Friday, March 21, 2014

North Carolina Court of Appeals Addresses Rights Under a Charging Order

North Carolina Court of Appeals Addresses Rights Under a Charging Order


The North Carolina Court of Appeals recently reviewed, and found to be over-broad, a charging order issued in connection with the judgment-creditors efforts to collect on a judgment.  First Bank v. S&R Grandview, L.L.C., ___ S.E.2d ___, 2014 WL 846671 (N.C. App. March 4, 2014).

            Donald Rhine was found to be indebted to First Bank for in excess of $3.5 million.  Seeking to collect on this judgment, First Bank sought a charging order against Rhine’s interests in S&R Grandview, LLC (“Grandview”).  The terms of the charging order that was entered are recited in the opinion, and in addition to directing that all distributions that would have been made to Rhine be made instead to First Bank (the charging order as well directions that all allocations be made to First Bank – clearly they have not thought through what it is they want from a charging order), it as well directed that:

  • “Until such time as the full amount of the judgment has been paid to First Bank, Defendant D. Rhine shall be enjoined from exercising any of the rights of a member of” Grandview; and
  • “Defendant D. Rhine’s membership right shall lie fallow until the judgment is satisfied ….”
Rhine appealed the scope of the charging order.

            The Court reviewed the charging order provisions of the old and new NC LLC Acts, finding them to consistently state that a judgment-creditor holding a charging order has only the rights of an assignee.  However, in that the rights of the judgment-creditor vis-à-vis the LLC will come to an end when the underlying judgment is satisfied, the holder of a charging order is not the same as an assignee.  In that the entry of a charging order did not affect an assignment of the judgment-debtor’s interest in the LLC, the member did not suffer the consequences of assignment, namely dissociation and the loss of the rights to participate in the LLC’s management.

Had the General Assembly intended a charging order to assign all membership interests and terminate a debtor’s membership in the LLC, as plaintiff contends, it could have easily included language to that effect.  Absent such language, we are bound by the words used by the General Assembly, and we hold that a charging order does not effectuate an assignment of a debtor-member’s total interest in an LLC.  2014 WL 846671, *3.

      The Court of Appeals reversed those aspects of the charging order precluding Rhine from exercising the management rights relating to the charged interest and requiring that they “lie fallow” until satisfaction of the judgment in favor of First Bank.

Tuesday, March 11, 2014

North Carolina Decision of Derivative Actions in Nonprofit Corporations

North Carolina Decision of Derivative Actions in Nonprofit Corporations


      The North Carolina Court of Appeals has recently addressed derivative actions brought in the context of a nonprofit corporation.  A review of that decision appears HERE.

Monday, March 10, 2014

Changes in New Jersey Charging Order Statute

Changes in New Jersey Charging Order Statute


      Doug Batey has reviewed the recent changes to the New Jersey law on charging orders.  Here is a LINK to his review.

      The growing number of distinctions between the remedies available the holder of a charging order increase the importance of resolving the choice of law question about which law applies, that of the jurisdiction in which the court issuing the charging order sits or the law of the jurisdiction in which the LLC was formed?

Wednesday, March 5, 2014

2014 Kentucky General Assembly Proposal for Updating Business Entities Laws

2014 Kentucky General Assembly
Proposal for Updating Business Entities Laws
        S.B. 178, sponsored by Senator Sara Beth Gregory, proposes a number of changes to Kentucky business entity laws, namely:
·                     The adoption of the Kentucky Revised Nonprofit Corporation Act (2014), a new nonprofit corporation act based on the ABA’s Model Nonprofit Corporation Act (3rd) (Sections 1-157)
·                     The adoption of the Kentucky Unincorporated Nonprofit Association Act (Sections 164-195)
·                     Significant updating of Kentucky’s LLC Act as it relates to nonprofit LLCs (Sections 200-204, 209)
·                     Miscellaneous clean-up and clarification edits to Kentucky’s business entities statutes (e.g., Sections 196, 197, 198, 199, 205, 206, 209, 212-215)
The Kentucky Revised Nonprofit Corporation Act (2014)
      The Kentucky Revised Nonprofit Corporation Act (2014) is based on the American Bar Association’s Model Nonprofit Corporation Act (3rd), as reviewed and modified by a committee of leading practitioners from across the Commonwealth.  This will be the first substantive re-write of Kentucky’s law on nonprofit corporations since 1968.
      Anyone familiar with the existing nonprofit corporation act has been frustrated by its lack of attention to many common questions and its outdated limitations upon many entirely appropriate business practices.  The new Act is intended to remedy those problems.  For example, the new statute will:
·                     provide maximum flexibility for meetings of the board, of the members and of delegates, allowing telephonic and internet meetings and allowing the electronic distribution of meeting notices;
·                     subject to appropriate limitations, permit nonprofit corporations to make “distributions” to parent organizations; and
·                     allow member meetings to be conducted by written ballot, thereby avoiding the expense of convening a physical meeting while protecting the rights of any members to participate in a meeting that, invariably, will be scheduled inconveniently for someone.
Further examples of this increased flexibility are set forth on Exhibit A hereto. 
     Of course, this discussion so far relates to membership corporations.  The new Act retains the option of organizing a nonprofit corporation without members.  The statute provides that, if the nonprofit corporation does not have members, anything that would otherwise be decided by the members will be decided by the board of directors.  Section 23(2). 
      The current statute often gives a blanket rule and only occasionally provides that the rule may be modified in the corporation’s articles of incorporation or bylaws.  Largely reversing that practice, the new Act is written substantially in the form of “unless otherwise provided in the articles of incorporation or bylaws.”  As such, particular organizations will more often than not be able to define its own rules, with the statute providing a default rule applicable when no specific rule has been agreed upon. 
      At the same time, it has been recognized that Kentucky’s laws are very successful in protecting directors of nonprofit corporations from personal liability.  Those provisions were added to the statute in 1988 and mirror the protections that exist in Kentucky business corporations.  Those protections have been retained in the new law, with additional procedural protections with respect to conflict of interest transactions, all with an aim to affording directors appropriate protection from personal liability.  Nonprofit corporations and their directors are also protected from non-meritorious and abusive law suits by exacting requirements for bringing a derivative action.  At the same time, directors who abuse their positions may still be held accountable.
         The statute provides a two-step transition regimen.  See Section 154.  Initially, all nonprofit corporations organized after the statute’s effective date will be subject to the new Act.  Thereafter, existing nonprofit corporations may elect to be governed by the new statute.  We anticipate that most organizations, after even cursory consideration, will determine to elect into the new statute.  In doing so, the existing rules of that organization will almost invariably be retained consequent to the statute’s continuous statement of “except as otherwise provided in the articles of organization or the bylaws.”  For that reason, existing nonprofit corporations should have few if any surprises upon electing to be subject to the new law.  The election into the new law by existing entities is entirely voluntary – there is no “drag in” provision, and corporations governed by the current law will not be forced to be governed by the new Act.  Still, certain “logistical” provisions (e.g., allowing notice of a member meeting to be set by e-mail) have been added to the old Act as a means of providing greater flexibility to those existing organizations.  See Sections 163, 149.
      Nonprofit corporations are an important segment of the economy.  No one is benefitted by having an archaic statute that often renders it impossible to answer simple questions or that imposes outdated limitations.  This new statute, while not entirely eliminating those questions, will greatly diminish them.  For that reason, the Kentucky Revised Nonprofit Corporation Act (2014) deserves your support.
The Kentucky Unincorporated Nonprofit Association Act
       Often individuals with a charitable bent will engage in projects without incorporating a nonprofit corporation.  Examples of such a venture might be a group that is sponsoring a Little League team or collecting funds in order to pay for an uninsured person’s medical procedure.  To date, Kentucky law has been silent as to how such groups should be treated.  They are not, obviously, nonprofit corporations because no corporation has been created.  They are not partnerships because a partnership must have a for-profit purpose.  KRS § 362.175(1); id. § 362.1-101(10).  The Kentucky Unincorporated nonprofit Association Act, based on a uniform act drafted by the National Conference of Commissioners of Uniform State Laws, fills this gap.  Essentially, with respect to nonprofit ventures, this statute will provide a default series of rules addressing factors such as management and control of the venture and ownership of any contributed or collected assets.  The statute affords significant flexibility; to the extent a particular group has agreed to rules and procedures, especially its internal management, they will be respected.  In addition, by making a simple filing with the Secretary of State, an unincorporated nonprofit association may afford its members limited liability from its debts and obligations.
      The uniform act upon which this is based is pending this year in Oklahoma and South Carolina, as well.  The act in this form or its earlier 1986 version has been adopted in approximately 13 other jurisdictions including Illinois, Texas and Delaware.
Nonprofit Limited Liability Companies
         When it was originally drafted, the LLC Act did not provide for nonprofit LLCs.  Skeletal nonprofit provisions were added in 2007.  Since then, there have been changes in Federal tax law that make nonprofit LLCs a useful tool.  For that reason, the LLC Act provisions governing nonprofit LLCs have been updated and expanded to make this a viable option.  At the same time, protections are retained with respect to donations for particular limited purposes.
Miscellaneous Revisions to Kentucky Business Corporation Statutes
      The miscellaneous revisions are typically technical in nature.  For example, one erroneous “reasonably” in the Business Corporation Act is corrected to “honestly.”  Section 215.  The assumed name act is updated to address unincorporated nonprofit associations (Section 199), as is the statute on annual reports.  Section 198.  Two technical corrections as to series under the statutory trust act are made.  Sections 213, 214.  A particular fact situation requiring a limited partnership to dissolve is added.  Section 212.

·                     Exhibit A

Notice of a Meeting of the Members


Under current law, notice of a meeting of the members must be in writing and may be either mailed or personally delivered.  KRS § 273.197. 

--          Is notice by e-mail “written”?

--          Is notice by e-mail “mailed”?

--          Is notice by UPS mailed?

u         The new act allows for notice by e-mail, courier services, and otherwise.  Section 5.

Lack of Clarity of Whether or Not a Corporation Has Members


·                     Under current law, whether or not a corporation has members may be determined by either the articles of incorporation or the bylaws.  KRS § 273.187(1).  This formula creates a variety of problems.  First, it is entirely possible for an organization’s articles of incorporation to provide that the corporation will not have members while its bylaws go on to provide for members and their respective rights.  Second, because the bylaws are not of public record, a third party dealing with any particular nonprofit corporation is unaware of whether or not it has members and is unable to plan accordingly.

u         Under the new law, whether or not a corporation has members will be determined exclusively by reference to the articles of incorporation, which must state whether or not there are members.  Section 11(1)(g).  See also Section 23(1).

Meeting of the Board by Conference Call


·                     The current statute is silent as to whether the board may meet by conference call.  There are no provisions to the effect that:

--          a meeting held by phone is valid

--          that a director attending by phone counts toward the quorum; or

--          that a director attending by phone is “present” for purposes of voting.

u         The new act expressly authorizes board meetings by conference call or other electronic means (e.g., Skype).  Section 68(2).

Meeting of the Members by Conference Call


·                     The current law is silent as to whether some or all of the members may meet by conference call or other electronic means.  As such it is not clear whether:

--          a meeting held by conference call is valid;

--          whether a member attending by phone counts as present for purposes of determining a quorum (KRS § 273.203); or

--          whether a member attending by phone is present for purposes of a vote (id.).

u         The new act expressly allows members to participate in a meeting of the members by conference call or other electronic means (e.g., Skype).  Section 39(5).

Lawsuit by Disgruntled Member Against the Board of Directors


·                     Under existing law, any disgruntled member of a nonprofit corporation can file a lawsuit (and in some instances, lawsuit after lawsuit) challenging the actions of the board of directors.  Such is the situation in the current saga of Flint v. Coach House, a dispute between a single member in a condominium association and that organization that spans now, I understand, eleven separate lawsuits and numerous appeals to the Kentucky Court of Appeals.  There are no statutory requirements funneling his and similar objections to the operation of a nonprofit corporation into the format of a derivative action nor providing for the early dismissal for such suit.

u         Under the new act, Flint could not bring his action against Coach House for the simple reason that he would not constitute 20% of the voting members of the corporation.  Section 116.  Under the new statute, absent satisfaction of the standing requirements, the suit will be automatically dismissed.  Further, even if standing requirements are satisfied, the board of the corporation is specifically authorized to appoint a special litigation committee.  If the special litigation committee determines that the action is not in the best action of the corporation, the court must dismiss the lawsuit.  Section 119(1).

Futile Notices


·                     Under current law, written notice of a meeting must be given “to each member entitled to vote at such meeting.”  KRS § 273.197.   Even if a member moves or cannot be reached, the corporation is required to continue sending notices.

u         Under the new law, if several notices are returned, the corporation is no longer obligated to send notices.  Section 145.

Delegate Meetings


·                     Many nonprofit corporations desire to organize voting and similar activities on a regional basis with delegates appointed by each region.  For example, a religious organization may wish to allow all of the churches in a particular congressional district to collectively appoint three members to the corporation’s board of directors, and those same churches would appoint three persons to attend a meeting of the members.  Under the current statute, absent extraordinarily well-drafted bylaws, it is unclear whether and how this format can be accomplished.

u         Under the new act, detailed provisions governing actions by and through delegates are addressed.

Non-Voting Directors and Quorum Requirements


·                     Many nonprofit corporations have non-voting directors.  A quorum of the board is typically a simple majority of the total number of directors.  The current act is silent as to whether and how those non-voting directors are counted for determining whether a quorum of directors is present. For example, if there are seven directors, four voting and three non-voting, it is unclear whether the presence of the three non-voting and one voting director could be considered a quorum.  KRS § 273.217. 

u         Under the new act, it is made clear that non-voting directors are not included in determining a quorum.  Sections 34, 39.

Tuesday, March 4, 2014

Delaware Supreme Court Holds No Duty to Repurchase Shares from a Minority Shareholder

Delaware Supreme Court Holds No Duty to Repurchase Shares from a Minority Shareholder

A recent decision of the Delaware Supreme Court has again confirmed that the board of directors does not owe a fiduciary obligation to a shareholder in the corporation to make a market for shares.  Blaustein v. Lord Baltimore Capital, 2014 WL 240628 (Del. Jan. 21, 2014).
In the oft-cited Donahue v. Rodd Electrotype Co. of New England, Inc., 328 N.E.2d 505 (Mass. 1975), that court held that shareholders in a closely-held corporation are subject, amongst themselves, to the same fiduciary obligations that are applicable to partners and, specifically, that where the corporation offers the majority shareholders the right to redeem shares, that right must be similarly offered to the minority shareholders.  While the Donahue decision may not have been the first to do so, it unfortunately gave rise to the notion that a closely-held corporation should be treated as an “incorporated partnership.”  This language has led to no end of confusion as to the how the duties in a closely-held corporation should be assessed and applied.
Fortunately, in the leading jurisdiction of Delaware, the rules of Donahue have been affirmatively rejected.  Specifically, in Nixon v. Blackwell, 626 A.2d 1366, 1380 (Del. 1993), that Court rejected the notice that there existed an obligation to redeem shares when the parties had not contracted for that right.
Most recently, in the Blaustein decision, the Delaware courts were called upon to consider another buyout dispute.  Blaustein had entered into a contract with Lord Baltimore Capital pursuant to which they would negotiate the terms of a share redemption, which redemption would take place if they were able to come to mutual agreement as to the terms.  Those negotiations took place but no agreement could be reached.  Blaustein then went to the Chancery Court, asserting that there was a breach of fiduciary duty by the board’s failure to appoint an independent committee to negotiate with her, that she had been deprived of liquidity and control of her asset portfolio and that there had been a violation of the implied covenant of good faith and fair dealing in not coming to an agreement for redemption.  The Court rejected all of these proposals.  In that Blaustein had no right to compel the corporation to redeem her shares, there could be no right to insist that an independent committee of the board review her proposal.  As to the alleged violation of the implied covenant of good faith and fair dealing, the subject agreement left to the discretion of each party a determination as to whether or not the terms were acceptable.  The agreement did not promise Blaustein a right to redemption at any particular price or that the negotiation would be accomplished by means of a committee of independent, disinterested directors.  Being merely a gap-filler applicable between the terms negotiated by the parties, the implied covenant of good faith and fair dealing would not serve to add those additional requirements.
I have otherwise argued that shareholders in a Kentucky corporation do not stand in a fiduciary relationship with one another.  HERE IS A LINK TO "SHAREHOLDERS ARE NOT FIDUCIARIES"  The Kentucky Supreme Court has recently confirmed that the fiduciary obligations of the board of directors run to the corporate entity and not to the individual members/shareholders thereof.  See Ballard v. 1400 Willow Council of Co-Owners, Inc., No. 2010-SC-000533-DC, 2013 WL 6134150 (Ky. Nov. 21, 2013), a decision which is reviewed HERE IS THE LINK.  The Blaustein decision should be further relied upon in Kentucky to make clear that the rights of a shareholder vis-à-vis a corporation are as set forth in the Business Corporation Act, the Articles of Incorporation, the Bylaws and such contractual arrangements as they may enter into, including a redemption agreement.  However, absent a shareholder contracting for particular protections not provided for by the statute, a shareholder should not be heard to insist they should be entitled to the rights they might therein have gained.

Kentucky Court of Appeals Affirms Piercing the Veil of an LLC (Although it is Not Clear This is a Piercing Case)

Kentucky Court of Appeals Affirms Piercing the Veil of an LLC
(Although it is Not Clear This is a Piercing Case)

In a recent decision, the Kentucky Court of Appeals affirmed the determination to pierce the veil of an LLC and hold the members thereof liable on a pre-dissolution contract.  Mountain Paving and Construction, LLC v. Workman, 2014 WL 272463, No. 2012-CA-001822-MR (Ky. App. Jan. 24, 2014).  (Not to be Published). 
Mountain Paving and Construction, LLC was owned by Sam Doyle and James Boyd.  Workman contracted, in 2007, for Mountain Paving to pave his driveway.  The performance on that job was unsatisfactory.  Because weather and equipment problems precluded redoing the job right away, Boyd, on a “company printed proposal pad”, wrote:
I agree to come and spray and re-surface with 1½” of asphalt and 100% signed garentee (sic) for 1 yr after resurfacing.
Workman paid $8,000 for this job to be done.  Mountain Paving did not, however, in 2008 return to re-do the job.  As described by the Court of Appeals, “Mountain Paving was dissolved as a  [LLC] shortly” after this written document was presented to Workman.
As to the timing of the dissolution vis-à-vis the giving of the written document, the opinion is rather confusing.  The LLC was administratively dissolved on November 3, 2009, and was then both reinstated and affirmatively dissolved on April 6, 2010.  Either way, the dissolution appears to have occurred at least two years after the written document quoted above was presented.
Regardless, Workman filed suit against Mountain Paving, Doyle and Boyd for failure to perform upon the contract.  The opinion states that the suit was initiated on June 11, 2007, but this would appear to be an error if the earlier statement that the initial contract was entered into in 2007 is correct.  Regardless, Workman asserted that:
Doyle and Boyd transferred the assets of the [LLC] to themselves without paying its lawful debts, and that the corporate veil should be pierced to hold them individually liable.
Ultimately, a jury would award Workman $6,000 in damages.  At a subsequent bench trial, it was determined that the LLC should be pierced and Doyle held liable on the claim.  The decision of the Court of Appeals does not indicate that any liability for the LLC’s obligations was imposed upon Boyd.  This is curious in that it was Boyd who gave the “garentee” document to Workman.
The Court of Appeals began by reciting the statutory rule that the members of an LLC are protected from liability on its debts and obligations.  KRS § 275.150(1).  The Court then referenced the rule of piercing the corporate veil as applied to corporations, noting that:

There is no legal basis why this equitable doctrine should not also be applicable to LLCs. 
After reviewing the factors for piercing identified in Inter-Tel Technologies, the court recited the factual finds that it alleged support same.  Curiously, throughout the court refers to an LLC as “the corporation.”  The balance of the Court of Appeals’ decision responds to the defendant’s assertions that the individual factors that justify piercing were not in this instance satisfied.  Ultimately, the Court of Appeals would find that the decision of the trial court were sufficiently supportive of those determinations and were not clearly erroneous. 
So there you have it, the Court of Appeals applying the law applicable to piercing the veil of a business corporation to piercing the veil of an LLC.  The decision is, however, unsatisfactory on a number of bases.
First, the Court nowhere explains that why it is that Doyle should be held liable for the LLC’s debts, rather than being a joint obligation of Doyle and Boyd.
Second, the LLC Act provides rules by which an LLC may dissolve, including the distribution of assets.  Essentially, upon dissolution, company assets must first be applied to the satisfaction of creditor claims.  Clearly, Workman was a creditor of the LLC.  If and to the extent company assets were distributed to one or more of the members before the satisfaction of those claims, the members were liable to return those assets to the LCC in order that they could be properly diverted to the creditor’s claim.  See KRS § 275.310; § 275.325(4)(b).  If, as asserted by Workman, the members of Mountain Paving “transferred the assets of the [LLC] to themselves without paying its lawful debts,” then there was a statutory mechanism by which those assets could be recovered without reference to the equitable remedy of piercing.  Rather, the General Assembly having determined how this factual situation should be addressed, there should have not have been reference to other law.
Also of concern is the court’s reliance upon the fact that certain of the equipment utilized by Mountain Paving was in fact owned by Doyle.  First, with respect to the assertion that the company assets were transferred back to the members, if that equipment had never been conveyed by Doyle to the LLC, it was not the LLC’s with which to satisfy its debts or obligations.  Second, it is not uncommon that business owners will retain in their personal ownership certain assets that are utilized by the business venture.  In Stettenbenz v. Butch’s Rod Shop, 2013 WL 4779862 (Ky. App. Sept. 6, 2013), a decision involving a claim for piercing that is reviewed HERE IS THE LINK, the fact that the individual owners owned the tools used in the shop was not a basis for piercing the veil.
Piercing law is maddingly murky in that piercing is an equitable remedy that within the constraints of the various decisions is based upon the judge’s assessment of the equities.  For this reason, it is especially incumbent upon the courts to clearly and precisely identify what is and what is not the basis for a determination to pierce.  Sadly, this decision does not meet that standard.

Settlement Agreement Set Aside When Plaintiff’s Daughter Posted About it on Facebook

Settlement Agreement Set Aside When Plaintiff’s Daughter Posted About it on Facebook

      Typically, settlement agreements will contain a confidentiality obligation precluding either side from disclosing, except as may be otherwise required by law, the terms of the settlement.  A recent decision in Florida illustrates how important it is that confidentiality be maintained.

      According to a news wire story, Patrick Snay sued his former employer, the Gulliver Preparatory School (Miami) for age discrimination.  A settlement in the amount of $80,000 was agreed to.  That agreement contained a standard confidentiality clause precluding either party from further discussing the dispute or disclosing its terms.  Snay’s daughter, however, then posted on her Facebook account about how her parents had won their lawsuit against the Gulliver Preparatory School and she was using part of the proceeds to go on vacation to Europe.  One posting featured a well known legal term, namely "suck it."  When news of this posting got back to the school and its attorneys, they sought to have the settlement set aside.  The Florida Third District of Appeals tossed the suit on the basis that:

Snay violated the agreement by doing exactly what he had promised not to do, namely disclose the settlement.