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Creditors and SMLLCs. Olmstead v. FTC (Fla. 2010)

Friday, June 25th, 2010

In Olmstead v. FTC, SC01-109 (Fla. June 24, 2010), the Supreme Court of Florida ruling that a charging order is not the exclusive remedy available to creditors of a member of an LLC.  In part, the Court relied on differences between the statutory language of the charging order remedy in Florida’s partnership and limited partnership statutes, both of which expressly make charging orders a creditor’s exclusive remedy, and the LLC provision, which does not. Slip Op., at 11-13.

More significant is the Court’s analysis of the assignment and charging order portions of the Florida LLC Act.  The dissent argues that the majority treats the charging order as applying only to single-member LLCs.  Id.at 15-35.  To be sure, the majority opinion is not amodel of clarity. On first read, the Court seems to suggest a difference between the assignment and charging portions of the LLC statute, so that the general creditors’ remedy has a broader reach than the charging order–”all right, title, and interest in the debtor‘s single-member LLC,”  rather than only “rights to profits and distributions.”  Id. at 3-4.

Ultimately, the Court finds no difference in the assignment and charging order provisions.  In the view of the court, while an assignee does not generally does not become a member, except upon the consent “of the remaining members,” id. at 5-7, in the case of a single-member LLC:

The limitation on assignee rights … has no application to the transfer of rights in a single-member LLC. In such an entity, the set of “all members other than the member assigning the interest” is empty. Accordingly, an assignee of the membership interest of the sole member in a single-member LLC becomes a member—and takes the full right, title, and interest of the transferor— without the consent of anyone other than the transferor.

Id. at 9.  To this extent, the majority views the statute as treating all assignments of the entire LLC iunterest of a SMLLCs differently than it treats a similar assignment by one member in a multi-member LLC.  That said, the court views the charging order in the same manner: 

[stating that] a “judgment creditor has only the rights of an assignee of [an LLC] interest” simply acknowledges that a judgment creditor cannot defeat the rights of nondebtor members of an LLC to withhold consent to the transfer of management rights. The provision does not, however, support an interpretation which gives a judgment creditor of the sole owner of an LLC less extensive rights than the rights that are freely assignable by the judgment debtor.

Id. at 10 (emphasis added).

Even though the majority continually phrases the issue as the exclusivity of the charging order in the context of an SMLLC, it views a charging order as having the same effect as an assignment, which is what would happen under the general creditors’ remedy.  The majority then turns to the differing approaches to exclusivity among the charging order provisions of the vrious UBE statutes.

To a certain extent, the problem is further confused by the fact that the LLC charging order follows the “rights of an assignee” approach of the Revised Uniform Limited Partnership Act, rather than the lien approach of the Revised Uniform Partnership Act.  The former seems inherently less nuanced and flexible than the latter.

There has been extensive discussion of this on LNET-LLC, under the thread Olmstead Case Decided.  Prof. Larry Ribstein also discusses Olmstead on Truth on the Market.

Hat tip to Carter Bishop.

Posted in Cases, LLCs | 2 Comments »

2010 Amendments to Delaware LLC Act

Monday, June 21st, 2010

Delaware has amended the Delaware LLC Act, effective as of August 2, 2010.  77 Del. Laws ch. 287 (June 10, 2010).  One of the most important changes is to section 18-101(7), which defines “limited liability company agreement.”  Although that section had specified that an LLC agreement could be “written or oral,” in Olson v. Halverson, 986 A.2d 1150 (Del. 2009), the Delaware Supreme Court had ruled that LLC agreements are subject to the Statute of Frauds.  The amendment bluntly overturns Olson:

A limited liability company agreement is not subject to any statute of frauds (including § 2714 of this title).

77 Del. Laws ch. 287, § 1.

As one correspondent asked me:  what makes LLC agreements more special than other contracts?  I suppose that the Delaware legislature must believe in

  • the inherent honesty of small business owners and investors,
  • the trustworthiness of their memories, and
  • the eerie consistency of those memories!

     posted by Gary Rosin

Posted in LLCs, Statutes | 1 Comment »

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

Posted in Cases, LLCs | 1 Comment »

“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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Posted in Cases, LLCs, Uncategorized | No Comments »

Series LLCs and 1934 Act Broker-Dealers

Friday, October 9th, 2009

In a  letter dated Sept. 1, 2009, the SEC staff responded to a Financial Industry Regulatory Authority (FINRA) request for guidance on the application of the financial responsibility rules to broker-dealer using LLC series.  In the view of the staff, the structure posed by FINRA would not be permitted.

The broker-dealer would be organized as an LLC with two series.  The Master LLC would have no business operations.  The LLC would have two Series:  (i) a series for retail broker-dealer operations; and a series for institutional activities.  Only the Master LLC would register as a broker-dealer.  The specific question was the treatment of series assets and liabilities for purposes of (i) the net capital rule, (ii) the consumer protection rule, and (iii) financial reporting purposes.  FINRA suggested a consolidated financial statements that included the assets and liabilities of the two operating series.

The SEC suggested the worst of all possible worlds when computing net capital:

…assets that are not available to all creditors would not be subject to the risks of the broker-dealer’s business and would be treated as non-allowable….

… liabilities, whether the liability of a Master LLC or a series, would be deducted from allowable assets….

Id.at 2.  Moreover, consolidated financial statement would not be permitted because

a user of the financial statements would be unable to determine which of the series controlled specific assets or was obligated to satisfy specific liabilities.

Id.  As to the consumer protection rules, a seireis LLC would also fall short:

… if the amount calculated for the special reserve account for customers included credits from one series and debits from another series the account could be underfunded. Therefore, a Series LLC that receives customer cash or securities would not be able to comply with the requirements of Rule 15c3-3.

Id.at 3.  For similar reasons, the use of series LLCs would be

problematic for purposes of a liquidation proceeding under the Securities Investor Protection Act….

Id.

Gary Rosin

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Is There Any Such Thing As An LLC Unit?

Saturday, October 3rd, 2009

That question is the title of a recent article written by L. Andrew Immerman.  See 11 No. 4 Bus. Entities 20.  Immerman argues that there is a real danger with attributing reality to LLC “units” and using that term to define LLC ownership interests.  The danger is possible unanticipated tax consequences and unfulfilled expectations of the parties as to what a business deal entailed.  Use of the word “unit” leads practitioners and business people to consider LLC units to be like stock, which they may not be.  An interest in an LLC is an undifferentiated mass, and references to “unit” may disguise this.  LLC interests are split into transferable economic interests and non-transferable governance rights.  They are not split in a way that corresponds to units.  As a result, Immerman believes defining LLC ownership interests as “units” can be risky if members do not understand exactly what is being defined.

Donald Scotten

Posted in Federal Taxation, LLCs, Scholarship | No Comments »

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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Authority of LLC Agents Other Than Its Manager. T.W. Herring Investments, LLC v. atlantic Builders Group, Inc. (Md. Ct. Spec. App. 2009)

Monday, August 24th, 2009

T.W. Herring Investments, LLC v. Atlantic Builders Group, Inc.,186 Md.App. 673, 975 A.2d 264 (Md. Ct. Spec. App. 2009) raises an issue so basic that you wonder how it the trial court got it wrong.  An authorized agent of an LLC formed undder North Carolina law, but not its manager, filed an affidavit and a verified answer to a complaint by builder seeking a mechanic’s lien.  The trial court accepted the argument that only the manager had authority to act for the LLC in the litigation.  Slip Op., at 4. 

The Court of Special Appeals reversed:

There is no requirement in the above statutes or rules relating to the legal sufficiency of the affidavit other than that the affiant have the required knowledge. Thus, there is no Maryland statute or rule that prohibits a party from extending authority to a person with knowledge for the limited purpose of executing an affidavit on the party’s behalf.  In this case, the actual authority for that limited purpose was not contested by appellant; it was admitted.  

Slip Op., at 7-8.  Builder argued that Section 57C-3-25(c) of the North Carolina LLC Act only allowed managers to file official documents:

   (c) Any document or instrument required or permitted by law to be filed, registered, or recorded with any public authority and to be executed by a limited liability company … shall be sufficiently executed for such purpose if signed on its behalf by one of its managers.

Slip Op., at 9.  The Court rightly recognized that the purpose of that provision was only to assure the authority of the manger of act in that situation, not to limit the ability of other agents to act.  Id.  The Court then noted that Section 57C-10-03(c) of the North Carolina LLC Act incorporated the law of agency.  Id.  at 10.  Section 57C-3-24(a) permits a manager to delegate authority to other persons:

The delegation is without limitation, including authority to conduct the business of the company. The act of any person within the scope of the authority delegated is as effective to bind the limited liability company as would the act by a manager….

Id. (citations omitted).

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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Posted in Cases, LLCs, Partnerships | No Comments »

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