Court of Appeals Holds Option Agreement Unenforceable for Failure to Address Material Terms

Court of Appeals Holds Option Agreement Unenforceable for

Failure to Address Material Terms

 

      In a decision rendered last week by the Kentucky Court of Appeals, it held that an option agreement o purchase a business and the related real property from which it operated was unenforceable in that it failed of itself to address all of the material terms of the purported deal.   Rose Mary Hubbs Brewer v. John M. Parsons 2007 Revocable Trust, No. 2013-CA-001309-MR (Ky. App. March 27, 2015).

      This dispute arose out of the question of whether there could be enforced in agreement “for the purchase [sic - of] all of the stock and assets of Knox Body Shop, Inc. (Knox), along with the real property that Knox was situated upon.” Consistent with other Kentucky law to the effect that only an agreement which sets forth all of the material terms will be enforcable to uncertainty (i.e., agreements to agree are not themselves enforceable; HERE IS A LINK to an earlier posting on the same topic) the court stated that an option agreement will be enforceable only if the “material terms” are “fixed with reasonable certainty. Citing Hisle v. Keltner, 495 S.W.2d, 773, 775 (Ky. 1973), it was observed that:

An option contract must be complete and certain in its terms, that is to say, the parties and its subject matter must be identified by it, and the terms and provisions of the contract must be stated in writing, if required to be in writing, or established by competent evidence, if not required to be in writing, with that certainty and definiteness which will enable a court to determine that the parties, by an election thereunder, have concluded an agreement and also what the exact terms of that agreement are.

      Turning to the language of the agreement under consideration, the court determined that the description of the real properly purportedly subject to the option was insufficient in that parole evidence would be necessary to supply its description; under Hisle, reference to parole evidence is not allowed with respect to the enforcement of an option. Further, the agreement was found to be insufficiently definite in that there was no agreement as to how the option price would be paid, including the terms of the promissory note that could be presented in payment.

      On this basis, the trial court’s determination that the option agreement was unenforceable was affirmed.

Kentucky General Assembly Corrects Typo in Business Corporation Act – Its Only Been There Since 1988

Kentucky General Assembly Corrects Typo in Business Corporation Act –

Its Only Been There Since 1988

 

The 2015 Kentucky General Assembly, in HB 440, corrected a typographical error that can be dated to 1988.  At that time, in the course of drafting the Kentucky Business Corporation Act, it being based upon the then existing version of the Model Business Corporation Act, a decision was made to define the aspirational standard of a director as including the more subjective “honestly” in place of the more objective “reasonably.”  However, even as this change was made with respect to the aspirational standard, a similar change was not made with respect to the standard for affording a director indemnification; that provision continued to utilize “reasonably.”  

 

In order to address this differential and provide for the intended consistency between the aspirational standard and the standard for indemnification, KRS § 271B.8-510 has been revised to delete “reasonably,” substituting in place thereof “honestly.”

The Indiana Religious Freedom Restoration Act

The Indiana Religious Freedom Restoration Act

 

Debate over the intent and effect of the recently enacted Indiana religious freedom restoration act has certainly been fast and furious.  Some of the comments and criticism is well informed. Much of it, however, it is not.  In my view, a review in the Religion Clause Blog does an excellent job of explaining the issues.  HERE IS A LINK to that review.

So Ends Gloriana

So Ends Gloriana

      Today marks the anniversary of the death, in 1603, of Queen Elizabeth I of England.  The last of the Tudor monarchs, it was under them, and particularly under Elizabeth, that England moved from being a relative backwater to a European power.  Not bad for a family whose claim upon the throne was at best tenuous; the great Tudor historian G.R. Elton described that Tudors as being “a political solution to a dynastic problem.”

      This anniversary comes even as England is in the process of translating the tomb of Richard III to Leicester Cathedral; it was Richard III who, at the Battle of Bosworth field in 1485, was defeated by Elizabeth’s grandfather, Henry VII.

      Elizabeth was succeeded by James I (being already James VI of Scotland), the great-grandson of her aunt Elizabeth Tudor who had in turn married James IV of Scotland.

Kentucky Moves from the Elizabethan Age to the 21st Century: The Kentucky Uniform Voidable Transactions Act

Kentucky Moves from the Elizabethan Age to the 21st Century:

The Kentucky Uniform Voidable Transactions Act

 

      Kentucky's existing statute on fraudulent transfers was written in 1855 and is itself based upon the Statute of 13 Elizabeth, a statute composed during the reign of Elizabeth I (i.e., the daughter of Henry VIII and Anne Boleyn).  To say the least the statute is archaic.  Further, it is significantly out of step with the fraudulent conveyance laws of most states and, likely of greater import, with the Bankruptcy Code.

     

      The only comprehensive review of this statute is an article written by Professor Doug Michael of the University of Kentucky  College of  Law.  See Douglas C. Michael, The Past and Future of Kentucky's Fraudulent Transfer and Preference Laws, 86 Kentucky Law Journal 937 (1997-98).  Therein he wrote:

“Kentucky has a unique and antique collection of laws governing fraudulent transfers and preferences.”

 

      That is about to change.  The 2015 Kentucky General Assembly approved Senate Bill 204, enacting in Kentucky the Uniform Voidable Transactions Act.  This bill was signed by Governor Beshear last Friday.  This Uniform Act, itself updating the Uniform Fraudulent Transactions Act, will bring Kentucky law into sync with the other states that enact this Act.  Also, based upon the significant similarities between this Act and the predecessor Uniform Fraudulent Transfers Act, greater consistency will be achieved with the other states.  In addition, in that the UVTA is meant to conform to modern bankruptcy law, Kentucky law and that federal law will now be more consistent.

      The new Voidable Transactions Act has an effective date of January 1, 2016.  HERE IS A LINK to the new statute.

Obligation Assumed by LLC’s Member is Enforced Against the Member

Obligation Assumed by LLC’s Member is Enforced Against the Member
(no big surprise here)

      A decision handed down last Thursday by the Sixth Circuit Court of Appeals affirmed the decision that an LLC’s member who “jointly and severally” agreed to indemnify the issuer of a surety bond would be required to do exactly that.  Lexon Insurance Co. v. Aziz Naser, No. 14-1844 (6^th Cir. March 19, 2015).

      Naser was a member in Michigan Orthopedic Services, LLC (“Orthopedic Services”); the opinion is unclear as to whether he held a 15% or a 20% interest therein.  Regardless, it is clear that the balance of the company was held by MOS Holdings, LLC.  Changes in Medicare regulations required that Orthopedic Services have in place a surety bond for each location.  Naser and MOS Holdings filed with Lexon Insurance an application for the required bonds, and they were issued pursuant to an agreement providing in part “I agree to indemnify Lexon Insurance Company… in connection with any bond executed on behalf of the person or entity named as ‘applicant’ below.”

      Naser completed one of the three signature blocks, it identifying Michigan Orthopedic Services, LLC as the “applicant.”  He likewise signed another block, it for Aziz Naser.  A representation of MOS Holdings signed the third signature block.

      Orthopedic Services entered bankruptcy in August, 2011.  Apparently thereafter Medicare began challenging claims it had previously paid.  Lexon advised Naser of the claims, asking if he would pay them or for a basis for assisting the claims to be invalid.  He responding by simply saying the claims were false and should not be paid; he proffered no evidence in support thereof.

      Lexon paid (it would seem) $256,913.64 to Medicare, then sued Naser under the agreement to provide indemnification.  A verdict was rendered in Lexon’s favor, and this appeal followed.

      On appeal, Naser asserted that he never in his individual capacity signed the agreement with Lexon.  The Court cited the rule that while typically a “corporate officer or shareholder” is not liable for the “corporation’s engagements” unless they personally undertake liability, where that is intended “the nearly universal practice is that the officer signs twice – once as an officer and again as an individual.  Slip op. at 7, citing Livonia Bldg. Materials Co. v. Harrison Coauster Co., 742 N.W.2d 140, 146 (Mich. Ct. App. 2007).  Noting that this “nearly universal practice” had been followed, the 6^th Circuit noted as well the absence of a reasonable explanation as to why Naser signed the agreement twice.

      Turning to a substantive objection to liability, Naser asserted that Lexon acted in bad faith by paying on the bond in the absence of proof of the validity of the claims.  Initially, this defense was rejected as it had not been raised in the trial court below.  Further, “when Lexon asked Naser for evidence that the claims were invalid, Naser declined to provide it.”

Disagreement over the Requirements for Issuing a Charging Order

Disagreement over the Requirements for
Issuing a Charging Order

      Within less than four months courts in Missouri and Georgia have disagreed over the showing that needs to be made by a judgment-creditor requesting a charging order.  In the Missouri case, Regions Bank v. Alverne Associates, LLC, No. ED 101121, 2014 WL 6913237 (Mo. Ct. App. Dec. 9, 2014), a judgment-creditor was denied a charging order when there was not tendered proof of the amount outstanding on the judgment.  In the Georgia decision, Gaslowitz v. Stablis Fund I, LP, Nos. A14A2029, A15A0433, 2015 WL 1059575 (Ga. Ct. App. March 12, 2015), a charging order was issued on the face of the judgment-debtor’s objection that the amount of the outstanding judgment had not been shown and was recognized as being in dispute.

      Berger guaranteed two loans from Regions Bank to Alverne Associates, LLC; the loans were also secured by two pieces of real estate.  The loans went into default, and Regions Bank received a judgment for $1,775,618.67 plus costs; the judgment provided for post-judgment interest until collected.  The assignee of the judgment, RBRE, subsequently sought a charging order against “any [LLC] in which Samuel B. Berger has an interest” and attached to the motion exhibits setting forth “the alleged outstanding balances on each promissory note and calculations of compound interest ‘at 9% per annum.’”  At some point the LLCs in which Berger had an interest were identified as they were named in the charging order that was issued by the trial court.  Before and after the entry of the charging order Berger objected on the basis that the principal and interest were improperly calculated; he would appeal on the same basis.

      On appeal, as previously noted, the charging order was set aside.  Looking to Missouri law outside the charging order statute, a motion “is not self-proving,” “the movant has the burden of proving the allegations made therein” and while “a movant may submit proof of facts on the form of affidavits, depositions or oral testimony,” exhibits attached to motions are not evidence or self-proving.  2014 WL 6913237, *4.  Based upon the absence of evidence of the total amount of the outstanding judgment, the charging order was lifted.

      Perhaps cribbing from Berger’s playbook, Gaslowitz argued that the charging order issued against his interest in G & A, LLC should be set aside as there was a dispute as to the remaining balance owed on the judgment to which Gaslowitz was subject.  The trial court held that the uncertainty as to the amount owed is not a bar to the issuance of a charging order.  On appeal Gaslowitz argued:

That it cannot be determined from the [charging] order what distributions are due Stablis, nor when such distributions can again be paid to Gaslowitz, rendering [the charging order] impermissibly vague and indefinite.  2015 WL 1059575, *2. 

      Rejecting this argument, the Georgia Court of Appeals wrote:

[T]he charging order gives the judgment creditor the right to receive distributions to which the member would otherwise be entitled on account of the member’s limited liability company interest until the judgment with interest is satisfied. But the amount of distributions subject to the charging order will not necessarily correspond to the specific amount of the judgment that remains unpaid on the date that the charging order is issued. The unsatisfied amount of the judgment could be reduced or even eliminated by funds received from other sources, especially where, as here, there are co-debtors on the judgment. Thus, we conclude, OCGA § 14–11–504(a) does not reasonably require that, as a prerequisite to the issuance of a charging order, the judgment creditor establish the specific amount of the judgment that remains unpaid on the date the charging order is issued.  It follows that the trial court did not err in granting Stablis’s motion for summary judgment.

The appellants also contend that, because the order issued by the trial court gives no direction to the parties as to the extent of funds to be distributed thereunder, the order is unenforceably vague. A charging order, however, cannot extend past the satisfaction of the underlying judgment because, by definition, the charge can only be against the “unsatisfied amount” of the judgment. OCGA § 14–11–504(a). Accordingly, the charging order at issue here does not continue indefinitely or contemplate an unlimited charge on Gaslowitz’s membership interest, but would remain until the $1,621,132.78 judgment, with interest, is satisfied. Nothing would preclude Gaslowitz from moving to extinguish the charge on the grounds that the judgment has been satisfied, and the trial court’s order does not allow Stablis to collect or retain payments beyond those necessary to satisfy its judgment.  2015 WL 1059575, *2-3 (footnote omitted)

      Still, Gaslowitz was successful in having set aside an order for the accounting of the assets of G & A, LLC.  Id. at *4.

      The analysis employed in the Regions Bank decision may be legitimate under Missouri law, but the paradigm set forth in the Gaslowitz decision, from the perspective of charging order law, is better.  It recognizes that the amount of the judgment is a matter determined by the trial court issuing the judgment (which may not be the court issuing the charging order) and that its satisfaction may come from any number of sources including distributions from the charging order before that court.  Over-payment is not a concern as the judgment-debtor has every incentive to track payouts made in satisfaction thereof and to file (or to prompt the judgment-creditor to file) a notice of satisfaction of judgment.

Fraudulent Conveyance and Piercing the Veil

Fraudulent Conveyance and Piercing the Veil

 

In a recent decision, the Federal District Court found (a) that certain mortgages and security interests were fraudulent conveyances and (b) that the veils of a variety of entities should be pierced in order to hold the control person liable for an arbitration award against two of those companies.  Kentucky Petroleum Operating Ltd. v. Golden, Civ. No. 12-164-ART, 2015 WL 927358 (E.D. Ky. March 4, 2015).

 

      Two LLCs, 7921 Energy LLC and Macar Investments, LLC (collectively the “Macar parties”) sold gas and oil well properties and equipment to Kentucky Petroleum Operating, LLC and Kentucky Petroleum Operating, Ltd.  (collectively the “KPO debtors”).  Disputes arose over performance under those agreements, and that dispute went to arbitration.  Between the arbitration hearing and the rendering of the decision, the KPO debtors, working in concert with affiliated companies, mortgaged/pledged their assets to those same affiliated companies, particularly Kentucky Petroleum Limited Partnership (“KPLP”).  The mortgage allowed KPLP to foreclose on the leases in the event of a transfer by operation of law, described by Judge Thapar as:

Taking a page out of playground negotiation, KPLP essentially called “dibs” in the event they ever left the KPO debtors’ possession.

      The Macar parties prevailed in arbitration, and were awarded against the KPO debtors a judgment of $466,187.  With the assets of the KPO debtors fully encumbered, the Macar parties (i) argued that the mortgages/pledges between the KPO debtors and the related companies were fraudulently transferred and (ii) the KPO debtors, KPLP and other entities are actually alter-egos of one another and their veils should be pierced to reach Mehran Ehsan, their common controller.

Fraudulent Conveyance

      Kentucky law voids any conveyance of property made with the intent to “delay, hinder, or defraud creditors,” KRS § 378.010; subsequent creditors are likewise protected.  Myers Dry Goods, Inc. v. Webb, 181 S.W.2d 56, 59 (Ky. 1944).  There was in this case no dispute that one “badge of fraud” existed, namely that the mortgages/pledges were given during the pendency of a lawsuit.  2015 WL 927358, *4.  With that badge of fraud the burden shifted to the KPO debtors to show that the mortgages/pledges were given in good faith.  This they failed to do.  In response to the position that the KPO debtors did not think the Macar parties to be creditors at the time of the mortgages/pledges, the Court found that their subjective view is largely irrelevant.  Rather:

Even if the KPO debtors did not consider the Macar parties their “creditors” when they recorded the UCC–1 and mortgage, the law did: “A person who has a claim for damages against a grantor is a creditor within the meaning of [the fraudulent conveyance statute].” Lewis, 49 S.W. at 329; Hager, 208 S.W.2d at 519–20 (finding a debtor-creditor relationship where the debtor had “reason to believe and anticipate” that the creditor would take action against him). Moreover, section 378.010 protects both then-existing and subsequent creditors from a debtor’s fraudulent conveyances. Myers, 181 S.W.2d at 59. Thus, section 378.010 applies even if the KPO debtors did not believe the Macar parties were creditors at the time they executed the mortgage and UCC–1. Id.

The Court rejected the assertion that good faith is a fact question requiring a jury trial on the basis that they failed, in the face of an admitted badge of fraud, to “present any evidence disputing that they harbored intent to defraud.” Id.  There was also rejected (on grounds that are not entirely clear) the claim that the mortgages/pledges were given in satisfaction of an existing indebtedness. Id. at *6.

The Macar parties were granted summary judgment on their claims for fraudulent conveyances.

Piercing the Veil

      The decision recites the piercing test adopted by the Kentucky Supreme Court in Inter-Tel Technologies, Inc. v. Linn Station Properties, LLC, 360 S.W.3d 152, 165 (Ky. 2012), noting that:

In Kentucky, alter ego liability boils down to “two dispositive elements: (1) domination of the corporation resulting in a loss of corporate separateness and (2) circumstances under which continued recognition of the corporation would sanction fraud or promote injustice.”

      As for the lack of separateness, it was found that the KPO debtors and the related companies share common leadership in Mehram Ehsan, there was inadequate capitalization of at least one of them, formalities were ignored and the entities comingled their funds.  Id. at *7.

      The fact that Mehram Ehsan was not named as a party in the suit, that raised as a bar to the Court piercing the veil, was described as “mistaken.”

      Having found a lack of separateness, the Court turned its attention to the second prong of the piercing analysis, namely whether or not piercing would sanction fraud or promote injustice.

      While acknowledging that the injustice needs to be more than the creditor is not paid, the Court determined:

[O]ne such injustice is a parent corporation or director causing a subsidiary’s liability and then rendering the subsidiary unable to pay that liability. Ehsan, who controls and directs all of the KPO entities, incurred liability on behalf of the KPO debtors by executing both the Macar and 7921 PSAs on behalf of the KPO debtors. An arbitrator found that the KPO debtors breached the PSAs and awarded damages to the Macar parties. Ehsan then rendered the KPO debtors unable to meet their PSA obligations. As the Court explained in section II, the KPO entities—at the direction of Ehsan—stripped assets from the KPO debtors, meaning that the Macar parties could not collect their arbitration award. Accordingly, continued recognition of the separate corporate forms of the various KPO entities would sanction an injustice.

A second injustice is a scheme to shift assets to a liability-free corporation while shifting liabilities to an asset-free corporation.  In this case, all of the liabilities fell on the KPO debtors because they are the only parties named in the arbitration award. Meanwhile, non-debtor KPLP took all of KPO, LLC’s assets and all of the KPO debtors’ revenue under the PSAs. On these facts, the continued recognition of the KPO entities’ supposedly “separate” corporate forms would sanction injustice. Because the Court finds that the KPO entities lack corporate separateness and that recognizing separate corporate forms would sanction an injustice, the Court will pierce the corporate veil and treat the KPO entities as a single entity. Id. at *8 (citations omitted).

From there the conclusion was a foregone, namely:

Because the Court finds that the KPO entities lack corporate separateness and that recognizing separate corporate forms would sanction an injustice, the Court will pierce the corporate veil and treat the KPO entities as a single entity. Id.

Federal Court Considers, Rejects on the Basis of Failure to Make Demand, Derivative Action Brought vis-à-vis a Church

Federal Court Considers, Rejects on the Basis of Failure to Make Demand,

Derivative Action Brought vis-à-vis a Church

 

            In a decision earlier this month from the Federal District Court in Maryland, the Court considered and ultimately rejected a derivative action brought vis-à-vis an incorporated church.  In this instance, the suit was set aside because the plaintiff failed to satisfy the requirement of either making a demand for action upon the board before filing suit or be able to demonstrate futility.  Here the plaintiff made no demand and her efforts to demonstrate futility were insufficient.  Franklin v. Jackson, Civ. Act. No. DKC 14-0497, 2015 WL 1186599 (D. Md. March 3, 2015).

 

            Franklin, whose membership in the “Jericho Baptist Church Ministries” was contested by the defendants, brought a derivative action asserting that the directors/trustees were engaging in a wide variety of improper activities including but not limited to financial improprieties.  The defendants directors sought a motion to dismiss or in the alternative summary judgment as to Franklin’s ability to bring suit.

 

            The Court began by a consideration of diversity jurisdiction and alignment of the corporation as either a plaintiff or a defendant; the defendants sought its realignment as a plaintiff, an action which would have destroyed diversity.  The Court found that the corporation’s alignment as a nominal defendant was proper.  The Court as well considered an Argument based upon Colorado River abstention, one it ultimately rejected.

 

            The Court then considered the plaintiff’s standing under Article III of the US Constitution and the question of whether this was a dispute that could be considered in light of the Free Exercise Clause of the First Amendment.  Ultimately it determined, based upon the record before it, that the controversy could be heard.

 

            Turning to the issue of demand futility, the Court applied Maryland law as to when futility is or is not present.  The Plaintiff argued, inter alia, that as the directors, or at least some of them, were alleged to have engaged in the improper conduct, they could not be expected to take remedial actions against themselves; on that basis a demand would be futile.  The Court reviewed the individual allegations and the factual basis for asserting futility, finding them to be insufficient.  The fact that the directors had been party to the challenged transaction alone was not a reason to excuse demand – if the challenge was brought to their attention they could have responded, including by acquiescing to any demand.  Further, the inter-personal relationships among the directors did not render all of them conflicted as to particular actions.

 

            Tellingly, the Court rejected the notion that Franklin lacked standing “because she has no property rights in Jericho.”  Id. at *13.

 

            Entirely as an aside, the opinion at one point cites Maryland Code § 4A-801(b) regarding the requirement to plead the demand made or futility.  This appears to be inapplicable as this provision is part of the Maryland LLC Act.

 

 

It's Not Just Delaware For Which You Need To Watch Out

 

For various historical reasons whose intrinsic validity can certainly be questioned, most business entities formed outside their home jurisdiction are organized in Delaware. This favoritism for Delaware is based upon the assumption that the Delaware statute are in some manner both unique and favorable.

 

It needs to be appreciated that, however, nearly every state has a business entity statute that is in some manner unique (or near unique) and, depending upon the objectives of particular constituents to a venture, favorable. At the same time, if a provision is favorable to some constituent, it may not be favorable to others.

 

There is currently pending in Delaware a dispute as to whether or not the Delaware General Corporation Law should be amended to preclude provisions in either the certificate of incorporation or the bylaws which, beyond the provisions already set forth in statute, would provide for the shifting of liability for expenses in derivative actions.  HERE IS A HERE IS A LINK to a prior posting on this topic.

 

The attention upon this controversy in Delaware should not be interpreted as an indication that similar debates have not taken place in other states or that they have not already adopted laws on the topic. Specifically, the Oklahoma legislature, in 2014, amended its Business Corporation Act to provide for mandatory fee shifting against plaintiffs in certain derivative actions. In effect, Oklahoma has already mandated the treatment that, even in an optional format, is right now being debated in Delaware. Specifically, Oklahoma law now provides that:

 

·        If the derivative action “confers a substantial benefit on the corporation,”, the court may order the corporation to pay the legal fees incurred by the plaintiff shareholders in prosecuting the action; and

 

·        in any derivative action, the court shall require the non-prevailing party to pay the expenses, including attorneys’ fees, incurred by the prevailing party. 18 Okla. Stat. § 1126.

 

As such, by statute, Oklahoma has already adopted an interim provision that will, undoubtedly, limit the willingness of shareholders of an Oklahoma corporation to challenge actions taken by the Board of Directors and management which may implicate their fiduciary duties to the corporation. HERE IS A LINK to that Oklahoma statute.

 

It is not just Delaware that has atypical laws.