llc law today & beyond

MARCH 10, 2015

LLC LAW TODAY

& BEYOND – 2015

PRESENTED BY:

TAMARA KLING, ESQ.

OVERVIEW OF SEMINAR

•Part I – An Overview of LLC Law

•Part II – LLC Statutory Law Today

•Part III – LLC Case Law Today

1

AN OVERVIEW OF LLC LAW

2

WHAT DO WE MEAN BY LLC LAW?

•State LLC statutes

– Laws authorizing formation of LLC and governing LLCs

formed there under

•LLC case law

– Cases involving LLC’s internal governance

– Cases involving rights, duties, liabilities of owners and

managers

3

WHY EXAMINE LLC LAW NOW?

• It has been over 35 years since 1st LLC statute was enacted and

15 years since the last LLC statute was enacted

•Most LLC statutes were enacted between 1992 and 1997

•Legislatures have had a chance to reassess and amend statutes

•Courts have had a chance to interpret LLC statutes and decide

cases involving LLC’s internal affairs and members’ rights and

duties

4

WHAT IS AN LLC?

•Statutory business entity

•Formed by filing document with entity filing office of one state

•Owners are called members

•May be managed by members or managers

•Main governing document is operating agreement

– Governs regulation of LLC’s affairs and conduct of business

– Governs relations among members, between members and LLC,

between members and managers

•LLC statutes consist mainly of default provisions

– Apply only in absence of OA provision

5

WHAT IS AN LLC?

•Exists as an entity separate and apart from owners

– Sue or be sued in own name

– Buy, own, use property

– Make own contracts

– Have own rights, responsibilities, liabilities

•Members have limited liability

– Member’s assets generally not available to satisfy LLC debts

•Pass-through tax entity

– LLC does not have to pay income tax

– Income, losses pass-through to members

– May choose to pay income tax

6

HOW ARE LLCS BEING USED?

•To own property

•To operate commercial businesses

•To do anything a privately held corporation is used for

– Not that many publicly traded LLCs

•Have also replaced GPs, LPs, business trusts for many purposes

7

POLLING QUESTION NO. 1

In your practice do you form more?

A. Corporations

B. LLCs

8

FIVE KEY FEATURES OF THE LLC

•These features affect both LLC statutes and case law

•An LLC is hybrid entity

•An LLC is, in most cases, a closely held entity

•An LLC is, in most cases, a “pick your partner” entity

•An LLC is a contractual entity

•An LLC is a flexible entity

9

AN LLC IS A HYBRID ENTITY

•LLC has features of corporation, GP, LP

• In enacting and amending statutes legislatures borrow from

corporation law and partnership law

•Courts, in interpreting LLC statutes look to comparable provision

in corporation, GP, LP statute

•Courts also look to case law precedent involving corporations,

GPs, LPs

10

AN LLC IS MOSTLY A CLOSELY HELD ENTITY

•What is a closely held entity?

– Not publicly traded

– No established market for ownership interests

– Small number of owners

– Owners generally manage

– Owners often work together

•Have different concerns and problems than public or large private entity

•Unique concerns of closely-held entity affects statutes and cases

11

AN LLC IS A “PICK YOUR PARTNER” ENTITY

•Members often run business together and have significant

personal interaction

•Success of LLC often depends upon unique skills of each member

•Thus, members do not want to have co-members not of their

choosing

•Legislatures and courts recognize this and it impacts LLC law

12

AN LLC IS A CONTRACTUAL ENTITY

•LLC is considered more of a contractual entity than a statutory

entity

•Legislatures anticipate that members will provide for

management in OA

•Legislatures anticipate that members will set forth their rights,

duties, liabilities in OA

•This anticipation results in statutes that do not contain many

protections for members

•Courts do not seek to rewrite agreements to protect members

but seek to enforce what parties agreed to

•Can cause problems if members do not have well drafted OA

13

AN LLC IS A FLEXIBLE ENTITY

•LLC was created, in part, to provide business entity with

flexibility of a partnership

•Leads to statutes with few restrictions on management

•Leads to statutes with few restrictions on allocation of rights

•Can lead to litigation if there are gaps in statute and OA

14

EVENTS INFLUENCING LLC LAW

•These events had significant impact on LLC statutes and case law

•Hamilton Bros. Oil Co. lobbies for LLC Act

•Revenue Ruling 88-76 is issued

•First flexible LLC statute is adopted

•Check-the-box is enacted

15

LLC STATUTORY LAW TODAY

16

THREE GENERATIONS OF LLC STATUTES

•First generation = bulletproof statutes

– Contained unalterable provisions designed to avoid corporate

taxation

•Second generation = flexible statutes

– Allowed members to opt out of statutory provisions

•Third generation = first and second as amended

17

WHY WERE STATUTES AMENDED?

•The check-the-box rule

– Provisions no longer had to be designed to avoid corporate

characteristics

– Allowed states to amend provisions governing dissolution,

dissociation, number of members, transferability

•The need to fill in gaps

– Over the years it became apparent where LLC statutes failed to

address necessary issues

• C.V. Properties v. State, 295 P.3d 1136 (Okla. 2013) – LLC

refused to pay annual certificate filing fee on grounds that OK

LLC Act did not specifically provide for it. OK leg amends LLC

Act to include fee

•The need to clarify ambiguities

– Over the years ambiguities in the original statutes became

apparent and were cleared up

• nonprofit purpose specified 18


•Legislative anticipation vs. realities

– In original statutes legislators guessed at needs, concerns and

problems LLCs and members would face in future

– Amendments address unanticipated needs, concerns

• Granting third parties rights in OA

•The need for consistency among the state’s entity statutes

– Name conflict

– Inter-entity merger

– Registered agent

•Reaction to court decisions

– Court may interpret statute or fill in gaps in manner legislature did

not intend

19


•Ott v. Monroe, 719 S.E.2d 309 (Va. 2011)

– Va SCt rules that a member’s control interest is not transferable on

the member’s death without the consent of the other members

even though OA seemed to allow the transfer

– According to Ct, Sec. 13.1-1040.1 provides that member’s death

causes dissociation unless OA provides otherwise. Here OA did not

state an intent to supersede the section and lacked specific

language that would constitute an exception to statutory rule

•S.B. 779, eff. 7/1/2013

– Amends Sec. 13.1-1039 to clarify that an OA can allow an assignee

of a member’s interest to also receive management rights and be

admitted as member

– Legislative history indicates intention to overturn Ott case

20

IS THERE A “TYPICAL” LLC STATUTE?

•Current LLC statutes are not uniform

•But some generalizations can be made

•Will look at “typical” provisions governing:

– Formation

– Members and management

– Mergers and conversions

– Compliance requirements

– Foreign LLCs

– Dissolution

•Will discuss how they have changed from original statutes, why

they changed and how they may change in future

21

FORMATION

•Form LLC by filing formation document

•Formation documents – current law

– Most often called articles of organization

– “Notice” filing – intended to notify the public of formation of

entity with limited liability

– Not intended to provide information on entity’s finances,

ownership or management structure

– Typical content

• LLC name

• Principal office address

• Name and address of registered agent

22

FORMATION

•Formation document – early statutes

– Generally required more information

– Latest date of dissolution, management structure, names of

members/managers, purposes

•Reasons for change

– Became unnecessary due to check-the-box

– Increased flexibility by allowing change in management structure,

dissolution date, etc. without needing amendment

•Organizers

– Current law - one or more authorized persons

– Early laws - two or more; some required member

23

FORMATION

•Purposes

– Current law

• Few restrictions

• For profit or not for profit

• Professional service

– Early laws

• Not for profit not specified

• Restrictions on banking or insurance

• Restrictions on professional service as purpose

24

FORMATION

•Operating agreement

– May be required or optional

– Generally may be written or oral

– Few restrictions on what members may set forth

•Amendments re operating agreement

– Expanded what OA may provide

– Clarified certain issues

•When OA may be entered to

•Whether required or optional

•Who is bound

25


Operating Agreement – when forming an LLC is your operating

agreement?

A. Individually drafted to accommodate the needs of the

members or managers, the type of industry and matters

particular to those initially forming the LLC

B. Mostly boilerplate from the LLC operating agreement on file

with my firm

C. The boilerplate form my firm uses is drafted so that it can

accommodate the individual needs of the users

26

MEMBERS

•Most provisions dealing with members are default provisions

•Number of members

– Current – one or more

– Early laws – two or more (to avoid corporate tax)

– Change made after check-the–box

•Single Member LLC

– Allowing SMLLC increased LLC’s usefulness

– SMLLC currently governed by same provisions as multi-

member

– May see amendments to clarify SMLLC treatment

•Future change? – Shelf LLC

– No members at formation

– Useful for certain business deals

27

MEMBERS

•Membership interest

– Financial rights – share in profit & losses and distributions

– Non-financial rights – participate in management, inspect records

•Springing member

– Member without economic interest

– Main purpose to take over management from last member of LLC

28

MEMBERS

•Allocating rights

– Statutes have default provisions

– States differ

• Some allocate equally, others based on capital contribution

• Legislatures have not found that one default rule is better than the

other

• Amendments may be made if it turns out that one formula works

better and is used more often than other

29

MEMBERS

•Transferability of interest

– Default rule allows members to transfer financial rights without

restriction

– Default rule provides that members may not transfer non-financial

rights without consent of other members

– Early statutes restricted transfer of non-financial rights to negate

corporate characteristic of free transferability

– Current statutes retained this rule because it reflects the desires of

members to control who their co-members will be

30

MEMBERS

•Withdrawal

– Early statutes gave members default right to withdraw and demand

payment of interests

• To avoid corporate characteristic of continuity of life

– Current statutes

• In some states default rule is members may not voluntarily withdraw

from LLC

• In others members may withdraw but will be treated like assignees (with

no right to demand payment of interests)

– Reasons for change

• Give LLC liquidity and stability

• Provide estate tax planning advantages for family LLCs

31

MEMBERS

•Withdrawal

– Consequences of not having right to withdraw and obtain payment

of membership interest

• Member is “locked in”

• Minority member becomes vulnerable to will of majority

32

MEMBERS

•Charging order

– Judgment creditor’s rights against debtor member’s interest

generally limited by statute to charging order

– Charging order entitles creditor to receive distributions only

– Creditor has status of assignee and does not become member unless

other members consent

– Part of “pick your partner” protection

• Prevent creditor from becoming unwanted co-member

– Future changes?

• Clarify exclusivity of remedy

• Clarify applicability to single member LLC

– Ex. – proposed 2013 DE amendment – “attachment, garnishment, foreclosure

or other legal or equitable remedies are not available to the judgment

creditor, whether the LLC has 1 member or more than 1 member”

33

MANAGEMENT

•Vested in members

– Current default rule is management by members

– Early statutes had this as default rule to negate corporate characteristic

of centralized management

– Legislatures did not change default rule because most LLCs are member

managed

– May be vested in managers if members so choose

•Formalities

– Few restrictions in statutes

– Members may decide what actions LLC will take, and how, as they wish

34

MANAGEMENT

•Fiduciary duties

– Duties owed by managing members or managers to members and

LLC

– Generally include a duty of loyalty and a duty of care

•Statutes differ significantly

– Some include exclusive list of duties owed

– Some include non-exclusive list of duties owed

– Some have no provisions, leaving it to members in OA

– Some adopt partnership law approach, some corporate law

•Source of litigation

– Future amendments may be made based on outcome

– Amendments may be made to specifically deal with public LLCs

35


Are the LLCs you form?

A. Usually member-managed

B. Usually manager- managed

C. Close to an even split

36

MERGERS AND CONVERSIONS

•Mergers

– Current LLC laws

• Permit LLCs to merge with or into other LLCs or any other type of entity

• Default rule generally is majority member approval

– Early laws

• Some limited merger to other LLCs or to only a few different types of entities

• Default rule was unanimous member approval

– Reason for amendments

• Expansion of entity constituents - Entities sought to change forms and acquire businesses operating in other forms

• Amendments to “mechanics” – Facilitate inter-entity merger

• Change in default rule – increase management flexibility

– Future changes?

• allow short form merger of LLC parent and corp sub

37

MERGERS AND CONVERSIONS

•Conversions

– Current LLC statutes

• Permit a domestic LLC to convert to any other form of domestic or

foreign entity

• Permit any other form of entity to convert to a domestic LLC

– Early statutes

• Permitted conversion of LP or GP to domestic LLC

• Did not permit domestic LLC to convert

– Conversions allowed now to meet needs of businesses that want to

change forms

– Amendments have been made to make provisions more consistent

with other entity statutes

38

COMPLIANCE REQUIREMENTS

•LLC acts are “enabling” not “regulatory”

•LLC acts do not have many compliance requirements

•Compliance requirements in business entity laws often there to protect owners

• In LLC it is thought members can protect themselves in their OA

•Three main compliance requirements

– Annual report

– Registered agent

– Recordkeeping

39


•Annual Report

– Furthers legislative purpose of helping public and state locate LLC

– Some states have biennial requirement

– Contains current information about LLC

• Name

• Principal place of business


– Failure to file grounds for dissolution/revocation

– Amendments made over the years to adjust filing fees or due dates

or permit/require e-filing

40


•Registered agent

– Agent who receives and forwards SOP

– Furthers legislative purpose of helping public find and serve

process on business entities

– LLC must appoint at time of formation/qualification and

continually maintain in state

– Statutes also prescribe how appointment and change of agent are

made; impose penalties for non-compliance

– Provisions are changing

• Distinguish between commercial and non-commercial agent

• Movement to make provisions consistent from state to state and within

a state from entity to entity

• MoRAA – model act dealing with registered agent requirement

41


•Recordkeeping requirement

– Many statutes require LLC to maintain certain records

– Varies by state but generally includes

• List of names and addresses of members and managers

• Articles of organization, OA, amendments thereto

• Tax returns and reports for last three years

• Financial statements for last three years

• Members’ capital contributions (if not in OA or articles of org)

42

FOREIGN LLCS

•Every LLC statute has an article dealing with foreign LLCs

•Defined in statutes as an LLC formed under a jurisdiction other

than that state

•Foreign article deals with limited issues

– Governing law

– Applying for authority (qualifying)

– Amendment/Cancellation

– Penalties for doing business with authority

•Foreign provisions have not changed much over years

•Future changes?

– Provide for qualification of series LLCs, L3Cs

43

FOREIGN LLCS

•Formation state governs internal affairs, liability of members and

managers

•Foreign LLC must qualify to do business in the state

– File application for authority

• Legal name; fictitious name if legal name unavailable

• Principal office address


• Certificate of existence generally required

• Some states require information such as statement as to

member/manager management, purposes, date business to begin

44

FOREIGN LLCS

•LLC doing business in state without authority

– May not bring action in state courts until qualified

– Fines may be imposed

– LLC may defend suit

– Failure to qualify does not void contracts or make members or

managers liable for LLC’s obligations

•LLC acts do not define “doing business” in state

– List activities that do not constitute doing business in state

– Include suing or being sued, holding member or manager meetings,

maintaining bank account, creating or collecting debts

– Much of law of “doing business” found in court decisions where

defendant asserts plaintiff’s failure to qualify as defense

45

FOREIGN LLCS

•Foreign LLCs subject to annual report and registered agent requirements

•Not subject to recordkeeping

46

DISSOLUTION

•Current LLC statutes

– LLC is dissolved upon consent of members or event or time set forth in

OA or formation document

– Default rule - LLC is not dissolved upon member’s death, resignation,

bankruptcy, incompetence

•Early statutes

– Sought to negate corporate characteristic of continuity of life

– Limited term of duration to 30 years

– Default rule – LLC dissolved upon member’s death, resignation, etc.

– LLC dissolved upon member’s voluntary withdrawal unless members

consent to continue

47

DISSOLUTION

•Amendments made after check-the-box

– Legislatures recognize most owners want continuity of life

– Easily dissolved entities are unstable and can have trouble

attracting business partners and financing

•Further changes?

– Allow member to apply for judicial dissolution upon oppression or

deadlock?

– Allow revocation of dissolution before cancellation document is

filed

48

DELAWARE’S LLC STATUTE

•Popular LLC formation state

•Why is DE popular?

– Flexible statute

– Statute amended annually

– Chancery court

– Case law precedent

– Division of Corporations

49

DELAWARE’S LLC STATUTE

•What does the statute provide?

– LLC is formed by filing certificate of formation

• Only requires LLC name and registered agent and office

– May carry on any business, profit or NP, except banking

– Must have at least one member

– Members must enter into LLC agreement

– Series LLCs allowed

•Sec. 18-1101

– States that it is policy of Act to give maximum effect to principle of

freedom of contract and enforceability of LLC agreements

– Directs courts to apply contract law principles

50


Do you form the most of your LLCs

A. In Delaware

B. In the state where I practice

C. Almost an even split

D. Varies, choose state of jurisdiction based on the needs of the owners

51

SERIES LLC

•Series LLC is an LLC that is divided into separate series

•Each series functions like a separate LLC

– Can have its own members, managers, assets, liabilities, purpose

• If properly formed and maintained, debts of a series can be

satisfied from that series only

– Formation document must state that it is a series LLC with series

having limited liability

– OA must establish series

– Separate and distinct records must be maintained for each series

– Assets associated with each series must be held separately

52

SERIES LLC

•Delaware was first state to authorize

•Other states include IL, NV, IA, OK, TN,TX, UT, DC, MT (10/13), KS

•Main advantage – segregate liabilities without costs of forming and

maintaining separate LLCs

•Suggested uses for Series LLC

– Ownership of real estate

– Ownership of multiple business ventures

– Hold securities

– Use for short term projects

•Main disadvantage – advantage is largely theoretical because of lack of

guidance from courts, legislatures, gov’t agencies

53

SERIES LLC

•Questions surrounding Series LLCs

– How will Series LLC and series be taxed?

• PLR 200803004 – IRS treated each series separately

– Will foreign state that does not provide for Series LLC respect

separation of liabilities?

– Can series, in its own name, enter into contracts, sue or be sued,

own legal title to real estate?

• DE and some other states specify they can

– Can series file for bankruptcy or register under securities laws?

54

LLC CASE LAW TODAY

55

SOME GENERAL OBSERVATIONS

•LLC law is also made by judges

•Steady increase in number of cases nationwide

– Not evenly distributed however; some states hearing more LLC related litigation than others

– Not a great deal of decisions from high courts

– Cases involving single member LLC

56

SOME GENERAL OBSERVATIONS

•Some issues seen in LLC cases today

– Cases requiring court to interpret LLC statute

– Cases requiring court to interpret OA

– Cases involving attempts to impose liability on member

– Cases seeking to hold manager liable for breaching fiduciary duties

– Cases questioning authority of member or manager to act for LLC

– Cases involving LLC treatment under statute not specifically

applicable to LLCs

57

INTERPRETING A STATE LLC STATUTE

•Goal of court is to give effect to legislative intent

•Begin with ordinary meaning of words

•Read words in context so that they are consistent with rest of

provision and statute

•Court may look to analogous provision of corporation, LP, GP law

•Court may look at what other state courts have done

58

DAVIS V. WINNING STREAK SPORTS, LLC

•2013 Kan. App. LEXIS 16

•Sec. 17-7670 of KS LLC act – To the extent that a member has been

successful on the merits or otherwise or in the defense of any

action that member shall be indemnified against expenses actually

and reasonably incurred

•Member sought a declaratory judgment that he owned a 49%

interest in an LLC

•LLC claimed he owned 0%

•Jury found plaintiff owned 0.96%

•Pl sought mandatory indemnification under Sec. 17-7670

59

DAVIS V. WINNING STREAK SPORTS, LLC

•Trial court found for LLC because Pl was only nominally

successful and not prevailing party

•KS Ct of App reversed

– Statute does not require complete success

– Pl was successful in obtaining a declaration that he was member

even though it was for less of an interest than he sought

– Pl was thus entitled to indemnification

60

NY DERIVATIVE SUIT CASES

•NY LLC Law does not have provision stating that member may bring

derivative suit

•Early draft of LLC law had a derivative suit provision; Provision

removed before enactment

•Lower state courts and federal district courts had split on whether

member had common law right

•Courts denying right found that removal of provision = legislative

intent not to allow derivative suits

•Courts granting right based it on fact shareholders and limited

partners have right and that removal of provision from draft is not

clear legislative intent to deny right

61

NY DERIVATIVE SUIT CASES

•Tzolis v. Wolff, 884 N.E.2d 1005 (N.Y. 2008)

– Court of Appeals upholds member’s right to bring derivative suit

– Courts have repeatedly recognized derivative suits in absence of

express statutory authorization

– Shareholders and limited partners have both statutory and common

law right to bring derivative suit; no reason to treat members

differently

– Reason for derivative suit - so that victims of faithless fiduciaries

have a remedy – still valid

– No evidence legislature intended to take radical step of abolishing

derivative suit

62

INTERPRETING OA

•Courts apply principles of contractual interpretation

•Function of court is to ascertain shared intentions of parties

•First give words ordinary meaning

•Avoid result parties could not have intended

63

MAJKOWSKI V. AMERICAN IMAGING MGMT SERVICES, LLC

•913 A.2d 572 (Del. Ch. 2006)

•Was plaintiff entitled to advancement of legal expenses?

•LLC agreement did not mention advancement

•LLC agreement stated that LLC would “indemnify and hold

harmless”

•Plaintiff claimed “hold harmless” included advancement

– Had to have meaning other than indemnify or phrase would be

surplusage

– Claimed harm by having to pay litigation expenses

64

MAJKOWSKI V. AMERICAN IMAGING MGMT SERVICES, LLC

•Ch Ct held that phrase “indemnify and hold harmless” had long

history of usage and was second nature to many drafters

•Held that plaintiff’s argument would bend contractual language

to read a meaning parties did not intend

65

FUNDAMENTAL LONG TERM CARE HOLDINGS, LLC V. CAMMEBY’S FUNDING LLC

• 2013 NY Slip Op 951

•OA required capital contribution of at least fmv of interests before new member admitted

• LLC entered into option agreement entitling holder to one-third interest for $1,000 upon exercise

• LLC refused to issue membership interest to option holder; sought declaration that holder had to provide capital contribution pursuant to OA

•NY Ct of App held option holder was entitled to one-third interest

– OA and option agreement were not intertwined

– Option agreement unambiguously granted holder right to acquire interest for $1,000

– Parties were sophisticated and if they meant for OA fmv provision to apply they would have so provided

66

MEMBER LIABILITY CASES

•Many LLC cases involve attempts to impose liability on member

•Third party seeking to hold member liable for LLC debts

•Third party seeking to hold member liable based on member’s

participation in LLC’s wrongful conduct

•Member, manager, LLC seeking to hold member liable for breach

of fiduciary duty

•Member seeking to hold member liable for breach of OA

67

3RD PARTY SUIT TO RECOVER LLC DEBTS

•LLC statutes provide that member is not liable for LLC’s debts based on status as member

•But member may be held liable if court “pierces veil”

•Court may pierce if plaintiff establishes:

– Member completely controlled LLC including policies and practices with respect to transaction complained of

– Control used to commit fraud, wrong, breach of duty

– Control and breach caused plaintiff’s injury

68

ORX RESOURCES V. MBW EXPLORATION, LLC

•32 So.3d 931 (La. App. 4 Cir. 2010)

•Pl was drilling an oil well. Contracted with LLC to share expenses

and profits

•Oil well failed. Pl sued LLC’s managing member for breach of

contract to recover LLC’s share of expenses

•Trial ct – veil piercing applies to LLCs; member was LLC’s alter ego

and liable for its debts

69

ORX RESOURCES V. MBW EXPLORATION, LLC

•Appellate court affirmed

– Piercing justified when LLC is used to defraud creditors

– Def member used LLC as a shell to avoid paying debts

– Evidence showed LLC was undercapitalized, funds were commingled,

formalities not followed

• All factors that support piercing the veil

– LLC had no bank account; LLC’s fees were paid from member’s personal

account or account of another company of his

– LLC had not yet been formed when member signed contract on its behalf

– No meetings had been held in over a year

70

SERIO V. BAYSTATE PROPERTIES, LLC

• 60 A.3d 475 (Md. App. 2013)

• Pl contracts with Md LLC

• Pl is to build homes on land owned by LLC’s member and be paid upon sales of

homes

• Pl is not paid for sales on two lots and files suit, seeking to pierce LLC veil to

hold member liable

•Md law – Cts will pierce only when necessary to (a) prevent fraud or (b) enforce

a paramount equity

• Trial Ct pierces LLC veil to hold member liable

– Finds no fraud

– But piercing necessary for equitable purposes

• Member misled Pl about sales

• LLC failed to create escrow account as agreed upon

• Member’s conduct left LLC insolvent

71

SERIO V. BAYSTATE PROPERTIES, LLC

•Md Ct of Special Appeals reversed

– Looks to corporate law cases

– Cts find no equitable interest more paramount than state’s interest

in limiting shareholder liability

– Therefore a finding of fraud is required to pierce

– Conduct trial court relied on – misleading Pl, rendering LLC

insolvent, trying to evade a legal responsibility – have not been

held as enough to pierce in the corporate cases

– Here, Pl knew it was contracting with LLC and was not expecting

member to make payments

– Thus, trial court erred in piercing the LLC’s veil in this case

72

LIABILITY BASED ON MEMBER’S CONDUCT

•Statutes do not insulate members from liability for their own

actions

• If plaintiff can establish that member participated in LLC’s

wrongful conduct, member can be held liable

73

MBAHABA V. MORGAN

•44 A.3d 472 (N.H. 2012)

•Tenant in building owned by LLC brought suit ag LLC and member

after tenant’s daughter was poisoned by lead paint

•Trial Ct dismissed claims ag member

•NH SCt reversed

•Under NH LLC Act member is not vicariously liable for LLC’s

obligations

•Here, Pl was attempting to hold member liable for his own

negligence in managing the building and breaching his duty to avoid

exposing tenants to unreasonable risk of harm

•Pl claim should survive motion to dismiss 74

MEMBER BREACH OF FIDUCIARY DUTY CASES

•Member may be sued for breaching a fiduciary duty

•Fiduciary duty may be based on LLC statute, OA provision,

common law

75

GOTTSACKER V. MONNIER

•2007 Wisc. App. Lexis 68

•LLC had 3 members – Gregory, Paul, Julie; no OA

•LLC’s asset was a piece of real estate

•Paul and Julie formed a new LLC. Without telling Gregory, they

voted to sell LLC’s real estate to their new LLC

•Gregory sued. Ct applied WI LLC law Sec. 183.0402

– No member or manager shall act in a manner that constitutes a

willful failure to deal fairly with LLC or members in connection with a

matter in which member or manager has a conflict of interest

•WI S Ct - Sec. 183.0402 forbids willful unfairness

76

GOTTSACKER V. MONNIER

•Court held willful unfairness requires both unfair conduct and

resulting injury

•On remand, trial court found Paul and Julie did not violate Sec. 183.0402; appellate court affirmed

•Certain actions of Paul and Julie could be construed as unfair

– No notice of meeting or opportunity to vote on sale

– No effort to find other buyers

– Sale left LLC without assets

•However result was not unfair

– Even if allowed to vote Gregory could not have prevented sale

– Purchase price was fair, it eliminated LLC’s debts and Gregory was paid his fair share

77

SUITS FOR BREACH OF OA

•One issue is whether breach occurred

•Another issue is if member breached OA, what is remedy?

•Court can use equitable powers to fashion remedy

78

EUREKA VIII LLC V. NIAGARA FALLS HOLDINGS LLC

•899 A.2d 95 (Del. Ch. 2006)

– Decision affirmed by DE Supreme Ct (Niagara Falls Holding, LLC v.

Eureka VIII LLC, No. 413, 2006 (Del. Supr. 2007)

•LLC formed to develop property

•2 members; Milstein provided financing, Cogan provided skills to

operate business and licensing rights

•Milstein invested based on Cogan’s know how and did not intend to

be partners with anyone else

•LLC agreement contained restrictions on transferability

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•Cogan went bankrupt and died, resulting in creditor taking over

Cogan’s interest in LLC

•Milstein sued for breach of LLC agreement’s transferability

restrictions

•Milstein sought a declaratory judgment that it was sole member -

a remedy not provided for by LLC agreement or statute

•Ch Ct found breaches occurred and declared that creditor had

rights of assignee only and that Milstein was sole member

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•Court’s remedy based on Sec. 18-702

– Provides that member ceases to have rights and powers of member

upon assignment

– Policy – it is far more tolerable to suffer a new passive investor than a

new co-manager

– Although no assignment here, it was analogous situation

– Breach of LLC agreement had same affect as if Cogan had assigned

interest to creditor

– Milstein should not be bound to manage and operate LLC with a co-

member it did not choose

– Creditor limited to financial interest

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MANAGER BREACH OF FIDUCIARY DUTY CASES

•May be brought by LLC or member

•May be direct or derivative suit

•Fiduciary duties may be imposed by OA, statute, or common law

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WOOD V. BAUM

•953 A.2d 136 (Del. Supr. 2008)

•Derivative suit alleging directors of public LLC breached fiduciary duties

– Caused LLC to issue false financial statements, failed to institute controls over reporting

•Plaintiff alleged demand futility based on directors’ substantial risk of liability

•OA exempted directors from liability except in cases of fraud or illegal conduct

•Del. S.Ct – directors’ exposure to liability was limited to claims that they knowingly engaged in fraudulent or illegal conduct or bad faith violation of implied contractual covenant of good faith and fair dealing

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WOOD V. BAUM

•Court ruled plaintiff did not allege particularized facts that, if proven, would show that majority of directors faced liability

•Complaint alleged directors engaged in following acts

– Executed LLC’s publicly filed financial reports

– Authorized certain transactions

– Served on audit committee

– Ignored red flags

•Court ruled none of those acts established knowing participation in illegal conduct

84

GATZ PROPERTIES, LLC V. AURIGA CAPITAL CORP.

•2012 Del. LEXIS 577

•Minority members sued manager alleging breach of fiduciary duties

after he bought them out for price well below market value

•Ch Ct holds that managers owe default fiduciary duties of care and

loyalty

•Ch Ct holds manager breached contractual and default fiduciary duties

– Refused to explore strategic options

– Refused to consider credible offer to buy LLC from 3rd party

– Made low ball offer to members

– Conducted a sham auction for the LLC

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GATZ PROPERTIES V. AURIGA CAPITAL

•De S Ct affirms ruling that manager breached his contractual fiduciary

duties

– LLC agreement imposed fiduciary duty on manager to obtain fair price in

conflict of interest transaction

– Manager acted in bad faith so statutory exculpation provision did not

excuse breach

•De S Ct states that Ch Ct’s ruling that managers owe default fiduciary

duties was dicta and had no precedential value

– Where there is a contractual provision imposing fiduciary duties there is

no need to decide if there are default duties

– No party asked the Ch Ct to decide the issue

– Reasonable minds can differ so it is up to General Assembly to clarify

•Legislative reaction – 2013 proposed amendment to LLC Act would

clarify that default fiduciary duties will apply in absence of LLC

agreement provision

86

INTERNAL MEDICINE ALLIANCE LLC V. BUDELL

•659 S.E.2d 668 (Ga. App 2008)

•Passive member sued managing member

•Alleged manager breached fiduciary duties by failing to have his accounts receivable processed and collected

•Court applied statutory standard

– Manager shall act in manner he/she believes in good faith is in LLC’s best interests and with care ordinarily prudent person would exercise

•Judgment for plaintiff - Evidence showed manager acted in bad faith in not collecting on plaintiff’s accounts

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AUTHORITY TO ACT CASES

• Informal manner in which LLC may be operated, combined with few

statutory provisions …

•Can lead to litigation over whether members or managers acting on

behalf of LLC had authority to do so

88

MAITLAND V. INT’L REGISTRIES, LLC

•C.A. No. 3669-CC (Del. Ch. 2008)

•LLC had 2 equal managing members (Maitland and Guida)

•Maitland sued LLC to enforce inspection rights

•Guida retained counsel for LLC, answer was filed

•Maitland moved to strike answer and disqualify counsel on grounds

that Guida lacked authority to retain counsel and file answer for

LLC without Maitland’s assent

89

MAITLAND V. INT’L REGISTRIES, LLC

•Chancery Court granted motion

– LLC agreement stated that decision of majority of interests

controlled

– Statement in LLC agreement that members are granted all rights,

powers, authority to manage LLC means that one member may

manage when other is silent; does not give one member power to

manage when other is opposed

– Neither can unilaterally agree to retain counsel and file answer

90

CROUSE V. MINEO

•658 S.E.2d 33(N.C. App. 2008)

•LLC sues member-manager to recover assets allegedly

misappropriated

•Suit filed on LLC’s behalf by other member-manager

• Issue – did member-manager have authority to file suit on LLC’s

behalf?

•LLC relies on section of LLC law stating that every manager is an

agent of LLC for purpose of carrying on in usual way LLC’s business

91

CROUSE V. MINEO

•Defendant relies on section of LLC law stating that management

decisions require approval of majority of managers

•Court agrees with defendant. Holds filing of lawsuit against

member/manager is a management decision and not the carrying

on in usual way of LLC’s business

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STATUTORY TREATMENT OF LLCS

•Early question about LLCs – how would they be treated under

statutes/regulations specifically dealing with corporations and/or

partnerships but not LLCs?

•Over the years some amendments have been made to clarify LLC

treatment

93

CHAMPLUVIER V. MISSISSIPPI

•942 So.2d 145 (Miss. 2006)

•Example of how some statutes were amended after a court case

alerted legislature to need

•Champluvier was convicted of embezzling money from LLC she

formed

•Section of law she was convicted under applied to agents,

officers, etc. of “incorporated company”

•Mississippi Supreme Court overturned conviction because LLC is

not an incorporated company

•Section of law amended shortly thereafter to broaden

application

94

LLC DIVERSITY CASES

•Federal diversity jurisdiction requires plaintiffs and defendants to be citizens of different states

•28 USC 1332(c)(1) – corporations are citizens of state of incorporation and state where principal place of business is located

• Issue – does Sec. 1332 (c)(1) apply to LLCs?

•Nearly all US Courts of Appeal have dealt with the issue. Every one held that Sec. 1332 (c)(1) does not apply to LLCs

– Congress chose to include corporations only

– Up to Congress to amend to include LLCs

• Current law – LLC is citizen of all states in which its members are citizens

•Future – Will Congress or US SCt make a change?

95

CASES INVOLVING SINGLE MEMBER LLCS

•LLC acts generally written with multi-member LLCs in mind

•Concept of SMLLC does not fit neatly in all provisions, especially

those protecting members from actions of co-members

• In some cases courts have declined to apply certain sections of

LLC act to SMLLC

96

IN RE MODANLO

•2008 US App LEXIS (4th Cir.), affirming, In re Modanlo, 2006 Bankr. LEXIS 4524 (D.Md)

•Member of DE SMLLC filed for bankruptcy

•Bankruptcy trustee sought to manage LLC

•Member argued trustee had, at best, rights of assignee, but no governance rights

97

IN RE MODANLO

•Court held for trustee. Ruled three sections of DE LLC Act did not apply to SMLLC

– Sec. 18-304 – default rule that member ceases to be member upon filing for bankruptcy

– 18-702, 18-704 – default rules that assignee has no right to participate in management and may become member upon consent of all members

– These sections are intended to protect member from actions of co-member. Not applicable when there is no co-member.

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OLMSTEAD V. FTC

• 44 So.3d 76 (Fla. 2010)

• FTC obtained $10 million judgment against individuals who owned FL SMLLCs

• 8th Cir certified question to FL SCt asking whether charging order provision

of FL LLC act permits court to order a judgment debtor to surrender all

rights, title, interest in debtor’s SMLLC to satisfy judgment

• FL SCt ruled that FL law permits court to order surrender of full interest in

SMLLC; court not limited to charging order

– Charging order provision is part of section on assignee rights; requires consent

of “all members other than member assigning interest” for assignee to take full

interest. In SMLLC – no other members

– Charging order is special remedy for creditor when debtor’s LLC interest is not

fully transferable but subject to right of other members to object to transferee

becoming member

– LLC act provision does not state that charging order is exclusive remedy; in

contrast, LP and GP provisions state remedy is exclusive

• Aftermath – FL and other states amended LLC acts to specify that charging

order provision applies to SMLLC

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