Saturday, December 31, 2011

Thomas T. Johnson dies at 88; judge ruled that Holocaust was a fact

Thomas T. Johnson dies at 88; judge ruled that Holocaust was a fact

Not that this has any bearing on business entity law, but Judge Johnson was a graduate of the U of L Law School.
I'm not even going to start in on Holocaust Deniers

Friday, December 30, 2011

Personal Guaranty Ruled Invalid

Personal Guaranty Ruled Invalid

      In a decision rendered in early November by the Kentucky Court of Appeals, a shareholder’s personal guaranty of a corporate obligation was held invalid for failure to expressly refer to the obligation guaranteed. Brunswick Bowling & Billiards v. Margaret L. Ng-Cadlaon, No. 2010-CA-001844-MR, 2011 WL 5244971 (Ky. App. Nov. 4, 2011).

      Ng-Cadlaon was a shareholder in and officer of R&S Enterprises, d/b/a “Blue Ribbons Lane.” It financed certain equipment purchased from Brunswick via a loan from Deutsche Financial Services Corporation. Ng-Cadlaon and the other R&S shareholders personally guaranteed this debt. When R&S defaulted, Bruswick filed a complaint against both R&S and the individual guarantors. Ng-Cadlaon moved for summary judgment on the basis that the guaranty was unenforceable for failure to satisfy the requirements of KRS § 371.065.

      The guaranty at issue was not part of the obligation being guaranteed and it did not specifically recite either the maximum aggregate liability of the guarantor or the date on which the guaranty would terminate. That being the case, the statute requires that the guaranty “must expressly refer to the instrument or instruments being guaranteed in order to be enforceable.” Slip Op. at 4. The guaranty provided that it would apply to:

          One or more security agreements, including but not limited to conditional sales agreements, leases,  chattel and/or real estate mortgages, notes or other deferred or time payment paper, and any and all agreements relating to the purchases of such paper or documents (all of the foregoing hereinafter called “Security Obligations”)….   Slip Op. at 3.

While it was Brunswick’s position that there was no doubt as to the obligation Ng-Cadlaon agreed to secure, she contended that the guaranty, containing “a generalized laundry list of potential present and future obligations of varying types” (Slip Op. at 4) was insufficient to satisfy the requirements of KRS § 371.065. Rejecting Brunswick’s assertion, the Court held that:

The fact that the note at issue falls within one of the categories of obligations listed in the guaranty is insufficient in itself to constitute an express reference.  Slip Op. at 5.

Thursday, December 29, 2011

Will No One Rid Me of This Turbulent Priest?

Will No One Rid Me of This Turbulent Priest?

            Today marks the anniversary of the murder in 1170 of Saint Thomas Becket.  This murder has always been the most serious stain upon the reign of King Henry II

            Of Norman descent (the movie Becket inaccurately has Henry referring to Becket as a Saxon), Becket rose to be appointed Lord Chancellor of England.  While Chancellor Henry nominated Becket (who at this time was not a priest) to the position of Archbishop of Canterbury, clearly hoping that Becket would use his power as primate of England to mold ecclesiastical policy in favor of royal interest.  Becket failed to do so, rather becoming an ascetic and placing the interests of the Church over those of the crown.  Eventually he was forced to resign as Lord Chancellor.

            The contest of wills between Henry and Becket over the Constitutions of Clarendon, they seeking to increase the power of the civil state over the Church and its constituents, led to a final break in the relationship, with Becket even fleeing England for France. 

            Likely well into his cups, Henry made a statement (exactly what was said is lost to history – there are conflicting accounts) that was interpreted by four knights as a direction to kill Becket.  They crossed the Channel and challenged Becket in Canterbury Cathedral, there killing him.  Becket was canonized barely three years later, and the four assassins were excommunicated and ordered to go on pilgrimage to the Holy Land (at least one of them thereafter became a Templar).  Henry would later do public penance at Becket’s shrine in Canterbury Cathedral.

            There is a passing reference to Becket in The Lion in Winter. 

Ohio LLC's Incentive Compensation Creates Partnership With Former Employee

Ohio LLC's Incentive Compensation Creates Partnership With Former Employee

Doug Batey's excellent review of this decision out of Ohio deserves a careful review. Better drafting as to the nature of the desired realtionship could have avoided this problem.

Tuesday, December 27, 2011

Larry Ribstein - A Short Remembrance

As already noted, Larry Ribstein passed away this past Saturday.  The various blogs are replete with thoughts and remembrances of Larry.  He was a giant in the field.  Anyone who thinks they can be involved in the fields of unincorporated business entity law without relying upon his thoughts is simply delusional.  The effects of his various treatises, Bromberg and Ribstein on Partnership and Ribstein and Keatinge on LLCs, permeat the thinking on the fields.  The cases and even the statutes often incorporate the guidence there provided.  Larry's input as Reporter on the 1992 Prototype LLC Act further influenced the manner in which nearly all LLC statutes were constructed and the rules set forth therein.

Some found Larry to be abrupt or domineering and unwilling to consider views at odds with his own.  Even accepting that view, he was in my experience always willing to discuss any theory and we as well always supportive of those of us joining the field.  I took it as a special indication that I was doing (in at leat one instance) something right when Larry cited one of my articles in a piece he wrote.

Larry will be missed, and the shoes he so well filled will likely remain empty for a long time.


The Kentucky Business Entity Filing Act

The Kentucky Business Entity Filing Act
Effective January 1, 2011, the Kentucky Business Entity Filing Act went into effect.  The review of that legislation, co-authored by myself and Laura K. Tzanetos, formerly with Stoll Keenon Ogden PLLC and now in-house counsel with Affiliated Computer Services, Inc., has just been released by The Northern Kentucky Law Review.  That article can be accessed HERE

The 2010 Amendments to Kentucky's Business Entity Laws

The 2010 Amendment to Kentucky’s Business Entity Laws
My review of the 2010 amendments to Kentucky’s various business entity laws has just been released by the Northern Kentucky Law Review.  That article can be accessed HERE.

Thursday, December 22, 2011

Fiduciary Standards for Corporate Directors

Kentucky Court of Appeals Hold That Business Corporation Act Sets Forth
An Exclusive Standard for Director Fiduciary Obligations

       Last Friday, the Court of Appeals issued an important decision on the interpretation of fiduciary duty provisions of the Business Corporation Act. The New Lexington Clinic, P.S.C. v. Cooper, ___ S.W.3d ___, 2011 WL 6260442 (Ky. App. Dec. 16, 2011).

        Cooper, a physician and director of The New Lexington Clinic (the “New Clinic”), while still a director, entered into negotiations with Baptist Hospital with respect to moving his practice. He entered into a letter of intent to make that move, and as well began negotiating, on Baptist’s behalf, with other New Clinic employees about likewise moving. After the move was announced, the New Clinic brought suit against Cooper and others alleging breach of various fiduciary duties, citing in support thereof Steelvest and Aero Drapery. The complaint did not, however, cite the Kentucky Business Corporation Act and specifically KRS § 271B.8-300. Summary judgment was granted the defendants on the basis that the New Clinic sought to bring its action under now defunct common law claims rather than relying upon the statutory standards set forth in KRS § 271B.8-300. Ultimately, the summary judgment has been reversed on the basis that the complaint was sufficient to set forth a claim for breach of fiduciary duty and on the basis that insufficient discovery had been completed prior to the dismissal.

       In my mind, the most important aspect of the case is the Court’s explication of the relationship of the common law fiduciary duties and the statutory standards. To that end, the Court wrote:

"At issue is whether KRS 271B.8-300 supplants the common-law claim as the circuit court found, or whether the common-law claim remains viable for the reasons articulated by NLC. We must conclude that the General Assembly intended for KRS 271B.8-300 to apply in all circumstances where money damages are sought in a claim of breach of fiduciary duty against a corporate director. The Legislature stated in clear and unambiguous language that “any action taken as a director, or any failure to take any action as a director, shall not be the basis for monetary damages . . . unless . . . [t]he director has breached or failed to perform the duties of the director’s office in compliance with this section[.]” (Emphasis added). KRS 271B.8-300(5). Using mandatory “shall” language, the General Assembly went on to state in section (6) that a “person bringing an action for monetary damages . . . shall have the burden of proving by clear and convincing evidence the provisions of subsection (5)(a) and (b) of this section, and the burden of proving that the breach or failure to perform was the legal cause of damages suffered by the corporation.” (Emphasis added).

In examining whether this language evinces the Legislature’s intent to supplant the competing common-law claim of breach of fiduciary duty, we look to James, supra, which held that a common-law claim may not be repealed by implication, and that the statutory intent to abrogate the common law must be clearly apparent. KRS 271B.8-300(5) provides that any action taken as a director or any failure to take action as a director shall not be the basis for a claim of monetary damages unless the director breached a duty under this section. In enacting this section, the Legislature cast a wide net which addresses any claim for monetary damages arising from a director’s alleged breach of fiduciary duty. The conclusion is bolstered by the inclusion of section (6), which sets out the mandatory burden of proving a breach by clear and convincing evidence — a burden which the parties acknowledge is greater than that of the common-law claim. Aside from this heightened burden of proof, KRS 271B.8-300(5) tracks the common law very closely. The Legislature has merely meticulously set forth the claims and remedies available under common law. We cannot say that the change in the burden of proof indicates an intent to abrogate the common-law claim entirely. Rather, it merely increases the burden of proof."

     Ergo, the General Assembly having comprehensively and in exclusionary language addressed the subject matter, the prior common law has been supplanted.

        This decision having been rendered just last week, there is no word yet on whether one side of the other will seek review by the Kentucky Supreme Court.

      IMHO, should there be an appeal, the decision of the Court of Appeals with respect to the exclusivity of KRS § 271B.8-300 should be upheld. As I have written previously (see, e.g., my posting with respect to the 1400 Willow v. Ballard, Sept. 29, 2011), the common law of fiduciary obligations is and should be applicable only where there exists a gap or where it is intended by the legislature, such as in the case partnerships, that the common law still apply. Where, in contrast, the legislature has comprehensively addressed the topic, such as here addressing the standards by which culpability for a breach of a duty is assessed, it is the statutory language that must control. However, the ultimate decision of the Court of Appeals (and the trial court) needs to be reversed.  While it is true that the statute is the exclusive recitation of the direcotor's fiduciary duties, it is exclusive as to actions taken as a director or any failure to act as a director.  Drs. Cooper et al.were not acting as directors when they engaged in discussions of joining a competing venture, decided to do so, and solicited company employees to leave with them to thereafter compete with the New Lexington Clinic.  As such the question is not whether 271B.8-300 is exclusive (which it is within its scope of application), but whether it is applicable as to conduct not on behalf of the venture.  To that latter question the answer is no.

Monday, December 19, 2011

Improper Personal Benefit - Two Models

Improper Personal Benefit: Is Benefit Dependent on the Presence of a Loss?

       Recent newspaper stories with the respect to the activities of an official of a California stadium authority serve as an interesting backdrop for a consideration of the distinction that exists between the law of corporations and the law of partnerships as to deriving personal benefit from venture assets.

      According to the various stories, a stadium official, when the stadium was otherwise engaged in an upgrade, made orders for high-end sound equipment, charging them to his personal credit card. In turn, he was reimbursed by the stadium authority. There is no suggestion that the ultimate price paid by the stadium authority was any higher than it would have been had the vendor been paid directly with the authority’s check. What did happen, however, is that the stadium official racked up significant bonus credits on his personal credit card, sufficient, by one newspaper’s calculation, to pay for several days at the Ritz-Carlton or several first class international plane tickets.

      Even as the stadium authority was in no worse position than it otherwise would have been, there has been a public uproar at the fact that the stadium official personally benefitted from these transactions. Apparently, the view of those detractors is that, even though the authority was in no worse position, it was inappropriate for the official to come out in a better position.

      This story got me thinking about the distinction that exists between the laws of corporations and partnerships as to the personal benefit derived from the use of venture assets.

      In the context of a business corporation, it would seem that the stadium official’s conduct would not be subject to sanction. In that paradigm, the utilization of corporate assets for personal benefit is permitted so long as the terms of the transaction are “fair to the corporation.” KRS § 271B.8-330(1)(c). Where, as is apparently the case with respect to the purchases of the high-end sound system equipment for the stadium, the venture has neither lost nor been deprived of anything it could have otherwise had, the terms are fair to the corporation (assuming, of course, that the corporation has neither a credit card nor an interest in flying first class or staying at the Ritz-Carlton) and there exists no injury.

      In contrast, the law of partnerships looks not to whether the transaction was “fair” to the partnership, but looks simply to whether a partner, utilizing partnership assets, personally benefitted. See, e.g., UPA § 21(1); KRS § 362.250(1). Thereunder, a partner who utilizes partnership assets and in so doing derives a benefit is obligated to hold that benefit in trust for the partnership. It matters not whether the partnership in any manner lost anything on the transaction, but only whether the individual partner realized a gain. For that reason, the fact that the transaction was “fair” to the partnership, i.e., that at minimum, the partnership was not worse off than it otherwise would have been, is not a defense to the charge of having derived an improper personal benefit.

      These different mechanisms for assessing personal benefit cases are simply different from one another; neither, on an objective basis, is more “correct” than is the other. What is important is that the distinctions between them be appreciated in a particular application and insuring that the appropriate test is applied.

Thursday, December 8, 2011

Why Corporations?

Why Corporations? 
            Although often vilified in the current “Occupy Wall Street” environment, the corporation is a tool of long vintage created to solve a particular problem, namely the ownership of property for longer than the lifetime of a particular person.  While limited liability, the principle that the owners of the venture are not, beyond their investments made, liability for the debts and obligations of the venture, is oft cited as the raison d’ĂȘtre of the corporation, such was a much later development.

            Property jointly held underwent, especially upon the death of a co-owner, a disruption in its ownership and the risk that at least a portion of the corpus would be alienated from the venture.  That risk was addressed by the creation of an artificial being, the corporation, it holding title independently of its constituent owners.  As described in a venerable treatise, namely James Grant, A Practical Treatise on the Law of Corporations in General as well Aggregate as Sole 16 (T & J.W. Johnson 1854):

“A corporation is an institution calculated for and capable of duration as long as the world lasts, though it may be brought to a termination by certain accidents or by certain defaults of duty on the part of its members at any period; but however long its duration, the corporation continues the same; and the same rights, privileges, duties and liabilities attach to is as it had at the first moment of its creation; precisely as though it were an individual.  Personae vice fungitar.

This unbroken personality, this beautiful combination of the legal characters of the finite being with the essentials of infinity appears to have been the primary object of the invention of incorporations, - an invention which, perhaps more than any other human device, has contributed to the civilization of Europe, and the freedom of its states.”
            You must appreciate the quality of the language, one of the reasons I enjoy the treatises of this era.

Wednesday, December 7, 2011

The Assassination of Cicero

The Assassination of Cicero

            Today marks the anniversary of Cicero in 43 B.C.  A lawyer, politician, writer and orator, his letters serve as both a source for the goings-on in Rome and its empire and as guidance for the art of letter writing.  Thinking Marc Antony to be little more than a thug, Cicero took the additional step of detailing his views in a series of speeches, hoping to reduce Antony’s influence for the benefit of Octavian, Caesar’s heir.  When, however, Octavian and Antony joined forces in the Second Triumvirate, Cicero’s days were numbered, and he was “proscribed” (i.e., ordered executed and his property seized).  While the depiction of his execution as portrayed in the HBO series Rome was true to his character, it in fact took place on a road with Cicero riding in a litter; he did not resist.

Tuesday, December 6, 2011

Diversity Jurisdiction and LLCs

Diversity Jurisdiction and LLCs
            In a recent decision, the Eastern District of Kentucky has again addressed diversity jurisdiction with respect to LLCs.  Citizens Bank v. Plasticwear, LLC, 2011 WL 5598883 (E.D. Ky. Nov. 17, 2011). 
            Most of this decision deals with the proper alignment of parties in a lawsuit as either defendants or plaintiffs in determining whether diversity jurisdiction exits.  Before moving on to that point of analysis, the Court addressed how the citizenship of a limited liability company should be assessed.  The plaintiff sought to ascribed to Plasticwear citizenship in (and apparently only in) Kentucky on the basis that its principal place of business, determined utilizing the “nerve center” of Hertz Corp. v. Friend, 130 S. Ct. 1181 (2010), is in Kentucky.  “Citizens Bank contends that Plasticwear LLC’s principal place of business is determinative of citizenship as it is for corporations,” citing 28 U.S.C. § 1332(c)(1).  It bears noting that this recitation of the test utilized for the corporation is incomplete.  In fact, a corporation has potentially two citizenships, that of its principal place of business and that of its jurisdiction of organization.  Based upon the Secretary of State’s website, Plasticwear is a Delaware LLC.
             The Court (correctly) noted that the principal place of business of an LLC “is not relevant to its citizenship determination.”  2011 WL 5598883, *3.  An LLC is not subject to the citizenship test that applies to a corporation, rather having the citizenship of each of its members.  Id., citing Homfeld II, LLC v. Comair Holdings, Inc., 53 F. App’x 731, 732 (6th Cir. 2002) and JMTR Enterprises, LLC v. Duchin, 42 F. Supp.2d. 87, 93 & n. 2 (D. Mass. 1999).

Monday, December 5, 2011

Doug Batey on Meyer v. Christie

Kansas Court Broadens Charging Order Against Single-Member LLC

Here if Doug Batey's review of the Meyer v. Christie decision on a charging order against the sole member of a Kansas LLC.

Friday, December 2, 2011

Landlord Not Protected by Exclusive Remedy of Workers Compensation

For Every Action there is an Equal and Opposite Reaction,
and What is it With Funeral Homes?

        A recent case from the Nebraska Supreme Court highlights a perhaps negative consequence of a common structure employed in closely held businesses.  The structure at issue is as follows:  a group of owners organize a business corporation or LLC to be the operating company.  They as well organize, typically in the form of a partnership or LLC, a parallel company that will own the real estate and facility in which the operating company operates.  Lease payments from the operating company cover the real estate company’s borrowing costs and, assuming that piercing is not an issue, protect the accumulated value in the real estate company from claims by the creditors of the operating company.
        It was this structure that was employed in the case under review in Nebraska.  Howsden v. Roper’s Real Estate Company, 2011 WL 5105810 (Neb. Oct. 28, 2011).  Howsden was an employee of Roper & Sons, Inc., a funeral home.  That funeral home operated from a facility owned by Roper’s Real Estate Company, Inc.; both Roper & Sons and Roper’s Real Estate had the same ownership.  Howsden, an employee of the funeral home company, was injured on the property, falling down a seldom-used elevator shaft.  In connection therewith, she received workers’ compensation benefits pursuant to the policy of the operating company.  From there, she brought as well a negligence action against the real estate company based upon improper maintenance of the elevator.
        The real estate company defended on the basis that Howsden’s rights under workers’ compensation coverage were the sole and exclusive remedy available to her, in effect arguing for consolidation of the operating and real estate companies.  This effort was unsuccessful.  The Court recognized that setting up separate business structures for different parts of an operation is entirely legitimate.  At the same time, the Court noted that doing so has consequences.  One of the consequences is, necessarily, that the different business ventures, absent circumstances justifying piercing, will be treated as distinct from one another.  Under Nebraska, law, piercing is not available absent fraud or a significant equitable basis, and the Court here found that there was neither fraud in the structuring nor an equitable basis for ignoring the legal distinctiveness of the different operation, stating that it would be at best near impossible for one to structure different operations in difference corporations and then argue, on an equitable basis, that they should be consolidated.  Ergo, Howsden’s suit against the real estate company could proceed, in not being barred by the exclusivity provision of Nebraska’s workers’ compensation statute; the real estate company was not her employer.
        Curiously, the Kentucky courts have considered a strikingly similar factual situation and came to a similar conclusion.  Jessie v. Dermitt, No. 2005-CA-0011961-MR (Ky. App. Dec. 8, 2006) (Not To Be Published).  Therein, the plaintiff fell through a hole in the floor of a funeral home that was being remodeled.  The operations of the funeral home venture were structured as an LLC; the real property was owned separately by the LLC’s members.  The real property owners defended on the basis of the exclusivity provision of the workers’ compensation law.  For essentially the same reasons as those applied in the Howsden decision, that effort was in Kentucky was rejected.  “[The owners] have cited no legal authority to this Court that permits the exclusive remedy provisions of the Workers’ Compensation Act to be extended to a landlord who owns the premises where the employer’s business is operated.”  Jessie v. Dermitt, slip op. at 7.

Thursday, December 1, 2011

Membership in a Nonprofit Corporation

The Kentucky Court of Appeals Again Addresses
Membership in a Nonprofit Corporation
          The Court of Appeals has again addressed the questions of membership in a nonprofit corporation and obligations owed to the members.  Fenley v. Kamp Kaintuck, Inc., 2011 WL 5443440 (Ky. App. Nov. 10, 2011) (Not to be Published).  This decision follows upon, in various aspects, 1400 Willow Council of Co-Owners, Inc. v. Ballard (reviewed here on September 29) and Tinsley v. Wildwood Country Club (reviewed here on October 4).
        The Fenleys were members of Kamp Kaintuck, Inc., a Kentucky nonprofit corporation.  Under KKI’s bylaws, all active members were required to attend once every three years.  There was no dispute that the plaintiffs did not do so.  On that basis, KKI’s Board of Directors terminated the plaintiffs’ memberships.  They in turn sued for wrongful termination of membership status, made allegations of breach of fiduciary duty, sought an accounting of KKI’s assets and as well its liquidation.
        As to the first complaint, namely that the Fenleys were wrongfully terminated from member status, the Court easily dismissed that count.  They were terminated for violation of the bylaw requirement that they attend the camp at least once every three years.  In support of this conclusion, the Court cited 14A C.J.S. Clubs § 14 (2011).  While no doubt this authority supports the proposition for what it was cited, it is curious that the Audubon County Club decision (785 S.W.2d 501 (Ky. App. 1990)), it having been relied upon by the Wildwood County Club court, was not cited.
          As to the count for breach of fiduciary duty, and consistently with the decision rendered in 1400 Willow v. Ballard, the Court stated that the fiduciary duties run to the corporation and the shareholders/members as a whole.  “Hence, a Board member or officer owes no common-law fiduciary duty directly to an individual shareholder/member,” citing 18B Am.Jur.2d Corporations § 1462 (2011).  From this position, the Court determined that any action for enforcement of those fiduciary duties, whether existing at common law or based upon statute, must be brought in the form of a derivative, rather than a direct, action.  To the extent that the plaintiffs sought to bring a derivative action, in that their membership status had already been terminated, the Court held that they lacked standing to do so.  With respect thereto, the Court cited Bacigalupo v. Kohlhapp, 240 S.W.3d 155, 157 (Ky. App. 2007) for the continuous ownership standard that is applicable in the context of a business corporation.  See also KRS § 271B.7-400(1).  Purely as an aside, why do courts, in addressing statutory requirements, cite cases that talk about the statute rather than directly citing to the statute?  The Court set forth its position that, in any derivative action involving a nonprofit corporation, a similar requirement would be applied, but specifically sidestepped the question as to whether derivative actions exist in nonprofit corporations.  2011 WL 5443440, *3, note 2.
           With respect to the claims for an accounting and for judicial dissolution, the Court held that, as the Plaintiffs were no longer members of KKI, they lacked standing to seek either of those remedies.

Wednesday, November 30, 2011

An Unincorporated Syndicate is Not Governed by Corporate Law

An Unincorporated Syndicate is Not Governed by Corporate Law
            In a recent decision, the Federal District Court for the Eastern District of Kentucky confirmed that an unincorporated syndicate is not, as a default matter, governed by the rules set forth in the Kentucky Business Corporation Act. KNC Investments, LLC v. Lane’s End Stallions, Inc., 2011 WL 5507395 (E.D. Ky. 2011).  In this instance, in a suit arising out of the interpretation of a stallion syndicate agreement, the plaintiff argued that the provisions of the Kentucky Business Corporation Act governing the inspection of corporate books and records should be referenced with respect to the interpretation of the books and records inspection right that existed under a syndicate agreement.  The court dismissed this argument, noting that:
No justification exists to extend Kentucky law that by its own terms is strictly limited to corporations to non-corporate entities such as the LDK Syndicate.  Id. at *4.

Monday, November 28, 2011

Vampires and Business Organizations

Vampires and Business Organizations
        The November/December 2011 issue of The Journal of Passthrough Entities includes my article Vampires and the Law of Business Organizations: The Fruitless Search for Authenticity.  This piece compares the various constructs used for the vampire in various books and movies, analogizing that to the various laws governing business organizations.  What is a vampire in a particular book or movie is determined by the author.  In the same way, what are the rights, duties and responsibilities of individuals within a particular organization are determined by the controlling statute and the governing documents.  Ultimately, each must be assessed on its individual terms, and assumptions that one characteristic applies in other contexts are often erroneous.
The article can be accessed HERE

NY's Top Court Hears Argument on LLC Promoter Liability

NY's Top Court Hears Argument on LLC Promoter Liability

Tuesday, November 22, 2011

Valuation of a Member’s Interest in an LLC Upon Dissociation

Valuation of a Member’s Interest in an LLC Upon Dissociation
            Last Friday, the Court of Appeals, in Eddy Creek Marina Resort, LLC v. Tabor, No. 2009-CA-001608-MR, 2011 WL 5599533 (Ky. App. Nov. 18, 2011) (Not to be Published), addressed the mechanism by which the interest of a resigning LLC member should be valued. 
        Tabor was a 10% member in Eddy Creek Marina Resort, LLC.  The Court of Appeals implied, but never stated expressly, that the operating agreement afforded a member the right to withdraw from the company; in my review of the agreement I can locate no such provision.  The briefs make clear that Tabor, by some undetailed mechanism, was forced out of the company.  The Court of Appeals' opinion recites that operating agreement provided that “the dissociated member … shall be entitled to receive the fair value of the Member’s Company interest as of the date of dissociation based upon the Member’s right to share in the distributions of the Company.”  Id. at *1 (more on this point below).  The operating agreement did not, however, either define fair value or set forth the mechanism by which fair value of a dissociated member’s interest would be calculated. 

         At a bench trial, experts presented estimates of the “fair market value” of the company as ranging from $3 million to over $5 million.  Mortgages on the company assets existed in the amount of approximately $2.3 million, and Tabor testified that he was liable for a potion of that debt.  The trial court determined a company FMV of $4 million and then applied a 10% marketability discount and a 10% minority discount.  The $4 million FMV determination did not, however, incorporate the $2.3 million of debt.  Ultimately, the court concluded that Tabor’s 10% in the company was worth $324,000.  Eddy Creek appealed from the trial court’s failure to subtract the $2.3 million in debt from the $4 million FMV in determining the value of Tabor’s interest.
            The Court of Appeals held that not incorporating the LLC’s debt in the determination of company value was an error and remanded the case for further fact-finding and presumably the calculation of the adjusted amount to Tabor.
            IMHO, while the outcome of this decision is entirely correct, the basis for the ruling was, at minimum, suspicious.  The court relied upon KRS § 275.205, the default rule for the allocation “of profits and losses amongst the members of an LLC.”  The court failed to recognize that, under the principles of partnership taxation, the sharing of profits and losses is an issue of allocation (i.e., who bears tax liability for the activities of the LLC) while it is distributions by which the members receive the net profits.  An allocation, which will give rise to a tax liability to an individual member, may not be accompanied by a distribution.  Further, assuming satisfaction of the substantial economic effect test of the Internal Revenue Code, it is possible to have differing allocations of profits and losses amongst the members.  In this instance, relying upon a provision addressing tax allocations likely did no harm, it being assumed that special allocations were not in issue in this LLC, but that will oftentimes not be the case.  The court’s decision would have been stronger if they had relied upon general principles of business valuation under which the company’s debt would have to be determined in valuing the ownership interest of a member.  Many such authorities were cited to it in the briefs presented.
            There exists as well a pair of issues that, even if not issues in this case, will be relevant in the future.
            With respect to the company debt, even as the value of Tabor’s interest in the LLC is calculated net of the debt, is he, in connection with the redemption, being released thereon?  As noted by the court:
Tabor testified that he was a signatory to the mortgage and thus liable for his portion of the debt.  It would be a waste of time and resources to give Tabor the full amount he seeks for his minority interest and then later require payment of his portion of the debt.  In the interest of judicial economy, we will make no such requirement.  Id. at *2.
The value of his interest in the company will be reduced, presumably on a dollar-for-dollar basis, to account for the outstanding balance on the mortgage as of the date of the redemption.  What will be the outcome if Tabor is not released on the mortgage and the obligation goes into default?  If he ever has to satisfy the mortgage, he will, in effect, have paid that debt twice. 
           With respect to the 10% minority interest discount and the 10% marketability discount applied by the trial court, there is a question as to whether doing so was appropriate.  Minority and marketability discounts are typically applied in determining “fair market value.”  In contrast, these discounts are not applied in determining “fair value,” and the Court of Appeals stated that the Eddy Creek operating agreement called for a payment of “fair value.”  See also Shawnee Telecom v. Brown, 2011 WL 5248307 (Ky. 2011) (rejecting, in the context of a dissenter rights statute and its directive that a dissenting shareholder receive the “fair value” of their shares, the application of discounts at the owner level).  While Tabor's Brief to the Court of Appeals accepted the application of these discounts (see p. 2), in another case on similar facts such an acceptance might not be appropriate. This may, however, be a problem of the Court of Appeals simply substituting "fair value" for "fair market value"; both briefs speak in terms of "fair market value."
            It bears noting that the facts of this case are markedly different from those in the Chapman decision.  Chapman v. Regional Radiology Associates, PLLC, 2011 Ky. App. LEXIS 251 (Ky. App. Mar. 25, 2011).  In this instance, as described byt he Court of Appeals, there was a written operating agreement providing, inter alia, that upon resignation a member would be entitled to a valuation of their interest in the company and redemption at that price.  Chapman, in contrast, involved an LLC that did not have a separate written operating agreement providing for a right of redemption. 

         As for the Court of Appeals' statement that “the dissociated member … shall be entitled to receive the fair value of the Member’s Company interest as of the date of dissociation based upon the Member’s right to share in the distributions of the Company.”, it is a verbatim recitation of part of KRS 275.215 as adopted in 1994, which language was repealed in 1998 

            Practice Pointer – Terms like “fair value” do not have objectively defined meanings.  An operating agreement that calls for redemption at “fair value,” without further defining what is meant by “fair value” and defining the mechanism by which that amount will be determined, simply invites further (and typically expensive) litigation.

Monday, November 21, 2011

Wisconsin Court Misses the Point of Choice of Entity

Wisconsin Court Misses the Point of Choice of Entity
            In a recent decision interpreting and applying the Wisconsin LLC Act, the Court, sadly, missed the point of choice of entity, suggesting that the fiduciary obligations amongst all businesses or organizations not only are but should be the same.  Executive Center III LLC v. Meieran, 2011 WL 4704274 (E.D. Wisc. Oct. 4, 2011).
            Meieran bought a 12.5% interest in BRIC Executive, LLC (“BRIC”) for $250,000 pursuant to an agreement under which that 12.5% interest would be redeemed by a date certain with penalties and additional expenses incurred for any delayed redemption.  A year and one-half after that agreement was entered into, and when the repurchase obligation was already in default, the Plaintiff entered into an agreement with BRIC for the sale/leaseback of a BRIC-owned building.  BRIC received approximately $1.3 million from that transaction and entered into a 3-year lease for one unit in the building.  BRIC distributed the $1.3 million it received to pay off various debts, including its redemption obligation to Meieran.  The redemption price had by then swelled to $425,000 – Meieran accepted $400,000 in full satisfaction thereon.  At that point, BRIC had no other assets, and immediately defaulted on its lease obligation to the Plaintiff.  They brought suit against Meieran, alleging a number of counts including fraudulent conveyance of the $400,000 paid to the Defendants, breach of fiduciary duty owed to the Plaintiff and receiving an improper inequitable distribution from BRIC. 
      My concern is with the statements made as to fiduciary duties. 
      After engaging in an effort to distinguish Gottsacker v. Monnier, 697 N.W.2d 436 (Wis. 2005), the Court discussed whether or not common law fiduciary duties exist in addition to those imposed by statute.  Apparently working from the positions that fiduciary duties amongst business owners are normative and that the fiduciary duties that are owed are equivalent amongst business organizations, the Court wrote:
In fact, there is growing consensus that common law fiduciary duties should apply to the operations of LLCs….  Logic dictates the same. Fiduciary duties exist to protect people who are affected by the actions of those who control businesses.  Therefore, it would not make any sense if the expectation for a business to act fairly were to be different simply due to the business owners’ choice of form – an LLC in this case.  If that were so, every dishonest owner could simply elect to operate its business as an LLC and claim that no fiduciary duties applied to its actions. 
For these reasons, the Court finds that common law fiduciary duties apply to LLCs.  2011 WL 4704274, *8-9. 
       Initially, there is a significant question, not addressed by the Court, as to why fiduciary duties are even being contemplated in this situation.  The suit here is filed by the purchaser of a commercial building who is, no doubt justifiably, upset that the seller has, in the capacity of a tenant, breached their obligations.  This appears to be, and the Court does not indicate anything to the contrary, an arms-length transaction.  Buyer is not a member of BRIC.  Setting aside the question of what are the fiduciary duties, there is no indication of a relationship from which the Plaintiff could assert there to have arisen a fiduciary obligation that was violated.  The opinion recites that the payment to Meieran rendered BRIC insolvent.  If the basis of the claim is a fiduciary shift on insolvency to the benefit of the creditors, that would be nice to know.
       Returning to the mindset issue, the dual suggestions by the Court that (a) as a normative matter fiduciary duties exist in business organizations and (b) that fiduciary duties do not change between organizations, are both demonstratively incorrect and indeed misleading. 
       The first proposition, namely that fiduciary duties are normative, is disproven by the fact that many statues expressly permit either the restriction or the elimination of fiduciary duties and/or permit the elimination of culpability for the breach of a fiduciary obligation.  See, e.g., Del. Code Ann. tit. 6, § 18-1101(c) (permitting an operating agreement to eliminate all fiduciary duties); KRS § 275.170 (permitting the statutory default fiduciary duties of care and loyalty to be altered in a written operating agreement); and id. § 275.185 (permitting a written operating agreement to eliminate culpability for breach of fiduciary duties of care and loyalty).  Ergo, the premise that all business organizations must impose upon their constituents fiduciary obligations is manifestly incorrect.
          Perhaps even more troubling is the Court’s suggestion that fiduciary duties are a constant across business organizations.  This is simply not the case.  As the U.S. Supreme Court stated so eloquently in SEC v. Cheney Corp., 318 U.S. 80, 85-86 (1945):
But to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry.  To whom is he a fiduciary?  What obligations does he owe as a fiduciary?  In what respect has he failed to discharge these obligations?  And what are the consequences of his deviation from duty?

       Different expectations and limits are placed upon different fiduciaries.  Simple paid agents are held to a care standard of simple negligence.  See Restatement (Third) of Agency § 8.08 (2006).  In contrast, corporate directors are held to a wanton or reckless standard.  See, e.g., KRS § 271B.8-300(5)(b).  Members of a Wisconsin LLC are held to a “willfull misconduct” standard.  Wisc. Code § 183.0402(1)(d). 
       Turning to the obligation of loyalty, partners, trustees and members of a member-managed are precluded from benefitting from a self-dealing transaction with the trust/partnership/LLC or the use of its assets.  See Restatement (Second) of Trusts § 203 (1959); Wisc. Code § 183.0402(2); KRS § 275.170(2); UPA § 21(1).  In contrast, corporate directors are permitted to enter into conflict of interest transactions and to utilize corporate assets for personal benefit provided the terms of the transaction are “fair” to the corporation.  See, e.g., KRS § 271B.8-310(1)(c).  Some jurisdictions even go so far as to remove from that director the burden of proving fairness, requiring, rather, that the complaining shareholder prove lack of fairness. 
         Clearly not every “fiduciary” is held to the same standard.  The failure to recognize this crucial aspect of business organization law generally and the entire point of the choice of entity calculus is the fundamental failure of Executive Center III LLC v. Meieran.

Friday, November 18, 2011

Martin v. Pack’s Inc.

Martin v. Pack’s Inc.:  The Court of Appeals
Adds Uncertainty and Risk to Dissolution

      Martin v. Pack’s Inc. involved a claim for construction services rendered by Pack’s prior to the administrative dissolution of Southeastern Construction, Inc.  After the administrative dissolution of Southeastern, Ed Martin, on the corporation’s behalf, entered into two agreements with Pack’s, Southeastern’s creditor, for resolution of that debt.  Southeastern failed to perform.  Pack’s then sought to enforce the debt against not only Southeastern but also Ed Martin and Jeff Collinsworth, Southeastern’s shareholders.  Granting summary judgment to Pack’s, the trial court held, and the Court of Appeals affirmed, that each of Martin and Collinsworth are personally liable on the debt.  Martin v. Pack’s Inc., 2011 WL 3207947 (Ky. App. 2011) (To Be Published). 
     IMHO, the grounds for that determination were erroneous.
The (Flawed) Understanding of the Effect of Dissolution on Shareholder Limited Liability
                One basis upon which the Court of Appeals affirmed holding Martin liable on the obligation to Pack’s was that the agreement for the resolution of the corporation’s debt was entered into after the corporation’s administrative dissolution, the court reasoning that after dissolution there was neither a corporation nor the consequent limited liability.  Id. at *5. “To reiterate, Martin cannot be shielded from personal liability by virtue of the statute, (sic) because his corporation was dissolved at the time of his actions.”  The Court said, in effect, that dissolution abrogates the rule of limited liability.
It appears there was not identified to the Court, and that its own research did not unearth, the 2007 amendment to the Business Corporation Act enacted in response to and legislatively overruling the Forleo decision (2006 WL 2788429 (Ky. App. 2006)).  That amendment expressly provides that a corporation’s dissolution does not “abate or suspend” the shareholder’s limited liability.  See Ky. Rev. Stat. Ann. § 271B.14-050(2)(i); see also Thomas E. Rutledge, The 2007 Amendments to the Kentucky Business Entity Statutes, 97 Ky. L.J. 229, 243 (2008-09). 
To the extent that the Court of Appeal’s affirmation of the trial court’s ruling was based upon the notion that, subsequent to dissolution, shareholders do not enjoy limited liability, that ruling was directly contrary to the controlling statute.
A (Flawed) Understanding of the Effect of Dissolution on Corporate Status
The second substantive failure of the decision is its assumption that upon dissolution a corporation ceases to exist.  Simply put, that is not the law.
        In a prior age it was the rule that upon dissolution a corporation simply ceased to exist – its property became vested in the shareholders, its debts were extinguished and suits by or against it were terminated.  See, e.g., 16A William Meade Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 8113; II Stewart Kyd, A Treatise on The Law of Corporations 516 (1794) (“The effect of the dissolution of a corporation is, that all its lands revert to the donor; its privileges and franchises are extinguished; and the members can neither recover debts which were due to the corporation, nor be charged with debts contracted by it, in their natural capacities.”)  Those rules have been long repealed.  See, e.g., Greene v. Stevenson, 175 S.W.2d 519, 523-24 (Ky. 1943).  Under the formula currently employed, a corporation, after dissolution, continues to exist as a corporation.  See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation shall continue its corporate existence….”).  A dissolved corporation is restricted to activities “appropriate to wind up and liquidate its business and affairs.”  Ky. Rev. Stat. Ann. § 271B.14-050(1). 
     At one time a corporation’s dissolution caused it to cease to exist.  Under the modern system as enacted by the General Assembly, a dissolved corporation continues to exist as a corporation.  See KRS § 271B.14-050(1); id. § 14A.7-020(3).  Ergo, any conclusion based upon the premise “a dissolved corporation no longer exists as a corporation” must fail as the premise is false.
The (Flawed) Understanding of the Winding Up Process
            Dissolution effects a limitation upon the proper activities of the dissolved organization, restricting it to those that are appropriate for its winding up and termination.  See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation … may not carry on any business except that appropriate to wind up and liquidate its business and affairs….”).  Whether any particular activity is appropriate for the winding up and termination of a particulate venture is a fact dependent issue.  For example, in the winding up and termination of a retail store, it is difficult to contemplate a situation in which the acquisition of additional inventory would be appropriate.  Conversely, in the winding up and termination of a landscaping business, the purchase of additional materials with which to complete a job that is under contract and partially completed likely would be appropriate.  The open and fact dependent nature of this assessment is implicit in the statute’s use of “including” in the description of activities that are appropriate after dissolution.  Id.
      The Martin court makes much of the fact that the agreement with Pack’s was created subsequent to the dissolution.  2011 WL 3207947 at *2-3.  Even accepting that characterization as true, it is not determinative of the outcome.  Rather, nothing in the law of dissolution precludes a dissolved corporation from entering into entirely new obligations.
      In the resolution of claims with creditors, whether they are known or unknown, there will often need to be a new agreement entered into pursuant to which the amount and manner of resolution are agreed upon.  While some of these agreements may constitute only a modification of existing agreements, a claim arising, for example, in quasi-contract will not.  Were the rule espoused in Martin v. Pack’s, Inc. to be correct, then the post-dissolution sale of assets sanctioned in Greene v. Stevenson would have exposed whoever signed the sale agreement to personal liability thereon.  Assume a creditor initiates an action against a dissolved corporation.  Is the corporation precluded from entering into an engagement with an attorney for the purpose of making a defense or even asserting a counter-claim?  That engagement letter with the attorney will be a new post-dissolution obligation.
      Curiously, neither the Court of Appeals nor the trial court explained how the post-dissolution agreement between Southeastern and Pack’s did not fall within KRS § 271B.14-050(i)(c) and its express authorization for a dissolved corporation to “mak[e] provision for discharging its obligations.” 
      The suggestion that a corporation, after dissolution, cannot in its own name and on its behalf enter into agreements in settlement of its debts and obligations is without analytic support and is contrary to the statute. 
A (Flawed) Understanding of the Effort of Dissolution Upon Agency
       A corporation “is an artificial being, invisible, intangible, and existing only in contemplation of law.”,  Trustees of Dartmouth Coll. v. Woodward, 17 U.S. (4 Wheat.) 518, 636 (1819), able to act only through those natural persons who are its agents.  Restatement (Third) of Agency § 3.04, comment d.  As noted above, a corporation continues to exist after dissolution for the purpose of its winding up and liquidation.  During the dissolution process the corporation must act through agents.  Presuming appropriate identification of the principal and that the action is within the agent’s authority, the agent is not a party to and is not personally liable on the agreement at issue.  Restatement (Third) of Agency § 6.01.
        There is currently pending before the Supreme Court a petition for discretionary review.

Thursday, November 17, 2011

History Note - Mary Tudor

       Today (Nov. 17) marks the anniversary of the death of Queen Mary Tudor.

      Mary has gone down in history with the label "Bloody Mary," attached to her by later English who were themselves of a Protestant viewpoint.  

      Life was in many respects not good to Mary.  The only surviving child of Henry VIII and Catherine of Aragon, she grew up within and firmly believed in her mother's strict Spanish Catholicicism.  As Henry withdrew England from obedience to the Pope as a mechanism for achieving the "divorce," obvious strains arose between Mary and her father.  That marriage being ultimately declared invalid, Mary found her position changed from Princess to a bastard unable to inherit the throne.  The birth of the presumably legitimate Princess Elizabeth further cut Mary off from her expected inheritance.  Enmity between Mary and Anne Boleyn made the situation even more difficult, Mary being required to serve Elizabeth even as a member of the Boleyn family, who likewise was against Mary, was in charge of the household.  While Boleyn's execution and the declaration of the invalidity of her marriage to Henry as well rendered Elizabeth illegitimate,  the birth of Edward (ultimately Edward VI) removed her even further from the throne.

     After the death of Edward VI Mary finally succeeded to the throne, but her reign was at best troubled.  Believing herself to be duty bound to undo the "reforms" of her father and their expansion under her brother, Mary reaffirmed the obedience of the English Church to Rome, recalled Cardinal Pole and made him Archbishop of Canterbury, and set about the return of the Catholic faith.  As demonstrated by the work of A.J. Scarisbrick and Eamon Duffy, this was for the most part a small task - the overlay and substitution of what we today consider to be "Protestant" aspects of faith were a thin facade.  Still, there were "true believers" who were executed, most notably Cramner, former Archbishop of Canterbury.

   Her marriage to Philip of Spain was a disaster, especially on a personal level.  

   While Tom Petty tells us "Its good to be king," at many levels Mary's refrain might have been "Its not good to be a king's daughter or to be queen."

Philanthropic Facilitation Act of 2011

Here is the text of the submitted legislation.
It has been referred to House Ways and Means.

HR 3420

Philanthropic Facilitation Act of 2011

Foundations on the Hill has posted a position paper on the Philanthropic Foundation Act of 2011.

Wednesday, November 16, 2011

Waiving Limited Liability

Waiving Limited Liability
       A recent case from a North Carolina Court of Appeals highlights how easy it may be to waive limited liability.  Consolidated Electrical Distributors, Inc. v. Wieltech Electric Co., LLC, No. COA 11-96 (N.C.) (Ct. App. Oct. 18, 2011).
      In September, 2006, Wieltech Electric Company was reorganized into an LLC; the opinion is silent as to its earlier form of organization.  In connection therewith, a letter was sent to Wieltech’s vendors and customers advising them as to the change and stating in part that the debts and obligations of the predecessor organization “shall be transferred wholly into the newly formed LLC and the two individual organizers.”  Slip op. at 2, emphasis added.  Jennifer Fortenberry and Benjamin Wieland had been identified as the organizers of the LLC.  When the claim of Consolidated Electrical Distributors, Inc. against the LLC was not satisfied, it initiated suit, including against Fortenberry and Wieland, the suit against the individuals being based upon the letter stating that the obligations were “transferred” to them.
      Fortenberry’s defense focused on the Statute of Frauds, asserting that the letter was insufficient to constitute an agreement to be responsible for the LLC’s debt.  Distinguishing the writing from that in a prior dispute to the effect that the individual would “try” to pay off an obligation, which was found to be insufficient under the Statute of Frauds to create a binding obligation, in this instance the letter stated that the accounts would be transferred to the LLC’s organizers including Fortenberry.  On that basis, the court found that the letter was sufficiently detailed to satisfy the Statute of Frauds and on that basis the trial court’s grant of summary judgment to the plaintiff was affirmed.
      Under the reasoning of this decision, it is obviously not going to require much in the way of formality for an individual to waive the limited liability they otherwise enjoy from the debts and obligations of an LLC.  Whether it reflects, however, the law that would be applied in Kentucky is open to question.  See Racing Investment Fund 2000, LLC v. Clay Ward Agency, Inc., 320 S.W.3d 654, 659 (Ky. 2010) (“To reiterate, assumption of personal liability by a member of an LLC is so antithetical to the purpose of a [LLC] that any such assumption must be stated in unequivocal terms leaving no doubt  that the member or members intended to forego a principal advantage of this form of business entity.”)

Tuesday, November 15, 2011

Good Faith, Fair Dealing, and the Stones v. The Beatles

The Delaware Court of Chancery Ranks the Beatles Versus the Rolling Stones (and Also Talks About the Obligation of Good Faith and Fair Dealing)
      Last Thursday (Nov. 10, 2011), the Delaware Court of Chancery (Chancellor Strine) issued the opinion in Winshall v. Viacom International, Inc., 2011 WL 5506084.  It is quite possible this opinion will be most remembered for the conclusion of Chancellor Strine that the Beatles were a better group than were the Rolling Stones.  See id. at footnote 44 and accompanying text.  Still, this decision is a furthering interesting stage in the definition of the parameters of the obligation of good faith and fair dealing.
      The Plaintiffs had sold Harmonix Music Systems, Inc. to Viacom by means of a merger agreement including a contingent right to receive certain payments based upon Harmonix’s financial performance in the two years following the merger.  Harmonix was itself a developer of video games.  A year after the closure on the merger and during the earn-out period, Harmonix released the “Rock Band” game.  In light of the success of Rock Band, Electronic Arts (“EA”) sought to renegotiate its distribution agreement with Harmonix for the purpose of acquiring greater distribution rights to both Rock Band and any sequels that might be issued.  As renegotiated, in return for the right to distribute certain Rock Band sequels and as well the right to expand its distribution channels to include hand-held devices, distribution fees being paid by Harmonix were reduced for future years, all after the expiration of the earn-out for Harmonix’s original shareholders.  Had the reduced distribution fees applied during the earn-out period, the payments to the former Harmonix shareholders under the earn-out would have been increased.  Those shareholders sued Viacom alleging that the amendment distribution agreement was “purposefully renegotiated to reduce the earn-out payments, thereby breaching the covenant of good faith and fair dealing.”  In effect, Harmonix’s former shareholders asserted that the obligation of good faith and fair dealing should be applied to capture for them the benefit of any renegotiated distribution agreement.  This assertion was squarely rejected by Chancellor Strine, he writing:
Even assuming that Viacom and Harmonix intentionally forewent possible opportunity to increase Harmonix’s profits during the earn-out period and structured the amended contract with EA so that Viacom and Harmonix could enjoy all the benefits for themselves, Viacom and Harmonix took no steps to reduce any reasonable contractual expectation of the Selling Shareholders.  It would be inequitable for this Court to imply a duty on Viacom and Harmonix’s part to share with the Selling Shareholders the benefits of a renegotiated contract addressing EA’s right to distribute Harmonix products after the expiration of the earn-out period.  The implied covenant of good faith and fair dealing is not a license for a court to make stuff up, which is what [the Plaintiffs] seeks to have me do.
     The Court reiterated the rule that the implied obligation of good faith and fair dealing is not a mechanism by which, after the fact, parties to an agreement may secure for themselves benefits that they failed to negotiate.  Focusing upon the situation as it existed at the time the merger agreement was entered into, that preceding the resounding success of the Rock Band game and the consequent shift in bargaining position to Viacom with respect to the renegotiation of the distribution agreement:
I find that Winshall has failed to allege facts that support a reasonable inference that the Selling Stockholders did not get the benefit of their bargain under the Merger Agreement.  On these facts, even viewed in the light most favorable to Winshall, the Selling Shareholders could not conceivably have a reasonable expectation that Viacom and Harmonix had a duty to renegotiate the [original distribution agreement] to increase the amount of earn-out payments the Selling Stockholders would receive.
     Contrasting these facts with the situation in which the acquirer manipulates the finances of the acquired company in order to reduce the amount of the earn-out, the Chancery Court was not willing to impose a reciprocal obligation that the benefits of any future events must be allocated in such a manner as to increase the earn-out amount.