Charging Orders and Two Kinds of Exclusivity

June 27th, 2010

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

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

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 | 3 Comments »

2010 Amendments to Delaware LLC Act

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

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

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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Drafting Delaware LLC Agreements

January 25th, 2010

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.

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

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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The Law of Closely Held Corporations

October 12th, 2009

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

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

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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Series LLCs and 1934 Act Broker-Dealers

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?

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 »

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