Unincorporated Business Entities Law

Over on Tax Prof, Paul Caron notes the recent opinion in Garnett v. Commissioner, 132 T.C. No. 19 (June 30, 2009), that allows LLC members to apply its losses to offset other income.

posted by Gary Rosin

Gilbert Street Developers, LLC v. La Quinta Homes, LLC, 94 Cal. Rptr. 3d 918 (Cal. Ct. App. 2009) the Court was called upon to interpret two parts of an LLC's operating agreement. The agreement provided for arbitration of "[a]ny controversy or dispute arising out of or relating to this agreement or the breach thereof (exclusive of matters which are expressly within the discretion of the Members)…."  94 Cal. Rptr. at 919 n.1; Slip Op. at 2 n.1 (emphasis added).  The agreement also provided that, under certain circumstances, one member could set a price, and demand that the other member buy or sell at that price.  94 Cal. Rptr. at 927-28; Slip Op. at 13-15. The question of arbitrability turned on whether the buy or sell provisions fell withing the exclusion for discretionary matters:

The Yee parties argue that there really isn‟t any discretion in the operation of the buy out agreement, other than, obviously the initial choice to invoke it. For them, it is essentially a machine that grinds to one of two inexorable results (you‟re bought out or you get bought out) once a lever is thrown.

   * * *

* * * A simple binary choice as here (shall I buy or shall I sell?) qualifies under the ordinary person‟s definition of discretion as well. Discretion is simply the act of separating or distinguishing, and that includes binary choices as well as ranges.

94 Cal. Rptr. at 928; Slip Op. at 15-16.

Interestingly, the buy-or-sell provisions could only be invoked "[i]n the event of a dispute among the Members which cannot be resolved[.]"   94 Cal. Rptr. at 927; Slip Op. at 13 (emphasis added).  To me, the real issue is whether arbitration would "resolve" the dispute.  In any event, the agreement provided for two dispute-resolution mechanisms, and did not clearly address how they related to each other.

posted by Gary Rosin

We all know how survival statutes work–or at least we think we do.  The recent opinion in Chadwick Farm Owners Ass'n v. FHC LLC,  207 P.3d 1251 (Wash. 2009) (en banc) (majority and dissenting opinions) may change that.

Under the Washington Limited Liability Company Act, Wash. Rev. Code, Chapter 25.15, dissolution of an LLC starts winding up.  § 25.15.270.  Dissolution does not impair remedies against the LLC, its managers or members, unless an action or proceeding is started within three years of dissolution.  § 25.15.303.  Those winding up the affairs have the right to bring or defend lawsuits after dissolution, but only until the filing of certificate of cancellation.  § 25.15.295(2).  The filing of a certificate of cancellation cancels the certificate of formation, § 25.15.080, and terminates the existence of the LLC as a separate entity, § 52.15.070(c). 

Chadwick Farm Owners Ass'ninvolved LLCs that had been administratively dissolved under Section 25.15.280.  An administratively dissolved LLC has two years to seek reinstatement.  § 25.15.290(1).  What happens if the LLC is not reinstated within two years?  Here the statutes conflict.  Under Section 52.15.270(6), that triggers dissolution (again?) of the LLC.  Under Section 25.15.290(4), the secretary of state "shall cancel the limited liability company's certificate of formation."  Which controls?  The majority in Chadwick Farm Owners Ass'n held that Section 25.15.290(4)controlled, and that pending suits against the LLC abated once a certificate of cancellation had been filed:

 Under the statutory scheme applying to limited liability companies that are administratively dissolved, if the company does not seek reinstatement it must wind up the company’s affairs within that two year period, because once the two years pass, the company no longer exists and has no power to act. While the company still exists, and during the time it is winding up (the time following dissolution and before cancellation of the certificate of formation), it has the power to prosecute and defend suits.  But once the company is canceled, it can no longer prosecute or defend suits; it no longer exists as a legal entity.

* * *

* * * The statutes do not permit an administratively dissolved limited liability company to continue winding up, including prosecuting and defending suits, on its own schedule after cancellation of the company’s certificate of formation.  * * *  There is no basis to treat a member canceled limited liability company differently than an administratively dissolved company.

207 P.3d at 1257-58 (citations and footnotes omitted).

What about three-year survival of actions under Section 25.15.303? 

By its plain language, RCW 25.15.303 provides that (1) dissolution does not affect any claim against a limited liability company and (2) there is a three-year limitations period from the date of dissolution in which to commence suit against a limited liability company. The statute never mentions “cancellation.” Of utmost importance, the legislature did not alter any provision in chapter 25.15 RCW and thus it left intact the statutes discussed above which provide that a limited liability company maintains its existence as a separate legal entity during dissolution but only until cancellation. In particular, as noted, RCW 25.15.295(2) unambiguously states that after a limited liability company is dissolved and before cancellation, i.e., during the winding up period, a manager or other representative who winds up the company’s affairs may “prosecute and defend suits” only until cancellation.

The Condominium Association in Emily Lane contends, however, that all canceled limited liability companies are also first dissolved companies, and logically the statute applies to dissolved companies that later cancel themselves. Amicus Washington State Trial Lawyers Association Foundation makes a similar argument.

However, there is a clear distinction between dissolution and cancellation.A dissolved company still exists for the purpose of winding up, during which it can sue or be sued. But once a limited liability company’s certificate of formation is canceled, it no longer exists as a separate legal entity for any purpose.  RCW 25.15.303 does not even mention cancellation, and the legislature did not alter any of the existing provisions in the Act. On its face, and read in the context of the entire Act, RCW 25.15.303 means that an action against a limited liability company, whether arising before or after dissolution, must be brought within three years of dissolution, but an action against a limited liability company will abate upon cancellation.

The plain language in RCW 25.15.303 and the other provisions in the Act resolve the statute’s meaning. * * *

207 P.3d at 1259 (emphasis added) (citations and footnotes omitted).

What happens after other dissolutions?  Could the members (or managers) file a certificate of cancellation, and stiff plaintiffs in pending suits?  Yes, but the Court warns:

* * * [That does] not take into account the whole statutory scheme, however. A dissolved limited liability company must, under the Act, properly complete the winding up process, which includes paying or making arrangements to pay known obligations and claims, even if unmatured or contingent. Members of a limited liability company who fraudulently attempt to use the provisions of the act to avoid liability and members who wind up a limited liability company improperly expose themselves to individual liability….

207 P.3d at 1261 (emphasis added); see also, id. at 1262-64 (discussing individual liability for improper winding up).

Finally, the Court rejected the argument that its interpretation was not the "bvest" result:

We recognize, however, that these arguments reflect the homeowners’ view that the statute is unfair when it is applied according to its express terms. However, if the result here is not what the legislature envisioned it is, nonetheless, what the statute plainly provides. We understand from the house and senate bill reports that a comprehensive review of the Act is underway. If the result here is not what the legislature wants, it will be positioned to make additional changes deemed necessary. It is not, however, the province of this court to rewrite RCW 25.15.303 or any other provision of the Act.

207 P.3d at1261.  So, the Washington legislature has some work to do.  I offer a couple of thoughts

• If the legislature intended for dissolution, rather than cancellation of the certificate of formation, to apply to LLCs not timely reinstated, the statutes should be amend to provide for an initial administrative suspension of the right to do business, followed by an administrative dissolution.
• Alternatively, it can change the survival statute to survival for three years after cancellation.

Also, the potential of personal liability, if widely known, may reduce the number of LLC "walk-aways," where the owners of an unsuccessful LLC abandon it to administrative dissolution, and make no attempt to wind up its affairs in an orderly fashion.

posted by Gary Rosin

I have criticized many Delaware opinions for dicta saying that there are no fiduciary duties in Delaware LLCs unless they are expressly contracted for (what I have called the "mere contractual entity" approach).  The recent opinion in Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC,C.A. No. 3658-VCS (Del. Ch. Ct. April 20, 2009) (Mem. Op.) ("Bay Center"), gives me reason to hope that Delaware has not lost its way.  In Bay Center,Vice Chancellor Strine denied a motion to dismiss, among other things, claims of breach of fiduciary duty.  In discussing the fiduciary duty claim, Strine began by emphasizing the inherently fiduciary character of the relationship between an LLC's manager and the LLC and its members.  Slip Op. at 17-18. 

Another important aspect of the opinion is VC Strine's treatment of a purported waiver of fiduciary duties in section 6.2 of the LLC Agreement:

Section 6.2  Liability of Members.  . . .  Except for any duties imposed by this Agreement . . . each Member shall owe no duty of any kind towards the Company or the other Members in performing its duties and exercising its rights hereunder or otherwise.

Slip Op.at 19 (emphasis in original).  Strine found that Section 6.2 conflicted with Section 6.1(b), which provided

Section 6.1  Relationship of Members. Each Member agrees that, to the fullest extent permitted by the Delaware Act and except as otherwise expressly provided in this Agreement or any other agreement to which the Member is a party: . . . (b) The Members shall have the same duties and obligations to each other that members of a limited liability company formed under the Delaware Act have to each other.

Slip Op. at 18-19 (emphasis in original).  As a result, the LLC Agreement was ambiguous.  Even though, to survive on a motion to dismiss, plaintiffs must offer only areasonable interpretation that supports their claim, VC Strine indicated that a reading of the LLC Agreement as allowing fiduciary duties under Section 6.1(b) was more reasonable than a reading that Section 6.2 controlled.  Accord to VC Strine, the latter reading would make Section 6.1(b) meaningless.  Slip Op.at 19-20.  Last, VC Strine invoked traditional principles of interpretation of fiduciary waivers:

And, the interpretive scales also tip in favor of preserving fiduciary duties under the rule that the drafters of chartering documents must make their intent to eliminate fiduciary duties plain and unambiguous.  As a result, the defendants’ interpretation of the fiduciary duty provisions of the LLC Agreement is not the most reasonable interpretation, let alone the only reasonable interpretation.

Slip Op. at 20 (footnote omitted) (emphasis added).

For additional discussion of various aspects of Bay Center, see analysis by Prof. Larry Ribstein, and by Francis G.X. Pileggi.

    posted by Gary Rosin

In 3519-3513 Realty, LLC v. Law, 967 A.2d 954 (N.J. Superior App.  Div. 2009) (slip opinion), the Court rejected an attempt by the sole member of an LLC to evict a tenant of a unit in a building owned by the LLC.  The statutory grounds for the attempted eviction was that the "owner" wanted to personally occupy the unit.  The Court refused to treat the building as owned by the sole member:

     Appellant argues that [the sole member]formed [the LLC] for the protection it afforded him individually in terms of potential liability.  [He] had every right to decide to arrange his affairs in that manner.  At the same time, he must accept the concomitant burdens that follow from the choice he made.

     Finally, appellant contends that adopting the trial court's construction unreasonably requires expenditure of money and time to transfer the property back to [the sole member's] name, individually, with the accompanying risk of incurring personal liability.  While not unsympathetic to the dilemma posed, we are not free to relieve [him] of the consequences which flow from the considered choices he earlier made.

posted by Gary Rosin