Delaware Chancery Court Addresses Obligation to Set Aside Reserves for Known Claims;“Undissolved” to LLCs so Creditor Claims May be Pursued

Delaware Chancery Court Addresses Obligation to Set Aside Reserves for Known Claims; “Undissolved” to LLCs so Creditor Claims May be Pursued

Yesterday, the Delaware Court of Chancery (Vice Chancellor Glasscock) issued an opinion addressing the obligation of an LLC to set aside reserves to satisfy likely claims. In this instance, the LLCs had dissolved and set aside nothing in the way of reserves to satisfy reasonably expected claims from some former members dissatisfied with the appraisal methodology utilized to determine their redemption price. Vice Chancellor Glasscock found that the zero reserve was inappropriate, and on that basis “undissolved” the LLCs. Capone v LDH Management Holdings, LLC, C.A. No. 11687-VCG (Del. Ch. April 25, 2018).

The plaintiffs in this action have been executive officers of defendant LDH. After termination of employment, LDH was entitled to redeem their interests in the company pursuant to a valuation performed as of the last day of the prior year. In this instance, however, LDH jumped the gun and performed the valuation before the end of the year. That valuation came it at essentially $1.4 billion.  However, an essentially contemporaneous offer to sell part of the company received significantly higher valuations. The plaintiffs objected that those higher valuations, determined by what third parties would actually pay for the business, should have been taken into account in the valuation.  Specifically, they asserted that the failure to consider those offers would violate the board’s obligation that they determine the value “in good faith” as specified in the operating agreement.

The Delaware LLC Act sets forth a detailed process for the dissolution of an LLC. One of those requirements, set forth at section 18-804(b)(3), requires that the LLC:

Make such provision as will be reasonably likely to be sufficient to provide compensation for claims that have not been made known to the limited liability company or that have not arisen but that, based on facts known to the limited liability company, are likely to arise or to become known to the limited liability company within 10 years after the date of dissolution.

Otherwise, the LLC Act requires as well that:

A limited liability company which has dissolved … shall pay or make reasonable provision to pay all claims and obligations, including all contention, conditional or un-matured contractual claims, known to the limited liability company.

Del. LLC Act § 18-804(b)(1).

The bulk of the opinion was then devoted to whether the complaints made by the plaintiffs over a series of emails and phone calls with respect to the valuation methodology employed by the company put it on notice of the claims. The court ultimately determined that the company had notice of the potential claims and had acted inappropriately in setting aside a zero reserve based thereon. The ultimate merits of that claim will be resolved in litigation already pending in New York.

What Vice Chancellor Glasscock did order was that the certificates of cancellation filed with respect to the subject LLCs be in effect withdrawn and the LLCs reinstated. This is necessary in that, under Delaware law, once a certificate of cancellation is filed, no suits can be brought by or against of the LLC. With those certificates of cancellation now no longer in effect, the LLCs continue in existence, and the New York lawsuit may proceed.

FYI, Kentucky does not have the concept of a certificate of cancellation, and a dissolved LLC may continue to sue or be sued after its dissolution.

Today Began the Renaissance (?)

Today Began the Renaissance (?)

By certain reckoning, today is the anniversary of an event in 1336 off from which is dated the Italian Renaissance. It was on that day that the poet Petrarch climbed to the top of Mount Ventoux in southern France. Petrarch was by no means the first person to have a climbed this “mountain” - it's only slightly over 6000 feet in height. Rather, his climb was considered noteworthy because he simply did it for the experience.

Whether this was, actually, the beginning of the Renaissance is open to significant debate. By then Petrarch had already completed a new epic poem in Latin titled Africa (it is about the second Punic war). Regardless, he would go on to be a prolific letter writer, corresponding with persons including Boccaccio, and would locate the writings of numerous classical writers, including Cicero.

All is not, however, good with Petrarch. He is credited with identifying the so-called “Dark Ages.” In fact, the purported “Dark Ages” never existed.

The Fall of Troy

Beware Greeks Bearing Gifts

      Today marks the anniversary of the traditional Fall of Troy in 1184 B.C., thereby bringing to its culmination the Trojan War.

 

      The Fall of Troy is not recounted in Homer’s Iliad, the iconic epic, it rather covering only a period of ten days to two weeks within the supposed ten-year span of the war.  The Fall of Troy through the subterfuge of the Trojan Horse is briefly mentioned in the Odyssey and is referenced in several other Greek sources.  The story would not find, however, its full development until Virgil’s Aeneid.

 

      Some modern historians have attempted to explain the story as an analogy, suggesting actually that an earthquake – Poseidon, whose portfolio included horses, was as well the god of earthquakes.  I, for one, would rather retain the literal interpretation.

 

      Regardless it is a great story, especially the fall of Achilles to Paris after the former killed Hector.  Speaking of which, the  movie Troy misstated the story, likely because they wanted to keep Brad Pitt on the screen.  Achilles was killed before the fall of Troy; he never entered the city.

 

            Some might consider the Trojan War to be ancient history.  It’s all matter of perspective.  At the time of the Fall of Troy the Egyptian civilization had been flourishing already for 2000 years.

Evidentiary Hearing to Determine Whether There Was an Agreement to Arbitrate

Evidentiary Hearing to Determine Whether There Was an Agreement to Arbitrate

Consequent to a recent decision, the defendant will be required to respond to certain discovery request so that there can be a substantive ruling as to whether the named plaintiff, on behalf of an as of yet uncertified class, is otherwise obligated to arbitrate the dispute. Tassy v. Lindsay Entertainment Enterprises, Inc., Civ. Act. No. 3:16-CV-00077-TDR, 2018 WL 1702335 (W.D. Ky. April 6, 2018).

At its core, this dispute involves whether or not there existed a valid agreement to arbitrate disputes. The question was whether the individual was properly classified as an independent contractor versus an employee. If classification should have been as an employee, there is a claim for failure to pay appropriate wages as mandated by federal law.

Tassy, an individual, on her behalf and on behalf of similarly situated persons, sought to bring a class action to resolve this dispute. In response, Lindsay Entertainment asserted that Tassy was bound by an agreement to arbitrate any disputes. Lindsay Entertainment could not, however, produce a copy of the allegedly signed agreement to arbitrate. In this dispute, the Sixth Circuit had directed that the District Court “‘summarily’ determine whether the parties had agreed to arbitrate.” Lindsay Entertainment wanted to rely upon testimony from Scott Lindsay, owner of Lindsay Entertainment, and another employee to that effect. Tassy, in part to collect testimonial evidence to the contrary, sought from Lindsay Entertainment a listing of all of the employees/independent contractors for a particular period, including their dates of service, last known address, last known phone number, etc. Lindsay Entertainment objected. That objection was overruled. To that end, the court wrote:

Allowing parties to conduct limited discovery prior to holding an evidentiary hearing, and for the purpose of determining the validity of arbitration agreements, is an accepted practice.

2018 WL 1702335,*4.

Still, Tassy was not granted free range but rather “discovery shall be limited to only the information necessary to prepare for the upcoming evidentiary hearing regarding whether there exists a valid agreement to arbitrate.”

Waiving the Few Rights of a Decedent’s Estate

Waiving the Few Rights of a Decedent’s Estate

Certain states, including New York, have a default statute that affords the estate of the deceased member certain rights (FYI, Kentucky does not). That said, a recent decision from New York applied an operating agreement that waived even those rights. Pappas v. 38-40 LLC, 2018 NY Slip op 30329(U) (Sup.Ct. NY County Feb. 22, 2018).

In this instance, Pappas had been a 25% member in an LLC controlled by Kirsch (70%). After Pappas passed away, his personal representative filed a direct and derivative complaint against Kirsch alleging that the company was being looted. Under the New York Limited Liability Act, specifically Section 608 thereof, “The member’s executor…  may exercise all of the member’s rights for the purpose of settling his or her estate or administering his or her property, including any partner under the operating agreement of an assignee to become a member.” All else being equal, the question would be whether this provision affords the executor the ability to bring a derivative action on the LLC’s behalf. That, however, would not be the focus of this case as the operating agreement modified that rule.  In this instance, a member’s death was defined as being a “Withdrawal Event” and went on to provide:

In the event of a Withdrawal Event with respect to any Member, any successor in interest to such Member (including without limitation any executor, administrator, heir, committee, guardian, or other representative or successor) shall not become entitled to any rights or interests of such Member in the Limited Liability Company other than the allocations and distributions to which such Member is entitled, unless such successor in interest is admitted as a Member in accordance with this Agreement.

In this instance, the executor was not admitted as a successor member in the LLC. Applying then the continuous ownership requirement for bringing a derivative action, the derivative claims were rejected. Further, on the basis that the alleged injuries were to the LLC and not uniquely to the decedent, the direct claims were rejected.

Peter Mahler, in his blog New York Business Divorce, provides a longer review of this decision, as well as a link to it. HERE IS A LINK to that review.

Volunteers at Church Operated Restaurant Were Not Employees

Volunteers at Church Operated Restaurant Were Not Employees

In a decision rendered yesterday by the Sixth Circuit Court of Appeals, it held that members of the church who volunteered to work at a for-profit restaurant operated by the church were not employees. Not being employees, there could not be a claim for violation of the Fair Labor Standards Act and its minimum compensation requirements. Acosta v. Cathedral Buffet, Inc., No. 17-3427 (6^th Cir. April 16, 2018).

The Grace Cathedral Church operated a restaurant on its campus named Cathedral Buffet. The restaurant, a for-profit venture, is open to the public. It is staffed by a combination of paid employees and unpaid church members. After a Department of Labor inspection, that followed by a trial with the District Court, it was held that the use of the unpaid volunteers violated the Fair Labor Standards Act (“FLSA”) and its minimum wage requirements. The Sixth Circuit would reverse the decision of the District Court (and in so doing hold against the Department of Labor) based upon the definition of who is an employee. In this instance, the court focused upon the fact that the volunteers never intended or expected to be compensated for their services. “We agree that a volunteer’s expectation of compensation is a threshold inquiry that must be satisfied before we assess the economic realities of the working relationship.” Slip op. at 7.

There was as well an interesting discussion of coercion. Various members of the church were regularly solicited to volunteer at the restaurant, solicitations that came both from the pulpit and by direct phone calls from the restaurant manager and even the pastor. It was reported as well that the restaurant manager would tell potential volunteers that if they did not provide services the pastor would hear about it. On the basis that these coercions were spiritual, rather than economic, the court found that they should not be part of its secular analysis.

The Religion Clause Blog has as well a review this decision; HERE IS A LINK to that review.

It Was a Most Successful War

It Was a Most Successful War

Today marks the anniversary of the 1986 treaty which drew to a close the (largely unknown) Three Hundred Thirty-Five Year’s War. “Fought” in only the loosest sense of the word, the war was between the Netherlands and the Isles of Scilly, they being at the south-west corner of England off of Cornwall. Over the Three Hundred Thirty-Five years of this conflict, it having commenced in the spring of 1651, there were no casualties. In fact, no hostile act was taken by one party against another during the course of the war. Needless to say, this was a significant cost savings versus the usual expense of munitions.

There exists something of a technical dispute as to whether there was actually a war in that the Isles are not themselves a nation-state. That should not, however, detract from the successful resolution of the dispute.

This treaty is, however, in no manner any sort of record. In 146 BC, at the conclusion of the Third Punic War, Rome destroyed Carthage. It was not until 1985, after passage of 2131 years, that a peace treaty between Carthage (now a suburb of Tunis), and Rome was signed.

The Passing of Lynn Stout

The Passing of Lynn Stout

Yesterday Lynn Stout, a leading scholar in many aspects of the law of business organizations, passed away after a battle with cancer. Lynn was a cogent scholar arguing against shareholder primacy and the suggestion that corporate directors have a shareholder wealth maximization obligation.

Joan Heminway has posted on the Business Law Prof Blog some reflections on Lynn’s passing; HERE IS A LINK to Joan's thoughts.

Kentucky, and Not Federal, Court to Hear Dissenter Rights Action

Kentucky, and Not Federal, Court to Hear Dissenter Rights Action

A recent decision from the federal district court held that, on the basis of “Burford Abstention,” an action arising under the dissenter rights statute should be heard in state, not federal, court. Henley Mining, Inc. v. Parton, Civ. No. 6:17-CV-00092-GFVT, 2018 WL 1526081 (E. D. Ky March 28, 2018).

In connection with the merger of several companies in which he was a shareholder, David Parton exercised dissenter rights in accordance with the dissenter-rights provisions of the Kentucky Business Corporation Act. The successor corporation paid to Parton what it thought was the amount due; Parton disagreed with that amount. In response thereto, and again consistent with the Kentucky Business Corporation Act, the corporation filed a complaint with the court seeking a determination of the fair value of Parton’s interest. This suit was filed in federal court on the basis of diversity jurisdiction, Parton being a citizen of Virginia while Henley Mining, the successor corporation, was incorporated (and presumably has its principal place of business) in Kentucky.

Henley asked that the action be dismissed on the basis of Burford Abstention, essentially an argument that, notwithstanding the fact that the federal court has jurisdiction, it should decline to exercise it because the matter in controversy is particular to the competency of state courts.

Citing Caudill v. Eubanks Farms, Inc., 301 F.3d 658, 659 (6^th Cir. 2002), it was observed that:

A corporation is “itself a creature of state law” and, specifically, “The Kentucky Legislature has enacted a comprehensive legislative scheme to govern businesses which elect to incorporate in the state.”

Finding that the question presented with respect to dissenter rights is “a difficult question of state law bearing on policy concerns,” the action was dismissed without prejudice so that it may be re-filed in state court.

Outsider Reverse Piercing of a Delaware LLC: The Fourth Circuit Court of Appeals Says It Can Happen

Outsider Reverse Piercing of a Delaware LLC: The Fourth Circuit Court of Appeals Says It Can Happen

In a recent decision from the Fourth Circuit Court of Appeals, it applying Delaware law, it was held that, on the facts presented, a single-member Delaware LLC may be reverse pierced with the effect that the assets of the LLC may be applied to the sole member’s judgment-debt. In doing so the court also addressed an always vexing question, namely personal jurisdiction over the party being held liable on the debt. Sky Cable, LLC v. DIRECTV, Inc., __ F.3d __, 2018 WL 1514413 (4^th Cir. March 28, 2018).

In 2013, Brandy Coley was found liable in the connection with a fraudulent scheme pursuant to which he provided content from DIRECTV to more than 2300 individual customers even while remitting payment for only 168 units. That judgment exceeded $2.3 million. Seeking to collect on that judgment, DIRECTV sought to pierce a trio of LLCs in which Coley was the sole member in order to “obtain access to the LLCs’ assets.” 2018 WL 1514413, *2. None of those LLCs had been party to the case against Coley and had not been served with process in connection therewith. The trial court, applying Delaware law found that an LLC could be reverse pierced and that:

(1) under Delaware law, the three LLCs were alter egos of Mr. Coley, and

(2) that Delaware would recognize reverse veil piercing under such circumstances.

Id. (footnote omitted).

In addition, it was held by the District Court that DirecTV’s failure to serve process on the LLCs did not prevent the court from exercising jurisdiction over them. Id. On appeal, each of these determinations would be affirmed.

Before continuing with the merits, there was as well a side discussion going on based upon an after-the-fact assertion by Coley’s spouse that she was a member in the LLCs. Reading between the lines, as she was not liable on the judgment in favor of First Bank, she wanted to assert an interest in the LLCs in order to defeat a reverse pierce on the basis that it would be detrimental to a person not liable on the judgment itself. However, earlier in the action, based on affidavits submitted to the effect she was not a member, she had been dismissed from the action. Applying principles of collateral estoppel, her efforts to reverse that position were rejected.

The challenges to the reverse pierce effected by the District Court were challenged on a pair of bases, namely that Delaware does not recognize reverse piercing and that the charging order provision of the Delaware LLC Act should set forth the exclusive remedy of a judgment creditor, thereby precluding a reverse pierce. Both of these arguments were rejected.

Reverse Piercing of a Delaware LLC

The Fourth Circuit began by reviewing on a number of veil piercing cases arising under Delaware law and discussing the nature of reverse piercing in both the insider and outsider realms, noting almost in passing that Delaware, being the jurisdiction of organization of the LLC, set the controlling law. From there reviewing a variety of Delaware cases as to the requirements for satisfying it’s alter ego test, it wrote:

Just as traditional veil piercing permits a court to hold a member liable for a company’s actions, reverse veil piercing permits a court to hold a company liable for the member’s actions if recognizing the corporate form would cause fraud or similar injustice.

Reverse veil piercing is particularly appropriate when an LLC has a single member, because the circumstances alleviate any concern regarding the effective veil piercing on other members who may have an interest in the assets of an LLC. Therefore, when an entity and its sole member are alter egos, the rationale supporting reverse veil piercing is especially strong.

Id., *5.

The court noted as well that Delaware has an interest in precluding the use of the business entities it allows to come into existence to be used for improper purposes. Therefore, the Fourth Circuit held that reverse feel piercing of the single-member LLC organized in Delaware is permissible.

Charging Order Exclusivity

Turning to the question of the charging order, the court found that reverse piercing is not in the nature of a remedy that is intended to be excluded by the “exclusivity” provision of the LLC Act’s charging order provision.

Finding Cooley to be the Alter Ego of the LLCs

Which then brought the opinion to the question of whether the District Court had properly determined that the LLCs at issue were Coley’s alter egos and therefore subject to piercing.

First, the court considered what is Delaware’s law on piercing. While acknowledging that it is not formulaic, in reliance upon NetJets Aviation, Inc. v. LHC Commc’ns, LLC, 537 F.3d 168 (2d Cir. 2008), the Fourth Circuit wrote:

In Delaware, to prevail under an alter ego theory, a plaintiff is not required to show “actual fraud that must show a mingling of the operations of the entity and its owner plus an ‘overall element of injustice or unfairness.’”

In this instance, it had been and was again found that Coley operated all three of the companies and himself as a “single economic entity in which money flows freely between them at [Mr.] Coley’s whim.” Id at *8. For example, it found:

The evidence that Mr. Coley and his LLCs are alter egos is substantial. Mr. Coley clearly controls ITT and, on multiple occasions, testified pre-judgment that he is ITT’s sole member. Mrs. Coley separately testified that she had no ownership interest in any of Mr. Coley’s business entities and was not a member of ITT.  Mr. Coley also produced an operating agreement during pre-judgment discovery listing himself as ITT’s only member, and testified that he is the only one who “get[s] a check” from his LLCs.

There is also abundant evidence in the record that Mr. Coley and his LLCs commingled their funds. Mr. Coley failed to keep complete records of how and why funds were deposited from one LLC’s account into another LLC’s account, or into his personal accounts. Checks made out to “East Coast Sales” were sometimes deposited into Mr. Coley’s personal account. However, Mr. Coley also received income directly from East Coast. Mr. Coley even reported East Coast’s profit and loss on his individual tax return. Yet, in his deposition testimony, Mr. Coley could not explain the amounts that he received from his LLCs as salary and other income.  ….

Funds also were transferred freely among the LLCs. For example, South Raleigh and East Coast collected the rental revenue on properties owned by ITT, but South Raleigh and East Coast then transferred that revenue, less their expenses, to ITT as profit. Mr. Coley failed to explain why the revenue did not go directly to ITT, the owner of the properties. And when asked why certain transfers of funds also were made from ITT to one of the other LLCs, Mr. Coley had no explanation.

Mr. Coley also testified that payments for ITT’s “major expenses” frequently were transferred from another LLC to ITT. He stated that these expenses included “major thing[s] like taxes, insurance, taxes, we make sure it’s all paid out of [ITT].” Other expenses, however, were paid by another LLC, without passing through ITT. For example, Mr. Coley speculated that certain checks written from the South Raleigh account might have been used to pay “HOA fees” on the properties owned by ITT. Yet, he stated confusingly that those checks “are paid to South Raleigh Air. [But t]hey are [ITT’s] money.” Still other funds from Mr. Coley’s LLCs were used to pay loans on two vehicles for which Mr. Coley personally was the borrower.

Finally, the LLCs also made payments on mortgages for properties owned by ITT. Mr. Coley testified that on one such property, East Coast made payments on the mortgage loan, but that he and his wife were the borrowers. South Raleigh also made mortgage payments on a separate property owned by ITT, for which Mr. and Mrs. Coley were the borrowers. Moreover, even the mortgage on Mr. Coley’s personal residence was paid by one of his LLCs. Nevertheless, Mr. Coley took the mortgage interest deduction on such properties on his personal tax return. This cumulative evidence strongly indicates that Mr. Coley and his LLCs were in fact a single economic entity utterly dominated and controlled by Mr. Coley. We also conclude that an “overall element of injustice or unfairness” is present in this case, because DIRECTV has not received any payment on its judgment against Mr. Coley although the district court found Mr. Coley liable over four years ago. We therefore hold that the district court’s finding that ITT and Mr. Coley are alter egos was not clearly erroneous.

Id. at *8-9 (citations and footnote omitted)

Jurisdiction Over the Pierced LLCs

Coley asserted that as the LLCs who are subject to being pierced were not parties to the action, the judgment cannot be enforced against them. The court quickly dispatched this argument, holding, inter alia, that if there was jurisdiction over the judgment-debtor, with respect to each business organization who is the judgment-debtor’s alter ego, there exist jurisdiction over the alter ego. Therefore, while “service of process is a precondition to the court’s exercise of personal jurisdiction over a defendant.”, “When a court has engaged in traditional veil piercing, the court may exercise personal jurisdiction vicariously over an individual, if the court has jurisdiction over the individual’s alter ego company.” Id. at *9.

All in all a quite satisfying decision.

On Charging Orders, Bankruptcy, and the Scope of the Automatic Stay

On Charging Orders, Bankruptcy, and the Scope of the Automatic Stay

      In a recent decision out of Louisiana, the Federal District Court, sitting as the appellate court from a Bankruptcy Court, pointed out some important issues to be considered in connection with the bankruptcy of an individual member of an LLC and the scope of the automatic stay. In this instance, certain of those important matters had not been fully considered by the Bankruptcy Court. For that reason, remand was ordered. In the Matter of: Thomas Mack and Mary Susan Mack, Civ. Act. No. 17-3587, 2018 WL 1532979 (E.D. LA. March 29, 2018).

 

Consequent to some financial setbacks, Thomas Mack, along with certain others, was held liable to First Bank for some $400,000 plus attorneys’ fees and additional collection costs. Mack, in turn, was a member in two LLCs, but the only one relevant to the opinion was Matrix Hospitality Group, L.L.C. Therein, he held a 60% membership interest, and apparently it was only through Matrix that Mack had any income, specifically:

Mack is paid by Matrix in three ways: (1) a monthly salary as a 1099 employee; (2) a periodic disbursement of profits as a part-owner; and (3) a performance bonus paid in April by particular clients if Matrix is able to meet client-set goals.

Seeking to collect on the judgment debt of approximately $400,000, First Bank sought a charging order against Mack’s interest in Matrix. The charging order was awarded and served on the company, but it failed to respond in accordance with Louisiana procedure. In addition, Matrix made distributions to Mack after the charging order was served. When legal action was then initiated against Matrix, Mack (both Thomas and Mary Susan) filed for Chapter 11 bankruptcy. At that point, the value of First Bank’s judgment had increased to $789,212.85.

From there the chronology of what happened gets somewhat confusing. What is known is that, on January 31, 2017, First Bank moved for relief from the automatic stay. Ultimately that relief was denied.

The reason this is confusing is that when a member files for bankruptcy, and the LLC is not itself in bankruptcy, and activities of the LLC are not automatically subject to the automatic stay there is an exception to this rule when, in the presence of “unusual circumstances,” “there is such identity between the debtor and the third-party defendant at the debtor may be said to be the real party defendant and that a judgment against the third-party defendant will in effect be a judgment or finding against the debtor.” 2018 WL 1532979, *3. In those circumstances, the automatic stay may extend to a non-debtor, in this instance Matrix. In this instance, however,:

The Court is unable to evaluate the Bankruptcy Court’s decision in denying the modification of the scope [of the automatic stay] because the Bankruptcy Court never made a finding on whether the scope of the stay included Matrix. Although it is arguably implied that the Bankruptcy Court determined that it did because it denied First Bank’s motion for relief, neither party raised the issue and the Bankruptcy Court did not state on the record whether the automatic stay applies to Matrix. Further, the Bankruptcy Court held that First Bank had the burden to modify the automatic stay, but the appellees [i.e., Mack], the parties seeking to maintain the stay, actually had the burden. The Bankruptcy Court failed to apply the appropriate standard to determine if modifying the stay was appropriate. Because the Bankruptcy Court did not require the appellees to meet their burden, the factual record is not sufficiently developed for this Court to determine whether the circumstances justify the rare finding that the stay applies to non-debtors [i.e. Matrix].

Id. (bracketed language added).

So the matter will go back to the Bankruptcy Court to determine whether Matrix and Mack are of such unitary interests that First Bank cannot, outside of the bankruptcy proceedings, seek to enforce its judgment by means of a charging order.

Fiduciary Duties Not Limited to Members In An LLC

Fiduciary Duties Not Limited to Members In An LLC

In a recent decision from Illinois, there applying Delaware law, the court considered and rejected the suggestion that not being a member in an LLC precludes fiduciary duties. Rather, the court found that the defendant, who had been an employee of the plaintiff LLC, may have violated fiduciary obligations arising consequent to the employment relationship. Act II Jewelry, LLC v. Elizabeth Ann Wooten, Case No. 15 C 6950, 2018 WL 1316715 (N.D. Ill. March 14, 2018).

The defendant Wooten was the Vice President of Product Development for Act II Jewelry, LLC, a company that marketed and sold jewelry through a sales representative network who held parties in customer homes. At the end of 2014, Act II determined that it was going to wind down its business model. Before that announcement, however, Wooten had organized a new LLC with the intention that it engage in the jewelry business through the direct sale model.

After addressing and resolving the question as to whether Illinois, where Wooten was located, or Delaware, where Act II was organized, law should apply, ultimately determining that it should be Delaware, the question became whether Wooten’s conduct, in setting up a new venture while still an employee of Act II violated her fiduciary obligations. Wooten defended on the basis that “only controlling members and managers of an LLC who are named as such in the LLC’s operating agreement owe fiduciary duties to the company.” 2018 WL 1316715,*7. Having never been a member or manager in Act II, she continued, no fiduciary duties could arise. The Court rejected this argument, holding rather that the allocation of fiduciary obligations among the members and the managers of an LLC pursuant to the Delaware LLC Act “does not govern the duties owed by employees who are not parties to the LLC’s operating agreement (or even those addressed within it).” Id. Rather:

Employees are not governed by an LLC’s operating agreement, but rather by employment contracts and traditional rules of agency. Many employees never read the operating agreement of the LLC and certainly have nothing to do with ownership decisions, even if the role they play in the business is vital. The LLC’s operating agreement may modify fiduciary duties imposed by the parties to that agreement, but to widen its control beyond what is specifically contemplated - especially to completely eradicate the entire doctrine of agency - goes too far.

Id. The court reviewed a variety of decisions which stand for the proposition that employees may owe fiduciary obligations to the employer, those obligations arising out of the law of agency. On that basis, rejecting Wooten’s motion for summary judgment seeking the dismissal of the fiduciary duty claims, the court wrote:

Thus, Wooten, may owe fiduciary duties to Act II if the plaintiff established that she was a key managerial employee and/or an agent of Act II. Whether those duties were breached we leave for another day.

Id., *8

Stoll Keenon Ogden at the Spring Meeting of the ABA Section of Business Law

Stoll Keenon Ogden at the Spring Meeting of the ABA Section of Business Law

Next week, the Section of Business Law of the American Bar Association will be meeting in Orlando. At the meeting, Lea Goff will be part of a panel discussing bankruptcy remote structures. A.J. Singleton will be on a panel discussing legal ethics and who is the client when an attorney is representing an LLC. I will be involved in several programs of the LLCs/Partnership Committee and the Corporate Laws Committee.

Kentucky Tax Reform

Kentucky Tax Reform

Tim Eifler and others in the State & Federal Tax Practice Group of Stoll Keenon Ogden have prepared a comprehensive review of H.B. 366, the 2018 Tax Reform. This new law occasions numerous significant changes to the tax law including the imposition of sales tax on a variety of services, changes in corporate and individual tax rates, a change in the apportionment formula and the elimination of the angel investor program.

HERE IS A LINK to this review.

The Obligation of Good Faith and Fair Dealing Versus Hanaway

The Obligation of Good Faith and Fair Dealing Versus Hanaway

Last year, the Pennsylvania Supreme Court, in considering challenges to actions taken by the general partner of a limited partnership, held that the contractual obligation of good faith and fair dealing is not applicable in limited partnership agreements formed under what are now the prior statutes. Characterizing limited partnership agreements as being different than typical contracts, the court found that they do not include the implied contractual covenant of good faith and fair dealing because the controlling Limited Partnership Act did not impose that obligation in limited partnership agreement. This is in contrast with the most modern of those statutes, which expressly incorporates the implied covenant of good faith and fair dealing.

My personal view is that this decision is simply wrong, and that every limited partnership agreement, as a contract, incorporates the obligation of good faith and fair dealing. The Journal of Passthrough Entities last week released my review of the Hanaway decision; HERE IS A LINK to that article.

Kentucky Tax Reform

Kentucky Tax Reform

            The General Assembly has approved and sent to the Governor significant changes in Kentucky’s tax code.  HERE IS A LINK to the review prepared by Dean Dorton Allen Ford.