Unincorporated Business Entities Law

Prof. Larry Ribstein (Illinois) passed away yesterday (via Prof. Brian Leiter, Prof. Geoffrey Manne). Larry was a major advocate for  ”uncorporations” (as he called them). His loss will be deeply felt.

I have already noted Thursday’s opinion of the Florida Supreme Court in Olmstead v. FTC that a statutory charging order is not the exclusive remedy available to creditors of a member of an LLC.  That opinion was in response to a certified question from the U.S. Court of Appeals for 11th Circuit.  Whether you agree, or disagree, with the holding in Olmstead, at least the lawyers, and the 11th-Circuit panel, recognized the existence of the charging order.  The same cannot be said of theat least 11  lawyers and 13 judges involved in the opinions in  Hotel 71 Mezz. Lender LLC v. Falor, 2010, No. 9 (N.Y. Feb. 16, 2010), rev’g 2008 NY Slip Op 09848 (NY AD [1st], December 16, 2008).  In Falor, the sole issue raised on appeal was the jurisdiction of New York courts to apply New York general creditors’ remedies to reach interests in LLCs formed under the laws of other states.  As I’ve discussed earlier, at least the Appellate Division panel recognized, via forum non conveniens, that it might be better to litigate in other states.

So there are two different exclusivity issues that should be addressed by legislatures drafting LLE statutes that include a charging order remedy.   To a large extent, both turn on the same a question:  are charging orders intended to be an integral component of an interest in an LLE, rather than merely a remedy?  If the answer is “yes,” then the local charging order should be exclusive, both locally, and in other states.  If the answer is “n0,” then the only reason to have a charging order at all is as one way to gets courts recognize the difference between ownership interests in corporations, and in LLEs.

The question of how to handle single-member LLCs is a different question.  Unfortunately, neither the Olmsread majority opinion does not do that as clearly as I would like.  That just makes it harder to keep everyone from conflating the two questions.

posted by Gary Rosin

Even though law schools are starting to put greater emphasis on practice skills, such as drafting transactional documents, most law professors have little occasion to draft organizational documents for business entities.  It came as a surprise when I was asked to note the relatively publication of Drafting Delaware LLC Agreements, by John M. Cunningham and Vernon R. Proctor (Aspen Law & Business 2009).  The focus of the book is on guiding lawyers drafting LLC Agreements.  According to Aspen,

On the basis of their ownership structure, management structure and federal tax structure, the book identifies 10 principal types of LLCs relevant in Delaware LLC formation practice, and in a compact disc, it provides a complete set of 29 forms specifically tailored for use in forming these LLCs.  These forms include six for single-member LLCs owned by individuals; three for single-member LLCs owned by entities; 19 for multi-member LLCs, including LLCs with general partnership, limited partnership and corporate management structures; and a special form for Delaware series LLCs.  The book also provides detailed guidelines for choosing among these forms for particular LLC formation clients.

The book seems comprehensive, with both checklists, and suggested signing memoranda–always good things.

Given the wide discretion in contracting with regard to fiduciary duties for Delaware LLCs, the May 2010 supplement will include a new chapter on fiduciary duties, and suggested drafting approaches and language.  It is here that I would disagree with the authors, who suggest silence, and reliance on common-law principles, as a drafting tactic. § 14A.01[D].  The authors do note in the following subsection that Chief Justice Myron T. Steele of the Delaware Supreme Court is of the view that the Delaware LLC Act abolishes common-law fiduciary duties.  In any event, the new chapter includes a broad discussion of, and forms for, key aspects of common-law fiduciary duties.

posted by Gary Rosin

Update:  Check out Peter A. Mahler’s interview of John Cunningham (01/25/2010) on the New York Business divorce blog.

Aspen has just published a treatise, The Law of Closely Held Corporations, by Contributing Editor Douglas Moll and his co-author, Robert Ragazzo (Houston). 

Gary Rosin

In Wilson v. Paine, 288 S.W.3d 284 (KY 2009), the Kentucky Supreme Court adopted the “adverse domination” doctrine.  Under that doctrine, the statute of limitations on claims of misconduct against a corporation’s officers and directors does not begin to run until the corporation “knows” of the misconduct giving rise to the claim.  Taking off from the “adverse agent” exception to the rule that the knowledge of agents is ‘attributed” to the principal, the adverse domination doctrine does not impute to the corporation the knowledge of the offending officers and directors.  The Court adopted the “majority” domination variant of the doctrine, under which the knowledge of an innocent corporate “agent” will not be attributed to the corporation so long the offenders control the Board of Directors.

The Court also held that the doctrine does not apply when a majority of the directors are merely negligent.  Instead there must be “intentional wrongdoing of some kind, which would include fraud”.  Slip Op. at 12.  The rationale of the court was two-fold.  First,

To [allow a negligence standard] would effectively eliminate the statute of limitations in all cases involving a corporation’s claims against its own directors . . . . [I]t could almost always be said that when one or two directors actively injure the corporation, or profit at the corporation’s expense, the remaining directors are at least negligent for failing to exercise “every precaution or investigation.” (Internal citation omitted.) If adverse domination theory is not to overthrow the statute of limitations completely in the corporate context, it must be limited to those cases in which the culpable directors have been active participants in wrongdoing or fraud, rather than simply negligent. 

Id. at 11 (quoting from FDIC v. Dawson, 4 F.3d 1303, 1310 (5th Cir. 1993)).  Second, the Court believed that

[T]he danger of fraudulent concealment by a culpable majority of a corporation’s board seems small indeed when the culpable directors’ behavior consists only of negligence.”

Id. (quoting from Dawson, 4 F.3d at 1312-13) (emphasis added by Court).

Here the Court drifts off the path.  First, the conduct of directors is protected by the business judgment rule, which generally requires at least gross negligence or bad faith before directors will be found liable.  Second, a similar standard protects directors against liability for failures to supervise or to monitor.

In case you’ve noticed, yes the archive is bigger.  I just imported posts from our predecessor blog, Unicorprorated Business Law Prof, from December 2008 to July 2009.  I’m seeing if I can get the older ones, too.

Gary Rosin

Who owns America?  American business entities?  That’s what Senator Carl Levin (MI) wants to know.   In 2008, Senator Levin (and co-sponsors, including then Senator Obama) introduced the Incorporation Transparency and Law Enforcement Act (S. 2956).   Earlier this year, Senator Levin (and co-sponsors) reintroduced the Act as S.569.IS.  on June 18, 2009, the Senate Homeland Security and Governmental Affairs Committee held a hearing on Examining State Business Incorporation Practices: A Discussion of the Incorporation Transparency and Law Enforcement Assistance Act.  Leslie Reynolds of the National Association of Secretaries of State (NASS) gave this summary of the hearing:

* * *  Sec. Elaine Marshall, NC Secretary of State and NASS Company Formation Task Force Co-Chair was one of the witnesses invited by Chair Lieberman (I-CT).

There were a total of five witnesses (all of their prepared testimony can be found on the [Senate Homeland Security and Governmental Affairs (HSGAC)] hearing page,along with the webcast of the hearing.) Witnesses representing the state perspective were Secretary Marshall and Harry Haynsworth, ULC drafting committee chair for the Uniform Law Enforcement Access to Entity Information Act (ULEAEIA). The Justice Department (DOJ), Immigration & Customs Department (ICE) and the ADA’s office in New York City had witnesses testifying from the perspective of law enforcement.

Three Senators were present for the hearing – Chair Lieberman (I-CT), Sen. Levin (D-MI) and Sen. Carper (D-DE). Chair Lieberman stayed for the first round of questions, but left and asked Sen. Levin to chair the second round of questions. The hearing lasted two and a half hours, with a 20 minute break for a floor vote.

The full opening statements of the Senators present can be found on the HSGAC hearing page.  Chair Lieberman commended the work of the Permanent Subcommittee staff and the commitment of Sen. Levin on this issue. He said there should be a way to draft balanced “sunshine” legislation which would provide the information that law enforcement needs and protect investor privacy without burdensome administrative costs to implement. Sen. Levin said that states were forming 2 million businesses each year without knowing who is behind them. He also said that states were reluctant to admit there was a problem. Sen. Carper (D-DE) said that he hoped that the committee seriously considered the offer of Haynsworth and the ULC to move forward working together and that the solution will be a balance of interests between privacy and transparency.

Janice Ayala of ICE said that her agency has recognized for quite some time that the state incorporation process poses a serious threat . She cited several examples of investigations that have taken place over the past few years and said that shell companies (those that exist only on
paper – her definition) are being formed by criminals in the US and then they are opening bank accounts overseas. She also said that criminals are purchasing “shelf companies – aged companies” that are being promoted on the Internet and used to conduct criminal activities. She
said that the solution is federal legislation but does not credit S.569 as the solution.

Jennifer Shasky of DOJ said that federal legislation must include four components:

   (1) law enforcement must have access to the names and contact information for those who have control over a company and the company’s assets;

   (2) define “beneficial owner” the same across all 50 states and collect name, address and photo ID from ALL recognized as beneficial owner,

   (3) obtain beneficial ownership information in an accurate and timely fashion which means it must be maintained on site in the state of formation, and it must be updated any time info changes and it must be certified annually, and

   (4) there must be a federal enforcement component.

Secretary Marshall outlined the work of the NASS task force, our request of the Uniform Law Commissioners and the ABA on drafting Uniform Law and the impact that S. 569 would have on NC specifically from a filing office standpoint. She explained, in detail, the challenges that state offices would face implementing S.569 – that you would be the front lines when it came to implementing- and the public education challenges you would face both in staffing and in costs.

Mr. Kaufman of the NY City ADA’s office said his office supports S.569 because they deal with the fallout of “shell companies” everyday. He called the issue a “no-brainer” and said that “these shell companies ust come to an end.” He said that as a country we have a “moral obligation” to lead on this issue and it is embarrassing when conducting an investigation with international authorities. He said that from a law enforcement perspective, the Uniform Law Commissioners draft is “worse than nothing” because it alerts an entity directly when they are being investigated. Often the law enforcement officials represented appeared to believe that those engaged in criminal activity would file truthful information. When Sec. Marshall pointed out that it was unlikely that criminal enterprises would file truthful information, Mr. Kaufman of the ADA’s office said false information was still helpful because once caught, prosecutors could show criminal intent with the filing of false information – this still wouldn’t aid in the investigation.

Harry Haynsworth of the Uniform Law Commissioners said that the solution has to be state legislation with a uniform standard because corporate law has been a matter for states. He is concerned that S.569 would result in massive unintentional non-compliance and that information would be frequently be outdated. He made an offer to move forward, working with the committee, to work on federal legislation that would require states to implement ULC version or they would be subject to federal legislation (S.569). The federal legislation would also include funding and federal penalties for non-compliance.

Sen. Levin asked Ms. Shasky if DOJ supported his bill. She said that DOJ thinks the bill needs to be amended to include photo ID for all beneficial owners not just international owners. DOJ also wants the beneficial ownership information updated anytime there is a change, not just updated annually. DOJ also wants to add an annual certification of the information. She did clarify that the Administration does not have an official position on S.569. ICE reported that Homeland Security is working on a position. Kaufman of the ADA’s office again said he thinks that the issue is a no-brainer and he doesn’t understand the state and business community perspective that the requirements will impose a burden. Law enforcement witnesses made it clear that they wanted the referenced provisions in place to address what they acknowledged were [0.1%] of the businesses out there conducting illegal activity.  Secretary Marshall and Harry Haynsworth referenced the fact that they were working on behalf of the 99.9% of the businesses conducting legitimate activities. Levin said that his approach to collecting the information was much simpler than the ULC approach.

Marshall and Haynsworth argued that the definition of beneficial ownership was extremely difficult to implement from a business filing perspective. Sen. Levin and law enforcement did not agree and said that the U.S. Treasury, Financial Action Task Force and S.569 all defined “beneficial ownership.” To support his point, Mr. Haynsworth read from the July 5, 2007 Financial Action Task Force Third Mutual Evaluation Report of the United Kingdom, page 234 Sec. 1132 and 1133.

(list spacing and hot-links added).

The NASS has established a Company Formation Task Force on this issue.  Its website has a veritable history on this issue, with links to more information.

posted by Gary Rosin

In Ederer v. Gursky, 9 N.Y.3d 514, 881 N.E.2d 204, 851 N.Y.S.2d 108, 2007 N.Y. Slip Op. 09960 (2007), the New York Court of Appeals interpreted the New York LLP shield to allow claims by partners for breach of obligations of other partners, or of the partnership.  See my earlier post, Liability of LLP partners To Each Other. 

Section 47 of Senate Bill 1442 amends Section 152.801(a) of the Texas Business Organizations Code to read as follows:

     (a) Except as provided by Subsection (b) or the partnership agreement, a partner in a limited liability partnership is not personally liable to any person, including a partner, directly or indirectly, by contribution, indemnity, or otherwise, for a debt or obligation of the partnership incurred while the partnership is a limited liability partnership.

Oddly, the Legislature chose to add "or the partnership agreement" to the introductory exception.  Like the RUPA, Texas has a central provision regarding partner autonomy and its limits.  TBOC § 152.002.  While the Legislature may have felt a "belt and suspenders" approach was necessary to catch the attention of the courts, it seems bad policy to start dropping in references to the partnership agreement.

posted by Gary Rosin