Tuesday, July 30, 2013

An LLC is Separate From its Members, and Vice-Versa

Georgia Court Again Confirms that an LLC is Separate From its Members,
and Vice-Versa

      A recent decision by the Georgia Court of Appeals highlights the fact that the LLC and its members are legally distinct from one another; the obligations of one are not the obligations of the other.  Primary Investments, LLC v. Wee Tender Care III, Inc., ___ S.E.2d ___ , 2013 WL 3665318 (Ga. App. July 16, 2013).
      Primary Investments, LLC, formerly known as Primary Prep Academy, LLC (“Primary LLC”), sold its assets to N & N Holdings, LLC, which assets were then operated by Wee Tender Care III, Inc.  The Asset Purchase Agreement included a non-competition clause providing that “neither Seller nor its agents” will operate a competing facility nor solicit from the parents of the children enrolled for the purpose of enrolling in a competing facility.  After the sale was completed in March of 2008, the members of Seller opened a new daycare facility within the prescribed radius of that which had been sold.  It was that new venture that precipitated this suit.
      Initially, it was not contested that Primary LLC, the “Seller” under the Asset Purchase Agreement, was in any manner involved in the operation of the new daycare facility.  Further, there was no evidence that the members of Primary LLC were acting on its behalf in opening the new facility.  On that basis, it could not be found that Primary LLC had violated the non-competition provision of the Asset Purchase Agreement.  The Court then turned to the language relating to the “agents” of Primary LLC.  Initially, certain of its members, who were likewise involved in the new challenge venture, never signed the Asset Purchase Agreement.  The member who did sign the Asset Purchase Agreement on behalf of Primary LLC did so in a representative capacity.  On the basis of black letter agency law that when an agent acts on behalf of a disclosed principal, the principal is bound and the agent is not, the Court found that this member was likewise not bound to the non-competition agreement.  In that they were not parties to the APA, the Court found that its non-competition agreement could not be enforced against the members of Primary LLC.
      Seeking to salvage their case, the Plaintiffs alleged that the term “agents” should be read within the context of the Georgia LLC Act, it providing that managers are agents of the LLC, and from there those who were managers of Primary LLC should be bound by the non-competition agreement.  While the managers may themselves have an agency authority of the LLC, the Court went on to note that the Georgia LLC Act provides that the members and managers of the LLC are not liable on its debts and obligations, the Court observing:
Accordingly, Primary LLC had no authority to bind [Primary’s managers] individually to the terms of the noncompetition agreement, and we find that under the Act, merely including the term “its agents” in a contract signed by a [LLC] does not bind its members or managers individually.  Rather, if [the Purchasers under the APA] wished to bind the [managers of Primary LLC] to the terms of the noncompetition clause, they were required to make them parties to the APA and to obtain their signature in their individual capacities.
     The Court of Appeals rejected a determination by the trial court that a pair of letters submitted to state regulatory authorities requesting transfer of the license had the effect of individually binding the members/managers of Primary LLC.  At the same time, the Court rejected a request for rescission of the contract on the basis that the 10-mile radius of the non-competition limitation (it already interpreted to apply only to the Primary LLC and those acting on its behalf) but was improperly listed at 10 rather than 5.
     The moral of the story is clear; if you intend the bind the members or managers of an LLC to a noncompetition or other agreement, it is necessary that they be named as parties to the agreement and sign it in their individual capacities.  Absent doing so, the protections that may be sought are likely to be illusory.

Friday, July 26, 2013

Citizenship of an LLC in Which a Trust is a Member

Citizenship of an LLC in Which a Trust is a Member
       A recent decision from the U.S. District Court for the Western District of Virginia has addressed in the seldom addressed question of how to determine the citizenship of an LLC of which one of the members is a trust.  Poulos v. Geomet Operating Co., 2013 WL 2456044 (W.D. Va. June 6, 2013).
      This case involved a dispute over the ownership of certain coal bed methane interests.  This suit appears to have been originally filed in federal court against defendants including LBR Holdings, LLC.  The plaintiffs then filed a motion to dismiss without prejudice on the basis that subject matter jurisdiction was lacking on the basis the LLC had the citizenship of North Carolina, sharing that citizenship with one of the plaintiffs.  The North Carolina citizenship was ascribed to the LLC on the basis that one of the members of the LLC was a trust, of which one of the beneficiaries was a citizen of North Carolina.  LBR, seeking to keep the case in federal court, argued that it should only be the citizenship of the trustee, rather than the citizenship of the beneficiaries, that should control as to the citizenship of the trust as ascribed to the LLC.  On the basis that the trustee was a citizen of Kentucky, diversity would have been preserved.
     Distinguishing Navarro Savings Association, the Court applied the Carden test to look to all of the “members” of the trust.  Relying on a number of cases including Emerald Investors, the court found that the citizenship of each beneficiary would be attributed to the LLC.  In doing so, the LLC took on the citizenship of the North Carolina beneficial owner, and on that basis, diversity of citizenship was lacking.
     Based upon the information available in the decision, it would appear that the trust at issue was a common law donative trust.  The outcome might have been different had it been a modern form of business/statutory trust.  As to that point, see Thomas E. Rutledge and Christopher E. Schaefer, The Trust as an Entity and Diversity Jurisdiction: Is Navarro Applicable to the Modern Business Trust, 48 Real Property, Trust and Estate law Journal  (Forthcoming).  The working draft of this article can be accessed through this link:  The Trust as an Entity and Diversity Jurisdiction

Thursday, July 25, 2013

Amendment of Syndicate Agreement and Ratification of Prior Actions Resolved the Dispute

Amendment of Syndicate Agreement and Ratification
of Prior Actions Resolved the Dispute
      In a pair of recent decisions, the U.S. District Court has dismissed the long-running dispute over the Lemon Drop Kid Syndicate.  KNC Investments, LLC v. Lane’s End Stallions, Inc., 2013 WL 3213081 (E.D. Ky. June 24, 2013) & 2013 WL 2313083 (E.D. Ky. June 24, 2013).
      KNC Investments, LLC was one of forty participants in the Lemon Drop Kid Syndicate.  KNC brought suit seeking a declaration that was entitled to certain records of the syndicate including the names and contact information of the other participants and challenging the allocation of excess nominations.  Cutting to the chase, after the suit was filed, Lane’s End Stallions solicited from the members of the syndicate both an amendment to the syndicate agreement confirming that the various participants in the syndicate are not entitled to the names and contact information of the other participants in the syndicate and ratifying the mechanism by which Lane’s End had allocated the additional nominations.  Subsequent challenges to the mechanism by which the consents to the amendment and ratification were sought were rejected on the basis that Lane’s End had, by contract, the capacity to provide its recommendations and suggestions.  Hence, there could be no breach of duty, including a fiduciary duty, in stating its recommendation that the proposed amendment and ratification be adopted by the members of the syndicate.
       In that all of the plaintiffs’ claims were functionally barred by the actions of the syndicate’s members, there existed no further “case or controversy,” and on that basis the various suits were dismissed.

Wednesday, July 24, 2013

Indiana Court of Appeals Addresses Agency on Behalf of an Administratively Dissolved LLC

Indiana Court of Appeals Addresses Agency
on Behalf of an Administratively Dissolved LLC

            In a recent decision, the Indiana Court of Appeals addressed the liability of a member of an LLC that had been administratively dissolved for legal fees incurred in connection with the LLC.  The court found that the member was no liable on those debts.  Pazmino v. Bose McKinney & Evans, LLP, 989 N.E.2d 784 (Ind. App. 2013). 
            Bose McKinney & Evans, LLP (“Bose”), a law firm, rendered services to Buena Vista Realty Group, LLC from February through June of 2008; the LLC was administratively dissolved in April of that year. These services were requested by Pazmino – the opinion does not address whether he was a member, a manager, or a mere agent of the LLC.  Of a total unpaid bill of $12,580.09, some $9,618.39 of that amount was incurred after the administrative dissolution.  Bose sought to hold Pazmino liable on the LLC’s debt on a pair of basis:  first, it was he who requested the work on the LLC’s behalf even after it was dissolved, and second that he was purporting to act on behalf of a non-existent principal and therefor liable on the obligation.  Bose was awarded summary judgment against Pazmino, and this appeal followed.
             Cutting to the chase, the summary judgment was reversed.  As to the first assertion, the Court of Appeals determined that if Pazmino was acting on behalf of the LLC in requesting that the legal work be done for it, then he was not liable for the related charges.  To that point the Court noted that the firm identified the LLC as the client in its invoices.  Therefore, Bose was not entitled to summary judgment against Pazmino.On the other hand, as Pazmino’s tender of evidence did not provide detail as to why and on whose behalf he requested the services, he was not entitled to summary judgment.
            Bose argued that, from the LLC’s administrative dissolution on April 24, 2009, it ceased to exist as a principal on whose behalf Pazmino could act.  There being no principal, Pazmino could not be acting on the LLC’s behalf.  In response, Pazmino pointed to section 23-18-10-3 of the Indiana Business Flexibility Act (i.e., the Indiana LLC Act) for the proposition that an LLC, after administrative dissolution, continues to exist but may not carry out on any business except that necessary for its winding up and termination.  While the Court’s language is not express – “Thus, regardless of the nature of the work performed by Bose, [the LLC] continued to exist as a principal that could be bound by the acts of its agents.” – it seems to interpret the statute as keeping in place a principal on whose behalf an agent may act, even if the principal may not properly engage in the activities for which the agent would bind it.  
      Treating for these purposes Pazmino as a mere employee (and not a member or manager) of the LLC, Bose argued that while members are shielded from liability post-dissolution, it follows that a mere employee does not, post-dissolution, enjoy limited liability.  Rejecting that notion, the Court of Appeals found that “[W]e do not agree that the notion that an employee who continues to act on behalf of a dissolved LLC is always personally liable on that conduct.”  Differentiating the statutory rule as to capacity to act from the common laws rules of agency allocating responsibility between the principal and the agent, the Court was not willing to interpret the statute as, by omission, imposing liability upon a mere employee:
In fact, none of the cases cited by Bose suggest that an employee properly acting on behalf of a dissolved LLC is personally liable for such acts, and nothing in the Act suggests that the Legislature intended to expose employees of a dissolved LLC acting on behalf of the LLC to personal liability while protecting members from personal liability.  Instead, we believe that reference to the personal liability of members in Indiana Code Section 23-18-9-3(b)(2) is intended to clarify that, even upon dissolution, an LLC, not its members, remains liable for the LLCs obligations.
      Likely the outcome of this case would not be different under Kentucky law.  Under KRS § 275.300(2), a dissolved LLC “shall continue its existence but shall not carry on any business except that appropriate to wind up and liquidate its business and affairs.”  As such, the Kentucky LLC Act has rejected the now quite dated notion that, upon dissolution, the legal existence of the business entity terminates.  Rather, upon dissolution the permissible activities of the entity are limited.  Still, there is a question as to whether an agent, on behalf of a limited principal, should be protected from liability on obligations undertaken after the dissolution that are not appropriate for winding up and termination.  While this Indiana court seems to have answered “no,” section 3.07(4) of the Restatement (Third) of Agency would answer “yes.”  Of course, the analysis changes again if the company is subsequently reinstated.

Wednesday, July 17, 2013

The Importance of Defining Value

The Importance of Defining Value

      Under Louisiana law, a member is entitled to resign from an LLC and received the “fair market value” of their interest in the company.  These rules are subject to modification in the operating agreement.  In a decision from earlier this year, a Louisiana court highlighted the importance of adopting specific rules as to valuation.  In this instance, the withdrawing member received far less than he thought he was entitled.  Fancher v. Prudhome, 112 So.3d 909 (La. App. 2 Cir. 2013).
      Diamond Shield Services, LLC was organized in Louisiana and by the time of this dispute had three equal members, Steven Prudhome, Ray Fancher and Cody Robbins.  Fancher, through his industry contacts, was the primary (almost exclusive) source of business to the LLC.  Fancher became aware that Robbins and Prudhome, on the LLC’s behalf, had entered into a loan agreement with a third party on terms he believed to be unreasonable. For that reason he elected to withdraw from the company.  See La. Stat. Ann. 12:1325(C).
      Fancher’s expert, a CPA, prepared and submitted a going-concern valuation of $2 million, yielding to Robbins’ a liquidation payment of $666,666.  This calculation did not reflect any adjustments for lack of marketability or lack of control.  In contrast, a book valuation of the company yielded a value of slightly less than $38,000, resulting in a payment to Fancher of $12,463.74.  It was this book valuation that was accepted by the trial court, leading the appeal.
      On appeal, the determination of the trial court was upheld.  In that Fancher was the primary source for company business, the court found, in effect, that upon his withdrawal a going-concern valuation was inappropriate.  Rather, the adjusted book value methodology was accepted.
      Under Kentucky law, a member resigning or otherwise withdrawing from an LLC is not entitled to any liquidating payment except to the extent provided in a written operating agreement.  That said, many agreements are incomplete and imprecise as to the valuation methodology to be employed.  Beyond the simple confusion as to what is the distinction between “fair value” and “fair market value,” there is typically lacking specificity as to the methodologies to be employed.  While, depending on whose ox is being gored, lack of detail may be advantageous to one party or another, specificity in the document avoids the need for costly litigation.  That specificity may include the valuation methodologies to be employed, distinctions to be drawn between individual members (in some instances, such as that discussed  in this Louisiana case, different methodologies may be appropriate depending on the services provided by the particular member) and similar factors.  A statement that company equipment will be valued based upon its “depreciated” value only invites the question of whether depreciation will be calculated on the basis of GAAP or tax rules.  All of these matters need to be considered.

Tuesday, July 16, 2013

Going to Delaware (?)

Going to Delaware (?)

      In this piece, published in the Journal of Passthrough Entities, I endeavor to review the all-to-often knee-jerk reaction of organizing business ventures in Delaware when they are not organized in the home jurisdiction, noting that even as Delaware’s statutes are often different, they are not necessarily better.  In fact, in many areas, there exists significant ambiguity in Delaware law.  For the reason, the entire choice of entity calculus needs to as well carefully assess in what jurisdiction the particular venture will be organized.  The article can be accessed through this link:  Going to Delaware (?)

Monday, July 15, 2013

Articles on Legal Ethics

Articles on Legal Ethics

Last fall, both my law partner A.J. Singleton and I were invited to participate in the Symposium on Legal Ethics for the Transactional Lawyer sponsored by The Northern Kentucky Law Review.  The issue of the law review containing the articles there presented has now been released, and we have posted them.  The articles are:
·                     Shannon “A.J.” Singleton, Should Borders Matter to the Transactional Lawyer?, 40 Northern Ky. Law Review 295 (2013); and
·                     Thomas E. Rutledge, When Your Client is an Organization – Some of the Problems Not Resolved by Rule 1.13, 40 Northern Ky. Law Review 357 (2013).

      AJ’s article can be accessed thru this link Should Borders Matter to a Transactional Lawyer?, and my article is available at this link  When Your Client is an Organization.

Thursday, July 11, 2013

Yet Again, An Agreement to Arbitrate Falls on the Lack of Actual Agency Authority

Yet Again, An Agreement to Arbitrate Falls on the Lack of Actual Agency Authority

      In yet another of a now long string of cases, a Kentucky court has struck down a purported agreement to arbitrate, again in a healthcare facility admissions document, based upon the failure of the person who executed that agreement to have actual authority to do so.  LP Pikeville, LLC v. Pinson, 2013 WL 3335013 (Ky. App. June 28, 2013).
      Lettie Totten was admitted to a long-term care facility on February 21, 2008.  She was assisted by her daughter Nannette Pinson, who signed the admission documents on her mother’s behalf.  In connection therewith, Nannette executed an agreement providing for arbitration of disputes.  Nannette did not hold from Lettie a power of attorney, nor had she been appointed her mother’s legal guardian.  Shortly after that admission, Lettie executed a health care surrogate form designating Nannette her surrogate.  The agreement to arbitrate was not re-executed subsequent to the delivery of that healthcare surrogacy, and neither was it a condition of receiving services. 
     Lettie subsequently passed away, and Nannette, on behalf of the estate, brought an action; the facility and other defendants sought to compel arbitration of the dispute.  The trial court denied arbitration, and the Court of Appeals heard an appeal thereof on an interlocutory basis.
      Starting with the rule set forth by the Kentucky Supreme Court in Ping v. Beverly Enterprises, Inc., 376 S.W.3d 581 (Ky. 2012), the court set forth, inter alia, a trio of rules to be applied in determining whether an agreement to arbitrate will in this situation will be enforced, namely:
·                     The party seeking arbitration bears the burden of showing there exists a valid agreement to arbitrate;
·                     The proponent of the arbitration bears the burden of showing that any agent who executed the agreement on behalf of a principal had actual authority to do so; and
·                     If entering into the arbitration agreement is not a prerequisite to admission into the healthcare facility, the determination to bind the admittee to arbitration is not a healthcare decision.

Wednesday, July 10, 2013

The Proponent of the Existence of Diversity Jurisdiction Bears the Burden of Demonstrating Same

The Proponent of the Existence of Diversity Jurisdiction
Bears the Burden of Demonstrating Same

      In a recent decision from Colorado, the court has reiterated that it is the burden of the party claiming the existence of diversity jurisdiction to demonstrate that it actually exists.  In this case, the court rejected the notion that it could proceed on the basis of incomplete information.  Mendoza v. Hospitality Staffing Solutions, LLC, Civ. Act. No. 13:-cv-1286-WJM-MJW (D. Col. June 10, 2013). 
      In this instance, the Defendants removed the case to federal court based upon alleged diversity jurisdiction.  Initially, the Defendants suggested that the citizenship of an LLC should be determined on the same basis as that of the corporation, namely its jurisdiction of organization and its principal place of business.  Although the 10th Circuit has not yet issued a ruling on that point, the trial court determined to follow the rulings of every other court that has considered the matter (they being the 1st, 2nd, 4th, 6th, 7th 8th and 9th Circuits) as well as other Colorado courts, it citing Hale v. MasterSaw International Pty, Ltd., 93 F. Supp.2d 1108, 1112 (D. Col. 2000) for the accepted rule, namely that citizenship is dependent upon all the members of the LLC.
      In response to an order to show cause, an affidavit had been submitted on behalf of Hospitality Staffing Solutions, LLC reciting two of its members, both of which are themselves partnerships.  The decision goes on to recite:
Mr. Woodward then states that the partners comprising Frontenac IX Private Equity Capital are unknown, and their identities are protected by a confidential agreement.
      In response thereto, the court wrote:
Defendants’ Response fails to provide the information necessary to definitively determine the citizenship of HSS.  The Response is therefore deficient, and does not satisfy the Court’s Order to Show Cause.
*   *   *
The Court notes that Defendants were specifically warned that this action would be dismissed if they did not properly respond to the Court’s Order to Show Cause.  Despite this warning, Defendants failed to provide the information requested.  On the current record, the Court finds that Defendants have not met their burden of showing that this Court has jurisdiction over this action.  Therefore, Defendants have failed to overcome the presumption against removal in this case, and remand of this case is appropriate. (citations omitted).
     Consistent with a number of other decisions, the inability to trace the ownership of an LLC back to either natural persons or corporations will be fatal to a claim of diversity jurisdiction.

Tuesday, July 9, 2013

North Carolina Takes a Step Forward By Repealing L3C Statute

North Carolina Takes a Step Forward By Repealing L3C Statute

      Here is a link to Doug Batey’s review of the (in my view well reasoned and insightful) decision of North Carolina to repeal its L3C statute.

North Carolina Drops L3Cs

Massachusetts Court Holds Managers of LLC Equivalent to Corporate Officers for Purpose of Liability Under Unpaid Wage Act

Massachusetts Court Holds Managers of LLC Equivalent to
Corporate Officers for Purpose of Liability Under Unpaid Wage Act

      Massachusetts, like most states, has a statute imposing personal liability upon certain individuals where corporate employer fails to pay the promised wages.  The Massachusetts statute imposes that liability on the president and treasurer of a corporation, as well as the officers or agents having management of the corporation, treating in certain situations each as the employer.  Mass. Gen. Laws. ch. 149, § 148.  In a recent decision, the Massachusetts Supreme Court has applied these rules to the managers of an LLC.  Cook v. Patient Edu, LLC, SJC-11272, 2013 Mass. LEXIS 464 (June 13, 2013). 
      Cook was an employee of Patient Edu, LLC, it having as managers Steven Graziano and Michael Schulman.  The LLC breached its agreement to pay certain compensation to Cook; at the time of his resignation, he was owed $61,538.56 in accrued but unpaid wages and was as well due $6,879.36 in expenses that had been accrued but not been reimbursed.  He brought suit for the unpaid wages, naming the LLC and each of the managers.  Those managers, individually, sought dismissal of the complaint, which was granted by the trial court.  The Massachusetts Supreme Court, of its motion, removed the dispute from the intermediate appellate court for its consideration. 
      Notwithstanding the fact that the statute referred to corporate officers, and was silent as to managers or other representatives of an LLC, the Court did not view the statutory language as a legislative determination to single out for individual liability only corporate officers.  Rather, the Court found the inclusion of the provisions on corporate officer liability and public officer liability serve to illustrate the circumstances in which an individual may be deemed a “person having employees in his service.”  On that basis, the Court rejected the defendant’s argument that there was an implicit exclusion of those acting on behalf of other limited liability forms.  The Court afforded no effect to a legislative proposal that would have amended the statute at question to expressly address LLCs, stating that legislative inaction could not be used to interpret a statute passed by a prior legislature.
      Holding the managers of an LLC to be functionally “persons having employees in his service,” the managers of the LLC were liable for the unpaid wages.
      If nothing more than to play devil’s advocate, decisions of this nature treating a “corporation” as a proxy for “any business entity affording limited liability” set a dangerous precedent.  Focusing on the Massachusetts statute in question, it imposes liability upon the corporation’s “president” and “treasurer.”  The Massachusetts Supreme Court provide no explication as to how or why the managers of this particular LLC would be treated as equivalent to a corporate president or a corporate treasurer.  Likewise, there was no explanation as to how one determines (or not) that an LLC’s managers, and these managers in particular, had the required degree of control.  Further, as Massachusetts is the home of the organizational form generically referred as to the “Massachusetts business trust,” it seems curious that the Supreme Court would in effect let the legislature off the hook in not considering other organization forms.