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LLC Member Liable under Municipal Law for Violations of Housing Code. Allen v. DackMan (Md. 2010)

Friday, May 21st, 2010

In Allen v. Dackman, 991 A.2d 1216 (Md. 2010), an LLC owned rental property in Baltimore that did not comply with the provisions of the Baltimore City Housing Code regarding lead-based paint.  A resident sued the LLC and the member who managed the LLC.  The trial court entered summary judgment in favor of the member on the basis that members of LLCs are not liable for LLC obligations.  The Court of Appeals reversed on the grounds that the Housing Code, imposed liability on “owners,” defined that term broadly:

… the City Council intended to expand the meaning of the term “owner” so that it referred not only to those who own the title to a dwelling, but also to a wider group of individuals who hold or control the title.

The parties agree that Respondent did not own or hold the title to the property, so we therefore determine whether he controlled the title to the property. We have never defined the term “control” as it was used in the Housing Code, but we agree with the Court of Special Appeals that it “carries with it a requirement that the entity in question have an ability to change or affect the” interest being controlled. This definition is consistent with the common definition of the term “control.” Black’s Law Dictionary 353 (8th Ed. 2004) (defining “control” as having the ability to “exercise power or influence over” property).

* * *

We recognize a number of ways in which a reasonable trier of fact could determine that Respondent had the “ability to change or affect” the title to the property. Respondent … that he was responsible for running the day-to-day affairs of [the LLC] during the time period when [it] both acquired and sold [the property.]  Respondent also executed the deed certification when [the LLC] acquired the property, signed the complaint seeking to remove Petitioners from the property, and signed the deed when [the LLC] sold the property. These facts are sufficient evidence for a jury to find that Respondent may have changed or affected the title. For example, the trier of fact could find that Respondent directed the acquisition of the property, the legal action that led to the ejection of Petitioners from the property, or the sale of the property. Furthermore, even if Respondent did not actually direct these actions, the trier of fact could find that he had the “ability” to do so. This would have also been sufficient to establish that he controlled the title to the property. Finally, there is no evidence that anyone other than Respondent was responsible for the day-to-day management of [the LLC] or for decisions affecting the title to the property, which supports the conclusion that Respondent was the person who made decisions affecting the title to the property.

Slip Op., at 17-19 (emphasis added)(citations and footnote omitted).

Earlier this month, Dackman was discussed on LNET-LLC.

posted by Gary Rosin

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“Contorts” and Limited Liability. Parker Oil Co. v. Mico Petro & Heating Oil, LLC (Pa. Super. Ct. 2009)

Monday, October 26th, 2009

Parker Oil Co. v. Mico Petro & Heating Oil, LLC, 979 A.2d 854, 2009 PA Super 105 (Pa. Super. Ct. 2009) involves a routine breach of contract.  For several years, a gasoline station had been buying gasoline on open account from a supplier.  The station had been struggling, with earlier delays or irregularities in payment.  Eventually, the station failed, and did not pay for its last batch of gasoline.  Of course, the LLC that owned and operated the station had “shallow pockets” at best.  The supplier sued the LLC’s sole member (Singh), alleging that he had participated in the conversion of the oil.  The Court summarily rejected this argument:

¶ 9 The situation may well have been different if there was one large transaction and evidence that Singh knew the corporation (sic) could not pay for it. However, that is not the situation here. First, it is undisputed that Parker knew that Singh was operating through a corporation, and in fact had dealt with him for years, always in a corporate rather than individual relationship. Second, it is undisputed that Parker knew for a long time that Mico Petro was having financial difficulty, as many checks were drawn with insufficient funds but later made good. This is evidence of a corporation struggling to make it, and a supplier going along with this. When the corporation finally goes out of business, this does not turn a long-time contractual relationship into a tort. This is a classic situation where an individ-ual wishes to shield himself from personal liability and uses the classic corporate structure, and a supplier knows about both the corporate structure and the finan-cial difficulties of the corporation and chooses to take the risk. The decision by the trial court in this case could drastically undermine our business structure by allowing creditors to end-run the normal burden of piercing the corporate veil under the little used “participation” theory. The only participation here was that of a corporation trying to stay afloat and a creditor going along with it in the hope that ultimately it will get paid–incidentally making a profit for a number of years along the way.

¶ 10 We also note that in the current economic situation, this is something that is likely to happen more and more. While there is certainly evidence that Mico Petro owed a great deal of money to Parker, we cannot find any evidence that Singh accepted the oil planning not to pay for it. There is nothing more than a showing that finally the corporation came to the conclusion that it was not profitable and had to close.

979 A.2d at 857.  The only surprise here is that the dissent bought-in to the participation argument, reasoning that “products were received and resold and … there is principal due….”  Id. at 860.

posted by Gary Rosin

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Partnership Property & Continuation. Faegre & Benson, LLP v. R & R Investors (Minn. Ct. App. 2009)

Friday, October 9th, 2009

Faegre & Benson, LLP v. R & R Investors, No. A08-1899 (Minn. Ct. App. Sept. 29, 2009) involves the same issue as Putnam v. Shoaf, 620 S.W.2d 510 (Tenn. App. 1981):  a dispute over a partnership claim against a third person after the sale of an interest in the partnership.  Putnam involved an unknown claim, while R & R Investors involved claims against the federal government related to a pending lawsuit in which the trial court had found in favor of the government. 

The partnership, R & R Investors, which owned and operated an apartment complex.  Over the years, several groups of partners came and went.  The “appellants” sold their interest in the business via several documents:

  1. a Purchase Agreement for the sale of the apartments and related personal property;
  2. an amendment to the partnership agreement transferring the selling partners’ interests in the partnership; and
  3. an indemnity agreement under which the purchasers assumed, and indemnified sellers against the obligations of the partnership.

Slip Op., at 5-6.  Unlike an earlier sale (id. at 4), no deeds or bills of sale seemed to have been used.  It is clear that the Purchase Agreement for the purchase and sale of the property was the primary document.  The Purchase Agreement provided that the purchase of the partnership was “[t]o facilitate the sale of this property”.  Id. at 5.

In Putnam, the Court rejected a claim that, because an existing, but unknown, claim was not included in the list of property being sold, the selling partner retained ownership of it.  The selling partners in R & R Investors took a different approach.  The sellers argued that

  • changes in partners dissolved the partnership,
  • the business was continued, but by a new partnership, and
  • the disputed claim was an undistributed asset of the earlier partnership.

Id. at 13-14.  The Minnesota Court of Appeals held that, under the Minnesota version of the UPA

we conclude that, absent agreement to the contrary, the partnership property of a dissolved partnership became the property of the partnership continuing the business without need for separate devise. We base our conclusion primarily on the former UPA’s treatment of partnership property and allowance for continuation of partnership businesses. Appellants’ reading of the former UPA would frustrate the purposes of these provisions.

Id. at 15-16.  Although the Court cited (Slip Op., at 16 n.6) only one portion of my article, The Entity-Aggregate Dispute:  Conceptualism and Formalism in Partnership Law,42 Ark. L. Rev. 395 (1989), its reasoning largely parallels my discussion of the treatment of partnership property in a continuation (id. at 427-43).

Gary Rosin

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Guardianships and Durable Powers of Attorney. Russell v. Chase Investment Services Corp. (OK 2009)

Tuesday, September 22nd, 2009

In Russell v. Chase Investment Services Corp., 212 P.3d 1178, 2009 OK 22 (2009)(on certified question), the Oklahoma Supreme Court, held that, under Oklahoma law, the appointment of a guardian for the estate of a person does not terminate an earlier Durable Power of Attorney.

Section 1074.A of the Oklahoma version of the Uniform Durable Power of Attorney Act provided:

If, following execution of a durable power of attorney, a court of the principal’s domicile appoints a conservator, guardian of the estate, … the attorney-in-fact is accountable to the fiduciary as well as to the principal. The fiduciary has the same power to revoke or amend the power of attorney that the principal would have had if he were not disabled or incapacitated.

29 OK 22 at ¶12 (emphasis in original).  The last sentence of Oklahoma Section 1074(b) differs from the bracketed last sentence of Section 108(b) the Uniform Act.

[The power of attorney is not terminated and the agent’s authority continues unless limited, suspended, or terminated by the court.]

Unif. Durable Power of Att’y Act § 108(b) (emphasis added).

Gary Rosin

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Deadlock, Judicial Dissolution and Liquidation. In re Ravitz (N.Y. App. Div. 2009)

Friday, September 18th, 2009

What happens after after a judicial dissolution of a corporation on the grounds of deadlock?  What usually happens in a dissolution.  The corporation winds up its business, pays its creditors, and distributes assets to its shareholders.  But if there’s a deadlock, there’s a good chance that the directors (and shareholders) won’t be able to agree on those matters, either.  What happens then?  In re Ravitz v. Gerard Furst and Marjorie Ravitz, DPM, P.C., 2009 NY Slip Op 06437 (N.Y. App. Div. Sept. 8, 2009), tells us what does not happen, at least under New York law. 

The corporation in question was a podiatry practice with two equal shareholders, three offices.   The two agreed that one office should be closed.  They agreed that they would split the two remaining offices.  The problem was that one office was more  profitable than the other. The shareholder who would  take the less profitable  office proposed a valuation of the goodwill of each office, and a cash settlement to equalize the distribution of assets.  When the other did not agree, the first asked the court to supervise the liquidation for the purpose of valuing the practices.  Both the trial and appellate courts held that such a procedure was not permitted under the pertinent provisions of the New York Business Corporation Law.

Section 1008(a) of the New York General Corporation Law (NY GCL) authorizes a court to

continue the liquidation of the  corporation  under  the  supervision  of the court and may make all such orders as it  may deem proper in all matters in connection with the dissolution or the winding up of the affairs of the corporation

The Court held that Section 1008(a) did not authorize the appointment of a referee.  Under Section 1005(a)(2), assets can only be sold at “public or private sale.”  In re Ravitz, Slip Op. at 1-2.  If the parties cannot agree on a private sale, the only recourse is a public sale.  Id.

The appointment of a referee (special master) to mediate a possible sale, and to value the businesses, should be within the power of the court.  If one of the parties is intransigent, and refuses to pay full value, should the only recourse seems to be a referee to conduct the public sale?

The Court also held that, in the absence of an agreement, goodwill was not a distributable asset.  More on that later.

Hat tip to Peter A. Mahler (New Business Divorce blog), who represented the prevailing party.

Gary Rosin

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Discretion and Fiduciary Duties. Bernards v. Summit Real Estate Management, Inc. (OR 2009)

Friday, August 28th, 2009

Bernards v. Summit Real Estate Management, Inc., 229 Or. App. 357, 213 P.3d 1 ( Ct. App. 2009) involves a demand-refusal derivative suit by a member of two member-managed Oregon LLCs.  Each LLC owns an apartment complex that is managed by Summit Real Estate Management, Inc. (apparently unrelated to any of the members).  After Summit and one of its officers embezzled substantial sums from each LLC, Bernards demanded that each LLC sue them.  When other members refused “without explanation,” Bernards filed a derivative suit against Summit and its officer.  Later, Bernards joining the other members, alleging that breach of both contract and fiduciary duties.  213 P.2d at 360-362.

Section 63.801(b) of the Oregon LLC Act allows derivative suits on a showing of demand futility, but allows the operating agreement to change that rule.  Section 5.4(d) of the operating agreement of each LLC required unanimous member consent for a derivative suit.  213 P.2d at 360-61 & 366.  The Court rejected the argument that Section 5.4:

Section 5.4(d) cannot carry the freight with which defendants would load it.  There is no logical connection between the premise that the consent of every member is a contractual prerequisite for legal action, and the conclusion that every member has the unfettered authority to withhold consent.  That is particularly true in light of the well-settled rule that the parties to a contract are bound by a requirement of good faith and fair dealing.  Even more to the point, another provision of the operating agreement, Section 5.10 (as noted above), provides that a member can be held liable for action or inaction taken in bad faith, “gross negligence, fraud, or willful or wanton misconduct.”  The operating agreements, then, confirm rather than contradict the proposition that, although every member’s consent is required before another member may take legal action, that consent cannot be withheld except for a valid business reason.

Id. at 366-67 (emphasis added)(citations omitted).

As indicated by the court, Section 5.10 of the operating agreement provided that members were not liable

… for honest mistakes of judgment or for action or inaction taken in good faith for a purpose reasonably believed to be in the best interest of the Company; provided that such mistake, action, or inaction does not constitute gross negligence, fraud, or willful or wanton misconduct.

Id.at 364 ( emphasis added) (internal quotations omitted).  The Court clearly saw good faith as that required of a fiduciary, rather than the contractual obligation of good faith and fair dealing. 

Although the Court did not discuss this, Section 63.160 of the Oregon LLC Act limits the use of operating agreements to eliminate member (and manager) liability of damages, and uses language similar to that of Section 102(b)(7) of the Delaware General Corporation Law to do so: 

However, no such provision shall eliminate or limit the liability … for … 

  1. Any breach of the member’s or manager’s duty of loyalty to the limited liability company or its members;
  2. Acts or omissions not in good faith which involve intentional misconduct or a knowing violation of law;
  3.  Any unlawful distribution …; or
  4.   Any transaction from which the member or manager derives an improper personal benefit.

Section 63.160.  Section 63.160(2) differs from DGCL Section 102(b)(7)(ii)

acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law

(emphasis added).  Arguably, the omission in the Oregon statute of the word “or” limits the scope of “good faith.”  That said, the Oregon statute also prohibits elimination of liability for breaches of the duty of loyalty.  If it was not already clear that acts not in good faith breach the duty of loyalty, the Delaware Supreme Court has now settled that question as a matter of Delaware law (In re Walt Disney Litigation and Stone v. Ritter).

In any event, Section 5.10 of the operating agreement in Bernards arguably conditions the waiver of liability to acts taken in “good faith.”  Thus, the exclusion of “gross negligence, fraud, or willful or wanton misconduct”  applies only to acts taken in good faith.

The problem with complaint was that it did not plead any specific facts indicating misconduct by the members in rejecting the demand.  The court rejected that argument that the misconduct by Summit and its officer was clear that a failure to sue them could only be explained by misconduct.  213 P.3d at 267-70.

Gary Rosin

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Attorneys of Aboite, LLC. In re Loomis (Ind. 2009)

Monday, August 24th, 2009

 In re Loomis, No. 02S00-0808-DI-422 (Ind. May 7, 2009), is a recent disciplinary case.  Three lawyers in Aboite, Indiana formed “Attorneys of Aboite, LLC.”  Although the three lawyers did not combine their practices, they

…used the names “Attorneys of Aboite, LLC” and “Attorneys of Aboite” in professional documents, communications, signage, telephone directory listings, numerous advertisements, and an internet website without revealing that they did not practice law as a firm.

Slip Op.at 1.  Unsurprisingly, they were disciplined for misleading clients as to whether they practiced as a firm.  Still …

What were they thinking?  I suppose that they wanted to share offices, and formed the LLC to lease or buy office space, and to share expenses. 

There may be some estoppel issues here, so that the LLC may be liable for malpractice, errors and omissions committed in the course of representing clients who thought they were dealing with a firm.

Hat tip, Mike Frisch (Legal Profession Blog).

Gary Rosin

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Twist on Pre-Formation Contracts. Baltimore Street Builders v. Stewart (Md. Ct. Spec. App 2009)

Monday, August 24th, 2009

Baltimore Street Builders v. Stewart, 186 Md.App. 684, 975 A.2d 271(Md. Ct. Spec. App 2009), involves an interesting twist on pre-formation contracts.  Lenkey and Kunkel were contractors, with separate businesses, each conducted through separate LLCs.  Apparently, Lenkey and Kunkel also conducted business as partners under the name Baltimore Street Builders.  Lenkey signed a construction contract in the name of Baltimore Street Builders, LLC.  Work under the contract began in January 2006.  The LLC was not organized until March 2007, shortly before the completion of the work in June 2007.  When the homeowner refused to pay for the work as performed, the LLC sued to establish and enforce a mechanic’s lien on the property.  The problem?  Neither Lenky, who signed the conttract, nor the LLC, nor its predecessor partnership, had a home improvement license, either at the time of contracting, or before starting or completing work.  No license, no lien.

The Court rejected the argument that the licensing requirement was met because work under the contract was done by Kunkel’s LLC, which did have a home improvement license.  The court reasoned that the statute required “persons” acting as contractors to be licensed, and defined person to include any “partnership, firm, association, corporation, or other entity.”  Slip Op., at 8-9. 

Inasmuch as neither Robert Lenkey or BSB [the LLC?]  of the informal partnership known as BSB ever had a home improvement contractor’s license, it cannot be said that the “person” with whom appellee contracted complied with [the licensing statute]. (sic).

Slip Op., at 9.  The Court also rejected a substantial compliance argument

Because BSB’s counsel admitted at oral argument before us that it was Mr. Kunkel’s company … that had the license, we interpret the appellant’s argument to be that BSB substantially complied with the statute because at the time the contract … was signed, BSB was a partnership and Mr. Kunkel was one of BSB’s partners, and an entity controlled by Mr. Kunkel had a license.  Such an attenuated relationship with a license holder can scarcely be considered “substantial compliance” in light of the requirement that the partnership [BSB] that contracts to do the home improvement work must be licensed.

Slip Op., at 12-13.

And, the mere fact that [Kunkel’s LLC], a sub contractor, was licensed does not fulfill the purpose of the Home Improvement Law insofar as [the homeowner] s concerned. After all, [the homeowner] never contracted with that entity and thus could not have successfully brought a breach contract action against [it.]

Slip Op., at 20.

Gary Rosin

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Unfinished Business & Law Firms

Wednesday, August 12th, 2009

As noted earlier, In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), involves the concept of unfinished business.  That concept grows out of UPA Section 34(1)(a), which provides that, after dissolution,  partners have the power to bind the partnership “[b]y any act appropriate for . . . completing transactions unfinished at dissolution.”  

In a law firm, the primary unfinished business would include the representation of clients in matters already begun, but not yet completed.  We often associate law-firm unfinished business with contingent-fee litigation, but even matters billed on an hourly basis could have substantial remaining work–consider a major acquisition or commercial litigation, for example.  Unfinished business in no different from unbilled hourly matters or unpaid receivable; all must be finished, billed and collected for the benefit of the old firm. 

The Brobeck waiver of the firm’s interest in unfinished business amounted to a distribution in kind of that business.  It is well-settled that partners may agree to distributions in kind, rather than liquidations by sale and distributions of cash.  As noted by the Brobeck court, completing unfinished business of a law firm “can be protracted”.  Slip Op. at *8.  Given that, the court concluded that

an agreement that immediately disposes of unfinished business and minimizes the disruptive impact of a dissolution is appropriate, and the court will not fault them for complying with this aspect of California law.

Id.

The problem was that the Brobeck firm was not only insolvent, but also an LLP; its partners were not liable for the obligations that the firm could not cover.  There is a very real difference between the interests of the firm and those of its partners.  In that context, partner consent should not be sufficient to avoid a breach of the duty of loyalty to the partnership.  Yet the court treated the duty to account as operating only as among the partners. 

The court gestured towards the principle that agreements solely among partners cannot override the rights of creditors.  Slip. Op.at *10.  That said, the court incorrectly viewed the insolvency of the partnership as relating only to the general creditors’ remedy of the fraudulent transfer laws.  The duty to act for the benefit of the partnership cannot allow partners to strip assets from an insolvent firm.  any assertion otherwise is “manifestly unreasonable.”

Gary Rosin

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Law-Firm Dissolutions & Fiduciary Duties. In re Brobeck, Pheleger & Harrison, LLP (Bankr. N. D. Cal 2009)

Wednesday, August 12th, 2009

Prior to filing bankruptcy, in order to facilitate an orderly liquidation and movement of attorneys to other firms, the law firm of Brobeck, Phleger & Harrison, LLP (“Brobeck”) amended its partnership agreement to include a waiver of the rights of the firm and its partners to any “unfinished business” of the firm, as that term is defined in Jewel v. Boxer. 

In In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), the bankruptcy court held that the provision was valid as a matter of California partnership law but was a fraudulent transfer because it was a transfer of interests in Brobeck’s property that was made while Brobeck was insolvent and without the receipt by Brobeck of any value in return.

In Jewel v. Boxer, 156 Cal.App.3d 171, 203 Cal.Rptr. 13 (1984), a California court of appeals held that, in the absence of an agreement otherwise, when a partnership dissolves, the partners have a duty to account to the dissolved firm and their former partners for profits earned on the dissolved firm’s unfinished business after deducting for overhead and reasonable compensation.  The Jewel case involved contingency fee matters, but later cases made clear that the rule also applies to hourly rate matters.  Many Brobeck partners were familiar with the Jewel duty to account because a law firm had recently sued Brobeck for an accounting of profits earned on unfinished business completed by former partners of that firm who went to Brobeck.  As the dissolution of Brobeck loomed, the Brobeck policy committee thus recommended that the  partnership agreement be amended to include a provision waiving Jewel claims that Brobeck would have against its former partners or their new firms except for two specified matters.  The amendment received the requisite approval of the partners, and Brobeck proceeded to dissolve.  After Brobeck entered involuntary bankruptcy, the trustee asserted various claims against the Brobeck partners and several firms who had hired Brobeck partners.  The trustee settled with most of the partners and the two firms to which most Brobeck partners moved, but certain Jewel claims were not settled, and the trustee asserted these claims against two firms and ten former Brobeck partners who moved to those firms.

The court first analyzed whether the Jewel waiver was valid under California partnership law.  The court concluded that the partners were not only free to adopt such a provision, but were, in fact, encouraged by the case law in this area to adopt an agreement as to how to handle unfinished business in a way that immediately disposes of unfinished business and minimizes the disruptive impact of the dissolution.  The court rejected the trustee’s arguments that the waiver ran afoul of the RUPA provision permitting modification of the duty of loyalty by identifying “specific types or categories of activities that do not violate the duty of loyalty” so long as the modification is not  “manifestly unreasonable.”  The trustee argued that the provision was not specific enough because it did not refer to the partners’ duty of loyalty, but the court stated that specific reference to the duty of loyalty, while “it may be a prudent exercise,” is not required for a valid modification of the duty under RUPA.  The court also rejected the trustee’s argument that the provision was “manifestly unreasonable.”  The court stated that it was left to rely on its common sense in the absence of case law defining the term, and the court concluded that the Jewel waiver was not “manifestly unreasonable.”  The court reasoned that the waiver did not eliminate the duty of loyalty, but merely modified the duty to account, which is just one of the three duties of loyalty set forth in RUPA.  The court stated that Brobeck’s insolvency at the time of adoption of the waiver did not affect its validity under RUPA because RUPA does not govern the relationship of the partnership or its partners to third parties, such as creditors.

While the court determined that the Jewel waiver was lawful and valid under RUPA, the court ultimately determined that the waiver was avoidable as a fraudulent transfer.  The court held that profits from unfinished business amounted to property of Brobeck and that the waiver effected a transfer of that property to the partners.  Although the court concluded that the trustee failed to meet his summary judgment burden with respect to actual intent to hinder, delay, or defraud a creditor, the court concluded that the trustee was entitled to summary judgment that the Jewel waiver was a constructively fraudulent transfer.  The parties did not dispute that Brobeck was insolvent when the waiver was approved, and the court concluded that there was no evidence that Brobeck received anything of value in exchange for the waiver.  Thus, the waiver was avoidable as a fraudulent transfer, and the partners, as initial transferees, and their new firms, as immediate transferees, were liable to the extent of profits received on Brobeck’s unfinished business.

Elizabeth Miller

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