What happens when the practice of the members of an Unincorporated Business Entity (UBE) varies from the terms of the UBE’s constitutive documents? In a recent opinion in Spellman v. Katz, C.A. No. 1838-VCN (Del. Ch. February 9, 2009), Vice Chancellor Noble invoked the Parole Evidence Rule to prohibit the consideration of evidence showing that the members of an LLC had disregarded a provision in the LLC Agreement.
In Spellman, Doctors Katz, Spellman and Alfieri formed Delaware Bay Surgical Services, P.A. as the vehicle for the joint practice of medicine. At the same time, the three also formed KSA, L.L.C. The LLC bought a piece of property, constructed a building, Bayview Medical Center, and leased it (or a portion of it) to the PA. At some point, Dr. Alfieri withdrew form the LLC (and, presumably, the PA), and bought one of what eventually became three "units" from the LLC. In February, 2002, after an unsuccessful attempt to force dissolution of the PA, Dr. Spellman withdrew from the practice. In 2002, presumably after Spellman’s departure, another unit in the building was sold. Dr Katz continues to practice through the PA, and the PA continues to lease a unit in the building. Slip Op., at 1-2 & nn. 1-4.
In his recent opinion, Chancellor Noble granted Dr. Spellman’s request for dissolution of the LLC and the appointment of a liquidating trustee. Section 5.1 of the LLC Agreement provided for dissolution and winding up of the LLC
as soon as possible after the construction of the building [Bayview Medical Center] has been completed, the condominium documents have been finalized and a certificate of occupancy has been issued with respect to each condominium unit . . .
Id. at 2 (bracketed portion in the opinion’s quotation of Section 5.1).
Although Dr Katz did not cast his argument in terms of mistake, he did argue that the members had intended the LLC to be used as the vehicle to own the facilities used by the PA in order to obtain tax benefits. Id. at 5. He claimed that the members did not know of the language of Section 5.1. Id. at 6. Chancellor Noble rejected those arguments out-of-hand:
Dr. Katz would have the Court ignore the plain language of Section 5.1 in deference to his recollection of the parties’ intention that KSA would continue as an entity long after the completion of Bayview Medical Center….
Id. at 5.
The Chancellor also noted that Dr. Katz had not argued waiver, estoppel or acquiescence. Id. at 6 n.20. In retrospect, that was a mistake. Whatever else is true, the LLC did continue doing business for over two years after the completion of the facility. Dr. Alfieri left the practice, withdrew from the LLC, and then bought his unit (presumably, the space he had already been using). The practice PA continued to lease the remainder of the building until Dr. Spellman left the practice, at which point the LLC sold a second unit.
How should the law handle a variance between the agreements and the practice of the parties? Continuation of a business beyond an agreed term or undertaking, and without an express agreement to do so, was common enough that, almost a hundred years ago, the UPA addressed it (Section 23). RUPA continues to provide for it (Section 406). ULLCA Section 802(b) does permit the members to waive winding up, but the ULLCA does not address a continuation without a waiver. Section 18-806 of the Delaware LLC Act does allow "revocation of dissolution," but only by "the affirmative vote or written consent of all remaining members…."
All the LLC statutes need to address the problem of "holdover" LLCs. The R/UPA approach of falling back on the statutory default may not be the right solution. For example, under Section 18-801(a)(1) of the Delaware LLC Act, the statutory default is perpetual existence. One the other hand, the substance of the RUPA statutory default–an "at will" entity–may well be proper to handle holdovers.
In the absence of a legislative solution, UBE documents should address the problem.
Time to get to work.
Hat tip to the Delaware Business Litigation Report.
posted by Gary Rosin
This entry was posted on Friday, February 20th, 2009 at 3:34 pm and is filed under Commentary, LLCs. You can follow any responses to this entry through the RSS 2.0 feed.
You can leave a response, or trackback from your own site.
Holdover LLCs. Spellman v. Katz (Del. Ch. 2009)
What happens when the practice of the members of an Unincorporated Business Entity (UBE) varies from the terms of the UBE’s constitutive documents? In a recent opinion in Spellman v. Katz, C.A. No. 1838-VCN (Del. Ch. February 9, 2009), Vice Chancellor Noble invoked the Parole Evidence Rule to prohibit the consideration of evidence showing that the members of an LLC had disregarded a provision in the LLC Agreement.
In Spellman, Doctors Katz, Spellman and Alfieri formed Delaware Bay Surgical Services, P.A. as the vehicle for the joint practice of medicine. At the same time, the three also formed KSA, L.L.C. The LLC bought a piece of property, constructed a building, Bayview Medical Center, and leased it (or a portion of it) to the PA. At some point, Dr. Alfieri withdrew form the LLC (and, presumably, the PA), and bought one of what eventually became three "units" from the LLC. In February, 2002, after an unsuccessful attempt to force dissolution of the PA, Dr. Spellman withdrew from the practice. In 2002, presumably after Spellman’s departure, another unit in the building was sold. Dr Katz continues to practice through the PA, and the PA continues to lease a unit in the building. Slip Op., at 1-2 & nn. 1-4.
In his recent opinion, Chancellor Noble granted Dr. Spellman’s request for dissolution of the LLC and the appointment of a liquidating trustee. Section 5.1 of the LLC Agreement provided for dissolution and winding up of the LLC
Id. at 2 (bracketed portion in the opinion’s quotation of Section 5.1).
Although Dr Katz did not cast his argument in terms of mistake, he did argue that the members had intended the LLC to be used as the vehicle to own the facilities used by the PA in order to obtain tax benefits. Id. at 5. He claimed that the members did not know of the language of Section 5.1. Id. at 6. Chancellor Noble rejected those arguments out-of-hand:
Id. at 5.
The Chancellor also noted that Dr. Katz had not argued waiver, estoppel or acquiescence. Id. at 6 n.20. In retrospect, that was a mistake. Whatever else is true, the LLC did continue doing business for over two years after the completion of the facility. Dr. Alfieri left the practice, withdrew from the LLC, and then bought his unit (presumably, the space he had already been using). The practice PA continued to lease the remainder of the building until Dr. Spellman left the practice, at which point the LLC sold a second unit.
How should the law handle a variance between the agreements and the practice of the parties? Continuation of a business beyond an agreed term or undertaking, and without an express agreement to do so, was common enough that, almost a hundred years ago, the UPA addressed it (Section 23). RUPA continues to provide for it (Section 406). ULLCA Section 802(b) does permit the members to waive winding up, but the ULLCA does not address a continuation without a waiver. Section 18-806 of the Delaware LLC Act does allow "revocation of dissolution," but only by "the affirmative vote or written consent of all remaining members…."
All the LLC statutes need to address the problem of "holdover" LLCs. The R/UPA approach of falling back on the statutory default may not be the right solution. For example, under Section 18-801(a)(1) of the Delaware LLC Act, the statutory default is perpetual existence. One the other hand, the substance of the RUPA statutory default–an "at will" entity–may well be proper to handle holdovers.
In the absence of a legislative solution, UBE documents should address the problem.
Time to get to work.
Hat tip to the Delaware Business Litigation Report.
posted by Gary Rosin
This entry was posted on Friday, February 20th, 2009 at 3:34 pm and is filed under Commentary, LLCs. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.