Monday, November 19, 2012

Decision of Trial Court Reversed, Inter Alia, For Lack of Jurisdiction

Decision of Trial Court Reversed, Inter Alia, For Lack of Jurisdiction
      A recent decision of the Kentucky Court of Appeals discusses a variety of interesting topics including standing to assert a claim for breach of fiduciary duty, the effectiveness of a release given to a fiduciary with respect to undisclosed activities and whether a secret profit earned in connection with the purchase of property by an LLC constitutes a breach of fiduciary duty.  Ultimately, however, this is all dicta in that the Court of Appeals determined that the trial court lacked jurisdiction to hear the dispute, it arising out of a contract containing an exclusive venue clause referring disputes to Cincinnati, Ohio.  Ziegler v. Knock, No. 2008-CA-002160-MR, 2012 WL 5273999 (Ky. App. Oct. 26, 2012).
      David Knock and Richard Knock, members of Knock Investments, LLC and Ziegler Group, owned by Michael Ziegler, joined together by means of a Membership Interest Purchase Agreement, to form Knock/Ziegler LLC for the purpose of acquiring a strip mall in Ohio.  The Membership Interest Purchase Agreement contained a warranty from Ziegler that he was not being paid, directly or indirectly, a sales commission on the transaction.  It came to pass that Ziegler, through a wholly owned LLC, did receive a sales commission on the property acquisition.  The Knocks and Knock Investments filed suit in Boone Circuit Court alleging that the commission was improper, including as a breach of fiduciary duty.  They would largely prevail at the Boone Circuit Court, receiving a judgment roughly equivalent to their percentage interest in the LLC multiplied by the amount of the secret commission.  Cross-appeals were then filed with the Kentucky Court of Appeals.
       In what is ultimately dicta, the Court of Appeals upheld the rulings of the Boone Circuit Court with respect to: (1) the capacity of the Knocks as individuals, as proper parties to the litigation (I believe I am in disagreement, on a normative matter, with that determination; more on it below); (2) that a release entered into between the parties was not enforceable; (3) that Ziegler did breach his fiduciary duty in taking the sales commission; and (4) a claim by Ziegler for reimbursement for tax work performed on behalf of the LLC. 
      Ultimately, however, none of it mattered.  The Membership Interest Purchase Agreement at issue provided an exclusive venue provision calling for any litigation to take place in Cincinnati, Ohio.  Finding that, inter alia, this provision stripped the Boone Circuit Court of jurisdiction to hear this dispute, its decision was reversed.

Choice of Venue Upheld an Appeal

      It is curious that the Court of Appeals was able to determine that the choice of venue clause is valid and enforceable.  In Midnight Terror Productions, LLC v. Winterland, Inc., 2012 WL 5457530 (Ky. App. Nov. 9, 2012) (reviewed here in November 14), in response to a challenge to the legitimacy of a venue clause, the Court of Appeals directed that that determination needed to be made by the trial court and on that basis remanded for a decision on the merits.  While the court wrote that “Nothing in the record demonstrates that Prudential Resources Corporation (v. Plunkett, 583 S.W.2d 97 (Ky. App. 1979)) should operate to void the application of the choice of venue clause in the Membership Interest Purchase Agreement,” neither does it recite that the various factors set forth therein have been considered by either the trial court or the Court of Appeals.
            This opinion gives far too few facts to come any binding conclusions as to the standing, but further understanding would be helpful.  It appears that the Knocks held their entire interest in the LLC that was the acquirer of the property through an LLC.  Normally, to the extent there was any breach of fiduciary duty, that duty would have been owed to the LLC that was itself a member of the purchaser LLC; the Knocks as individuals, would not have individual standing to object.  The opinion does not specify, however, whether the Knocks individually or their LLC were the signatories to the Membership Interest Purchase Agreement. 
Breach of Fiduciary Duty
            It is unfortunate that the decision of the Boone Circuit Court’s as supported (in dicta) by this holding of the Court of Appeals must ultimately be ignored.  Clearly, the earning of an undisclosed commission on the LLC’s acquisition of property, unless specifically disclosed and approved by the disinterested members (see KRS § 275.170), is a breach of fiduciary duty.  See also Thomas E. Rutledge and Thomas Earl Geu, The Analytic Protocol for the Duty of Loyalty Under the Prototype LLC Act, 63 Arkansas Law Review 473 (2010).  At the same time it is not clear that recourse to fiduciary duty law was necessary.  Ziegler warranted that he was not to receive a commission when in fact he was.  Clearly he violated his warranty, a matter that can be resolved as a straight-forward breach of contract action.

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