A Case of Stolen Corporate Identity

A Case of Stolen Corporate Identity

      In a decision rendered in January of this year, the Federal District Court for the Western District of Kentucky considered a dispute that included an effort to in effect steal the identity of a business corporation. Burkesville Hardwoods, LLC v. Coomer, Civil Act. No. 1:18-CV-00018-GNS-HEB, 2020 WL 353232 (W.D. Ky Jan. 17, 2020).

     It requires a careful review of the opinion, including its footnotes, to put together what seem to be predicates of the dispute. Essentially, the estate of R. T. Baker leased certain lands in Cumberland County to Travis Coomer Drilling Company, a corporation (“TCD”), for oil and gas extraction. TCD was administratively dissolved on September 30, 2014, for failure to file its annual report. In the meantime, the property subject to the lease with TCD was conveyed to Burkesville Hardwoods, LLC (“Burkesville”). After TCD was dissolved, Burkesville caused there to be incorporated a new corporation under the name Travis Coomer Drilling Company (“TCD2”). Ergo, Burkesville, the property owner, created a new corporation with the exact same name of its administratively dissolved lessee. The nature of the back story of the relationship between Burkesville and TCD is not reviewed in the decision, but clearly there was something going on.

      A point not addressed in the opinion is why TCD was never reinstated from its administrative dissolution under either its original name (if done before the incorporation of TCD 2 on April 10, 2017), or thereafter under a different name.

     As an aside, in reviewing the records of the Kentucky Secretary of State, several notices from that office relating to the annual report and subsequent administrative dissolution were returned to the Secretary of State as undeliverable, presumably because the company had moved from that address and not updated its records with the Secretary of State. This decision is yet further admonition in making sure that those addresses are kept current.

     Regardless, Burkesville filed this action against Travis Coomer individually, asserting he had no right to extract oil and gas from the leased property. Coomer brought counterclaims in order to enforce that lease, alleging as well that Burkesville had misappropriated the identity of TCD by incorporating TCD2. This decision was rendered in response to Burkesville’s  application for a preliminary injunction and for summary judgment.

      With respect to the requested preliminary injunction, it was rejected because the only claimed injuries could be fully compensated with monetary damages. In addition, notwithstanding an assertion to the contrary, Burkesville had made no showing that the continued extraction of the oil and gas by Coomer would have a negative impact upon its goodwill or reputation. In addition, the court found that the equities did not balance in favor of Burkesville, noting that it had interfered with Coomer’s rights under the lease (here it would seem the court conflated Travis Coomer and his dissolved corporation) and that it had acted “unscrupulously” by having “incorporated a company using Coomer’s name for no discernible reason other than disrupting Coomer’s business operations.” 2020 WL 353232, *3. As to that last point, in a footnote, the court explained and rejected the assertion that the incorporation of TCD 2 constituted a “squeeze out”, going on to explain what is an actual squeeze out transaction.

      Turning to Burkesville’s motion for summary judgment with respect to the validity of the lease, the motion was resoundingly rejected. With respect to business organization law, there was rejected the assertion that TCD could not enforce the lease because it had been administratively dissolved. This assertion was rejected on the basis of KRS § 271B.14-050(2)(f), which provides that the dissolution of a corporation does not prevent the corporation from commencing a legal proceeding in its own name, and as well citing Robert W. Keats et al., Kentucky Practice Series: Methods of Practice § 14.82. Rather: 

Hardwoods is incorrect when it asserts that simply because TCD was administratively dissolved that entity cannot maintain an action to enforce the Lease. Nor does administrative dissolution transfer title of the Lease in any way. KRS 271B.14-050(2)(a) (“Dissolution of the corporation shall not [t]ransfer title to the corporation’s property ….”). Because title to TCD’s interest in the Lease was not destroyed by the corporation’s administrative dissolution, Hardwoods is incorrect when it asserts that the Lease should be rendered void for unenforceability. Id.,*6.

      The court went on to reject the notion that Coomer no longer owned TCD subsequent to its administrative dissolution and Burkesville’s incorporation of TCD2. 

Burkesville Hardwoods, however, points to no authority supporting the assertion that filing Articles of Incorporation in an administratively dissolved entity’s former name gives the new corporation ownership over the previous entity itself. Coomer did not lose ownership of TCD simply because Burkesville Hardwoods incorporated TCD2 after TCD’s administrative dissolution. Neither does Burkesville Hardwoods point to any authority supporting its claim that a business owner loses ownership of an entity that is been administratively dissolved, nor the proposition that Burkesville Hardwoods somehow acquired an interest in the lease because it now operates under the name matching the lessee under the Lease. Id.

      In addition to allowing Coomer’s counterclaim for Burkesville’s interference with contract (these being the contracts between Coomer and third parties) to proceed, the court as well allowed a claim for misappropriation of name and identity theft to proceed. Writing as to this topic, the court wrote:

Coomer’s misappropriation claim against Hardwoods for filing Articles of Incorporation under the name “Travis Coomer Drilling Company” also survives. The Kentucky Supreme Court in Montgomery v. Montgomery, 60 S.W.3d 524 (Ky. 2001), explained that the “right of publicity protects the right to control the commercial value of one’s identity.”  Id. at 528. “[I]t is clearly the commercial interests in one’s identity that the appropriation prong of tort serves to protect the most.” Id. (citing Restatement (Second) of Torts § 652C cmt. a). As this Court has recognized before, the Kentucky Supreme Court adopted the principles of the invasion of privacy tort from the Restatement (Second) of Torts.  Thornton v. W. & S. Fin. Grp. Beneflex Plan, 797 F. Supp. 2d 796, 813 (W.D. Ky. 2011) (citing  McCall v. Courier-Journal & Louisville Times Co., 623 S.W.2d 882, 887 (Ky. 1981)). A branch of this tort is a cause of action for the appropriation of one’s name or likeness, which the Restatement (Second) for Torts defines as a claim arising when “[one appropriates to his own use or benefit the name or likeness of another....” Restatements (Second) of Torts § 652C.

Hardwoods cannot refute that Coomer’s given name is the primary component of the corporate name used by Hardwoods in incorporating the new entity. Although Hardwoods asserts Coomer is currently not legally entitled to use of the name “Travis Coomer Drilling Company,” Hardwoods cannot refute the potential commercial benefit to Hardwoods by appropriating Coomer’s name. Whether Hardwoods obtained a benefit with its use of Coomer’s name is a factual issue precluding summary judgment on Coomer’s misappropriation claim.

In sum, Coomer’s counterclaim for interference with the Lease is dismissed with prejudice, while Coomer’s misappropriation and interference with other contracts claims survive. Id. at **8-9.

Pannell v. Shannon – A Cornicopia of Guidance on Contract Law, Statutory Interpretation and the Place of LLCs in the Law

Pannell v. Shannon – A Cornicopia of Guidance on Contract
Law, Statutory Interpretation and the Place of LLCs in the Law

      The Kentucky Supreme Court’s decision in Pannell v. Shannon is of great utility on a variety of fronts including identifying a test for when an agreement is executed by an agent versus by a principal, the effect of administrative dissolution/reinstatement upon an agent’s liability, rules for interpreting statutory amendments, and the importance on focusing upon the LLC Act over the common law in assessing LLCs.  Pannell v. Shannon, 425 S.W.3d 58 (Ky. March 20, 2014).

      The dispute arose out of a defaulted lease.  Shannon’s LLC was the tenant – that LLC was during the term of the lease administratively dissolved.  A replacement lease was entered into in the period between the administrative dissolution and the LLC’s reinstatement.  When the LLC ultimately defaulted the landlord sought to hold Shannon liable on the obligation.

Was the Lease with Shannon or the LLC?

      The lease agreement entered into during the period of the LLC’s administrative dissolution described the tenant as being the LLC, but the signature line did not specify that Shannon signed it in a representational capacity (e.g., “Ann Shannon, Sole Member, on behalf of Elegant Interiors, LLC”).  The Court held that level of specificity to not be necessary.  Rather, noting that it indicated “By:” and in reliance upon Fletchers Cyceopedia, the Court found this format, combined with the fact that the body of the lease identified the LLC as the tenant, to be sufficient to indicate she was not signing in an individual capacity.

[T]he simple fact is that Shannon did not have to list her title, although clearly the better practice is to include it.  425 S.W.3d at 64.

Scrivener Error?

      Pannell sought to argue that the identification of the LLC as the tenant was a “scrivener error” and that it was always intended that Shannon as an individual be the tenant.  This argument was rejected on the basis that “full, clear, and decisive evidence” of a mutual mistake was not presented.  425 S.W.3d at 67.

The Effect of Administrative Dissolution/Reinstatement

      The real crux of the decision is the impact of administrative dissolution and subsequent reinstatement upon each of (i) a member’s limited liability and (ii) the liability of an agent on a contract entered into after dissolution and before reinstatement.  425 S.W.3d at 68.  The Court recognized that these are distinct questions based upon distinct legal principles:

“[T]he liability of a director, officer, employee or agent of a limited liability entity during a period of administrative dissolution is technically a separate question from the liability of the owners of the entity.”  425 S.W.3d at 77.  

Member Limited Liability After Administrative Dissolution

      The Court could not have been more express about the continuity of a member’s limited liability after reinstatement:

This Court concludes that a member of an [LLC] enjoys statutory immunity from liability under KRS 275.150 for actions taken during a period of administrative dissolution so long as the company is reinstated before a final judgment is rendered against the member.  425 S.W.3d at 67.

      Distancing LLCs from the common law of corporations (more on that below), the Court looked to the statutes addressing a member’s limited liability (KRS § 275.150) and the retroactive effect of reinstatement (KRS § 275.295(3)(c); now KRS § 14A.7-030(3)) and determined that reinstatement wiped the slate clean.

The plain meaning of the relate-back language is that the company is deemed viable on reinstatement from the point of administrative dissolution onward, which necessarily includes the time of suspension between the date of administrative dissolution and reinstatement.

Reinstatement under the statute literally undoes the dissolution. This is why the Secretary of State was required to “cancel” the certificate of dissolution and issue a certificate of existence. See KRS 275.295(3)(a). And that certificate of existence took effect, by statute, retroactively on the date of dissolution.  425 S.W.3d at 68.

Hence Pannell’s argument that a member’s limited liability is suspended during the period between administrative dissolution and reinstatement was rejected.

Agent Limited Liability After Administrative Dissolution

      Turning to the question of Shannon’s liability as an agent for the LLC’s obligation undertaken while the LLC was administratively dissolved, the Court noted that the question divides into a pair of inquiries, namely:

First, can Shannon under the circumstances of this case be personally liable by reason of her merely being an agent?  Second, can she be personally liable because she acted as an agent without authority?

       In response to the first question, the Court referred to KRS § 275.175(1) and noted that its rule of limited liability extends to the LLC’s agent.  As the LLC’s existence had been reinstated and:

reinstatement is retroactive to the date of dissolution, and it is as if the dissolution never occurred, giving the company a seamless existence.  The limitation on the agent’s liability simply for being an agent is likewise seamless.  425 S.W.3d at 78.

      In that the LLC in question was subsequently reinstated, the Court found there to be no opportunity for imposing liability on an agent.  Rather, as the LLC Act protects agents from liability on the LLC’s debts (KRS § 275.150(1)), then: 

To the extent that any liability is claimed solely because Shannon was a manager or agent of the LLC, the analysis above for why she cannot be liable as a member applies.  The reinstatement is retroactive to the date of dissolution, and it is as if the dissolution never occurred, giving the company a seamless existence.  The limitation on the agent’s liability simply for being an agent is likewise seamless.  425 S.W.3d at 78. 

     Providing an appropriate critical eye to the question before it, the Court observed:

The immunity provided by KRS 275.150 extends only to liability by reason of her being an agent.  By alleging that Shannon acted without authority, Pannell is not claiming she is liable solely because of her status as an agent, but because she had no authority to act as an agent.  425 S.W.3d at 81. 

In reliance upon the statutory statement that a dissolved LLC continues to exist after its dissolution, the Court found that when combined with reinstatement, Shannon never lost the capacity of being the LLC’s agent.

In response to the argument that giving such a broad affect to the effect of reinstatement is improper, the Court observed:

The simple fact is that Kentucky’s corporation law and other business entity laws differ from those in other states ….  The existence of a majority rule can only be persuasive if the rule is based on statutes like those in Kentucky.  425 S.W.3d at 79, 80.

The Nature of LLCs

No end of confusion has resulted from efforts to force LLCs into the prior models of partnerships and LLCs and to them impose the supposed common law of these organizational forms onto the LLC.  The first decision of the Kentucky Court of Appeals in Patmon v. Hobbs, 280 S.W.3d 589 (Ky. App. 2009) is a classic example of a court trying to do so.  Why that does not work was been extensively reviewed.  See, e.g., Rutledge and Geu, The Analytic Protocol for the Duty of Loyalty Under the Prototype LLC Act, 63 Arkansas Law Review 473 (2010). 

      In Pannell, the Supreme Court, building upon prior decisions, made the rule express – LLCs are creatures of statute divorced from the common law.

[The] common law of business entities has largely been abrogated by the adoption of the various statutes like the Kentucky Business Corporation Act and the Kentucky Limited Liability Company Act.  In fact, “limited liability companies are creatures of statute controlled by Kentucky Revised Statutes (KRS) Chapter 275,” not primarily by the common law. To the extent that common law doctrines could arguably govern limited liability companies, the Kentucky Limited Liability Company Act “is in derogation of common law,” KRS 275.003(1), and the traditional rule of statutory construction that “require[s] strict construction of statutes which are in derogation of common law shall not apply to its provisions.” Id. Thus, to the extent the statutes conflict with common law, the common law is displaced.

This Court must therefore first look at the controlling statutory law.  425 S.W.3d at 67-68.  (citations omitted).

      Consequently, in assessing matters involving LLCs the court needs to focus upon the LLC Act and the operating agreement of that particular LLC.  Whether, for example, LLC members are more like partners or more like shareholders is irrelevant to the question of whether the members have fiduciary duties and what those duties are – the LLC Act expressly addresses whether the members owe fiduciary duties, what those duties are and to whom they are owed.  See KRS §§ 275.170(1), (2), (4).  At the risk of redundancy:

[F]irst look to the controlling statutory law.

Continuity in Statutory Construction

      The Kentucky LLC Act provides that a LLC’s dissolution will not “abate or suspend” the rule of limited liability set forth in KRS § 275.150.  KRS § 275.300(4)(e).  Accord KRS § 271B.14-050(2)(i).  While this statute was adopted only in 2007, the Kentucky Supreme Court found this provision was not an alteration of the law but rather “clarified the intent of the legislature as to the effect of dissolution on the liability of … corporate shareholders.”  425 S.W.3d at 72.  This application of in pari mataria, which requires a nuanced consideration as to whether the General Assembly sought to alter versus clarify the meaning of a prior enactment, stands in contrast to the far more clumsy, and typically inapplicable, rule to the effect that by each amendment the legislature seeks to alter and depart from the prior rule.  In the area of business entity law, based as it is upon typically comprehensive statutory schemes, tweaking the words employed for the purposes of providing greater clarity and precision is far more typical than is a reversal or abandonment of a principle.  That is not to say it never happens, but it is relatively rare.

Subsequent Statutes Address Liability Absent Reinstatement

      While Pannell v. Shannon limits its application to the treatment of member and agent liability after there has been reinstatement, it does not follow that member and agent liability absent reinstatement remains unresolved.  Rather, questions of member limited liability have been addressed in statutory amendments enacted subsequent to the time the Pannell v. Shannon dispute arose. 

      First, KRS § 275.300, it addressing the effects of dissolution, now provides that dissolution does not “abate or suspend” the rule of limited liability.  In consequence, it cannot be argued that a member’s/manager’s/agent’s limited liability is lost upon dissolution.  In this respect it is important to note an important distinction between the corporate and LLC Acts.  The Business Corporation Act, at KRS § 271B.6-220, affords the shareholders limited liability from the corporation’s debts and obligations.  Hence, KRS § 271B.14-050(2)(i), in preserving limited liability upon dissolution, preserves it only for the shareholders.  Put another way, KRS § 271B.14-050(2)(i) does not speak to the liability of corporate directors, officer and agents for a corporate liability undertaken post-dissolution and absent reinstatement.  In contrast, the grant of limited liability in the LLC Act, KRS § 275.150(1), applies not only to members but also managers and agents.  Hence the preservation of limited liability after dissolution as affected by KRS § 275.300(4)(e) is broader than is the equivalent provision in the Business Corporation Act.  Now, whether after dissolution and before reinstatement one was an “agent” may be in dispute, but that is resolved under other law.

      Second, it has been made express that upon reinstatement following administrative dissolution, the liability of an agent for actions undertaken during the period of dissolution “shall be determined as of the administrative dissolution or revocation had never occurred.”  KRS § 14A.7-030(3)(b).  See also 425 S.W.3d at 81, note 20.

      Third and last, in response to Martin v. Pack, the acts now provide that an agent may after dissolution enter into contracts appropriate for the entity’s winding up and liquidation.  See KRS § 275.300(2)(a); id. § 271B.14-050(1)(c).

More on Member Limited Liability

      Building upon the earlier decision in Racing Investment Fund 2000, LLC, the Court highlighted the centrality of limited liability to the LLC and imposed a high bar for setting it aside.  425 S.W.3d at 66.  As such, where it is questionable whether an agent enjoys limited liability, the presumption will be that it is available.  It remains to be seen whether and how this attitude will impact upon whether and how is developed a distinct theory for piercing LLCs.

More on the Nature of Administrative Dissolution

      In Pannell, the Kentucky Supreme Court considered the purpose of administrative dissolution and rejected an effort by a third-party to impose liability upon a dissolved LLC’s agent for an LLC obligation based upon “the temporary faltering of the relationship between the LLC and the state to [the third-parties’] advantage when [the third-party] has no interest in that relationship.”  425 S.W.3d at 84.  Administration dissolution to be little more than a speed-bump in the bilateral relationship between the Commonwealth and an entity created under the laws thereof.

More on the Source of Duties in LLCs

      The Supreme Court has directed that the first source of LLC law is the LLC Act and recognized that LLCs are strangers to the common law.  In Patmon v. Hobbs, the Court of Appeals imposed fiduciary obligations upon the “officers and members” of an LLC based upon the determination that LLCs are “similar to Kentucky partnerships and corporations.” 280 S.W.3d at 594-95.  The Pannell decision significantly undercuts (if not more) this analytic path, and directs that rather than relying upon analogy to other organizational forms the focus needs to be upon the language of the LLC Act.  In that the LLC Act defines who owes fiduciary duties, to whom they are owed and what are those duties (KRS § 275.170), there the question should end.

A Small Footfault on Member – versus – Manager-Managed

      It bears noting that the Court made a small misstep in its consideration of agency and the application of KRS § 275.135.  This statute provides, inter alia, that in a member-managed LLC each member as a member is an agent of the LLC while if the LLC is manager-managed the managers are agents and the members are not by reason of that status agents.  The Court suggested that the determination of whether the LLC is member or manager managed is determined by a factual assessment of the management employed.  See 425 S.W.3d at 76, fn. 17.  In fact, whether an LLC is member or managed is a positive law question determined by reference to the election made in the articles of organization.  See also KRS § 275.025(1)(d).  As set forth in the comment to Prototype section 401, “Irrespective of the provisions in the operating agreement, whether a LLC is ‘manager managed,’ as that phrase is used in the Act, depends on whether the articles of organization so provide.”

 

A Pair of Recent Equine Dispute Decisions Illuminate Principles of Contract, Agency and Fiduciary Duty Law

A Pair of Recent Equine Dispute Decisions Illuminate Principles
of Contract,  Agency and Fiduciary Duty Law

      A pair of May, 2014 decisions, while themselves not inter-related, provide a litany of useful direction on numerous points of contract, agency and fiduciary duty law.  Crestwood Farm Bloodstock v. Everest Stables, Inc., __ F.3d __, 2014 WL 1856697 (6^th Cir. May 9, 2014); James T. Scatuorchio Racing Stable, LLC v. Walmac Stud Management, LLC, 2014 WL 2116096 (E.D. Ky. May 20, 2014).  As a concession to the brevity of life, this review will focus upon the legal rules explicated in the decisions and skip their tortured factual background.

The Covenant of Good Faith and Fair Dealing

      Every contract includes an implied covenant of good faith and fair dealing, it imposing an affirmative obligation “to do everything necessary to carry [the agreement] out.”, Ranier v. Mt. Sterling Nat. Bank, 812 S.W.2d 154, 156 (Ky. 1991); Ram Eng’g & Constr., Inc. v. Uni. of Louisville, 127 S.W.3d 579, 585 (Ky. 2003), and a negative burden to not act to “prevent [ ] the creation of the condition under which payment would be due.”  Oden Realty Co. v. Dyer, 45 S.W.2d 838, 840 (Ky. 1932). Crestwood Farm, 2014 WL 1856697, *8; Scatuorchio, 2014 WL 2113096, *8.

      In the Crestwood case, Everest directed Crestwood to sell certain horses at auction with no reserve.  Crestwood did so.  Everest “planted a separate agent at the auction (without Crestwood’s knowledge)” who sought to raise the price by bidding against the unrelated bidders.  Effectively, Everest set a reserve on the auction.  Crestwood 2014 WL 1856697, *1.  Everest argued that it did not violate the agreement in that it was Crestwood who was barred from setting a reserve.  Id. at *8.  The Court found this conduct to violate the obligation of good faith and fair dealing, consequent to which Crestwood was entitled to $219,513.89, that being what would have been its share of the sale proceeds of the failed high bid.

      At the same time the implied covenant will not supersede the express terms of the agreement.

But the “implied covenant of good faith and fair dealing does not prevent a party from exercising its contractual rights.”  Farmers Bank & Trust Co. v. Willmott Hardwoods, Inc., 171 S.W.3d 4, 11 (Ky. 2005); see also Hunt Enters. v. John Deere Indus. Equip. Co., 18 F.Supp.2d 697, 700 (W.D. Ky. 1997) (the covenant of good faith and fair dealing, “does not preclude a party from enforcing the terms of the contract….  It is not ‘inequitable’ or a breach of good faith and fair dealing in a commercial setting for one party to act according to the express terms of a contract for which it bargained”).  Put another way, “a party’s acting according to the express terms of a contract cannot be considered a breach of the duties of good faith and fair dealing.”  Big Yank Corp. v. Liberty Mut. Fire Ins. Co., 125 F.3d 308, 313 (6^th Cir. 1997). 

Scatuorchio, 2014 WL 21113096, *8.

      On that basis, the claim that a fee determined in accordance with a formula in the subject agreement could not be challenged a violating the implied covenant.  Rather, “the plaintiffs may not at this time re-write the unambiguous, agreed-upon language of the SHLA under the guise of the implied covenant of good faith and fair dealing.”  Scatuorchio, 2014 WL 211096, *9.

      Another important point is that the implied covenant does not serve to preclude self-dealing conduct, but rather only police it at the margins by protecting the express contracted terms.

As to allegations that “constitute self dealing,” a party may act in its own interest and not breach the covenant of good faith and fair dealing, as long as its discretion is not used in a way that is contrary to the spirit of the agreement. 

Scaturochio, 2014 WL 2113096, *9.

      Where, as in this case, the plaintiff was unable to show the defendant “acted in bad faith, or in an arbitrary, capricious, or unreasonable manner,” the use of contractually afforded discretion would not be second-guessed. 

Fiduciary Relationships

      Both Courts highlighted the necessary and high thresholds for the creation of a fiduciary relationship, essentially the agreement by the fiduciary to act for the benefit of the other even if doing so is to the detriment of the fiduciaries’ interest.  In Crestwood the plaintiffs sought to leverage facts including the principal’s failing health and a long course of business into a fiduciary relationship.  The Court disagreed, holding that: 

That the two were friends, even close friends, may well explain why they did business together.  But that does not establish a fiduciary relationship – that Crestwood was charged with putting Everest’s interests above its own.  Many friends do business together.  But not all friends are fiduciaries, and in the world of arms-length commercial negotiations few are.  See, e.g., Sallee, 286 F.3d at 891-92 (“[T]he fact that the relationship has been a cordial one, of long duration, [is not] evidence of a [fiduciary] relationship.”  (internal quotation marks omitted)); 90 C.J.S. Trusts § 197 (“The mere existence of mutual respect and confidence does not make a business relationship fiduciary.”)

Crestwood, 2014 WL 1856697, *5. 

      Setting forth a tour-de-force recitation of the elements of a fiduciary relationship, the Scatuorchio Court, at 2014 WL 2113096, *12, wrote:

            Under Kentucky law, to establish the existence of a fiduciary duty, a party must demonstrate that: (i) the parties’ relationship existed prior to the transaction that is subject of the claim; (ii) the reliance was not merely subjective but reasonable; and (iii) the nature of the relationship imposed a duty upon the fiduciary to act in the principal’s interest, even if such action were to the detriment of the fiduriary.  In re Salle, 286 F.3d at 892; Ballard v. 1400 Willow Council of Co-Owners, Inc., No. 2010-SC-533-DG, 2013 Ky. LEXIS 579, at *33-35 (Ky. Nov. 21, 2013).  A fiduciary duty requires more than the generalized business obligation of good faith and fair dealing.  See In re Salle, 286 F.3d at 891; see also Gresh v. Waste Servs. of Am., 311 F. App’x 766, 771 (6^th Cir. 2009); Quadrille Bus. Sys. v. Ky. Cattlemen’s Ass’n, 242 S.W.3d 359, 365 (Ky. Ct. App. 2007) (“An ordinary business relationship or an agreement reached through arm’s length transactions cannot be turned into a fiduciary one absent factors of mutual knowledge of confidentiality or the undue exercise of power or influence.”  (quotation marks and citation omitted)).  “Only in rare commercial cases is it reasonable to believe the other party will put your interests ahead of their own.”  In re Salle, 286 F.3d at 892.  Rather, “extraordinary facts are necessary” to support such a believe.  Id.; see also Crestwood Farm Bloodstock v. Everest Stables, Nos. 13-5688/13-5689, 2014 U.S. App. LEXIS 8751, at * 14-15 (6^th Cir. May 9, 2014). 

      Where “commercially sophisticated parties enter into arm’s-length business agreements” that do not “expressly or impliedly contain any provision supporting the creation of a fiduciary relationship” or indicate that one party has agreed to act primarily in the interest of others to its own detriment,” no fiduciary relationship will be found. 

The Principal-Agent Contract Controls

            Everest alleged that Crestwood had violated certain duties imposed by agency law by not maximizing the value of the horses sold, including by not setting reserves.  In that Crestwood was barred by the written agreement from setting reserves, the Court found Everest’s objection to be without merit. 

            Where a contract exists defining the scope of the principal-agent relationship ...  the existence and extent of the agent’s duties are determined by the agreement between the parties.”  Monumental Life Ins. Co. v. Nationwide Retirement Solutions, Inc., 242 F.Supp.2d 438, 449 (W.D.Ky.2003) (applying Kentucky law); Restatement (Second) of Agency § 376. 

Crestwood, 2014 WL 1856697, *6. 

Takeaways

            A few takeaways:

·         the implied covenant of good faith and fair dealing with not alter express contractual obligations;

·         the obligations of an agent to a principal are determined first by reference to their express agreement and only thereafter by reference to general agency law; and

·         commercial relationships will almost never be fiduciary in nature.  

The 2012 Amendments to Kentucky’s Business Entity Statutes

The 2012 Amendments to Kentucky’s Business Entity Statutes

            The Kentucky Law Journal Online has released The 2012 Amendments to Kentucky’s Business Entity Statutes.  This article reviews the various statutory updates set forth in 2012 H.B. 341.  The article can be accessed through the KLJ’s website – here is a LINK to the article.

Administrative Dissolution + Reinstatement = No Personal Liability of Officers

Administrative Dissolution + Reinstatement = No Personal Liability of Officers

      The wisdom of the 2012 amendments to the Kentucky statutes providing that, upon reinstatement after administrative dissolution, the liability of any agents of the entity will be determined as if the dissolution had never taken place, has been confirmed by a  recent decision of the Kentucky Court of Appeals.  Harshman Construction & Electric, Inc. v. Witte, No. 2011-CA-000609-MR, 2012 WL 2471445 (Ky. App. June 29, 2012) (Not To Be Published).

      The Wittes contracted with Harshman Construction & Electric, Inc. to build a home.  They ultimately had a falling out over failures by Harshman to conform the construction to the plans and excessive delays in construction, and the decision reviews the measure of damages available to them.  In addition, the Wittes asserted that certain of the officers and Harshman’s sole shareholder should be held personally liable on the basis that, during part of the construction phase, Harshman Construction was administratively dissolved.  Specifically, while the contract was entered into in March 2007 and construction began in May 2007, Harshman Construction was administratively dissolved in November 2007, one month before the final break in their relationship leading to the Complaint being filed in February 2008.  Harshman was reinstated in March 2010.  In January 2011, three years after the filing of the Complaint, the individual defendants moved to dismiss the claims against them.

The trial court denied the motion to dismiss stating that:  (1) the corporation was dissolved at the time work was being performed; therefore, the Wittes were dealing with individuals at that time and not agents of the corporation; (2) dismissing [the individual defendants] could be prejudicial because the motion to dismiss was filed nearly three years after the action was commenced; and (3) the [individual defendants] actively engaged in litigation and individually raised counterclaims against the Wittes.  Slip Op. at 4.

Ultimately, two of the individual defendants were found liable on the Witte’s claims.  Needless to say, that decision was appealed.

      Reversing the determination that the individuals were personally liable, the Court parsed KRS 271B.14-22(3), the predecessor to now applicable KRS § 14A.7-030, both of which provide that upon the reinstatement of a dissolved entity, the reinstatement shall “related back to and take effect as of the effective date of the administrative dissolution or revocation” and the organization shall proceed forward as if the administrative dissolution “had never occurred.”  Slip Op. at 5.  Noting that the statute does not impose a time limitation for seeking reinstatement after administrative dissolution, it relied upon the 2005 ruling of the Court of Appeals in Fairbanks Arctic Blind Co. v. Prather & Associates, Inc., the Harshman Court writing that:

As reinstatement of a corporation relates back to the effective date of dissolution and operates as if dissolution never occurred, it naturally follows that the shareholders and officers of such corporation are not individually liable for actions undertaken on behalf of the corporation during its dissolution.  Slip Op. at 6.

      The Court of Appeals did remand to the trial court the argument, not previously addressed, that the corporate veil of Harshman Construction should be pierced.

      As to the effect of the reinstatement, this ruling of the Court of Appeals is normatively accurate for the reasons previously reviewed in section 9.5 of Dissolution of a Limited Liability Company, that being Chapter 9 of Limited Liability Companies in Kentucky (UK/CLE 2011).   The holding is as well consistent with both eServices, L.L.C. v. Energy Purchasing, Inc., 2012 WL 404957 (E.D. Ky. Feb. 6, 2012) and Pannell v. Shannon, No. 2010-CA-001172-MR (Ky. App. Aug. 26, 2011).  Further, it is consistent with the statutory amendments approved by the 2012 Kentucky General Assembly.  By means of that amendment, it creating KRS § 14A.7-030(3)(c), it is now express that upon reinstatement:

The liability of any agent shall be determined as if the administrative dissolution or revocation had never been heard.

KRS § 14A.7-030 as amended by 2012 Ky. Acts, ch. 81, § 83.

Resolution of Claims Against Dissolved Company

Martin v. Pack’s Inc. Overruled – Contracts may be Entered

Into on Behalf of a Dissolved Corporation or LLC

      The 2012 General Assembly, by means of H.B. 341, has legislatively overruled the holding of the Kentucky Court of Appeals in Martin v. Pack’s Inc., 358 S.W.2d 481, 2011 WL 3207947 (Ky. App. 2011).  The substance of this decision was previously reviewed on this blog on November 18, 2011.

       Martin v. Pack’s Inc. held, inter alia, that a corporate officer who, after the corporation’s administrative dissolution, entered into, on the corporation’s behalf, an agreement with a third party was personally liable on that obligation, treating, in effect, the corporation as an incapacitated principal.  The net effect of this holding is that one attempting to resolve outstanding claims against a dissolved corporation or LLC does so at their personal peril.

      To address these issues and to avoid future confusion, various of the statutes have been amended to provide that, in the course of dissolution, it is permissible to enter into contracts for the purpose of resolving the liabilities of the dissolving organization.  See 2012 H.B. 341, amending KRS §§ 271B.14-050, 272.325, 273.333 and 275.300.

Forleo v. American Products Overruled

Forleo v. American Products of Kentucky, Inc. Has Been Legislatively

Overruled – The Reinstatement of an Administratively Dissolved

Organization is Effective as to the Organization’s Agent

      In Forleo v. American Products of Kentucky, Inc., 2006 WL 2788429 (Ky. App. 2006), notwithstanding the reinstatement of the corporation, the Court of Appeals held that the shareholders/officers/directors who, in the period of dissolution prior to reinstatement, entered into a contract with a third-party would be held personally liable thereon.  In 2007, the statutes were amended to overrule Forleo as to corporate shareholders and LLC members, it being stated that the administrative dissolution does not deprive them of the otherwise applicable rule of limited liability.  See Thomas E. Rutledge, The 2007 Amendments to the Kentucky Business Entity Statutes, 97 Kentucky Law Journal 229, 239-243 (2008-09).

      Now addressing the broader issue, namely the liability of an agent for actions undertaken during the period of administrative dissolution but prior to the reinstatement, various of the acts have been amended to expressly provide that upon reinstatement, the liability of any agent acting on behalf of the administratively organization shall be determined as if the administratively dissolution “had never occurred.”  See 2012 H.B. 341, amending KRS § 14A.7-030.

      This amendment has the effect of affirming the holdings of Judge Coffman rendered in eServices, LLC v. Energy Producing, Inc., reviewed here on February 22, 2012, and that of the Court of Appeals in Pannell v. Shannon, 2011 WL 3793415 (Ky. App. Aug. 26, 2011).

Forleo Again Rejected - Officer Not Liable on Contract Entered into During Administrative Dissolution

U.S. District Court Rejects Forleo, Holds Officer Not Personally Liable on Contract Signed While Company Administratively Dissolved

The fact pattern is straightforward – Company is administratively dissolved for failure to file its annual report.  Still it continues in operation and, on its behalf, an officer enters into an agreement with a third party.  Thereafter the Company is reinstated by the Secretary of State.  Eventually Company defaults on the contract, whereupon third party assets that the officer is personally liable on the agreement.  A recent decision of the District Court has rejected that assertion.  eServices, LLC v. Energy Purchasing, Inc., 2012 WL 404957 (E.D. Ky. Feb. 6, 2012).

The argument for officer liability is that from administration dissolution a company is restricted to activities appropriate for its winding up and liquidation.  See, e.g., KRS § 14A.7-020(3).  Actions accomplished by an agent purportedly on behalf of the dissolved company that exceed that limited scope involve purported agency on behalf of a principal who cannot so act.  Not actually acting on behalf of a competent principal, the agent may be held liable on the agreement.  See generally Thomas E. Rutledge, Dissolution of a Limited Liability Company § 9.5, in Limited Liability Companies in Kentucky (UKCLE 2010)

This argument begs a crucial question, mainly the impact of the company’s reinstatement.  The statute provides, inter alia, that reinstatement relates back to and has the effect of nullifying the prior administration dissolution.  See, e.g., KRS § 14A.7-030(3).  The principal’s incapacity having been retroactively cured, the agent was clothed with authority and is therefore not a party to or liable on the agreement.

Because Energy Purchasing was reinstated after Buchart signed the contracts, the corporation is treated as having been in existence when the contracts were signed…

2012 WL 404957,*2

eServices pinned its hopes on the Forleo decision in which, notwithstanding reinstatement, the corporation’s officers were held personally liable on an agreement entered into during the period of administrative dissolution.  Forleo v. American Products of Kentucky, Inc., 2006 WL 2788429 (Ky. App. 2006).  Judge Coffman dissected and discarded any application of Forleo, finding its reasoning unpersuasive, that it conflicts with the operation of the express statutory language and as well conflicts with the published Fairbanks decision.  2012 WL 404957, *2-3; Fairbanks Arctic Blind Co. v. Prather & Assoc., 198 S.W.3d 143 (Ky. App. 2005).

Hopefully this decision will serve as a final nail in the Forleo coffin.

All that said, there are two points in this opinion with which I would quibble.  There is an extensive discussion of limited liability, suggesting that it is the touchstone of the corporate form and must be afforded an officer with respect to obligations undertaken with respect to the corporation.  While limited liability is commonly perceived to be the most important aspect of the corporate form, and its availability has greatly enhanced capital formation for over a century, limited liability is not actually central to the corporate structure.  It is rather a late development with respect to the corporate form, and not all corporations have had this attribute.  Rather, the sine qua non of the corporate form has been continuity of life. 

        Of greater importance is the suggestion that the rule of limited liability somehow impacts upon whether an officer is or is not liable for a contract entered into in the name of the principal.  The rule of limited liability as set forth in the Kentucky Business Corporation Act extends exclusively to the shareholders; it is not this rule that affords either the directors or the officers limited liability from the debts and obligations of the entity.  See KRS § 271B.6-220(2) (referencing shareholders but not directors, officers or agents).  While officers are not personally responsible for the performance on and any default of an agreement entered into on behalf of a corporation, that absence of exposure arises not from the substantive law governing corporations (including the rule that shareholders enjoy limited liability), but rather from the common law of agency.  See, e.g., Restatement (Third) of Agency § 6.01.  As to why directors are not liable for the debts and obligations of a corporation, in that directors are not agents, that is a discussion for another day.

Martin v. Pack’s Inc.

Martin v. Pack’s Inc.:  The Court of Appeals

Adds Uncertainty and Risk to Dissolution

      Martin v. Pack’s Inc. involved a claim for construction services rendered by Pack’s prior to the administrative dissolution of Southeastern Construction, Inc.  After the administrative dissolution of Southeastern, Ed Martin, on the corporation’s behalf, entered into two agreements with Pack’s, Southeastern’s creditor, for resolution of that debt.  Southeastern failed to perform.  Pack’s then sought to enforce the debt against not only Southeastern but also Ed Martin and Jeff Collinsworth, Southeastern’s shareholders.  Granting summary judgment to Pack’s, the trial court held, and the Court of Appeals affirmed, that each of Martin and Collinsworth are personally liable on the debt.  Martin v. Pack’s Inc., 2011 WL 3207947 (Ky. App. 2011) (To Be Published). 

     IMHO, the grounds for that determination were erroneous.

The (Flawed) Understanding of the Effect of Dissolution on Shareholder Limited Liability

                One basis upon which the Court of Appeals affirmed holding Martin liable on the obligation to Pack’s was that the agreement for the resolution of the corporation’s debt was entered into after the corporation’s administrative dissolution, the court reasoning that after dissolution there was neither a corporation nor the consequent limited liability.  Id. at *5. “To reiterate, Martin cannot be shielded from personal liability by virtue of the statute, (sic) because his corporation was dissolved at the time of his actions.”  The Court said, in effect, that dissolution abrogates the rule of limited liability.

It appears there was not identified to the Court, and that its own research did not unearth, the 2007 amendment to the Business Corporation Act enacted in response to and legislatively overruling the Forleo decision (2006 WL 2788429 (Ky. App. 2006)).  That amendment expressly provides that a corporation’s dissolution does not “abate or suspend” the shareholder’s limited liability.  See Ky. Rev. Stat. Ann. § 271B.14-050(2)(i); see also Thomas E. Rutledge, The 2007 Amendments to the Kentucky Business Entity Statutes, 97 Ky. L.J. 229, 243 (2008-09). 

To the extent that the Court of Appeal’s affirmation of the trial court’s ruling was based upon the notion that, subsequent to dissolution, shareholders do not enjoy limited liability, that ruling was directly contrary to the controlling statute.

A (Flawed) Understanding of the Effect of Dissolution on Corporate Status

The second substantive failure of the decision is its assumption that upon dissolution a corporation ceases to exist.  Simply put, that is not the law.

        In a prior age it was the rule that upon dissolution a corporation simply ceased to exist – its property became vested in the shareholders, its debts were extinguished and suits by or against it were terminated.  See, e.g., 16A William Meade Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 8113; II Stewart Kyd, A Treatise on The Law of Corporations 516 (1794) (“The effect of the dissolution of a corporation is, that all its lands revert to the donor; its privileges and franchises are extinguished; and the members can neither recover debts which were due to the corporation, nor be charged with debts contracted by it, in their natural capacities.”)  Those rules have been long repealed.  See, e.g., Greene v. Stevenson, 175 S.W.2d 519, 523-24 (Ky. 1943).  Under the formula currently employed, a corporation, after dissolution, continues to exist as a corporation.  See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation shall continue its corporate existence….”).  A dissolved corporation is restricted to activities “appropriate to wind up and liquidate its business and affairs.”  Ky. Rev. Stat. Ann. § 271B.14-050(1). 

     At one time a corporation’s dissolution caused it to cease to exist.  Under the modern system as enacted by the General Assembly, a dissolved corporation continues to exist as a corporation.  See KRS § 271B.14-050(1); id. § 14A.7-020(3).  Ergo, any conclusion based upon the premise “a dissolved corporation no longer exists as a corporation” must fail as the premise is false.

The (Flawed) Understanding of the Winding Up Process

            Dissolution effects a limitation upon the proper activities of the dissolved organization, restricting it to those that are appropriate for its winding up and termination.  See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation … may not carry on any business except that appropriate to wind up and liquidate its business and affairs….”).  Whether any particular activity is appropriate for the winding up and termination of a particulate venture is a fact dependent issue.  For example, in the winding up and termination of a retail store, it is difficult to contemplate a situation in which the acquisition of additional inventory would be appropriate.  Conversely, in the winding up and termination of a landscaping business, the purchase of additional materials with which to complete a job that is under contract and partially completed likely would be appropriate.  The open and fact dependent nature of this assessment is implicit in the statute’s use of “including” in the description of activities that are appropriate after dissolution.  Id.

      The Martin court makes much of the fact that the agreement with Pack’s was created subsequent to the dissolution.  2011 WL 3207947 at *2-3.  Even accepting that characterization as true, it is not determinative of the outcome.  Rather, nothing in the law of dissolution precludes a dissolved corporation from entering into entirely new obligations.

      In the resolution of claims with creditors, whether they are known or unknown, there will often need to be a new agreement entered into pursuant to which the amount and manner of resolution are agreed upon.  While some of these agreements may constitute only a modification of existing agreements, a claim arising, for example, in quasi-contract will not.  Were the rule espoused in Martin v. Pack’s, Inc. to be correct, then the post-dissolution sale of assets sanctioned in Greene v. Stevenson would have exposed whoever signed the sale agreement to personal liability thereon.  Assume a creditor initiates an action against a dissolved corporation.  Is the corporation precluded from entering into an engagement with an attorney for the purpose of making a defense or even asserting a counter-claim?  That engagement letter with the attorney will be a new post-dissolution obligation.

      Curiously, neither the Court of Appeals nor the trial court explained how the post-dissolution agreement between Southeastern and Pack’s did not fall within KRS § 271B.14-050(i)(c) and its express authorization for a dissolved corporation to “mak[e] provision for discharging its obligations.” 

      The suggestion that a corporation, after dissolution, cannot in its own name and on its behalf enter into agreements in settlement of its debts and obligations is without analytic support and is contrary to the statute. 

A (Flawed) Understanding of the Effort of Dissolution Upon Agency

       A corporation “is an artificial being, invisible, intangible, and existing only in contemplation of law.”,  Trustees of Dartmouth Coll. v. Woodward, 17 U.S. (4 Wheat.) 518, 636 (1819), able to act only through those natural persons who are its agents.  Restatement (Third) of Agency § 3.04, comment d.  As noted above, a corporation continues to exist after dissolution for the purpose of its winding up and liquidation.  During the dissolution process the corporation must act through agents.  Presuming appropriate identification of the principal and that the action is within the agent’s authority, the agent is not a party to and is not personally liable on the agreement at issue.  Restatement (Third) of Agency § 6.01.

        There is currently pending before the Supreme Court a petition for discretionary review.