Sunday, May 31, 2015
Another Case on Contract Architecture and a Signature Not at the Bottom of the Writing
In a decision rendered on May 1, 2015, the Kentucky Court of Appeals considered the enforceability of an agreement that was signed not at the end but above the final provisions of the agreement. See C.A.R.S. Protection Plus, Inc. v. Mamrak, No. 2014-CA-000470-MR (Ky. App. May 1, 2015) (not to be published).
Mamrak bought a used car and, in connection therewith, bought a vehicle service agreement from C.A.R.S. Protection Plus, Inc. (“CARS”). At the time he bought the car, a used BMW, the odometer read 130,269 miles. CARS issued a “warranty coverage card” reciting (a) the coverage would begin on October 20, 2011 (nine days after the car was acquired) and end on January 20, 2012, and (b) identifying the mileage range for which coverage was provided as between 130,269 and 134,769. Essentially, the coverage period was the lesser of six months or 4,500 miles.
The day after the car was purchased, it exhibited trouble which was, at least temporarily, resolved by a new thermostat. However, problems again arose, and the thermostat was replaced again, as was the water pump. When problems continued the vehicle was towed to a garage, where Mamrak was told that the motor would have to be replaced. Mamrak incurred cost of $7,785.93, of which CARS paid $63.48. CARS defended any additional liability on the basis that the engine problems manifested themselves on October 12, 2011, the day after the vehicle was purchased but before the service contract’s effective date of October 20. Further, CARS would rely upon the terms of the service agreement which provided: “component failures that occur before [CARS] approves this limited warranty application are not covered.” Mamrak noted that this language appeared in the contract below his signature line, and therefore the limitation did not constitute part of the agreement. In response thereto:
CARS argued that the location of Mamrak's signature on the application was irrelevant to the operation of the vehicle service contract. It contended that even if Mamrak's signature had been required to make an enforceable contract, language sufficient to incorporate all the terms of the agreement was immediately proximate or adjacent to his signature. Finally, CARS contended that if Mamrak’s position were accepted, and only those terms found above his signature are part of the agreement, then the service contract is utterly meaningless since all of the operative terms (including the coverage description) are included below his signature on the application. It argued that no agreement could exist under the circumstances.
Initially, the Oldham Circuit Court issue partial summary judgment in Mamrak’s favor to the effect of the language under his signature was not part of the agreement. This determination was based upon KRS § 446.060(1), which requires, inter alia, that any signature on a document appear at close to the end of the document when the contract is otherwise required by law to be signed by a party thereto. In response to a second motion for summary judgment, and here limited by the prior determination striking the language below Mamrak’s signature, “CARS argued the no valid contract had been created. It claimed that the document--as redacted by the Court--lacked definite and essential terms and did not reflect any actual agreement between the parties. CARS sought summary judgment on the basis that no contract had been formed between the parties.” In turn the trial court determined that the language above Mamrak’s signature was sufficient to create a contract. After further fact-finding based on affidavits, CARS was ordered to pay $5,519.61 towards the powertrain repairs.
In my view, unfortunately, the Court of Appeals essentially sidestepped the interrelationship of Kentucky's rules as to the formation of the contract, including as set forth in Cinelli, and the treatment of the language below a signature as being excluded from the contract. Rather, resolving the question “without reference to the location of the signature line and [the] dispute over terms appearing above or below it,” the Court found that the agreement was binding on October 20, 2011, that the car was still operating on that date and that “the bulk of the necessary repairs occurred on October 25 and again in November 2011.” From there the Court was able to determine that “[T]he vehicle service agreement standing alone was in effect and covered the cost of repairs.” Presumably this last clause was meant to apply as of the date the repair costs were incurred.
In addition, albeit without analysis, the Court of Appeals determined that the service contract is enforceable under the Magnuson-Moss Warranty-Federal Trade Commission Improvement Act, it being simply stated that “Mamrak is entitled to enforcement of a vehicle service contract under both the spirit and the letter of the Act.”
Friday, May 29, 2015
Delaware Chancery Court Addresses When a Corporation is “Insolvent” for Purposes of a Creditor Derivative Action
Delaware Chancery Court Addresses When a Corporation is “Insolvent” for Purposes of a Creditor Derivative Action
In a decision issued earlier this month, the Delaware Chancery Court defined the test to be employed in determining whether or not a corporation is insolvent such that a creditor will have standing to bring a derivative action. Quadrant Structured Products Company, Ltd. v. Vertin, C.A. No. 6990-VCL, 2015 WL 2062115 (Del. Ch. May 4, 2015).
Quadrant held debt securities issued by Athilon Capital Corp. Premised upon Athilon’s insolvency, Quadrant brought a derivative action alleging that certain Athilon transactions were approved by the Athilon on Board of Directors in violation of its fiduciary duties, as well as alleging that those transactions violated the Delaware Fraudulent Transfer Act. Under Delaware law:
[T]he creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the Corporation for breaches of fiduciary duties.
North American Catholic Education Programming Foundation, Inc. v Gheewalla, 930 A.2d 92, 101 (Del. 2007).
Athilon resisted, asserting that a high bar is necessary with respect to insolvency to exist, and further positing that that high bar had not been met. Specifically, Athilon asserted that insolvency required all of:
(i) that the corporation was insolvent at the time the derivative action was filed;
(ii) that the corporation continues to be insolvent throughout the pendency of the derivative action; and
(iii) with respect to insolvency, such should be more than a mere balance sheet or cash flow analysis, as well satisfy the requirement for the appointment of a receiver, “namely that the corporation has no reasonable prospect of returning to solvency.”
The Chancery Court rejected these tests, finding it sufficient that the plaintiff demonstrate the corporation was insolvent at the time the suit was filed, with insolvency measured under either the balance sheet or the cash flow test.
In explaining its decision, the Court began with an analysis of the purpose of the derivative action (a theme I recently considered in the context of Kentucky law in Who Will Watch the Watchers?: Derivative Actions in Nonprofit Corporations, 103 Kentucky Law Journal Online 31 (2015)), it was determined that:
The derivative action exists to prevent injustice by facilitating a lawsuit that otherwise would not have been or could not be pursued, and stockholders have standing to assert a corporation’s claim derivative because they can be regarded as the ultimate beneficial owners of the corporate assets, including litigation assets, and therefore have an interest in pursuing the claim.
Rejecting the assertion that the corporation must remain insolvent throughout the pendency of the action, the Court observed that this “attempt to impose a continuous insolvency requirement tries to build by analogy on the contemporaneous ownership requirement” applicable with respect to shareholder derivative action. This the Court rejected in favor of a requirement that the creditor bringing the action continue to hold the debt claim against the corporation throughout the action.
With respect to the sought requirement that the corporation remain insolvent throughout the course of the action, it was observed that a corporation could, during the term of the proceeding, move back and forth across the line of insolvency. Recognizing this could give rise to fact situations in which both the shareholders and the creditors could bring derivative actions, it was concluded that a court under its general supervisory authority of the derivative action would be able to weigh and balance the conflicting interests of the claims of equity holders versus creditors.
The Court then turned its attention to determining whether Athilon was actually insolvent, ultimately determining that the balance sheet test was the most appropriate measure. Based upon the facts put forth by the plaintiffs, the Court determined that Athilon was insolvent as of the time the derivative action was filed, and on that basis it was allowed to proceed.
The Fall of Constantinople and the End of the “Middle Ages”
On this day in 1453 the city of Constantinople, and with it the Byzantine Roman Empire, fell to the forces of the Ottoman Empire under Mehmed II. Refounded as the Eastern capital of the Roman empire in the early years of the 4th Century, it had previously fallen only once, then in 1204 to an army of Western Crusaders. The strength of its walls, especially those on the land side, were legendary. The Hun army under Attila is reputed to have ridden up to the walls, taken a good look and ridden away, knowing they could not take the city. Since the fall of the Western Roman Empire in the 5th Century, it was the Eastern “Byzantine” Empire that continued the traditions and namesake of the “Roman Empire.”
Mehmed was able, however, to utilize the still relatively new cannon, but cast at sizes never before seen. A combination of the battering of the city’s walls, siege and the deprivation of supplies, and a city without the necessary military forces to patrol and protect the walls set the stage for its downfall. Ultimately the Ottoman forces were able to force entry through a gate left open in the walls through which a wounded Byzantine commander (he himself was from Genoa) had been evacuated. The last of the Byzantine emperors, Constantine XI, died leading his troops in a final push against the enemy (or at least it is so assumed; the accounts record him leading the troops and his whereabouts are never again reported, his body was never recovered).
Some scholars treat the Fall of Constantinople as the end of the Middle Ages. An interesting notion, but since scholars can’t agree as to what are the characteristics of the Middle Ages, it is hard to say the age ended as of one point in time or another. Maybe for that reason May 29, 1453 is as good a day as any.
Thursday, May 28, 2015
Last week, the United States Supreme Court agreed, in the 2015-2016 term, to review the question presented in Evenwel v. Abbott, an interesting case which will essentially present the question of “when does one equal one?”
Typically every 10 years, state legislatures redistrict in order to balance the populations in the various districts, thereby assuring, within some measure, that each state representative or senator represents an equal number of state citizens. This “one-person, one-vote” requirement follows from the decision from the United States Supreme Court in 1964 named Reynolds v. Sims. The question arises as to what measure should be used in making those determinations. For example, the state could look at the total population of the state and then, as equally as possible, divide them among districts. Alternatively, a state may use the registered voters as the measure against which population is divided. Another possibility would be to utilize the number of persons eligible to be registered to vote, i.e. base apportionment upon the voting-age population.
Curious distinctions can flow from which measure is used. For example, if the voting age population is used rather than the number of registered voters, it is possible to create a district in which there are relatively fewer voters consequent to the fact that the district also holds a prison; the residents thereof will be of voting age, but they will not be eligible to vote. Conversely, working from the assumption that voter registration increases in proportion to age, a large retirement development would be afforded more weight than would be a significant apartment development inhabited by recent college graduates and other young professionals.
You Do Have To Worry About a Club Which Will Have Me As a Member
Under Delaware law, with respect to a conflict of interest transaction, it is required that there be (a) a fair process and ultimately that (b) there be a fair price. This pair of requirements is referred to as the “entire fairness” test. The combination of procedural and substantive safeguards is intended to protect the interests of minority participants in the transaction. By way of example, if the 51% shareholder of a business corporation desires that the company undergo a merger in which the 49% shareholder will be cashed out, the fair process/fair price requirements should ensure that the minority shareholder receives the appropriate value for his or her shares. A recent decision from the Delaware Chancery Court considered the treatment of a situation in which the process was manifestly flawed from a prototypical “fair” process, but objectively a price that was more than a fair price was achieved. In re Nine Systems Corporation Shareholders Litigation, Consol. C.A. No. 3940-VCN, 2014 WL 4383127 (Del. Ch. Sept. 4, 2014).
The Court neatly summarized the challenge presented as follows:
The board decisions and stockholder actions at the heart of this lawsuit present one of the long-standing puzzles of Delaware corporate law: for a conflicted transaction reviewed by this Court under the entire fairness standard, “[t]o what else are shareholders entitled beyond a fair price?” The entire fairness standard of review has long mandated a dual inquiry into “fair dealing and fair price” that this Court should weigh as appropriate to reach a “unitary” conclusion on the entire fairness of the transaction at issue. Delaware courts have contemplated this issue before. What unites the resulting range of explications of this area of Delaware law is the principle that the entire fairness standard of review is principally contextual. That is, there is no bright-line rule on what is entirely fair.
Here, the Court concludes that a price that, based on the only reliable valuation methodologies, was more than fair does not ameliorate a process that was beyond unfair. At least doctrinally, stockholders may be entitled to more than merely a fair price, but the difficulty arises in quantifying the value of that additional entitlement. A more challenging question thus arises: what damages may stockholder plaintiffs receive where the transaction at issue was approved and implemented at a fair price? This memorandum opinion contemplates one practicable—and contextual—answer to that question. (Slip op. at 1 (footnotes omitted)).
In a subsequent decision, the Chancery Court would award $2,000,000 to the plaintiff’s attorneys. See In re Nine Systems Corporation Shareholders Litigation, C.A. No. 3940-VCN, 2015 WL 2265669 (Del. Ch. May 7, 2015). Admittedly, plaintiff’s counsel did request nearly $12,000,000.
My question is where this decision leaves the “entire fairness” test and it’s elements of fair process and fair price. In this instance, notwithstanding that the process was manifestly flawed, the plaintiffs were granted no relief because they had already been compensated in an amount higher than they would have been had the process been entirely fair. Does this mean that a “fair price” is, in effect, a defense to the failure to employ a “fair process”? Alternatively, are we now at the place where the entire fairness test is really one that looks to fair process for the purposes of dismissal on either a 12(b)(6) or summary judgment motion, but on the merits requires a demonstration of damages by the plaintiffs in order to recover on what had been the “fair price” element? But then what does that do to the requirement that, in a transaction subject to the entire fairness test, the defendant Board of Directors demonstrate a fair price? Is a burden being shifted? Again, is fair price a defense to flawed process?
Wednesday, May 20, 2015
Confusion Over Charging Orders – Distributions of Contributed Capital
A recent decision from the Ohio Court of Appeals held, inter alia, that a charging order did not extend to distributions from the LLC of contributed capital, saying those amounts are not “distributions.” Knollman-Wade Holdings, LLC v. Platinum Ridge Properties, LLC, No. 14AP-595, 2015 WL 1913565 (Ohio Ct. App. 10th Dist. April 28, 2015). With due respect, this decision is incorrect.
Knollman-Wade Holdings (“KWH”) held a judgment against against Platinum Ridge Properties (“PRP”) for some $288,330.07. Seeking to collect thereon, KWH sought a charging order against PRP’s interest in Platinum Polaris partners, LLC (“PPI”). PRP objected to the tendered charging order, asserting that it went beyond the scope of the statute to include withdrawals of contributed capital. The trial court entered the requested order, and this appeal followed.
The Ohio Court of Appeals wrote:
Pursuant to R.C. 1705.19(A), a judgment creditor of a member of a limited liability company may apply to the court of common pleas to charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest. A charging order is a judgment creditor’s sole and exclusive remedy to satisfy a judgment against the membership interest of a limited liability company member. R.C. 1705.19(B). A membership interest is defined by R.C. 1705.01(H) as a “member’s share of the profits and losses of a limited liability company and the right to receive distributions from that company.” Id. at *2
After discussing rules of statutory construction, the Court determined:
The charging order issued by the trial court impermissibly expands the scope of R.C. 1705.18(A). The plain language of the statute does not include either “withdrawals of capital” or payments made “through” a judgment debtor as items subject to a charging order. Rather, R.C. 1705.18(A) expressly provides that an assignee such as KWH is entitled only to receive “the distributions of cash and other property and the allocations of profits, losses, income, gains, deductions, credits, or similar items” to which PRP would be entitled. Had the General Assembly intended what KWH contends, it could have employed language to that effect. Because it did not, we conclude the trial court erred in inserting these phrases into the charging order. Id. at *4.
For that reason the portion of the charging order which extended its reach to “withdrawals of capital” was set aside.
Again, with due respect, the Court of Appeals got it wrong.
While the language from *2 of the decision quoted above is correct, the Court of Appeals failed to analyze whether a return of contributed capital is a “distribution.” In fact it is.
Under the Ohio LLC Act, capital contributed to an LLC is property of the LLC – a member will typically receive a limited liability company interest, which is personal property, in consideration of the contribution. See Ohio Code § 1705.09(A) (“The contributions of a member may be made in cash, property, services rendered, a promissory note, or any other binding obligation to contribute cash or property or to perform services; by providing any other benefit to the limited liability company; or by any combination of these.”); id. § 1705.17 (“A membership interest in a limited liability company is personal property.”); id. § 1705.34 (“Real and personal property owned or purchased by a limited liability company shall be held and owned in the name of the company.”)
Consider ABC, LLC, to which Amy contributes unimproved real property, Whiteacre. Once she makes that contribution Amy has not ownership interest, direct or indirect, in Whiteacre. Rather, Whiteacre belongs to ABC, LLC. Amy’s contribution to ABC, LLC, is valued as the members agree among themselves, and that value is utilized in determining the shareing ratio in distributions made by the LLC. See, e.g., Ohio Code § 1705.11(A) (“A [LLC] from time to time may distribute cash or other property to its members. Unless otherwise provided in the operating agreement, distributions that are made shall be made to the members in proportion to the value as stated in the records of the company required to be kept under section 1705.28 of the Revised Code of the contributions made by each member to the extent the contributions have been received by the company and have not been returned.”)
Upon liquidation, the statute makes clear that there will be “distributed” to the members a traunch determined by reference to their respective capital contributions. See id. §1705.46:
(A) Upon the winding up of a limited liability company and the liquidation of its assets, the assets shall be distributed in the following order:
(1) To the extent permitted by law, to members who are creditors and other creditors in satisfaction of liabilities of the company other than liabilities for distributions to members;
(2) Except as otherwise provided in the operating agreement, to members and former members in satisfaction of liabilities for distributions to members;
(3) Except as otherwise provided in the operating agreement, to members as follows:
(a) First, for the return of their contributions;
(b) Second, with respect to their membership interests. (emphasis added).
Simply put, a “distribution” is the means by which the assets of the LLC are converted into the property of the members – until the declaration of a distribution the LLC’s assets are its as a legal entity. The only means by which an LLC’s member may receive either the positive fruits of the venture or the assets contributed to the LLC (either in kind or in cash) is for the LLC to declare a “distribution.”
A charging order that by the terms of the statute extends to the distributions made by the LLC encompasses withdrawals and returns of contributed capital.
Tuesday, May 19, 2015
I Have But Such a Little Neck
Today marks the anniversary, in 1536, of the execution of Anne Boleyn on spurious charges of adultery and therefore (by one argument) treason. While she would be included in Foxe’s Book of Martyrs, a 16th century effort at Protestant hagiography, all indications are that Anne died a Catholic; it is difficult to otherwise understand her request that the Eucharist be placed in her chambers at the Tower of London in the days before her execution.
Famously, Anne was executed not with the traditional English ax, but rather by a French swordsman. The chronology makes this suggestion questionable. The “Calais Swordsman’s” participation does lend an interesting element to the consideration of Anne’s trial. Anne was consigned to the Tower on May 2, her alleged partners in adultery (other than her brother George) were tried on May 12; she and George were tried on May 15. The swordsman, normally resident in Calais, may have been ordered to come to England before her trial. Even though her trial had not yet taken place, the manner of her dispatch may have already been selected. Still she came out ahead (no pun intended); her sentence was commuted to beheading – the regular sentence for a woman convicted of treason was burning at the stake.
The statement about having a little neck was made by Anne while being held in the Tower in anticipation of her execution. Anne’s execution was rescheduled twice due to the delay in the arrival of the Calais Swordsman, and the delay was understandably rather rough on her nerves. Notwithstanding the recent (and excellent) PBS “Wolf Hall,” the statement was not made before her trial.
I have never found a satisfactory explanation as to why the swordsman was requested over the axeman; Friedmann suggested, and Ives admits it as a possibility, that it was at Anne’s request, she desiring the French manner of execution in light of her having been raised in the French court. But if the “Calais Swordsman” was summoned to London before her trial, it is curious as to whether and how Anne was consulted about her manner of dispatch.
Anne was buried in St. Peter ad Vincula, the church on the grounds of the Tower of London.
Henry would marry Jane Seymour, his third wife, on May 30.
On Further Reflection, “No”
At the UKCLE/KBA Section of Business Law Business Associations Institute I mentioned that the General Assembly had just passed an amendment to the Kentucky LLC Act providing by statute for derivative actions in LLCs (2015 Ky. Acts, ch. 34, § 50). Jim Seiffert, also on the panel on fiduciary duties, asked whether the operating agreement could limit or eliminate the ability of a member to bring a derivative action? I think I told him I don’t think so, but I can’t swear that was my response.
That said, on further reflection, and after considering the decision of the Delaware Supreme Court in In re Carlisle Etcetera, LLC, C.A. No. 10280-VCL, 2015 WL 1947027 (April 30, 2015), I’ve come to the view that the operating agreement cannot modify the capacity of a member to initiate on the LLC’s behalf a derivative action.
Still, that leaves open the question as to whether an “all disputes” arbitration clause would under the Federal or Kentucky Arbitration Act require the court to refer the derivative action to arbitration.