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.
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