Dissolved Maryland LLC Barred from Further Prosecuting Appeal of the Lawsuit It Brought

Dissolved Maryland LLC Barred from Further Prosecuting Appeal of the Lawsuit It Brought

      In a recent decision, the Maryland Court of Appeal considered the effect of a Maryland LLC’s failure to make certain tax payments and to thereby keep itself in good standing. When the LLC allowed its a good standing status to lapse, it lost the ability to prosecuting appeal of a trial court judgment. 7222 Ambassador Road., LLC v. National Center on Institutions and Alternatives, Inc., __A.3D ___, 2020 WL 4289773 (MD. July 27, 2020).

      Before I go any further, a “thank you” to Peter Mahler for bringing this decision to my attention.

      7222 Ambassador Road, LLC (the “Company”) leased office space to the National Center on Institutions and Alternatives, Inc. When the tenant did not renew the lease, a dispute arose of the condition in which the property had been returned to the Company. It brought suit, and at trial the tenant prevailed. In an appeal to the Court of Special Appeals, the tenant again prevailed. After that decision, the Company sought review by the Court of Appeals, which agreed to hear the case on a writ of certiorari. However, before that application for certiorari was filed, the Company forfeited its charter for failure to make certain required tax payments. Specifically, the Maryland law provides, at Maryland Code, Corporations and Associations § 4A- 911(d) “after the lists [of delinquent LLCs] are certified, the Department shall issue a proclamation declaring that, subject to § 4A-920 of this subtitle, the right to do business in Maryland and the right to use the name of each limited liability company is forfeited as of the date of the proclamation, without proceedings of any kind either outlaw or in equity.” It is provided, however, that the forfeiture of the right to do business does not impair the validity of contracts and other acts of the LLC entered into either before or after the forfeiture or prevent the [LLC] from “defending any action, suit, or proceeding in a court of this State.” Maryland Code, Corporations and Associations § 4A-920. Upon receiving notice of the forfeiture of its charter, an LLC is afforded 60 days within which to pay the overdue assessments. Maryland Code, Corporations and Associations § 4A-912. If the correction is made within 60 days it will be given retroactive effect. Maryland Code, Corporations and Associations § 4A-912.

         In this instance, the Company lost its right to do business and did not correct the failure within the 60 day period required for reinstatement. Rather, at the time it filed the application for certiorari with respect to the ruling of the Court of Special Appeals, the Company was without authority to transact business in Maryland. While the savings statute (§ 4A-920, supra) applies with respect to defending an action, in this instance the Company was not defending but rather prosecuting. Ergo, “in our view, [the Company] lacked authority to file a petition for writ of certiorari at the time it did so and the restoration of its rights to do so came long after the deadline for filing such a petition.” 2020 WL 4289773, *4. The court would go on to reject the Company's assertion that an “act” preserved by the statue would include filing for a writ of certiorari, finding that such a reading is so broad that it “would merely negate the forfeiture provision altogether.” Id., *5.

       In dismissing the appeal, the court wrote: 

Dismissal of this second-level appeal may seem like a harsh result. However, requiring a business entity to make a few timely filings and payments - or at least filings that are less than two months late after the entity is specifically notified of its delinquency - is not an unfair price for its owners to have the shield against individual liability and the tax benefits, together with the organizational flexibility, that the LLC Act provides for a business organization. As this Court recently stated, “[T]he privileges associated with an LLC, such as tax benefits and liability protections, are afforded with the expectation that an LLC will fulfill its statutory obligations.” Mayor and City Council of Baltimore v. Prime Realty Associates, LLC, 468 Md. 606, 623, 228 A.3d 200 (2020). 2020 WL 4289773, *7.

Fun and Games and LLCs: In re Stacey Friedrich

Fun and Games and LLCs: In re Stacey Friedrich

       In a recent decision from a Bankruptcy Court in Wisconsin, the court considered and rejected efforts by the sole member of an LLC, through its dissolution, to change the nature of its assets and in so doing prevent a lender from exercising its rights.  In re: Stacey L. Friedrich, Case No. 19-13843-13, 2020 WL 2306532 (Bankr. W.D. Wisc. May 5, 2020).

        Friedrich was the sole member of Total Body Laser Center, LLC, it organized in Wisconsin. The LLC had entered into three loans with State Bank of Cross Plains (the “Bank”), which were secured by the LLCs assets and as well personally guaranteed by Friedrich. The LLC defaulted on the notes, and the Bank filed a lawsuit seeking the appointment of the state law receiver. On the day that motion was to be considered, Friedrich dissolved the LLC, purported to transfer to himself all of its assets and debts. Still, the receivership motion was heard, and the receiver was appointed. On that same day, Friedrich filed for personal bankruptcy under Chapter 13. The question being considered in this opinion is whether the LLCs assets were or were not part of Friedrich's bankruptcy estate. Another issue would be whether those liabilities, now personally assumed by Friedrich, would be characterized as secured or unsecured. In order to be eligible for Chapter 13 bankruptcy, Friedrich needed to fall within the scope of 11 U.S.C. § 109(e), which provides that: 

Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $419,275 ... may be a debtor under Chapter 13 of this title. 2020 WL 2306532, *2.

The court framed the dispute as follows:

The Bank asserts it did not consent to the transfer of its collateral from the LLC to the Debtor. The Bank argues the LLC’s assets are not part of the Debtor’s bankruptcy estate as the Assignment is void and ineffective under Wisconsin law. The bank also argues that even if the Assignment was successful, the LLC’s assets do not qualify as part of the Debtor’s secured debt in his Chapter 13 case. In other words, the Assignment did not change the Debtor’s obligation to the Bank - flowing from the personal guarantee on the Notes - from an unsecured to a secured claim. As a result, the Bank believes it's unsecured claim against the Debtor stands at $620,121.97. Debtor counters that the Bank’s $621,121.97 claim is secured against the Debtor by virtue of the transfer of all of the LLC’s assets and liabilities to himself personally. Id., *1.

As to the question of whether the LLC’s assets became property of Friedrich and from there part of his bankruptcy estate, the court answered in the negative. While LLC property may be transferred by an instrument executed by a member of the LLC in its name (Wisc. Stat. § 183.0702(1)), a transfer may not be made if, consequent thereto, the LLC will be unable to pay its debts as they come due in the ordinary course of business. Id. § 183.0607(1)(a). Furthermore, in liquidation, the assets of an LLC must first be distributed to its creditors. Id. § 183.0905. From there the court observed: 

Here, it is clear the LLC was unable to pay its debts as they became due. The attempted transfer of all the LLC’s assets further impaired its ability to pay its debts to the Bank. The LLC’s attempted distribution of its assets occurred in violation of Wis. Stat. § 183.0607(1)(a). It also violated the established priority for distribution of assets under Wis. Stat. § 183.0905. During its wind-upstage, the LLC’s assets must have first been distributed to its creditors, such as the Bank, and not to its sole member, the Debtor. 2020 WL 2306532, *3.

Turning to the question of whether, when assumed by Friedrich, the LLC’s obligations to the bank remained secured (a hurdle with respect to whether he was eligible to file for Chapter 13 bankruptcy), the court again answered in the negative. Recall that, on an unsecured basis, Frederick had guaranteed the LLC’s Bank debt. As argued by the Bank: 

The Bank argues that even if the Assignment was valid, the transferred LLC assets do not qualify as part of a secured debt in the current Chapter 13 case because the Debtor now owns assets subject to the Bank’s liens. Mere title to the asset does not create secured debt. Put differently, the Debtor’s acquisition of assets did not convert the Bank’s position and status as an unsecured creditor in his case to that of a secured creditor. Id., *4.

Agreeing with the bank, and after reviewing the applicable provisions of the Uniform Commercial Code, the court observed: 

The LLC’s attempt to transfer the Bank’s collateral to the Debtor does not mean the Debtor has pledged assets to the Bank. The Assignment did not change the Debtor’s relationship with the Bank. Assuming the Assignment was valid, the Debtor - as the new owner of the LLC’s assets, now owns assets subject to the Bank’s liens. Id., *6.

Holding that Friedrich’s liability to the Bank under his unsecured guarantee of the LLC’s  debt is valued at $620,121.97, his unsecured debt exceeded the statutory limit of $419,275 as set by 11 U.S.C. § 109(e), and for that reason it was held that he could not seek relief under Chapter 13 of the Bankruptcy Code.

Dissolved LLCs and the Attorney-Client Privilege

Dissolved LLCs and the Attorney-Client Privilege

      In recent decision from Mississippi, the court considered whether a dissolved corporation continues to enjoy an attorney-client privilege. On the facts of this case, it was held that it did not. United States v. Walters, 2020 WL 1934803 (S.D. Miss. April 21, 2020).

      Walters served a subpoena duces tecum upon Jonell Beller, an attorney with the Baker Donelson law firm seeking records relating to, amongst others, Prime Care Marketing, LLC and Total Care Marketing, LLC. The exact relationship between Walters and either of these business entities was not recited in the decision, although Walters had, in 2015, filed the articles of dissolution with respect to Prime Care Marketing, LLC.

       In response to the subpoena duces tecum, Beller filed a motion to quash on the basis of privilege, to which Walters responded that Beller “had no standing to assert the privilege because it belongs to the clients” and he “has authority to waive the privilege for the companies.” The court granted the motion to quash, finding that Beller had standing to assert the privilege and that Bellers had failed to demonstrate, on behalf of each of the LLCs, that he had authority to waive the privilege. That ruling led to a motion for reconsideration, which is the subject of this decision.

      On reconsideration, the focus was upon the extent to which a dissolved corporation (although this case involved LLCs) enjoys a post-dissolution attorney-client privilege. Drawing a distinction between natural persons, for whom the privilege does survive death, the court cited a variety of authorities that stand generally for the proposition that a business entity, after its dissolution, notwithstanding the possibility of reinstatement thereafter, does not continue to enjoy an attorney-client privilege. For example, the court cited TAS Bistriv. Co. v. Cummins, Inc., 2009 WL 3255297 (C.D. Ill. Oct. 7, 2009) for the proposition “absent some compelling reason to the contrary, the attorney-client privilege does not survive the death of the corporation.”

      On that basis, the motion to reconsider was granted, the quashing of the subpoena was set aside, and Beller was directed to produce the documents responsive to the subpoena duces tecum.

Delaware Limited Partnership Judicially Dissolved Where General Partner Was Unwilling to Pursue its Business

Delaware Limited Partnership Judicially Dissolved Where General Partner Was Unwilling to Pursue its Business

      In a decision rendered in August, the Delaware Chancery Court ordered the judicial dissolution of a limited partnership. GMF ELCM Fund L.P. v. ELCM HCRE GP LLC, No. CV 2018-0840-SG, 2019 WL 3713844 (Del. Ch. Aug. 7, 2019).

      White, the initial general partner, organized a variety of entities to operate nursing homes. He was, however, apparently not very good at doing so. The court found that he engaged in “unsatisfactory practices” including failure to send bills and failure to cash checks received. Eventually, the nursing homes in which the investments were made were unable to pay their staffs or buy food for the patients. In prior rulings in this dispute, a receiver was appointed to operate the companies. The plaintiffs then brought this action for judicial dissolution of the limited partnerships on the basis that it could not fulfill its purpose. 

      The Delaware Limited Partnership Act, at section 17-802, provides for dissolution of a limited partnership “whenever it is not reasonably practicable to carry on the purpose of the business in conformity with the partnership agreement.”

      The court found that the standard was here met. Initially, the limited partnership had not been successful under White’s control. Once the receiver (over time, there were actually two), was appointed, White refused to cooperate with them in operating the business. 

      While the court noted that dissolution is an extraordinary remedy that is not to be lately invoked, on these facts it was held that judicial dissolution of the limited leadership was appropriate. 

      After this ruling, there were additional efforts to compel White to appear for related depositions. The latter decision with respect to compelling White’s appearance at depositions is set forth at 2019 WL 4096855.

Limited Partnership Dissolved At the Request of Assignees of Limited Partners

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?

Improbability in Determining When a Firm is Insolvent

Improbability in Determining When a Firm is Insolvent

 

            A firm, whether it be a LLC, an LLP or a general partnership, may not make distributions to its owners when it is insolvent.  If and to the extent distributions are made when the firm is insolvent, they may be “clawed back” into the firm for satisfaction of creditor claims.

            According to a story published today in Law360, a settlement of the claims against the partners has been reached.  As reported, there were alternative dates at which a determination of insolvency could be made.   The amount of the settlement is less than the full amount that would be due if the earlier date were used, but more than the amount that would be due if the later date were used.

The article is Sedgwick Strikes Clawback Deal With Former Equity Partners, by Emma Cueto, Law360 (June 7, 2019).

A Few Interesting Points as to Dissolving an LLC

A Few Interesting Points as to Dissolving an LLC

      A recent decision from the Utah Court of Appeals points out a few interesting facts and principles applicable in the dissolution of an LLC. Unfortunately, many of the most interesting points were not preserved for review by the plaintiff, so the Court of Appeals was able to avoid them. Still, the case is interesting reading. Blanch v. Ferrell, 2018 UT App. 172, 2018 WL 4261526 (Utah Ct. App. Sept. 7, 2018).

      Blanch and Ferrell were, with three other brothers, the owners of certain real property in Utah as well as shares in an irrigation company. In 2005 they conveyed all of those assets to an LLC in which each was an equal 20% member. There was no written operating agreement. The articles of organization provided a three year lifespan for the LLC. The LLC expired in 2008, but it was not until 2015 that any efforts were taken to wind up its affairs. At that time, four of the five members adopted a written resolution authorizing the sale of the company’s assets and authorizing the Ferrell to be in charge of that process. Blanch filed this lawsuit, alleging a variety of theories including that the approval of the asset sale required unanimous approval, and he objected. The District Court granted the defendants motion to dismiss, and this appeal followed.

      Initially, the court noted that Blanch had made three arguments with respect to the written consent of the four of the five members authorizing the sale of the LLC’s. He alleged (i) that the consent was a backhanded effort to amend the LLC’s articles of organization, which would be invalid without unanimous approval, (ii) that the written consent was approved without any notice to him, notice being required by the then applicable LLC Act, with the effect that it is invalid and (iii) that two of the four signatories were actually assignees without voting rights. The court, with respect to these arguments, found that none of them had been made below to the District Court and thus could not be raised on appeal.

      Next, Blanch argued that the written consent needed to be unanimous because, with the adoption of Utah’s new LLC Act, acts outside the ordinary course require unanimous approval. Under the predecessor LLC Act, in effect at the time of the adoption of the written consent, actions outside the ordinary course require the approval of two-thirds of the members. In effect, Blanch argued that, with the effectiveness of the new LLC Act, all prior approvals became subject to the new unanimous standard. The Court of Appeals, after having first assessed the written consent under the old law and found it to be effective thereunder, turned its attention to the new law. The court rejected the supposition that the effectiveness of the new law “had the effect of invalidating previous actions taken by a limited liability company.” 2018 UT App 172, ¶ 28.

      Ultimately, Blanch sought a partition of the LLC’s property so that he could retain 20% of it in his own name. Here the court was able to hoist Blanch on the petard of his argument that the new LLC Act is applicable. Under it, in winding up a company, surplus assets must “be paid in money.” Id. at footnote 5, citing Utah Code Ann. § 48-3a-711(4). Applying this provision, the court held, inter alia, that he could not receive hard assets in substitution for money.

Exercise of Voting Rights After Death

Exercise of Voting Rights After Death

       The recent decision from Louisiana is focused upon the obligation to make distributions to an assignee, in this case an estate, and the question of whether the surviving member’s failure to make distributions was dischargeable in bankruptcy. There is, however, an interesting side question with respect to voting rights. Free v. Winborne, Civ. Act. No. 17-1606, 2018 WL 4265254 (W.D. LA. Sept. 6, 2018).

      Samuel Free and James Winborne were each 50% owners in two real estate related businesses. Windborne passed away, and the plaintiff in this action, Leasa Winborne, was appointed to administer his estate. She would eventually bring suit against Free alleging he was converting assets belonging to the LLCs and withholding her rights to 50% of the net proceeds.

      As recited by the court, basing its analysis upon the work of the underlying Bankruptcy Court, “The operating agreements also provide that upon the member’s death, that member’s successor shall become an asset in the of the deceased member’s interests in the companies.” 2018 WL 4265254, *2. Those same operating agreements went on to provide that “an assignee has no management rights and the member for whom the assignee acquired its interest retains their voting rights until such time as the assignee is admitted as a Member.” Id. In this instance, the Leasa Windborne, the assignee, was never admitted as a substitute member. It was provided in the operating agreements that the LLCs would dissolve with the consent of a Majority in Interests of the Members.” Id. *3.

      Free asserted that he had voted to dissolve both of the LLCs in his capacity as the sole remaining member, thereby giving effectively unanimous consent to that transaction. This argument was set aside on the basis that:

However, the Bankruptcy Court determined that Free did not account for Mr. Winborne’s remaining voting rights, noting that per the terms of the operating agreements Free did not have a Majority in Interest because his share was only 50%. Id. at *3.

      And there the problem arises. Any action requiring a majority vote of the members would, necessarily, have to include the deceased Mr. Winborne. Alternatively, Free would need to admit Winorne’s widow, Leasa, as a member. Absent one of those actions, it would seem that the LLC could not take any action. It is somewhat difficult to accept that that was their intent in drafting the operating agreement. Still, it was part of the holding in this decision.

      Also featured in the opinion is a most curious reading of the provision addressing the “Events of Dissolution” of this LLC. As recited by the court, it read:

The Company shall be dissolved upon the occurrence of any one of the following events: (a) expiration of the Company’s term; (b) entry of an order for relief with respect to the Company under Chapter 7 of the Bankruptcy Code; (c) entry of the judgment of dissolution of the Company pursuant to La Rev Stat Ann section 12:1335; and (d) consent to dissolve the company by a Majority in Interest of the Members.

      The Bankruptcy Court had found that, even in the context of a consent to dissolve given by a Majority in Interest of the Members, that alone would not be effective absent entry of a decree of dissolution pursuant to La. Rev. Stat. Ann. section 12:1335. This interpretation is most curious in that the lead-in provision of the clause referred to “any one of the following events.” How the “and” between subsections (c) and (d) could be read as requiring both elements is, a curious question.

Death, Dissolution and Dissociation: Louisiana Court Considers the Effect of Seriatim Deaths

Death, Dissolution and Dissociation: Louisiana Court Considers the Effect of Seriatim Deaths

      In a recent decision from the Louisiana Court of Appeals considered the effect of the seriatim deaths of several members of an LLC and, ultimately, whether an action for judicial dissolution initiated by a member who subsequently passed away could continue. In this instance, the court found that the action for judicial dissolution of the LLC could continue.  Schauf v Schauf, No. 51, 919-CA, __ So.3d __, 2018 WL 1937068 (La. App. 2 Cir. April 25, 2018).

      Angela Schauf organized the Schauf Family LLC in 2001, keeping 50% of the ownership for herself and distributing to each of her four children a 12.5% interest. Those four children were Peter, Paul, Mary and Kathryn. Angela and all of the children executed an operating agreement; the LLC’s only asset was farmland that was leased out. Angela passed away, and her interest in the LLC was divided amongst the four children, resulting in each of them becoming a 25% member. Then, each of Peter and Kathryn passed away, leaving their interests in the LLC to their respective spouses, Jo Ann and Michael.

      Thereafter, there arose disagreements with respect to the LLC and each of Jo Ann (assignee of Peter) and Michael (assignee of Kathryn) as well as Mary, an original member, sought to dissolve the LLC, sell its assets and distribute the proceeds. Paul objected to any dissolution, and as well rejected the proposal that he buy out the other members. Nonetheless, everyone except Paul did vote to dissolve the LLC and appoint Jo Ann as its liquidator.

      Paul filed suit, asking for a ruling that the appointment of the liquidator and vote to dissolve the LLC was null and void. Then, Mary passed away, and a motion was filed to substitute Jo Ann, Mary’s executrix, in the lawsuit. In turn, the trial court granted Paul’s application for summary judgment, in which there was declared void the vote to liquidate and the appointment of Jo Ann as the LLC’s liquidator. Conversely, the defendant’s motion for summary judgment was denied on the basis that they had no authority to dissolve the LLC and liquidate its assets. The defendants filed this appeal.

      The court’s opinion begins with a review of the status of the estate of a deceased member under the Louisiana LLC Act. Specifically, the estate does not become a member (absent a contrary provision in either the articles or operating agreement).

“Thus, an LLC’s articles of organization or a written operating agreement could, but have not in this case, provide that a person who inherits a decedent member’s interest in the LLC would become a member of the LLC or would have certain rights that are provided only to members.”

      From there the court offered some observations as to the status of a decedent member’s estate vis-a-vie the LLC, namely:

The rule treating a decedent member’s legal representative as an assignee of the decedent’s interest may be problematic. As an assignee of the decedent member’s interest, the decedent’s legal representative is entitled only to receive distributions from the LLC as authorized by the LLC’s operating agreement or by the members, to share in the LLC’s profits and losses, and to receive allocations of the LLC’s items of income, gain, loss, deduction, and credit. A decedent member’s legal representative may not become a member of the LLC or exercise any of the rights or powers of a member unless the LLC’s articles of organization or a written operating agreement provides otherwise or the legal representative is admitted as a member of the LLC. Thus, the legal representative of a decedent member may not participate in the management of the LLC, vote on the LLC’s affairs, or inspect the LLC’s records unless the LLC’s articles of organization or an operating agreement specifically accords such management rights to the decedent’s legal representative or the legal representative is admitted as a member of the LLC. Without the right to vote or inspect records, a decedent member’s legal representative will have little ability to protect the interests of the decedent’s estate or heirs with respect to the decedent’s interest in the LLC. Id at *6-7.

      Still, the court noted that an action for judicial dissolution may be brought by any member on the grounds that it “is not reasonably practicable to carry on the business of the LLC in conformity with its articles of organization and operating agreement.” La. R. S. 12:1335. The court went on to find that Mary had been a member of the LLC at the time the petition for judicial dissolution was filed, that “[h]er death did not terminate the dissolution process once it had been initiated.” and that JoAnn, as Mary’s executrix, could continue the dissolution action. Id., *8.

      Almost in passing, the court rejected the suggestion that, consequent to the articles of organization providing that the LLC would dissolve after 25 years, it could not be dissolved prior to that time.

      If this decision is restricted to its facts, namely an action for judicial dissolution, it is an entirely reasonable outcome. At the time the action for judicial dissolution was filed, three of the four persons having a derivative economic interest in the LLC’s assets no longer wish to be in business together. Likewise, one half of the members did not want to be in business with the other half. It would be dangerous, however, to extend this decision beyond the context of an action for judicial dissolution. If, in contrast, the suit were to have involved a derivative action or a request to inspect documents by a member who then passes away, different policy concerns, they being focused upon the LLC’s internal management, would arise.

Delaware Chancery Court Addresses Obligation to Set Aside Reserves for Known Claims;“Undissolved” to LLCs so Creditor Claims May be Pursued

Delaware Chancery Court Addresses Obligation to Set Aside Reserves for Known Claims; “Undissolved” to LLCs so Creditor Claims May be Pursued

Yesterday, the Delaware Court of Chancery (Vice Chancellor Glasscock) issued an opinion addressing the obligation of an LLC to set aside reserves to satisfy likely claims. In this instance, the LLCs had dissolved and set aside nothing in the way of reserves to satisfy reasonably expected claims from some former members dissatisfied with the appraisal methodology utilized to determine their redemption price. Vice Chancellor Glasscock found that the zero reserve was inappropriate, and on that basis “undissolved” the LLCs. Capone v LDH Management Holdings, LLC, C.A. No. 11687-VCG (Del. Ch. April 25, 2018).

The plaintiffs in this action have been executive officers of defendant LDH. After termination of employment, LDH was entitled to redeem their interests in the company pursuant to a valuation performed as of the last day of the prior year. In this instance, however, LDH jumped the gun and performed the valuation before the end of the year. That valuation came it at essentially $1.4 billion.  However, an essentially contemporaneous offer to sell part of the company received significantly higher valuations. The plaintiffs objected that those higher valuations, determined by what third parties would actually pay for the business, should have been taken into account in the valuation.  Specifically, they asserted that the failure to consider those offers would violate the board’s obligation that they determine the value “in good faith” as specified in the operating agreement.

The Delaware LLC Act sets forth a detailed process for the dissolution of an LLC. One of those requirements, set forth at section 18-804(b)(3), requires that the LLC:

Make such provision as will be reasonably likely to be sufficient to provide compensation for claims that have not been made known to the limited liability company or that have not arisen but that, based on facts known to the limited liability company, are likely to arise or to become known to the limited liability company within 10 years after the date of dissolution.

Otherwise, the LLC Act requires as well that:

A limited liability company which has dissolved … shall pay or make reasonable provision to pay all claims and obligations, including all contention, conditional or un-matured contractual claims, known to the limited liability company.

Del. LLC Act § 18-804(b)(1).

The bulk of the opinion was then devoted to whether the complaints made by the plaintiffs over a series of emails and phone calls with respect to the valuation methodology employed by the company put it on notice of the claims. The court ultimately determined that the company had notice of the potential claims and had acted inappropriately in setting aside a zero reserve based thereon. The ultimate merits of that claim will be resolved in litigation already pending in New York.

What Vice Chancellor Glasscock did order was that the certificates of cancellation filed with respect to the subject LLCs be in effect withdrawn and the LLCs reinstated. This is necessary in that, under Delaware law, once a certificate of cancellation is filed, no suits can be brought by or against of the LLC. With those certificates of cancellation now no longer in effect, the LLCs continue in existence, and the New York lawsuit may proceed.

FYI, Kentucky does not have the concept of a certificate of cancellation, and a dissolved LLC may continue to sue or be sued after its dissolution.

Administratively Dissolved California LLC May Not Appeal Adverse Tax Ruling

Administratively Dissolved California LLC May Not Appeal Adverse Tax Ruling

      In a recent decision, a California State Court of Appeal rejected an effort by an administratively dissolved LLC to appeal an adverse decision against it. Creditors Adjustment Bureau, Inc. v. Big Valley Cold Storage LLC, 2017 WL 1076371 (Cal. App. 5^th Dist. Feb. 22, 2017).

      Creditors Adjustment Bureau, Inc. (“CAA”) was awarded a default judgment against Big Valley Cold Storage LLC (“Big Valley”). Initially, after CAA filed its complaint, Big Valley Cold Storage sought to answer, but it's response to the complaint was rejected on the basis that it had not paid a filing fee and as well filed an answer without representation by an attorney. Ultimately, a default judgment was entered against Big Valley. Some six months later, Big Valley would retain counsel, who was unsuccessful in seeking to have the default judgment set aside. Specifically, CAA alleged that as the Franchise Tax Board had suspended Big Valley’s status as an LLC, it lacked the capacity to defend the action or to prosecute an appeal. From there, the appeal followed.

      On appeal, Creditors Adjustment was successful in arguing that, as Big Valley had been administratively dissolved consequent to its failure to pay taxes, it lacked the capacity to bring an appeal of the default judgment. Specifically, under California law:

In support of its request for dismissal of the appeal, plaintiff presented a printout from the Secretary of State’s Web site, showing that Big Valley is currently suspended by the Franchise Tax Board (the Board) and the Secretary of State.  The Board may suspend the powers, rights and privileges of a limited liability company that fails to pay its taxes or fails to file a required tax return.  (Rev. & Tax. Code, §§ 23301, 23301.5, 23302, 23305.5, subd. (a)(2).) The Secretary of State may suspend the company’s powers, rights and privileges if the company fails to file the required statement of information with the Secretary of State. (Corp. Code, §§ 17702.09, 17713.10.)

A corporation or other entity that has had its powers suspended for failure to pay its taxes lacks the legal capacity to prosecute or defend a civil action, or to appeal from an adverse judgment.  (Bourhis v. Lord 92013) 56 Cal.4^th 320, 324; Tabarrejo v. Superior Court (2014) 232 Cal.App.4^th 849, 861-862.) “The same rule applies when a corporation fails to file the required statement of information.” (Friends of Shingle Springs Interchange, Inc. v. County of El Dorado (2011) 200 Cal.App.4^th 1470, 1486 (Friends).) The suspended entity may, however, be sued and have a default judgment entered against it. (Grell v. Laci Le Beau Corp. (1999) 73 Cal.App.4^th 1300, 1306.)

The policy underlying the statutory provisions regarding failure to comply with the tax statutes is “ ‘to prohibit the delinquent corporation from enjoying the ordinary privileges of a going concern, in order that some pressure will be brought to bear to force the payment of taxes.’ ” (Peacock Hill Assn. v. Peacock Lagoon Constr. Co. (1972) 8 Cal.3d 369, 371.) The delinquent entity may revive its powers by complying with the applicable statutory requirements and, in the case of the failure to pay taxes or file a tax return, obtaining a certificate of reviver from the Board. (Rev. & Tax Code, § 23305; Corp. Code, § 17713.10, subd. (d).) Once its powers are revived, the corporation or other entity may again sue and defend in court. (Friends, supra, 200 Cal.App.4^th at p. 1486.)

      Of course, similar result would not happen in Kentucky. Initially, the Kentucky Department of Revenue does not have the authority to effect the administrative dissolution of a business organization. Rather, that capacity is reserved exclusively to the Secretary of State. Second, under Kentucky law, a company that has been dissolved, whether voluntarily, administratively or judicially, continues to be a business organization with the capacity to initiate and defend all legal actions. See, e.g., KRS § 275.300(4)(a)-(b).

Court Incorrectly Treats Assets of Dissolved LLC as the Assets of the LLC's Members

Court Incorrectly Treats Assets of Dissolved LLC as the Assets of the LLC's Members

      The procedure followed in Ceres Protein, LLC v Thompson Mechanical & Design, Civ. Act. No. 3:14-CV-00491-TBR-LLK, 2016 WL 6090966 (W.D. Ky. Oct. 18, 2016) upon the administration of dissolution of an LLC was simply incorrect.

      Therein, Ceres Protein, LLC, a plaintiff in the action along with Shannon, one of its members, was administratively dissolved. Thereafter the defendants moved to substitute Tarullo, the other of Ceres Protein, LLC's members, for the LLC. When, ultimately, the LLC was reinstated, it was substituted back in for Tarullo, in effect returning the parties to the place they were at the initiation of the lawsuit.

      The issue is that the LLC need never have been removed as a party to the suit. The dissolution of an LLC does not limit its capacity to participate in litigation. See KRS § 275.300(4)(a). Furthermore, dissolution does not vest in the members the property, including the legal rights, of the LLC. See KRS § 275.300(3)(a). But that is what the substitution of Tarullo purported to do.

      The error of treating the members of Ceres Protein LLC as the owners, upon dissolution, of the LLC’s assets was ultimately corrected, but it should not have needed to be remedied in the first place.

Louisiana Court Denies Retroactive Reinstatement of Dissolved LLC

Louisiana Court Denies Retroactive Reinstatement of Dissolved LLC

I      n a recent decision from the Louisiana Court of Appeals (Fifth Circuit), the court denied retroactive reinstatement of an LLC that had been affirmatively dissolved by its members.  In denying retroactive reinstatement, in effect the court affirmed the application of an atypical Louisiana statute which provides inter alia that upon voluntary dissolution the members of the LLC are liable severally for the LLC’s debts and obligations.  In re: Reinstatement of S & D Roofing, LLC, ___So.3d___, No. 16-CA-85, 2016 WL 5231860 (La. Ct. App. Fifth Cir. Sept. 22, 2016).

      Shane Dufrene and David Cain organized S&D Roofing, LLC as a Louisiana limited liability company. S&D contracted to provide roofing services to 9029 Jefferson Highway, LLC. Apparently the work was never done, because Jefferson sued S&D for breach of contract.  Cain received the service of process although Dufrene never did.  Thereafter, a default judgment was entered against S&D for $15,000. Apparently neither Cain nor Dufrene ever received that notice of the default judgment.  Some seven months after that default judgment was entered, Cain and Dufrene voluntarily dissolved S&D, and in connection therewith submitted an affidavit which provided in part that S&D owed no debts. This dissolution was pursuant to Louisiana Revised Statute 12:1335.1, which provides in part:

In addition to all other methods of dissolution, if a [LLC] is no longer doing business and owes no debts, it may be dissolved by filing an affidavit with Secretary of State executed by the members… attesting to such facts and requesting that [LLC] be dissolved.  Thereafter, the members… shall be personally liable for any debts or other claims against the [LLC] in proportion to their ownership interest in the company.

      When Jefferson sought to enforce its default judgment against Dufrene and Cain, they sought to reinstate the LLC pursuant to court order and as well to have that reinstatement be retroactive to the effect that they would not be personally liable on Jefferson’s claim.  This reinstatement was sought pursuant to a statute that provides:

The Secretary of State shall reinstate a [LLC] that has been dissolved pursuant to this Section only upon receipt of an order issued by a court of competent jurisdiction directing him to do so.

     While the court did grant reinstatement, it did not do so retroactively.  When Dufrene and Cain complained that the reinstatement was not retroactive, the court referenced a number of other Louisiana LLC statutes that do provide for retroactive reinstatement.  As the provision here relied upon did not provide for retroactive reinstatement, the court found that that was outside the statutory scope.  In addition, the court recited a number of policy reasons why retroactive treatment was not appropriate, including the ability of third parties to rely upon the public record.