Language of the Statute Matters

 

            Not everyone owes everyone fiduciary duties.  Rather, fiduciary duties are the exception to the usual rules of caveat emptor that apply throughout commercial, arms-length relationship.

 

            Amazingly, often courts, in assessing fiduciary duties in business entities, entirely ignore the statutory language as to the nature of the duties.  For example, in Mason v. Underhill, No. 2006-CA-002144-MR, 2008 WL 1917179 (Ky. App. May 2, 2008), notwithstanding that Kentucky had adopted both the Uniform Partnership Act (1914) and the Revised Uniform Limited Partnership Act (1985), neither of those statutes was actually mentioned, the Court quoted the New York case of Meinhard v. Salmon at length in describing what are the fiduciary duties of the general partner of a limited partnership; the fact that the statutes actually defined those duties was somehow entirely ignored.

 

            Fortuately that error was not repeated by the Michigan Court of Appeals in BSA Mull, LLC v. Garfield Investment Company, 2014 WL 4854306, *6 (Mich App. Sept. 30, 2014).  Therein it was asserted that a duty of loyalty owed among the members was violated.  Upholding the rejection of that violation, the Court of Appeals wrote:

 

The LLCA’s requirement that a manager discharge duties “in the best interest of the [LLC],” MCL 450.4404(1), indicates that a manager’s fiduciary duties are owed to the company, and not the individual members.

 

In that no duty was owed the individual member, the claim failed.

 

This determination is in accord with that of the Virginia Supreme Court in Remora Investments, LLC v. Orr, 673 S.E.2d 845 (Va. 2009).

 

The Kentucky Supreme Court, in Ballard v. 1400 Willow Council of Co–Owners, Inc., 430 S.W.3d 229 (Ky.2013), held that the statutory duty owed by non-profit directors is owed solely to the corporation on the basis that the statute requires directors to act “in the best interests of the corporation.”  See also Baptist Physicians Lexington, Inc. v. New Lexington Clinic, P.S.C., 436 S.W.3d 189, note 4 (Ky. 2014).

 

In LLCs organized in Kentucky, the duty of loyalty which binds members in a member-managed LLC and managers in a manager-managed LLC is by statute “to account to the LLC and hold as trustee for it …”  KRS § 275.170(2). 

 

The words of the statute matter, both for defining what is the duty owed and just as importantly to whom it is owed.

Pillars of the Earth & the Sinking of the White Ship

Pillars of the Earth & the Sinking of the White Ship

 

            Pillars of the Earth is in my view an excellent book both for its description of events “from the ground level” of the period of English history known as the Anarchy as well as its treatment of medieval as people just like those of the modern era who are just trying as best they can to make it through each day.

 

            The fulcrum of the macro-political events described in the book is the Anarchy, the contest between Matilda, daughter of King Henry I (and former spouse of the Holy Roman Emperor, hence her title “Empress”), and Stephen of Blois, Henry’s nephew (just to keep things confusing Stephen’s wife was named Matilda) for the English throne after Henry’s death.  The expected heir to Henry I was his son William.  William, however, drowned on this day in 1120 in the sinking of the White Ship, thereby affording Follett the pivot around which to write Pillars of the Earth.

The Death of Mary Tudor and Reginald Pole

The Death of Mary Tudor and Reginald Cardinal Pole

       November 17 marks the anniversary of the deaths in 1558 of both Queen Mary Tudor and Reginald Cardinal Pole.

      Mary has gone down in history with the label "Bloody Mary," attached to her by later English who were themselves of a Protestant viewpoint.  

      Life was in many respects not good to Mary.  The only surviving child of Henry VIII and Catherine of Aragon, she grew up within and firmly believed in her mother's strict Spanish Catholicicism.  As Henry withdrew England from obedience to the Pope as a mechanism for achieving the "divorce," obvious strains arose between Mary and her father.  That marriage being ultimately declared invalid, Mary found her position changed from Princess to a bastard unable to inherit the throne.  The birth of the presumably legitimate Princess Elizabeth further cut Mary off from her expected inheritance.  Enmity between Mary and Anne Boleyn made the situation even more difficult, Mary being required to serve Elizabeth even as a member of the Boleyn family, who likewise was against Mary, was in charge of the household.  While Boleyn's execution and the declaration of the invalidity of her marriage to Henry as well rendered Elizabeth illegitimate,  the birth of Edward (ultimately Edward VI) removed her even further from the throne.

     After the death of Edward VI Mary finally succeeded to the throne, but her reign was at best troubled.  Believing herself to be duty bound to undo the "reforms" of her father and their expansion under her brother, Mary reaffirmed the obedience of theEnglish Church to Rome, recalled Cardinal Pole and made him Archbishop of Canterbury, and set about the return of the Catholic faith.  As demonstrated by the work of A.J. Scarisbrick and Eamon Duffy, this was for the most part a small task - the overlay and substitution of what we today consider to be "Protestant" aspects of faith were a thin facade.  Still, there were "true believers" who were executed, most notably Cramner, former Archbishop of Canterbury.

          Her marriage to Philip of Spain was a disaster, especially on a personal level.  

          By coincidence, today as well marks the death of Cardinal Reginald Pole, who under Mary served as the last Roman Catholic Archbishop of Canterbury.  Pole had been exiled  by Henry VIII when Reginald wrote against the "divorce" from Catherine of Aragon, subsequent marriage to Anne Boleyn and rejection of Papal Supremacy.  Pole was then in Italy and out of Henry's reach.  Pole's mother, Margaret Pole, however, was in England - she was executed at Henry's orders when she was 67 years old.  Reginald Pole returned to England with Mary's rise to the throne, taking on the See of Canterbury from the disgraced (and soon dead) Cramner.

        Where Mary's reign of just over 5 years was one of tumult at the highest political levels, for at least a significant and perhaps a majority of the population it was a return to the preferred old ways, a view put forth expertly by Professor Scarisbrick in his The Reformation and the English People. Elizabeth's reign would by contrast be seen as one of peace and growth, later dubbed the Gloriana. As they say, the winners write the history.  Elizabeth would rule until 1603.  

Massachusetts Court Addresses Contractual versus Fiduciary Obligations

Massachusetts Court Addresses Contractual versus Fiduciary Obligations

 

In a recent decision, a Massachusetts court discussed the treatment of claim that involves breach of contract and which, absent a contract, would be a breach of fiduciary duty.  The court found that the contract controls, and that there is not a separate action for breach of fiduciary duty.  In effect, where the terms of the contract fully encompass the alleged improper activity (in this case investment in a competitor), the contract controls.  Gatof v. Northland Investment Corp., 2014 WL 5819364 (Sup. Ct. Mass. Oct. 20, 2014).

North Carolina Business Court Addresses Recovery of Attorney Fees in an LLC Derivative Action

North Carolina Business Court Addresses Recovery of Attorney Fees

in an LLC Derivative Action

 

Sterling Minor has reviewed on his blog North Carolina Business Litigation Report  the November 10, 2014 decision rendered in Ekren v. K&E Real Estate Investments, LLC, 2014 NCBC 56, 2014 WL 5823136.

 

HERE IS ALINK to his review.

Wyoming Supreme Court Upholds Decision to Pierce the Veil of Single-Member LLC

Wyoming Supreme Court Upholds Decision to Pierce the Veil of Single-Member LLC

 

In the decision rendered last week, the Wyoming Supreme Court has pierced the veil of the single-member LLC.  That Court’s determination that issues of tax classification and treatment could be utilized as part of a decision to pierce is troubling.  Green Hunter Energy, Inc. v. Western Ecosystems Technology, Inc., No. S-14-0036, 2014 WL 5794332 (Wyoming Nov. 7, 2014).

 

Green Hunter Energy, Inc. was the sole member of Green Hunter Wind Energy, LLC (the “LLC”).  The LLC contracted with Western Ecosystems Technology, Inc. (“Western”) for certain consulting services.  Western was never paid for those services.  After receiving a judgment in its favor against the LLC exceeding $43,000 and finding the LLC without assets to satisfy the judgment, this action was brought against the corporate member, seeking to pierce the veil of the LLC.  Initially, it is worthy of note that the opinion describes piercing as the “extraordinary equitable remedy,” providing further support to the notion that piercing is not of itself a cause of action.  Further, the Court noted that this determination, as are all determinations on piercing, must be made “under the specific circumstances of [the] case.”  ¶¶ 1, 39.

 

The single-member LLC had, for itself, no employees.  Rather, employees of the parent corporation perform services on behalf of the LLC.  The most damning factor in support of piercing was the under capitalization of the LLC.  Essentially, it had no ongoing capital.  Rather, from time to time, the parent corporation would contribute certain amounts to the LLC with the direction that certain invoices be satisfied.  Needless to say, no contribution was ever made for the purpose of satisfying the plaintiff’s invoices.  This control of what invoices would (and would not) be satisfied also indicated the parents inappropriate domination of the LLC’s activities.

 

To this point, the opinion appears to be well within the accepted grounds and factors for piercing the veil.  That said, there are troubling aspects of this opinion in that the trial courts relied upon, which reliance was permitted by the Wyoming Supreme Court, issues with respect to the tax classification and treatment of the LLC. This single-member LLC had a federal default tax classification as a “disregarded entity,” which classification was not altered by an election to treat the LLC as an association taxable as a corporation.  For example, it was noted that the LLC’s tax return was consolidated with that of its corporate parent; consequent thereto the parent was able to deduct $884,092 in expenses and claim an additional loss of $61,047.  ¶45.  The Court noted as well that:

 

Appellant has enjoyed significant tax breaks attributable to the LLC’s losses, without bearing any responsibility for the LLC’s debt and obligations that contributed to such losses.  Such a disparity of the risk and rewards resulting from this manipulation would lead to injustice.

 

When the corporate defendant pointed out that “Federal tax law allows the LLC’s losses to be attributed to [the single-member] and a consolidated tax return filed,” the Supreme Court noted that the tax treatment was only one factor utilized in the determination to pierce the veil:

 

Instead, [the trial court] considered Appellant’s tax filings as only one of many relevant pieces of evidence demonstrating that Appellant directed benefits from the LLC to itself, while at the same time it concentrated wind farm project debts it decided would not be paid in the LLC. ¶48.

 

It is my view that it is not appropriate to incorporate into piercing analysis the question of tax classification.  Initially, to do so draws a line between entities that are for tax purposes treated on a pass-through basis versus those that are taxed on the entity basis, setting the former on a path towards piercing while the latter are not.  Simply put, tax classification in no manner impacts upon whether the entity in question has been misused to the detriment of the third-party. In this particular case, had the LLC been taxed as a C Corporation, with all other facts remaining the same, the LLC still would have been without assets with which to satisfy the plaintiff’s claim.  In addition, this sort of analysis introduces an unnecessary level of complexity in that numerous jurisdictions impose entity level taxes on what are, for federal tax purposes, disregarded entities. See, e.g., KRS § 141.0401.  If piercing analysis is to look at tax classification as a factor, what will be the result when there is a divergence between federal and state treatment?