Wednesday, June 22, 2016

Once Again, An LLC and Its Members Are Legally Distinct

Once Again, An LLC and Its Members Are Legally Distinct
      In a recent decision by a federal court in Virginia, the court held, inter alia, that “Question Eight” on an insurance application about prior criminal acts of the “applicant,” where the applicant for the insurance policy is the LLC, did not extend to any criminal activity by that LLC’s sole member. Jeb Stuart Auction Services, LLC v. West American Insurance Co., Case No. 4:14-cv-00047 (2016 WL 3365495 (W.D. Va. June 16, 2016).
      Jeb Stuart Auction Services, LLC (“Jeb Stuart”) was a single member LLC wholly owned by Robin Hiatt. Jeb Stuart applied for an insurance policy to be issued by West American, West American being represented by Burch Hodges Stone, Inc. With respect to a question on the application regarding certain criminal convictions within the past five years, the “Question Eight,” Hiatt, on behalf of Jeb Stuart, answered “no.” While it was true that the LLC had not been convicted of any such crime, Hiatt had himself, within that time period, been convicted of insurance fraud. Ultimately the insured property would suffer a fire loss. In investigating the claim, counsel for West American learned of Hiatt’s criminal convictions. On the basis thereof, West American denied the claim. Needless to say, that lead to litigation.
      This decision is focused upon whether Jeb Stuart could recover from West American attorney’s fees expended in successfully challenging the denial of coverage. In the course of this opinion, however, the Court refers to certain prior summary judgment determinations it had made to the effect that, while Hiatt may have been the sole member of Jeb Stuart, Hiatt’s crimes were not attributable to and were not those of Jeb Stuart. Specifically, the Court wrote:
At the summary judgment stage, I held that, by its terms, Question Eight only addressed the “applicant’s” criminal history and that, because Jeb Stuart was a legal entity separate and apart from Hiatt, Hiatt’s answer to Question Eight was correct. As a result, West American wrongfully voided Jeb Stuart’s policy and was liable for the appropriate coverage. (citation to record and footnote omitted).

Monday, June 20, 2016

More on Corporification

More on Corporification

      “Corporification” is the term, invented I believe by Steve Frost, to describe the incorporation (pun intended) into limited liability companies of concepts and principles that have arisen in the context of corporations. Oftentimes the utilization of concepts developed initially in corporate law into an LLC leads to either confusing or unintended consequences as there exist ambiguity as to the degree to which corporate law is intended to be incorporated. A recent case out of Delaware provides a clear illustration of these problems. Obeid v. Hogan, No. 11900-V CL, 2016 BL 185285 (Del. Ch. June 10, 2016).

       This dispute arose out of a pair of limited liability companies, Gemini Equity Partners, LLC and Gemini Real Estate Advisors, LLC. Each of these LLC was owned one third by plaintiff William T. Obeid, one-third by Christopher S. La Mack and one-third by Dante Massaro. Between the two LLCs, they held in excess of 1 billion in real estate assets, including 11 hotels and 22 commercial properties. Prior to the disputes addressed in this litigation, Obeid managed the hotel properties while the La Mack and Massaro managed the commercial properties. The defendant Hogan is a retired federal judge who was retained to serve as the special litigation committee on behalf of each of the LLCs; La Mack and Massaro were not parties to this action. The court throughout referred to Gemini Equity Partners, LLC as the “Corporate LLC” while referring to Gemini Real Estate Advisors, LLC as the "Manager-Managed LLC."
      The Corporate LLC, organized in Delaware, utilized a board of directors comprised of a Obeid, La Mack and Massaro through July, 2014, at which time the La Mack and Massaro removed Obeid. With respect to the Manager-Managed LLC, also organized in Delaware, each of Obeid, La Mack and Massaro served as a manager.
      On July 1, 2014, La Mack and Massaro voted to remove Obeid as the president of the Manager-Managed LLC, installing Massaro in his place. In effect, while Obeid remained a manager, Massaro took on day-to-day control of the Manager-Managed LLC. After a flurry of litigation ranging from North Carolina to federal and state courts in New York, the Corporate LLC and the Manager-Managed LLC, under the control of the La Mack and Massaro, hired the Brewer firm to serve as outside counsel. One of its recommendations was that a retired federal judge be hired to serve as a special litigation counsel to respond to a derivative action filed with respect to each of the LLCs in New York. After a meeting at which no formal resolutions were adopted, the Brewer firm circulated the names of two retired federal judges it had identified as being appropriate to serve as the special litigation committee. Hogan, one of those judges, was ultimately retained pursuant to an engagement letter signed by La Mack and Massaro to serve in that role. Crucially for the outcome of this decision, Hogan was not appointed a director of the Corporate LLC nor appointed a manager of the Manager-Managed LLC. Upon learning that Hogan had been so retained, Obeid filed this action in Delaware seeking a determination that Hogan could not act as special litigation committee on behalf of either LLC or otherwise take any action with respect to the derivative suit. In addition, Obeid sought a declaratory judgment that his removal as a director of the Corporate LLC was invalid.

      With respect to Hogan’s service as the special litigation committee for the Corporate LLC, after setting forth its ultimate conclusion that he could not do so, the court began its analysis with a telling section heading, namely “The Implications Of Mimicking A Corporation's Governance Structure.” From there it observed that LLCs may design their inter-see management structure as they see fit, citing Robert L. Symonds, Jr. & Matthew J. O’Toole, Delaware Limited Liability Companies § 9.01[B] at 9-9 (2015) for the principle that “Virtually any management structure may be implemented through the company’s governing instrument.” From there the Court wrote:
Using the contractual freedom that the LLC Act bestows, the drafters of an LLC agreement can create an LLC with bespoke governance features or design an LLC that mimics the governance features of another familiar type of entity. The choices that the drafters make have consequences. If the drafters have embraced the statutory default rule of a member-managed governance arrangement, which has strong functional and historical ties to the general partnership (albeit with limited liability for the members), the parties should expect the court to draw analogies to partnership law. If the drafters have opted for a single managing member with other generally passive, non-managing members, a structure closely resembling and often used as an alternative to a limited partnership, then the parties should expect a court to draw analogies to limited partnership law. If the drafters have opted for a manager-managed entity, created a board of directors, and adopted other corporate features, then the parties to the agreement should expect a court to draw on analogies to corporate law. Depending on the terms of the agreement, analogies to other legal relationships may also be informative. (citation and footnotes omitted).

      While going on to recognize that there are limitations in drawing analogies between LLCs and other organizational forms, the Court, citing Elf Autochem, 727A.2d at 293, observed that “the derivative suit is a corporate concept grafted onto the limited liability company form.”, leading the conclusion that “absent other convincing considerations, case law governing corporate derivative suits is generally applicable to suits on behalf of an LLC.” (footnote omitted).
      Having determined that the corporate law governing special litigation committees in derivative actions would be applicable to the corporate LLC, the Chancery Court turned its attention to the Zapata Corp. v Maldonado, 43 A.2d 779 (Del. 1981) decision.

      After an extensive review of the Zapata decision and the role of the special litigation committee, the Court noted an absence of situations in which the special litigation committee was comprised of non-directors, observing that as derivative litigation does not fall into the ordinary course, these matters would, in the corporate context, need to be resolved by the board. It was observed that:
A board may not make a similarly complete delegation to an officer or a non-director. Doing so would risk an improper abdication of authority. Hence the requirement exists that a Zapata committee be made up of directors.
From there was ultimately concluded:

Judge Hogan is not a director of the Corporate LLC. Consequently, under the Corporate LLC Agreement, he cannot function as a one-man special litigation committee on behalf of the Corporate LLC.
      Turning to the Manager-Managed LLC, even as the Court acknowledged it was not utilizing a board of director management model, it was concluded that the manager-managed system employed was sufficiently analogous to a board structure to justify the application of Zapata and the ultimate determination that Hogan could not, with respect to that LLC, serve as a special litigation committee. “In my view, the resulting structure is sufficient to cause the reasoning that governed the Corporate LLC to apply equally to the Manager-Managed LLC.”
      The court had little problem, applying the operating agreement and the Delaware LLC Act, to find that Obeid's removal as a director was permissible.
      Which brings us back to Corporification. The drafter of the limited liability company agreement for the Corporate LLC wrote into the document significant aspects of the laws of corporate derivative actions. From that utilization, the Chancery Court assumed that the entire body of law governing derivative actions, including that developed exclusively through court decisions, was intended to be applied in the context of this LLC. In effect, the Court read into the express terms of the LLC agreement the common-law penumbra of derivative actions. Whether that is what was actually intended by the drafter is unknown. Were they intending that the common law of derivative actions be incorporated by a deemed incorporation by reference, or rather where they intending that only so much of that law as was set forth in the agreement would apply? Curiously, the Court did not reference the terms of the merger clause of either LLC agreement.
      Regardless, this decision well highlight the perils of utilizing in an LLC agreement principles developed under corporate law. Absent particularly careful drafting, concepts not intended to be applied with respect to that LLC may be found applicable.

Friday, June 17, 2016

More On the Location of LLC Interests and Priority of Charging Orders

More On the Location of LLC Interests and Priority of Charging Orders

      Previously, I reviewed a decision of the Colorado Court of Appeals addressing the priority of various charging orders against the same interest in the LLC as well as the capacity of a court to issue a charging order with respect to the interest in a foreign LLC. That case was McClure v. JP Morgan Chase Bank, NA., No. 14CA1774 (Co. Ct. App. August 13, 2015). HERE IS THE LINK to my review of that decision.
      On May 31, 2016, the Colorado’s Supreme Court granted a petition for a writ of certiorari in this case (available at 2016 WL 3180645), agreeing to address the following questions:
(1) Whether the membership interests of a non-Colorado citizen in a Colorado LLC are located in the citizen’s home state or in Colorado for purposes of determining the enforceability of charging orders and lien enforcement.
(2) Whether the court of appeals erred in holding that the priority of charging orders issued against the membership interests of a non-Colorado citizen in a Colorado LLC is determined by first in time service of either charging orders issued by Colorado courts or foreign charging orders that have been domesticated in Colorado courts.

Thursday, June 16, 2016

Assignee May Not Move for Dissolution of LLC

Assignee May Not Move for Dissolution of LLC
      In a recent decision from Connecticut, it was affirmed that an Assignee of an interest in an LLC does not have the rights afforded a member to move for its dissolution, winding up and termination. Styslinger v Brewster Park, LLC, 321 Conn. 312 (Conn. Sup. Ct. May 17, 2016).
      This case was succinctly summed up in the first paragraph of the decision, it providing:
In this appeal, we must determine whether the assignee of a membership interest in a Connecticut limited liability company (“LLC”) has standing to seek a court order forcing the winding up of the affairs of an LLC in the absence of the LLC’s  dissolution. We conclude that the Assignee does not have standing to do so.
      Brewster Park, LLC had two members, Michael Weinshel and Joyce Styslinger. In the course of her divorce, Joyce assigned her membership interest in Brewster Park to her husband William Styslinger III with the effect that William would receive the distributions from the LLC while Joyce would remain at member of the company unless and until William was admitted as a member. While William did ask Michael Weinshel that he be admitted as a member, Weinshel had not consented to that happening. William brought suit against both the LLC and Weinshel asserting that Weinshel has breached his fiduciary obligations to the LLC and to William by not making distributions to William while taking distributions for himself, and for refusing to allow William to inspect the LLC’s books and records. William’s prayer for relief included dissolution of the LLC and an appointment of a receiver to wind up its affairs and distribute its assets. Weinshel and the LLC responded, asking that the complaint be dismissed on the basis that an assignee does not have the standing to seek the dissolution of an LLC.
      The trial court agreed that an assignee does not have standing to seek the dissolution of an LLC. Then, on appeal, William made an interesting, but ultimately ineffective, twist in his argument, asserting that, even as he abandoned his efforts to dissolve the LLC, he should be granted standing to seek the winding up and distribution of the LLC’s assets without the LLC undergoing a dissolution.
      Noting that this is a case of statutory interpretation, the court found that, under the Connecticut LLC Act, the winding up of an LLC and the distribution of its assets are integral to dissolution of the entity; there cannot be a winding up absent dissolution. Ultimately it would find:
In the present case, none of the events of dissolution specified in § 34-206 has occurred and the plaintiff therefore cannot trigger a winding up of Brewster Park’s affairs. First, the plaintiff has not alleged that Brewster Park’s articles of organization have triggered a dissolution and it has no operating agreement. Second, the plaintiff has not alleged that its members voted to dissolve. Third, because the plaintiff is not a member of Brewster Park, he cannot pursue a judicial dissolution under § 34-207. Unless and until the plaintiff is admitted to membership, Joyce Styslinger continues to hold the sole power to exercise the rights accompanying her membership interest; see General Statutes §§ 34-170(a)(4) and 34-172(d); and she has not sought a judicial dissolution of Brewster Park in this action. Because no event of dissolution has occurred, and the plaintiff cannot force a judicial dissolution under § 34-207 as an assignee, we conclude that the Act does not grant the plaintiff standing to seek a winding up of Brewster Park’s affairs.
      In a footnote, the court dismissed the plaintiff’s efforts to rely on the general incorporation of “principles of law and equity” into the LLC Act as granting him by the right to move for dissolution. Rather, the court noted that those principles were incorporated only to the extent not displaced by the language of the LLC Act. From there the court noted that, even accepting that equitable principles might otherwise grant an assignee the right to seek a winding up of an LLC, those principles have been displaced by the express terms of the LLC Act.
        The court, in a footnote, distinguished the Delaware opinion in In re Carlisle Etc., LLC, 114 A.3d 592 (Del. Ch. 2015) on the basis of the differing treatments between Connecticut and Delaware law of the assignor. Under Delaware law, the assignor of all of their limited liability company interests ceases to be a member in the company. Under Connecticut law, the assignor (in this case Joyce) remains a member, to the effect that there is not a void in the exercise of rights with respect to the assigned limited liability company interest.

Wednesday, June 15, 2016

The Mythology of Magna Carta

The Mythology of Magna Carta


      Last year there are being held a series of events commemorating the 800th anniversary of the Magna Carta, the “Great Charter” imposed on “Bad” King John in 1215; that makes today the 801st anniversary (yeah, that just does not sound as good)  of its signing.  Last year’s events included a display of the Magna Carta at the Kentucky State Fair, a presentation supported by both the Kentucky Bar Association and the Louisville Bar Association.

      June 15 is celebrated for the signing of Magna Carta by King John and his leading nobles, all at Runnymede.  From there the foundation of Magna Carta is espoused as a foundational document in the development of the rule of law.  The only problem is that the Magna Carta of June, 1215 was a dead letter.  John repudiated the charter, and that repudiation was affirmed by Pope Innocent III.

      John's after-the-fact rejection of Magna Carta precipitated the First Barons War, a contest in which a group of disaffected nobles actually aligned themselves with the King of France. Had history turned out only slightly differently, the Angevin house of England could have been replaced by the French royal house, thereby uniting England and France under a single crown.  That, of course, was the ultimate aim of the English in the Hundred Years War in the 14th and 15th centuries, but that is a different story.  Still, the First Barons War was a close call, and John could easily have lost.  King John would die in October, 1216, the Crown being inherited by his nine year old son Henry III.  As part of the effort to bring the First Barons War to a conclusion, William Marshal, the prototypical knight of the period and the Regent of Henry III, caused there to be issued a shorter version of Magna Carta. This effort was not entirely successful, but the shorter version was ultimately incorporated into the settlement the brought about the resolution of the First Barons War.

      Henry III would again issue Magna Carta during his reign as a trade-off for new taxes, and his son Edward I would as well issue Magna Carta in his own name.  Subsequent monarchs would do the same through the 14th century.

      That said, none of the issuances of Magna Carta, irrespective of a specific content, had the same theatrical flair as the June 15, 1215 signing at Runnymede.  For that reason, it remains the event to which everybody refers.

      But it did not bring Magna Carta into law. 

      In other anniversaries, today is without question the date of issuance, in 1520, of the bull Exsurge Domine by Pope Leo X.  Addressed to formerly obscure theology professor Martin Luther, it threatened excommunication if Luther did not recant certain heretical views. He did not do so, and the threatened excommunication was carried out in January 1520.  Whereas the 1215 Magna Carta never had legal effect, Exsurge Domine did and does.

Wednesday, June 8, 2016

Another Hog Gets Slaughtered: Delaware Bankruptcy Court Invalidates Lender's Efforts to Preclude Debtor's Bankruptcy

Another Hog Gets Slaughtered: Delaware Bankruptcy Court Invalidates Lender's Efforts to Preclude Debtor's Bankruptcy

      In a decision rendered on June 3, 2016, the United States Bankruptcy Court for Delaware invalidated certain requirements requested by a lender that had the effect of rendering its debtor incapable of filing bankruptcy. In re: Intervention Energy Holdings, LLC, Case No. 16-11247 (KJC) (Bankr. De. June 3, 2016).
      Intervention Energy Holdings, LLC and its wholly-owned subsidiary, Intervention Energy, LLC were jointly indebted to EIG Energy Fund X V-A, L.P. EIG had purchased senior secured notes issued by Intervention; those notes were secured by various liens. Over time, various amendments have been made to the relevant note purchase agreements, including with respect to certain coverage covenants. Certain of those coverage covenants were ultimately violated. Those violations led to Intervention and EIG entering into a Forbearance Agreement and Contingent Waiver (the “Forbearance Agreement”) pursuant to which, assuming EIG would raise $30 million of equity capital to pay down the secured notes, the coverage violations would be waived. However, as a condition to the effectiveness of that Forbearance Agreement, EIG required Intervention to amend its operating agreements to provide:

·         that a single unit would be issued to EIG, making it a member in Intervention; and

·         requiring the unanimous approval of the members before any filing for bankruptcy could take place.

      Ultimately Intervention would file for bankruptcy protection notwithstanding that it did not have the consent of EIG to it doing so. That led to a motion to dismiss, brought by a EIG against Intervention, on the basis that Intervention lacked the authority to file for bankruptcy protection. In its decision, the Bankruptcy Court would reject that motion to dismiss. As such, the bankruptcy will proceed.
      EIG, in support of its motion to dismiss, argued that, under the LLC Act, there is essentially full freedom of contract, including to set the requisite threshold for filing a petition in bankruptcy. intervention relied upon the fact that a waiver of the capacity to file for bankruptcy is invalid and as well the recent decision rendered in In re Lake Michigan Beach Pottawatamie Resorts LLC in which a bankruptcy remote structure relying upon a “independent director” who lacked fiduciary duties was held to be unenforceable.

      Obviously the arguments of Intervention would prevail.  After string citing numerous decisions rejecting the notion that the right to file bankruptcy can be waived by contract, including a decision from the United States Supreme Court, it was observed:
A provision in a limited liability company governance documents obtained by contract, the sole purpose and effect of which is to place into the hands of a single, minority equity holder the ultimate authority to eviscerate the right of that entity to seek federal bankruptcy relief, and the nature and substance of whose primary relationship with the debtor is that of creditor - not equity holder – and which owes no duty to anyone but itself in connection with an LLC’s decision to seek federal bankruptcy relief, is tantamount to an absolute waiver of that right, and, even if arguably permitted by state law, is void as contrary to federal public policy.  Slip op. at 9 (citations omitted).
      From there, in light of the factual background of the mechanism by which EIG acquired its single interest in Intervention and the amendment of the LLC agreement requiring unanimity in order to file bankruptcy, it found those to be “the unequivocal intention of EIG to reserve for itself the decision of whether the LLC should seek federal bankruptcy relief.” Following the other federal bankruptcy courts, it was the determination of the Intervention court that it would not enforce a waiver of the right to seek bankruptcy protection and, from there, it concluded that Intervention had the necessary authority to commence its Chapter 11 proceeding.
      Decisions such as this as well as the In re Lake Michigan Resort decision (HERE IS A LINK to my review of that decision) identify outlier structures that will not be enforced with respect to bankruptcy remoteness. They do not stand for the proposition that bankruptcy remoteness is itself either improper or unattainable. The proper structuring of these relationships can be achieved, but that structuring should begin at the beginning of the debtor/creditor relationship.