Wednesday, November 5, 2014

Michigan Court Parses Requirements For Admission of Assignee as a Member of an LLC

Michigan Court Parses Requirements
For Admission of Assignee as a
Member of an LLC


A decision of a Federal Court in Michigan provides useful lessons as to who is a member of an LLC either by admission as a substitute member or a member by estoppel.  That said, I also wonder how this case is properly in Federal Court.  Patel v. Bhakta, No. 13-cv-14099, 2014 WL 5023460 (E.D. Mich. Oct. 8, 2014).
Pravin Patel (“Patel”) and Chandrakant Bhakta (“CD”) formed Motor City Hospitality, LLC (the opinion incorrectly refers to the LLC as having been “incorporated”); each was a 50% owner thereof.  The LLC required a Holiday Inn Express in Detroit.  CD then assigned a 15% interest in the Company to Jyotsma (10%) and Mayar (59%).  Patel assigned a 15% interests in the Company to Riti (5%), Kruti (5%) and Priti (5%).  A matter in dispute was whether any of these assignors became members; they were trusted as “partners” on the tax returns.
There was a falling out between Patel and CD.  CD offered to buy out the Patel family for $750,000, or in the alternative that the CD family be bought out for the same amount.  Patel accepted the offer to sale and asked that CD proceed to have the documentation prepared.  That was on January 14, 2013.  Within days, either (i) Patel sought to reverse and be the buyer or (ii) CD acted as if the deal were already consummated.  What is clear is that on January 18, 2013 the LLC agreed to sell the Holiday Inn for $12,500,000.  The opinion is silent as to the net proceeds on the sale to the LLC; it is clear the proceeds have gone into escrow until the dispute between Patel and CD is resolved.
Praveen, Priti, Riti and Kruti Patel brought suit against CD, Mayar and Jyotsma Bhakta alleging breach of contract and breach of fiduciary duty as well as other claims.  This decision was rendered in response to a motion for summary judgment.
The defendants initially challenged the standing of Riti, Priti and Kruti Patel to act as plaintiffs; that question turned on whether any of the three was a “member” in the LLC.  Under the Michigan LLC Act, an assignee became a member only with the unanimous vote of the incumbent members.  Mich. Comp. Laws § 450.4506(1).  No vote had ever taken place.  The court rejected the motion that the statute is inapplicable in small LLCs.
Plaintiffs argued at the hearing that a formal vote was unnecessary because there was consent between “two long-time friends and partners.”  But the size and collegiality of the Company does not alter the clear requirement of the statute.  Many LLCs governed by Michigan’s LLC Act are undoubtedly small businesses like this one.  Absent evidence that both members formally argued to admit new members to the LLC, the Court cannot find that the statute’s requirement was met.  2014 WL 5023460, *4.
That was not, however, the end of the story.  Rather, the court found that the CB faction may be estopped from challenging the member status of the Patel children by reason of prior conduct consistent with membership status.  For that reason summary judgment as to their membership status was denied.
Flipping the case, the Patel faction argued that Jyotsma and Mayar Bhakta were improperly named as defendants in that they were never admitted as members of the LLC.  There being no evidence of a vote to admit them and no assertion of facts that would support estoppel, the Court held they were not members.
The guidance of this case to the effect that actual compliance with the statutory requirements for admission of an assignee as a member is useful.  Note that under Kentucky laws the admission is subject to a statute of frauds – the interest of admission must be written, dated and signed by the required threshold (majority-in-interest is the default rule) of the incumbent members excluding the assignor.  KRS § 275.265(1).  No Kentucky case has addressed whether estoppel can control over these requirements.
My wonderment as to this case is how it is in federal court.  The opinion is silent as to the domicile (citizenship) of the parties.  Regardless, the claims made by the plaintiffs include one for an accounting, and it is difficult (impossible?) to see how a claim for an accounting cannot have the LLC as a party.  While the Court cited Michigan law to the effect that an action for an accounting may be brought without joining the LLC, that position is weak.  It is as to the asset sand liabilities of the LLC that the accounting is sought.  As the LLC is in most states a necessary party to the action, and as the LLC has the citizenship of each of its members, then there should be no diversity jurisdiction. 

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