Wednesday, September 25, 2013

Court of Appeals Addresses Expectancy Damages, Rejects Claim to Pierce the Veil

Court of Appeals Addresses Expectancy Damages, Rejects Claim to Pierce the Veil

      A recent decision of the Kentucky Court of Appeals addresses the standards required to award expectancy damages with respect to a breach of contract action while as well rejecting a suggestion that the veil of the corporate debtor should be pierced.  Stettenbenz v. Butch’s Rod Shop LLC, 2013 WL 4779862 (Ky. App.  Sept. 6, 2013).  This opinion has been designated as “Not To Be Published.” 
      Before beginning the review of this decision, it is important to note a factual mistake that appears several times in the decision.  In both the style of the case and in the first and seventh paragraphs thereof, Butch’s Rod Shop is described as being an “LLC.”  The entirety of the decision as written, however, is in terms of the law of business corporations.  In fact, upon a review of the records of the Secretary of State, it is clear that Butch’s Rod Shop is a business corporation, and that the correct name of the entity is Butch’s Rod Shop, Inc.  This discrepancy has been communicated to Judge Dixon, author of the opinion.
      Returning to the substance of the issue, Stettenbenz hired Butch’s Rod Shop to undertake the restoration of a 1966 Chevy Nova.  That restoration extended over a period of years with Stettenbenz making progress payments as work was completed.  Ultimately, it was estimated that the work would be completed for an additional $14,000, and Stettenbenz continued to make progress payments thereon.  Finally, upon being told that $6,100 would complete the work, Stettenbenz tendered a check for that amount.  Over a year later with the work still not completed, Stettenbenz was advised that Butch’s was in financial difficulty.  Stettenbenz removed the vehicle and remaining parts and as well received a refund check for the remaining parts that had not yet been ordered against the last tendered $6,100 check.  In September of that year, Stettenbenz filed suit against Butch’s Rod Shop and as well the Whitakers, its individual shareholders.  Thereafter, the Whitakers approved and filed with the Kentucky Secretary of State articles of dissolution of Butch’s Rod Shop, Inc.   Those articles of dissolution, although such was not required by the statute, recited “that no debt of the corporation remains unpaid.”  This statement, not required by KRS § 271B.14-030, would ultimately lead to questions that, had it not been said, would not have needed to be addressed.
      Stettenbenz also asserted that the corporate veil of Butch’s Rod Shop should be pierced and the Whitakers held individually liable for the damages they had suffered.

      At a bench trial, Stettenbenz brought in an expert witness who testified that the completion of the car would cost between $50,000 and $55,000, including $3,000-$8,000 required for the completion of the interior, work that had not been undertaken by Butch’s.  However, the trial court issued its decision awarding Stettenbenz $12,901.73, that being the difference between the $14,000 paid under the last agreement for completion of the car less the $1,198.27 that was refunded (the opinion is inconsistent as to whether the refund check was in the amount $1,198.27 or $1,198.22).   The Court rejected the claims for piercing the veil and for liability consequent to the statement in the articles of dissolution that all debts had been satisfied.  This appeal followed.
      With respect to the damages awarded, the Court noted the rule that damages must not be speculative.  At the same time, it cautioned that it did not be required that the plaintiff “provide exact calculations of its damages.”  On the basis of the expert testimony provided on behalf of Stettenbenz, at least $42,000 was necessary to complete the work that had been originally undertaken by Butch’s Rod Shop. 
Thus, we are of the opinion that at least $42,000 in damages was proven with reasonable certainty.  According, we reverse on this ground and remand for a determination on the issue of expectancy damages.
      All of which may be moot in that the corporation has been now long dissolved.  For that reason, Stettenbenz argued on appeal that the grounds for piercing the veil had been satisfied.  The Court of Appeals, however, disagreed.  Reciting the various elements of piercing as set forth by the Kentucky Supreme Court in its 2012 Inter-Tel Technologies decision, the Court found that the Whitakers control of their closely-held corporation and its day-to-day operations was itself “insufficient to justify imposing personal shareholder liability unless such control is calculated to defraud or harm the corporation’s creditors.”  To that end, the trial court had found that the corporation maintained its own bank accounts, paid its corporate taxes from that bank account, paid all of its employees a salary, leased the facility from which it located and filed its annual reports with the Secretary of State.  There was, in contrast, no showing that the business was purposely undercapitalized or any indication of utilization of corporate assets to pay personal debts.  Judge Thompson would dissent from this portion of the decision, stating his view that the elements for piercing had been satisfied.
      Last, Stettenbenz sought to impose liability based upon the Whitakers based upon the allegedly false statement (curiously identified as being an “affidavit”) set forth in the articles of dissolution filed with the Secretary of State to the effect that all corporate debts had been paid.  In connection therewith, Stettenbenz relied upon KRS § 271B.140-020, it setting forth the steps to be employed when corporation dissolution is approved by both the directors and the shareholders.  Reviewing this statute, the Court found it to be purely procedural in nature.  Further, to the extent that the statement in the articles of dissolution was inaccurate, that point should be addressed through whatever administrative remedies are available through the Secretary of State’s office.  The Court also rejected the notion that allowing dissolution with an outstanding claim should not be permitted as means of avoiding liability, noting that a dissolved corporation may still be sued and “[i]f any corporate assets exist, the judgment can be collected from them.”

The Last Viking Invasion of England

The Last Viking Invasion of England

      Today is the anniversary of the battle at Stamford Bridge in 1066, it ending, for all intents and purposes, the Viking invasions of England.  Beginning in the 8th century, England had repeatedly suffered both Viking raids and invasions/migrations.  The great King Canute II was an aspect of this chain of events; he was himself Danish.
      Earlier in 1066, King Edward the Confessor died.  The crown was assumed by Harald Godwinson.  His dispute with William the Bastard of Normandy over whether Harald had previously agreed to surrender the crown to William would ultimately lead to the Battle of Hastings.  In the meantime, Harald Godwinson had to deal with an invasion from Norway led by another claimant to the throne, Norwegian King Harald Hardrada; Hardrada was supported in this invasion by Tostig Godwinson, Harald’s Godwinson brother.
      Two factors were crucial to the resolution of the battle.   First, the invading force was dispersed on both sides of the river.  Thus, when the English army attacked the Norse contingent on the south side of the river, they outnumbered their opponent.  Second, the intelligence of the Norse army failed; they did not realize the English army was already present and ready to launch an attack.  It being a warm day, the invading army had left much of their armor on board their ships.  Initially, the English forces largely massacred the Norse forces on the south side of the river.  They then proceeded to attack over the bridge, an effort that, in what was an apocryphal story, was delayed by a single Viking yielding an ax who single-handedly killed some forty soldiers before he was himself slain.  With the English having now crossed the bridge, the two armies again faced one another.  Ultimately, the Norse army would collapse consequent to its lack of armor and the deaths in battle of both Harald Hardrada and Tostig.  The few Normans who survived the battle entered into a truce with Harald agreeing to leave and never return.  While the invading fleet filled some 300 ships, the Norse survivors of the battle were able to return home in only 24 of them.

Tuesday, September 24, 2013

Court of Appeals Addresses Requirements for Enforcement of Choice of Venue

Court of Appeals Addresses Requirements for Enforcement of Choice of Venue
      In a recent decision of the Kentucky Court of Appeals, it returned to the trial court for further findings its determination to enforce a choice of venue provision in a written contract.  Robinson v. Colorado Personnel Resources Inc., 2013 WL 5050489 (Ky. App. Sept. 13, 2013).  This opinion is designated as “Not To Be Published.”
      Robinson, a certified registered nurse anesthetist, entered into a one-year agreement with Colorado Personnel Resources (“CPR”).  Six months into the agreement, CPR terminated that agreement, and in response Robinson filed suit in Jefferson Circuit Court.  CPR, in turn, filed a motion to dismiss the action on the basis of a choice of forum provision in its agreement with Robinson, that provision providing:
The laws of the State of Colorado shall govern this agreement.  Any dispute arising under the term or execution of this agreement shall be submitted to arbitration in the State of Colorado pursuant to the laws of the State of Colorado.
      In response to CPR’s motion, the trial court entered an order pursuant to which it “declines to exercise jurisdiction in this matter as a result of the parties’ selection of forum, and that this action is thereby dismissed.”
      The Court of Appeals noted that Kentucky has adopted § 80 of the Restatement (Second) Conflict of Laws, it providing, inter alia, that a venue selection will be given effect unless it is unfair or unreasonable.  In reliance upon Prezocki v. Bullock Garages, Inc., 938 S.W.2d 888, 889 (Ky. 1997), it stated that the following will be applied in determining whether the venue clause is either unfair or unreasonable, namely:

·                    Inconvenience of the chosen forum;

·                    Disparity in bargaining power between the parties; and

·                    Whether Kentucky maintains more than a minimal interest in the dispute.

            In this instance, the Court of Appeals acknowledged that the trial court may have undertaken this analysis, but the record was silent as to whether or not it did so.  Signaling an apparent lack of concern with the substance of the decision and critiquing only its form, the Court of Appeals wrote:
While trial court likely reached the proper conclusion in dismissing the action, because it did not make the appropriate findings as to the reasonableness of the choice of forum provision in the parties’ agreement, we must reverse and remand for further proceedings. On remand, the trial court is directed to make findings on the record in conformity with Prudential [Resources Corp. v. Plunkett, 583 S.W.2d 97 (Ky. App. 1979)].
      At least two consequences need to be recognized.  First, in any contractual action, it appears that the party seeking enforcement of a choice of venue is going to be saddled with an affirmative burden to demonstrate the reasonableness of that provision.  This burden is only going to give rise to additional, likely unjustified, arguments by a counterparty who, for whatever reason, seeks to avoid the choice of venue.  Second, with respect to transactional attorneys, decisions of this nature, qualifying the effectiveness of a contractual provision upon an ex-post facts and circumstances analysis, make it more difficult to give legal opinions and other assurances as to the enforcement of agreements as written.


New Rule 506(c)

Following is a short piece on new Rule 506(c) distributed by my firm on September 23, the effective date of the new rule.




The Securities and Exchange Commission’s new Rule 506(c) takes effect today, September 23, 2013.  Under this new rule, companies are allowed to publicly advertise sales of securities and broadly solicit potential investors, opening the gates to additional sources of capital for many businesses.  Sales may be made only to verified accredited investors.

Until now, unless a company complied with the (quite expensive) rules for a registered offering, advertising an offering was prohibited.  Prohibited advertisements included cold calling investors, advertisements in trade publications, website solicitation and distributing brochures (including at a horse auction).  As of today, companies will be able to advertise to potential investors, provided that sales of the securities are made only to “accredited investors” whose status as such is “verified.”

While it has been possible to raise funds from “accredited investors” (e.g., individuals with income in excess of $200,000 for each of the previous two years, with that amount reasonably expected in the current year, or individuals with a net worth, excluding their primary residence and related debt, exceeding $1 million), finding enough interested accredited investors has been difficult for many businesses, especially for start-ups and small businesses.  Under the old rule, a company could receive investments from accredited investors, but it was not allowed to advertise its offering or call on potential investors with whom the company’s representatives did not have a prior relationship.  Placing an advertisement in the paper, “cold calling,” or soliciting investors on your website were effectively prohibited.  While, subject to certain limitations, accredited investors could be identified through brokers, that route has been cumbersome and expensive.

Taking advantage of the new rule may greatly increase the chance of success of an offering.  For example, a manufacturer needs an additional $2 million to expand its business, but after two months of calling on all its investor contacts, the manufacturer has commitments for only $500,000.  Traditionally, its offering would have likely failed.  However, under the new rule, the manufacturer may advertise its offering in a trade publication, making the opportunity known to potential investors located in California, Texas and wherever else that trade publication is distributed, and pitch the opportunity to potential investors anywhere and everywhere.  Both of these alternatives would greatly expand the chance of the offering having success.

The new rule is not industry restricted – service provides as well as physical product businesses may use it.  To that end both the software developer and the film producer may advertise the offering of securities.  For instance, the new rule presents significant opportunities for raising funds for equine ventures, including stallion syndication.

There is no ceiling under the new rule on either the number of investors or the maximum amount that may be raised in the offering.  That being said, there remain a number of particular requirements:

1. The issuer must “verify” the status of each investor as an “accredited investor.” There are numerous avenues through which verification may take place, including confirmation from a CPA, a lawyer, a securities broker-dealer or an investment advisor that he or she has taken steps to review an investor’s financial statements and determined that the income or the $1 million net worth requirement is satisfied.  Third-party verification companies are already up and running.

2. Beware of Integration.  Consequent to the “integration” rules, it will be important to clearly separate investments made by “friends and family” who are not accredited investors from the 506(c) advertised offering.  If the offerings are “integrated,” which requires a technical legal analysis, the sales to non-accredited friends and family will taint the 506(c) offering, rendering the exemption unavailable.

3. Nothing about the new rule eliminates or limits the anti-fraud rules of the securities laws. Companies and their management still need to disclose all material information about the company and the risks of the investment.  While there is no set formula, this most frequently takes the form of an offering circular that sets forth all company history, its prospects, biographies of directors and management, business plan, anticipated use of the funds, financials (either audited or reviewed) and pro-formas.  Disclosure of risks is a defense to later suits charging fraud in the sale of the securities.

Raising needed capital will always be a difficult task for most businesses, but new Rule 506(c) should open new avenues for start-ups and growing companies. The above is a summary of the very detailed and technical rules regarding the Regulation D exemption from registration of securities. Advice of legal counsel should be sought before commencing any offering of securities. If you have any questions about the new rule, please contact Allison Donovan, Rich Mains or Tom Rutledge.

Monday, September 23, 2013

Athenian Forces Defeat Invading Persians at Marathon

Athenian Forces Defeat Invading Persians at Marathon
      Today might be the anniversary of the great battle, fought in 490 at Marathon, at which the forces of Athens defeated the Persian invasion sent by Darius the Great. The exact date of the battle is subject to controversy, although there is something of a consensus on the 21st.
      At this time, the Persian Empire extended from the western boundaries of what is today India across the Middle East, Turkey and to Southwest Europe.  Darius had decided that the land we refer to today as Greece, inhabited by a variety of city-states, would be next incorporated into his empire.  An invasion fleet landed its troops some 26 miles northeast of Athens at the Bay of Marathon.  Working with collaborators in Athens, it was thought that the army could be drawn away and destroyed even as the collaborators led an internal revolt, taking control of the city and making it available to Darius.  It would not turn out that way.
      At news of the landing, Athens sent word to Sparta seeking its assistance, the Spartan hoplite troops being the strongest force in the region.  Famously, the Spartans were unwilling to send their forces in light of an upcoming religious festival.  Athens would stand alone.  The Athenian army, well smaller than the Persian forces, camped facing their enemy for over a week.  On the 8th day, seeing that the Persians were re-embarking some troops onto ships, and fearing that they intended to launch a direct assault on Athens, the Greek forces attacked.  Although outnumbered, by skillful flanking maneuvers the Greeks were able to envelop the Persian forces.  While the historical records recite what must be grossly inflated figures, certainly the Persians lost in excess of 6,000 men while the Greeks lost fewer than 200.  Although not recounted in the contemporary historic record, a runner took off to announce the victory to Athens.  Just over 26 miles later, he entered the city, announced “nickomen” (“victory”) and dropped dead from exhaustion.  Meanwhile, the Persian ships set out from the Bay of Marathon with the apparent intent of directly attacking Athens.  The Athenian army force-marched itself back to the city, manning its walls as the Persian fleet approached.  The Persians decided that another attack was not in their best interest and they withdrew.
     A decade later, the Persian forces under Xerces, son of Darius, would again invade Greece.  They would ultimately fall victim to the Spartan and allied forces at Thermopylae, the Greek naval forces at Salamis and again the allied forces at Plataea.

Friday, September 20, 2013

Sixth Circuit Court of Appeals Affirms Dismissal of Derivative Action Brought Without Demand, Holds Futility Exception Not Satisfied

Sixth Circuit Court of Appeals Affirms Dismissal of Derivative Action
Brought Without Demand, Holds Futility Exception Not Satisfied

      A just-released decision of the Sixth Circuit Court of Appeals has affirmed the trial court’s dismissal of a derivative action filed with respect to a public corporation incorporated in Tennessee where the plaintiff shareholder did not make a demand upon the corporation and was held to have not satisfied the demand futility requirements.  Lukas v. McPeak, ___ F.3d ___, 2013 WL 5272924 (6th Cir. Sept. 19, 2013).
      Lukas was a shareholder in Miller Energy Resources, Inc., a Tennessee corporation.  The corporation had made numerous misstatements as to its value and as well had entered into an increasingly beneficial compensation with its CEO.  Ultimately it was disclosed that certain assets, recorded on the books as having a value of $350 million, were worth only $25-30 million, and that value was further offset by $40 million in liabilities.  Dismissal of the derivative action was sought on the basis that he had not made a demand upon Miller’s board prior to filing the suit and had failed to state claims against the individual directors.  The District Court granted the motion to dismiss on the grounds that he had failed to make the pre-suit demand and that failure should not be excused.
      The Sixth Circuit found that under Tennessee law, a modified version of Delaware’s Aronson v. Lewis, 473 A.2d. 805, 814 (Del. 1984) test would be applied with respect to assertions of futility.  Under Lewis ex rel. Citizens Sav. Bank & Trust Co. v. Boyd, 838 S.W.2d 215 , 221 (Tenn.Ct.App.1992), futility requires:
In demand-excused cases, the grounds for the shareholder’s claim are (1) that the board is interested and not independent and (2) that the challenged transaction is not protected by the Business Judgment Rule.
      This test as applied in Tennessee is conjunctive, rather than a disjunctive test as utilized in Delaware.  The Sixth Circuit analyzed on the string of Tennessee cases that it was argued indicate that demand is excused when all of the directors are named as defendants.  Ultimately, the Sixth Circuit would determine that, of itself, that was not sufficient to excuse demand.  Ultimately, Lukas’ claims would fail because he had not shown that a majority of the board was interested and lacked independence:
The District Court did not err in its disinterested – and, independent analysis.  At best, Lukas’ allegations make out what the District Court already acknowledged, that [the CEO/director’s] disinterest and independence may have been comprised.  However, Lukas does not allege any specifics regarding other board members and does not city any Tennessee authority supporting his contention that board members’ exposure to potential liability via allegations consisting primarily of nonfeasance – as opposed to malfeasance – should suffice to demonstrate a reasonable doubt as to independence and disinterest.
      There was a dissent, it arguing that certain dated Tennessee law remains in place and effective, and suggesting that the Sixth Circuit should have certified the decision to the Tennessee Supreme Court for resolution.

Wednesday, September 18, 2013

Sixth Circuit Court of Appeals Upholds Contraceptive Mandate of the PPACA

Sixth Circuit Court of Appeals Upholds Contraceptive Mandate of the PPACA
and Holds That Corporations Do Not Have Religious Rights

      On September 17 the Sixth Circuit Court of Appeals issued its decision in Autocam v. Sibelius, there addressing a challenge to the contraceptive mandate brought by a for-profit business venture.  Essentially, the company and its shareholders argued that they should be exempt from the requirement under the PPACA that insurance plans cover contraceptives (the “Mandate”) on the basis that they, the shareholders, as Catholics, has religious objections thereto.  Consistent with the holding of the Third Circuit Court of Appeals in Conestoga, but in contrast to the ruling of the Tenth Circuit in Hobby Lobby, the Sixth Circuit held that no religious rights were being violated.
      The opinion begins with a short discussion of the Anti-Injunction Act, which, if applied, would preclude the Court from hearing the dispute.  The Sixth Circuit determined that the limitations of the Anti-Injunction Act are not applicable.
      Turning to Autocam, the corporation, it was determined that it had Article 3 standing under the Constitution to challenge the Mandate.  In contrast, the shareholders of Autocam do not have Article 3 standing to assert a claim either under the Free Exercise Clause of the First Amendment or under the Religious Freedom Restoration Act (“RFRA”).  The obligation of the Mandate is upon the Corporation, and no burden is imposed upon the shareholders.  They bearing no burden, they have no standing to object to the Mandate.
       With respect to the suggestion that any actions taken by the Corporation to comply with the Mandate will require the shareholders to act against their religious beliefs, the Court noted that when they act on behalf of the Corporation they do so as officers and directors of the Corporation, fiduciary roles obligating them to act on behalf of that distinct legal entity.  Those actions do not of themselves give rise to a distinct injury suffered by the shareholders that would otherwise allow them to pursue an individual, as contrasted with a corporate, claim against the Mandate.
      Acknowledging that there are two decisions of the Ninth Circuit Court of Appeals allowing a for-profit corporation to assert the Free Exercise rights of the owners, the Sixth Circuit noted that those decisions “seem[] to abandon corporate law doctrine at the point that matters most,” namely the legal existence of the corporation as a person distinct from the shareholders.  “For this reason, the Kennedys cannot bring claims in their individual capacities under RFRA, nor can Autocam assert the Kennedys’ claims on their behalf.”  Turning then to the substance of Autocam’s argument that the Mandate violates its rights under RFRA, the Court held that a corporation is not a “person” capable of a “religious exercise” as contemplated by RFRA.

Agreement to Arbitrate Not Enforced Because, Well, There Was No Agreement

Agreement to Arbitrate Not Enforced Because, Well, There Was No Agreement

      In a recent decision, the Sixth Circuit Court of Appeals held there to be no binding agreement to arbitrate where the underlying agreement was itself illusory.  Day v. Fortune Hi-Tech Marketing, Inc., __ Fed. Appx ___, 2013 WL 4859781 (6th Cir. Sept. 12, 2013).
      Certain individuals who had paid to become independent representatives of Fortune Hi-Tech Marketing, Inc., a company that was ultimately a multi-level marketing (pyramid scheme) company, brought suit against Hi-Tech.  Hi-Tech, in turn, sought to compel arbitration of their claims.  The trial court initially ordered the claims to go to arbitration, but later reversed that decision.   Presented to the Court of Appeals was the question of whether there existed valid agreements to arbitrate.
      The various agreements between the independent representatives and Fortune Hi-Tech, while calling for arbitration, also provided that Fortune Hi-Tech had the authority to modify those agreements in any manner at any time with those modifications being effective upon notice of the change, going on to define that notice is effective when issued.
      Both the trial court and the Sixth Circuit Court of Appeals agreed that the arbitration agreement was unenforceable because the contract between the independent representatives and Hi-Tech Marketing lacked adequate consideration.  “Because [Hi-Tech] retained the ability to modify any term of the contract, at any time, its promises were illusory.”
      This finding that the contract was illusory was not set aside on the basis that the parties had performed in accordance therewith and Hi-Tech had never modified the agreements as it had the right to, the Sixth Circuit observing that there is a distinction between performance and the legal enforceability of an obligation.

Tuesday, September 17, 2013

An Innovative Use of LLCs

An Innovative Use of LLCs

      A story in the L.A. Times, Immigrants Lacking Papers Work Legally – As Their Own Bosses (Sept. 14, 2013) reports on the use of limited liability companies by persons who, lacking legal status and the ability to be employed in the U.S., instead organize an LLC.  That LLC agrees to perform services on behalf of what would otherwise the employer.   In turn, the illegal immigrant, as a member of the LLC, does the work on its behalf.  In the example cited in the article, Carla Chavarria cannot be directly employed to render the graphics design and branding services she provides.  However, it is legal for her LLC to be hired to do the same work.

Monday, September 16, 2013

Another Application of the Rule That an LLC is Separate From Its Members

Another Application of the Rule That an LLC is Separate From Its Members

      A recent decision from the Appellate Court of Illinois has applied the rule that an LLC and its members are legally distinct from one another.  Peabody-Waterside Development, LLC v. Islands of Waterside, LLC, No. 5-12-0490 (Ill. App. 5th Dist. Sept. 3, 2013).
      Peabody-Waterside Development, LLC was one of the two equal members of Islands of Waterside, LLC; the other equal member was Praxis Waterside, LLC.  Peabody performed significant work on property owned by Islands.  It was, however, not paid for that work.  Seeking to protect its position, Peabody filed a mechanic’s lien against Islands’ property.  The lender on the project, Regents Bank, sought to have the mechanic’s lien set aside on the basis that Peabody performed the work for its own benefit as co-owner of the property.  The trial court agreed with that analysis.  Peabody then appealed, arguing that “being a member of a limited liability company does not equate with being jointly interested or having a co-ownership in the real property owned by that limited liability company.”
      The Court of Appeals agreed with Peabody.  Noting the statutory rule that an LLC is a legal entity distinct from its members, it went on to differentiate an LLC from a joint venture, which is not a distinct legal entity and in which the co-venturers are treated as the co-owners of the property held by the venture.  This is contrasted with the Illinois LLC Act, which provides “that membership in a [LLC] does not confer any ownership interest in the property, real or personal, of the LLC.”, the Court citing 805 ILCS 180/30-1(a).
      On that basis, the mechanic’s lien was held to be valid.
      It is all too common for courts to recite that LLCs are similar to partnerships but have the limited liability characteristic of a corporation.  This mindset fosters an environment in which the significant distinctions between LLCs and partnerships are ignored.  It is important always to carefully review the issue at hand in light of the law governing LLCs.

Wednesday, September 11, 2013

The Trust as an Entity and Diversity Jurisdiction

The Trust as an Entity and Diversity Jurisdiction

      Chris Schaefer and I have written "The Trust as an Entity and Diversity Jurisdiction: Is Navarro Applicable to a Modern Business Trust?," which article was just released in the Journal of Real Property, Trust and Estate Law Journal.  This article discusses how to apply the rules of diversity jurisdiction to the modern business (sometime called a statutory) trust, a problem that to date has not been considered in a rigorous manner but which will become more important as this new organizational form sees greater use.
      You can access the article by clicking HERE IS THE LINK TO THE ARTICLE.

Tuesday, September 10, 2013

A Rose By Any Other Name?

A Rose By Any Other Name?

      A case recently filed raises an interesting existential question, namely when does a particular business entity exist.  Pharmacogenetics Diagnostic Laboratory, LLC v. Essential Molecular Testing Corporation, LLC – PGXL Partners, LLC, Civil Action No. 3-13-cv-867-H (W.D. Ky.).  This dispute has been assigned to Judge Heyburn. 
      Essentially, Pharmacogenetics entered into a contract, signed by Scott Goodman, to which Essential Molecular Testing (“EMT”) was a party.  However, it turned out that EMT did not, at the time the contract in dispute was signed, exist under that name.  Rather, after the date of the contract’s execution, Scott Goodman caused a previously existing LLC to change its name to that on the contract.
      Which brings us to the Bard’s question.  Clearly if an LLC or other business entity of the name set forth in the contract as of the date of its execution were to subsequently change its name, it would be undisputed that the entity under its new name remains bound by the agreement.  What should be, however, the answer on the reverse, namely that an existing entity adopts the name of the entity named in the contract.  Is this a question of intent: if Goodman always intended that the existing LLC would be the party to the contract, that he simply dropped the ball in getting its name changed to that set forth in the contract prior to its date of execution (or promptly thereafter), does the contract fail as, at least to, that business entity?  If that is the case, is the agent who acted on behalf of the existing, but improperly named, LLC personally liable on the obligations thereby created?
      Judge Heyburn has his work cut out on this one. 
       Before closing, it bears noting that the complaint as filed, contains a number of apparent errors with respect to various organizational forms.  For example, the plaintiff is identified in the caption of the case as a LLC, is identified in paragraph 3 of the complaint as a corporation, and is identified in paragraph 8 of the complaint as that mythical entity a “limited liability corporation.”  Meanwhile, EMT is described in the style as an LLC, in paragraph 4 of the complaint as a corporation of which Scott Goodman is, at paragraph 5 of the complaint, identified as the sole member.  Those details aside, I would not be surprised if the complaint is initially attacked on the basis of jurisdiction.  While diversity jurisdiction is claimed, no averments are made with respect to the citizenship of either the plaintiff or the defendants.

And So Begins a New Phase of the Hundred Years’ War

And So Begins a New Phase of the Hundred Years’ War

      Today marks the anniversary of the assignation, in 1419, of John the Fearless, Duke of Burgundy.
      The long-running Hundred Years’ War (it would actually last more than 100 years, but was interspersed with long periods of truce) was churning along.  France was, however, effectively paralyzed.  The King, Charles VI, was at best mentally unstable, a characteristic all too common in the Valois line – this deficiency would ultimately be introduced into the English royal house and exhibited in Henry VI, whose own mental instability would lead to the War of the Roses.  The House of Burgundy, of which John was the head, held Charles captive.  The opposition Armagnac house, however, held his heir, the Dauphin, in its custody.  At the same time, Henry V of England was leading an army across northern France, leaving the countryside rather the worst for wear.
      The proposal had been that the Burgundians and Armagnacs would meet to agree on some sort of reconciliation so as to present a unified force against the invading English.  The Burgundians were represented by John and the Armagnacs represented by the Dauphin.  In response to a perceived slight as he knelt to acknowledge his liege obedience, John was assassinated by being struck with an ax.  The Burgundians then signed an alliance with the English against the Armagnacs.  Within a year, Henry V would have the Treaty of Troyes whereby, had it terms actually been fulfilled, Henry would marry the daughter of Charles VI (that part did happen) and succeed to the French throne (that part did not happen).  The treaty was largely undone by the untimely deaths of both Charles VI and Henry V.

Sixth Circuit Addresses Claims of Fraudulent Misrepresentation with Respect to Warranties

Sixth Circuit Addresses Claims of Fraudulent
Misrepresentation with Respect to Warranties

      A recent decision from the Sixth Circuit Court of Appeals considered and rejected claims by a purchaser that a manufacturer should be liable under various misrepresentations theories for the ultimate failure of warranties provided by a third-party parts supplier.  Morris Aviation, LLC v. Diamond Aircraft Industries, Inc., ___ Fed. Appx. ___, 2013 WL 4564740 (6th Cir. Aug. 29, 2013). 
      Dr. John Morris organized Morris Aviation, LLC for the purpose of starting an air taxi business.  In connection therewith, and working with his associate, Dr. Todd House, numerous discussions were held with Diamond Aircraft Industries, Inc. regarding the purchase of a number of Diamond aircraft.  Those aircraft incorporated a relatively new power plant, a turbo diesel, manufactured by a German company, TAE.  Those TAE engines, when incorporated into a Diamond aircraft, were covered by a TAE, and not a Diamond, warranty.  One effect of this warranty was to protect Morris from higher than otherwise expected maintenance costs with respect to the relatively new power plant design.  However, shortly after Morris took the delivery of the first aircraft including a TAE-manufactured engine, TAE filed for bankruptcy protection under German law, and pursuant therewith, voided all of its warranty obligations. 

       With TAE now unavailable, Morris brought suit against Diamond on the basis that Diamond had misled Morris as to the viability of the warranty.  Ultimately all of those claims would be dismissed.
      Based upon the facts recited in this decision, it does not appear that Morris had any direct contact with TAE.  Rather, Diamond passed on TAE prepared information as to the warranty and spoke favorably of its terms.  Essentially:
[Morris] claims that Diamond misrepresented the terms of the warranty, including its length. Diamond stated that the warranty was good for 2,400 flight-hours; as it turned out it was good for zero….
Second, Morris claims that describing TAE and its warranty as “quality” and “reliable” misrepresented TAE’s status as financially troubled and potentially bankrupt.
      All of these assertions were rejected, each on a variety of grounds.  With respect to the quantitative aspects of the TAE warranty, it had not been shown that Diamond’s statements were inaccurate.  In effect, the warranty provided for certain things and Diamond’s description thereof was accurate.  The fact that TAE was ultimately unable due to its bankruptcy to perform upon the warranty did not retroactively render Diamond’s descriptions thereof as misleading or fraudulent.  With respect to statements as to reliability and quality, they went to the functioning of the engines themselves and did not extend to TAE’s financial stability.  Further, the fact that TAE was in financial distress was publicly available, and Morris had just as much ability to access and consider that information as did Diamond.  Further, Diamond had not made a partial disclosure of information with respect to TAE’s finances intending to create an impression of full disclosure, and they were not in a position where they had both superior knowledge and an obligation to disclose same.
      Clearly where risk is allocated by contract in the form of a warranty, the principle caveat emptor continues to apply – the buyer needs to investigate and understand the limits of what it is that is being purchased.  When they fail to do so, it is an assumed risk.

Kentucky Supreme Court Applies Rule of At-Will Employment to Court Employee

Kentucky Supreme Court Applies Rule of At-Will Employment to Court Employee

      In a recent decision, the Kentucky Supreme Court applied the rule of at-will employment to a court employee.  Travis v. Minton, 2013 WL 4620532 (Ky. Aug. 29, 2013). 
      Travis was an employee at the Barren-Metcalf County Family Court working for Judge Nance.  An investigation had revealed that Travis was creating a hostile work environment and atmosphere of fear in the court and as well that she had violated certain confidentiality rules.  It was then requested of Judge Nance that he terminate Travis; he declined to do so.  The Administrative Office of the Court, acting through its director pursuant to authority granted by Chief Justice Minton, then acted to terminate Travis’ employment.
      After efforts to bring an action in the lower courts, an original action was filed in the Supreme Court in which Travis sought to challenge the termination of her employment, seeking reinstatement with full back pay.
      Under the rules of court employees, Travis was in a non-tenured position.  She asserted that she was still entitled to challenge the determinations that were the basis of her termination.  The Court determined, however, that as she was an at-will employee she could be terminated with or without cause.  As such, it would be “absurd and illogical” to hold that she had a right to challenge the basis of her termination when no cause was required.  On the same basis, she was not entitled to a pre-termination hearing, that right being restricted to those who hold a property interest in their employment.  Being an at-will employee, she held no such property interest.  As for claims that she was entitled to due process protections in order to protect reputational rights, in that the courts had not promulgated any explanation for her termination, no such rights were infringed.  Simply put:
Ms. Travis was an at-will employee who had no due process rights relating to her non-tenured employment.  She was not entitled to a hearing to challenge her termination.

Monday, September 9, 2013

Chief Justice Steele to Resign

Chief Justice Steele to Resign

            Chief Justice Steele of the Delaware Supreme Court has announced that effective November 30, 2013 he will be stepping down from the bench.  No reason for his resignation was provided.  Here is a link to a Reuters story on his announcement.

Wednesday, September 4, 2013

Kentucky Supreme Court Upholds Arbitration Against Challenge on Basis of Merger Clause and Against Non-Signatory

Kentucky Supreme Court Upholds Arbitration Against Challenge
on Basis of Merger Clause and Against Non-Signatory


      In a decision rendered last week by the Kentucky Supreme Court, it determined that an agreement to arbitrate disputes arising out of the purchase of a mobile home entered into subsequent to the purchase and signed by only one of the purchasers would be enforced.  Energy Home, Division of Southern Energy Homes, Inc. v. Peay, No. 2001-SC-000462-DJ, 2013 WL 4608187 (Aug. 29, 2013) (To Be Published).
      Brian and Lori Peay purchased a manufactured home from American Dream Housing, that home having been manufactured by Southern Energy Homes, Inc. (“SEHI”).  The Purchase Agreement identified the purchasers as Brian and Lori, but it was signed only by Brian.  SEHI was not a party to that Purchase Agreement.  That Purchase Agreement did provide a merger and integration clause, namely:
This agreement contains the entire understanding between the dealer and the buyer and no other representation or inducement, verbal or written, has been made which is not contained in this contract.
      Several weeks later, the home was delivered by SEHI to American Dream, and American Dream in turn delivered it to the Peay’s home site, there placing it on a foundation that had been separately contracted for by the Peays.  After delivering of the home to the Peays, there was a final closing to effect the transfer of ownership.  Thereat, SEHI offered certain written warranties on the home to the Peays in exchange for their agreement that any disputes would be submitted to binding arbitration.  Brian Peay accepted those warranties and signed the agreement to arbitrate.  As part of that closing, Mr. Peay also watched a “closing video” that described closing matters including the Arbitration Agreement.

      After that closing, the Peays began noticing flaws in the home.  In response thereto, Lori requested and received warranty services from SEHI, signing acknowledgments thereof.  Those remedial efforts were apparently unsuccessful, and in 2008 the Peays filed suit naming SEHI as one of the defendants.  SEHI moved to enforce the Arbitration Agreement, a motion that was denied by the trial court.  The Court of Appeals affirmed the trial court on a trio of bases, namely that:
·                     The Arbitration Agreement violated the merger and integration provisions of the Purchase Agreement;
·                     The Arbitration Agreement was not enforceable because it was unconscionable;  and
·                     Lori Peay did not sign the Arbitration Agreement and therefore could not be bound by its waiver of her rights to bring suit.
This appeal to the Supreme Court then followed. 
      The Court first addressed and disposed of the argument that the integration/merger clause of the original Purchase Agreement somehow precluded enforcement of the subsequently entered into Arbitration Agreement.  Rejecting this argument, the Court noted that a merger clause functions to preclude variation of the written agreement by prior agreement; it does not preclude the parties from making a subsequent modification or even rescission of the agreement, citing both Vinaird v. Bodkin’s Adm’x, 72 S.W.2d 707 (Ky. 1934) and Elliot on Contracts §§ 1987, 1989.  From there the Court noted that the Arbitration Agreement is itself a valid contract for which there was consideration in the exchange of the express warranties for the agreement to arbitrate rather than litigate.  The Peays were free to reject the express warranties and the agreement to arbitrate.
       Turning to the argument of unconscionability, the Court rejected the determination by the Court of Appeals that the agreement to arbitrate was unconscionable.  Describing both procedural and substantive unconscionability, the Court found neither to be present.  Rather, the Arbitration Agreement was conspicuous and fully explained and the fact that it was proposed after the delivery of the home did not create procedural unconscionability.  Rather, in this instance, the Peays were offered the opportunity to enhance the value of the manufactured home they had purchased by the receipt of express warranties from the manufacturer, which warranties required as well arbitration of disputes.  Such a combination is not unconscionable and the fact that the Peays were not permitted to negotiate the independent provisions thereof did not created unconscionability.

      With respect to the argument that Lori Peay is not bound by the Arbitration Agreement on the grounds that she did not sign either the Purchase Agreement or the Arbitration Agreement, the Court began by noting that there is no general requirement that a party sign a contract in order to be bound thereby.  From there, while noting that language of the interrelated agreements could indicate that Lori was a party to the Arbitration Agreement, or that Brian may have acted as her agent, points ultimately not resolved, the Court placed reliance upon the fact that she requested and signed acknowledgments of warranty services.  Having accepted the benefits of the express warranties that were provided in conjunction with the agreement to arbitration, “We conclude that by her actions in accepting the warranty services expressly agreed to by Brian, Lori Peay assented to the Arbitration Agreement and bound herself to its terms and conditions.”



And So Begin the Middle Ages

And So Begin the Middle Ages
      By a certain measure, today marks the anniversary of the date in 476 from which the “Middle Ages” may be dated. On this day, the last emperor of the Western Roman Empire, Romulus Augustus, who was little more than a child and was completely controlled by his father, Orestes, the Magister Militum of the Roman military, was deposed by Odoacer. Orestes had little standing to complain about the over-throw of his son's reign - Orestes had revolted against the prior emperor and put his son on the imperial throne. 
      With Romulus' resignation the imperial regalia was packed up and shipped off to Byzantium. With this event, the Western Roman Empire ceased to exist, its fragments now under control of various “barbarian” tribes.

Tuesday, September 3, 2013

Characterization of Claim as One for Economic Loss Precludes Claim for Contribution

Characterization of Claim as One for Economic Loss Precludes Claim for Contribution

      In a recent opinion of the Federal District Court (Judge Simpson), on the basis that the claim for breach of contract implicated the economic loss rule, it was determined that indemnification, which applies between joint tort-feasors, was not available.  Ronald A. Chisholm, Ltd. v. American Cold Storage, Inc., 2013 WL 4042036 (W.D. Ky. Aug. 8, 2013).
      To suggest that this dispute has been hard fought would likely be an understatement.  This is the fifth Memorandum Opinion to be issued by Judge Simpson.  Going back to the first decision (2012 WL 5362306 W.D. Ky. Oct. 31, 2012), Abilene Texas Foods, Inc., the third-party defendant herein, entered into an agreement to purchase meat from Chisholm.  American Cold Storage stored products for both Abilene and Chisholm.  Chisholm had authorized American Cold Storage to give Abilene access to Chisholm’s inventory, or at least some of it.  One aspect of this suit involved a claim by Chisholm against American Cold Storage alleging that the latter has released Chisholm’s inventory to Abilene without permission to do so.  The claims asserted by Chisholm against American Cold Storage were for breach of contract, breach of fiduciary duty of good faith and the covenant of good faith, and breach of a contractual bailment.  In this Memorandum Opinion, Judge Simpson was responding to American Cold Storage’s request for summary judgment requiring that Abilene indemnify it on the basis that it was Abilene’s actions in withdrawing the inventory that exposed American Cold Storage to liability.
      Repeating the rule that contribution and indemnity arise with respect to claims in tort, citing in support thereof Ohio River Pipeline Corp. v. Landrum, 580 S.W.2d 713, 719-20 (Ky. App. 1979), the Court went on to note:
Under Kentucky law, the failure to perform a contractual obligation typically does not give rise to a cause of action in tort.
      There is, however, a narrow exception to this rule based upon the existence of a “independent legal duty,” the Court citing in support thereof Mints v. W.S. Agency, Inc., 226 S.W.3d 833, 836 (Ky. App. 2007).  From there the Court proceeded to review the various counts brought by American Cold Storage against Abilene with a view to determining whether they arise in contract or in tort, and if in the contract did there exist an independent legal duty.
      The Court analyzed each of the counts and determined that each arose in contract without breach of an independent legal duty, and therefore, arising in contract and not tort.  On that basis, the motion seeking indemnification was denied.