Monday, February 25, 2019

If It Is Not In Writing It Did Not Happen

If It Is Not In Writing It Did Not Happen

      The main take away from a Ohio decision delivered last November is that where the statute requires that a particular action, in this instance the admission of a new member to an LLC, be in writing, when it is not in writing it did not happen. B. T. Environmental Solutions, L.L.C. v. B.T. Energy Group, Inc., No. 17 CO 0010, 2018 WL 6719424 (Ohio Ct. App. Seventh Dist. Dec. 10, 2018).
      In 2012, Steven Beight and David Tod, Jr. decided to start a brine water removal company. In furtherance thereof, Beight filed articles of organization with the Ohio Secretary of State, creating B.T. Environmental Solutions, L.L.C. There was no written operating agreement at the time of B.T.’s organization, even as Beight and Tod were the only members of the company. One of the objectives of the company was to acquire a piece of property in Pennsylvania referred to as the “Essroc Property.” Shortly after the LLC’s formation, a checking account was opened in its name to which Beight deposited $100. Shortly thereafter, Tod deposited $5,000 into the account, and not long thereafter Tod’s father deposited $50,000 in that checking account.
      A law firm was retained for the purpose of drafting an operating agreement, but for reasons not explained the draft was not produced until August 2012. Ultimately, no written operating agreement was ever a finalized.
      In the spring of 2012, the plaintiffs in this action, Daniel J. and Daniel P. O’Horo, agreed to contribute another $500,000 to B.T. Environmental Solutions. There was apparently no agreement as to what would be the exact nature of this contribution and what the O’Horos would receive in return.
      And then, so to speak, the wheels really fell off the relationship:
With this $500,000 influx of funds, the B.T. checking account contained approximately $555,100. Tod, Jr. believed the parties would not spend B.T. funds, except for the salaried employee and truck, until they had all of the requisite funds secured in order to purchase the Essroc Property. However, at some point Tod, Jr. learned that Beight had purchased vehicles in his name using B.T. funds and had paid himself a salary. The parties disagreed about Beight’s ability to spend the funds, causing the parties’ relationship to deteriorate.

      A year later, in August of 2013, the O’Horos filed suit individually and on behalf of B.T. Environmental. Then Beight brought a third party complaint against Tod seeking a variety of relief, to which Tod filed counter and cross-claims. There followed a bench trial in which, as addressed in this opinion, the court held that the O’Horos did not have standing on behalf of B.T. Environmental bring a derivative action, the basis for that determination being that they were not members of B.T. Environmental. They appealed on the basis that they were in fact at least de facto members of the LLC, an assertion rejected by the Court of Appeals.
      Under the Ohio LLC Act, a “member” is “a person whose name appears on the records of the [LLC] as the owner of a membership interest in that company.” Ohio Code § 1705.01(G). Under the Ohio LLC Act, § 1705.14(B), there are set forth the rules for the admission of a member of an LLC when they are not one of the initial members at the time of formation. This statute requires, inter alia, that the admission of those new members must be set forth in a written instrument. Specifically, it provides:
After the filing of the articles of organization of a limited liability company, a person may be admitted as an additional member in either of the following ways:
(1) If he acquires an interest directly from the limited liability company, upon compliance with the operating agreement or, if the operating agreement does not so provide, upon the written consent of all of the members;
(2) If he is an assignee of the interest of a member who has the power as provided in writing in the operating agreement to grant the assignee the right to become a member, upon the exercise of that power and compliance with any conditions limiting the grant or exercise of the power.

      In this instance, the O’Horos admitted they were not part of the initial membership group of the LLC, but rather that they were subsequently (at least they argued) admitted as members of the company. They did not have, however, a written instrument recording that admission. The statutory requirement of a writing not having been satisfied, it was held that the O’Horos were not members. As such, they lacked standing to bring a derivative action.
      Not addressed by the opinion is whether and by what mechanism the O’Horos may recover the $500,000.
      There was a dissenting opinion that would have found that the O’Horos were “de facto” members in the LLC.

      The Kentucky LLC Act contains a provision, KRS § 275.275, that reflects the same theme as does the Ohio statute applied in the B.T. Environmental decision. That provision of the Kentucky LLC Act provides:
(1) Subject to subsection (2) of this section, a person may become a member in a limited liability company:
(a) In the case of the person acquiring a limited liability company interest directly from a limited liability company, upon compliance with an operating agreement or, if an operating agreement does not so provide in writing, upon the written consent of all members; and
(b) In the case of an assignee of the limited liability company interest, as provided in KRS 275.255 and 275.265.
(2) The effective time of admission of a member to a limited liability company shall be the later of:
(a) The date the limited liability company is formed;
(b) The time provided in the operating agreement or, if no time is provided, when the person's admission is reflected in the records of the limited liability company; or
(c) The time the member is admitted under KRS 275.285(4).

      Persons becoming members of an LLC after its initial formation need to be aware of the requirement of writing and insist upon a clear agreement as to what is being received in consideration for whatever capital contribution they might be making. Absent compliance with the writing requirement, they may find that they are not members. This burden is in addition to other necessary due diligence such as the review of the operating agreement, etc.

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