Plaintiffs Fail in Effort to Substantively Consolidate Archdiocese With Various Parishes and Other Organizations

Plaintiffs Fail in Effort to Substantively Consolidate Archdiocese With Various Parishes and Other Organizations

      In a decision rendered yesterday by the United States Bankruptcy Court for Minnesota, it denied an effort by those representing alleged victims of clerical sexual abuse to substantively consolidate the Archdiocese of St. Paul and Minneapolis with over 200 other Catholic, nonprofit (and not debtors in bankruptcy) entities. In Re: The Archdiocese of St. Paul and Minneapolis, Case No. 15-30125 (Bankr. D. Minn. July 28, 2016).

      In connection with allegations of clerical sexual abuse, on July 16, 2015, the Archdiocese of St. Paul and Minneapolis filed for Chapter 11 bankruptcy. On May 23, 2016, the unsecured creditors committee filed a petition to substantively consolidate with the Archdiocese in excess of 200 Catholic entities, none of themselves parties to the bankruptcy. Those entities included individual parishes, a foundation, various cemeteries and various high schools. Numerous of those entities filed objections to the consolidation. Ultimately, the effort to achieve substantive consolidation would be rejected.

      After determining that the unsecured creditors committee did have standing to bring the substantive consolidation motion, the bankruptcy court first found that it lacks the capacity to effect the substantive consolidation of these numerous nonprofit corporations. The bankruptcy Code at § 303(a) bars the involuntary bankruptcy of “a corporation that is not a moneyed business, or commercial corporation.” In connection therewith, the Court cited the legislative history, it stating that “Eleemosynary institutions, such as churches, schools, and charitable organizations and foundations, likewise are exempt from the involuntary bankruptcy.” Finding that all of the other entities that would be swept into the substantive consolidation are religious, nonprofit organizations exempt from involuntary bankruptcy consequent to § 303(a), the court wrote that “I conclude that I lack authority to substantively consolidate the debtor with the targeted entities.”

      The court continued its analysis from the legal bar to a granting substantive consolidation to a factual basis, namely that the plaintiffs had failed to allege facts sufficient to justify consolidation. Rather, notwithstanding generalized allegations of interrelationship, “The committee failed to sufficiently establish that the interrelationship warrants consolidation.” The court went on to observe:

Those allegations concerning generic actors are insufficient because they failed to identify and show how each non-debtor’s characteristics or actions make them individually subject to substantive consolidation. It is also unreasonable to infer all the non-debtors are liable for the actions or characteristics of a few named non-debtors because the plausibility standard generally does not allow holding hundreds of non-debtors liable for the conduct of one. Facts demonstrating grounds for substantive consolidation should have been alleged as to each and every non-debtor individually, but the committee did not do so here.

      From there the court would expand on its determination that there been no showing that the finances of the various debtors and non-debtors had been inextricably intertwined, and as well found that the committee had failed to demonstrate the benefits of consolidation would outweigh the harm to creditors of the to be consolidated entities.

Plaintiff Allowed Jurisdictional Discovery with Respect to Partnership and LLC Defendants

Plaintiff Allowed Jurisdictional Discovery with Respect to Partnership and LLC Defendants

 

      In an action brought in federal court on the basis of diversity, the party asserting diversity jurisdiction bears the burden of showing that it exist, i.e., that no defendant is a citizen of the same state as is any plaintiff. This can be an especially daunting task when one of the defendants is a partnership or LLC. A partnership or an LLC is deemed to have the citizenship of each of its members, but who are those partnerships or members is not a matter of public record. On the recent decision from Pennsylvania, the court allowed the plaintiff to undertake discovery as to the membership of the defendant partnership and LLC in order to determine whether or not diversity actually existed. Bissell v. Graverley Brothers Roofing Corp., Civ. Act. No. 15-04677, 2016 WL 3405455 (E.D. Penn. June 21, 2016).

      Bissell brought suit against the various defendants after a house she owned was bulldozed by the defendants. In response to that complaint, the defendants filed a motion to dismiss on the basis that Bissell had not identified in the complaint who are all the partners of Graverley Family Partnership, one of the defendants, or the members of Gerard Commons, LLC, also a defendant. In response, the court first noted that those defendants had not advised the court of who are those partners/members, from which the court could have made a factual determination. Second, based upon Lincoln Benefit Life Co. v. AEI Life, LLC, 800 F.3d 99, 105 (3^rd Cir. 2015), “affirmative allegations of citizenship for unincorporated associations are not required when a party can allege in good faith that it is diverse from each member.” 2016 WL 3405455,*7. The court then recounted the efforts made by Bissell to investigate the partners and members of the LLC, and found that she had undertaken sufficient efforts of reasonable investigation.

      From there, the court ordered that there will be jurisdictional discovery as to who are the partners of the partnership and who are the members of the LLC.

Because members of the unincorporated associations are not within Plaintiff’s reach, jurisdictional discovery is appropriate with regard to the citizenship of the two disputed Defendants. Therefore, plaintiff shall be afforded an opportunity to conduct discovery to establish the existence of diversity jurisdiction with regard to the unincorporated associations. This, however, is not an invitation to Plaintiff to embark on a fishing expedition - discovery shall be narrowly tailored to address the limited issues set forth herein. 2016 WL 3405455,*7.

Kentucky Supreme Court Clarifies Responsibility of Landowner Towards Party Crasher

Kentucky Supreme Court Clarifies Responsibility of

Landowner Towards Party Crasher

 

      In a recent case, the Court of Appeals held that a party crasher is to be treated as an “licensee,” and for that reason the landlord was not responsible when she fell off the landing of a fire escape, sustaining significant injuries. Phillips v. Touchstone Properties, LLC, No. 2014-CA-001851-MR (Ky. App. July 1, 2016).

      Touchstone Properties, LLC leased an apartment to Jason Orr and Gabriel Dent. The apartment was comprised of the second and third floors of the house.  Orr thereat held a party with Dent’s knowledge. Madison Phillips was not invited to the party, but was rather invited by someone who had been; in effect she crashed the party.

      A fire escape ran up to the third floor of the building. At some point in the course of the party, the window through which the fire escape could be accessed (the window itself had been painted closed at some point in the past) was broken. Phillips followed a friend of hers out onto the fire escape so that the friend could smoke a cigarette. Phillips, while holding both her cell phone and a can of beer, stepped backwards and fell through the ladder opening of the fire escape. Ultimately Phillips and her parents would file a suit against Touchstone, Orr and Dent alleging negligence in the failure to keep the premises in a reasonably safe condition.

      Under the law of real property, a person is upon real property either as an invitee, a licensee or a trespasser. Different obligations are owed to the different classes, with the highest obligations being owed to an invitee with minimal obligations owed to a trespasser. Touchstone, Orr and Dent defended on the basis that Phillips was either a licensee or a trespasser to whom no duty with respect to the fire escape was owed. Phillips maintained that she was an invitee and that, if instead she was classified as a licensee, still a duty of care to her was breached. Summary judgment was granted to Touchstone, Orr and Dent, to the effect that Phillips’ lawsuit was dismissed. This appeal followed:

Phillips contends that the Circuit Court committed error by rendering summary judgment dismissing her premises liability action against Touchstone, Orr, and Dent. Phillips maintains that she was an invitee and that under Shelton v. Kentucky Easter Seals Society, Inc., 413 S.W.3d 901 (Ky. 2013), granting defendant’s summary judgment was improper. Alternatively, Phillips argues that even if she is classified as a licensee, the precepts of Shelton, 413 S.W.3d 901, nevertheless are still applicable and preclude the granting of summary judgment. Accordingly, whether being an invitee or as a licensee, Phillips argues that Touchstone, Orr, and Dent owed Phillips a duty of reasonable care to prevent foreseeable harm in the premises liability action based upon Shelton, 413 S.W.3d 901. Shelton, Phillips maintained that any issue of foreseeability are to be left to [sic] fact-finder for resolution and that summary judgment was thus improper. Slip op. at 4.

      The Court of Appeals rejected that reading of Shelton and the suggestion that there is no distinction between the obligations owed invitees versus licensees. Rather, those distinctions continue to exist, so it was necessary for the court to determine whether Phillips was an invitee, licensee or trespasser.

      In reliance upon authorities including Shipp v. Johnson, 452 S.W.2d 828 (Ky. 1969), a social guest is a licensee (and not an invitee). Notwithstanding the fact that Phillips had not been directly invited to the party, but rather was invited to it by someone who had been invited, “viewing the facts most favorable to Phillips, she was invited as a social guest to the party on the evening of December 28, 2011, and thus, qualifies as a licensee.” Slip op. at 5.

      From there, the court would determine that none of the defendants were aware that anybody was using the fire escape on the night of the party. Likewise, none of them failed to warn Phillips of an unreasonably dangerous condition known to them. While Phillips stepped backwards and fell through the ladder opening in the fire escape, her fall was not caused by any unreasonably dangerous “hidden peril” known to Touchstone, Orr, or Dent and not to Phillips. Slip op. at 6.

 

Federal District Court in Virginia Reverse Pierces Delaware LLC

Federal District Court in Virginia Reverse Pierces Delaware LLC

 

Based if nothing else upon the outrageous facts of the case, a recent decision from the Federal District Court in Virginia is worth rending. Substantively, reverse pierced three Delaware LLCs in order to access their respective assets to satisfy a judgment debt of the sole member. Sky Cable, LLC v. Coley, Civ. Act. No. 5:11cv00048, 2016 U.S. Dist. LEXIS 93537 (W.D. Va. July 18, 2016).

A judgment had been entered in favor of DirectTV, LLC against Coley and East Coast Cable Vision in the amount of $2,393,000. In post-judgment collection actions, in language detailed by the court, Coley engaged in a pattern of recalcitrance including failing to produce documents by set deadlines, the apparent submission of fraudulent documents, and giving inconsistent answers with respect to a number of matters, including whether he is the sole member, or in contrast is a member with his wife, of three Delaware LLCs, they being Its Thundertime, LLC, East Coast Sales, LLC and South Raleigh Air, LLC. There was in addition comingling of funds between Coley and these three LLCs. In depositions, he was either unable or unwilling to explain how the money moved between these three companies and his personal account. Also, his personal residences were held by one of these LLCs, even as Coley and his family lived in them rent-free. DirectTV, in order to collect on a judgment, petitioned the court to reverse pierce the three LLCs.

Finding that Delaware law is controlling as to whether these three LLCs may be pierced, it collected and reviewed the laws with respect to whether or not outsider reverse piercing would be permissible under Delaware law. Ultimately concluding that outsider reverse piercing would be permissible, that determination being based upon hints in certain Delaware decisions as well as the long list of other states that have allowed outsider reverse piercing on appropriate facts, reverse piercing was ordered. In addition, the court pointed a receiver for each of the LLCs, finding this to be a “extraordinary case.” Specifically:

Randy Coley’s deception and efforts to evade judgment have plagued this litigation. Based on this history, there is a probability that Coley’s deceitful tactics will continue in an effort to frustrate DirectTV’s valid claim as a judgment creditor in this case, and that the corporate assets are in imminent danger of being “concealed, lost, or diminished in value.

For that reason, the receiver was justified.

If Your Thing is the Organization of the Insurance Companies, This is a Really Interesting Opinion

If Your Thing is the Organization of the Insurance Companies, This is a Really Interesting Opinion

     In a recent decision, the Kentucky Court of Appeals in the course of determining whether an exemption from garnishment was available, undertook a detailed review of the various manners in which an insurance company may be organized. Choate  v. Bank of Cadiz & Trust Co., No. 2015-CA-000435-MR, 2016 WL 3453326 (Ky. App. June 17, 2016).

      The primary issue in this case was whether certain proceeds from an insurance policy are exempt from garnishment. Specifically, KRS § 427.110 exempts the proceeds of fire insurance policies from garnishment if those policy proceeds constituted “money or other benefit to be paid or rendered by any assessment or cooperative life or casualty insurance company.” Whether the proceeds of a policy would go to the policyholder or, alternatively, to the Bank of Cadiz pursuant to a garnishment to satisfy a deficiency judgment on a real property mortgage was the question facing the court.

      The decision reviews the various means and mechanisms by which insurance companies are organized. Thereafter, the Court of Appeals determined that State Farm, the insurer at issue, did not fall within the class of an “assessment or cooperative life or casualty insurance company.” On that basis, the proceeds of the policy were not exempt from garnishment.

Tennessee Adopts New Standard for the Direct Versus Derivative Distinction

Tennessee Adopts New Standard for the Direct Versus Derivative Distinction

      On July 11, the Tennessee Supreme Court adopted a new test, it based on Delaware law, for when a lawsuit is direct versus derivative.  Keller v. Estate of Edward Stephen McRedmond, No. M2013-02582-SC-R11-CV (Tenn. July 11, 2016). 

      Professor Joan Heminway has already done a review of this decision.  HERE IS A LINK to that discussion.

Alter Ego Applied to “Reverse Pierce,” But We Don’t Know on What Grounds

Alter Ego Applied to “Reverse Pierce,” But We Don’t Know on What Grounds

      A July 15, 2016 decision of the Court of Appeals upheld the treatment of an LLC as being the alter ego of its sole member, in effect reverse piercing the LLC to make its assets available to satisfy a debt of the sole member.  Unfortunately, the decision does not detail the basis for the alter ego determination.  Lee v. Lee, No. 2014-CA-000387-MR, 2016 WL 3886884 (Ky. App. July 15, 2016).

      This dispute had its inception in the Lee’s divorce.  John Lee was held liable for Jill’s attorney fees to the sum of $70,000.  In December, 2011, John’s company, Lee Development Group d/b/a Acceleris, was found to be jointly and severally liable on that $70,000 judgment.  The opinion is silent as to the basis on which that determination was made.  In May, 2012, the Acceleris bank account was garnished.  In May, 2012, John formed a new company, Acceleris LLC.  Learning of it, the Plaintiffs sought to garnish its accounts on the basis that it was John’s alter ego.  That order of garnishment was entered.

      The substance of the decision was upon whether the trial court properly complied with the garnishment statute, KRS § 425.501, and not upon the finding of alter ego. Rather:

On appeal, the Appellants do not challenge any of the court’s factual findings regarding “alter ego” liability; rather, they contend the garnishment order was void ab initio because Appellees did not have a final judgment against Acceleris, LLC, before obtaining the order of garnishment. Slip op. at 3 (footnote omitted).

      Upholding the garnishment against Acceleris, LLC on the basis it was John Lee’s alter ego, the Court of Appeals quoted the trial court’s findings of fact.

Mr. Lee testified that he was the sole member of Acceleris, LLC, and that he alone made all the managerial decisions.

Mr. Lee acknowledged that he used money from Acceleris, LLC, to pay personal debt.  Introduced as an Exhibit is a copy of a check on an Acceleris, LLC, account made payable to the Internal Revenue Service, which he acknowledged was used to pay his personal back taxes.  Mr. Lee also testified that he used Acceleris, LLC, funds to fund his son’s baseball team.  Mr. Lee contended that Acceleris, LLC, funds that were used to pay personal debt was salary.  He further acknowledged that funds from Acceleris, LL, were used to pay his personal providers.

Mr. Lee acknowledged that he opened a checking account with a bank located in Indiana.  When questioned as to whether he opened the account to avoid garnishment, he stated that he did business with his business associates.  As to the Acceleris, LLC, bank account, Mr. Lee testified that he used his personal social security number to identify the account even though Acceleris, LLC, has its own Federal ID number.

      It would be comforting to have more details as to why the finding of alter ego was justified.  For example, being a single member LLC is by statute not a basis for piercing the veil.  See KRS § 275.150(1).  As for paying personal expenses out of the LLC, were the examples given typical or atypical versus all company activities?  Is any use of company funds to pay personal expenses sufficient to support a finding of alter ego, or must there be some higher threshold?  That point was not addressed.  Yes, I know the alter-ego finding was not appealed, but if not appealed why this quotation as to why alter-ego treatment was appropriate?

      This decision is one of only a few that have addressed reverse piercing in Kentucky.  I submit it deserved a more detailed analysis, especially as it is designated “to be published.” 

More on How an LLC is Not a Corporation

More on How an LLC is Not a Corporation

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 both Hoffmen v. L & M Arts, Civ. Act No. 3:10-CV-0953-D, 2015 WL 1000838 (N.D. Texas March 6, 2015), and more recently in Alta Mesa Holdings, L.P. v. Ives, 488 S.W.3d 438 (Tex. App. Houston [14^th Dist.] April 14, 2016) 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. Both of these suits 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.” Hoffmen, 2015 WL 1000838, *5.

The Hoffmen 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. Likewise, the Alta Mesa case rejected the suggestion that “corporation” should be interpreted as including LLCs.  Rather, “the legal entities identified by the terms ‘corporation’ and limited liability company’ are distinct entities with some but not all the same features.” Alta Mesa, 488 S.W.3d at 453.  “In other words, the use of one of the terms does not encompass the other type of entity.” Id. at 454.

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.

Treasury Department Proposes to Impose Additional Tax Reporting Obligation on Foreign Owned LLCs

Treasury Department Proposes to Impose Additional Tax Reporting Obligation on Foreign Owned LLCs

       The Treasury Department, on May 5, 2016, proposed regulations that would increase the reporting and record maintenance requirements of US organized disregarded entities (typically single member LLCs) owned by foreign persons.

      In support of the objective of receiving additional information with respect to these foreign-owned disregarded entities, the Treasury began with a definitional sleight-of-hand; a domestic disregarded entity that is wholly owned by a foreign entity or person will be treated as if it is a domestic corporation. As a corporation, the disregarded entity will be treated as separate from its owner for the purpose of all reporting, record maintenance and other compliance requirements that are already apply with respect to domestic corporations that are owned 25% or more by foreign entities or persons. The proposed regulations require that, each foreign-owned disregarded entity (“FODE”):

·         file a Form SS4 with the IRS, thereby obtaining a Federal Tax Identification Number and as well identifying to the IRS who is a “responsible party” with respect to the FODE;

·         file, on behalf of the FODE, IRS Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in U.S. Trade or Business setting forth, irrespective of whether they are subject to federal income tax, reportable transactions between the FODE and its foreign owners or foreign related parties; and

·         maintain records sufficient to establish the accuracy of any Form 5472 and in the US tax treatment of those transactions.

      If finalized, and there is little reason to think they will not be, these regulations will constitute a significant change with respect to the treatment of FODE’s. Currently, most FODE s do not file a Form SS-4 and are not subject to either tax reporting or record maintenance obligations under the Internal Revenue Code. These proposed regulations would affect a 180° change in that treatment. Further, as the IRS would have new information with respect to the US activities of FODE’s, the IRS may share that information with foreign tax authorities pursuant to various information sharing agreements to which the US is a party.

      HERE IS A LINK to the proposed regulations as published in the Internal Revenue Bulletin.

Finally, Some Clear Direction On Diversion Of Business Opportunity: Patmon v. Hobbs III

Finally, Some Clear Direction On Diversion Of Business Opportunity:
Patmon v. Hobbs III

Last Friday, the Kentucky Court of Appeals issued its third decision in the Patmon v. Hobbs, No. 2014-CA-001411-MR, 2016 WL 3886831 (Ky. App. July 15, 2016). This third opinion acknowledges certain of the errors made in Patmon v. Hobbs I, clarifies the measure of damages upon the diversion of an opportunity and perhaps most importantly adopts a strict test as to the defense that a venture was financially unable to act upon the opportunity. In doing so, the Court of Appeal cited the article I wrote with Professor (now Dean) Tom Geu on Patmon I, namely The Analytic Protocol for the Duty of Loyalty Under the Prototype LLC Act, 63 Arkansas Law Review 473 (2010).

      Grossly oversimplifying the dispute, Hobbs, purporting to act as the managing member of an LLC, unilaterally transferred for no consideration certain contract rights and other assets of the LLC. Hobbs was a co-owner of that transferee company. Patmon, another member of the original LLC, brought an action charging Hobbs with having breached his fiduciary duties to the LLC. In the first Patmon v. Hobbs decision, Patmon v. Hobbs, 280 S.W.3d 589 (Ky. App. 2009), it was ultimately held that he might have done so, but that Patmon would have the burden, on remand, showing that the LLC could have performed on the transferred contracts. While the ultimate conclusion that Hobbs was bound by fiduciary obligations was (and is) normatively correct, the analytic path used in the decision was hopelessly flawed. Those errors were reviewed in the Analytic Protocol article; HERE IS ALINK to that article. The decision has as well been parsed, including against subsequent amendments to the LLC Act, via its annotation; HERE IS A LINK to that annotation (see Exhibit 7.7.2). Also, since Patmon I was decided, the LLC Act has been amended to cut off further misinterpretation of the Act as to both the statutory definition of the fiduciary duties in LLCs and the availability of a “fairness” defense to the appropriation of company assets. See KRS §§ 275.170(1), (2), as amended by 2010 Ky. Acts, ch. 133, § 32 (expressing labeling the various provisions is the duty of care and the duty of loyalty owed in LLCs); KRS 275.170(2) as amended by 2012 Ky. Acts, ch. 81, § 106.

      After remand and another appeal, the Court of Appeals considered the further actions of the trial court.  See Patmon v. Hobbs, 2014 WL 97464 (Ky. App. Jan. 10, 2014.) inding that the trial court did not resolve necessary issues, the Court of Appeals criticized the measure of damages it had employed. HERE IS A LINK to my review of that decision.

      After that remand and another appeal, now this case comes to the Court of Appeals for a third time. Cutting to the chase, it continues to be unhappy with the work done by the trial court, and the case has for the third time been remanded.

      The first substantive portion of the opinion calls the trial court to task for not providing, as it had been previously directed to do so, specific findings of fact and conclusions of law. On that basis the reversal and remand was granted. Slip op. at 11. “Nevertheless, we find it helpful to further explain the trial court’s on remand as described in Patmon I. Id.

      From there, the Court of Appeals (Judges Dixon, Lambert and Thompson) first addressed who had the burden of proof on the question whether the LLC had the financial wherewithal to perform on the leases that had been transferred. Hobbs had defended on the basis that the LLC could not perform, so it was in effect deprived of nothing by the transfer of the leases. “Hobbs defended his actions opining that American Leasing did not have the financial ability to take advantage of the O’Reilly.” Slip op. at 4. Patmon asserted that the burden should be upon Hobbs to prove the absence of the ability to perform, while Hobbs responded that Patmon I had allocated that burden to Patmon and that under the “law-of-the-case” that allocation could not be revisited. Over several pages the Court all but said that this allocation of the burden should have been upon Hobbs, but under the law-of-the-case rule it must in this case be as set forth in Patmon I. “There is some appealing logic to the reasoning that the inability of the Corporation (sic - this case involves an LLC) to undertake the diverted opportunity as an affirmative defense to be proven by the defendant.” (slip op. at 14), but:

[W]e agree with Hobbs that the law-of-the-case doctrine applies to the holding in Patmon I that Patmon had some burden to demonstrate that American Leasing had the financial ability to take advantage of the O’Reilly leases to prevail under the doctrine of diversion of business opportunity.

Although we must apply the legal principles pronounced in Patmon I to the facts as stated in that opinion, the law-of-the-case doctrine applies only to the extent that an issue was actually resolved….  Although Patmon I placed the burden of proof on Patmon on remand to demonstrate American Leasing had the financial ability to perform the O’Reilly leases, Patmon I did not address the proof necessary to meet that burden. We now do so. Slip op. at 14.

      The Court would require that Patmon demonstrate (presumably in further disputes this burden will be upon the defendant) that the LLC was able to utilize the opportunities. Crucially, at this juncture the Court would also define what is the standard for insolvency such that it will release a fiduciary from the charge of having diverted an opportunity.

       The Court began by reviewing foreign law to the effect that only actual insolvency as a defense to the diversion of what is otherwise a company opportunity. Slip op. at 14-15. Quoting Klinicki v. Lundgren, 678 P.2d 1250 at 1253-54 (Or. App. 1984), the Patmon III Court wrote:

To allow a corporate fiduciary to take advantage of a business opportunity when the fiduciary determines the corporation to be unable to avail itself of it would create the worst sort of temptation for the fiduciary to rationalize an inaccurate and self-serving assessment of the corporation’s financial ability and thereby compromise the duty of loyalty to the corporation if a corporate fiduciary’s duty of loyalty conflicts with his personal interest, the latter must give way. Unless a corporation is technically or de facto insolvent, a determination whether a business opportunity is corporate or personal does not depend on the corporation’s relative financial ability to undertake the opportunity. Slip op. at 15.

It went on to state:

We hold that unless American Leasing was insolvent or legally prevented from performing the O’Reilly leases, Hobbs must compensate it for his diversion of the O’Reilly leases. The trial court is instructed to make the requisite finding. Slip op. at 16-17 (emphasis added).

      The Court then turned to how damages are to be measured. Previously the trial court had in effect awarded Patmon a percentage interest in the net proceeds realized by Hobbs from the disposition of the leases transferred from the LLC. That measure was rejected. Rather, first Hobbs is liable to the LLC for the full measure of the benefits and the gains generated from the use of those assets. “KRS 275.170 requires that Hobbs completely disgorged himself of any benefits received.” Slip op. at 18. Those benefits are to go to the LLC, rather than directly to Patmon. Further, “in addition to statutory damages, if the trial court finds on remand the American Leasing is not financially insolvent, the measure of damages is the lost profits the corporation (sic - LLC) would have received had the opportunity not been diverted.” Slip op. at 18-19. The Court noted as well that pre-judgment interest may be in order. Slip op. at 19.

      Then, returning to Patmon I and Patmon II, the LLC is to be dissolved, and in the course thereof the trial court may reset the sharing ratios between the members. Slip op. at 9.

This decision is important for a variety of reasons including:

·         Recognition of the separation of LLCs from the common law of corporations and partnerships (Slip op. at 13);

·         Recognition of the prior error in the allocation of the burden of demonstrating inability to perform, strongly hinting that in the future the burden is upon the person alleging the inability to perform;

·         Defining actual insolvency as the threshold for an inability to perform;

·         Giving teeth to the statutory directive that, in the event of the diversion of company assets from an LLC, the person effecting the diversion is obligated to remit to the LLC all gains and benefits derived therefrom;

·         Specifying, on remand, that the trial court is not to accept the price at which Hobbs ultimately transferred the LLCs assets, but rather to independently determine their fair market value;

·         Affirmation of the rule that, upon dissolution of the LLC, sharing ratios may be reset in order to, on an equitable basis, account for Hobbs’ a breach of duty; and

·         Raising, with respect to the award of damages to the LLC, the possibility of an award of prejudgment interest.

      For myself, I have been far from reticent in criticizing the decision rendered in Patmon I. This Patmon III decision goes a long way to bringing Kentucky’s law on fiduciary duties in LLCs into compliance with the LLC Act and more generally principles of fiduciary duty law.

Kill Them All, God Will Know His Own

Kill Them All, God Will Know His Own

     Today is the anniversary of the Massacre at Béziers, an event that took place in 1209 during the Albigensian Crusade. Whether, however, “Kill them all, God will know his own” was actually uttered is open to debate.

      The Albigensian Crusade was launched early in the 13th century in response to the rise of the Cathar heresy in southern France. The Crusader army, not as coherent as it should have been, entered the territories in which Catharism was strong, encountering Béziers as the first significant town. Efforts to negotiate a settlement were unsuccessful, and the army began preparations for mounting a siege. Almost inadvertently, a skirmish broke out between some of the irregular troops with the Crusader army and town residents. Ultimately, that mob was able to push into the town through open gates, whereupon a general sack began. Although many of the citizens of Béziers sought to take refuge in various churches in the town, they were all broken into, and nearly all the residents were put to the sword. When discord later broke out between the regular troops of the Crusader army and the irregular troops who had successfully broken into the town, it was put to the torch.  In response to the sack and the execution of the town’s residents, when asked what should be done to separate the orthodox from the heretics, Arnaud Amalric, the Abbot of Citeaux and the Papal Legate traveling with the army is reputed to have said words to the effect of “Kill them all, God will know his own.”

      Amalric filed a letter with the Pope describing what had happened. It does not report the line quoted above. Rather, the line arises from a story told some 20 years later by Caesarius. He was not, however, present at Béziers.  Hence, whether the now famous line, “Kill them all, God will know his own.” was there said is open to question.

Which Partnership Law?

Which Partnership Law?

      In a recent and otherwise not very interesting (at least from my perspective) decision out of the Kentucky Court of Appeals, it seems there was confusion as to which partnership law controls. Carlotta v. Reed, No. 2013-CA-001567-MR (Ky. App. July 15, 2016).

       This dispute involved the winding up and termination of a limited liability partnership, Mark & Barry Foods, LLP, which had as its constituent partners Mark G. Carlotta and Barry G. Reed. Most of the opinion deals with the effect in the litigation of failures by Carlotta to produce documents in discovery, failures which were strongly held against him in the trial on the merits.

 

       That aside, the court seemed to be confused as to which statute would apply. For example, on the first page of the slip opinion, it recited that KRS § 362.345 was being applied in the “partnership dissolution and allocating the parties respective partnership interests.” That statutory reference is to the Kentucky Uniform Partnership Act, originally adopted in 1954. However, later in the opinion (page 10 of the slip opinion), both KRS §§ 362.1-806 and 362.1-807 are cited in connection with Carlotta’s challenge to “the sufficiency of the evidence supporting the trial court set’s final judgment as concerns the division of partnership assets and contends that his filings did not comply with KRS 362.1-806 and KRS 362.1-807, which govern the settlement of liabilities and accounts upon the dissolution of the partnership.” Of course, both KRS §§ 362.1-806 and 362.1-807 are from the Kentucky Revised Uniform Partnership Act (2006).

      Ultimately, it may not matter which statute applied as they will largely yield the same results. However, both cannot apply to the same partnership.

It's Not Me, It's You: Planning for Expulsion of Members from LLCs

It's Not Me, It's You: Planning for Expulsion of Members from LLCs

 

       I have recently published in the Journal of Passthrough Entities this article, It's Not Me, It's You: Planning for Expulsion of Members from LLCs.  The thrust of the article is the need to consider expulsion of a member when writing operating agreements and the consequences of failing to do so.

       HERE IS A LINK to the article.

No Claim for Breach of Duty Against Court Appointed Receiver

No Claim for Breach of Duty Against Court Appointed Receiver

      In a decision rendered last Friday by the Kentucky Court of Appeals it was held, inter alia, that the owners of a business undergoing dissolution have no claim for breach of fiduciary duty against a court-appointed receiver. Rather, the receiver is an officer of the court and is covered by quasi-judicial immunity. Farmer v Miller, No. 2014-CA-000330-MR (Ky. App. July 15, 2016).

      John Farmer and Dennis Boehm had been the co-owners of a company named Bluegrass Recovery & Towing, LLC. The company was subject to a series of both financial difficulties and disagreements between Farmer and Boehm, leading to several pieces of litigation between them. At one juncture, Farmer and Boehm agreed to the appointment of a receiver, Stephen Miller. Miller was charged to “work with the parties to liquidate the business,”, and both Farmer and Boehm were charged to “cooperate with Mr. Miller so that he can appropriately perform his work.” Slip op. at 4. But then:

Pursuant to the directives of the trial court, Miller took control of the remaining assets of Bluegrass and attempted to assist the parties in finalizing dissolution and liquidation. However, the parties continue to quarrel and did not cooperate with Miller's efforts. Miller ultimately liquidated all of the assets of Bluegrass except the real property encumbered by the National City Bank mortgage. Id.

       After additional litigation, including in connection with the bank's foreclosure on the real property, Farmer filed this lawsuit against Miller alleging negligence, breach of fiduciary duty and breach of contract. Slip op. at 6. Filed against Miller in his individual capacity rather than in his role as the court-appointed receiver:

The Complaint alleged Miller had acted outside the scope of his court-order duties as receiver for Bluegrass, resulting in substantial negative financial implications for Farmer. Specifically, Farmer alleged Miller failed to make regular mortgage payments to National City Bank, real property taxes, insurance and property maintenance expenses although he had sufficient Bluegrass assets from which to do so. Farmer contended these actions resulted in foreclosure, imposition of tax liens, seizure of his personal funds, and reduction in value of the real property. Slip op. at 7.

      In response, Miller filed a motion to dismiss on the basis of quasi-judicial immunity. Farmer responded by asserting that the actions of which he complained were ministerial in nature, and that no immunity should attach for the negligent performance thereof.

      The trial court granted the motion to dismiss, treating it as a motion for summary judgment, and this appeal followed.

       Adopting the reasoning of the trial court, the Court of Appeals found that Miller, as a court-appointed receiver, was entitled to quasi-judicial community. The court held that a receiver is obligated to do only those things that the court has directed them to do, and that efforts such as that of Farmer to impose additional duties, if enforced, “would result in sanctioning an inappropriate expansion of Miller’s duties beyond the trial court’s explicit directives.” Slip op. at 12.

Early Applications of the Americold Decision on Diversity Jurisdiction

Early Applications of the Americold Decision on Diversity Jurisdiction

      There have already been two published decisions by federal courts applying the Supreme Court’s ruling of earlier this year in Americold Realty Trust v. ConAgra Foods, Inc., 136 S. Ct. 1012 (2016). Therein, the Supreme Court made clear that, where a trust has the capacity to sue and be sued in its own name, the rule of Carden v. Arkoma, and not the rule of Navarro Savings Association, will be applied to determine the citizenship, for purposes of diversity jurisdiction, of a trust. HERE IS A LINK to my earlier review of the Americold decision. It is also discussed in an article from the Journal of Passthrough Entities; HERE IS A LINK to that article.  Specifically, in RTP LLC v. ORIX Real Estate Capital, Inc., Nos. 14-3671 & 15-1153, 2016 WL 3568090 (7th Cir. July 1, 2016), Americold was held to apply to certain pension fund members of the plaintiff to the effect that they would be treated as members whose citizenship must be determined. In the second case, Wells Fargo Bank, N.A. v. Transcontinental Realty Investors, Inc., No. 3:14-cv-3565-BN, 2016 WL 357-0648 (N.D. Texas July 1, 2016), Americold was applied with respect to a securitization trust that was deemed the real party in interest.

       In RTP LLC v. ORIX Real Estate Capital, ORIX had made a loan of some $41,000,000  to RTP for the purchase of buying a commercial building in North Carolina. While that loan was itself nonrecourse, RTP LLC and an entity now named RSCD Opportunity Fund I, LLC but previously named Inheritance Capital Group, LLC, executed conditional guarantees with respect thereto. Ultimately the loan went into default, at which time ORIX accelerated the obligation and demanded that RTP and inheritance satisfy their respective guarantees. While it appears they asserted the guarantees were invalid or in some other basis ineffective (the opinion does not address this point beyond a statement that they sought “a declaration that they do not owe ORIX anything beyond what can be paid out of the building’s assets.”), the trial court would hold them liable to the tune of $30,000,000. This action before the District Court had been brought on the basis of diversity jurisdiction.

      It was on the basis of diversity jurisdiction that the action would be largely set aside. RSCD Opportunity Fund I, LLC, identified in the opinion under former name Inheritance Capital Group, LLC, has the citizenship of its members. That LLC had as its members two retirement plans, namely the General Retirement System of the City of Detroit and the Police and Fire Retirement System of the City of Detroit; each is organized as a trust with the capacity to sue and be sued in its own name. In reliance upon, inter alia, Navarro Savings  v. Lee, ORIX claimed that diversity jurisdiction should be assessed by looking only to the citizenship of the trustees of each of those trusts, ignoring, for purposes of citizenship, the citizenship of the beneficiaries of those trusts.

      In reviewing the matter, the Seventh Circuit would first hold that two decisions, May Department Stores Co. v. Federal Insurance Co., 305 F.3d 597 (7th Cir. 2002) and Hicklin Engineering, L.C. v. Bartel, 439 F.3d 346 (7th Cir., 2006) “did not survive Americold.” From there, it was observed that “the trusts themselves, not the trustees, are the members of the two LLCs. Detroit’s two pension funds contract (and litigate) in their own names. These trusts therefore have the citizenships of their own members.” The court would also note that the members of a trust of this nature include not only current participants who are paying into the trust fund, but also current beneficiaries thereof. Ultimately, in order to demonstrate diversity jurisdiction, ORIX, the party who sought removal in the first place, is going to need to investigate the domicile of each of the trusts that are in turn members of one of the guarantor parties. Specifically:

ORIX may think it pointless to conduct a detailed inquiry into the domiciles of the 59 persons who resided in these two states in 2013, especially because it would become necessary to consider the possibility that beneficiaries who then resided elsewhere (say, Oklahoma or Maryland) were domiciliaries of Texas or Delaware at the time. But ORIX may choose its own litigation strategy.

      Ultimately, the judgment of the District Court was vacated, the case was remanded for further proceedings. It was specified that if ORIX does not seek to determine the domicile of those trust beneficiaries as of 2013, “then the District Court must remand this litigation to state court.”

      The second of these decisions, Wells Fargo Bank, N.A. v. Transcontinental Realty Investors, Inc., involved the treatment of a securitization trust. Wells Fargo filed this action initially in federal court on the basis of diversity jurisdiction. In doing so, Wells Fargo identified only its own citizenship, namely South Dakota, as the basis for diversity; Transcontinental is a Nevada corporation with its principal place of business in Texas. Transcontinental sought dismissal of the action on the basis that diversity did not exist. As summarized by the court:

Wells Fargo is the trustee of the Trust, and an unincorporated entity, and the Defendant argues that Wells Fargo cannot rely solely on its own citizenship for diversity jurisdiction. Instead, Defendant alleges, Wells Fargo must establish the diverse citizenship of all of the Trust’s members to establish diversity jurisdiction.

      As any award of relief would be to the benefit of the trust, and not Wells Fargo alone, it was found that “a careful review of the complaint makes clear that Wells Fargo is only a nominal or formal party suing on behalf of the trust, which is the real and substantial party to the controversy with Defendant.”

      Without parsing the particular characteristics of the trust at issue, the court would hold, inter alia, that it is not a traditional, donative trust, but rather a trust for which the citizenship of all of the beneficiaries would be attributed for determining citizenship.

Here, unlike a human trustee suing in her own name on her own behalf as in Navarro, the Trust is the plaintiff and real party in interest, and, as an unincorporated entity, the Trust is a citizen of the states in which its members are located. Because Wells Fargo has not established the citizenship of each of the Trust’s members, Wells Fargo has failed to properly invoke federal diversity jurisdiction.

On that basis, Transcontinental’s motion to dismiss was granted and the action was dismissed for lack of subject matter jurisdiction.