Monday, July 29, 2019
Judicial Expulsion of a Member from an LLC
I have published Judicial Expulsion of a Member: What We Have Learned from All Saints University of Medicine Aruba, IE Test and Kenny v. Fulton Associates in the July-August 2019 issue of Journal of Passthrough Entities.
In this article I review a trio of cases that involved the judicial expulsion of a member. In IE Test it was held that there was not a basis for expulsion, while Medical College of Aruba found that the facts justified expulsion, leaving the court to fashion an appropriate remedy. The Kenny case involved an interesting application of expulsion, in this instance based upon a member’s breach of the operating agreement and his fiduciary duties.
HERE IS A LINK to the article.
New York Election Law and Disclosure of LLC’s Members
New York state’s election law has been amended to require the disclosure of the membership of LLCs that are engaged in political activity. N.Y. Election Law § 14-116(3) now provides:
Each [LLC] that makes an expenditure, or contribution, for political purposes shall file with the state board of elections, by December thirty-first of the year in which the expenditure is made, on the form prescribed by the state board of elections, the identity of all direct and indirect owners of the membership interests in the [LLC] and the proportion of each direct or indirect member's ownership interest in the [LLC].
It is not clear whether those reports will be available for public inspection.
Thanks to Bruce Rich for the lead.
Friday, July 26, 2019
On Thursday, August 1, I will be presenting on a panel at the Southeastern Association of Law Schools (“SEALS”) Conference, where I will be addressing the topic of benefit corporations and other socially minded business structures. Looking forward to sharing ideas and insights with friends including Joan Heminway, Cass Brewer and Benjamin Means.
Wednesday, July 24, 2019
Limited Partnership Dissolved At the Request of Assignees of Limited Partners
In a recent decision from Minnesota, a limited partnership was ordered to be dissolved in an action brought by the assignees of the limited partners. Storeland v. Nordic Townhomes Limited Partnership, A18-1564, 2019 WL 1983500 (Minn. Ct. App. May 6, 2019).
Nordic Townhomes was originally organized with three limited partners and three general partners. With the passage of time, all of the original limited partners died. No new limited partners were admitted, and the heirs of the various limited partners became transferees of their respective interests in the partnership. The partnership agreement of Nordic Townhomes and the present situation were summarized by the court as:
Once Nordic did not have any limited partners, the partnership was to dissolve, liquidate, and cease doing business. Despite the fact that Nordic does not have any limited partners, continue to exist as an entity and conduct business.
The plaintiffs, they being some of the assignees of now deceased limited partners, filed a complaint seeking that Nordic Townhomes wind up its business, satisfy its debts and obligations and distribute the net proceeds to those holding the economic rights in the partnership. The limited partnership responded by claiming that the plaintiffs did not have standing to seek either judicial or nonjudicial dissolution of the partnership on the basis that they were neither limited or general partners. The trial court granted the plaintiffs’ summary judgment, in effect finding that they could enforce the provision of the limited partnership agreement with respect to the partnership’s dissolution. This appeal followed.
Applying a “injury-in-fact” paradigm, the Court of Appeals found that the assignees of the limited partners had standing to enforce that provision of the limited partnership agreement directing that the partnership be dissolved upon having no limited partners:
Here, respondents suffered an injury-in-fact sufficient to give them standing to ask the district court to enforce the partnership agreement. The partnership agreement is clear: Nordic was to be dissolved when there were no longer any limited partners. That process involves liquidating assets, and respondents are entitled to their share of any profits remaining once partnership obligations are resolved. See Minn. Stat. § 321.0702(b)(2) (2018) (stating that “upon the dissolution and winding up of the limited partnership’s activities [a transferee is entitled to] the net amount otherwise distributable to the transferor”). Because respondents are entitled to their share of that money, and because Nordic refused to take steps to dissolve the partnership and liquidate assets, respondents suffered an injury-in-fact sufficient to confer standing.
2019 WL 1983500, *2.
Further rejecting the claim that the court was allowing a non-partner to move for judicial dissolution, the court observed that “respondents’ action is more properly characterized as seeking enforcement of the partnership agreement rather than seeking judicial dissolution of the partnership. And because we conclude that respondents have standing because they suffered an injury-in-fact, respondents do not need a statutory basis to have standing.” Id. (citation omitted). Still on that same point, the court would also write:
[T]he partnership agreement clearly states that Nordic was to be dissolved when there were no limited partners. Accordingly, as transferees, respondents had standing to ask the district court to enforce the partnership agreement and the district court correctly required Nordic to follow the partnership agreement’s mandate of dissolution and liquidation.
Finally, although our opinion rests on our application of the law, we observe that adopting Nordic’s position could effectively result in no one having standing to seek enforcement of the partnership agreement. We do not discern the Minnesota law leaves transferees like respondents without redress in cases where remaining general partners fail to abide by the partnership agreement.
Id.,*3 (footnote omitted).
For myself, I find this decision somewhat troubling. Yes, all the court is doing is enforcing the agreement. The court is, however, enforcing the agreement on behalf of persons who are not parties to it. As transferees of an economic interest in the limited partnership, the plaintiffs in this action have no right to participate in the management of the limited partnership. While the original limited partners may have been parties to the limited partnership agreement and in that role had the capacity to bring an action for its enforcement, that right did not devolve to the transferees upon the death of the limited partner. They are not parties to the limited partnership agreement, and for that reason an “injury-in-fact” paradigm fails; the failure of strict compliance with the limited partnership agreement gave no rise to an injury in the transferees as they were never parties to that agreement to begin with. In effect, the court is allowing non-parties to an agreement to insist upon its enforcement. What about the requirement of privity before bringing an action for enforcement?
Tuesday, July 23, 2019
A recent decision from California considered and rejected the suggestion that an individual who had been a member of an LLC and then a shareholder in a successor converted corporation was, individually, a client of the firm retains to effect that conversion. Brafman v. Wilson Sonsoni Goodrich & Rosati P.C., No. A153595, 2019 WL 2267049 (Ca. Ct. App. 1st Dist. May 28, 2019).
Ori Brafman and Peter Sims started a business assisting business authors. In December of 2014, under the name “Silicon Guild,” they retained an unnamed law firm to organize their venture as an LLC, jointly owned by each of them.
By mid-2015, they decided the company should be a C corporation in order that it could take in additional capital. Sims contacted Wilson Sonsoni (“WSGR”) to assist in the incorporation process. In connection therewith, Sims, on behalf of Silicon Guild, signed an engagement letter with WSGR, it providing that WSGR had been “retained to advise Silicon Guild (the “Company') with respect to formation and general corporate matters.” That same engagement letter went on to specify that the representation was of the company “and not any of its affiliates, owners, or agents, or any of the individuals associated with the Company.” The engagement letter went on to provide that WSGR’s representation of the company did not mean that it “represent[ed] any of the Company’s parents, subsidiaries, employees, officers, directors, shareholders, or founders.” After signing the engagement letter, Sims emailed a copy of it to Brafman. Shortly thereafter, WSGR realized that Silicon Guild LLC already existed, and that the process would involve the conversion of that LLC into a C corporation. Throughout this process, WSGR communicated primarily with Sims. While that process was continuing, and even as the company was signing up customers, the relationship between Sims and Brafman deteriorated, and Sims was no longer willing to proceed as an equal owner in Silicon Guild. Working with WSGR, Sims drafted a proposal in which he would become the 90% owner of the corporation, Brafman would hold 5%, and two other individuals would split the remaining 5%.
Sims and Brafman agreed to mediate their dispute over the ownership of the company. While that mediation process was taking place, Sims retained WSGR to incorporate a new company, Parliament, it having the same purpose as Silicon Guild. To that end, Sims signed a new engagement letter with WSGR for the incorporation of Parliament.
WSGR asserted it did not know, and had no reason to know, that Parliament was intended to compete with Silicon Guild. WSGR did send an e-mail to both Brafman and Sims setting forth its understanding that its relationship with Silicon Guild was ending, and that WSGR was going forward engaged by Parliament. Brafman, having certainly by this point learned of Sims' efforts with respect to Parliament and WSGR’s relationship thereto, “did not seek a temporary restraining order or injunction to stop Sims or WSGR's actions with respect to Parliament.”
At the culmination of the mediation, Brafman sold his interest in Silicon Guild to Sims, and Sims, Silicon Guild and Parliament, as well as Brafman, entered into comprehensive releases. Two months after that settlement, Brafman filed his initial complaint against WSGR, which a year and a half later was followed by an amended complaint alleging seven causes of action against WSGR. Each of these claims was premised, inter alia, upon the notion that Brafman was a client of WSGR. WSGR then moved for summary judgment and, after oral argument, the trial Court issued a ruling granting the requested summary judgment on the basis that WSGR owed no duty to Brafman. This appeal followed:
Affirming the summary judgment and a determination that WSGR owed no fiduciary or similar obligations to Brafman, the court began by reviewing the necessary elements for the attorney-client relationship to arise, including that the clients belief that they were being represented is of itself “not sufficient to create such a relationship, as that belief must have been reasonably induced by representations or conduct by the attorney.”, citing Fox v. Pollack, 181 Cal. App. 3d 954, 959 (1986). In this respect, the court looked to the engagement letter, which “limited the scope of representation to formation and corporate matters and expressly disclaim representation of any person or entity other than the company Silicon Guild.” In addition, “WSGR did not perform any other work for Brafman or have any interaction with Brafman that would have led him to reasonably believe WSGR represented him personally in any capacity.” The court as well rejected Brafman’s efforts to recharacterize Silicon Guild LLC as a partnership and to then apply the elements of an attorney-client relationship arising from a partnership circumstance, finding that even under that paradigm, Brafman failed to demonstrate that an attorney-client relationship would have arisen.
Turning to the assertion that the engagement letter with WSGR was invalid on the basis that the intended C corporation did not exist, and after noting that Silicon Guild LLC, while perhaps inartfully described, was in existence, the court noted that a contract with a nonexistent party is simply void. The invalidity of that engagement letter between the firm and the not yet existing business entity would not have the consequence of creating an attorney-client relationship between WSGR and Brafman Even then:
Moreover, public policy favors allowing attorneys to represent only the entity being incorporated, to avoid potential conflicts that could arise with continued representation of the newly-incorporated company and its founders after incorporation.
Next, the court dismissed, on the basis of derivative action standing, Brafman’s allegations that WSGR’s actions caused him injury. Finding there to be no standing, the court determined that, even if the allegations were true, the injury was to Silican Guild, LLC. As such, Brafman had no individual injury, and having not satisfied the requirements for bringing a derivative action, he lacked standing to proceed.
This case is yet another that may be categorized under the heading “no good deed goes unpunished.” WSGR, while perhaps without as firm a grasp of the facts as would have been desired, at least got a signed engagement letter specifying who was its client and what it was engaged to do. That letter was provided to Brafman, the plaintiff in this action. It was that written engagement letter that provided the bulk of the successful defense of this action. Still, it is unfortunate that the firm, through an appeal, had to defend the allegation of an attorney-client relationship that was in direct opposition to that written agreement.
Monday, July 22, 2019
Kill Them All, God Will Know His Own
Today is the anniversary of the Massacre at Béziers, an event that took place in 1209 during the Albigensian Crusade. Whether, however, “Kill them all, God will know his own” was actually uttered is open to debate.
The Albigensian Crusade was launched early in the 13th century in response to the rise of the Cathar heresy in southern France. The Crusader army, not as coherent as it should have been, entered the territories in which Catharism was strong, encountering Béziers as the first significant town. Efforts to negotiate a settlement were unsuccessful, and the army began preparations for mounting a siege. Almost inadvertently, a skirmish broke out between some of the irregular troops with the Crusader army and town residents. Ultimately, that mob was able to push into the town through open gates, whereupon a general sack began. Although many of the citizens of Béziers sought to take refuge in various churches in the town, they were all broken into, and nearly all the residents were put to the sword. When discord later broke out between the regular troops of the Crusader army and the irregular troops who had successfully broken into the town, it was put to the torch. In response to the sack and the execution of the town’s residents, when asked what should be done to separate the orthodox from the heretics, Arnaud Amalric, the Abbot of Citeaux and the Papal Legate traveling with the army is reputed to have said words to the effect of “Kill them all, God will know his own.”
Amalric filed a letter with the Pope describing what had happened. It does not report the line quoted above. Rather, the line arises from a story told some 20 years later by Caesarius. He was not, however, present at Béziers. Hence, whether the now famous line, “Kill them all, God will know his own.” was there said is open to question.
Deed from LLC Void Where There Was No Actual or Apparent Agency Authority to Sign It on LLC’s Behalf
Deed from LLC Void Where There Was No Actual or
Apparent Agency Authority to Sign It on LLC’s Behalf
Apparent Agency Authority to Sign It on LLC’s Behalf
In a decision from Indiana, it was held that a deed of property from an LLC was void where the person who executed it on behalf of the LLC had neither apparent nor actual authority to do so. On the facts of this case, the subsequent transferees of the real property were held to not have valid title thereto. GO Properties, LLC v. BER Enterprises, LLC, 112 N.E.3d 200 (Ind. Ct. App. 2018).
GO Properties, LLC had two members, Olicorp Properties, LLC and Gracie Properties, LLC. Olicorp’s sole member was Larry Oliver while Gracie Properties’ sole member was Stacy Phillips. As described by the court, Phillips “went rogue,” holding herself out as having authority to act on behalf of GO Properties. This she did withstanding the fact that Olicorp was designated as the “Member Manager” of GO Properties with the sole authority “to sign agreements and other instruments on behalf of [the] Company.” The court noted as well that “Neither Oliver nor Phillips was authorized, as an individual, to do any business on behalf of GO Properties.”
Notwithstanding these limitations on her authority, Phillips purported to sell certain real property owned by GO Properties. For that purpose, she hired Best Title Services to examine the title and provide closing services. Best Title failed to identify a mortgage that GO Properties had granted to Maxim Alliance Group. Further, “Best Title relied on Phillips' representation that she was the owner of GO Properties and as it conducted to examination and later acted as closing agent for the transaction.” After the closing, the purchaser flipped the purchased properties.
Some 20 months later, GO Properties filed a complaint seeking to quiet title in the transferred properties in itself; BER Enterprises, the named defendant, was a subsequent purchaser of one of the parcels of real estate. While the trial court would grant summary judgment in favor of the purchasers, the Court of Appeals reversed.
Reviewing the law of the apparent agency and its requirement that the principal have made a manifestation to the third-party that would instill a reasonable belief that Phillips had authority to act on behalf of GO Properties, such a communication was found to be lacking. Rather:
Here, GO Properties made absolutely no direct or indirect statements indicating that Phillips had authority to act on its behalf. The Operating Agreement clearly states that Olicorp was the sole Member Manager. Neither Oliver and Phillips as individuals nor Gracie Properties as an entity was authorized to act on behalf of GO Properties.
Addressing the due diligence that should have been undertaken, in opposition to Phillips’ bare representation that she was an owner, the court observed:
At the trial court’s request, GO Properties provided examples of underwriting standards for title insurance. Among other things, to insure title from an LLC, it is necessary to obtain a copy of the LLC’s operating agreement, any and all amendments thereto, and a certificate that the operating agreement is a true and correct copy of the agreement in effect at the time of the sale. This practice is wise because it protects both the other members of the LLC and all future purchasers of the property. Had this practice been observed in this case, neither the original nor subsequent transactions would have occurred.
In sum, Phillips did not have actual or apparent authority to sell the Properties on behalf of GO Properties. As a result, the original sale of the Properties to Elden Investments was void. Because the deed that Phillips executed on behalf of GO Properties was void, all future conveyances of the Properties were likewise void. Therefore, the trial court erred by entering summary judgment in favor of BER Enterprises and New Field and by denying GO Properties’ summary judgment motion.
112 N.E.3d at 204 (footnotes and record citation omitted, emphasis in original).
Saturday, July 20, 2019
July 20, 1969
Today marks the 50th anniversary of what may be fairly characterized as the most momentous act to have ever taken place in human history, namely Neil Armstrong and Buzz Aldrin successfully landing and then walking on the moon.
The scale of the endeavor was huge. Some 400,000 people were employed by either NASA or its many contractors. The effort to build the flight control computer was a significant factor in the development by the integrated circuit and the modern computer industry. By another estimation, one million man hours of work were accomplished for every hour of the eight day mission.
Essentially, the first and second stages of the Saturn V rocket were expended in order to put the third stage in an orbit from which it could launch the command module, service module and lunar lander into a moon intercept orbit. Just to clear the launch tower, the point at which control was shifted from Cape Canaveral to Houston, required 4% of the rocket’s fuel load. Ultimately, only the command module, essentially the size of a minivan, would return to earth.
Fairly described as the most alone man in history, Michael Collins remained in the command module while Armstrong and Aldrin descended to the surface. While some half-billion people watched the broadcast, Collins had no way to watch the event.
Had something gone wrong, Collins would have returned to Earth alone. Things could easily have gone wrong. There were fears that the lunar soil, upon contact with the oxygen in the lunar module, would combust. And that was only one of things that could have gone wrong. Armstrong and Aldrin carried with them suicide pills, and there had already been written for then President Nixon an announcement to be read in the event of mission failure.
But they were successful, and all returned safely to Earth as challenged by President Kennedy.
When I was an undergrad, I was fortunate to be able to take a class on space history from Father Faherty, S.J., who had been an official NASA historian; check out his book Moonport. Not only did he know what had happened, but he knew all of the people involved and as such had great anecdotes about the major players.
Friday, July 19, 2019
Court Corrects References to Limited Liability Corporation
In the Business Law Prof Blog, Professor Joshua Fershee (who is, by the way, transitioning from a professorship at West Virginia Law to the Dean of Creighton University Law) has reviewed a decision from Tennessee in which the court (if not the parties) paid attention to the nomenclature of LLCs. In this case, Fernando Campspl v. Gore Capital, LLC, 3:17-CV-1039, 2019 WL 2763902 (M.D. Tenn. July 2, 2019), the plaintiff filed a complaint alleging that a particular defendant organized in Delaware was a limited liability corporation. In a footnote, the court noted that in fact the entity was a “limited liability company.” (emphasis added).
The title of that posting is Tennessee Court Subtly Affirms that LLCs are Not Corporations; HEREIS A LINK to that posting.
Thursday, July 18, 2019
Derivative Actions and the Requirement That Demand Be Made
A central requirement of bringing a derivative action is that the complaining member or shareholder have made a demand upon those in control of the business entity to investigate and take remedial action with respect to the complained of actions. I recently reviewed a decision from the Federal District Court here in Kentucky in which it was determined that the plaintiffs had satisfied that requirement. That posting is titled Federal District Court Addressed Derivative Actions, Allows Case to Proceed; HERE IS A LINK to that posting.
In a recent posting in his blog New York Business Divorce, Peter Mahler has reviewed a number of recent decisions touching upon the same topic. That posting is titled The Demanding Demand Requirement in Shareholder Derivative Actions; HERE IS A LINK to that posting.
The Edict of Expulsion
Some events in history may be celebrated for the change they brought about or their ultimate impact. Other events must simply be acknowledging the sadness thereof recognized. The Edict of Expulsion, issued this day in 1290 by King Edward I of England, is clearly in the second category. Under the Edict, all Jews were required to either convert to Catholicism or leave the country not later than All Saints Day (November 1). Almost the entirety of the Jewish community in England, probably counting 2,000, chose the second option.
While medieval Europe with a fairly be characterized as being anti-Semitic, England was particularly so. While there appears to be no Jewish community in England until after the Norman Conquest of 1066, a community soon thrived. Precluded from owning land or engaging in most trades, many members of the community, the archetype being Aaron of Lincoln, probably the richest man in the country, turned to moneylending as a trade. Under then existing Canon law, interest could not be charged to or by Catholics. Canon law did not, of course, govern Jews. Jewish law permitted the lending of money on the interest between Jews and non-Jews. Meanwhile, all Jews were declared direct subjects of the king, with the effect that they could be taxed (or compelled to make “loans”) without going through Parliament. Meanwhile, particularly despicable anti-Semitic views, often based upon allegations of either ritual murder of children and continuing allegations of deicide, were all too common. These views led to occasional pograms, including that in 1190 when a significant portion of the Jewish community in York was killed.
The 1290 Edict of Expulsion was only the last in a chain of events. In 1218, Jews had been required to wear a badge. By the middle of the century there were not only expanded requirements with respect to identification, but also segregation of residences. Then, in 1275, the lending of interest by Jews was forbidden, depriving the community of its primary source of income. The hypocrisy of these events was evidenced by the actions of certain nobles to buy the debt and, upon default, to seize the land of the borrowers. Meanwhile monasteries and abbeys were regular borrowers.
In the course of the expulsion, the Jewish community was forbidden to take much of its property, including gold, rendering them effectively penniless as they dispersed to Scotland, what is today the Netherlands, France and Poland.
The Edict of Expulsion was issued in 1290. Comfort should not be taken that, in the last 729 years, much has changed. Rather, only yesterday, at a political rally, the chant “send her back!” was the common refrain.
Wednesday, July 17, 2019
A recent decision from the Texas Court of Appeals required that it parse the language of the Texas LLC Act, applying certain rules of grammar, particularly the present perfect tense. Ultimately, the court would hold that a former member may be entitled to inspect books and records. Davis v. Highland Coryell Ranch, LLC, ___ S.W.3d ___, No. 07-18-00185-CV, 2019 WL 2524080 (Tx. Ct. App. Amarillo June 18, 2019).
Applying the Texas LLC, this case addressed the question of what is “the right, if any, of the former member of a limited liability company to business records of the company?” Flipping to the other side of the coin, the court described the problem as can a former member of an LLC “be denied access [books and records] simply because he is not a current member of the company?” There the question would turn upon the definition of a “member,” which, as set forth at § 1.002(53)(A) of the Business Organization Code, is “a person who is a member or has been admitted as a member in the limited liability company under its governing documents.”
In this instance, while Davis had been a founding member of Highland Coryell Ranch, he relinquishes his interest in the company in 2005. In this instance, Davis did not satisfy the requirement of “is a member” as that is a “present verb tense, that is, a verb tense requiring the person to be an existing member of the company.” As Davis ceased to be a member in 2005, clearly that was not applicable.
From there the court would turn its attention to that portion of the definition of “member” that references one who “has been admitted as a member in the LLC.” The court would characterize the distinction as follows:
The debate here focuses upon whether the phrase “has been admitted as a member” encompasses a person who once was but no longer is a member. Davis says “yes,” while Highland says “no.” Again, harkening back to high school English would lead one to categorize “has been” as the present perfect tense of the verb “to be.” Additionally, the present perfect tense of a verb is susceptible to use in several different situations. It could refer to a past action that continues. For instance, the sentence “she has gone to the store” denotes the departure of a person who remains absent. In this sense, “has been admitted as a member” of a limited liability company could mean that the person was admitted sometime in the past and remains a member.
Present perfect tense may also describe a past action that simply occurred at some time or another without continuing effect. For example, let us envision Jim, Jack, and Joe talking over a cup of coffee. Let us also picture Jim asking Jack if Joe ever lost his car keys. Jack may answer: “Yes, Joe has lost his car keys.” In so replying, Jack is not suggesting that Joe’s keys remain lost, but only that he lost them in the past at some time or another. In that sense, “has been admitted as a member” of a limited liability company could mean that the person was admitted at some time or another in the past without requiring that his status as a member continues.
The court would reject Highlands’s interpretation because doing so would render superfluous the distinct clause of the definition of who is a member; “is a member” and “has been admitted as a member” would be coextensive, violating the rule against reading language in a statute to be redundant. Under this reading, while Davis is not currently a member of Highland, in that he had been admitted as a member, he would have, subject to satisfaction of other statutory requirements such as a demonstration of a proper purpose, the right to inspect books and records.
While the opinion is as well noteworthy for footnote references to both the Godfather, Part III and the song Don’t Let Me Be Misunderstood by the Animals, and while the analysis may make high school English teachers quite happy, it somewhat strains credulity to suggest that having been admitted as a member, one may thereafter always inspect company books and records. Allowing a former member, one who may have been entirely redeemed by the company or one who assigned his or her interest therein to an assignee, to inspect books and records would, even subject to a proper purpose requirement, simply encourage voyeurism even as the LLC is required to expend assets in responding to a request, even one that lacks a proper purpose. Also disturbing is dicta in this opinion that would indicate that an operating agreement may not entirely eliminate a former member’s right to inspect company books and records. Id., *4.
While the Court of Appeals encouraged the Texas Supreme Court to take up the question and provide additional guidance, it would appear that the biggest problem is with the statutory language itself. Hopefully this will be taken up with the legislature, who will clarify that, absent contrary private ordering in the operating agreement, one who is a former member will not have the right to inspect books and records. It may want to consult the Indiana LLC Act, which at § 23-18-1-15 defines a “Member” as “a person admitted to membership in a [LLC] under IC 23-18-6-1 and as to whom an event of dissociation has not occurred.”