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.
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
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).
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.
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.
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.
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.
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