I’m Not Understanding Why This is a Question

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.