That’s Not Funny

That’s Not Funny

      Today marks the anniversary (well, it was a leap year, so February 29) of the death in 468 of Pope Hilarius.

If It Is Not In Writing It Did Not Happen

If It Is Not In Writing It Did Not Happen

      The main take away from a Ohio decision delivered last November is that where the statute requires that a particular action, in this instance the admission of a new member to an LLC, be in writing, when it is not in writing it did not happen. B. T. Environmental Solutions, L.L.C. v. B.T. Energy Group, Inc., No. 17 CO 0010, 2018 WL 6719424 (Ohio Ct. App. Seventh Dist. Dec. 10, 2018).

      In 2012, Steven Beight and David Tod, Jr. decided to start a brine water removal company. In furtherance thereof, Beight filed articles of organization with the Ohio Secretary of State, creating B.T. Environmental Solutions, L.L.C. There was no written operating agreement at the time of B.T.’s organization, even as Beight and Tod were the only members of the company. One of the objectives of the company was to acquire a piece of property in Pennsylvania referred to as the “Essroc Property.” Shortly after the LLC’s formation, a checking account was opened in its name to which Beight deposited $100. Shortly thereafter, Tod deposited $5,000 into the account, and not long thereafter Tod’s father deposited $50,000 in that checking account.

      A law firm was retained for the purpose of drafting an operating agreement, but for reasons not explained the draft was not produced until August 2012. Ultimately, no written operating agreement was ever a finalized.

      In the spring of 2012, the plaintiffs in this action, Daniel J. and Daniel P. O’Horo, agreed to contribute another $500,000 to B.T. Environmental Solutions. There was apparently no agreement as to what would be the exact nature of this contribution and what the O’Horos would receive in return.

      And then, so to speak, the wheels really fell off the relationship:

With this $500,000 influx of funds, the B.T. checking account contained approximately $555,100. Tod, Jr. believed the parties would not spend B.T. funds, except for the salaried employee and truck, until they had all of the requisite funds secured in order to purchase the Essroc Property. However, at some point Tod, Jr. learned that Beight had purchased vehicles in his name using B.T. funds and had paid himself a salary. The parties disagreed about Beight’s ability to spend the funds, causing the parties’ relationship to deteriorate.

      A year later, in August of 2013, the O’Horos filed suit individually and on behalf of B.T. Environmental. Then Beight brought a third party complaint against Tod seeking a variety of relief, to which Tod filed counter and cross-claims. There followed a bench trial in which, as addressed in this opinion, the court held that the O’Horos did not have standing on behalf of B.T. Environmental bring a derivative action, the basis for that determination being that they were not members of B.T. Environmental. They appealed on the basis that they were in fact at least de facto members of the LLC, an assertion rejected by the Court of Appeals.

      Under the Ohio LLC Act, a “member” is “a person whose name appears on the records of the [LLC] as the owner of a membership interest in that company.” Ohio Code § 1705.01(G). Under the Ohio LLC Act, § 1705.14(B), there are set forth the rules for the admission of a member of an LLC when they are not one of the initial members at the time of formation. This statute requires, inter alia, that the admission of those new members must be set forth in a written instrument. Specifically, it provides:

After the filing of the articles of organization of a limited liability company, a person may be admitted as an additional member in either of the following ways:

(1) If he acquires an interest directly from the limited liability company, upon compliance with the operating agreement or, if the operating agreement does not so provide, upon the written consent of all of the members;

(2) If he is an assignee of the interest of a member who has the power as provided in writing in the operating agreement to grant the assignee the right to become a member, upon the exercise of that power and compliance with any conditions limiting the grant or exercise of the power.

      In this instance, the O’Horos admitted they were not part of the initial membership group of the LLC, but rather that they were subsequently (at least they argued) admitted as members of the company. They did not have, however, a written instrument recording that admission. The statutory requirement of a writing not having been satisfied, it was held that the O’Horos were not members. As such, they lacked standing to bring a derivative action.

      Not addressed by the opinion is whether and by what mechanism the O’Horos may recover the $500,000.

      There was a dissenting opinion that would have found that the O’Horos were “de facto” members in the LLC.

      The Kentucky LLC Act contains a provision, KRS § 275.275, that reflects the same theme as does the Ohio statute applied in the B.T. Environmental decision. That provision of the Kentucky LLC Act provides:

(1) Subject to subsection (2) of this section, a person may become a member in a limited liability company:

(a) In the case of the person acquiring a limited liability company interest directly from a limited liability company, upon compliance with an operating agreement or, if an operating agreement does not so provide in writing, upon the written consent of all members; and

(b) In the case of an assignee of the limited liability company interest, as provided in KRS 275.255 and 275.265.

(2) The effective time of admission of a member to a limited liability company shall be the later of:

(a) The date the limited liability company is formed;

(b) The time provided in the operating agreement or, if no time is provided, when the person's admission is reflected in the records of the limited liability company; or

(c) The time the member is admitted under KRS 275.285(4).

      Persons becoming members of an LLC after its initial formation need to be aware of the requirement of writing and insist upon a clear agreement as to what is being received in consideration for whatever capital contribution they might be making. Absent compliance with the writing requirement, they may find that they are not members. This burden is in addition to other necessary due diligence such as the review of the operating agreement, etc.

Statute Discriminating Against Foreign Corporations and LLCs Struck Down

Statute Discriminating Against Foreign Corporations and LLCs Struck Down

      In a decision rendered last September, the Federal District Court in North Dakota considered the validity of a statute that allowed corporations and LLCs, organized in North Dakota, subject to some additional requirements, to engage in farming, while at the same time precluding corporations and LLCs organized in states other than North Dakota from likewise engaging in farming activities. This statue was struck down for violation of the Commerce Clause of the U.S. Constitution. North Dakota Farm Bureau, Inc. v. Stenehjem, __ F. Supp. 3d __, 2018 WL 4550391 (D. N.D. Sept. 21, 2018).

      North Dakota has a statute that generally precludes farming activity through a corporation or LLC. There exists, however, a “family farm exception” to this exclusion. As part of its requirements, the corporation or LLC must be organized in North Dakota. This limitation was challenged on the basis of the dormant Commerce Clause, which limits the ability of the states to raise barriers to interstate commerce, thereby precluding the “economic Balkanization” of the various states. In this instance, it was found that the requirement that the corporation or LLC be organized in North Dakota violates the dormant commerce clause as it “would clearly discriminate against out-of-state interest in violation of the dormant Commerce Clause under current Eighth Circuit case law.”

First, Who Owes What Fiduciary Duties To Whom?

First, Who Owes What Fiduciary Duties To Whom?

      The recent decision from Texas highlights the importance of clarifying exactly who owes fiduciary duties to whom. If no duty is owed to the plaintiff, it follows there can be no breach of duty. Jang Won Cho v. Kum Sik Kim, No. 14-16-00962-CV, 2018 WL 6836199 (Tex. Ct. App. 14^th Dist. Dec. 28, 2018).

      This case arose out of a failed real estate venture organized through a limited partnership. The three persons involved, Lee, Cho and Kim, were all shareholders in a corporation that was in turn the general partner of the limited partnership. Cho was the sole director of that corporation. When the venture ultimately failed, Kim and Lee brought suit against Cho alleging breach of fiduciary duty and other claims. The court would dismiss the claims based upon the breach of fiduciary duty.

      With respect to the assertion that Cho, as a corporate director, breached a fiduciary duty, the court found that Cho owed fiduciary duties to the corporation, but not to the individual shareholders. Further, Kim and Lee could not bring claims against Cho in his capacity as a shareholder because Texas law does not recognize fiduciary obligations amongst the shareholders of a closely held corporation.

      With respect to the limited partnership, the court acknowledged that the corporate general partner would owe fiduciary duties to the individual limited partners, citing in support Crenshaw v. Swenson, 611 S.W.2d 886, 890 (Tex. Civ. App. - Austin 1980). From there, however, the court noted that the general partner was the corporation, not Cho as an individual. Thus, while the corporation may have owed fiduciary duties to Lee and Kim in their capacities as limited partners, Cho the individual did not.

Hold the Date - The 2019 LLC Institute

The 2019 LLC Institute

 

 

SAVE THE DATE

 

The 2019 LLC Institute has been scheduled for

 

November 7-8, 2019

 

In Tampa, Florida

 

The Institute will be held at Stetson University College of Law

 

More details to follow, but for now please block out these dates

New York Court Applies the Near “Absolute Privilege” to Claims of Defamation in Litigation

New York Court Applies the Near “Absolute Privilege” to Claims of Defamation in Litigation

      In a posting drafted by Franklin C. McRoberts in Peter Mahler's blog New York Business Divorce, he reviews a recent New York decision that consider whether certain statements made in the course of family business litigation gave rise to claims of defamation and slander. Applying the “ancient law” of “absolute privilege” (as explained therein, absolute is a little overly broad), it was found that the statements made in this lawsuit were privileged. That posting is titled Sue for Dissolution - Get Sued For Defamation?; HERE IS A LINK to that posting.

Failure to Disclose Principal Exposes Shareholders to Personal Liability

Failure to Disclose Principal Exposes Shareholders to Personal Liability

      It is practically axiomatic that the shareholders are not liable for the debts and obligations of the corporation. The “practically” is, however, crucial. The rule of limited liability as set forth in the various business corporation statutes is that, essentially, the shareholders are not liable for the debts and obligations of the corporation merely because they are shareholders. There are, however, a variety of other ways in which a shareholder may expose themselves to personal liability. In a recent case from Nebraska, the shareholders were held liable on what would have been a corporate debt because they never adequately disclosed that it was a corporation that was incurring the obligation.  Thomas Grady Photography, Inc. v. Amazing Vapor, Ltd., 918 N.W.2d 853 (Neb. 2018).

      Calderon and Anderson formed “Amazing Vapor, Ltd.” as a corporation in March, 2014. Thereafter, Anderson contacted Thomas Grady, a commercial photographer he had met several years previously, about photographing some of the electronic vapor products being sold by Amazing Vapor. The trial court accepted “that Anderson did not inform Grady of the corporate status of Amazing Vapor.” Ultimately, Grady would submit an invoice for $2,400.00, which went unsatisfied. After Grady declined a request to pay a reduced fee in consideration for future work, Grady brought suit against Calderon and Anderson as well as Amazing Vapor. While a default judgment was entered against the corporation and Calderon, Anderson represented himself, alleging that he was the minority owner of Amazing Vapor and that “Calderon closed the business, took the inventory and started his own business at an undisclosed location.”

      The trial court imposed personal liability against Anderson on a variety of theories including piercing the veil and the fact that Anderson had taken distributions during the time when the company was indebted to Grady. Under Nebraska law, as is the law under most states, a distribution may not be made if the company is not able to pay its debts as they come due in the usual course of business. Neb. Rev. Stat. § 21-252(c)(1). In addition, there was evidence presented that Anderson had referred to Calderon as his “partner.”

      The decision of the trial court was appealed to the District Court where it was affirmed, whereupon it was appealed again to the Nebraska Supreme Court.

      The Nebraska Supreme Court, while setting aside the determination based on piercing principles, affirmed the liability of the basis of agency and the failure to identify the corporation as the party entering into the agreement. The Nebraska Supreme Court wrote:

The cases provide that it is the agent’s duty to disclose his or her capacity as an agent of a corporation if the agent is to escape personal liability for contracts made, and in the absence of such disclosure, the agent bears the burden of proof of showing that the contract was made while acting in a corporate, not individual, capacity. See, Purbaugh v. Jurgensmeier, 240 Neb. 679, 483 N.W.2d 757 (1992); 3 C.J.S. Agency § 565 (2013). The uncontradicted testimony at trial was that neither Calderon nor Anderson disclosed Amazing Vapor’s incorporated status during discussions leading up to the agreements. In text messages, Anderson referred to Calderon as his “partner.” At Anderson’s request, Grady sent the March 27, 2014, invoice to Anderson’s personal or attorney email, not an address associated with Amazing Vapor. The invoice reads, “Art Buyer: Tom Anderson & Manny Calderon Client: Amazing Vapor,” indicating that Grady believed the buyers were Calderon and Anderson for their client, Amazing Vapor. After the invoice remained unpaid after several attempts to collect on the contract, Grady texted Anderson: “You are also part owner. It’s time for you to pay and take it up with [Calderon] on your own.... [Y]ou are responsible for hiring me ... and therefore you are responsible just as much as [Calderon].” The series of communications between Grady and Anderson leading up to and following the photography services supports the county court’s finding of a breach of two oral agreements for which Anderson was liable, and we find no plain error with regard to the district court’s affirmance thereof.

      Cases such as this pop up with far more familiarity than they should. The rule is simple; the agent has the responsibility to tell the person with whom the contract is being entered into who is the principal undertaking the obligation. Handing over a business card providing the full name of the business entity and the title of the agent may be all that is necessary in order to satisfy that obligation. Also, while not directly relevant to this case as the contracts were oral, agents should be sure that the signature blocks on documents clearly identify the party to the agreement as the business entity, and that the agent signature is in that capacity. For example, “Bob Smith, as president of ABC, Inc.” makes clear who is the principal and the capacity of the signatory.”

The Death of Michelangelo

The Death of Michelangelo

 

      Today marks the anniversary of the death in 1564 of Michelangelo Buonarroti.

 

      Originally trained by means of an apprenticeship in sculpture, he had previously spent time as well living with the family of a stone mason.  While living with the mason he was struck and his nose was broken; the consequences of the mishap can be seen thereafter in his portraits.  Before reaching the age of thirty, Michelangelo created any number of significant works, including the Pieta, now in the Vatican, and his statue of David, which remains in Florence.  He as well created the statue of Moses with Horns (the horns being based upon a translaion error in the Bible) that is a portion of the tomb of Pope Julius II; the final tomb was far smaller than intended.

      He was a contemporary of Leonardo da Vinci, Raphael and Titian.

      Although throughout his life he claimed he was a sculptor and not a painter, Michelangelo created innumerable paintings, most memorably the frescos on the ceiling of the Sistine Chapel and as well as the Last Judgment painted on the alter wall of the chapel.  Famously, Michelangelo’s portrait appears in the latter, appearing on the flayed skin of St. Bartholomew.  Today, the Cardinals of the Roman Catholic Church gather under those paintings when called upon to elect the next Bishop of Rome.

 

      Michelangelo had also been commissioned (although the work was never put in place) to provide a new façade to a basilica in Florence and as well served as the architect for St. Peter’s Basilica in Rome.  With respect that second project, much of the current shape of the basilica is his invention as is the design of the dome.

      While he died in Rome, Michelangelo was buried in Florence. As recorded by Vasari:

 

They [those gathered for his funeral] did so eagerly that those who could approach near and get a shoulder under the bier could indeed count themselves fortunate, for they realized that in the future they would be able to boast of having carried the remains of the greatest man their arts had ever known.

 

     February 18 is also the anniversary of the death in 1546 of Martin Luther.  Following the admonition that if you don’t have anything nice to say about somebody you should say nothing , ....

2018 In Review

2018 In Review

      CT Corporation has prepared a short 2018 In Review addressing business law developments across the country, whether legislative or judicial. HERE IS A LINK to that document.

Missouri Court Interprets Operating Agreement, But Sets Up a Foot Fault as to a Member’s Disassociation

Missouri Court Interprets Operating Agreement, But Sets Up a Foot Fault as to a Member’s Disassociation

      In this recent decision from the Missouri Court of Appeals, it was called upon to apply an operating agreement and the LLC Act to a dysfunctional two-member company. Nicolazzi v. Bone, No. ED 106292, 2018 WL 6052144, 564 S.W.3d 364 (Mo. Ct. App. Div. 4 Nov. 20, 2018).

      Nicolazzi and Boone were the members in Spirit Adult Day Care, LLC, it formed in 2005. The company had a written operating agreement, it providing that each member would contribute $50,000 to the LLC. The agreement did not, however, set a deadline for making those capital contributions. At trial, the LLC’s CPA testified that Bone contributed in excess of $50,000, while Nicolazzi contributed only $25,700. In 2011 Nicolazzi inquired of a competitor whether they would like to buy his interest in the LLC. It would appear those discussions went nowhere. Over 2011 the relationship between Nicolazzi and Bone “steadily deteriorated,” and Nicolazzi ultimately ceased to participate in the LLC’s activities. The opinion does not specify whether or not the operating agreement detailed the job responsibilities of the members and their commitment to provide services. On June 20 Bone filed articles of incorporation for a new corporation named “Young in Spirit Adult Day Care Center, Inc.,” and the next day advised Nicolazzi that she was dissolving the LLC. The operating agreement, addressing involuntary dissolution, provided “Either Member may initiate a dissolution of the LLC after 30-days’ written notice to the other Member in which case the affairs of the LLC shall be wound up as soon as is reasonably possible and all remaining assets divided as provided for by law.” Shortly after receiving notice of Bone’s plans, Nicolazzi filed suit, requesting:

·         a determination as to whether Bone was a member of the LLC;

·         whether Bone had misappropriated LLC assets or herself and the new corporation;

·         for the recovery of distributions to Bone exceeding her 50% interest in the LLC;

·         for an accounting; and

·         for a constructive trust.

      Bone counter-claimed, asking for a ruling that Nicolazzi  was not a member of the LLC because he:

·         failed to make the required $50,000 capital contribution;

·         failed to participate in the LLC’s management;

·         breached the operating agreement by soliciting the purchase of his interest without Bone’s consent; and

·         fraudulently misrepresented the amount of his capital contribution.

      A bench trial followed, ending on October 9, 2012. Judgment was entered on November 1, 2017. Ultimately, Bone prevailed, it being found that Nicolazzi had breached the LLC’s operating agreement both by failing to make the required capital contribution and soliciting the sale of his interest in the company without Bone’s consent. The trial court deemed those breaches as constituting “events of withdrawal” from the LLC to the effect that Nicolazzi he was no longer a member of the LLC. That left Bone as the sole member of the LLC. It was also found that all payments due to Nicolazzi that were due and owing had been satisfied. This appeal followed.

Nicolazzi was a Member in the LLC

      Based upon the operating agreement’s recitation that Nicolazzi (as well as Bone) were the members of the LLC, and that the operating agreement did not set any additional prerequisites or conditions to being a member, Nicolazzi was a member: “As [Nicolazzi] is named as a member of the LLC in the operating agreement and sign the operating agreement when the LLC was formed, he was a member of the LLC from that point onward.”

Nicolazzi Breached the Capital Contribution Obligation

      While, at trial, Nicolazzi and his expert had testified that he had contributed in excess of $50,000 to the venture, the LLC’s CPA testified that he had not done so. The trial court accepted the testimony of the LLC’s CPA. Addressing that determination, the appellate court wrote that “We defer to the trial court’s findings of fact in a court-tried case.” On that basis, it was determined that Nicolazzi had failed to satisfy his obligation to contribute $50,000 to the LLC. With respect to the absence, in the operating agreement, of a deadline for making the contribution, it was written:

and even though there was no deadline in the operating agreement or Appendix A for when the parties were required to make the initial capital contributions, we need not analyze the meaning of the word “initial” as used in the operating agreement here. At trial, it was established that both parties intended and understood that “initial,” as used in “initial capital contribution,” meant the agreed upon amount of $50,000 would be paid within six months of the execution of the LLC’s operating agreement; as such, we give effect to that intent. …. Further, under any definition of the word “initial,” [Nicolazzi’s] failure to make the required $50,000 capital contribution within a five-year time span, as the trial court found, undoubtedly constitute breach of the operating agreement. 2018 WL 6052144, * 6.

Nicolazzi Did Not Breach the Operating Agreement by Soliciting a Sale of His Interest

      The LLC’s operating agreement provided that a member could not sell his or her interest in the LLC without the consent of the other member. The trial court had found that Nicolazzi, by soliciting a potential sale of his interest, had breached the operating agreement. This determination was set aside on appeal; “We find that this conclusion is an erroneous application of the law.” Id. Rather, the court found that while consent was required to actually consummate a sale or other transfer, those provisions did not prohibit or even address an attempt to sell or discussion of the sale of an interest. Id.

Nicolazzi Did Not Withdraw From the LLC; Bone is Not the Sole Member

      The determination that Nicolazzi had withdrawn from the LLC was set aside on the basis that none of his actions fell within any of the statutory events that constitute a withdrawal from the LLC; the operating agreement itself did not define what would constitute a withdrawal. Specifically, it was found that while he had breached the obligation to make his capital contribution, that breach did not constitute withdrawal.

And Then the Court of Appeal Sets Up the Foot Fault

      Continuing its analysis of whether or not Nicolazzi had withdrawn, the Missouri Court of Appeals unfortunately set up a foot fault as to withdrawal.  As do many LLC Acts, that of Missouri, at § 347.123(4)(c), identifies the events of withdrawal as including:

Unless otherwise provided in the operating agreement whereby specific consent of all members at the time, the member … files a petition or answer seeking for himself any reorganization, arrangement, composition, readjustment, liquidation or similar relief under any statute, law or regulation.

       And here’s where the problem is set up. The Court of Appeals wrote that, notwithstanding the question needs to be resolved by the trial court:

We remand this case with instructions for the trial court to determine whether [Nicolazzi’s] filing of his petition constitutes an “event of withdrawal” pursuant to § 347.123(4)(c).

      First, it is unclear how the relief sought by Nicolazzi would fall within any of the categories referenced in this statute. Second, these provisions apply with respect to a member of the LLC (“for himself”) and not with respect to the LLC itself. At least two courts, namely Darwin Limes, LLC v. Limes, No. WD-06-049, 2007-Ohio-2261, 2007 WL 1378357 (Ohio Ct. App. 6^th Dist May 11, 2007) and Sayers v. Artistic Kitchen Design, 633 S.E. 2d 619 (Ga. App. 2006) have already made clear that language of this nature refers to the member itself, and does not extend to actions vis-a-vie the LLC such as moving for its judicial dissolution.

Employment Supervisor Relationship Is Not a Fiduciary Relationship

Employment Supervisor Relationship Is Not a Fiduciary Relationship

      A recent decision from Colorado considered whether an employee’s relationship with her supervisor created a fiduciary relationship. It did not. Grays v. Granicus, LLC, Civ. Act. No. 18-CV-02271-CMA-NRN, 2018 WL 6788150 (D. Colo. Dec. 26, 2018).

      Grays was an employee of Granicus where she reported to Richey. Grays was terminated from employment, and brought this action alleging a variety of claims, including breach of fiduciary duty. Specifically, Grays alleged that Ritchey “was acting as a fiduciary of the Plaintiff, with respect to the Plaintiff’s position and employment at Granicus, LLC.” The court characterized this claim as “deficient.” 2018 WL 6788150, * 9. Specifically, the court found that:

Ms. Grays fails to allege that Ritchey was acting as Ms. Grays’ fiduciary. There is no allegation that a fiduciary relationship was established by law. Ritchey was merely Ms. Grays’ supervisor. This type of common supervisor/subordinate relationship is not one to create any type of “special trust for competence” between the parties. Ritchey was not tasked to act in Ms. Grays’ interest, nor did she exercise “substantial control” or exert “extensive influence over Ms. Grays.” Accordingly, Ms. Grays fails to state a breach of fiduciary duty claim against Defendant Ritchey, and this claim should be dismissed.

Jurisdictional Piercing

Jurisdictional Piercing

      In a case from last year, a federal district court in California applied the law of “jurisdictional piercing” in order to find that it had personal jurisdiction over an individual. Platypus Wear, Inc. v. Bad Boy Europe Ltd., Case No. 16-CV-02751-BAS-DHB, 2018 WL 3706876 (S.D. Ca. Aug. 2, 2018).

      Platypus Wear and Deep Blue Sports entered into a license agreement. That agreement included provisions calling for the application of California law and agreeing that the parties consented to jurisdiction of the courts in San Diego County in California. In 2013, that agreement was assigned to Bad Boy Europe. In 2013 an audit was performed, which purported to show that Platypus Wear was owed in excess of $300,000 by Bad Boy Europe and Deep Blue Sports exceeding $300,000. In 2015, the agreement was renegotiated by Paul Gardner, until then a director and officer of Bad Boy. After Gardner’s resignation, Platypus Wear became aware that Bad Boy was in dire financial condition. When suit was ultimately brought in San Diego, Gardner asserted that the court lacked personal jurisdiction over him.

      Applying a long-arm analysis, the court found that it had personal jurisdiction over Gardner based upon his contacts with California.

      The court then turned its attention to the “fiduciary shield doctrine,” which generally provides that “a person’s mere association with the corporation that causes injury in the form state is not sufficient in itself to permit that form to assert jurisdiction over the person.” 2018 WL 3706876, * 7, quoting Davis v. Metro Prods, Inc., 885F. 2d 515, 520 (9^th Cir. 1989). Because of that limitation, the court undertook an analysis of whether Gardner was the alter ego of either of the subject business corporations, thereby justifying piercing the veil and thereby holding him subject to personal jurisdiction in California. Holding that the plaintiff need only make a prima facia showing of alter ego in order to justify jurisdictional piercing, the court wrote:

Plaintiff makes a prima facie showing that there is a unity of interest between Gardner, Deep Blue Sports, and BBE sufficient for alter ego liability. Plaintiff alleges that Gardner was the sole owner, stockholder, and managing director of both Deep Blue Sports and BBE. In addition, the two companies share the same office and employees, operate the same type of business, and Gardner freely transferred assets between them. Plaintiff also alleges that BBE sold products on a website registered to Deep Blue Sports and Gardner. Finally, Plaintiff alleged that Deep Blue Sports and BBE failed to observe corporate formalities, that BBE was so undercapitalized that it was illusory, and that BBE was a mere shell company without capital, assets, or stock, and was used a device to avoid liability. The Court finds that these allegations demonstrate a unity of interest between Gardner, Deep Blue Sports, and BBE. See Flynn, 734 F.2d at 1393. Thus, Plaintiff establishes a prima facie showing that separate personalities of the companies and Gardner do not exist, and rather they are alter egos. Plaintiff also makes a prima facie showing that failure to find alter ego liability would result in injustice. Because Plaintiff alleges that Gardner engaged in asset stripping and using BBE as a device to avoid liability, failure to find alter ego would allow Gardner to succeed in his alleged fraudulent scheme to avoid liability. Gardner allegedly placed BBE’s assets in Deep Blue Sports’s name, and simultaneously negotiated with Plaintiff to release Deep Blue Sports from liability for its past debts without disclosing the asset transfer to Plaintiff. Plaintiff remained under the impression that BBE was adequately capitalized to operate as a business and maintain a prosperous relationship. Based on these allegations, Gardner may be liable for Deep Blue Sports and BBE’s contract breach and subsequent debts, especially if he caused BBE’s insolvency to the detriment of its creditors, like Plaintiff. If the allegations against Gardner, Deep Blue Sports, and BBE prove to be true, then adhering to the fiction of their separate existence would permit an abuse of corporate privilege. As suggested by Plaintiff, it would be inequitable for Gardner to escape liability to Plaintiff by virtue of his fraudulent scheme. And though Gardner contests Plaintiff’s claims of fraud and asset stripping, for jurisdiction, “the plaintiff need only demonstrate facts that if true would support jurisdiction over the defendant.” Unocal, 248 F.3d at 922.

      Speaking for myself, and this is a topic on which I need to do some more research and an expanded discussion, decisions such as this are analytically flawed in that this is a misapplication of piercing law. Piercing is not a cause of action, but is rather a remedy by which individual owners of the business venture may be held personally liable on the venture’s debts. Because piercing sets aside the statutory rule of limited liability, high thresholds are required for its application. When courts use piercing in order to exercise personal jurisdiction over the constituents of the business, they are applying a post-judgment remedy as substantive law. In addition, they are doing so without a developed factual record, but based only upon the assertions of the plaintiff. If it is ultimately determined that a defendant is both liable and is unable to satisfy the judgment, there then may be a post-trial determination as to whether or not piercing is appropriate. It should not happen, however, at the beginning of a proceeding.

The Difficulties of Fiduciary Duties in Indiana Corporations

The Difficulties of Fiduciary Duties in Indiana Corporations

 

      A recent decision from Indiana highlights particular challenges that exist in assessing and applying fiduciary duties in an Indiana business corporation.  The decision is an interesting read with respect to the operation as a closely held company that, like so many, spent little effort in satisfying various corporate formalities and consistent attention to the rights and responsibilities of directors, officers and shareholders.   The decision is noteworthy with respect to a claim for breach of fiduciary duty. Tracy v. Minne, Cause No. 3:15-cv-212 RLM, 2018 WL 6583911 (N.D. Ind. Dec. 12, 2018).

 

       Minne had been brought into the company as its white knight manager and investor. By the time of the actions at issue, he, with his wife, was a 50% shareholder in the company, was its president and was on the Board of Directors. In connection with a prior loan of $200,000, he proffered a promissory note and security agreements. He signed it as the lender, and another officer/shareholder, Madison, signed the document on behalf of the company. Madison was declared by the Board of Directors to be the vice president of the company even though the bylaws did not provide for a vice president. The court keyed up the question of whether Minne could rely upon the apparent agency of authority of a corporate officer where the bylaws did not provide for that officer. Ultimately, it was able to avoid that question.

       The court did find, however, that Minne, in tendering the promissory note and security agreement, breached his fiduciary duties to the company. The plaintiffs, the Tracys (the other 50% shareholders), were never advised that the company’s obligation to Minne had been so memorialized. The court wrote:

Nonetheless, Mr. Minne breached the fiduciary duty he owed to the Tracys when he failed to disclose the note and security agreement to the Tracys. As an officer of a close corporation, Mr. Minne owed the Tracys, as shareholders, a duty to deal fairly, honestly, and openly, Rapkin Group v. Cardinal Ventures, 29 N.E.3d at 757, and to act in the honest belief that the action taken was in Phoenix Pallet’s best interests.  G & N Aircraft v. Boehm, 743 N.E.2d at 238. Mr. Minne acted solely in his own interest. Granting himself a security interest in the money he already had put into the company gave his interest priority over investments by the Tracys and Madisons, who were shareholders. Mr. Minne argued that the note and security agreement benefitted Phoenix Pallet because he wouldn’t have put any more money into the business without them, but the evidence presented at trial doesn’t support that contention. Phoenix Pallet couldn’t benefit from the note and security agreement.

That Mr. Minne, as he says, never thought to tell the Tracys is easily believed in light of their lack of involvement after the Kokomo Cracker Barrel meeting. But the fiduciary duty doesn’t ebb and flow with the extent of thought one gives it. Mr. Minne filed his note and security agreement in January 2012, but couldn’t reasonably expect the Tracys to discover those papers as a result. Instead of telling the Tracys that he now held the only non-bank security interest in Phoenix Pallet’s assets, Mr. Minne kept that security interest like an ace up his sleeve for three years. Had he told the Tracys, they, too, could have secured their equipment loan to Phoenix Pallet.

Mr. Minne breached his fiduciary duty to the Tracys as shareholders a second time when he shuttered the company and moved its liquid assets to the Lake City Bank account without notice to the Tracys.

A couple of observations:

Ø  The court treats the fiduciary duties owed by a director or officer of the corporation as being owed to each shareholder notwithstanding that the Indiana Business Corporation Act says that the directors and officers owed a fiduciary duties to the corporation. See Indiana Code § 23-1-35-1 (directors to act “in the best interests of the corporation.”)

Ø  The opinion is somewhat muddled as to whether the breach of fiduciary duty was consequent to the tender and receipt of the note and security interest, the failure to disclose same, or a combination of the two.

Ø  The court seems to find an affirmative fiduciary duty of disclosure rather than an obligation to respond to inquiries when made.

All in all, this decision highlights the difficulty of advising the constituents of an Indiana business corporation with respect to their fiduciary obligations.

 

An Oldie But a Goodie - Rock, Paper Scissors

An Oldie But a Goodie - Rock, Paper Scissors

      Not too long ago, I wrote an article discussing the pros and cons of some atypical dispute resolution mechanisms. Rock Paper Scissors Lizard Spock and Other Innovative Dispute Resolution Mechanisms, 20 J. Passthrough Entities 41 (July/August 2017); HERE IS A LINK to that article.

      Recently, my friend Professor Daniel Kleinberger, retired from MitchellHamlin Law School, stumbled upon and forwarded to me a Kentucky decision in which the utility of rock paper scissors as a mechanism for dispute resolution was discussed (and rejected).

      In Hardin Cty. Sch. v. Foster, 40 S.W.3d 865, 873 (Ky. 2001), the court wrote:

I recognize that, at the trial court level, without stipulating to the material facts, the parties entered into an agreed order stating that “there are no genuine issues of material fact.” Exactly how they reached this conclusion remains a mystery to me, as the only disagreement in this case concerns a fact question. In any event, this Court is not required to engage in make-believe and attempt to resolve this case solely as a question of law because the parties mistook the nature of the issue at the trial court level. While the parties to a case usually may settle the case upon any basis they desire, they cannot, by agreement, bind this Court, or any court, to resolve the issues in a case under a legally impossible standard.  I cannot imagine that this Court would allow the litigants before it to stipulate that a given case be decided by a “best-of-three” match of rock-paper-scissors in the Chambers of the Supreme Court. In my opinion, for this Court to attempt to resolve this matter solely as a legal issue would be every bit as absurd.

     Whether Rock Paper Scissors Lizard Spock would be acceptable is not addressed (but I’m thinking probably not).

More On “Except As Otherwise Provided”

More On “Except As Otherwise Provided”

      Earlier this week, I posted a review of a recent Pennsylvania decision in which it was held that a general statement that the members would make decisions by majority vote is not of itself sufficient to override the statutory default requiring unanimous approval of the members in order to amend the operating agreement. That posting was titled Except as Otherwise Provided: Pennsylvania Court Holds That Rule For Amending the Operating Agreement Was Not Changed;  HERE IS A LINK to that posting.

      Following from what I wrote, Professor Joshua Fershee (West Virginia Lw) has posted on the Business Law Prof Blog a piece titled Entity Lesson: Be Explicit When Changing Default Voting Rules; HERE IS A LINK to that posting. Therein, he reviewed a limited partnership decision from Delaware about the standard to be employed when considering whether an agreement effectively changed a default rule as to a fundamental right.

Bad Faith, Deadlock and Judicial Dissolution

Bad Faith, Deadlock and Judicial Dissolution

      In his blog New York Business Divorce, Peter Mahler has reviewed a recent decision from New York in which the bad-faith petitioner defense to a proceeding seeking judicial dissolution was applied. That posting is titled The Bad-Faith Petitioner Defense Makes Successful Debut in LLC Dissolution Case; HERE IS A LINK to that post.

      New York has long recognized a defense to an action for judicial dissolution where the owner who is claiming they are being oppressed orchestrated the circumstances. In effect keeping those minority owners from benefiting by their own conduct, “the minority shareholder whose own acts, made in bad faith and undertaken with a view toward forcing an involuntary dissolution, give rise to the complaint-of oppression should be given no quarter in the statutory protection.” Matter of Kemp & Beatley, 64 NY2d 63 (1984).

      In this case, Advanced 23, LLC v. Chambers House Partners, LLC, 2019 NY Slip Op 30173(U) (Sup. Ct. NY County Jan. 22, 2019), the subject LLC owned a five-story mixed-use building in Manhattan. The petitioner, who purchased a 50% interest in the LLC in 2013, was adverse to the other 50% owner, a husband and wife who were 94 and 81 years old respectively. The petitioner had, putting it nicely, been intransigent about certain necessary financings and, in doing so, breached the operating agreement, which provided that one of the purposes of the business was to provide residential housing for the members.

      As noted by Peter in his blog, while the court did not specifically employ the label “bad-faith petitioner” defense, the facts and the holding fall within its scope.

Insurance Agents Are For ERISA Independent Contractors

Sixth Circuit Court of Appeals Addresses Whether Insurance Agents Are, For Purposes of the Employee Retirement Income Security Act of 1974 (“ERISA”),
To Be Classified as Employees or Independent Contractors

      In this case, the Sixth Circuit reversed the trial court and held that the insurance agents are independent contractors. Jammal v. American Family Insurance Company, No. 17-4125 (6^th Cir. Jan. 29, 2019).

      In this class-action lawsuit, the agents for American Family alleged they should be classified as employees and that their incorrect independent contractor classification “‘deprived [them] of the rights and protections guaranteed by state and federal law to employees, including their rights under ERISA.’” Slip Op. at 3.

      While the trial court determined that the correct classification was as employees, that was reversed by the Sixth Circuit, it applying the various factors set forth by the United States Supreme Court in Nationwide Mutual Insurance Co. v. Darden, 503 U.S. 318 (1992), they being:

In determining whether a hired party is an employee under the general common law of agency, we consider the hiring party’s right to control the manner and means by which the product is accomplished. Among the other factors relevant to this inquiry are the skill required; the source of the instrumentalities and tools; the location of the work; the duration of the relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party; the extent of the hired party’s discretion over when and how long to work; the method of payment; the hired party’s role in hiring and paying assistants; whether the work is part of the regular business of the hiring party; whether the hiring party is in business; the provision of employee benefits; and the tax treatment of the hired party.

            The Sixth Circuit noted as well that it would take account of the express agreement between the parties as a relevant factor in determining. In this instance, the agents had signed agreements with American Family providing that they were independent contractors. Those agreements provided:

It is the intent of the parties hereto that you are not an employee of the Company for any purpose, but are an independent contractor for all purposes, including federal taxation with full control of your activities and the right to exercise independent judgment as to time, place and manner of soliciting insurance, servicing policyholders and otherwise carrying out the provisions of this agreement. As an independent contractor you are responsible for your self-employment taxes and are not eligible for various employee benefits such as Workers and Unemployment Compensation.

      Giving weight to this express written agreement and applying the various Darden factors, the Sixth Circuit determined that the insurance agents are properly characterized as independent contractors.

      Demonstrating the closeness of these questions, there was a dissent by one of the three members of the panel.

Except as Otherwise Provided; Pennsylvania Court Holds That Rule For Amending the Operating Agreement Was Not Changed

Except as Otherwise Provided; Pennsylvania Court Holds That Rule For Amending the Operating Agreement Was Not Changed

      As a general proposition, LLC operating agreements may change the default rules provided for in the LLC Act.  A recent decision from Pennsylvania found that a general provision as to decision making by majority vote did not alter the statutory default of unanimous approval to amend the operating agreement.  Saltzer v. Rolka, No. 702 MDA 2017, 2018 WL 5603050 (Pa. Super. Ct. Oct. 30, 2018).

      Rolka Loebe Saltzer Associates, LLC (the “LLC”) had three members: Rolka (40%), Loebe (40%) and Saltzer (20%).  Saltzer’s employment was terminated, whereupon Rolka and Loebe sought to amend the LLC’s operating agreement to add a provision valuing and providing for the redemption of a terminated member’s interest.  Saltzer (not surprisingly) objected.  While Rolka and Loebe set the value of Saltzer’s interest at $63,389, the trial court fixed the value at $294,000. Each side appealed.

      The trial court’s determination that Rolke and Loebe did not have the authority to amend the operating agreement was affirmed by the appellate court.  Under the Pennsylvania LLC Act, the default rule for amendment of the operating agreement is unanimous approval of the members.  15 Pa.C.S.A § 8942(b).  That rule may be altered in a written operating agreement. Id. The LLC’s operating agreement provided that it could be amended by the members at a regular or special meeting, but in that section did not address the threshold for the required vote.  Another section of the agreement provided “Except as otherwise provided in the [LLCA], or this Agreement, whenever any action is to be taken by vote of the members, it shall be authorized upon receiving the affirmative vote of a majority of the votes cast by all Members entitle to vote upon.” 2018 WL 5603050, *4.  The court found that this provision was of itself insufficient to alter the statutory default as to amending the operating agreement.  Unfortunately the decision did not detail why it was insufficient or what more it would have needed to be sufficient.