Tuesday, September 29, 2015

More on the Nature of Sole Proprietorships and the Filing of Certificates of Assumed Name

More on the Nature of Sole Proprietorships and the Filing of Certificates of Assumed Name

      Previously I reviewed the decision of the Kentucky Supreme Court in Sparkman d/b/a In-Depth Sanitary Service Group v. Console Energy, Inc. (Ky. Aug. 20, 2015).  Therein, I reviewed the Kentucky Supreme Court's excellent discussion of the nature of a sole proprietorship. Here is a link to that earlier review.  I did note, however, a small “quibble” with the opinion and its suggestion that a sole proprietor files a certificate of assumed name with the Secretary of State.  Rather, so proprietorship's file a certificate of assumed name only with the County Clerk.
     Last week (and let me be clear that I make no claim of causation), the Kentucky Supreme Court issued an amended opinion in this case.  While I have not done a comprehensive comparison of the two decisions in order to identify any other changes made between the original and the correct decisions, on page 13 of the slip opinion, it now provides that:
To operate under an assumed name, Kentucky Revised Statute (KRS) 365.015(3) stipulates that a sole proprietor must first file a certificate of the assumed name with the “County Clerk where the person maintains his or her principal place of business.”

More as to the Complexities of Single-Member LLCs

More as to the Complexities of Single-Member LLCs

     As I noted previously (HERE is a link), at the recent Annual Meeting of the American Bar Association's Section of Business Law, Kelley Bender, Robert Keatinge and I did a presentation on the complexities of single-member LLCs.  If you would like a copy of the PowerPoint presentation, IT is available through this link.

Monday, September 28, 2015

Federal Crowdfunding Rules

Federal Crowdfunding Rules

      We for several years have been waiting for the federal Crowdfunding rules.  According to this blog posting by Steven Bradford, the wait may soon be over.

      HERE IS A LINK to that posting

Friday, September 25, 2015

The Last Viking Invasion of England

The Last Viking Invasion of England
      Today is the anniversary of the battle at Stamford Bridge in 1066, it ending, for all intents and purposes, the Viking invasions of England.  Beginning in the 8th century, England had repeatedly suffered both Viking raids and invasions/migrations.  The great King Canute II was an aspect of this chain of events; he was himself Danish.
      Earlier in 1066, King Edward the Confessor died.  The crown was assumed by Harald Godwinson.  His dispute with William the Bastard of Normandy over whether Harald had previously agreed to surrender the crown to William would ultimately lead to the Battle of Hastings.  In the meantime, Harald Godwinson had to deal with an invasion from Norway led by another claimant to the throne, Norwegian King Harald Hardrada; Hardrada was supported in this invasion by Tostig Godwinson, Harald’s Godwinson brother.
      Two factors were crucial to the resolution of the battle.   First, the invading force was dispersed on both sides of the river.  Thus, when the English army attacked the Norse contingent on the south side of the river, they outnumbered their opponent.  Second, the intelligence of the Norse army failed; they did not realize the English army was already present and ready to launch an attack.  It being a warm day, the invading army had left much of their armor on board their ships.  Initially, the English forces largely massacred the Norse forces on the south side of the river.  They then proceeded to attack over the bridge, an effort that, in what was an apocryphal story, was delayed by a single Viking yielding an ax who single-handedly killed some forty soldiers before he was himself slain.  With the English having now crossed the bridge, the two armies again faced one another.  Ultimately, the Norse army would collapse consequent to its lack of armor and the deaths in battle of both Harald Hardrada and Tostig.  The few Normans who survived the battle entered into a truce with Harald agreeing to leave and never return.  While the invading fleet filled some 300 ships, the Norse survivors of the battle were able to return home in only 24 of them.

Thursday, September 24, 2015

The 2015 LLC Institute Agenda

LLCs, Partnerships and Unincorporated Entities Committee
2015 LLC Institute
November 12 – 13, 2015

Thursday, November 12, 2015
7:20 a.m. - 8:00 a.m.
Breakfast (included in registration)
8:00 a.m. – 8:05 a.m.
Welcome; Housekeeping
8:05 a.m. – 8:45 a.m.
Prepared remarks from and Q&A with Senator Grassley (Iowa, senior member of the Committee on Finance and member of the Joint Committee on Taxation)
8:45 a.m. - 10:45 a.m.
Program (2 hrs.) Case Law Review
This panel will discuss recent LLC and partnership cases on various topics of significance, including cases dealing with fiduciary duties and veil piercing and cases illustrating pitfalls in drafting operating agreements.
Chair:  Prof. Elizabeth “Beth” Miller, Prof. of Law, Baylor Law School
Presenters: Lou Hering, Partner, Morris, Nichols, Arsht & Tunnell LLP; Christina Houston, Partner, DLA Piper
10:45 a.m. - 11:00 a.m.
11:00 a.m. - 12:30 p.m.
Program (1.5 hrs.) Legal Opinions Not In Delaware
Transaction docs most often are governed by laws other than Delaware, so that was why I made that change.  Otherwise, you da best.
Opinion letter practice is typically focused upon Delaware entities.   Notwithstanding the view that Delaware is the "dominant" jurisdiction, it is a simple fact that most LLCs nationwide are not organized in Delaware.  Join us as we review both similarities and pitfalls in rendering opinions on LLC's and other unincorporated entities organized outside of Delaware.
Chair:  Christina Houston, DLA Piper LLP
Presenters: Anna Mills, The Van Winkle Law Firm, Bill Callison, Faegre Baker Daniels LLP; Johnny Lyle, Adams and Reese LLP; Cristin Keane, Carlton Fields, P.A.
12:30 p.m. - 1:45 p.m.
Luncheon with Keynote Speaker Prof. Robert Thompson (Georgetown Law Center)
2:00 p.m. - 3:30 p.m.
Program (1.5 hrs.) The Legal Death of a LLC: A Nationwide Hodgepodge of Rules and Practices
This panel focuses on LLC dissolution, wind-up, and termination.  The presentations and discussion are designed to address, among other things, the statutory differences in dissolution schemes as among various states, the policy reasons underlying these differences, and how the differences work in theory and practice.
Chair:  Prof. Joan Heminway, The University of Tennessee College of Law
: Prof. Carter Bishop, Suffolk University Law School; Prof. Doug Moll, University of Houston Law Center
3:30 p.m. - 3:45 p.m.
3:45 p.m. - 5:15 p.m.
Program (1.5 hrs.) What Is An Operating Agreement and Why Do We Care?
Like Shimmer Floor Wax, which was both a floor wax and dessert topping (N.B. http://www.nbc.com/saturday-night-live/video/shimmer-floor-wax/n8625), one of the many questions about the operating agreement is whether it is a contract, the organic formation constitution of a business organization, or something else (like a business plan or statement of intention).  Of course in some cases it is all of these and in others of more limited effect.  But in any case it is critically important in understanding the tax and business relationship that is an LLC.  This panel will consider some of the important questions of what the operating agreement is (or are in the case of multiple components), how it comes into being, what its function is in various contexts (among the members, with the LLC, and under different legal regimes such as tax and bankruptcy), and how we go about determining its contents and explaining what it is an how it works to others.
Chair:  Robert Keatinge, Holland & Hart LLP
Presenters: Kelley Bender, Chapman & Cutler; Ann Conaway, Widener University School of Law; Elizabeth S.  Fenton, Saul Ewing; Joan Heminway, University of Tennessee College of Law; Jessica Liou,Weil, Gotshal & Manges LLP
6:30 p.m. - 7:30 p.m.
Cocktail Hour – Cash Bar
7:30 p.m. - 10:00 p.m.
Lubaroff Award Dinner - (this event is a separately ticketed event--$125.00 - obtain through the registration process)
Friday, November 13, 2015
7:30 a.m. - 8:30 a.m.
Breakfast (included in registration)
8:30 a.m. - 10:30 a.m.
Program (2 hrs.) Navigating the Ethical Maelstroms When the Law Firm Ship is Going Down
The profession has seen a number of law firms dissolve in the last few decades. When law firms fail, a number of ethical and risk management issues surface that require careful and conscious planning to successfully navigate.  These issues relate to everything from client property and client files, to conflicts of interest, client confidentiality, billing and collection of legal fees, and migration of lawyers and staff. This program will address many of these issues by reviewing hypotheticals to pose rules-based and practical solutions to ethical issues.”
Chair:  George Coleman, Bell Nunnally & Martin LLP
Co-Presenters: Susan S. Fortney, Texas A&M University School of Law; A.J. Singleton, Stoll Keenon Ogden PLLC
10:30 a.m. - 10:45 a.m.
10:45 a.m. – 12:15 a.m.
Program (1.5 hrs.) Unfinished Business Doctrine
Drawing upon the experience of some large law firm bankruptcies and other recent decisions, this presentation will discuss claims by creditors and former partners seeking repayment of prior distributions or for profits earned by other firms after the dissociation of the attorneys handling the matter from, or dissolution of, the firm and will focus on potential liability issues and the pertinent ethical issues presented by such claims.
Chair:  Robert Keatinge
Presenters: Christopher Murray, Diamond McCarthy LLP
12:15 p.m. - 1:00 p.m.
Luncheon: Working Committee Discussion (this event is a separately ticketed event - $35.00 - obtain through the registration process)
1:00 p.m. - 1:15 p.m.  
1:15 p.m. - 3:15 p.m.
Program (2 hrs.) S-Corp LLCs
It is increasingly common for limited liability companies to elect taxation as subchapter S corporations.  Traditionally, LLC operating agreements have been drafted on the assumption that the entity will be taxed as a partnership under subchapter K, or, in the case of single member LLCs, as a disregarded entity.  While pass-through taxation is a common attribute of both partnerships and subchapter S corporations, there are significant differences between these two tax regimes.  This panel will discuss issues associated with the de-coupling of the form of an entity from its taxation and associated planning considerations in the context of LLCs that elect to be taxed as S corporations or as qualified subchapter S subsidiaries.  Among other topics, it will address the characteristics of subchapter S corporations, factors influencing the choice of S corporation tax status, operating agreement provisions tailored to the subchapter S tax regime, the implications of “disregarded” entity status (and loss of that status), fundamental differences between qualified subchapter S subsidiaries and LLCs that are disregarded under the check-the-box regulations, and implications for acquisitions, dispositions and succession planning.
Chair:  Dan Sheridan, Stark & Stark
Presenters:  Martin J. McMahon, Jr., James J. Freeland Eminent Scholar in Taxation and Professor of Law, Fredric G. Levin College of Law,  University of Florida; Warren P. Kean, Shumaker, Loop & Kendrick, LLP
3:15 p.m. - 3:30 p.m.
3:30 p.m. - 5:00 p.m.
Program (1.5 hrs.) Did you really mean what you wrote in that IRR distribution waterfall?
This panel will discuss the prevalent use of internal rate of return (IRR) in distribution waterfalls and how it compares to more traditional “preferred return” waterfalls. The speakers will explain the economic and tax considerations, including concepts of compounding, time value of money, use of Excel references, benefits of IRR waterfall provisions, and common drafting errors.  The speakers will compare and contrast many sample waterfalls and determine if there really is a difference in the current varied definitions of IRR in documents. 
Chair:  Prof. Brad Borden, Brooklyn Law School
Presenters: Steve Schneider, Goulston & Storrs; Thomas Kaufman, Goulston & Storrs (invited); John Grumbacher, Goulston & Storrs (invited)
5:00 p.m. - 5:15 p.m.

Wednesday, September 23, 2015

Massachusetts Court Affirms Assessment of Damages for Breach of Fiduciary Duty

Massachusetts Court Affirms Assessment of Damages for Breach of Fiduciary Duty

      In a recent decision, the Massachusetts Court of Appeals affirmed the trial court's assessment of damages for breach of fiduciary duty.  Integrated Pharmaceuticals, Inc. v Chatterjee, No. 14-P-955, 2015 WL 5206457 (Mass. App. Sept. 8, 2015).
      Chinmay and Nilu Chatterjee, among others, founded Integrated Pharmaceuticals, Inc., to which the Chatterjee's licensed patent rights relating to a water-soluble calcium powder. Several years later, without making any disclosure to Integrated Pharmaceuticals, Chinmay Chatterjee, along with others, formed a company, Naples Marketing Systems, LLC. Chinmay then proposed to Integrated’s board that Naples be hired as the distributor and marketing agent for the calcium powder. Ultimately some “$200,000 would be paid to Naples for marketing services that, in fact, were never performed. Chinmay would later take complete control of Naples, and Nilu would continue working for Integrated until such time as it ran out of money. Thereafter, it was discovered in Integrated's accounting records various communications to and entries for Naples and another company created by Chinmay. Ultimately, Integrated would sue the Chatterjees for a variety of claims including breach of fiduciary duty.
      After finding that the Chatterjee's had breached their fiduciary duties to Integrated, damages were assessed in the amount of the salaries received by Chinmay and Nilu for the period they were acting with divided loyalties and as well liability for the $200,000 paid to Naples for marketing services that were never provided.
      On appeal, it appears (the opinion is rather short) that the main argument made by the Chatterjee's was that the three-year statute of limitations under Massachusetts law barred the fiduciary duty claims. While there may have been suspicions, as early as 2005 that Chinmay was being dishonest, they “did not know the extent of his involvement until the accounting records were discovered on Nilu’s computer” in 2008. Suit having been brought in 2010, the plaintiffs acted within the statute of limitations.
      As for the damages, the Court of Appeals affirmed damages in the amount of the salaries paid to Chinmay and Nilu for the period 2005 through their separations from Integrated. Also, the Court of Appeals affirmed the assignment to each of them of one half of the $200,000 paid to Naples.

Monday, September 21, 2015

Research Handbook on Partnerships, LLCs and Alternative Forms of Business Organizations

Research Handbook on Partnerships, LLCs and Alternative
Forms of Business Organizations


      Professors Robert W. Hillman and Mark J. Loewenstein have edited a just-released book, Research Handbook on Partnerships, LLCs and Alternative Forms of Business Organizations  (Edward Elgar Publishing).  They generously invited me to submit a chapter, it on fiduciary duties upon dissolution of an unincorporated entity; in doing so I was invited to box well above my weight class.  The book provides guidance from some of the best thinkers in the field.  The chapters and their respective authors are as follows:

Hon. Leo E. Strine and Hon. J. Travis Laster
The Siren Song of Unlimited Contractual Freedom
Mark J. Loewenstein
Freedom of Contract in Delaware -- Myth or Reality?
Benjamin Means
Contractual Freedom and Family Business
Douglas M. Branson
Alternative Entities in Delaware -- Reintroduction of Fiduciary Concepts by the Backdoor?
J. William Callison
Achaian and Interest Transfers Among Existing Partners and Members
Deborah A. DeMott
Agency in the Alternatives: Common-Law Perspectives on Binding the Firm
Allan G. Donn
Is the Limited Liability of Limited Liability Entities Really Limited?
Jennifer Ivey-Crickenberger and Michelle M. Harner
Mitigating the Impact of a Counterparty LLC's Financial Distress
Franklin A. Gevurtz
Attacking Asset Protection LLCs
Bradley T. Borden
Tax Aspects of Partnerships, LLCs and Alternative Forms of Business Organizations
Donald J. Weidner
Capital Accounts in LLCs and in Partnerships
Joan MacLeod Heminway
Fundamental Changes in the LLC:  A Study in Path-Divergence and Convergence
Thomas E. Rutledge
Care and Loyalty After the Dissociation From or Dissolution of an Unincorporated Entity
Cassady V. “Cass” Brewer
Nonprofit and Charitable Uses of LLCs
J. Haskell Murray
State Laboratories and Social Enterprise Law
Peter B. Oh
Business Trusts
Allison Martin Rhodes and Robyn Axberg
The Law Firm as an Industry Model for Entity Choice and Management
Robert R. Keatinge
Harmonization, Rationalization, and Uniformity: the Good, the Bad, and the Ugly
Nadelle Grossman
Casual Convergence in Unincorporated Entity Law
Mohsen Manesh
Dictum in Alternative Entity Jurisprudence and the Expansion of Judicial Power in Delaware
Elspeth Berry
Partnership Options in the UK: Good Things Come in Threes
Zenichi Shishido
Legislative Policy of Alternative Forms of Business Organization: The Case of Japanese LLCs
Nicholas Calcina Howson
Return of the Prodigal Form?  Partnerships and Partnership Law in the People’s Republic of China
Vladimir Orlov
Alternatives to Capital Oriented Corporations under Russian Law
Afra Afsharipour
The Advent of the LLP in India
Andrew Jen-Guang Lin
The Evolution of Non-Corporate Forms of Business in Taiwan--Introducing the LLP as an Alternative Business Form
André Antunes Soares de Camargo
Brazilian Alternatives to the Corporate Form of Organization

Single-Member LLCs Are Not So Simple

Single-Member LLCs Are Not So Simple

      Last Thursday, Kelley Bender, Bob Keatinge and I presented a two hour seminar at the ABA BLS Annual Meeting on single-member LLCs.  All too often, SMLLCs are treated as being very simple.  Without too much effort (actually we had more materials than we could deliver in the available time), we came up with two hours of discussion of situations and circumstances in which the expected outcome of the SMLLC might not be what is expected.


Our Lady of Perpetual Exemption and Securities Fraud

Our Lady of Perpetual Exemption and Securities Fraud

      No doubt by now you have heard of the already discontinued the church founded by comedian John Oliver, Our Lady of Perpetual Exemption.
      It occurred to me, in listening to the skit and the quotations from numerous of the “prosperity gospel” ministers upon which it was based (and whom it lampoons), that in the context of securities regulation there would be a prima facie case for securities fraud. 
      Just a thought.

Monday, September 14, 2015

Court of Appeals Holds that Self-Defense is Not an Exception from Employment At Will

Court of Appeals Holds that Self-Defense is Not an Exception from
Employment At Will

      Under Kentucky law, absent a contract to the contrary, the employer/employee relationship is “at will”; either party may terminate the agreement any time. As characterized by one court, the relationship may be terminated “for a good cause, for no cause, or for a cause that some might view as morally indefensible.” Wymer v. J. H. Properties, Inc., 50 S.W.3d 195, 198 (Ky. 2001).  There are, however, a few narrow exceptions to this rule, typically to the effect that an employee may not be terminated for engaging in certain protected activities such as filing a claim for worker’s compensation or engaging in union organizing activities.
      In this case, the Court of Appeals considered, and rejected, the suggestion that an employee's exercise of the admitted right of self-defense does not constitute an exception to the rule of employment at will. Smith v Norton Healthcare, Inc., No. 2014-CA-000352-MR (Ky. App. Sept. 11, 2015).
      Smith was an employee of Norton Healthcare where he worked as an environmental services supervisor. On May 23, 2012, when dropped off to work near the Norton facility, he was attacked by a hotdog vendor who both insulted and struck him on the face. As reported by the Court of Appeals, “After Smith took up a defensive posture, he became entangled with the vendor but never hit him. Norton security officers broke up the altercation and reported the incident to the Norton.” A week later, on May 30, Norton terminated Smith, citing a violation of its workplace violence policy. Smith claimed wrongful termination on the basis that it violated Kentucky's public policy of the right of self-defense as set forth in both the Kentucky Constitution § 1 and KRS § 503.050(1).
      Still, the court required that the right at issue have “an employment related nexus”, citing Grzyb v Evans, 700 S.W.2d 399, 402 (Ky. 1985). As formulated by the court there “may not be a sufficient nexus if the statute was not designed to protect the employee from the specified harm that resulted.” The court held that (i) Ky. Const. § 1 does not apply to private, as contrasted with state, actors and (ii) the right of self-defense set forth in KRS § 503.050(1) was not designed or intended to relate to termination of an employment relationship.
      For that reason, the trial court's dismissal of Smith's complaint for failure to state a cause of action (CR 12.02(f)) was affirmed.

Saturday, September 12, 2015

Athenian Forces Defeat Invading Persians at Marathon

Athenian Forces Defeat Invading Persians at Marathon

      Today might be the anniversary of the great battle, fought in 490 at Marathon, at which the forces of Athens defeated the Persian invasion sent by Darius the Great. The exact date of the battle is subject to controversy, although there is something of an alternative consensus on the 21st.

      At the time of the battle, the Persian Empire extended from the western boundaries of what is today India across the Middle East, Turkey and to Southwest Europe.  Darius had decided that the land we refer to today as Greece, inhabited by a variety of city-states, would be next incorporated into his empire.  An invasion fleet landed its troops some 26 miles northeast of Athens at the Bay of Marathon.  Working with collaborators in Athens, it was thought that the army could be drawn away and destroyed even as the collaborators led an internal revolt, taking control of the city and making it available to Darius.  It would not turn out that way.

      At news of the landing, Athens sent word to Sparta seeking its assistance, the Spartan hoplite troops being the strongest force in the region.  Famously, the Spartans were unwilling to send their forces in light of an upcoming religious festival. In consequence, Athens would stand alone.  The Athenian army, well smaller than the Persian forces, camped facing their enemy for over a week.  On the 8th day, seeing that the Persians were re-embarking some troops onto ships and fearing that they intended to launch a direct assault on Athens, the Greek forces attacked.  Although outnumbered, by skillful flanking maneuvers the Greeks were able to envelop the Persian forces.  While the historical records recite what must be grossly inflated figures, certainly the Persians lost in excess of 6,000 men while the Greeks lost fewer than 200. 

Although not recounted in the contemporary historic record, a runner took off to announce the victory to Athens.  Just over 26 miles later, he entered the city, announced “nickomen” (“victory”) and dropped dead from exhaustion.  Meanwhile, the balance of the Persian army embarked on their ships and set out from the Bay of Marathon with the intent of directly attacking Athens.  The Athenian army force-marched itself back to the city, manning its walls as the Persian fleet approached.  The Persians decided that another attack was not in their best interest and they withdrew.

     A decade later, the Persian forces under Xerces, son of Darius, would again invade Greece.  They would ultimately fall victim to the Spartan and allied forces at Thermopylae, the Greek naval forces at Salamis and again the allied forces at Plataea.

Thursday, September 10, 2015

Diversity Jurisdiction and Jurisdictional Discovery: The Third Circuit Holds That “Hiding The Ball” Will Not Work

Diversity Jurisdiction and Jurisdictional Discovery: The Third Circuit Holds That “Hiding The Ball” Will Not Work
      Federal diversity jurisdiction, 28 U.S.C. § 1332, requires that the dispute both involve more than $75,000 and that there be complete diversity, i.e., that no defendant be a citizen of any state of which a plaintiff is a citizen. While corporations, consequent to specific legislative designation, are deemed to be citizens of the jurisdiction of incorporation and the jurisdiction in which is located the corporation’s principal place of business, an unincorporated association such as a partnership, limited partnership or LLC is deemed to be a citizen in which any of its partners/members are citizens to the effect that, for example, if a member of an LLC is itself another LLC or a partnership, citizenship must be tracked through all layers until there are reached either natural persons or corporations. A plaintiff bringing an action in federal court, or a defendant seeking to remove an action to federal court, is required to plead facts demonstrating that diversity exists. This obligation can be at best difficult to satisfy when one considers that the membership of partnerships and LLCs is almost never of public record. How then, can either the plaintiff or the defendant seeking to enlist diversity jurisdiction adequately plead its existence?
      This dilemma was recently faced and addressed by the Third Circuit Court of Appeals. In this case, the plaintiff brought an action in federal court against defendants including LLCs. Those defendants moved to dismiss the action on the basis that diversity jurisdiction had not been adequately pled.  Of course, the information as to the membership of those defendant LLCs was uniquely within their control. As such, the plaintiff had pled diversity jurisdiction on the basis of “information and belief.” Ultimately, the Third Circuit would confirm that “information and belief” pleading is at least initially sufficient. Lincoln Benefit Life Company v. AEI Life, LLC, No. 14-2660, 2015 WL 5131423, ___ F.2d__ (3rd Cir. Sept. 2, 2015).

      Lincoln Benefit brought suit in order to have declared void two life insurance policies, alleging they were procured by fraud or for the benefit of third-party investors (i.e., “Stranger Originated Life Insurance” or “STOLI”). AEI Life, LLC and ALS Capital Ventures, LLC were identified as the record owners and beneficiaries of those two policies. In its Complaint, originally filed in New Jersey, Lincoln Benefit alleged that it is a citizen of Nebraska based upon its organization and principal place of business. It alleged, “upon information and belief,” that AEI Life, LLC and ALS Capital Ventures, LLC were citizens of, respectively, New York and Delaware. In response:
The defendants filed motions to dismiss for, among other things, lack of subject-matter jurisdiction. Their primary argument was that Lincoln Benefit failed to adequately plead diversity jurisdiction: an LLC’s citizenship is determined by the citizenship of its members, and Lincoln Benefit had not alleged the citizenship of the members of the LLC defendants.

      Lincoln Benefit, in response, pointed out that none of the defendants had asserted that it was a citizen of Nebraska and further that, as information as to the membership of an LLC is not publicly available, it should be allowed to proceed on a “information and belief” basis or, in the alternative, it should be afforded the opportunity to undertake limited discovery for the purposes of confirming that diversity did exist. The trial court held against Lincoln Benefit, holding (a) that pleading diversity on the basis of information and belief is insufficient and (b) that allowing jurisdictional discovery would be inappropriate when it was not clear that the federal court did not already have jurisdiction. It was from these determinations that Lincoln Benefit appealed to the Third Circuit Court of Appeals.

      The Third Circuit, after providing a brief review of the rules of diversity jurisdiction, noted that there are two bases for challenging jurisdiction. First, there is a “facial attack,” which, as was done in this case, alleges a deficiency in the pleadings. There is as well a “factual attack,” which challenges whether the alleged facts justify jurisdiction. Distinguishing, in the setting of this dispute, a facial from a factual attack, the Court, wrote:
If the defendants here had challenged the factual existence of jurisdiction, Lincoln Benefit would have been required to prove by a preponderance of the evidence, after discovery, that it was diverse from every member of both defendant LLCs. Instead, however, the defendants mounted a facial challenge to the adequacy of the jurisdictional allegations in Lincoln Benefit’s complaint. 2015 WL 5131423,* 3.

      In reliance, at least in part, on the decision rendered in Lewis v. Rego, Co., 757 F.2d 66 (3rd Cir. 1985), and as well limiting Chem. Leaman Tank Lines, Inc. v. Aetna Cas. & Sur. Co., 177 F.3d 210, 222 n. 13 (3rd Cir., 1999), for the proposition that “rather than affirmatively alleging the citizenship of the defendant, a plaintiff may allege that the defendant is not a citizen of the plaintiff’s state of citizenship.” To the effect that:
A State X plaintiff may therefore survive a facial challenge by alleging that none of the defendant association’s members are citizens of States X. Id. at *4.
provided that the plaintiff has undertaken reasonable inquiry in support thereof. To that end:
[B]efore alleging that none of an unincorporated association’s members are citizens of a particular state, a plaintiff should consult the sources at its disposal, including court filings and other public records. If, after this inquiry, the plaintiff has no reason to believe that any of the Association’s members share its state of citizenship, it may allege complete diversity in good faith. The unincorporated association, which is in the best position to ascertain its own membership, may then mount a factual challenge by identifying any member who destroys diversity. Id.

Explaining the rationale for its holding, the Court wrote:
We believe that allowing this method of pleading strikes the appropriate balance between facilitating access to the courts and managing the burdens of discovery. District courts have the authority to allow discovery in order to determine whether subject-matter jurisdiction exists. Rule 8(a)(1), however, serves a screening function: only those plaintiffs who have provided some basis to believe jurisdiction exists are entitled to discovery on that issue. The corollary of this principle is that a plaintiff need not allege an airtight case before obtaining discovery.
Depriving a party of a federal forum simply because it cannot identify all of the members of an unincorporated association is not a rational screening mechanism. The membership of an LLC is often not a matter of public record. Thus, a rule requiring the citizenship of each member of each LLC to be alleged affirmatively before jurisdictional discovery would effectively shield many LLCs from being sued in federal court without their consent. This is surely not what the drafters of the Federal Rules intended.
Moreover, the benefits of such a stringent rule would be modest. Jurisdictional discovery will usually be less burdensome than merits discovery, given the more limited scope of jurisdictional inquiries. It seems to us that in determining the membership of an LLC or other unincorporated association, a few responses to interrogatories will often suffice. So long as discovery is narrowly tailored to the issue of diversity jurisdiction and parties are sanctioned for making truly frivolous allegations of diversity, the costs of this system will be manageable. Id. at * 5.

      This opinion was followed by a concurrence written by Judge Ambro that, while not specifically commenting upon this dispute, urged the U.S. Supreme Court to in effect abandon the rule of Carden v. Arkoma Associates, 494 U.S. 185 (1990), and allow at least limited liability companies, notwithstanding the fact that they are unincorporated, to proceed under the rules for determining citizenship that are applicable to corporations.
      Assuming the reasoning employed in the Lincoln Benefit decision is followed by the other circuits, this could be a most important decision. First, it significantly undercuts the large number of decisions that, to date, have held that citizenship must be pled specifically and not on information and belief.  See, e.g., Principle Solutions LLC v. Feed.Ing BV, Case No. 13-C-223 (E.D. Wisc. June 5, 2013) (“It is well-settled that a plaintiff claiming diversity jurisdiction may not do so on the basis of information and belief, only personal knowledge is sufficient.”); Pharmerica Corp. v. Crestwood Care, LLC, No. 13C 1422, 2015 WL 1006683 (E.D. Ill. March 2, 2015) (“[I]t is not sufficient to assert jurisdiction based on information and belief.”); MCP Trucking, LLC v. Speedy Heavy Hauling, Inc., 2014 WL 5002116 (D. Colo. Oct. 6, 2014) (denying jurisdictional discovery and remanding action to state court even as it acknowledged that further discovery in that forum could demonstrate that diversity exists, leading to subsequent removal); Lake v. Hezebicks, 2014 WL 1874853 (N. D. Ind. May 9, 2014) (allegations of subject matter jurisdiction must be based on personal knowledge and may not be based upon information and belief and collecting cases to that effect). Further, it stands in direct challenges to those decisions that have held that citizenship must be affirmatively pled and that negative statements as to citizenship are insufficient. See, e.g., D.B. Zwirn Special Opportunities Fund, LP v. Mehrotra, 661F.3d. 124 (1st Cir. 2011), citing Cameron v. Hodges, 127 U.S. 322 (1888). While it may do nothing to address the fact that diversity jurisdiction may be unavailable consequent to de minimis indirect ownership (see, e.g., Fadal Machining Centers, LLC v. Mid-Atlantic CNC, Inc., 2012 WL 8669, 2012 U.S. App. LEXIS 48 (Jan. 3, 2012), Alphonse v. Arch Bay Holdings, L.L.C., 2015 WL 4187585 (5th Cir. July 13, 2015)), it does limit the ability of a defendant to “hide the ball” as to its citizenship while objecting that the other side has not adequately pled citizenship and therefore diversity.

Tuesday, September 8, 2015

More Confusion on Charging Orders

More Confusion on Charging Orders

      As previously noted (HERE IS ALINK to that posting), recently the Colorado Court of Appeals held that a charging order issued by a foreign court could be enforced in Colorado against a Colorado LLC only if it, in addition to the judgment for whose enforcement it was entered, were domesticated in Colorado. In effect, the court held that a charging order entered by a foreign court against an interest in a Colorado LLC could not be enforced absent domestication of the charging order.
      Fine, but now a decision from the U.S. District Court in Utah has, in effect, held to the reverse. Earthgrains Baking Companies, Inc. v. Sycamore Family Bakery Inc., Case No 2:09CV523DAK, 2015 WL 5009376 (D. Utah Aug. 21, 2015).
      Earthgrains held a judgment in the range of $6,000,000 against Sycamore Family Bakery and Leland Sycamore, its 48% member. This decision was rendered, in part, in response to Earthgrain’s motion for sanctions against Sycamore Family LLC for failure to make distributions, which would be captured by the charging order, to Leland even as distributions were made to his spouse, Jeri, the other 48% member. Ultimately, the court punted on sanctions, stating that additional discovery is needed. However, in doing so it rejected Sycamore’s assertion that the charging order is invalid “because it was entered under Utah law instead of Nevada law, which it submits is the proper law on the basis that the LLC was organized in Nevada.” In rejecting that assertion, it noted that a charging order does not implicate the internal affairs of the LLC, which are governed by the laws of the jurisdiction of organization, but rather governs the rights of a third party vis-a-vis the LLC.
      Based upon the information provided, the Earthgrains’ decision, being largely in response to a motion for contempt, is somewhat skimpy on the background facts, in one instance we have a court saying that the charging order cannot be enforced until it is domesticated even as another court says that an LLC with notice of a charging order (no suggestion that domestication is necessary) can be held in contempt for not complying with it.  Charging orders, of themselves, are already confusing. These disagreements among various courts as to procedural requirements are only making it worse.