Tuesday, March 26, 2019
Unilateral Issuance of Shares Rejected
A recent decision from the Delaware Court of Chancery involved the question of whether shares constituting, on a fully diluted basis, a 25% ownership in the corporation had been validly issued. In this instance, the board was comprised of one person, and he approved the issuance of the shares to himself. Even without the fundamentally flawed appraisal utilized, the court was able to strike the transaction on the basis that the one individual did not constitute a legitimate Board of Directors. Applied Energetic, Inc. v. Farley, C.A. No. 2018-0489-TMR, 2019 WL 334426 (Del. Ch. Jan. 23, 2019, rev’d Jan. 24, 2019).
Applied Energetics was a publicly traded company that was essentially dormant after the demand for its technology ceased. At the time of going dormant, the company had a board of three members. Two of those directors, Lister and Levy, would resign from the board before the events here at issue, leaving Farley as the sole director. As the sole director, Farley executed a written consent pursuant to which the corporation would issue to him 25 million shares at the price of $0.001 per share. While Farley retained Rahne to value the shares, Farley proceeded with the transaction before the valuation was delivered. Farley and Rahne went back and forth as to the appraised value, Farley finely advising Rahne “I need the value to be $0.001 or lower.” As recounted by the court, “Within three hours” Rahen sent a valuation report at the requested $0.001 price.
Responding here to a motion for a preliminary injunction following a complaint alleging a variety of claims against Farley, including breach of the duty of loyalty, that relief was granted. The court had little problem finding that the plaintiff would likely prevail on the merits with respect to the challenge of the share issuance if only for the reason that the majority of a three person board did not approve the issuance.
The Company argues that Farley caused the Company to invalidly issue twenty-five million shares to himself because Farley acted without proper board authorization. “The Delaware General Corporation Law requires that the board of directors of a company approve any issuance of stock by the corporation.” Applied Energetics’ bylaws require “a majority of the total number of directors” to be present to constitute a quorum for the transaction of business at a board meeting. The board members may also take action without a meeting if all members of the board sign a written consent. In 2012, the Company’s board reduced the number of directors from five to three. The size of the board remained three members through February and March 2016. The parties have not identified any board resolution or other action that reduces the size of the board to less than three members; nor do the parties identify anything that purports to reduce the threshold for a quorum to less than a majority of the directors.
It is reasonably probable that Farley could not cause the board to validly issue stock acting as the only board member of the Company’s three-member board. Stated differently, it is reasonably probable that any board action to validly issue stock, whether at a board meeting or through written consent, required the affirmative vote of at least two members of the Company’s board. Only Farley signed the written consents dated February 15, 2016, and March 25, 2016, authorizing the issuance of twenty million and five million shares, respectively. It is reasonably probable, therefore, that the twenty-five million share issuance is invalid. 2019 WL 334426, *6 (footnote omitted).
Monday, March 25, 2019
LLC Bootcamp at the ABA Section of Business Law Spring Meeting
This Thursday, at the spring meeting of the ABA's Section of Business Law, I'll be presented "LLC Bootcamp." This program will focus on how to draft (and how to read) operating agreements with the aim of reflecting the deal and avoiding litigation. Johnny Lyle and Brian Lewis will be on the panel with me.
Friday, March 22, 2019
Professional Malpractice, Punitive Damages Addressed by
the Kentucky Supreme Court
the Kentucky Supreme Court
In a December ruling from the Kentucky Supreme Court, it addressed claims against the Grant Thornton LLP accounting firm with respect to allegations of professional misconduct involving a discredited tax shelter. The trial court found that the accounting firm had engaged in professional malpractice, and in addition to awarding compensatory damages of some $20 million awarded punitive damages in the amount of $80 million. The Court of Appeals affirmed the determinations of liability and the compensatory damages, but reduced the punitive damages to $20 million, creating equivalency (a ratio of 1:1) between the compensatory and punitive damages. On its review, the Kentucky Supreme Court affirmed the determination of professional malpractice and the compensatory damages award of $20 million. It reversed, however, the reduction of the punitive damages award and reinstated them in the amount of $80 million. Yung v. Grant Thornton, LLP, 563 S.W.3d 22 (Ky. Dec. 13, 2018).
In 2000, the Yungs purchased from Grant Thornton the “Grant Thornton Leverage Distribution Product,” otherwise referred to as “Lev301,” with the aim of repatriating from the Cayman Islands significant accumulated earnings garnered through the ownership and operation of hotels and casinos. Grant Thornton represented to Yungs, that through the use of the Lev301 shelter, those funds could be repatriated without being subject to federal tax. As recounted by the Kentucky Supreme Court:
As to the Yungs, the Lev301 involved moving money from the Cayman Islands into the U.S. by distributing the Cayman corporations’ profits to the shareholders as fully encumbered securities. First, the Cayman corporations bought $30 million in Treasury notes (T-notes) using borrowed money, with the T-notes serving as security for that debt. Next, the corporations transferred the T-notes to the shareholders in the U.S. Because they were 1005 encumbered, the T-notes ostensibly had no taxable value, and accordingly, the shareholders would not report the distributions on their federal tax returns. The Cayman corporations would then pay off the debt six months to a year later, but the loan repayment would also not result in reportable income to the shareholders because they were not co-obligors for the loan’s repayment. This tax shelter strategy, Lev301, theoretically allowed the shareholders to avoid tax consequences on $30 million in profits brought into the U.S. by means of the eventually unencumbered T-notes. 563 S.W.3d at 32.
The Supreme Court then reviewed various elements of IRS scrutiny and rejection of tax shelters including the BOSS Notice and the various disclosures required with respect to purchasers of tax shelters. Notice 99-59, 1999-52 I.R.B. 761; T.D. 8875, 2000-11 I.R.B. 761. The Supreme Court also cited an article by Lee Shepperd from Tax Notes, which it says Grant Thornton was aware of, in which she suggested that transactions similar to that employed in Lev301 would be disallowed by the IRS. Still, with those limitations already in place, as well as concerns with respect to other issues including a business purpose and economic substance, Grant Thornton promoted the Lev301 Program to the Yungs by means of a meeting with their CFO: In connection therewith, Grant Thornton:
They did not disclose that Lev301 was substantially similar to the BOSS; that the February 2000 tax shelter regulations imposed disclosure and listing requirements on corporate participants in such transactions; that the Treasury would likely retroactively make Arthur Andersen’s equivalent “Bossy” product unlawful; or that GT believed that there was a 90% chance that the IRS would disallow the Lev301 tax benefits on audit. 536 S.W.3d at 35.
The marketing efforts continued including presentations to members of the Yung Family. During the pendency of the considerations, Great Thornton represented a “worst-case scenario” by which there would be impose taxes and interest on the repatriated funds but there would not be interest., This in opposition to the known treatment of transactions falling within the scope of the BOSS Notice. When Yung indicated they did not want to be the first out of the gate and therefore the “guinea pig” on the Lev301 structure, it was thereafter represented to him, “without any factual basis” that two local companies had used the strategy. 536 S.W.3d at 37.
Then, notwithstanding additional action by the IRS and an article in the Wall Street Journal, it was represented to the client that there was not a problem. This was done even though Grant Thornton had otherwise suspended efforts to sell the Lev301 product. Also, Grant Thornton made a “business decision” to not maintain the required list of investors and did not advise the client of that IRS imposed obligation. Likewise not disclosed to the client was that the outside law firm retained to review the Grant Thornton “more likely than not opinion refused to endorse it on bases including that the transaction did not satisfy business purpose, economic substance and separate transaction issues. Still, the closing on the transaction proceeded on December 29, 2000 with Grant Thornton committing to deliver a “more likely than not” opinion letter notwithstanding that, internally, they could not come to that level of confidence.
Within days thereafter, the Treasury Department issued temporary and proposed regulations that invalidated the Lev301 structure, they collectively invalidating the suggestion that the recourse liability to the company making the distribution would reduce, as to the shareholder, the value of the distributed assets. Even in the base of that authority, Grant Thornton made several representations to the Yungs that the transaction was not in trouble.
Ultimately, by means of an audit of Grant Thornton, the IRS learned of the Yungs’ participation in the Lev301 transaction. They were in turn audited, and the IRS assessed back taxes and penalties, resulting in a settlement. The Yungs then initiated suit against Grant Thornton.
A bench trial lasting 22 days and more than 600 documents, as well as 40 witnesses, yielded a return to the Yungs of the $900,000 engagement fee paid to Grant Thornton, taxes, interest and penalties of approximately $19 Million, an additional $80 Million in punitive damages.
As noted above, the determination of liability was affirmed by the Court of Appeals, but the punitive damages were reduced to approximately $20 Million yielding a 1:1 ratio between compensatory and punitive damages.
In its decision, the initial substantive determination is that, under Kentucky law, tax and related interest liability will be recoverable, notwithstanding Grant Thornton’s argument that those payments put the Yungs in a position better than they would have been absent the Lev301 transaction. Specifically:
[W]e join those jurisdictions that deem the issue of whether the plaintiff has actually been damaged by incurring tax and interest liability a question of fact. Consequently, we refuse to adopt the blanket “matter of law” rule advocated by GT forbidding tax and IRS interest recovery in accounting fraud and negligence actions. Under our traditional tort damage principles, if the taxpayer has been injured, recovery should be allowed if the taxpayer meets the burden of proving causation and damages. Therefore, if the tax liability (i.e., taxes and interest paid to the IRS) is a direct result of an accounting’s fraudulent or negligent conduct, a plaintiff’s out-of-pocket damages are recoverable. Ultimately, the issue depends on the circumstances of each case, and in this case, we conclude the trial court properly awarded taxes and interest as compensatory damages. 563 S.W.3d at 59-60.
Turning to the topic of punitive damages, the Supreme Court began by holding that the Court Of Appeals does have the capacity to order remittitur of punitive damages. From their return to the question of whether the initial award of $80 Million of punitive damages was constitutionally excessive. Applying a de novo standard of review and KRS § 411.184, the Supreme Court found Grant Thornton’s conduct to have satisfied the reprehensible element of punitive damages, it observed:
Over the course of time, despite multiple IRS notices and regulations, professional articles, opinions of outside legal counsel, and internal confusion alerting GT that the Lev301 was likely an abusive tax shelter and IRS regulations likely would apply retroactively to the Yungs’ detriment, GT never once disclosed to the Yungs the problems with the Lev301 concept in general nor specifically, e.g., the use of a recourse bank loan and the need for a stated business purpose for the transaction. When the Yungs discovered on their own that the IRS could possibly disallow the Lev301 tax benefits and communicated that concern to GT, GT misrepresented its confidence in the product. Although GT stopped selling Lev301 multiple times in response to IRS notices and new regulations, the Yungs were not told even once about the cessation of sales of an increasingly dubious product. At one point, the Yungs’ Lev301 use was described as a successful sale to GT’s staff for promotional purposes and the staff was also told, despite it not being so, that the Lev301 was vetted and approved by outside counsel. Furthermore, although the Yungs were never informed of the problems associated with their particular transaction, the knowledge of those problems (e.g., recourse loan, business purpose) was reflected in numerous internal communications with GT and personnel sought to avoid like circumstances with other sales. When GT was subject to an IRS examination because of the Lev301, GT did not inform the Yungs; instead these “trusting” clients learned of the scrutiny from a tax publication.
These various misrepresentations and nondisclosures were made to save the $900,000 deal and to cover GT’s negligent and fraudulent acts that accumulated over time. This summary of GT’s grossly negligent and fraudulent behavior does not fully reflect GT’s reprehensible behavior in the marketing and sale of the Lev301 to the Yungs. In our view, these individual and cumulative acts place GT’s behavior toward their clients at the high end of professional reprehensibility. Although the Yungs may not have been financially vulnerable, the reprehensibility of GT’s orchestrated, on-going deceit is not lessened or mitigated by the fact GT defrauded people of wealth, rather than the financially vulnerable. We noted above in the discussion of justifiable reliance that a plaintiff’s wealth and business experience cannot preclude a finding of reliance on that plaintiff’s trusted accounting and tax advisors nor should it preclude a punitive damage award where the advisors’ conduct is reprehensible. 563 S.W.3d at 67. (emphasis in original).
Turning to the ratio, it was held that the 4.1 ratio here applied was acceptable “We do not view the $80 million punitive damage award to be disproportionate to the harm suffered by the Yungs.”
Last, turning to an the question of whether there was a disparity between the compensatory and punitive damages, in what can at least in part the characterize as a conclusory determination, it was held that this element was satisfied.
Thursday, March 21, 2019
Clergy Housing Allowance Upheld
Section 107(2) of the Internal Revenue Code provides, inter alia, that housing allowances provided to members of the clergy (sometimes referred to as the “Parsons Exemption”) are exempt from income taxation. In recent years there have been a number of challenges to this exemption, asserting that it constitutes an unconstitutional endorsement of religion. In this most recent decision, the Seventh Circuit Court of Appeals held that the Parsons Exemption is constitutional. Gaylor v. Minuchin, No. S. 18-1277 and 18-1280 (6th Cir. March 15, 2019).
In this case, the Freedom From Religion Foundation brought suit claiming that section 107(2) of the Internal Revenue Code violates the Establishment Clause. The District Court agreed. In this appeal, the Seventh Circuit Court of Appeals phrased the question as:
We must decide whether excluding housing allowances from ministers’ taxable income is a law “respecting an establishment of religion” in violation of the First Amendment.
Generally speaking, housing provided to employees for the employer’s convenience, examples being sailors aboard ship, workers in camps, and hospital employees, does not give rise to taxable income. In reaction to a 1921 decision of the Treasury Department that would tax ministers on the fair rental value of the parsonages, Congress quickly reverses that decision. Under the current statute, both the fair rental value of provided housing or payments made towards housing are, with respect to a minister, exempt from classification as income.
The Seventh Circuit considered this exemption in the context of the broader exemptions from income classification, particularly those that likewise relate to housing provided for the convenience of the employer. In addition, the blanket exemption of parsonage, whether in-kind or in cash, prevents inappropriate IRS investigation into religious beliefs. “The categorical nature of §107(2) also avoid excessive entanglement by providing ministers and their churches certainty as to whether there housing allowances will be exempt from tax.” Slip op. at 20.
Wednesday, March 20, 2019
Burford Abstention in Dissenter Rights Case Reversed
Previously I reviewed a decision in which the federal district court, on the basis of Burford Abstention, indicated that a state, and not a federal, court should hear a dissenter rights action involving a Kentucky corporation. That decision has now been reversed.
Initially, Judge Van Tatenhove ruled that a dissenter rights action should be heard by a state, and not a federal, court. See Kentucky, and Not Federal, Court to Hear Dissenter Rights Action (April 16, 2019); HERE IS A LINK to that posting.
In a second opinion rendered in March, Judge Van Tatenhove reversed himself and determined that abstention was not appropriate in this case. Henley Mining, Inc. v. Parton, Civ. No. 6:17-CV-00092-GFVT, 2019 WL 1048839 (E.D. Ky. March 5, 2019).
Ruling on a motion for reconsideration under Rule 59(e), Judge Van Tatenhove wrote that he had not in making his prior ruling undertaken the balancing test outlined in Cleveland Housing Renewal Project v. Deutsche Bank Trust Co., 621 F.3d 554, 562 (6th Cir. 2010). Applying that test, and giving weight to the benefit of federal diversity jurisdiction, it was held that a dissenter rights action is different than the corporate dissolution at issue in the Caudill case. Rather, all that is at issue is the fair value of the defendant's interest in the company.
As Henley Mining points out, the law that governs the fair value determination in Kentucky is well settled. See Shawnee Telecom Resources, Inc. v. Brown, 354 S.W.3d 542 (Ky. 2011). In Shawnee Telecom, the Kentucky Supreme Court elucidated the meaning of “fair value” as used in Subtitle 13 of Kentucky’s Business Corporation Act, and explained how such a determination is to be made. See id. at 548. Mr. Parton posits no reason, and the Court cannot think of none, why this Court should be unable to follow the law as explained in Shawnee Telecom in the same manner as a Kentucky state court.
Tuesday, March 19, 2019
More Certified Questions: Fiduciary Duties in Arizona LLCs
Earlier this year, the bankruptcy court in Arizona asked the Arizona Supreme Court to answer certified questions with respect to fiduciary duties in LLCs. In re: Swift Air, LLC, Case No.: 2:12-BK-14362-DPC (Bankr. D. Ariz. Jan. 29, 2019).
In this action, the bankruptcy court asked the Arizona Supreme Court to address two questions, namely:
1. Whether managers and/or members of an Arizona LLC owe fiduciary duties to the LLC?
2. Whether the terms of an Arizona LLC’s operating agreement may lawfully limit or eliminate those fiduciary duties?
No word yet as to whether the Arizona Supreme Court will agree to answer these questions.
Monday, March 18, 2019
I’m Not Understanding Why This is a Question
In a December, 2018 ruling, the Federal District Court in South Dakota referred a trio of questions to the South Dakota Supreme Court, all dealing with limited liability company law. As of yet, it does not appear that the South Dakota Supreme Court has taken any action or issued any ruling as to whether or not it will answer the referred questions. SDIF Limited Partnership 2 v. Tentexkota, LLC, 1:17-cv-01002-CBK, 2018 WL 6493160 (D. S.D. Dec. 10, 2018).
First the background. SDIF made two loans to Tentexkota totaling $32.5 million, which funds were to be used to develop a casino and resort in Deadwood, South Dakota. The funds that were loaned had been generated through investments from individual foreign investors seeking to participate in the EB-5 Lawful Permanent Resident Visa Program. Under that program, it is required that the loans be guaranteed by the members of the borrower organization. When the loan went into default, SDIF sought to collect on those guarantees.
As recounted by the court, Tentexkota’s articles of organization contained a provision that the members were not liable for the debts and obligations of the company, citing section 47-34A-303(c) of the South Dakota LLC Act. That provision provides that some or all of the members of an LLC may agree to be liable for all or specified debts or obligations of the LLC if “(1) A provision to that effect is contained in the articles of organization; and (2) A member so libel has consented in writing to the adoption of the provision or to be bound by the provision.” It may be important to the case that the articles, rather than reciting that the members may become liable as contemplated by this provision, provides rather, inter alia, that no election into that provision has been made. The operating agreement as well provided that there could be mandatory capital calls and that “The Members may also be required by the vote of the Majority to personally guarantee the obligations of the Company.” The district court noted there is no evidence of any such vote had taken place.
In addition, the court referenced South Dakota § 53-9-1, which provides “a contract provision contrary to an express provision of law or to the policy of express loss, though not expressly prohibited or otherwise contrary to good morals, is unlawful.”
The guarantee documents provided that they were executed by “[name of guarantor], as member of Borrower.” Another decision rendered the same day as that cited above indicates that the member capacity may be the core issue:
The parties do not dispute that there is no controlling precedent in South Dakota determining whether DSCL 47-34A-303 would invalidate personal guarantees signed by members of an LLC in their capacity as members where the LLC has not amended its articles of organization to provide for this outcome and the members have not otherwise consented in writing to the adoption of such a provision.
SDIF Limited Partnership 2 v. Tentexkota, LLC, 1:17-CV-01002-CBK, 2018 WL 6486467, *3 (D. S.D. Dec. 10, 2018) (emphasis added).
With that background, three questions were tendered to the South Dakota Supreme Court, namely:
· does the provision of the South Dakota LLC Act affording members limited liability invalidate the personal guarantees signed by the LLCs members in their capacity as members where the LLC’s articles do not provide that the members are liable for its debts and obligations in their member capacities and the members have not consented in writing to be so bound [inter alia, adopting South Dakota § 47-34A-303(c)];
· if the guarantees violate the LLC Act, does South Dakota § 53-9-1 prohibit recovery under the guarantees; and
· “what is the legal effect of the LLC’s operating agreement permitting members to personally guarantee corporate debts but only by a “vote” of the majority of members when there is no evidence of any such “vote”?
I am confused as to why any of this is in dispute. A provision such as subsection (c) of the otherwise applicable rule of limited liability exist so that members may, ab initio, waive their limited liability. This faculty is typically employed in highly lawyered transactions where, for example, limited liability needs to be waived in order to avoid the application of section 469 of the Internal Revenue Code in connection with oil and gas deals and the pass-through deduction for intangible drilling costs. Other times it is employed to avoid the need for contractual guarantees by providing, ab initio, that the members, all or some, are as well obligors on the debt. In still another application, an election to accept responsibility for an LLC obligation would, as to that member, convert the obligation from nonrecourse to recourse with attendant impact upon the ability to claim basis. This suit is, to my knowledge, the first time that someone has asserted that language of this nature protects a guarantor from enforcement of a guarantee.
More broadly, a guarantee is a bilateral contract between the lender and the guarantor pursuant to which the guarantor provides credit enhancement with respect to the debtor's obligation. As such a guarantee is not part of the LLC’s operating agreement, which is the agreement of all of the members with respect to the management and affairs of the LLC. The borrower is typically not a party to the guarantee agreement.
Ultimately, I cannot imagine how the limited liability provision of the LLC Act is implicated in the dispute between the lenders and the guarantors. Admittedly, it is unfortunate that the guarantors provided their signatures “as members of” the LLC.
Regardless, we wait and see whether the South Dakota Supreme Court will accept the question and provide answers.
Sunday, March 17, 2019
The Worst Decision of Marcus Aurelius Comes Home to Roost
Today marks the anniversary of the death in 180 of the great Roman Emperor Marcus Aurelius. It is as well the date upon which his worst decision was inflicted upon the world.
There is no question that Marcus was a great emperor. In fact he is the only emperor to have written a book, namely the Meditations, that to this day remains in print (while Caesar's Gaelic Wars remain a staple of classes in both Latin and military history, Caesar was never emperor). Marcus was one (and the last) of a string of excellent emperors. After the tragedy that was Nero and the tumult of the Flavians (Vespasian, Titus and Domitian), the emperors of the Nervan-Antonian dynasty had consistently been effective leaders. This had been largely achieved by the sitting emperor adopting his heir. This path avoided the deficiency of restricting passage of control to only natural heirs, necessarily limiting the pool of possible successors; the Flavians had been lucky in this regard, but they were only two generations – the father Vespasian to his son Domitian and then upon Domitian’s death the throne went to his brother Titus. Hadrian was only a cousin to his predecessor Trajan. While Hadrian would in turn adopt Antoninus Pius, it does not appear they were related to one another. It is reported that a condition imposed by Hadrian on Antoninius’ adoption was that he in turn adopt Marcus Aurelius.
Marcus broke with this approach, appointing his natural son Commodus as his heir (Commodus was appointed co-emperor some three years before Marcus' death). He was a disaster. A man of apparently no character, he is described by Aelius Lampridius as “even from his earliest years he was base and dishonorable. and cruel and lewd, defiled of mouth, moreover, and debauched.” A megalomanic, he took to fighting in the gladiatorial games. Of course he always won; who is going to try to kill the emperor in front of thousands of witnesses. Of course it did not hurt that he secretly directed that his opponents be given dulled weapons. Meantime he ignored the operation of the Empire, leaving decisions to his chamberlain and other officials. He did, however, both order a devaluing of the currency and imposed excessive taxes. Gibbons, in his monumental The History of the Decline and Fall of the Roman Empire, dated the decline of the Roman Empire from Commodus.
Finally he was assassinated. There was, however, no natural heir to the position of Emperor, and his death would be followed by the “Year of Five Emperors.”
Had Marcus Aurelius followed the path of the other Nervan-Antonian emperors and adopted as his heir a proven leader, the path of the Roman Empire would well have been substantially different. But he did not. Such decisions are the stuff of history.
In closing, contra the movie “Gladiator,” Marcus was not killed by Commodus. Rather, he died of natural causes (it has been suggested that an unidentified plague was involved), possibly in what is now Vienna. Commodus was not killed in the gladiatorial games, but rather was assassinated in 192 by being strangled.
Friday, March 15, 2019
Beware the Ides of March
“Et tu, Brute?”
Today, the Ides of March, marks the anniversary of the assassination of Julius Caesar in 44 B.C. Caesar was famously assassinated at a meeting of the Roman Senate after having (almost certainly apocryphally) been warned to “Beware the Ides of March.” According to Seutonius, The Lives of the Twelve Caesars, “When a note revealing the plot was handed him by some one on the way, he put it with others which he held in his left hand, intending to read them presently.” Marc Antony, to whom the plot had been divulged, tried to intercept Caesar, but he was himself interrupted. As for the Beware” waring, Seutonius wrote: “Again, when he [Caesar] was offering sacrifice, the soothsayer Spurinna warned him to beware of danger, which would come not later than the ides of March. …. [H]e entered the House [the Theater of Pompey] in defiance of portents, laughing at Spurinna and calling him a false prophet, because the ides of March were come without bringing him harm. Spurinna replied that they had of a truth come, but they had not gone.”
Although stabbed twenty-three times by the various conspirators, only one wound was fatal. At the time of his death he was 56, and by some measures was among the richest men to have ever lived.
Caesar rose to power out of the First Civil War that resulted from the dissolution of the First Triumvirate, it comprised of Caesar, Pompey (a/k/a Pompey Magnus) and Crassus. Crassus was killed when he invaded Parthia. The relationship between Caesar and Pompey fell apart over person differences, and Pompey was killed in Egypt.
Caesar’s murder by members of the Senate (some 60 senators were part of the plot, but not Cicero – the conspirators were unsure he had the stomach for such an act) was premised upon the notion that they were somehow preserving liberty for Rome; after the deed they paraded through the streets shouting “liberty.” This against the fear that Caesar sought to be king, an especially galling notion in light of Rome having been, at least as part of its foundation myth, ruled by kings and then thrown them off. Still, at this stage Caesar had been appointed Dictator for Life (Dictator Perpetuo) by the Senate. It seems this subset of the Senate sought to undo what the whole Senate had approved.
As set forth in Adrian Goldsworthy’s biography of Caesar titled (surprisingly) Caesar:
The conspirators spoke of liberty, and believed that this could only be restored by removing Caesar. Most, perhaps all, thought they were acting for the good of the entire Republic. With Caesar dead the normal institutions of the State ought to function properly again and Rome could be guided by the Senate and freely elected magistrates. To show that this was their sole aim they decided they would kill the dictator but no one else, including his fellow consul and close associate Antony. Brutus is said to have persuaded them to accept this, against the advice of some of the more pragmatic conspirators.
The huddled masses of Rome were less worried about Republican principles than they were with the loss of Caesar’s largess and the interruption of public work programs that provided desperately needed employment. As recounted by Nicolaus of Damascus in his Life of Augustus, “Even their [The assassin’s] houses were besieged by the people, not under any leader, but the populace itself was enraged on account of the murder of Caesar, of whom they were fond, and especially when they had seen his bloody garment and newly slain body brought to burial when they had forced their way into the Forum and had there interred it.”
“Liberty” was not to be had. Caesar’s death unleashed upon the tottering Roman Republic the Second Civil War of Caesar’s heir Octavian (18 years old at the time of Caesar’s death and later to be Caesar Augustus) and Marc Antony (Lepidus, the third member of the Second Triumvirate, was a place holder) against the assassins and their various supporters. Octavian and Antony were not friends. Rather, applying the adage “the enemy of my enemy is my friend,” they were joined in opposition to Caesar’s assassins and little else. Regardless, the decision of the night before the assignation to not as well target Marc Antony, in retrospect, was no doubt regretted.
Assassins Brutus and Cassius (Gaius Cassius Longinus) would each commit suicide after losing a phase of the Battle of Philippi (notwithstanding the presentation in the HBO series “Rome,” they died on different days). Cicero (who as noted above was not himself part of the conspiracy) would be executed as part of the proscriptions after the victory of the Second Triumvirate.
Still later Octavian and Antony would turn on one another, Antony’s forces being routed at Actium. Octavian would go on to be the first Roman emperor, Caesar Augustus.
But back to Caesar’s dying words. “Et tu Brute” is not recorded by any classical historian – it is a quote from Shakespeare. Plutarch, who was born exactly 100 years after the assassination, reports that Caesar said nothing after the attack began in earnest. Suetonius wrote that others reported his last words to be “καὶ σύ, τέκνον” (Greek still being the lingua franca of the Romans), transliterated as “Kai su, teknon” or “You also child,” addressed to Brutus (that is Marcus Junius Brutus the Younger, not to be confused with Decimus Junius Brutus, another party to the assignation). There were rumors, later reported by Plutarch (Suetonius is silent on the topic) that Caesar was in fact Brutus’ father – it was known that Brutus’ mother Servilia was Caesar’s mistress. Still that would appear to be something of a stretch; Caesar was 16 at the time of Brutus' conception; Servilla was at that time 28.
For anyone who watched the “Spartacus” series, while the sources do not exclude Caesar's participation in the war against Spartacus (i.e., the “Third Servile War”), they provide no details of that participation. Ergo, the portrayal of Caesar's actions are pure fiction.
Thursday, March 14, 2019
With All Due Respect, Inspection of Books and Records Is An Internal Affair
In a recent decision from South Carolina, in my humble opinion, the court botched the question of whether or not the inspection of books and records in a corporation is an internal affair governed by the law of the jurisdiction of organization. Gault v. Thacher, No. 9:18-CV-03157-DCN, 2019 WL 651856 (D. S.C. Feb. 15, 2019).
In this dispute, there was before the South Carolina District Court a Georgia corporation that was qualified to transact business in South Carolina. The plaintiff, presumably a citizen of South Carolina, sought to inspect the books and records of that Georgia corporation. So far, so good. He argued, however, that he should be able to inspect those books and records under the law of South Carolina, rather than the law of Georgia. While the court cited decisions from Florida and Colorado, as well as a rather dated Pennsylvania decision, in support of its decision, the court ordered that the inspection of the books and records of the Georgia corporation would be made in accordance with the South Carolina law.
The rule set forth in this case should be rejected. If it is not universal it is near universal the qualification to transact business in a jurisdiction does not subject a foreign corporation to the application of the laws of that state with respect to internal affairs. There is no possible reading of “internal affairs” that does not encompass the right of a shareholder to inspect the corporation’s books and records. The Restatement (Second) of Conflicts, § 302, cmt. A(1954), references “shareholders’ rights to examine corporate records” as encompassed within “internal affairs.”
In Sostarich v. Zirmed.com, Inc., No. 03-CI-00498 (Jefferson Cir. Ct., Div. 8), Opinion and Order March 26, 2003, a Kentucky court ordered inspection, in accordance with the Kentucky Business Corporation Act, of the records of a Delaware corporation. The court reasoned:
(“KRS § 271B.15-050(2) specifies that a foreign corporation with a valid certificate of authority shall have the same rights and privileges as a domestic corporation of like character and, except as otherwise provided in KRS Chapter 271B, shall be subject to the same duties, restrictions, penalties, and liabilities imposed on a domestic corporation of like character. One of these duties would be to allow inspection of corporate records to an entitled shareholder. While subsection (3) of KRS § 271B.15-050 prevents the state of Kentucky from regulating the organization or internal affairs of a foreign corporation authorized to transact business in the state, the Court finds that inspection of corporate records would not qualify as regulating the organization or internal affairs of ZirMed.” (emphasis in original).
In response, language was added to several acts to make express that the right of inspection of books, records, and documents of a foreign business entity will be determined by reference to the laws of the jurisdiction of organization of that foreign business entity. See Ky. Rev. Stat. Ann. § 271B.15-050(3); § 275.380(1)(a); § 362.495; and § 362.2-901(1). A ruling like Gault v. Thacher cannot happen (again) in Kentucky.
Wednesday, March 13, 2019
California Court Enforces the Spirit of the Prohibition on Transfer of an Interest in a Limited Partnership
California Court Enforces the Spirit of the Prohibition on Transfer
of an Interest in a Limited Partnership
In SP Investment Fund III, LLC v. Zell, B278003, 2018 WL 6787328 (Ca. Ct. App. 2nd Dist. Div. 3 Dec. 26, 2018), the court considered a purported sale of an interest in a limited partnership for which the partnership agreement required the general partner’s consent for a transfer of a limited partner’s interest. Unable to acquire that consent, the purchaser sought to receive all of the distributions as made and as well the right to direct the record holder as to how to vote the interest. The seller sought to rescind the purchase/sale, and the purported purchasers brought suit. After reviewing the default rule under the N.Y. Limited Partnership Act (N.Y. Partnership Law, art. 8-a, §§ 121-101 et seq.), the court also observed that:
However, as we have described, the RLPA permits partnerships, through their partnership agreements, to restrict transfers of partnership interest without consent. Newport Highlands has opted to exercise this statutory right: Its partnership agreement provides that a limited partner’s transfer of distribution rights and withdrawal from the partnership, as well as a transferee’s admission to the partnership, are “[s]ubject to the Consent of the Operating General Partner.” Id. at *8.
From there, the court held:
Newport Highland’s restrictions on transfer, and the general partner’s ability to control with whom it does business, would be wholly frustrated if we were to enforce the purchase agreement in the present circumstances. That is, were we to enforce the purchase agreement according to its terms, SP, although not formally a member of the partnership, would have all the rights of a limited partner-to receive partnership profits and distributions, to review partnership documents, and to direct how Zell “vote[s], elect[s] or act[s] with regard to the partnership or Partnership Interest.” As such, the partnership’s ability to restrict with whom it does business-and specifically to choose not to do business with SP, which it repeatedly has expressed it desire to do-would be entirely thwarted. Id. at *9.
On that basis the court found there to be no enforceable agreement for the purchase/sale of Zell’s limited partnership interest.
Tuesday, March 12, 2019
In a posting made in his blog New York Business Divorce, Peter Mahler has posted A Cross-Country Tour of Five Recent Stock Appraisal Cases (March 10, 2019). Therein, while acknowledging that the states are generally consistent as to valuation methodologies applied in appraisal cases, there still exist differences, often based upon the precise language of the statute or, where a stock redemption agreement was in play, the precise wording of that agreement.
HERE IS A LINK to his posting.
Monday, March 11, 2019
Kentucky Court of Appeals Addresses First Breach Doctrine, Implied Covenant of Good Faith and Fair Dealing, But the Case Is Really About Finality and Appealability
Kentucky Court of Appeals Addresses First Breach Doctrine, Implied Covenant of Good Faith and Fair Dealing, But the Case Is Really About Finality and Appealability
A recent decision from the Kentucky Court of Appeals is focused upon whether a decision of the trial court was final and appealable. Still, in the course of the decision of the court referenced both the first breach doctrine and the obligation of good faith and fair dealing. Market Plus Wine, LLC v. Walker Properties of Central Kentucky, LLC, No. 2017-CA-001265-MR, 2019 WL 911046 (Ky. App. February 22, 2019).
This dispute arose out of a lease dispute, that for the National Provisions restaurant/bakery/grocery that formerly operated in Lexington. Apparently the tenant was often late in making its rent payments. However, in turn, Walker accepted those payments. Eventually the tenant sought Walker’s consent to an assignment of the lease, but Walker refused and evicted Market Plus from the premises. Walker asserted that he only evicted the tenant after the tenant violated the lease by effectively vacating the premises (and being insolvent)
The trial court held that, consequent to the First Breach Doctrine, the tenant’s claims against Walker would fail.
“Walker could not be held liable on either claim because Market breached the contract first. It held that because Market had breached first and had consequently forfeited the lease, Market had lost any right to insist upon Walker’s consent to any subsequent assignment of the lease or to complain about being evicted from the leased premises.” Id., *2.
The trial court did not, however, resolve the tenant’s liability for its breach of the lease. While the fact of the breach was determined, the amount of damages was not. Specifically, Walker could not be liable for any breach under the lease, in this instance with respect to failure to consent to its assignment, because the tenant had already breach the lease. Therefore, with respect to the tenants claim for breach of the lease and interference with prospective contractual relationship with the proposed new tenant:
In addition, Market had asserted a claim against Walker for breach of the implied covenant of good faith and fair dealing. In a footnote, the court wrote that “Kentucky recognizes that every contract contains an implied covenant of good faith and fair dealing.“ The court went down to observe that:
However, Kentucky has only ever recognized a breach of the implied covenant of good faith and fair dealing as tortious (e.g., as a violation of a general duty owed independently of a contract) where the situation has involved parties in a special relationship not found in ordinary commercial settings, such as between an insurer and an insured, where distinct elements are present such as unequal bargaining power, vulnerability and trust among the parties. See Hulda Schoening Family Tr. v. Powertel/Kentucky, Inc., 275 F. Supp. 2d 793, 797-98 (W.D. Ky. 2004) (citing Ennes v. H & R Block E. Tax Serv., Inc., Civ. A. No. 3:01CV-447-H, Not Reported in F. Supp. 2d, 2002 WL 226345, at *2-*3 (W.D. Ky. Jan. 11, 2002) ). Here, even if Walker had breached the implied covenant of good faith in the lease, no such special relationship between Walker and the appellants was present under the circumstances of this case, nor is one even alleged to have existed. Therefore, any alleged violation by Walker of the implied covenant of good faith and fair dealing could not have served as the basis of any claim apart from breach of contract.
In the end, however, the court determined that no final determination could be given by the Court of Appeals because the trial court had not yet finished its work with respect to Walker’s claim against Market Plus.
Friday, March 8, 2019
Court Issues Charging Order, Avoids Question of Priority
In a recent decision from a federal district court sitting in New Jersey, it both entered a charging order and determined it would not address the question of that charging order’s priority over an already existing lien. Government Employees Insurance Co. v. Hamilton Healthcare Center, P.C., Civ. No. 17-674, 2019 WL 251740 (D. N.J. Jan. 17, 2019).
Various persons affiliated with the Hamilton Healthcare Center were found to have engaged in insurance fraud. A judgment exceeding $2.3 million was entered against them. One of those judgment debtors, Kahn, had ownership interests in Pennsauken Diagnostic Center, LLC and Professional Medical Resource Management, LLC. The judgment creditor sought a charging order against Kahn’s interest in each of those companies. In accordance with New Jersey law on charging orders, that charging order was awarded the judgment creditor.
Apparently as a defense to the issuance of the charging order, it was asserted that the law firm Stark and Stark had a lien on Kahn’s interest in each of these LLCs, and those liens should have priority over the charging order addressed in this opinion. The court noted, however, that Stark and Stark is not a party to this case, and on that basis declined to address the priority of its lien over this charging order.
Thursday, March 7, 2019
The Passing of Great Minds
Today marks a pair of deaths, separated by centuries but of persons intellectually linked.
On this day, is 322 b.c. Aristotle passed away.
On this same date, is 1274, St. Thomas Aquinas passed away. It was Aquinas who in the Summa Theologiae (an easy 36 volume read) integrated Catholic theology with the precepts of philosopy, primarily that of Aristotle.
Wednesday, March 6, 2019
New York Court Dismisses Derivative Action Brought by Non-Member of LLC
A recent decision from New York reiterates the rule that only a member may bring a derivative action on the LLC’s behalf. Kaminski v. Sierra, 2029 NY Slip Op. 01067, 2019 WL 576474 (NY App. Div. 2nd Dept. Feb. 13, 2019).
Kaminski, in 2009 or 2010, acquired an interest in Melange Med Spa, LLC from a former member. Kaminski was never admitted as a substitute member in the LLC. Still, in 2016 she commenced this derivative action against Sirera, a managing member of the LLC, and against the company’s attorneys, alleging a variety of claims including breach of fiduciary duty.
After noting that a member of an LLC may bring a derivative action on its behalf, it was observed that here the plaintiff was not a member. No explanation was provided as to how Kaminski argued the suit should be permitted to proceed. Rather, the decision went right to the fatal fact, namely that a non-member does not have standing to bring a derivative action. Specifically, “[T]he plaintiff, as a nonmember purchaser who had not been admitted as a member of the LLC, lacks standing to pursue derivative causes of action on behalf of the LLC.” (Citations omitted).
Not much more to say about that.
Tuesday, March 5, 2019
California Court Addresses Priority of Unperfected Security Interest and Charging Order
In a decision rendered last Wednesday by the California Court of Appeals, it addressed the question of whether an unperfected security interest would have priority over a subsequently entered charging order. On the facts of this case, it was held that the charging order had priority. MDQ, LLC v. Gilbert, Kelly, Crowley & Jennett LLP, B283025, 2019 WL948726, ___ Cal. Rptr. 3d __ (Feb. 27, 2019).
To secure payment for certain legal fees, Gilbert Kelly took a security interest in certain expected distributions to its client. In that same litigation, the client from whom Gilbert Kelly took the security interest was held liable for almost $1 million. For reasons not explained in the decision, Gilbert Kelly never filed a UCC-1 in order to perfect its interest in the to be distributed funds. This case would turn upon the question of whether the unperfected security interest, created first in time, would have precedence over the subsequent charging order.
A charging order creates a lien on the distributions made from an LLC. A charging order is not a voluntary lien subject to Article 9 of the Uniform Commercial Code. In consequence, a charging order is not subject to Article 9’s “perfection” requirements. In contrast, the court determined that the interest held by the law firm was indeed a security interest covered by the UCC. As such, its priority with respect to other liens would be determined based upon the date of perfection.
In that the security interest held by Gilbert Kelly was never perfected before the entry of the charging order, it being deemed perfected, the charging order took precedence. As such, until such time as the distributions from the LLC or other funds satisfy the judgment entered, Gilbert Kelly will have to await payment.Jay Adkisson has published a review of this decision; HERE IS A LINK to that review.
Monday, March 4, 2019
KRS § 275.177 Says What It Means and Means What It Says
In LAWWAL, L.L.C. v. Wallace, No. 2016 CA-000358-MR, 2019 WL 103960 (Ky. App. Jan. 4, 2019), it was held that the writing necessary to satisfy the written requirement imposed by an operating agreement (see KRS § 275.177) may be set forth in documents other than an express amendment of the operating agreement. Therein the court wrote:
The general rule of contract law is that parties may orally agree to modify a prior agreement even though they previously agreed that all future modifications must be in writing. See Restatement (Second) of Contracts § 283 (1981) (“Even a provision of the earlier contract to the effect that it can be rescinded only in writing does not impair the effectiveness of an oral agreement of rescission. In the absence of statute, such a self-imposed limitation does not limit the power of the parties subsequently to contract.”). “[A]s to operating agreements [KRS 275.177] altered this rule and provided for specific enforcement of requirements that amendments be in writing.” Mark A Sargent & Walter D. Schwidetzky, Limited Liability Company Handbook (2018-19 ed.) (Kentucky Manager-Managed LLC Operating Agreement found in Appendix KY-7).
Specifically, KRS 275.177 states:
If a written operating agreement contains a provision to the effect that any amendment to the operating agreement of the limited liability company shall be in writing and adopted in accordance with the provisions of the operating agreement, then the provision shall be enforceable in accordance with its terms, and any agreement as to the conduct of the business and affairs of the limited liability company which is not in writing and adopted in accordance with the provisions of the operating agreement shall not be considered part of the operating agreement and shall be void and unenforceable.
Significant to the present dispute, the only requirement imposed by KRS 275.177 is that modifications must be in writing if required by the operating agreement. It does not require modifications be in set forth in any specific type of written document or even technically labeled as such. Therefore, to the extent that KRS 275.177 is implicated, it was complied with in this case. The parties’ agreements with respect to the sale and ownership of the LLCs were reduced to writing—first in the original Sales Agreement and later in the Settlement Agreement.
Id. at *5-6.
Friday, March 1, 2019
South Carolina Court Considers What Must Be Alleged In Order To Create a Partnership; Here the Plaintiff Failed
South Carolina Court Considers What Must Be Alleged In Order To Create a Partnership; Here the Plaintiff Failed
In a recent decision from a federal district court in South Carolina, it considered a complaint alleging there to have existed a partnership. The court found those allegations lacking, and as well rejected the notion that the use of the term “partner” was enough to create a partnership. Dombek v. Adler, Civ. Act. No. 2:18-CV-391-RMG, 2019 WL 459019 (D. S.C. Feb. 5, 2019).
Something weird was going on here. Defendant Adler was an attorney hired to represent a venture involving the plaintiffs, they having “invested hundreds of thousands of dollars in a venture to export freshly mined gold ingots from the Democratic Republic of Congo through an attorney in Nairobi, Kenya.” In connection therewith “Adler represented that he would serve as legal counsel for the enterprise and any risk of loss would be covered by his insurance.” But then:
The plan fell apart and the gold shipment was ultimately seized and retained by the sellers even after the Plaintiffs paid hundreds of thousands of dollars to secure its release. The Plaintiffs allege that Adler failed to do basic due diligence on the sellers, failed to set up appropriate legal instruments to protect their investments, and paid himself for his work in the scheme.
Adler denied any liability, and asserted as part of a counter-claim that he along with the Plaintiffs Dombeck and Cossano had “entered into a partnership, and therefore they are all jointly and severely liable for any claims against the partnership.”
The court would entirely reject a suggestion that a partnership existed.
In order for a partnership to exist, there must exist an agreement to share the profits and losses of the venture. In this instance, the court found that “Adler, however, fails to allege that Dombeck or Cossano intended to share in profits or losses.” Further, Adler indicated that he was for himself assuming all liabilities of the venture. On that basis, the court was able to reject the creation of a partnership and the resultant fiduciary obligations.
With respect to Adler’s reliance upon the use of the term of “partnership” in certain communications, it was held that “the mere use of the term ‘partner’ in the colloquial sense does not suffice to allege a partnership.” The court went on to find that the use of the term “partner” could not overcome Adler’s failure to argue that there was an agreement to share in the profits and losses of the venture.