Thursday, December 13, 2018
That Pesky Direct Versus Derivative Distinction
In a recent decision from Florida, the direct versus derivative distinction had the effect of the terminating the lawsuit. Home Title Company of Maryland, Inc. v. LaSalla, Case No. 2017-998, 2018 WL 6005232 (Fla. Dist. Ct. App. 2nd Nov. 16, 2018.
This dispute arose out of a two-member LLC that owned three residential property lots. One of the members, without authority to do so, directed the title company to transfer those three properties to himself and his spouse. The second member brought suit against the title company for having effected that improper transfer. He prevailed at trial. However, upon appeal, the complaint was set aside. While the suit had been brought by the second member in his name and for his own account, it was held by the court that the actions alleged in the complaint could be resolved only in a derivative action brought in the name and on behalf of the LLC. It was the LLC that had suffered the injury of the unauthorized transfers, so any resolution needed to be for the benefit of the LLC. The suit, not having been brought as a derivative action, was in consequence dismissed.
Wednesday, December 12, 2018
Additional Questions on Piercing the Veil
Yesterday, Beth Fenton and I presented an ALI webinar on Piercing the Veil. After the program, we received two questions from participants. Those questions, and the answers provided, are as follows:
You mentioned that, for LLC's, annual meetings are not required if there are written consents (as long as the operating agreement allows). Does this rule apply to corporations as well?
To my knowledge, every state allows the directors and the shareholders of a corporation to act by written consent. Sometimes the consent must be unanimous, as is the case with directors, or a majority, as is the case in Delaware for shareholders. The problem is that there are cases that state as a factor in support of piercing that all actions were done by written consent and nobody ever had a meeting. Now this is (in my opinion) an unjustified criticism as the statute expressly allows action by written consent, and typically says an action by consent should be treated the same as an action at a meeting. The remedy/response is to advise your clients to from time to time have live meetings (even by phone) so as to break the chain of actions “only” by written consent.
As for LLCs, there is typically no requirement of an annual or other meeting of the members (unless created in a particular operating agreement). If the LLC Act does not authorize actions by consent, I’d add that capacity into the operating agreement. If the operating agreement says there will be a meeting, make sure it happens whether live or by consent.
I hope that helps.
What about member's spouse trying to pierce LLC veil to collect divorce judgment? Any trends with this?
This will typically be an outside reverse pierce in which the spouse holding the judgment will seek to pierce the entity holding assets even as the former spouse pleads poverty. I can’t say that I am aware of any trends in this area, but I think family court judges are aware of the games that people will play and are able to spot former-spouses who are playing fast and loose with the rules. If I had to make a prediction it would be that the courts will often award the judgment-creditor spouse the ownership in the corporation or LLC (assuming there to be no other shareholders or members) to enforce the judgment. That said, outside reverse piercing will be rare in a multi-shareholder / multi-member situation. In the case of a multi-member LLC the judgment-creditor former spouse can get a charging order against the interest in the LLC and thereby collect on any distributions when made. Foreclosure on a charging order can be a useful approach as to single member LLCs, but not all states permit foreclosure (Del does not).
I hope that helps.
Monday, December 10, 2018
Nobody Comes Out Looking Good in this Charging Order Dispute
In a recent decision from Arizona, everybody, they being the law firm that held a charging order against a former client and that former client, came out looking good. Campbell Law Group Chartered v. Jagelski, No. 1 CA-CV 17-0032, 2018 WL 3853518 (Ariz. Ct. App. August 14, 2018).
Campbell Law Group Chartered (“CLG”) held a judgment of some $454,000 against its former client Monica Jagelski for failure to pay attorney fees. CLG sought a charging order against Jagelski’s interest in Empire Vista, LLC. Jagelski was the sole member of that LLC. It in turn owned a one-third interest in real property worth in excess of half a million dollars. Having been awarded a charging order against Jagelski’s interest in Empire Vista, CLG filed with the Arizona Corporation Commission articles of amendment to the LLC’s articles, identifying CLG as the 100% member therein. Then, CLG contacted the other co-owners of the property, claiming to be Empire Vista’s new sole member. CLG as well advised those co-owners that all proceeds from a pending sale of the property should be conveyed to CLG “In its capacity as the new sole member and manager of Empire Vista, LLC.”
Shortly after CLG obtained the charging order with respect to Empire Vista, Jagelski caused there to be formed a new LLC, Northern Mancore LLC, it owned by her children. By a mechanism not explained in the decision, Empire Vista “Then transferred the real property” to that newly owned LLC; how and what was done is unclear in that the opinion earlier says that Empire was a one third, not a 100% owner in the property. Regardless, Northern Mancore then transferred the property back to Empire Vista, whereupon Empire Vista transferred it to another LLC, Southwest Mancore, “In exchange for a promissory note in the amount of $550,000 and a deed of trust.” It is recited that “Jagelski admits the purpose of the transfer from Empire Vista to Southwest Mancore was to ‘protect the assets of Empire Vista’ from CLG.” Thereafter, CLG obtained a charging order against Jagelski’s interest in Southwest Mancore and as well sought a court ruling that CLG was in consequence the member in Southwest Mancore.
The decision would then focus upon three points, namely: (i) is the holder of a charging order a substitute member for the judgment-debtor, (ii) did Jagelski’s efforts to transfer the property from Empire Vista constitute a fraudulent conveyance; and (iii) did the property transfers violate the terms of the charging order?
The Holder of a Charging Order is a Not a Substitute Member
The court began by rejecting the assertion that the person holding a charging order is a substitute member, even for a sole member. Rather, under the statute, the holder of the charging order has only the rights of an assignee.
The court did not address the penalty to be suffered by CLG for, without authority, amending the articles of Empire Vista.
Transfers Done to Avoid Creditor Claims are Fraudulent
With respect to the various transfers of property amongst the LLCs, the court found that they did constitute a fraudulent conveyance in that they were undertaken for the purpose of thwarting the claims of CLG. Balancing the equities, the court wrote:
Though arguably undertaken as a practical means of thwarting CLG’s own unlawful efforts to take over control of the LLCs, the transfers were no less fraudulent. The fraudulent transfer statutes contain no exceptions for debtors faced with malfeasant creditors. Debtors faced with unlawful attempts at collection may seek emergency relief from the court - they may not violate the law in the name of self-help.
The Property Transfers Did Not Violate the Charging Orders
The court rejected the suggestion that the transfers of property amongst the various LLCs, beginning with Empire Vista, violated the charging order CLG had been awarded with respect to Jagelski’s interest therein. While fraudulent, the transfers did not result in any distribution to Jagelski that was not properly diverted to CLG pursuant to the charging order.
Don’t Sign a Contract on Behalf of a Corporation or LLC Until the
Corporation or LLC is Organized
If you sign a contract for a corporation or an LLC before it is organized, you can be held liable on that obligation. This rule has long existed under the law of agency, and is expressly set forth in many corporation and LLC statutes. Still, people do exactly what they should not and get held liable, as evidenced by a recent decision from Idaho. KDN Management, Inc. v. WinCo Foods, LLC, 164 Idaho 1, 423 P.3d 422 (Idaho July 30, 2018).
Here, an individual entered into an agreement for certain maintenance services at grocery stores. He entered into the agreement prior to formation of the corporation. When the relationship went south, and the corporation could not satisfy its debt, the court held that the individual would be held jointly and severally liable with the corporation on the subject obligation, citing Idaho Code § 30-29-204.
“Because KDN was not incorporated until after the contract with WinCo was formed, the District Court’s holding that Nelson was jointly and severally liable with KDN under the theory of pre-incorporation liability is affirmed.”
Friday, December 7, 2018
The Assassination of Cicero
Today marks the anniversary of Cicero’s assassination in 43 B.C. A lawyer, politician, writer and orator, his letters serve as both a source for the goings-on in a tumultuous period in Rome and as guidance for the art of letter writing. The discovery of his letters by Petrarch was a, and some would argue the, event that precipitated the Renaissance.
After the assignation of Julius Caesar, thinking Marc Antony to be little more than a thug, Cicero took the additional step of detailing his views in a series of speeches, hoping to reduce Antony’s influence for the benefit of Octavian, Caesar’s heir. When, however, Octavian and Antony joined forces in the Second Triumvirate, Cicero’s days were numbered. Ultimately he was “proscribed” (i.e., ordered executed and his property seized). While the depiction of his execution as portrayed in the HBO series Rome was true to his character, it in fact took place on a road with Cicero riding in a litter; he did not resist.
Tuesday, December 4, 2018
Partner in LLP Is Not the LLP’s Employee
There is now pending before the Eighth Circuit Court of Appeals a suit that may turn on whether the relevant question, namely whether an LLP’s partner is an employee of the LLP, has already been determined by a state court. In that underlying judgment, the Circuit Court of Cole County, Missouri, issued a judgment dated October 9 18, 2017 in the case Joseph S. Vaughn Kaenel v. Warren, Case No.: 15 AC-CC 00472. That judgment provided in part:
As an equity partner of Armstrong Teasdale, LLP, [Kaenel] is not a covered employee protected by the Missouri Human Rights Act.
Whether a partner in an LLP, or a member in an LLC, can as well be an “employee” of the venture is a question that is contextual and as well highly fact dependent. For tax purposes it is clear that they are not. Here, in the context of employment discrimination law, we are told they are not. What is the rule in other cases needs to be addressed under the law governing that situation.
Monday, December 3, 2018
Enforcing Capital Contribution Obligations
A recent trio of cases have addressed, in the context of an LLC that was losing money, the enforcement of a member’s agreement to contribute additional funds to the company. These cases, as well as additional thoughts with respect to capital contribution obligations, are addressed in an article co-authored by Professor Bradley Borden and myself, Interest Dilution and Damages as Contribution-Default Remedies in Failing LLC’s and Partnerships. This article appears in Business Law Today; HERE IS A LINK to that article.
Sunday, December 2, 2018
California’s Law Governing Gender Composition of Boards of Directors
Previously, I reviewed a recently passed California statute that mandates, with respect to publicly traded companies either organized in or having the principal place of business in California, a requirement of a minimum board composition of women. HERE IS A LINK to my review of that statute.
There is been recently released in Business Law Today an article questioning the legitimacy of this statute, namely An Unconstitutional Mandate? California’s Gender-Based Board Law and Its Uncertain Legal Future. HERE IS A LINK to that article.
Friday, November 30, 2018
In my most recent column in the Journal of Passthrough Entities, I considered whether the various garnishment limits apply to charging orders. Under both federal and state law, as a general proposition, no more than 25% of the “wages” paid an employee may be garnished in order to satisfy a judgment-creditor. This column explores whether those limitations apply with respect to a charging order issued against a member’s distributions from an LLC. There is, perhaps surprisingly, essentially no law directly on point. However, when I look across a range of circumstances, I conclude that the weight of authority is that the garnishment limits do not apply to charging orders.
HERE IS A LINK to that article.
Wednesday, November 28, 2018
Be Careful of Other Rules When Enforcing a Charging Order
A recent decision from Mississippi is a helpful reminder that, when seeking to enforce a charging order, it is necessary to pay attention to other rules. PNC Bank, National Association v. Walnut Grove Office Gardens, LLC. No. 3:17-MC-17-DMB, 2018 WL 4855212 (N.D. Miss. October 5, 2018).
PNC had made a series of loans to various LLCs, all personally guaranteed by Walter D. Wills, III. All of the loans went into default. Judgment was entered in favor of PNC against each of the borrower LLCs and Wills in his capacity as guarantor. That happened on September 28, 2017. Then, on October 4, 2017, the court entered an amended judgment. That all happened in the Western District of Tennessee. On November 2, 2017, PNC registered the amended judgment in the Northern District from Mississippi and then, some seven months later, filed an application for a charging order. It was whether that charging order could be issued that is the subject of this decision.
Under 28 U.S.C. § 1963, a judgment from one court (in this instance, the Western District of Tennessee) may be registered in another court (in this instance, the Northern District of Mississippi) “when the judgment has become final by appeal or expiration of the time for appeal.” Wills never appealed the judgment holding him and the various LLCs liable to PNC Bank. In consequence, the question was whether there had occurred the “expiration of the time for appeal”? As to this point, the court relied upon Federal Rule of Appellate Procedure 4(a)(1)(A), which provides that a notice of appeal “must be filed with the district clerk within thirty (30) days after entry of the judgment or order appealed from.” The amended decision in this case was issued on October 4, 2017. It was registered in Mississippi on November 2, 2017. In consequence, less than 30 days had passed from the date of the amended order of the Tennessee court and its registration in Mississippi.
On that basis, the Mississippi court refused to issue the requested charging order, writing:
Accordingly, the registration was premature and may not form the basis for the enforcement PNC Bank seeks here.
PNC was granted leave to reregister the amended judgment from the Tennessee court.
Tuesday, November 27, 2018
More from Jay Adkisson on Series; Series in Interstate Commerce
Jay Adkisson has in Forbes published a multi-part article on issues involving series. His latest component addresses the treatment of series across state lines. HERE IS A LINK to his article.
New Geographic Targeting Order
A new Geographic Targeting Order was released Nov. 15..
The press release and the GTO itself are available here:
· Financial Crimes Enforcement Network, FinCEN Reissues Real Estate Geographic Targeting Orders and Expands Coverage to 12 Metropolitan Areas (Press Release Nov. 15, 2018), available at https://www.fincen.gov/news/news-releases/fincen-reissues-real-estate-geographic-targeting-orders-and-expands-coverage-12
· Financial Crimes Enforcement Network, Geographic Targeting Order Covering TITLE INSURANCE COMPANY (Nov. 15, 2018), available at https://www.fincen.gov/sites/default/files/shared/Real%20Estate%20GTO%20GENERIC_111518_FINAL%20508.pdf
For some additional commentary, see also Samuel Rubenfeld, U.S. Expands Coverage of Real Estate Anti-Money Laundering Program (Wall Street Journal, Nov. 15, 2018), available at https://www.wsj.com/articles/u-s-expands-coverage-of-real-estate-anti-money-laundering-program-1542322224
A Few Interesting Points as to Dissolving an LLC
A recent decision from the Utah Court of Appeals points out a few interesting facts and principles applicable in the dissolution of an LLC. Unfortunately, many of the most interesting points were not preserved for review by the plaintiff, so the Court of Appeals was able to avoid them. Still, the case is interesting reading. Blanch v. Ferrell, 2018 UT App. 172, 2018 WL 4261526 (Utah Ct. App. Sept. 7, 2018).
Blanch and Ferrell were, with three other brothers, the owners of certain real property in Utah as well as shares in an irrigation company. In 2005 they conveyed all of those assets to an LLC in which each was an equal 20% member. There was no written operating agreement. The articles of organization provided a three year lifespan for the LLC. The LLC expired in 2008, but it was not until 2015 that any efforts were taken to wind up its affairs. At that time, four of the five members adopted a written resolution authorizing the sale of the company’s assets and authorizing the Ferrell to be in charge of that process. Blanch filed this lawsuit, alleging a variety of theories including that the approval of the asset sale required unanimous approval, and he objected. The District Court granted the defendants motion to dismiss, and this appeal followed.
Initially, the court noted that Blanch had made three arguments with respect to the written consent of the four of the five members authorizing the sale of the LLC’s. He alleged (i) that the consent was a backhanded effort to amend the LLC’s articles of organization, which would be invalid without unanimous approval, (ii) that the written consent was approved without any notice to him, notice being required by the then applicable LLC Act, with the effect that it is invalid and (iii) that two of the four signatories were actually assignees without voting rights. The court, with respect to these arguments, found that none of them had been made below to the District Court and thus could not be raised on appeal.
Next, Blanch argued that the written consent needed to be unanimous because, with the adoption of Utah’s new LLC Act, acts outside the ordinary course require unanimous approval. Under the predecessor LLC Act, in effect at the time of the adoption of the written consent, actions outside the ordinary course require the approval of two-thirds of the members. In effect, Blanch argued that, with the effectiveness of the new LLC Act, all prior approvals became subject to the new unanimous standard. The Court of Appeals, after having first assessed the written consent under the old law and found it to be effective thereunder, turned its attention to the new law. The court rejected the supposition that the effectiveness of the new law “had the effect of invalidating previous actions taken by a limited liability company.” 2018 UT App 172, ¶ 28.
Ultimately, Blanch sought a partition of the LLC’s property so that he could retain 20% of it in his own name. Here the court was able to hoist Blanch on the petard of his argument that the new LLC Act is applicable. Under it, in winding up a company, surplus assets must “be paid in money.” Id. at footnote 5, citing Utah Code Ann. § 48-3a-711(4). Applying this provision, the court held, inter alia, that he could not receive hard assets in substitution for money.
Monday, November 26, 2018
More Fun and Games and Charging Orders;
If It Is Yours It Can Be Reached With a Charging Order
If It Is Yours It Can Be Reached With a Charging Order
A recent decision from Illinois is yet another illustration of the steps that judgment-debtors will undertake in order to avoid satisfying a judgement. In this instance, an individual sought to use a dissolved LLC as, effectively, his personal piggy bank. Golfwood Square LLC v. O’Malley, No. 1-17-2220, 2018 IL App. (1st) 172220-U, 2018 WL 4370875 (Sept. 11, 2018).
Golfwood Square LLC held a judgment exceeding $900,000 against O’Malley and another individual. O’Malley was the 90% owner of SSG, LLC, which he acknowledged “doesn’t do anything.” In turn, SSG was the sole member of 3 Squared, an LLC that had owned a condo. After judgment had been entered against O’Malley, 3 Square sold the condo, and after satisfaction of the related mortgage retained some $224,000. The operating agreement of 3 Square provided that upon the sale of its assets, the company would be dissolved and, after satisfaction of claims of creditors, the net proceeds would be distributed to the members.
O’Malley, who admitted that he had “unfettered access” to the account in which those proceeds were deposited, use substantial portions to pay both personal debts and as well the obligations of other companies with which he was affiliated.
In order to enforce a charging order that had previously been injured, Golfwood sought an order from the court requiring O’Malley to turn over the remaining 3 Square funds.
In addition to applying several portions of the Illinois law governing supplemental proceedings and collection on judgments, the trial court found that “according to the clear language of 3 Square’s operating agreement, upon selling the Garlands Condo, 3 Square should have dissolved and distributed the sale proceeds to SSG. From there, per the charging order, any distributions that SSG would otherwise have made to O’Malley would instead go to Golfwood. But O’Malley circumvented the charging order by keeping the funds normally under 3 Square’s control while he retained “unfettered access” to the accounts - essentially making a direct distribution to himself in all but name.”
On that basis, the court of appeals affirmed the turnover order, finding it to be necessary both to enforce the charging order and on otherwise applicable provisions of collection law.
O’Malley sought to avoid the charging order, by arguing that, in effect, it effected an improper piercing of the veils of each of 3 Square and SSG. This was rejected on the basis that the assets being held (and dispersed from) 3 Square were already O’Malley's.
Sunday, November 25, 2018
Pillars of the Earth & the Sinking of the White Ship
Pillars of the Earth is in my view an excellent book both for its description of events “from the ground level” of the period of English history known as the Anarchy as well as its treatment of medieval as people just like those of the modern era who are just trying as best they can to make it through each day.
The fulcrum of the macro-political events described in the book is The Anarchy, the contest between the Empress Matilda, daughter of King Henry I (and former spouse of the Holy Roman Emperor, hence her title “Empress”), and Stephen of Blois, Henry’s nephew (just to keep things confusing Stephen’s wife was named Matilda) for the English throne after Henry’s death. The expected heir to Henry I was his son William. William, however, drowned on this day in 1120 in the sinking of the White Ship, thereby affording Follett the pivot around which to write Pillars of the Earth.
The Anarchy was resolved by Stephen holding the throne and appointing Matilda’s son Henry his heir. That Henry would be Henry II, one of England’s great kings.
Wednesday, November 21, 2018
No Valuation Distinction Between a Mere Assignee and a Limited Partner
In a recent decision from the Tax Court, it was held that an assignee and a limited partner would have the same valuation discounts. Estate of Streightoff v. Commissioner, T.C. Memo 2018-178 (October 24, 2018).
The Tax Court was called upon to determine whether a donor had transferred the entirety of a limited partnership interest, or merely an assignee right therein. The court held, in this instance, that the donor had transferred the limited partnership interest, and not a mere assignee interest. The court went on to hold that, however, the distinction did not matter, and that the discount applied would be the same irrespective of whether a limited partnership interest or a mere assignee interest were conveyed. Both had the same right to distributions. While a limited partnership interest did convey a right to vote, that right existed only with respect to the removal of the general partner (thereby effectuating the partnership’s termination), and the limited partners had, to date, never held a vote.
Monday, November 19, 2018
Death and Conversion of a General Partner
A recent decision from California addresses two changes with respect to general partners in limited partnerships. One of those situations was the death of a natural person, and the other was the conversion of the corporation into an LLC. Wong v. California Forefront, Inc., B281939, 2018 WL 4404148 (Ca. Ct. App. Second Dist. Sept. 17, 2018).
Lily Wong was one of the two original general partners in Park Center Partnership. The other original general partner was California Forefront, Inc. An individual, Wyman Ip was the only limited partner. When Lily Wong died, her husband, as trustee of the Lily Y. Wong Family Trust, asserted that he was the successor general partner. In the alternative, it was asserted that when CFI, in 2010, converted from a corporation to a limited liability company, it was in effect disassociated as a general partner. Both of these assertions were rejected.
While it was acknowledged that, upon the death of Lily Wong, her trust became the assignee of her economic interest in the partnership, applying the terms of this particular limited partnership agreement, which imposed specific limitations upon affiliates of existing partners, it was found that the trust could not be a successor general partner.
With respect to the conversion of CFI from a corporation into a LLC, the court cited the applicable provision of the statute, it providing that upon conversion the converted entity is “the same entity that existed before the conversion.” That being the case, it was held that the conversion of a corporate general partner into the form of an LLC did not effect that corporation’s disassociation from the limited partnership or the alteration of its status as a general partner.
Saturday, November 17, 2018
So Begins Gloriana
On this day in 1558 Mary Tudor, who would later have foisted upon her the moniker “Bloody,” died, leaving the English throne to her half-sister Elizabeth. Where Mary's reign of just over 5 years was one of tumult at the highest political levels, for at least a significant and perhaps a majority of the population it was a return to the preferred old ways, a view put forth expertly by Professor Scarisbrick in his The Reformation and the English People. Still, her marriage to Philip of Spain was never popular. Elizabeth's reign would by contrast be seen as one of peace and growth, later dubbed the Gloriana.
Elizabeth would rule until 1603.
Today is as well the anniversary of the death of Reginald Cardinal Pole, who under Mary had been named Archibishop of Canterbury. He was the last Catholic to hold that post.
Friday, November 16, 2018
Action on Beneficial Ownership?
At today’s Federal Regulation of Securities luncheon at the ABA’s Fall Meeting, the Keynote speaker was Joe Carapiet, Chief Counsel at the U.S. Senate Committee on Banking, Housing, and Urban Affairs. During his remarks, he alluded to a hearing the Committee will be holding the week after Thanksgiving and said that beneficial ownership will one of the topics addressed. He characterized the topic as “challenging."
Best guess is that these are those hearings –
Best guess is that these are those hearings –
Tuesday, November 13, 2018
Court Will Enforce Agreements As Written, Even If Poorly Written
In his blog New York business divorce, Peter Mahler has reviewed a recent decision from the New York trial court enforcing, as written, the quorum requirements under an operating agreement. Casilli v. Natan, 2018 NY Slip Op 32621(U) [Sup Ct NY County Oct. 12, 2018].
In a blog entry titled Think Twice Before Putting 100% Quorum Requirements in By-Laws or LLC Agreements (Nov. 12, 2018), Peter explained that, in this particular LLC, there were three managers, and the quorum requirement for a meeting of the managers was all of the managers. Not surprisingly, one of them refused to attend the meetings. While there was no unanimity requirement with respect to meetings of the members, the operating agreement provided, inter alia, that members could consider matters only after they were considered and recommended by the managers. In effect there was a “two-house rule,“ and the members were precluded from acting outside of a recommendation from the managers. When the two of the three members sought to call a meeting of the members to consider the filing of the bankruptcy petition, a topic that had not been considered and recommended by the board of managers, that effort was enjoined.
The court rejected the suggestion that the operating agreement be reformed to require only a majority to constitute a quorum. I’m with Peter in viewing that determination as not surprising. As a general proposition, courts should enforce agreements and not question the wisdom of what was agreed to.
HERE IS A LINK to Peter’s review of this case.
Monday, November 12, 2018
Political Contributions Through LLCs – Not in Cincinnati
Last week, voters in Cincinnati Ohio approved an amendment to the City Council Charter (Issue 13) that forbids the making of political contributions through LLCs. Previously, the donation limit for an individual was $1,100. However, LLCs likewise were subject to that $1,100 limit, and an individual controlling multiple LLCs could, through each, make that same maximum contribution.
The amendment received the approval of 86% of the votes cast.
Friday, November 9, 2018
Don’t Hold Your Breath on the Series Classification Regulations
There were published, in September, 2010, proposed regulations with respect to the classification of a series. Since then no action has been taken, but for a number of years those regulations remained on the Priority Guidance Plan. But then they fell off. Yesterday, November 8, the 2018-2019 Priority Guidance Plan of the Department of the Treasury was released. The series classification regulations are notably absent therefrom.
Wednesday, November 7, 2018
LLC’s Members are not Clients of the LLC’s Attorney
In a recent decision from the Seventh Circuit Court of Appeals, it affirming the holding of the trial court, it was confirmed that an attorney to an LLC is not, consequent to that role, the attorney for the LLC’s members. Reynolds v. Henderson & Lyman, __ F.3d __, 2018 WL 4348013 (7th Cir. Sept. 12, 2018).
Reynolds was a member of several LLCs that had retained Henderson & Lyman (“H&L”) as its legal counsel. Reynolds would allege that H&L gave advice, ultimately incorrect or incomplete, that led him to violate certain federal securities disclosure laws in the preparation of the LLC’s financial statements. Reynolds, for himself, brought suit against H&L. The trial court rejected that suit on the basis that Reynolds could not bring a malpractice suit for himself when he did not have a personal attorney-client relationship with Henderson & Lyman. It was that determination that was appealed to the Seventh Circuit Court of Appeals.
As recounted by the Seventh Circuit, in the course of upholding the trial court’s dismissal, it was observed that:
Reynolds admits that he never asked H&L to represent him and that H&L never said anything that suggested it thought it was representing him. In other words, the parties never entered into any agreement that would have created an attorney-client relationship between them. H&L did have an attorney-client relationship with the LLCs that Reynolds co-owned and managed, but that is different. It was in his capacity as a managing member of these LLCs that Reynolds communicated with, and was advised by, H&L. Reynolds’s primary argument on appeal is that H&L owed him something akin to a third-party duty of care arising out of its representation of the LLCs, because his personal interest were so closely bound with the interest of the LLCs as to be functionally indistinguishable. This theory might sound plausible on its face, but unfortunately for Reynolds it is foreclosed by decades of Illinois law.
Illinois courts consistently have held that neither shared interest nor shared liability gives rise to third-party liability. For third-party liability in Illinois, Reynolds must have been a direct and intended beneficiary, and “[s]imply because the [officers of a business entity] were at risk of personal liability does not transform the incidental benefits of [the law firm’s] representation of [the business entity] into direct and intended benefits for [the officers]. In fact, the only time an Illinois attorney owes a duty of care to third party is when the attorney was hired for the primary purpose of benefitting that third party. Illinois courts have emphasized that the primary purpose of a retainer agreement between a business entity and a lawyer is to benefit the business entity, not to benefit that entity’s owners or officers, however closely aligned their interests might be. (citations omitted)
The court went on to observe that any “contrary rule would undermine the integrity of the attorney-client relationship by forcing attorneys to assume competing duties of care to non-clients.” and that:
In addition, the rule that Reynolds asks us to adopt would chip away at the legal distinction between entities and individuals-a distinction that serves as the basis for the existence of many business structures, including that of the LLC. It would be bizarre indeed if a business’s owners or officers could cloak themselves in the protections provided by the limited-liability corporate structure when they entered contracts or defend against a lawsuit, yet cast that structure aside when seeking to recover as plaintiffs for injuries sustained by the business. In law, as in life, double standards are frowned upon.
Tuesday, November 6, 2018
Exercise of Voting Rights After Death
The recent decision from Louisiana is focused upon the obligation to make distributions to an assignee, in this case an estate, and the question of whether the surviving member’s failure to make distributions was dischargeable in bankruptcy. There is, however, an interesting side question with respect to voting rights. Free v. Winborne, Civ. Act. No. 17-1606, 2018 WL 4265254 (W.D. LA. Sept. 6, 2018).
Samuel Free and James Winborne were each 50% owners in two real estate related businesses. Windborne passed away, and the plaintiff in this action, Leasa Winborne, was appointed to administer his estate. She would eventually bring suit against Free alleging he was converting assets belonging to the LLCs and withholding her rights to 50% of the net proceeds.
As recited by the court, basing its analysis upon the work of the underlying Bankruptcy Court, “The operating agreements also provide that upon the member’s death, that member’s successor shall become an asset in the of the deceased member’s interests in the companies.” 2018 WL 4265254, *2. Those same operating agreements went on to provide that “an assignee has no management rights and the member for whom the assignee acquired its interest retains their voting rights until such time as the assignee is admitted as a Member.” Id. In this instance, the Leasa Windborne, the assignee, was never admitted as a substitute member. It was provided in the operating agreements that the LLCs would dissolve with the consent of a Majority in Interests of the Members.” Id. *3.
Free asserted that he had voted to dissolve both of the LLCs in his capacity as the sole remaining member, thereby giving effectively unanimous consent to that transaction. This argument was set aside on the basis that:
However, the Bankruptcy Court determined that Free did not account for Mr. Winborne’s remaining voting rights, noting that per the terms of the operating agreements Free did not have a Majority in Interest because his share was only 50%. Id. at *3.
And there the problem arises. Any action requiring a majority vote of the members would, necessarily, have to include the deceased Mr. Winborne. Alternatively, Free would need to admit Winorne’s widow, Leasa, as a member. Absent one of those actions, it would seem that the LLC could not take any action. It is somewhat difficult to accept that that was their intent in drafting the operating agreement. Still, it was part of the holding in this decision.
Also featured in the opinion is a most curious reading of the provision addressing the “Events of Dissolution” of this LLC. As recited by the court, it read:
The Company shall be dissolved upon the occurrence of any one of the following events: (a) expiration of the Company’s term; (b) entry of an order for relief with respect to the Company under Chapter 7 of the Bankruptcy Code; (c) entry of the judgment of dissolution of the Company pursuant to La Rev Stat Ann section 12:1335; and (d) consent to dissolve the company by a Majority in Interest of the Members.
The Bankruptcy Court had found that, even in the context of a consent to dissolve given by a Majority in Interest of the Members, that alone would not be effective absent entry of a decree of dissolution pursuant to La. Rev. Stat. Ann. section 12:1335. This interpretation is most curious in that the lead-in provision of the clause referred to “any one of the following events.” How the “and” between subsections (c) and (d) could be read as requiring both elements is, a curious question.
Monday, November 5, 2018
Deceased Member’s Right of Redemption Subordinated to LLC’s Bank Obligations
A recent decision from Louisiana councels that a member’s rights to distributions from an LLC, in this instance a liquidating distribution upon death, may be subordinated to the right of the LLC’s lender. Succession of Dinesh Shaw, M. D. v. Alexandria Investment Group, LLC, 2017-1026, __ So.3d __, 2018 WL 4000485 (La. Ct. App. 3rd Aug. 22, 2018).
Shaw was a member of Alexandria Investment Group, L.L.C. (“AIG”). AIG’s operating agreement provided, inter alia, that upon a member’s death, they would receive the member’s percentage interest in the appraised fair market value of the LLCs assets. Shaw passed away in May, 2016, and the representative of his estate was appointed later that month. That representative, Munsterman, advised AIG of Shaw’s death and requested that the payout begin. When the LLC asserted that it was not obligated to affect a redemption, but merely had the right to do so, Munsterman brought suit against the LLC seeking Shaw’s portion of the value of its assets, an amount exceeding $1.3 million. In turn, Red River Bank (“RRB”), AIG’s primary creditor, intervened in that action, asserting it had a first priority security interest in substantially all of AIG’s assets and that Shaw had assigned to it all claims he might have against AIG. That assignment provided:
Guarantor hereby assigns to lenders all claims which it may have or acquire against Borrower or any assignee or trustee of Borrower in bankruptcy; provided that, such assignment shall be effective only for the purpose of assuring the Lender full payment of Borrower’s indebtedness guaranteed under this Guaranty.
Finding that the claim of Shaw’s estate would have to await satisfaction of AIG’s debt to RRB, it was found that:
We find most compelling the language which found under the provision “Guarantor’s receipt of payment,” wherein the Guarantor (Dr. Shaw) agreed to refrain from attempting to collect or enforce his own collection and reimbursement rights against AIG “until such time as all of [AIG’s] indebtedness that then remains is fully paid and satisfied.” We find the facts of his case fall under this provision. The Succession is attempting to collect from AIG the [death payment] of Dr. Shaw’s Ownership Interest prior to AIG’s indebtedness being fully satisfied. This action is truly prohibited under the terms of the Commercial Guaranty, to which Dr. Shaw agreed. As such, we find the Succession does not have a right of action to recover at this time, based on the prematurity of the claim.
This fact pattern, not atypical, sets up a curious conflict. The LLC is obligated, within so many days of the member’s death, to begin making a redemption payment, and the member’s estate is not able to enforce that right. What then is the impact upon the estates right to a liquidating distribution? Is it merely suspended until such time as the bank covenants have been satisfied and, by contract, the LLC is permitted to make the distribution, or rather is it lost, and the estate, absent a separate negotiated agreement, is forever to be a transferee of the decedent? If there is only a suspension of the right, is the valuation still determined by the decedent’s date of death, or should the redemption price be reassessed as of the date on which the redemption payment may be made.
It is also worth considering what would be the outcome if the decedent had not assigned all of his rights against the LLC to the bank and there was only either a bilateral guarantee of the bank debt between the bank and each member? In addition, what would be the effect of only a loan covenant between the LLC borrower and the bank to the effect no distributions would be made until the loan was satisfied?
Sunday, November 4, 2018
Liquidating Distribution Was a Fraudulent Conveyance
In the decision and render by a New York intermediate appellate court, it was held that the liquidating distribution of an LLC, thereby rendering it insolvent, when it remained subject to certain indemnification and similar claims, constituted a fraudulent conveyance. Medical Arts-Huntington Realty, LLC v. Meltzer Rosenberg Development, LLC, 149 A.D.3d 824, 52 N.Y.S.3d 382 (2nd App. Div. 2017).
The defendants in this action had been the members in 21 Wall Associates, LLC. That company sold its sole asset, certain real property. The purchase agreement provided that certain claims against 214 Wall or the propertywould survive the closing and remain its responsibility. In support thereof, the members of 214 Wall agreed to guarantee the LLC’s obligations. When suit was brought by the purchaser against 214 Wall, judgments exceeding $300,000 were rendered against it. Seeking to collect, it was asserted that the distribution by 214 Wall of its assets to the LLC’s members was a fraudulent conveyance. Finding that those members had provided no consideration for the distributions, violation of the fraudulent conveyance law was found.
Friday, November 2, 2018
In a recent decision from Florida, a defendant's efforts to remove a case to federal court were for naught when that defendant failed to accurately describe itself to the court. Winn-Dixie Stores, Inc. v. Primary One, LLC, Case No. 3:18-cv-1168-J-34 MCR, 2018 WL 4771058 (M.D. Fl. Oct. 3, 2018).
Primary One, as a defendant, sought to remove this action to federal court under diversity jurisdiction. It pled, in connection with the removal, that it is “a limited liability company duly organized and existing under the laws of the state of New York with its principal place of business located in New York.” With respect to another plaintiff LLC, BI-LO, Primary alleged its jurisdiction of organization and principal place of business address. In response, the court wrote: “These allegations are wholly insufficient to establish the citizenship of primary or [the other LLC], and as such, the Court is unable to discern whether it has diversity jurisdiction in this case.”
While Primary had recited the proper test, namely that an LLC has the citizenship of each state in which a member is a citizen, it had not included that information in its notice of removal; “Primary nevertheless fails to identify its members and their respective states of citizenship.” As to BI-LO, LLC, the plaintiff LLC, Primary had alleged only that it “has no knowledge of any member of BI-LO being a citizen of the state of New York.” This was rejected by the court on the basis that diversity cannot be established in the negative, but rather an affirmative identification of the relevant citizenships is necessary.
Primary was afforded two weeks to provide the court with the information necessary to determine citizenship and whether diversity jurisdiction exists.
A Louisiana Partnership in Commendam Is For Diversity Jurisdiction Purposes Just Like Any Other Limited Partnership
A Louisiana Partnership in Commendam Is
For Diversity Jurisdiction Purposes Just Like Any Other Limited Partnership
For Diversity Jurisdiction Purposes Just Like Any Other Limited Partnership
For diversity purposes, a limited partnership is deemed a citizen of every state in which any of its partners, whether general or limited, is a citizen. Louisiana does not, however, have a business entity called a “limited partnership”; rather, it has a “partnership in commendam. In a recent decision, it was confirmed that the same test applied to limited partnerships would be applied to determine the citizenship of a Louisiana partnership in commendam. Walters v. Pinnacle Entertainment, Inc., Civ. Act. No: 18-6543, 2018 WL 5024078 (E.D. La. October 17, 2018).
Thursday, November 1, 2018
The Election of the “Warrior Pope” Julius II
Today marks the anniversary of the election of Giuliano della Rovere to the papacy, whereupon he took the regnal name Pope Julius II. He would serve as Pope from his election in 1503 through his death in 1513.
While famously criticized by Erasmus of Rotterdam for his willingness to utilize force to protect the Church, including having led a papal army (it is often ignored that this action against the city of Bologna resulted in the city’s surrender), Julius is famous for:
· hiring Michelangelo to paint the Sistine Chapel;
· authorizing that the then entirely decrepit St. Peters Basilica, its fabric in many cases dating back to the fourth century, be torn down and the current St. Peters erected in place thereof;
· hiring Michelangelo as an architect on the new St. Peters;
· hiring Raphael to paint various frescoes in the Vatican.
Also, it was Julius II who:
· issued the dispensation allowing Henry VIII of England to marry the widow of his brother Arthur, namely Catherine of Aragon.
· founded the Papal Swiss Guard.
While ultimately buried in the Vatican, his tomb, not completed until 1445, is in San Pietro in Vincoli. The famous statue of Moses featuring horns (consequent to poor translation of the original Hebrew into Latin by St. Jerome) is part of that tomb (actually a cenotaph).
The only modern biography is Julius II: The Warrior Pope by Christine Shaw.