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

Friday, 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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Guardianships and Durable Powers of Attorney. Russell v. Chase Investment Services Corp. (OK 2009)

Tuesday, September 22nd, 2009

In Russell v. Chase Investment Services Corp., 212 P.3d 1178, 2009 OK 22 (2009)(on certified question), the Oklahoma Supreme Court, held that, under Oklahoma law, the appointment of a guardian for the estate of a person does not terminate an earlier Durable Power of Attorney.

Section 1074.A of the Oklahoma version of the Uniform Durable Power of Attorney Act provided:

If, following execution of a durable power of attorney, a court of the principal’s domicile appoints a conservator, guardian of the estate, … the attorney-in-fact is accountable to the fiduciary as well as to the principal. The fiduciary has the same power to revoke or amend the power of attorney that the principal would have had if he were not disabled or incapacitated.

29 OK 22 at ¶12 (emphasis in original).  The last sentence of Oklahoma Section 1074(b) differs from the bracketed last sentence of Section 108(b) the Uniform Act.

[The power of attorney is not terminated and the agent’s authority continues unless limited, suspended, or terminated by the court.]

Unif. Durable Power of Att’y Act § 108(b) (emphasis added).

Gary Rosin

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“Check the Box” as Diagnostic

Tuesday, September 22nd, 2009

Heather M. Field (UC-Hastings) argues in Checking in on “Check-the-Box,” 42 Loy. L.A. L. Rev. 451 (2009) that

… the check-the-box election … lacks a coherent set of limitations….  …the policy weaknesses … of the check-the-box regulations stem fundamentally from the existence of a multi-regime system for taxing businesses.

It’s not just the “multi-regime system.”  Partnership taxation is built on an extreme aggregate view of partnerships that was not true in 1954 (or before) and still isn’t true.  Even under the UPA’s tenancy-in-partnership, partners have no meaning individual rights in, or access to, partnership property.  Partnership property is dedicated to partnership purposes; all an individual partner has is the right to distributions (if, as and when approved by the partners).  RUPA-based partnership statutes now vest title to partnership property in the entity, and not the partners. 

It’s hard to ensure economic substance in partnership allocations when the partnership tax regime itself has no economic substance.  Well, apart from the tax regime itself.

Now, if I were the Tax Czar, I’d  like to see

  1. an entity-level income tax on all multi-owner businesses, with deductions of distributions to owners, and
  2. an income tax on distributions to owners, except for, in a liquidating distribution, the amount of the original investment.

That level would the field, both as between entities, and as between debt and equity. 

Hat-tip to Paul Caron (Tax Prof blog).

Gary Rosin

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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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LLC Not Bound by Agreement Signed by Manager. Credit Suisse Securities (USA) LLC v. West Coast Opportunity Fund LLC (Del Ch. 2009)

Friday, August 21st, 2009

The facts in Credit Suisse Securities (USA) LLC v. West Coast Opportunity Fund, LLC, C.A. No. 4380-VCN (Del. Ch. Ct. July 30, 2009) are fascinating, though complicated. 

  • Evans was the sole member and manager of Investment Hunter LLC (“Holding LLC”), which was the sole member of WindHunter LLC. 
  • In December 2006, Holding LLC became the controlling shareholder of GreenHunter Energy, Inc. (“Operating Corp.”) after a reverse-merger of WindHunter into an insolvent corporation.  Evans became Operating Corp.’s CEO and President.
  • In March 2007, Operating Corp. entered into a PIPE transaction with group of investors.  That is, it issued shares, and agreed that “as soon as possible” (but within a year) register the shares for resale to the public (“registration rights”). 
  • In connection with the registration rights, all of the executive officers of Operating Corp., including Evans entered into a Lock-up Agreementagreeing that they would not, without the consent of the lead investor, pledge or sell, directly or indirectly, any shares of Operating Corp. until 360 days after the effective date of the registration statement covering the shares purchased by the investors.
  • Evans signed the Lock-Up Agreement in his own name, and described himself as “Chief Executive Officer”, but did not name either Operating Corp. or Holding LLC.
  • In July 2008, Holding LLC opened a margin account with, and borrowed substantial sums from, Credit Suisse.  At that time, Holding LLC pledged its shares of Operating Corp. to secure repayment of the loan.
  • “Within a few months” the value of the Operating Corp. shares dropped, and Credit Suisse issued a margin call.  Operating Corp. and the lead investor claimed that any sale of the pledged shares by Credit Suisse would violate the lock-up agreement.
  • On December 29, 2009, a registration statement covering the sale of the lead investor’s shares was declared effective.

In February, 2009, Credit Suisse sued, claiming, among other things, that the lock-up agreement did not prevent its sale of the pledged shares to meet the margin call.   Vice Chancellor Noble held that the Holding LLC was not bound by the lock- up agreement, and granted judgment on the pleadings on that claim.

Evans does not own the GreenHunter stock in question. It is entirely the property of [Holding LLC] , and Evans’s status as a member does not alter this fact.  Evans did not sign the Lockup Agreement in his capacity as a member or manager of Investment Hunter, and there is, as noted, no evidence of an intent to act in that capacity. Therefore, the Lockup Agreement does not serve to bind [Holding LLC]. ‘[T]he ordinary rule is that only the formal parties to a contract are bound by its terms.  Because [Holding LLC]  is not a party to the Lockup Agreement it is not bound by it. Evans cannot encumber property he does not own.

Id.at 8-9 (footnotes omitted) (emphasis added).   It does not appear that Credit Suisse claimed that Evans acted on behalf of Holding LLC.  Because Evans was not designated as the ‘Chief Executive Officer’ of Holding LLC, the addition of that language does not show an intent to act on behalf of the LLC.  Still, given that the Chancellor was dismissing on the pleadings, it seems odd for him to refer to the lack of evidence that Evans was acting on behalf of Holding LLC.  I’m a transactional sort, but I thought that evidence came after the pleadings.

As to the argument that the “directly or indirectly” language of the lock-up agreement was broad enough to include the Holding LLC’s shares, Chancellor Noble responded

Perhaps [the parties] intended that the Lockup Agreement prohibit the very behavior Evans is alleged to have engaged in. Yet, nothing on the face of the Lockup Agreement evinces such an intent to bind [Holding LLC] or any other entity with which Evans has a relationship. Instead, it binds only Evans.

Slip Op., at 9.  Earlier, in a footnote, the Chancellor had noted that there were no allegations sufficient to make out a claim for disregard of the corporate fiction.  Id. at 9 n.23.

 

Hat-tip Francis G.X. Pileggi.

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Lawyer Duties to Third-Parties. Moore v. Weinberg (SC 2009)

Saturday, August 15th, 2009

In Moore v. Weinberg, Opinion No.  26702 (SC August 12, 2009), a lawyer was representing a plaintiff in a law suit in which $100,000 had been deposited in escrow with the clerk of the court.  The lawyer’s client borrowed money from Lender, and gave Lender a security interest in the client’s interest in the escrowed funds.  The lawyer had drafted the documents for the loan and lien.  When the lawsuit settled, and the lawyer received the funds in escrow, the lawyer apparently forgot about the lien, and paid the money to the client. 

Lender sued lawyer for negligence and conversion, and the trial court granted summary judgement in favor of the lawyer.  On the negligence claim, the Supreme Court reasoned that the lawyer had assumed the role of an escrow agent:

[Lawyer] contends that allowing a cause of action against an attorney under these circumstances will intrude upon the attorney/client relationship and greatly hinder an attorney’s ability to represent his client.  In our view, [this] argument misses the mark.  [Lawyer] acted as the escrow agent and owed a fiduciary duty to [Lender] by virtue of this role.  Therefore, it makes no difference that [Lawyer] was [the client’s]  lawyer and represented him in other matters.  Under the facts of this case, the duty arises from an attorney’s role as an escrow agent and is independent of an attorney’s status as a lawyer and distinct from duties that arise out of the attorney/client relationship. 

* * * … [Lawyer]  essentially admitted that he was negligent in failing to disburse the funds in accordance with the agreement by testifying that he simply overlooked the terms of the agreement. 

I would agree with the Court if the lawyer had assumed the role of escrow agent.  According to the opinion, the funds were in the registry of the Court–the county clerk was the escrow agent.  It seems to me that the lawyer never assumed the role of escrow agent.  If that’s the case, it’s hard to see how the lawyer owed fiduciary duties to Lender.  Still, the opinion only reversed the summary judgment; there is no finding by the fact-finder that the lawyer acted as escrow agent.  There’s still time to get this issue right.

Apart from the negligence claim, there was also a conversion claim.  As to that, the Court found that there a material issue was a material question of fact on the issue of whether the lawyer had knowing converted the funds by [paying them to the client.

Hat tip Legal Profession Blog.

Gary Rosin

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Sole Proprietorships as Entities?

Thursday, August 13th, 2009

In a recently published article, Unconscious Classism: Entity Equality for Sole Proprietors,11 U. Pa. J. Const. L. 215 (2009), Mitchell F. Crusto (Loyola) argues that sole proprietorships are discriminated against in that they are not afforded entity treatment.  To remedy this, he proposes a Uniform Sole Proprietorship Act (USPA) modelled on the UPA and the RUPA.   Id. at 268 app B. 

Crusto’s USPA largely follows the structure of the UPA.  For example, he would not follow RUPA sections 203 and 502 and make the sole proprietorship the owner of property.  Rather, under Section 16(a),

“A sole proprietor is the sole owner of specific sole proprietorship property holding as an “owner in sole proprietorship.”

USPA § 16(a). 

USPA section 16 differs from UPA section 25 in two major respects.   First, there is no requirement that the sole proprietor can use firm property only for firm purposes.  Second, the sole proprietor’s rights in specific property of the sole proprietorship are assignable, USPA § 16(b), but can be attached or executed against only for claims against the sole proprietorship, USPA § 16(c).

I assume the rationale is that the sole proprietor’s consent may be presumed.  Yet, in USPA Section 5 tracks UPA Section 9 in limiting the apparent authority of a sole proprietor to acts “apparently carrying on in the usual way the business of the sole proprietorship”.  USAP § 5(1) & 5(2).  Oddly, though, the USPA would give the sole proprietor authority to take the extraordinary acts listed in UPA Section 9(3).  USPA § 5(3).

More importantly, strict asset segregation is the hallmark of the modern view of an “entity.”  Without that there is little chance of limited liability for firm obligations.  Although Crusto at times argues for that, id.at 262,  USPA Section 9 makes the sole proprietor fully liable for firm obligations.  In Crusto’s view, granting general entity status is “an essential first step toward a limited liability sole proprietorship statute (“LLSP”).  Id. at 263.  But not without strict asset segregation.

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Unfinished Business & Law Firms

Wednesday, August 12th, 2009

As noted earlier, In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), involves the concept of unfinished business.  That concept grows out of UPA Section 34(1)(a), which provides that, after dissolution,  partners have the power to bind the partnership “[b]y any act appropriate for . . . completing transactions unfinished at dissolution.”  

In a law firm, the primary unfinished business would include the representation of clients in matters already begun, but not yet completed.  We often associate law-firm unfinished business with contingent-fee litigation, but even matters billed on an hourly basis could have substantial remaining work–consider a major acquisition or commercial litigation, for example.  Unfinished business in no different from unbilled hourly matters or unpaid receivable; all must be finished, billed and collected for the benefit of the old firm. 

The Brobeck waiver of the firm’s interest in unfinished business amounted to a distribution in kind of that business.  It is well-settled that partners may agree to distributions in kind, rather than liquidations by sale and distributions of cash.  As noted by the Brobeck court, completing unfinished business of a law firm “can be protracted”.  Slip Op. at *8.  Given that, the court concluded that

an agreement that immediately disposes of unfinished business and minimizes the disruptive impact of a dissolution is appropriate, and the court will not fault them for complying with this aspect of California law.

Id.

The problem was that the Brobeck firm was not only insolvent, but also an LLP; its partners were not liable for the obligations that the firm could not cover.  There is a very real difference between the interests of the firm and those of its partners.  In that context, partner consent should not be sufficient to avoid a breach of the duty of loyalty to the partnership.  Yet the court treated the duty to account as operating only as among the partners. 

The court gestured towards the principle that agreements solely among partners cannot override the rights of creditors.  Slip. Op.at *10.  That said, the court incorrectly viewed the insolvency of the partnership as relating only to the general creditors’ remedy of the fraudulent transfer laws.  The duty to act for the benefit of the partnership cannot allow partners to strip assets from an insolvent firm.  any assertion otherwise is “manifestly unreasonable.”

Gary Rosin

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Law-Firm Dissolutions & Fiduciary Duties. In re Brobeck, Pheleger & Harrison, LLP (Bankr. N. D. Cal 2009)

Wednesday, August 12th, 2009

Prior to filing bankruptcy, in order to facilitate an orderly liquidation and movement of attorneys to other firms, the law firm of Brobeck, Phleger & Harrison, LLP (“Brobeck”) amended its partnership agreement to include a waiver of the rights of the firm and its partners to any “unfinished business” of the firm, as that term is defined in Jewel v. Boxer. 

In In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), the bankruptcy court held that the provision was valid as a matter of California partnership law but was a fraudulent transfer because it was a transfer of interests in Brobeck’s property that was made while Brobeck was insolvent and without the receipt by Brobeck of any value in return.

In Jewel v. Boxer, 156 Cal.App.3d 171, 203 Cal.Rptr. 13 (1984), a California court of appeals held that, in the absence of an agreement otherwise, when a partnership dissolves, the partners have a duty to account to the dissolved firm and their former partners for profits earned on the dissolved firm’s unfinished business after deducting for overhead and reasonable compensation.  The Jewel case involved contingency fee matters, but later cases made clear that the rule also applies to hourly rate matters.  Many Brobeck partners were familiar with the Jewel duty to account because a law firm had recently sued Brobeck for an accounting of profits earned on unfinished business completed by former partners of that firm who went to Brobeck.  As the dissolution of Brobeck loomed, the Brobeck policy committee thus recommended that the  partnership agreement be amended to include a provision waiving Jewel claims that Brobeck would have against its former partners or their new firms except for two specified matters.  The amendment received the requisite approval of the partners, and Brobeck proceeded to dissolve.  After Brobeck entered involuntary bankruptcy, the trustee asserted various claims against the Brobeck partners and several firms who had hired Brobeck partners.  The trustee settled with most of the partners and the two firms to which most Brobeck partners moved, but certain Jewel claims were not settled, and the trustee asserted these claims against two firms and ten former Brobeck partners who moved to those firms.

The court first analyzed whether the Jewel waiver was valid under California partnership law.  The court concluded that the partners were not only free to adopt such a provision, but were, in fact, encouraged by the case law in this area to adopt an agreement as to how to handle unfinished business in a way that immediately disposes of unfinished business and minimizes the disruptive impact of the dissolution.  The court rejected the trustee’s arguments that the waiver ran afoul of the RUPA provision permitting modification of the duty of loyalty by identifying “specific types or categories of activities that do not violate the duty of loyalty” so long as the modification is not  “manifestly unreasonable.”  The trustee argued that the provision was not specific enough because it did not refer to the partners’ duty of loyalty, but the court stated that specific reference to the duty of loyalty, while “it may be a prudent exercise,” is not required for a valid modification of the duty under RUPA.  The court also rejected the trustee’s argument that the provision was “manifestly unreasonable.”  The court stated that it was left to rely on its common sense in the absence of case law defining the term, and the court concluded that the Jewel waiver was not “manifestly unreasonable.”  The court reasoned that the waiver did not eliminate the duty of loyalty, but merely modified the duty to account, which is just one of the three duties of loyalty set forth in RUPA.  The court stated that Brobeck’s insolvency at the time of adoption of the waiver did not affect its validity under RUPA because RUPA does not govern the relationship of the partnership or its partners to third parties, such as creditors.

While the court determined that the Jewel waiver was lawful and valid under RUPA, the court ultimately determined that the waiver was avoidable as a fraudulent transfer.  The court held that profits from unfinished business amounted to property of Brobeck and that the waiver effected a transfer of that property to the partners.  Although the court concluded that the trustee failed to meet his summary judgment burden with respect to actual intent to hinder, delay, or defraud a creditor, the court concluded that the trustee was entitled to summary judgment that the Jewel waiver was a constructively fraudulent transfer.  The parties did not dispute that Brobeck was insolvent when the waiver was approved, and the court concluded that there was no evidence that Brobeck received anything of value in exchange for the waiver.  Thus, the waiver was avoidable as a fraudulent transfer, and the partners, as initial transferees, and their new firms, as immediate transferees, were liable to the extent of profits received on Brobeck’s unfinished business.

Elizabeth Miller

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Series LLCs & Assumed Names

Tuesday, June 23rd, 2009

Delaware, § 18-215(a), Illinois, 805 ILCS 180/37‑40(a), and Texas, Tex. Bus. Org Code § 601.101 (added by Section 45 of SB 12442), all allow the operating agreement (however named) to 'establish" one or more series.  Only Illinois conditions asset and liability partitioning on the filing of a certificate of designation, § 37-40(b), that specifies the name of the series, § 37-40(d).  Also, only llinois expressly provides that

  • a series with asset and liability partitioning may be a separate entity:  "A series with limited liability shall be treated as a separate entity to the extent set forth in the articles of organization."   § 37-40(a).

  • the existence of a series begins when a certificate of designation is filed, § 37-40(d),

But what about assumed name filing requirements?  Presumably, that ought not to be an issue in Illinois–the name is already of record, and would not be an assumed name of the LLC itself.  Or at least, that's the way I'd set it up. 

In Delaware and Texas, not only is establishing an LLC entirely private, but also a series is not formally a separate entity.  The use of a series name would then seem to require a filing under the assumed name statute.  For example, under Tex. Bus. & Commerce Code Section 71.002(2)(H), an LLC's name in its "certificate of formation or comparable document" is not an assumed name. Interestingly, although Section 62 of SB 1442 amended TBCC section 71.002, it did not amend subdivision (2)(H). 

A question for practitioners who are UB readers : how are handling the assumed name issue?

posted by Gary Rosin

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