Diversity Jurisdiction Returns to the Supreme Court: What is the Citizenship of a Business Trust?

Diversity Jurisdiction Returns to the Supreme Court: What is the Citizenship of a Business Trust?

      There is currently pending a case before the US Supreme Court which it is considering the appropriate treatment all a trust for purposes of diversity jurisdiction.  Americold Logistics LLC v. ConAgra Foods. Oral argument in this case was held on January 19, 2016.

      The question presented in this case is relatively straightforward, namely whether in determining the citizenship of a trust for purposes of diversity jurisdiction (28 U.S.C. § 1332), the trust will be deemed to have citizenship of only the trustees, only of the beneficiaries, or other combination of the two. Presumably, the ultimate decision will address the interface of the Supreme Court’s 1980 decision rendered in Navarro Savings Association, in which suit was brought by the trustees as the trustees and, on those facts, only their citizenship was relevant, and Carden v Arkoma Associates, a 1990 decision in which it was held that the citizenship of every “member” of an unincorporated association should apply to determine its citizenship.

       Americold is arguing that the citizenship of only the trustees should be relevant in assessing a trust’s citizenship. This argument is to the effect that a broadly held trust should be able to access the federal courts through diversity jurisdiction. In contrast, ConAgra Foods is seeking the return of the suit to state court by its argument that the citizenship of all of the beneficiaries of Americold is relevant to determine its citizenship.

      Below, the district court, on the merits, ruled with respect to the dispute between Americold and ConAgra Foods. On appeal, however, that decision was dismissed, and the District Court was directed to remand the case to state court on the basis that all the beneficiaries of Americold should be assessed in determining the trust citizenship and there was no diversity jurisdiction.  See Conagra Foods, Inc. v. Americold Logistics, LLC, 776 F.3d 1175 (10^th Cir. 2015).

      While it is always dangerous to make predictions, especially about the future, a question/statement from Justice Elena Kagan may well indicate where the Court is going, namely a continued application of the bright line rule of Carden (the citizenship of all members apply in assessing the availability of diversity jurisdiction), she observing:

I thought that one of the virtues of Carden was that it set up a very categorical, bright-line rule. Everything that’s an artificial legal entity that’s not a corporation ought to be treated in the same way. Doesn’t matter what you call yourself. You can put trust in the title, or not put trust in the title. If you’re an artificial legal entity that is not a corporation, [you are] subject to the rule of Carden.

In favor of that bright line test, counsel for ConAgra argued:

In this case there’re an association.  We measure by those persons that have an ownership interest floodgates of uncertainty for the under - - for the lower courts. 

And I’ll tell you why. 

The Court has never explicitly addressed a limited liability company, and they’re common throughout the United States.  Limited liability companies can call their board of managers boards of trustees.  And in certain instances under those uniform laws, both the general partnership law and the LLC law, managers can hold property in trust for the entity just like the trustees in this case can hold property in trust for the entity.

At the end of the day, if we’re going to now say it’s the board of managers that are called trustees that we look to, everyone’s going to analogize in the circuits that haven’t decided the LLC questions: I’m much more like the board of managers in Americold and much different than the limited partners in Carden.  And it’s going to create uncertainty.

Our rule, the bright-line rule, is very clear.  When an artificial entity is sued or being – - or suing in its own name, we look to the members, which in this case constitutes those persons that own the beneficial interest in the entity, the shareholder members, just like this Court did in Chapman, Great ownership, and they periodically vote on important matters that affect the entity.

They are, in most instances, virtually identical.

So in my view - - and I think this case rests upon defining a clear rule, a clear rule that says when you have an artificial entity, we’re going to measure by those persons that I consider to be the beneficial owners.

      In addition, Chief Justice Roberts raised a question about increasing the number of disputes that would be directed to federal court through the adoption of the rule propounded by Americold.

Does it is it a pertinent consideration in terms of the impact on Federal jurisdiction? I mean, this is standard, run of the mill commercial dispute about a commercial accident. And adopting one position would limit the number of times that such disputes would be brought in Federal court. The other one will expand it. Is that I mean, does Americold really feel that it's not going to get a fair shake in the Kansas courts in this case?

This attitude is in opposition to a 2015 proposal approved by the American Bar Association’s House of Delegates to the effect that the diversity jurisdiction rule should be amended to, in effect, increase the availability of federal diversity jurisdiction for unincorporated organizations.

Yes, We Have No Series

Yes, We Have No Series

       In a decision rendered by the Court of Special Appeals of Maryland, it considered and in turn rejected the assertion that an improper series LLC had, in effect, been created. Kurz v. AMCP-1, LLC, No. 1301, 2016 WL 547146 (M.D. Ct. Spec. App. Feb. 10, 2016).

       The facts of the dispute are somewhat involved. Essentially, Kurz, along with several others, was an investor in a multi-component real estate development. While Kurz participated in the early capital calls, he ceased doing so. The agreement at issue contemplated a participant failing to satisfy future capital calls, and provided a dilution mechanism for that eventuality. Kurz would allege that the dilution mechanism was improperly applied in that his percentage interest in the already completed portions of the project were reduced. He asserted, rather, that the dilution should be applied only with respect individual components of the project.

      After the trial court determined that the dilution mechanism had been properly applied, this appeal followed.

      On appeal, Kurz asserted, inter alia, that the operation of the project and the court’s interpretation of the operating agreement created an “impermissible” (slip op. at 12) series LLC. Specifically:

Honey G-R’s theory proceeds in three steps: First, that the structure that the trial court’s order creates is not a traditional Maryland LLC; second, that the trial court must instead have created a “series LLC”; and third, that a Maryland court is prohibited from creating a series LLC. Slip op at 12-13.

      Each of these assertions was rejected, it being explained that all the court did was interpret what was done, not create any new organizational forms. In connection therewith, the court made an interesting observation with respect to at least its understanding of the series LLC, namely:

Many of the benefits of a series LLC can be obtained by creating a family of traditional LLCs, with one master traditional LLC of which the members are, in turn, other traditional LLCs. The only difference is that we perceive-at least in the abstract, are differences of nomenclature and the requirement for filing fees. Slip op. at 13.

      Let’s for now set aside the fact that likely the court meant that the master traditional LLC would be the member of other traditional LLCs.

      Ultimately, however, this is not a case about series LLCs.

More on Limited Liability Partnerships

More on Limited Liability Partnerships

 

      Joan Heminway, on the Business Law Prof Blog, has written a follow up to my posting of Tuesday on LLPs.  HERE IS A LINK to Joan’s posting.

No Change (Yet?) For Texas LLCs and Statutory Liability for Attorney’s Fees

No Change (Yet?) For Texas LLCs and Statutory Liability for Attorney’s Fees

      Texas has a curious statute which provides that in any breach of contract action against a person or a corporation, the prevailing party may recover their attorney’s fees. This rule is set forth in Section 38.001 of the Texas Civil Practice and Remedies Code. Specifically, with respect to claims arising in certain categories, “[a] person may recover reasonable attorney’s fees from an individual or corporation, in addition to the amount of a valid claim and cost.” In Hoffmen v L & M Arts, Civ. Act No. 3:10-CV-0953-D, 2015 WL 1000838 (N.D. Texas March 6, 2015), the court was called upon to assess who is potentially liable under this provision.

      While Section 38.001 allows recovery to a “person”, which is itself a defined term (see Tex. Gov’t Code Ann. § 311.005(2)), that term is not utilized as defining who was potentially subject to liability. Rather, that is restricted to “an individual or corporation.”, and neither of those terms is defined. As this suit involved a claim against an LLC, the court was faced with the conundrum that:

Thus while it is apparent from the text of § 38.001 that the universe of those who may recover attorney’s fees is broader than those from whom such fees may be recovered, the court must decide whether an LLC falls within the scope of “an individual.” 2015 WL 1000838, *5.

      The court easily disposed of the suggestion that an LLC constitutes an “individual,” finding rather that the term is restricted to natural persons. The court likewise dismissed the suggestion that “corporation” encompasses LLCs, noting that they are organized under different statutes and that corporation as a defined term under the Business Association Act does not include LLCs.

      There has been submitted to the Texas legislature a proposal to expand § 38.001 to include claims against LLCs and other organizational forms in addition to corporations. See 2015 HB 230. To date, however, that legislation has not passed.

Differential under New York Law in Liability for Unpaid Wages

Differential under New York Law in Liability for Unpaid Wages

       The New York statute governing corporations has a well-known provision, Section 630, which imposes liability for unpaid wages, which can include for example vacation pay and unpaid employee trust fund taxes, upon the 10 largest shareholders of a New York corporation. The New York LLC Act, at Section 609, a provision approved at the very end of 2014, likewise provides for personal liability for unpaid wages upon the 10 largest members of a New York LLC.

      Historically, in response to the application of Section 630 of the Business Corporation Code, it has been common for those organizing businesses that will have New York employees to organize in another jurisdiction such as Delaware. Such a foreign corporation would not, by its terms, be subject to Section 630.  In response to this arbitrage, last year Section 630 was amended to apply to foreign corporations with employees in New York. In consequence, organization of a corporation that will have New York employees outside of New York no longer provides a shield from liability for unpaid wages.

       There continues to exist, however, a differential with respect to LLCs. Section 609 of the New York LLC Act does not apply to LLCs organized outside of New York.  A proposal considered in 2015 to extend Section 609 of the LLC Act to foreign LLCs has not (to date) been approved.

The Contingent Nature of the Liability Protection Provided by the LLP Election

The Contingent Nature of the Liability Protection Provided by the LLP Election

      An LLP is first a general partnership that makes a special election for LLP status, thereby achieving Limited liability for the partners.  Many states, including New Jersey (and Kentucky), require that, in order for a law firm to elect LLP status, they must have in place malpractice insurance or similar protections for clients. In New Jersey, that is rule 1:21-1C, Limited Liability Partnerships for the Practice of Law.  The Kentucky rule is set forth at SCR 3.022, Forms of Practice of Law, and SCR 3.024, Requirements of Practicing Law in Limited Liability Entities. The rules as to the maintenance of malpractice insurance are generally silent as to the consequences when that requirement is not satisfied.

      Currently pending before the New Jersey Supreme Court Mortgage Grader Inc. v. Ward & Olivo, is a case squarely presenting these issues. Oral argument was held on February 1.

      This dispute involves an allegation of malpractice by Mortgage Grader arising out of allegedly deficient advise delivered by Olivo; there is no allegation that Ward had any involvement with the file.  After the (allegedly) deficient advice was rendered: (a) Ward withdrew from the firm; (b) the firm proceeded to wind-up its affairs; and (c) the firm allowed its malpractice coverage to lapse. That process commenced in June 2011; the malpractice insurance lapsed in August, 2011. See Mortgage Grader, Inc. v. Ward & Olivo, LLP, 438 N.J. Super. 202, 206, 102 A.3d 1226, 1228 (N.J. Super. Ct. 2014). It was not until October, 2012 that Mortgage Grader filed its complaint. Id.

      Ward, in addition to defending on a procedural basis, sought dismissal on the basis that he was a partner in an LLP and thereby shielded from personal exposure on partnership obligations. 438 N.J. Super. at 207, 102 A.3d at 1228. The trial court would reject that assertion, finding that Ward & Olivo had continued collecting fees even as it allowed its malpractice coverage to lapse.  From there, applying Rule 1:21-1C(a)(3), it was concluded that “‘[t]he condition precedent to attorneys operating as an LLP is [maintaining] malpractice insurance.’”  438 N.J. Super. at 208; 102 A.3d at 1229. The firm having been still operation as it collected fees but allowing its malpractice coverage to lapse, the trial court held that Ward  & Olivo reverted to a general partnership and that Ward lost the benefit of an LLP Election.

      The Appellate Division would reverse that determination, finding (a) the N.J. partnership Act did not impose the loss of limited liability as a consequence of the failure to have insurance and likewise (b) the New Jersey Supreme Court, in adopting Rule 1:21-C(a)(3), did not impose a similar consequence. As to the first point:

The Legislature has been aware of Rule 1:21–1C since 1996. The Legislature has decided not to amend the UPA to require an LLP to revert to GP status as a sanction for failing to purchase a tail insurance policy when attorneys practice as an LLP. Therefore, our interpretation of the available sanctions is supported by a long period of legislative acquiescence by failing to amend the UPA.

Thus, if attorneys practice as an LLP, and the LLP fails to maintain malpractice insurance as required by the court rules, then the Supreme Court may terminate or suspend the LLP’s right to practice law or otherwise discipline it. As currently written, however, the court rules do not authorize a trial court to sanction a partner of an LLP for practicing law as an LLP without the required professional liability insurance by converting an otherwise properly organized LLP into a GP. 438 N.J. Super. at 211-12; 102 A.3d at 1231 (citation omitted).

       As to the second point:

Our Supreme Court has chosen to discipline attorneys without malpractice insurance that are organized as professional corporations, rather than dissolve their corporate structure. See, e.g., In re Aponte, 215 N.J. 298, 298–99, 72 A.3d 243 (2013) (censuring an attorney for failing to maintain liability insurance while practicing as a professional corporation in violation of R. 1:21–1A(a)(3)); In re Muldoon, 213 N.J. 79, 61 A.3d 145 (2013) (same); see also In re Tiffany, 217 N.J. 519, 520, 90 A.3d 1254 (2014) (disbarring an attorney for, among other things, violating the rule requiring professional corporations to file a certificate of insurance with the Clerk of the Supreme Court). 438 N.J. Super. at 212; 102 A.3d at 1231.

      From there this appeal to the New Jersey Supreme Court was filed. Based upon published summaries of the oral argument, counsel for Ward argued that the LLP had insurance in place while it was practicing law, and that a change in the law requiring tail coverage could be applied only prospectively. Counsel for Mortgage Grader asserted that failure to have insurance in place effects the loss of the benefits of LLP statutes.

      One potentially disturbing aspect of the language used by the Court of Appeals and in the oral argument is the notion that the loss of LLP states and the treatment of the firm as a general partnership is some sort of conversion.  But it isn’t. An LLP is a general partnership that has elected into a special status – it is still a general partnership but for the rule of partner limited liability. See RUPA § 201(b), 6 (pt. 1) U.L.A. 91 (2001).

      This decision follows on at least two other cases where courts of had to consider what is the effect of no longer being an LLP.

      In Apcar Inv. Partners VI, Ltd. v. Gaus, 161 S.W.3d 137 (Tex. App.-Eastland 2005, no pet.), a partner was held to be personally liable on a lease executed by the partnership in its LLP name three years after failure to renew its initial LLP registration and rejecting “substantial compliance” argument based on the clear language of the LLP statute.

      Evanston Ins. Co. v. Dillard Dep’t Stores, Inc., 602 F.3d 610, 616 (5th Cir. 2010), involved a claim of trademark infringement by a law firm that had been an LLP. After the firm dissolved and allowed its LLP election to terminate, the judgment against the firm was entered. In response to the argument that the operative conduct took place while the firm was an LLP, and therefor that limited liability should apply, the court would rule that the debt was not incurred until the judgment against the partnership was entered, at which time the LLP registration had expired, and the partners thus were not protected from liability.  See also generally Elizabeth S. Miller, The Perils and Pitfalls of Practicing Law in a Texas Limited Liability Partnership, 42 Texas Tech L. Rev. 570, 571-75 (2011).

      There are at least two “take aways” from these cases, namely:

(a) the “contingent” nature of the limited liability shield provided by the LLP election should be considered in electing that form where limited liability is important; and

(b)  persons departing a professional firm organized as an LLP need to consider the potential lingering exposure should the firm either (i) continue but fail to maintain both of a valid LLP election and required insurance or (ii) dissolve and not maintain in place both an LLP election and tail insurance for a period sufficient to address potential claims that arguably accrued during their tenure at the firm.

 

Manning Warren Article from the Kentucky Law Journal Receives “Top 10” Recognition

Manning Warren Article from the Kentucky Law Journal Receives “Top 10” Recognition

 

      An article, The Role of the States in the Regulation of Private Placements, written by my friend Manning Warren and published in the Kentucky Law Journal, has received “Top 10” recognition for particles published in 2014.

 

        HERE IS A LINK to the announcement on the U of L website.

 

      Congrats.

Claim for Legal Malpractice Dismissed Based on Statute of Limitations

Claim for Legal Malpractice Dismissed Based on Statute of Limitations

      An action for legal malpractice must be brought within a single year of when the plaintiff knew or should have known of the claim. In a decision from the Kentucky Court of Appeals, it affirmed the dismissal of a claim for legal malpractice because the plaintiffs did not act within the required period. Curtsinger v. Patrick, No. 2014-CA-000609-MR (Ky. App. January 29, 2016).

      Patrick served as legal counsel to the Curtsingers in connection with the title review of a farm and closing on its acquisition. Both the general warranty deed and the mortgage prepared by Patrick all referred to a passway in favor of Robinson, an adjoining landowner. The closing, which included the signing of the general warranty deed and mortgage, took place on December 15, 2010. The Curtsingers did not review those documents, but rather simply signed them.

      Eight months after the closing was apparently the first time Robinson sought to use the passway over the property.  Then, in October, 2012, 16 months after the closing, the Curtsingers filed a legal malpractice action against Patrick and as well as declaration of rights action against Robinson. The dispute with Robinson was ultimately settled by a payment from the Curtsingers to her, resulting in a modification of the terms of the passway. Thereafter, Patrick filed a motion for summary judgment on the basis that it was time-barred. The Circuit Court would dismiss the action based upon the statute of limitations, leading to this appeal.

     Reading between the lines, it appears that the Curtsingers asserted that the one year statute of limitations of the legal malpractice claim against Patrick should not have begun until October, 2011, when Robinson claimed the right to use the passway. In contrast, Patrick, it would appear, relied upon the closing date. It would be held, ultimately, that the statute of limitations began to run from the time of the closing:

The Curtsingers signed the deed and mortgage but read neither. The limitation period is triggered upon the occurrence of a negligent act and resulting damages. The alleged negligence occurred when Patrick conducted the title search, the deed preparation, and closing upon the farm without informing the Curtsingers of the reserved passway. The damages occurred when the Curtsingers purchased the farm with the reserved passway easement. At that time, the damages were fixed and nonspeculative. (Slip op. at 5).

      Based thereon, the statute of limitations began to run as of the closing.  In that the lawsuit was not filed within a year, it was barred by the statute of limitations:

The discovery limitation period is triggered when a cause of action, in the exercise of reasonable diligence, should have been discovered. It was incumbent upon the Curtsingers to read the deed and mortgage at the closing and if confused by its language, to inquire of Patrick as to the contents. However, the Curtsingers sat quietly at the closing, did not read the deed or mortgage, and signed both without objection, they cannot now claim they were reasonably unable to discover the reservation of the pass way in the deed or mortgage at closing.  The Curtsingers simply failed to exercise reasonable diligence. Hence, we conclude that the Curtsingers’ cause of action, in the exercise of reasonable diligence, should have been discovered on December 15, 2010, at the closing. (Slip op. at 6; citation omitted).