IRS Further Clarifies That Tax “Partners” Are Self-Employed and Not Employees

IRS Further Clarifies That Tax “Partners” Are Self-Employed and Not Employees

      In ECC 201916004 (April 19, 2019), clarifying certain proposed regulations dealing with Certified Professional Employer Organizations (proposed Treas. Reg. § 301.7705-1), the Service again made the point that a person who is a member in an LLC taxed under subchapter K and is therefore a “partner” under the tax code may not as well be an employee of the entity (barring extraordinary facts as identified in an example therein).

Kentucky Supreme Court Declares That Lawyer Ethical Rules Constitute Public Policy

Kentucky Supreme Court Declares That Lawyer Ethical Rules Constitute Public Policy

      In the decision rendered the week before last,, the Kentucky Supreme Court held that the ethical rules of binding attorneys, to the extent they benefit the public generally, constitute public policy for purposes of employment. To that end, any agreement that would violate that public policy would be unenforceable against attorneys, but more importantly it would be unethical to either on-site to enter into that agreement. Greissman v. Rawlings and Associates, PLLC, ___ S.W.3d ___, 2019 WL 1747057, 2017-SC-000518-DG (Ky. April 18, 2019).

      This dispute arose out of Greissman’s employment with Rawlings and Associates PLLC, a law firm. In 2011, Greissman, an attorney, was presented with an agreement pursuant to which Greissman would agree, for a period of three years after the termination of her employment, “not to solicit, contract, interfere with, or attempt to divert any of Rawlings & Associates’ customers or potential customers after ceasing employment with Rawlings & Associates.” - this is the summary of the provision provided by the Supreme Court; the opinion as well recited the provision in full. The provision as well contained a “savings clause,” limiting its application “Except to the extent necessary to comply with the rules of professional responsibility applicable to attorneys.”

      Rule 5.6 of the Kentucky Supreme Court, governing attorneys licensed in Kentucky, provides that attorneys may not enter into any agreement that restricts the right of an attorney to practice after termination of a partnership or similar relationship (there is a carve-out for retirement benefits) or an agreement restricting the lawyer’s right to practice. Greissman, being of the view that the contract that the tendered agreement violated Rule 5.6, refused to sign it. In turn, Rawlings terminated her employment. Greissman then brought suit, alleging that her termination was improper in that it was premised upon her refusal to violate Kentucky public policy as set forth in Supreme Court Rule 5.6.

      Kentucky law is generally that all employment is at-will (absent a contract to the contrary), but even when it is at-will an employee may not be terminated for refusing to violate an express constitutional or statutory provision.

      The trial court found in favor of Rawlings on the basis that the Savings Clause of the agreement precluded violation of Rule 5.6. On that basis, summary judgment was granted to Rawlings. At the Court of Appeals, the decision of the trial court was upheld, but it is well held that Rule 5.6 not provide public policy in it is not either a statute or part of the Kentucky Constitution. Previously I reviewed that decision of the Court of Appeals; HERE IS A LINK to that review. There then followed this appeal to the Kentucky Supreme Court.

      The Supreme Court rejected the determination by the Court of Appeals below that the ethical rules binding attorneys, to the extent “designed to serve the interests of the public at large, rather than the sole interest of the profession”, do not constitute public policy. 2019 WL 1747057, *4. This determination is based upon the fact the legal profession is exclusively regulated by the Supreme Court. Therefore, “For purposes of wrongful termination actions, we believe that an obligatory Rule of Professional Conduct for attorneys carries equal public policy weight as any public policy set forth in our Constitution or in a statute enacted by the General Assembly.” Id.

      On that basis, all else being equal, if a firm terminated an employee for refusing to sign an agreement that would violate Rule 5.6, there would arise the basis of a legitimate wrongful termination claim.

      However, the Court would go on to determine that Greissman’s claim ultimately failed. That determination was based upon the Savings Clause language, the Court holding that it effectively limited the application of the nonsolicitation agreement to matters not contemplated by Rule 5.6, to wit:

On its face, the savings clause applies only to restrict Greissman’s ability to solicit non-legal business; it exempts the solicitation of legal work from coverage under the non-solicitation clause, expressly noting that the signor does not agree to those terms to the “ accent necessary to comply with the rules of professional responsibility applicable to attorneys.” Unambiguously, the signor agrees not to solicit Rawlings’ non-legal business; the savings clause does not apply to the solicitation of legal work since that would violate the Rules of Professional Conduct. Indeed, the savings clause expressly recognizes that the Rules of Professional Conduct govern if any conflict exists between them in the agreement. Since the plain wording of the savings clause excludes any interpretation of the agreement that conflicts with the Rules of Professional Conduct, the agreement did not violate SCR 3.130, Rule 5.6. Id. (citation omitted).

      In closing, the Court noted that Greissman could have sought direction from the Ethics Hotline of the Kentucky Bar Association, which would have protected her from any potential disciplinary action had she signed the agreement.

Delaware Secretary of State Gets Squeamish About Names

Delaware Secretary of State Gets Squeamish About Names

      According to a number of published reports, the Delaware Secretary of State has refused to file a certificate of formation for “Illegal Pete’s,” it’s actually comical a new entity and tended to be the successor to the existing organization based in Colorado.

       HERE IS A LINK to one of the published reports on this dispute, it setting forth a not insignificant number of already existing Delaware entities with what may be characterized as questionable names.

Beware Greeks Bearing Gifts

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.

            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.

Jury Decision Reversed When Instructions Were Inconsistent With the Operating Agreement

Jury Decision Reversed When Instructions
Were Inconsistent With the Operating Agreement

      In a recent decision from North Carolina, a jury decision with respect to breach of fiduciary duty in an LLC was reversed where the jury instructions were inconsistent with the operating agreement. Claudio v. Sellers, No. COA18-636, 2019 N.C. App. LEXIS 288 (N.C. Ct. App. March 26, 2019).

      This decision turned upon whether a particular member, Wilson, owed fiduciary duties to the other members of an LLC. North Carolina follows the rule that a majority shareholder in a corporation owes a fiduciary duty to the minority members in the corporation, and that rule has been carried over to the law of LLCs. Ergo, a majority member of an LLC owes fiduciary duty to the minority member. It was on that basis that this decision was rendered. However, the operating agreement defined a “majority (i.e., that threshold of the members required to act) as 67% of the members. While Wilson was more than a 50% member, be was not a 67% member. 

      In this instance, it was asked of the jury whether a fiduciary duty was owed and, had in turn been breached. Where, however, the jury was not advised that it took a 67% vote of the members to constitute a majority, the jury instruction was erroneous.  Whether Wilson owed a fiduciary duty should have been a jury question. 

Kentucky Court of Appeals Issues Decision Addressing Matters Including Wrongful Interference with Expectation of Inheritance and Fiduciary Duties in LLCs

Kentucky Court of Appeals Issues Decision Addressing Matters Including Wrongful Interference with Expectation of Inheritance and Fiduciary Duties in LLCs

 

      In a decision rendered the last Friday of March, the Kentucky Court of Appeals addressed a number of issues raised in a lawsuit that arose out of certain intra-family disputes. While the entirety of the decision should be reviewed, it is noteworthy for at least two points. First, it rejected a cause of action for expectation of inheritance. Secondly, it addressed the proper jury instruction with respect to an allegation of breach of fiduciary duty in an LLC. Dickson v. Shook, ___ S.W.3d ___, 2019 WL 1412497 (Ky. App. March 29, 2019).

      The opinion's lead-in paragraph set the stage, namely:

This intra-family dispute began with Appellee Mary Louise (Mollie) Dickson Shook’s allegations of wrongdoing by her mother, Appellant Roberta M. Dickson, and her brother, William Dickson (Bill), regarding Bill’s management of a closely held family business entity, and allegations of Roberta’s interference with Mollie’s expectancy interest in the estate of her father, Stanley Dickson.

      After a recitation of the unfortunate internecine falling out in this family, the Court of Appeals considered a number of items, two of which I will here highlight.

      The first question involved the question of a claim brought under the theory of a “wrongful interference with devise/expectation of inheritance.” Addressing the viability of such a claim, the court wrote:

There is no Kentucky Supreme Court opinion regarding the tort of interference with an expectation of inheritance. However, since 2003, this Court has explicitly stated in several unpublished opinions that Kentucky does not recognize such a tort. “On all questions of law the circuit and district courts are bound by and shall follow applicable precedents established in the opinions of the Supreme Court and its predecessor court and, when there are no such precedents, those established in the opinions of the Court of Appeals.” SCR 1.040(5). Although not binding precedent, “unpublished Kentucky appellate decisions, rendered after January 1, 2003, may be cited for consideration by the court if there is no published opinion that would adequately address the issue before the court.” CR 76.28(4)(c).  2019 WL 1412497, *5 (citations omitted).

      From there, the court would go on to hold:

We expressly hold that Kentucky does not recognize the cause of action known as tortious interference with inheritance or gift, or as Mollie expresses it in this litigation, wrongful interference with devise. Id., *6

      In that the trial court below had instructed the jury with respect to this cause of action, one which is ultimately nonexistent, there is a presumption of prejudice and that portion of the trial court's verdict was reversed.

      Still in the context of estate litigation, the Court of Appeals provided guidance as to why certain claims need to be brought in the District Court, and not in the Circuit Court. On that basis, portion of the jury verdict below were reversed in that the Circuit Court never had jurisdiction.

      Speaking for myself, the most interesting part of this decision deals with the jury instruction given in connection with an allegation that the plaintiff’s brother, William “Bill” Dickson, mismanaged an LLC in breach of his fiduciary obligations under the LLC Act. Specifically, the trial court had instructed the jury to find for the plaintiff if they believed that Bill, in managing the LLC, failed:

To always exercise the utmost good faith in the best interests of the company and the best interests of Mollie, as a member, in conducting the affairs of the family business, managing its property and handling matters related to the operations of Glen Oak, LLC, including the duty to exercise sound and reasonable business judgment to protect and further the financial interests of Mollie[.] Id., *15.

      This jury instruction was rejected on the basis that it did not recite the standard applicable to an LLC’s member. In this instance, the operating agreement did not modify the fiduciary duties. As such, the statutory default controlled, and the jury instruction needed to conform to that statutory default. “Appellees have not cited any provision in the operating agreement that would make the KRS 275.170(1) standard of care inapplicable. We have read the agreement for ourselves and find none. The statute therefore applies.” Id. at *15-16.The court wrote:

However, this is not the standard of care established by the legislature to guide juries in measuring the line between actionable conduct and acceptable conduct by a limited liability company manager. KRS 275.170(1). Bill argues the instruction was fatally flawed because it did not incorporate the statutory language of KRS 275.170. We agree.

“[W]here statutes are applicable, trial courts must instruct in statutory language.”  Farmland Mut. Ins. Co. v. Johnson, 36 S.W.3d 368, 390 (Ky. 2001) (citation and internal quotation marks omitted). Kentucky limited liability companies are creatures of statute and thus governed by applicable provisions of the Kentucky Revised Statutes.  Turner v. Andrew, 413 S.W.3d 272, 275 (Ky. 2013). KRS 275.170 plainly states the standard of care for managers of limited liability companies, as follows:

Unless otherwise provided in a written operating agreement:

(1) With respect to any claim for breach of the duty of care, a member or manager shall not be liable, responsible, or accountable in damages or otherwise to the [LLC] or the members of the [LLC] for any action taken or failure to act on behalf of the [LLC] unless the act or omission constitutes wanton or reckless misconduct.

KRS 275.170(1) (emphasis added in original).

     

       Speaking only for myself, this instruction with respect to fiduciary duties in LLCs has application not only in the conclusion of the litigation, but also at its inception. I regularly see complaints involving LLCs claiming that a member or manager, in breaching their fiduciary duty, has violated something akin to a “obligation of utmost good faith” or some other aspirational standard that is not consistent (i.e., is different from) either the standard set forth in that particular operating agreement or, by default, the LLC Act. For example, in a complaint filed last November in Jessamine Circuit Court, it was alleged that a member of an LLC owed to the company and the fellow members:

Duties of utmost good faith, fairness, honesty, full disclosure, accounting, safekeeping of company property, and loyalty, which required him to act in their best interests and to share any business opportunities closely related to the existing or prospective activity of the company, which it had the financial legal ability to undertake, and to not profit or benefit from such opportunities without the informed consent of his principals.

 

I wonder whether, in reliance upon this decision, complaints alleging the breach of a standard that is different from that imposed should be subject to a motion to dismiss.

      There is another aspect of the decision that is noteworthy and, frankly, that I find confusing. With respect to the subject LLC, Glen Oak, Mollie, the plaintiff in this action, was not directly a member. Rather, she owned her interest through an apparently single-member LLC, Dickson Oaks. However, Mollie, the individual, was permitted to recover at the trial court level a claim against Bill for breach of the operating agreement. Just to be clear, Mollie was never a party to that operating agreement; rather, Dickson Oaks, her LLC, was a party to the operating agreement.

      The Court of Appeals let this distinction pass, observing:

“It is the law in this jurisdiction that no stranger to a contract may sue for its breach unless the contract was made for his benefit.” Sexton v. Taylor County, 692 S.W.2d 808, 810 (Ky. App. 1985). That is to say, “one for whose benefit a contract is made may maintain an action thereon in his own name even though the undertaking is not directly to or with him.”  Aetna Ins. Co. v. Solomon, 511 S.W.2d 205, 208 (Ky. 1974).

The proof supports the conclusion that Dickson Oaks was created for Mollie’s sole benefit, and Glen Oak, in turn, was created for the benefit of its four owners, including Mollie through Dickson Oaks. Consequently, though better practice would have been to list Dickson Oaks as the party entitled to recover for breach of the operating agreement, the trial court’s decision to permit Mollie to recover was at most harmless error. Id., *17.

      I find this determination confusing in that on the prior page the court had cited Turner v. Andrew, 413 S.W.3d 272 (Ky. 2013), wherein it was held that a claim for injury to the property of an LLC could not be brought by the LLC’s sole member, but had to be brought by the LLC itself. Also, while Dickson Oaks may have been organized for Mollie's convenience, I struggle to see how it necessarily follows that a contract to which Dickson Oaks was a party, that bing the Glen Oak operating agreement, was necessarily for the benefit of the sole member in Dickson Oaks. There seems to be a conflict between this decisions “better practice” and the strict lines drawn between an LLC and its members by the Turner v. Andrew decision and the numerous provisions of the LLC Act that, cumulatively, provide the LLC and its member are separate and distinct. Nonetheless, this may be all dicta because the court would go on to find that the jury should never have been instructed with respect to the breach of operating agreement claim consequent to a directed verdict already granted on that point.