The Citizenship of a Limited Liability Company

The Citizenship of a Limited Liability Company

      In a recent decision by Judge Bunning, he considered how to determine the citizenship of a limited liability company, itself owned by a limited liability company, ultimately finding the diversity of citizenship existed. In doing so, he also dismissed consideration of a poorly reasoned decision from Pennsylvania. Carr v. Lake Cumberland Regional Hospital, LLC, Civ. Act. No. 15-138-DLB, 2016 WL 868869 (E.D. Ky March 7, 2016).

      This dispute arose out of an allegation of medical negligence against parties including Lake Cumberland Regional Hospital, LLC (“LCRH”). The suit was removed to federal court on the basis of diversity jurisdiction, i.e., the plaintiff Carr did not share the same citizenship with any of the defendants. In an effort to remand the action back in Kentucky state court, Carr alleged that LCRH is a Kentucky citizen and therefore removal was barred by the “forum-defendant rule,” it provided, inter alia, that even if diversity of citizenship exists, a defendant may not remove to federal court if sued in the jurisdiction in which they are a citizen. Ergo, if LCRH is a Kentucky citizen, removal was improper.

      LCRH has only a single member, LifePoint of Lake Cumberland, LLC, and its sole member is LifePoint Holdings 2, LLC. The sole member of LifePoint Holdings 2, LLC is LifePoint Hospitals Holdings, LLC, a Delaware corporation with its principal place of business in Tennessee. Under the rules governing the citizenship of LLCs, LCRH would be deemed a citizen of both Delaware and Tennessee.

      The plaintiffs in this action, in support of remand of the action to state court, relied upon Brewer v. SmithKline Beacham Corp., 774 F. Supp. 2d 720 (E.D. Pa. 2011), for the proposition that, where a holding company is utilized in a multilevel structure involving LLCs, citizenship is determined based on the “nerve center”/the location where the operational decision-making takes place. As correctly recognized by Judge Bunning, the Brewer decision both conflicts with the ruling of the Sixth Circuit in Delay v Rosenthal Collins Group, LLC, 585 F.3d 1003, 1005 (6^th Cir. 2009) as to the citizenship of an LLC and wrongly incorporates the “principal place of business” test applicable to corporations in accordance with 28 U.S.C. § 1332(c) into the realm of the unincorporated limited liability company.

      In that complete diversity existed (the plaintiff was a citizen of Ohio, LCRH was a citizen of Delaware and Tennessee, and another defendant was a citizen of California) and because LCRH was not a citizen of Kentucky, the forum-defendent rule did not apply. Hence, no remand.

Wyoming Amends LLC Act to Make Piercing the Veil at Least More Difficult

Wyoming Amends LLC Act to Make Piercing the Veil at Least More Difficult

       The Wyoming legislature has passed, and it should be assumed that it will go into law, changes to its LLC Act making the equitable remedy of piercing the veil of an LLC at minimum more difficult and except in highly unusual circumstances perhaps impossible. Act No. 45, 60-3rd legislature of the State of Wyoming, amending Wyoming Statute § 17-29-304. Based upon a legislative fact sheet, these changes are in response to the Green Hunter decision of last year. Green Hunter Energy, Inc. v. Western Ecosystems Technology, Inc., No. S-14-0036, 2014 WL 5794332 (Wyoming Nov. 7, 2014). HERE is a link to my prior review of the Green Hunter decision.

      Section 17-29-304 addresses the limited liability enjoyed by the members and managers of a Wyoming LLC. The Statute has been amended to add new subsections (c) and (d), they providing:

(c) for purposes of imposing liability on any member or manager of a limited liability company for the debts, obligations or other liabilities of the company, a court shall consider only the following factors no one (1) of which, except fraud, is sufficient to impose liability:

(i)         Fraud;

(ii)        Inadequate capitalization;

(iii)       Failure to observe company formalities as required by law; and

(iv)       Intermingling of assets, business operations and finances of the company and the members to such an extent that there is no distinction between them.

(d)  In any analysis conducted under subsection (c) of this section, a court shall not consider factors intrinsic to the character and operation of a limited liability company, whether a single or multiple member limited liability company.  Factors intrinsic to the character and operation of a limited liability company include but are not limited to:

(i)         The ability to elect treatment as a disregarded or pass-through entity for tax purposes;

(ii)        Flexible operation or organization including the failure to observe any particular formality relating to the exercise of the company’s powers or management of its activities;

(iii)       The exercise of ownership, influence and governance by a member or manager;

(iv)       The protection of members’ and managers’ personal assets from the obligations and acts of the limited liability company.

      With respect to the four factors set forth in (c), it is noteworthy that there must be a combination of any of factors (ii) through (iv); in effect, none of them, standing alone, will be sufficient to justify piercing the veil. Yes, while any of the factors (ii) through (iv) could be combined with (i), that being “fraud,” to justify piercing, that step will presumably never be reached in that, upon a finding of fraud, presumably piercing will take place.

      The statute goes on to provide that a nonexclusive list of “factors intrinsic to the character and operation of an LLC” will not support a conclusion to pierce. New Section 17-29-304(d)(iii) is particularly interesting as it could be interpreted to the effect that traditional “alter ego” analysis is inapplicable as either a justification for piercing or as a contributing factor towards piercing.

      There is also been deleted from the Act Section 17-209-304(b), a provision which previously indicated a failure to observe formalities as to the operation and management of an LLC, nor an election be treated as a disregarded entity for federal income tax purposes, was sufficient to justify setting aside the otherwise applicable rule of limited liability.

      Thanks to Bob Keatinge for the lead.

The Decline Accelerates

The Decline Accelerates

 

      Today marks the anniversary of the assassination, in 193, of the Roman Emperor Pertinax. This assassination would precipitate the “Year of the Five Emperors.”

      Marcus Aurelius, without question otherwise one of the great Roman emperors, had failed in one of his most crucial responsibilities, namely to secure the succession in someone qualified and competent to assume the leadership of the empire. Rather, during his life, Marcus Aurelius had made his son Commodus his co-emperor, and Commodus succeeded his father upon his father's death.  HERE IS A POSTING about the passing of Marcus Aurelius.

      Ultimately, Commodus was assassinated.  Upon his death Pertinax was appointed emperor.  However, his reign was short, the Praetorian Guard being unhappy with its treatment after having participated in Commodus’ assignation and Pertinax’ elevation.  Not receiving the “bonus” they anticipated, Pertinax was removed to make way for a candidate who might pay.

       Thereafter, recalling the “Year of Four Emperors” that followed after the assassination of Nero, Rome would over the year 193 see five emperors.  The year would end with Septimius Severus on the imperial throne, and the Empire would see almost 50 years of dynastic stability.

Shareholders Are Not Fiduciaries

Shareholders Are Not Fiduciaries

In a decision rendered earlier this week, Griffin v. Jones, Civ. Act. No. 5:12-CV-00163-TBR, 2016 WL 109287 (W.D. Ky. March 21, 2016), the court found that the shareholders of a Kentucky corporation are not as to one another fiduciaries.  Therein the court wrote:

In Kentucky, a stockholder does not owe a fiduciary duty. Compare KRS § 271B.7 with KRS § 271B.8-300 and KRS § 271B.8-420. Other states have held that a stockholder may owe a fiduciary duty in the special case of closely-held corporations. See e.g. Crosby v. Beam, 548 N.E.2d 217, 220 (1989) (explaining circumstances in which a stockholder can owe a fiduciary duty to another stockholder under Ohio law). Kentucky has not adopted this rule. Estep v. Werner, 780 S.W.2d 604 (Ky. 1989); Thomas E. Rutledge, Shareholders Are Not Fiduciaries: A Positive and Normative Analysis of Kentucky Law, 51 U. Louisville L. Rev. 535, 535 (2013) (explaining the history of cases and legislation on this issue and advocating that Kentucky not adopt such a rule).

Congratulations to the U of L Employment Law Moot Court Team

Congratulations to the U of L Employment Law Moot Court Team

      Congratulations to the University of Louisville College of Law’s Employment Law Moot Court Team; they WON the national championship.  Special congratulations to team member Megan Diffenderfer, who clerked with (and greatly impressed) Stoll Keenon Ogden.

      Hereis a link to a story about their success.

Fun and Games and Charging Orders: Calling it a “Salary” Does Not Mean It Is Not a Distribution

Fun and Games and Charging Orders:

Calling it a “Salary” Does Not Mean It Is Not a Distribution

 

       A recent decision from Ohio reviewed  and rejected an effort by a judgment – debtor to characterize the funds he received from his LLC as “salary” not subject to the charging order and its application to “distributions.” Firstmerit Bank, N.A. v. Xyran, Ltd., No. 102905, 2016 WL 763092 (Ohio Ct. App. Feb. 25, 2016).

      Xyran borrowed $480,000 from Firstmerit; Dr. Sawhny guaranteed the debt. Eventually the bank would foreclose on the real property purchased with the borrowed funds and would pursue Sawhny on the guarantee.

      Sawhny founded and practiced through The Center for Neurosurgery, LLC – he was the only member. Firstmerit sought and was awarded a charging order against Sawhny’s interest in the LLC, it extending to all “distributions” and “profits.” No payments were made to the bank. Upon a debtor examination it was learned that Sawhny was receiving a$12,000 per month salary from the LLC, but it being asserted that this was not a “distribution.” As characterized by the court.

At the close of the Bank’s examination of Dr. Sawhny, appellants moved to dismiss on the ground that, “there is no evidence at all that there has been any profit paid or earned by the Center. Dr. Sawhny is receiving a salary. They can go furnish his salary, if they wish.” (Tr. 15.) “The charging order doesn’t apply to the salary. It applies to distribution[s] from the company over and above.” Id.

       After disposing of a jurisdictional challenge, the court turned its attention to the question of whether the charging order had been violated. The trial court had found (i) the “salary” was a “distribution” to which the charging order attached and (ii) Sawhny acted in contempt of the charging order.

      The court of appeals upheld the determination that the “salary” was a “distribution” on the basis of Sawhny’s testimony that it came from the LLC’s “profits.” Because of the now-existence of support for Sawhny’s argument, the finding of contempt was likewise upheld.

IRS Successfully Argues that One Corporation is the “Alter Ego” of the Other, Holding the Newly Created Company Liable for the Tax Debts of the Former

IRS Successfully Argues that One Corporation is the “Alter Ego” of the Other, Holding the Newly Created Company Liable for the Tax Debts of the Former

      From time to time the question is presented, on behalf of a business entity that it owes significant liabilities, including liabilities to the IRS, about the option of simply shutting down that venture, using the net assets to satisfy, typically on a pennies on the dollar basis, the existing creditors, and then starting up essentially the same venture in a new corporate or LLC shell. As is identified in a recent decision, this methodology has significant problems. WRK Rarities LLC v United States, No.4:13-cv-00791, 2016 WL 775422 (N.D. Ohio February 29, 2016).

      It is important to note that this is not a case about “piercing the veil.” In a piercing case, the plaintiff, holding a judgment against the corporation or LLC, seeks to hold the shareholders or members, who otherwise enjoy limited liability, liable upon that obligation. Here, the effort was to hold one company liable for the debts and obligations of the other, even though there was no ownership relationship between them. That this is not a “piercing” case is specifically noted in footnote 1 to the decision. Rather, this analysis involves “alter ego” as that doctrine has been applied under the Internal Revenue Code.

      William R. Kimple, through a pair of acquisitions from the founders, by 1994 was the sole shareholder of Kimple’s Jewelry & Gifts (“KJG”). Apparently (the opinion is nowhere express as to the point), KJG was a C-corporation. In 2005 KJG filed for Chapter 11 bankruptcy. In that proceeding, the IRS filed a proof of claim for unpaid federal taxes including corporate income taxes and employment taxes. Notwithstanding the approval of a plan of reorganization in 2007, KJG failed to perform thereunder, and the bankruptcy was subsequently dismissed. In addition, from 2007 forward, KJG ceased to make quarterly deposits of federal employment taxes, and federal tax liens were ultimately filed. On December 31, 2010, KJG “allegedly” ceased operations.

      However, even as KJG was still in operation, Kimple formed a new LLC, WRK Rarities, LLC, with a d/b/a of Kimple’s Fine Diamonds (“WRK”). WRK would go on to operate a jewelry store from the same location they KJG had operated from since 1957, with Kimple as its sole manager and member. Further, WRK utilized KJG’s signage, furniture and fixtures and continued to utilize the services of the same employees, they having the same titles and salaries they had when working for KJG. WRK even use the same bank as had KJG.

      When, in 2011, the IRS levied on the accounts of KJG, there was little recovery as those accounts contained only minimal funds. Later in 2011, the IRS determined that WRK was “the nominee, alter ego, and/or fraudulent conveyee of KJG,” and proceeded to levy on WRK’s accounts in order to collect on the taxes owed by KJG. Ultimately the IRS would seize WRK’s assets. Thereafter, suit was filed, alleging wrongful levy. From there, this decision was rendered to the government’s motion for summary judgment.

      After determining that it is Ohio law that would govern whether alter ego liability applies, and recognizing the general rule of Ohio that successor liability does not attach in the instance of an asset acquisition, it noted as well that there are at least four exceptions to this rule, and that “a successor corporation may be held liable when (1) the buyer expressly or impliedly agrees to assume such liability, (2) the transaction amounts to a de facto consolidation or merger, (3) the buyer corporation is merely a continuation of the seller corporation, or (4) the transaction is entered into fraudulently for the purpose of escaping liability.” (Citation omitted).

      The court would find it WRK was merely a continuation of KJF

      Citing law to the effect that common ownership is crucial as it would indicate an inadequacy of consideration, in this instance Kimple was the sole owner of both KJG and WRK. Further, the government was able to demonstrate that inadequate consideration was paid for any assets transferred from KJG to WRK.

      With careful and conscientious planning, sometimes it is possible to abandon a failed venture and start a new one. That is possible only with, however, careful planning. In the absence of that planning, successor liability for taxes, and potential successor liability for other claims, should not be treated as a surprise.

Beware the Ides of March

Beware the Ides of March 

“Et tu, Brute?”

        Today, the Ides of March, marks the anniversary of the assassination of Julius Caesar in 44 B.C. Caesar was famously assassinated at a meeting of the Roman Senate after having (almost certainly apocryphally) been warned to “Beware the Ides of March.” He was presented with a written warning of the conspiracy against him as he was taken to the Senate meeting, but seems to have never read the warning. Although stabbed twenty-three times by the various conspirators, only one wound was fatal.

            Caesar’s murder by members of the Senate (but not Cicero – the conspirators were unsure he had the stomach for such an act) was premised upon the notion that they were somehow preserving liberty for Rome; after the deed they paraded through the streets shouting “liberty.”  This against the fear that Caesar sought to be king, an especially galling notion in light of Rome having (at least as part of its foundation myth) having been ruled by kings and then thrown them off.  Still, at this stage Caesar had been appointed by the Senate Dictator for Life.  It seems this subset of the Senate sought to undo what the whole Senate had approved.

         “Liberty” was not to be had. Caesar’s death unleashed upon the tottering Roman Republic the Second Civil War of Caesar’s heir Octavian (later to be Caesar Augustus) and his compatriot Marc Antony (Lepidus, the third member of the Second Triumvirate, was a place holder) against the assassins and their various supporters. Assassins Brutus and Cassius (Gaius Cassius Longinus) would each commit suicide after losing a phase of the Battle of Philippi (notwithstanding the presentation in the HBO series “Rome,” they actually died on different days).  Cicero (who as noted above was not himself part of the conspiracy) would be assassinated as part of the proscriptions after the victory of the Second Triumvirate. Still later Octavian and Antony would turn on one another, Antony’s forces being routed at Actium.  Octavian would go on to be the first Roman emperor, Caesar Augustus.

 

         But back to Caesar’s dying words. “Et tu Brute” is not recorded by any classical historian – it is a quote from Shakespeare. Plutarch, who was born exactly 100 years after the assassination, reports that Caesar said nothing after the attack began in earnest. Suetonius wrote that others reported his last words to be “καὶ σύ, τέκνον” (Greek still being the lingua franca of the Romans), transliterated as “Kai su, teknon” or “You also child,” addressed to Brutus (that is Marcus Junius Brutus the Younger, not to be confused with Decimus Junius Brutus, another party to the assignation). There were rumors, later reported by Plutarch (Suetonius is silent on the topic) that Caesar was in fact Brutus’ father – it was known that Brutus’ mother Servilia was Caesar’s mistress.  Still that would appear to be something of a stretch; Caesar was 16 at the time of Brutus' conception; Servilla was at that time 28. 

      For anyone watching the “Spartacus” series, while the sources do not exclude Caesar's participation in the war against Spartacus (i.e., the “Third Servile War”), they provide no details of that participation.  Ergo, the details of Caesar's actions as recounted are pure fiction.

More on Tax Scams

More on Tax Scams

      The IRS yesterday released a description of the latest morphing of the tax scams.  Be on the alert for these calls, and make sure your friends and relatives, especially the elderly who may be more at risk, are aware.  Bottom line - the IRS DOES NOT CALL to confirm tax information.

     
       HERE IS A  LINK to that latest release. 

Sheldon Cooper’s LLC Mistake

Sheldon Cooper’s LLC Mistake

            For those not familiar with the Big Bang Theory, well, I cannot fully explain it.  Here is a link to the wikipedia entry for the show; HERE IS A LINK.  For these purposes, suffice it to know what Sheldon Cooper is a genius physics prodigy who notwithstanding a delightful lack of social skills is very well informed about a bewildering array of subjects, including the recurring vexillology.

            But apparently Sheldon does not know LLCs.  In the episode broadcast last week (HERE IS A LINK), Sheldon was drafting a partnership agreement between himself, Leonard and Howard addressing the division of the proceeds from a joint invention.  In response to some criticism from Howard regarding entering into the partnership, Sheldon responded:

 

Are you suggesting a limited liability corporation, because I did not LLC that coming.

            Ughhhh.   LLC ≠ limited liability corporation.  Rather, LLC = limited liability company.

US Supreme Court Addresses the Citizenship, for Purposes of Diversity Jurisdiction, of a Business Trust

US Supreme Court Addresses the Citizenship, for Purposes of Diversity

Jurisdiction, of a Business Trust

            In a decision released earlier today, the US Supreme Court has addressed and resolved the question of how the citizenship of a business trust is to be resolved.  Cutting to the chase, it is at least that of the beneficial owners in the trust.  Americold Realty Trust v. Conagra Foods, Inc., No. 14-1382 (March 7, 2016).

            The decision, written by Justice Sotomayor, was unanimous.  It also had a quick turnaround.  The case was only argued on January 19.

            As I have previously discussed (HERE IS A LINK to that posting), the question presented in this case is relatively straightforward, namely whether in determining the citizenship of a business 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. The ultimate decision needed to 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.

            The Court came down squarely on the side of Conagra and of the Navarro decision.  Essentially, Navarro was limited to the traditional common law trust in which the trust is itself not subject to being sued – in those cases on the trustees may sue or be sued, and in that circumstance only the citizenship of the trustees will be considered.  Otherwise, as is the case here with respect to a “trust” that is organized under a law that affords it the capacity to sue and be sued in its own name, then the Carden rule is applicable, and the citizenship of all “members,” namely the beneficial owners/shareholders in the trust, will apply.

            My law partner Chris Schaefer and I considered this question in The Trust as an Entity and Diversity Jurisdiction: Is Navarro Applicable to the Modern Business Trust?, 48 Real Property, Trust & Estate Law Journal 83 (Spring 2013) (HERE IS A LINK to that article), and I am glad to say that the analysis we suggested is what the Court adopted. 

No Personal Jurisdiction Notwithstanding Qualification to Transact Business

No Personal Jurisdiction Notwithstanding Qualification

to Transact Business

 

In a recent decision from the Kentucky Court of Appeals, it affirmed the trial court's determination that a foreign insurer was and not subject to suit in Kentucky. Taylor v. Bristol West Insurance Company, No.  2014-CA-001648-MR, 2016 WL 675912 (Ky. App. February 19, 2016).

Day Taylor, an Indiana resident, was insured by Bristol West Insurance Company. Taylor was ultimately involved in an auto accident in Jefferson County Kentucky. The other motorist, who was at fault, settled with Taylor for that driver's $25,000 motor vehicle liability policy limit. Thereafter, Taylor filed suit in Jefferson County Circuit Court against Bristol West seeking to recover additional amounts pursuant to the underinsured motorist benefits available under her insurance policy with Bristol West. Bristol answered the complaint, asserting that Kentucky lacked personal jurisdiction over it, specifically:

 Bristol West maintained that it was a foreign corporation, Taylor was an Indiana resident, the policy of motor vehicle insurance was issued to Taylor in Indiana, and the insured vehicles were primarily garaged in Indiana. Bristol West argued that Kentucky did not have personal jurisdiction under its long-arm statute (Kentucky Revised Statutes (KRS) 454.210(2)) and that the action must be dismissed. The only nexus to Kentucky between the parties was that the accident occurred in Kentucky.

 

 Taylor objected on a variety of grounds including the fact that Bristol West had been issued a certificate of authority to transact the insurance business in Kentucky, that in consequence to holding a certificate of authority Bristol West had appointed the Secretary of State as its agent for service of process (see KRS § 304.3-230(7)) and that Bristol West was also qualified to transact business in Kentucky under the Kentucky Business Corporation Act and the Kentucky Business Entity Filing Act.  She asserted that these contacts gave rise to jurisdiction over Bristol West.

Ultimately the determination of the trial court as to the absence of personal jurisdiction would be upheld.

Reviewing the Kentucky Long Arm Statute and the decision of the Kentucky Supreme Court rendered in Caesar's Riverboat Casino, LLC v. Beach, 336 S.W.3d 51 (Ky. 2011), it was found that the contacts with Kentucky arising out of this fact pattern were insufficient to give rise to personal jurisdiction.  In rejecting jurisdiction, the Court of Appeal wrote:

 

While the motor vehicle accident occurred in Kentucky, all tort claims related to the accident have been settled. This case looks exclusively to an insurance contract dispute between Bristol West and its insured, Taylor.  

 

While Bristol West might have qualified to issue insurance in Kentucky, the contract of insurance here at issue was entered into in Indiana. In consequence, KRS § 454.210(7)(a)7 was not applicable to confer jurisdiction.

The court dismissed (“We review any remaining contentions of error as moot or without merit.”) the suggestion that qualification to transact business and the appointment of registered agent, of itself, would give rise to jurisdiction.