Friday, June 27, 2014

Pannell v. Shannon – A Cornicopia of Guidance on Contract Law, Statutory Interpretation and the Place of LLCs in the Law

      The Kentucky Supreme Court’s decision in Pannell v. Shannon is of great utility on a variety of fronts including identifying a test for when an agreement is executed by an agent versus by a principal, the effect of administrative dissolution/reinstatement upon an agent’s liability, rules for interpreting statutory amendments, and the importance on focusing upon the LLC Act over the common law in assessing LLCs.  Pannell v. Shannon, 425 S.W.3d 58 (Ky. March 20, 2014).
      The dispute arose out of a defaulted lease.  Shannon’s LLC was the tenant – that LLC was during the term of the lease administratively dissolved.  A replacement lease was entered into in the period between the administrative dissolution and the LLC’s reinstatement.  When the LLC ultimately defaulted the landlord sought to hold Shannon liable on the obligation.

Was the Lease with Shannon or the LLC?

      The lease agreement entered into during the period of the LLC’s administrative dissolution described the tenant as being the LLC, but the signature line did not specify that Shannon signed it in a representational capacity (e.g., “Ann Shannon, Sole Member, on behalf of Elegant Interiors, LLC”).  The Court held that level of specificity to not be necessary.  Rather, noting that it indicated “By:” and in reliance upon Fletchers Cyceopedia, the Court found this format, combined with the fact that the body of the lease identified the LLC as the tenant, to be sufficient to indicate she was not signing in an individual capacity.
[T]he simple fact is that Shannon did not have to list her title, although clearly the better practice is to include it.  425 S.W.3d at 64.

Scrivener Error?

      Pannell sought to argue that the identification of the LLC as the tenant was a “scrivener error” and that it was always intended that Shannon as an individual be the tenant.  This argument was rejected on the basis that “full, clear, and decisive evidence” of a mutual mistake was not presented.  425 S.W.3d at 67.

The Effect of Administrative Dissolution/Reinstatement

      The real crux of the decision is the impact of administrative dissolution and subsequent reinstatement upon each of (i) a member’s limited liability and (ii) the liability of an agent on a contract entered into after dissolution and before reinstatement.  425 S.W.3d at 68.  The Court recognized that these are distinct questions based upon distinct legal principles:
“[T]he liability of a director, officer, employee or agent of a limited liability entity during a period of administrative dissolution is technically a separate question from the liability of the owners of the entity.”  425 S.W.3d at 77.  
Member Limited Liability After Administrative Dissolution
      The Court could not have been more express about the continuity of a member’s limited liability after reinstatement:
This Court concludes that a member of an [LLC] enjoys statutory immunity from liability under KRS 275.150 for actions taken during a period of administrative dissolution so long as the company is reinstated before a final judgment is rendered against the member.  425 S.W.3d at 67.
      Distancing LLCs from the common law of corporations (more on that below), the Court looked to the statutes addressing a member’s limited liability (KRS § 275.150) and the retroactive effect of reinstatement (KRS § 275.295(3)(c); now KRS § 14A.7-030(3)) and determined that reinstatement wiped the slate clean.
The plain meaning of the relate-back language is that the company is deemed viable on reinstatement from the point of administrative dissolution onward, which necessarily includes the time of suspension between the date of administrative dissolution and reinstatement.
Reinstatement under the statute literally undoes the dissolution. This is why the Secretary of State was required to “cancel” the certificate of dissolution and issue a certificate of existence. See KRS 275.295(3)(a). And that certificate of existence took effect, by statute, retroactively on the date of dissolution.  425 S.W.3d at 68.
Hence Pannell’s argument that a member’s limited liability is suspended during the period between administrative dissolution and reinstatement was rejected.

Agent Limited Liability After Administrative Dissolution

      Turning to the question of Shannon’s liability as an agent for the LLC’s obligation undertaken while the LLC was administratively dissolved, the Court noted that the question divides into a pair of inquiries, namely:
First, can Shannon under the circumstances of this case be personally liable by reason of her merely being an agent?  Second, can she be personally liable because she acted as an agent without authority?
       In response to the first question, the Court referred to KRS § 275.175(1) and noted that its rule of limited liability extends to the LLC’s agent.  As the LLC’s existence had been reinstated and:
reinstatement is retroactive to the date of dissolution, and it is as if the dissolution never occurred, giving the company a seamless existence.  The limitation on the agent’s liability simply for being an agent is likewise seamless.  425 S.W.3d at 78.
      In that the LLC in question was subsequently reinstated, the Court found there to be no opportunity for imposing liability on an agent.  Rather, as the LLC Act protects agents from liability on the LLC’s debts (KRS § 275.150(1)), then: 
To the extent that any liability is claimed solely because Shannon was a manager or agent of the LLC, the analysis above for why she cannot be liable as a member applies.  The reinstatement is retroactive to the date of dissolution, and it is as if the dissolution never occurred, giving the company a seamless existence.  The limitation on the agent’s liability simply for being an agent is likewise seamless.  425 S.W.3d at 78. 
     Providing an appropriate critical eye to the question before it, the Court observed:

The immunity provided by KRS 275.150 extends only to liability by reason of her being an agent.  By alleging that Shannon acted without authority, Pannell is not claiming she is liable solely because of her status as an agent, but because she had no authority to act as an agent.  425 S.W.3d at 81. 
In reliance upon the statutory statement that a dissolved LLC continues to exist after its dissolution, the Court found that when combined with reinstatement, Shannon never lost the capacity of being the LLC’s agent.
In response to the argument that giving such a broad affect to the effect of reinstatement is improper, the Court observed:
The simple fact is that Kentucky’s corporation law and other business entity laws differ from those in other states ….  The existence of a majority rule can only be persuasive if the rule is based on statutes like those in Kentucky.  425 S.W.3d at 79, 80.
The Nature of LLCs

No end of confusion has resulted from efforts to force LLCs into the prior models of partnerships and LLCs and to them impose the supposed common law of these organizational forms onto the LLC.  The first decision of the Kentucky Court of Appeals in Patmon v. Hobbs, 280 S.W.3d 589 (Ky. App. 2009) is a classic example of a court trying to do so.  Why that does not work was been extensively reviewed.  See, e.g., Rutledge and Geu, The Analytic Protocol for the Duty of Loyalty Under the Prototype LLC Act, 63 Arkansas Law Review 473 (2010). 

      In Pannell, the Supreme Court, building upon prior decisions, made the rule express – LLCs are creatures of statute divorced from the common law.
[The] common law of business entities has largely been abrogated by the adoption of the various statutes like the Kentucky Business Corporation Act and the Kentucky Limited Liability Company Act.  In fact, “limited liability companies are creatures of statute controlled by Kentucky Revised Statutes (KRS) Chapter 275,” not primarily by the common law. To the extent that common law doctrines could arguably govern limited liability companies, the Kentucky Limited Liability Company Act “is in derogation of common law,” KRS 275.003(1), and the traditional rule of statutory construction that “require[s] strict construction of statutes which are in derogation of common law shall not apply to its provisions.” Id. Thus, to the extent the statutes conflict with common law, the common law is displaced.
This Court must therefore first look at the controlling statutory law.  425 S.W.3d at 67-68.  (citations omitted).
      Consequently, in assessing matters involving LLCs the court needs to focus upon the LLC Act and the operating agreement of that particular LLC.  Whether, for example, LLC members are more like partners or more like shareholders is irrelevant to the question of whether the members have fiduciary duties and what those duties are – the LLC Act expressly addresses whether the members owe fiduciary duties, what those duties are and to whom they are owed.  See KRS §§ 275.170(1), (2), (4).  At the risk of redundancy:
[F]irst look to the controlling statutory law.

Continuity in Statutory Construction
      The Kentucky LLC Act provides that a LLC’s dissolution will not “abate or suspend” the rule of limited liability set forth in KRS § 275.150.  KRS § 275.300(4)(e).  Accord KRS § 271B.14-050(2)(i).  While this statute was adopted only in 2007, the Kentucky Supreme Court found this provision was not an alteration of the law but rather “clarified the intent of the legislature as to the effect of dissolution on the liability of … corporate shareholders.”  425 S.W.3d at 72.  This application of in pari mataria, which requires a nuanced consideration as to whether the General Assembly sought to alter versus clarify the meaning of a prior enactment, stands in contrast to the far more clumsy, and typically inapplicable, rule to the effect that by each amendment the legislature seeks to alter and depart from the prior rule.  In the area of business entity law, based as it is upon typically comprehensive statutory schemes, tweaking the words employed for the purposes of providing greater clarity and precision is far more typical than is a reversal or abandonment of a principle.  That is not to say it never happens, but it is relatively rare.

Subsequent Statutes Address Liability Absent Reinstatement

      While Pannell v. Shannon limits its application to the treatment of member and agent liability after there has been reinstatement, it does not follow that member and agent liability absent reinstatement remains unresolved.  Rather, questions of member limited liability have been addressed in statutory amendments enacted subsequent to the time the Pannell v. Shannon dispute arose. 
      First, KRS § 275.300, it addressing the effects of dissolution, now provides that dissolution does not “abate or suspend” the rule of limited liability.  In consequence, it cannot be argued that a member’s/manager’s/agent’s limited liability is lost upon dissolution.  In this respect it is important to note an important distinction between the corporate and LLC Acts.  The Business Corporation Act, at KRS § 271B.6-220, affords the shareholders limited liability from the corporation’s debts and obligations.  Hence, KRS § 271B.14-050(2)(i), in preserving limited liability upon dissolution, preserves it only for the shareholders.  Put another way, KRS § 271B.14-050(2)(i) does not speak to the liability of corporate directors, officer and agents for a corporate liability undertaken post-dissolution and absent reinstatement.  In contrast, the grant of limited liability in the LLC Act, KRS § 275.150(1), applies not only to members but also managers and agents.  Hence the preservation of limited liability after dissolution as affected by KRS § 275.300(4)(e) is broader than is the equivalent provision in the Business Corporation Act.  Now, whether after dissolution and before reinstatement one was an “agent” may be in dispute, but that is resolved under other law.
      Second, it has been made express that upon reinstatement following administrative dissolution, the liability of an agent for actions undertaken during the period of dissolution “shall be determined as of the administrative dissolution or revocation had never occurred.”  KRS § 14A.7-030(3)(b).  See also 425 S.W.3d at 81, note 20.
      Third and last, in response to Martin v. Pack, the acts now provide that an agent may after dissolution enter into contracts appropriate for the entity’s winding up and liquidation.  See KRS § 275.300(2)(a); id. § 271B.14-050(1)(c).

More on Member Limited Liability
      Building upon the earlier decision in Racing Investment Fund 2000, LLC, the Court highlighted the centrality of limited liability to the LLC and imposed a high bar for setting it aside.  425 S.W.3d at 66.  As such, where it is questionable whether an agent enjoys limited liability, the presumption will be that it is available.  It remains to be seen whether and how this attitude will impact upon whether and how is developed a distinct theory for piercing LLCs.

More on the Nature of Administrative Dissolution

      In Pannell, the Kentucky Supreme Court considered the purpose of administrative dissolution and rejected an effort by a third-party to impose liability upon a dissolved LLC’s agent for an LLC obligation based upon “the temporary faltering of the relationship between the LLC and the state to [the third-parties’] advantage when [the third-party] has no interest in that relationship.”  425 S.W.3d at 84.  Administration dissolution to be little more than a speed-bump in the bilateral relationship between the Commonwealth and an entity created under the laws thereof.

More on the Source of Duties in LLCs

      The Supreme Court has directed that the first source of LLC law is the LLC Act and recognized that LLCs are strangers to the common law.  In Patmon v. Hobbs, the Court of Appeals imposed fiduciary obligations upon the “officers and members” of an LLC based upon the determination that LLCs are “similar to Kentucky partnerships and corporations.” 280 S.W.3d at 594-95.  The Pannell decision significantly undercuts (if not more) this analytic path, and directs that rather than relying upon analogy to other organizational forms the focus needs to be upon the language of the LLC Act.  In that the LLC Act defines who owes fiduciary duties, to whom they are owed and what are those duties (KRS § 275.170), there the question should end.

A Small Footfault on Member – versus – Manager-Managed

      It bears noting that the Court made a small misstep in its consideration of agency and the application of KRS § 275.135.  This statute provides, inter alia, that in a member-managed LLC each member as a member is an agent of the LLC while if the LLC is manager-managed the managers are agents and the members are not by reason of that status agents.  The Court suggested that the determination of whether the LLC is member or manager managed is determined by a factual assessment of the management employed.  See 425 S.W.3d at 76, fn. 17.  In fact, whether an LLC is member or managed is a positive law question determined by reference to the election made in the articles of organization.  See also KRS § 275.025(1)(d).  As set forth in the comment to Prototype section 401, “Irrespective of the provisions in the operating agreement, whether a LLC is ‘manager managed,’ as that phrase is used in the Act, depends on whether the articles of organization so provide.”


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