L3Cs - A Bad Idea

Low-Profit Limited Liability Companies (L3Cs)

     My objection to the L3C is based upon the fact that (a) specific enabling legislation is not required in order to achieve the purported objective and (b) the legislation, if enacted, is ultimately ineffective in achieving the purported objective.

     L3C legislation purports to make an LLC more able to receive a Program Related Investment (“PRI”) from a foundation.  PRIs are governed by Section 6694 of the Internal Revenue Code as well as a complex series of regulations and other IRS guidance related thereto.  Suffice it to say that the requirements for a valid PRI investment are intricate.  Without delving into that complexity, it is important to recognize that PRIs have existed for many years without the need of a particular enabling organizational statute in which the target of a PRI would be organized.  Put another way, PRIs have long existed without L3C legislation.

Specific LLC Enabling LLC Legislation is Not Necessary

     As noted above, various business organizations, including LLCs, have for many years been the beneficiary of PRIs, all of which has been accomplished without L3C-specific legislation.  Not only is it possible to organize a limited liability company that contains all of the language that would be included consequent to the enactment of L3C legislation, such has been done.  Previously I filed the Articles of Organization of “L3C, LLC,” a limited liability company organized in Kentucky.  Those articles contain everything that would be required by the L3C legislation.  Clearly the enactment of L3C legislation is unnecessary.

L3C Legislation Does Not Further the Receipt of a PRI

     Notwithstanding the representations of certain L3C promoters, having been organized under L3C enabling legislation does not further the ability of a particular venture to receive a PRI.  A valid PRI is dependent upon a significant number of factors including (i) the purpose of the foundation desiring to make the PRI, (ii) the purpose of the PRI recipient, and (iii) the specific terms of the PRI including what return may be recognized by the foundation and from what source that return will come.  These crucial aspects of a valid PRI are in no manner furthered by L3C legislation.  Hence, the suggestion that organization under an L3C statute facilitates receipt of a PRI is simply inaccurate.

The Views of the IRS, the Regulatory Community, the Foundation Community and the ABA Committee on LLCs

     The IRS has not indicated that L3C legislation will in any manner facilitate the issuance of a private letter ruling or other guidance endorsing a particular PRI structure.  At the same time, efforts by certain of the L3C promoters to enact legislation amending the Internal Revenue Code to achieve that result have been rejected.

     An article by David E. Spenard of the Kentucky Attorney General’s Office titled Panacea or Problem:  A Statue Regulator’s Perspective on the L3C Model, published in the February 2010 issue of The Exempt Organization Tax Review, reviews, from the regulator’s perspective, many of the problems presented by the L3C.  In an article titled L3Cs:  Less Than Meets the Eye, published in the May/June issue of Taxation of Exempts, David Chernoff, Associate General Counsel of the MacArthur Foundation, responded to a series of six myths regarding PRIs and L3Cs.  Therein he debunks a number of statements made with respect to L3Cs, including that L3Cs are necessary before a PRI may be made into an LLC and that the L3C structure results in less costs in the making of a PRI.  Numerous other authors have weighed in on the debate and found the L3C concept to be ineffective.

     Last, consider a Resolution of the Committee on Limited Liability Companies, Partnerships and Unincorporated Entities, Section of Business Law of the American Bar Association, approved at its April, 2010 meeting.  By this Resolution, the body of the American Bar Association charged with LLCs determined that L3C legislation is not appropriate, and on that basis stated that it:

formally opposes the incorporation into existing limited liability company acts of low-profit limited liability company (‘L3C’) amendments and respectively urges all state legislators not to adopt L3C legislation.

If someone can demonstrate to me that L3C amendments to the Kentucky (or any) LLC Act will facilitate a transaction that the current act cannot accommodate, I’m happy to listen.  Until, however, you show me the need for a new tool. I’m not going to further clutter up my tool box.

Attorney Ethics – “Blame It on the Chablis”

Attorney Ethics – “Blame It on the Chablis”

The following is reproduced from the September update from the newsletter of the Disciplinary Board of Pennsylvania, it discussing an attorney disciplinary case from Illinois.  Certain footnotes have been deleted.

Blame It on the Chablis

The most interesting disciplinary case this month is the decision of the Review Board of the Illinois Attorney Registration and Disciplinary Commission in the matter of Kelly Maureen Murawski.

Ms. Murawski’s problems arose out of her decision to represent a married man by the name of Matthew, with whom she had formerly had an intimate relationship.  It seems Matthew also had an affair with one Chablis, whom he met on match.com.  His profile failed to disclose that he was married to Sally.  A year later, Chablis found out Matthew was married, threatened to tell his wife, and began a pattern of appearing at and telephoning his home.

On a recommendation from a police officer that he obtain a protective order, Matthew contacted Respondent, who agreed to represent him “as a friend.”  Matthew neglected to advise Respondent of the precise nature of his relationship with Chablis.  Respondent filed papers for an ex parte protection order, which was scheduled for a hearing.  Respondent appeared at the hearing with Matthew, at which Chablis appeared with 59 pages of emails and texts from Matthew professing his love and twice proposing marriage.  Respondent asked to see the documentation and sat down on a bench with Chablis to read it.  The sight of his former inamoratas sharing notes on their experience was too much for Matthew, who became enraged and discharged Respondent as his attorney.  She went back into the courtroom and withdrew as his attorney, and after an ensuing scuffle over possession of the documentation, Respondent filed a battery charge against Matthew, who was arrested and jailed.  The protection order was dismissed.

Later that day, Respondent telephoned Sally and informed her that Matthew was in jail, and also of his relationships with Respondent and Chablis.  Ostensibly, this was to arrange a time for service of a protective order.  It turned out Sally already knew about Chablis.  Nonetheless much unpleasantness ensued, and Matthew and Sally divorced.

Despite the bad judgment evident in Respondent’s handling of the matter, all disciplinary charges were dismissed.  Murawski was found not to have violated a requirement of Rule 1.16(d) to deliver documents to her client upon withdrawal because Matthew never had a right to the documents.  The documents remained Chablis’s property unless introduced in the proceeding, which never happened.  She did not betray a client’s confidence in violation of Rule 1.6(a) by her call to Sally because Sally already knew about Chablis.  She did not use information adverse to a former client in violation of Rule 1.9(a)(2) because Matthew’s relationship with Chablis was known not only to Sally, but also to those in the public courtroom.

Although Ms. Murawski was not disciplined, a few lessons appear from the case:

1.       Representing a married former paramour “as a friend” is probably a bad idea.

2.       Representing a married former paramour in a domestic dispute with another former paramour “as a friend” is definitely a bad idea.

3.       Representing a married former paramour with anger issues in a domestic dispute with another former paramour named Chablis he met while trolling match.com as a single man is absolutely a bad idea.

4.       Not asking your married former paramour with anger issues why he wants you to file a protective order against a woman named Chablis is a very bad idea.

5.       Calling your married former paramour’s wife to explain that her husband is in jail and that you are filing a protective order against him because of his behavior in a protective order case you filed against another former paramour named Chablis he met on match.com cannot possibly have seemed like a good idea at the time.

Shareholders Voting by Proxy

Oh How Things Have Changed – Shareholders Voting by Proxy

Today we are entirely accustomed to shareholders, especially in publically traded corporations, voting by proxy.  This right to vote by proxy is incorporated in the various business corporation statutes.  See, e.g.,  Del. Code Ann. tit. 8, § 212; Ind. Code § 23-1-30-3(a) (“A shareholder may vote the shareholder’s shares in person or by proxy.”); Ky. Rev. Stat. Ann. § 271B.7-220.  What is often unrecognized is that permitting shareholders to vote by proxy was an innovation accomplished by state legislatures changing the common law.  Under the prior common law, shareholders could not vote by proxy.

• II Arthur W. Machen, Jr., A Treatise on the Modern Law of Corporations (1908) § 1252 (“At common law each member of a corporation could vote in person only, and could not give a proxy or power of attorney for that purpose.”)

•  Charles B. Elliott, A Treatise on the Law of Private Corporations § 472 (3^rd ed. 1900) (“At common law all votes must be given in person.  There is no right to vote by proxy unless it is conferred by statute, charter or by-law.”) (citations omitted)

•  II William W. Cook, A Treatise on the Law of Corporations Having a Capital Stock § 610 (4^th ed. 1898) (“At common law a stockholder has no right to cast his vote by proxy.”) (citation omitted).

•  Victor Morawetz, A Treatise on the Law of Private Corporations Other than Charitable § 360 (1882) (there is no right of a shareholder to vote by proxy unless authorized by the by-laws)

• James Grant, A Practical Treatise on the Law of Corporations In General as well Aggregate as Sole [*256] n. (q) (1854) (“In general the personal presence of the voter is necessary; and it seems that a corporation not authorized so to do by charter or statute, could not establish a mode of voting by proxy.”) (citation omitted)

• Commissioners’ Note to Section 28 of the Uniform Business Corporation Act (1928) (“At common law, voting could be done only in person and not by proxy.”)

Kentucky versus Delaware

Kentucky versus Delaware –

Amending the Operating Agreement

I always enjoy hearing that businesses are organized in Delaware because the law there (as contrasted with that in Kentucky) is so settled.  While it is true that the Delaware Courts have given us a deep body of case law, it does not follow that the Delaware law has resolved questions that Kentucky has not.

Take, for example, the fundamental question of amending an LLC’s operating agreement.  Under Kentucky law since 1998, unless otherwise provided in writing, the agreement may be amended by a majority-in-interest of the members.  KRS § 275.175(2)(a).

Surely, if this point is so well settled in a “fly over” state like Kentucky, it must be equally as well resolved in Delaware.  That is not, however, the case.

It was only in 2011 that Delaware adopted a statutory default rule of the unanimous approach of the members in order to amend the operating agreement.  Further, this rule is applicable only to those LLCs whose certificate of formation is filed on or after January 1, 2012.   Delaware first adopted its LLC Act in 1992.  For all LLCs formed from that date through the end of this year, there is no statutory default rule as to the requirement to amend the operating agreement.  The Delaware Bar is in disagreement as to what is today the rule, namely all members or all parties.  Assume a non-member manager of a Delaware LLC.  Some argue that the manager’s approval is required to amend the operating agreement; others say the manager’s consent is not necessary.  The Delaware courts have not addressed the question.

Things are not always more clear in Delaware.



Expulsion from a Non-Profit Corporation - Tinsley v. Wildwood County Club, Inc.

Expulsion from a Non-Profit Corporation -

Tinsley v. Wildwood County Club, Inc.

In Tinsley v. Wildwood County Club, Inc., No. 1010-CA-001295-MR (Ky. App. 2011), the Court addressed (a) whether a member had been afforded the “procedural due process” provided for in the bylaws and (b) whether the expelled member was entitled to a refund of his $25,000 membership fee.

In response to allegations of inappropriate conduct including harassment of female employees, the Wildwood Board met and made a preliminary determination that Tinsley would be expelled.  By letter, in furtherance of a bylaw affording a member the opportunity to be heard as to expulsion, Tinsley was invited to meet with the Board.  Notwithstanding an objection that the hearing would be “moot,” he did appear and through counsel objected to alleged procedural errors on the Board’s behalf – he did not respond as to the merits of the charges.  The prior decision to expel Tinsley was affirmed, and a suit followed.  The appeal followed the trial court’s denial of summary judgment to Tinsley as to certain points, holding that Wildwood did not violate its bylaws, and a grant of summary judgment to Wildwood on all other matters.

As to the procedural points, relying upon Hartung v. Audubon Country Club, 785 S.W.2d 501 (Ky. App. 1990), the court noted “that judicial review of a club’s actions concerning membership is limited only to enforcement of the club’s own rules.”  Slip op. at 11.  The Court of Appeals found that the process employed, namely a board vote to expel with an opportunity to be heard and for that vote to be reconsidered, met the requirements of the bylaws.  It as well cited Kirk v. Jefferson County Medical Society, 577 S.W.2d 419, 422 (Ky. App. 1978) for the proposition that it is “sufficient that the constitution and bylaws are substantially observed.”  Slip op. at 13, n. 11.

As to the right to a refund of his $25,000 (and as to this point there was a dissent), the Court of Appeals determined that the bylaws and related documents provided for three treatments:  (i) expulsion for cause with a refund of the fee; (ii) expulsion not for cause with a refund of the fee; and (iii) expulsion for cause with the opportunity for a hearing to challenge the expulsion, but no refund if the expulsion is upheld.  Slip op. at 16.  Finding Tinsley fell into the third category, he was not entitled to a refund of his $25,000.

Fun and Games and Charging Orders

Fun and Games and Charging Orders

Husband (Anthony Buffa) is the 99% member of LLC with Wife (Nancy Haar) the remaining 1% member.  Hubby, as an individual, is indebted to Lender as reflected in a judgment.  Lender applies for and is awarded a charging order against Husband’s distributions from the LLC.  Nothing or at most nearly nothing came to the Lender and it went to investigate why.  Buckeye Retirement Co. v. Buffa, 2011 WL 3439022 (D. Conn. 2011).

Having reviewed the LLC’s and the personal tax returns, it was discovered that in return for working more than fifty hours a week, Husband was receiving a “salary” of $20,000 per year.  Wife, working maybe thirty hours a week while being focused primarily on raising the children, received a “salary” of $120,000.  Of course, Wife is not indebted to Lender and there was no charging order against her interest in the LLC.

In a deposition, Husband admitted (although he later tried to disclaim his testimony) that the allocation between him and his wife was driven by the desire to reduce his assets subject to creditor claims.

While the Court did not rule on the merits, it did order further investigation “concerning the allocation of salary and/or distributions from Endeavor, LLC by and between Anthony Buffa and Nancy Haar.”

Those planning to use disproportionate distributions, at least between related parties when the constraints of arms-length negotiations are absent, should (rightfully) expect scrutiny.

More on Deference to Statutory Language

“The propriety, wisdom and expediency of statutory enactments are exclusively legislative matters.”

Wilfong v. Commonwealth, 175 S.W.3d 84, 93 (Ky.App.2004) (citing Owens v. Clemons, 408 S.W.2d 642, 645 (Ky.1966)).