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Delaware, Charging Orders and SMLLCs

Friday, May 10th, 2013

House Bill No. 126, introduced in the Delaware legislature on May 9, 2013, would make two amendments to the Delaware LLC Act that would affect the rights of creditors. First, Section 6 of the Bill would Section 18-703(d) of the Delaware LLC Act to read as follows:

(d) The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or a member’s assignee may satisfy a judgment out of the judgment debtor’s limited liability company interest and attachment, garnishment, foreclosure or other legal or equitable remedies are not available to the judgment creditor, whether the limited liability company has 1 member or more than 1 member.

House Bill No. 126, 147th Leg., § 6 (Del. May 9, 2012)(underlining in original, italics added). Second, Section 7 of the Bill would amend § 18-1101 of the Delaware LLC Act by inserting a new sub-paragraph (j), to read :

(j) The provisions of this chapter shall apply whether a limited liability company has 1 member or more than 1 member.

Id. at § 7 (underlining in original).

The first part of the amendment to § 18-703(d) elaborates on what “exclusive remedy” means. Among other things, it seems intened to avoid the result in cases such as would avoid the result, in cases such as Hotel 71 Mezz. Lender LLC v. Falor, 2010 NY Slip Op 01348, 14 NY3d at 307, 926 N.E.2d 1202 (2010) (slip Op.) and Olmstead v. Federal Trade Commission, 44 So. 3d 76 (Fla. 2010)(slip Op.), in which courts held that general creditors remedies, such as attachment (Falor) and levy and execution (Olmstead), can be used to reach interests in LLCs.

The second part of the amendment to §18-703(d), and new 18-1101(j) is aimed at the result, in cases such as Olmstead, and In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003), that allow a transferee of the interest of the sole member in a single-member LLC (SMLLC) to succeed to both the economic and the management rights of the member. With the SMLLC amendments, Delaware joins the race-to-the-bottom for the state most-friendly to the use of SMLLCs for asset p;rotection.

Gary Rosin

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Posted in Delaware, Legislation & Regulations, LLCs, Ownership Interests in UBEs, Statutes, Uncategorized | No Comments »

Delaware Default Fiduciary Fix

Friday, May 10th, 2013

In its per curiam opinion in Gatz Properties, LLC v. Auriga Capital Corporation, 59 A.3d 1223 (Del. 2012)(en banc) (slip opinion), the Delaware Supreme Court called on the Delaware legislature to settle the questions of whether, when the LLC agreement is silent, those involved with LLCs owe fiduciary duties. See Gary Rosin, Gatz Properties, LLC. v. Auriga Capital Corp. (Del. 2012): Strine Affirmed on other Grounds and Chastised (Nov. 8, 2012).

Proposed legislation has been working its way through the Delaware State Bar Association. On May 9, 2012, the result, House Bill No. 126, was introduced in current Delaware legislative session. Section 8 of the bill provides:

Section 8. Amend § 18-1104, Title 6 of the Delaware Code by making insertions as shown by underlining as follows:

In any case not provided for in this chapter, the rules of law and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern.

As noted by Doug Batey, Uncertainty Over Delaware LLC Fiduciary Duties To Be Clarified (April 16, 2013), the bill implicitly endorses the reasoning of Chancellor Stine in Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. 2012) (slip op.) that fiduciary duties are rooted in equity.

As a side note, in his opinion in Feeley v. NHAOCG, LLC, C.A. No. 7304-VCL (Nov. 28, 2012)(slip op.), Vice Chancellor Laster noted that , in Gatz Properties, LLC, the Delaware Supreme Court had left open the question of default fiduciary duties, and had Chancellor for even discussing the question. Laster then treated Strine’s opinion as if it were a law review article, slip op, at 16-17, and adopted Strine’s reasoning. Feeley , slip op. at 14-22. Laster’s opinion also has a nice discussion of the introductory phrase to Del. Sec. 18-1101(c), which allows contracting out of fiduciary duties:

To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties),

As explained by the Vice Chancellor, whether a member, or some other person, owes fiduciary duties is context specific. For example, in a manager-managed LLC, a non-controlling member does not owe fiduciary duties. Likewise, a person who is not a manager or a member might assume fiduciary duties by becoming and office or agent of the LLC. Feeley, slip op. at 18-21.

Gary Rosin

 

 

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Manesh on Dictum & Default Duties

Tuesday, March 12th, 2013

 

Mohsen Manesh (Oreg.) has a working paper with the alliterative title Damning Dictum: The Default Duty Debate in Delaware” (February 21, 2013)(SSRN). The paper reacts to the Delaware Supreme Court’s opinion in Gatz Properties, LLC. v. Auriga Capital Corp., C.A. 4390 (Del. Nov. 7, 2012)(per curiam), aff’g on other grounds, Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. 2012) (slip opinion). As discussed in Gatz Properties, LLC. v. Auriga Capital Corp. (Del. 2012): Strine Affirmed on other Grounds and Chastised, in his opinion below, Chancellor Strine had outlined the basis for applying default fiduciary duties to persons managing Delaware LLCs, and the Delaware Supreme Court rebuked him for doing so.

Prof. Manesh criticizes the Delaware Supreme Court’s opinion in Gatz Properties, LLC on several grounds. Two of the most important are:

  • The Court needlessly unsettled expectations that default fiduciary duties apply, except where modified or eliminated by agreement.
  • Not only have both the Delaware Chancery and Supreme courts long used dicta to guide the development of the law, that practice is central to the pre-eminence of those courts, and of Delaware generally, in the law of business organizations.

Gary Rosin

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Ethics and Ellipsis. Ly v. Jimmy Carter Commons, LLC (Ga. 2010)

Thursday, February 7th, 2013

Probably, every lawyer has used an ellipsis to show that a portion of the text was left out of a quotation. But what are the ethics of elision and inclusion?

Consider, if you will, the opinion in Ly v. Jimmy Carter Commons, LLC, 286 Ga. 831, 691 S.E.2d 852 (2010). A manager of an LLC (Byun) purported to borrow money on behalf of the LLC in connection with a real estate development. As part of the closing documents, the manager gave the lender a purported “Unanimous Consent of the Manager and Members” that authorized the manager to borrow the money, sign the promissory note, and the mortgage on the LLC’s land to secure payment of the note. As it turned out, one of the signatures was forged. When the LLC defaulted on the note, the LLC sued the lender to enjoin foreclosure, and to void the note and mortgage, on the grounds that the manager lacked the authority to borrow the money, or to sign the note and the mortgage. The trial court granted summary judgment in favor of the LLC. The Georgia Supreme Court reversed, holding that there was a question of fact.

What is interesting about the opinion is not the result; rather it is the reasoning of the opinion, and the way the opinion used the Georgia LLC statute.

* * * … there is still a genuine issue of material fact as to whether Appellants had knowledge that the unanimous consent documents were ineffective and did not give Byun the authority to act alone on behalf of Jimmy Carter Commons.

[T]he act of any manager [of a limited liability company] … binds the limited liability company, unless the manager so acting has, in fact, no authority to act for the limited liability company in the particular matter, and the person with whom he or she is dealing has knowledge of the fact that the manager has no such authority. (Emphasis supplied.)

OCGA § 14-11-301(b)(2). Thus, “[n]o act of a manager … in contravention of a restriction on authority shall bind the limited liability company to persons having knowledge of the restriction.” OCGA § 14-11-301(d).

Consequently, even if Byun acted beyond his authority as a manager of Jimmy Carter Commons, the limited liability company may still be bound by his actions if Appellants did not know that he lacked such authority. In its summary judgment order, the trial court did not cite, and Jimmy Carter Commons has not identified, undisputed evidence showing that Appellants knew that Choi’s signatures on the consent documents were forged. * * *

691 S.E.2d at 853.

Here is the complete text of Section 14-11-301:

§ 14-11-301. Powers, duties, and authority of members and managers

(a) Except as provided in subsection (b) of this Code section, every member is an agent of the limited liability company for the purpose of its business and affairs, and the act of any member, including, but not limited to, the execution in the name of the limited liability company of any instrument for apparently carrying on in the usual way the business and affairs of the limited liability company of which he or she is a member, binds the limited liability company, unless the member so acting has, in fact, no authority to act for the limited liability company in the particular matter, and the person with whom he or she is dealing has knowledge of the fact that the member has no such authority.

(b) If the articles of organization provide that management of the limited liability company is vested in a manager or managers:

(1) No member, acting solely in the capacity as a member, is an agent of the limited liability company; and

(2) Every manager is an agent of the limited liability company for the purpose of its business and affairs, and the act of any manager, including, but not limited to, the execution in the name of the limited liability company of any instrument for apparently carrying on in the usual way the business and affairs of the limited liability company of which he or she is a manager, binds the limited liability company, unless the manager so acting has, in fact, no authority to act for the limited liability company in the particular matter, and the person with whom he or she is dealing has knowledge of the fact that the manager has no such authority.

(c) An act of a manager or a member that is not apparently for the carrying on in the usual way the business or affairs of the limited liability company does not bind the limited liability company unless authorized in accordance with a written operating agreement at the time of the transaction or at any other time.

(d) No act of a manager or member in contravention of a restriction on authority shall bind the limited liability company to persons having knowledge of the restriction.

(emphasis added).

Any partnership lawyer will recognize subsections (a), (b)(2), and (d) as taken from section 9 of the Uniform Partnership Act, and adapted for member-managed and manager-managed LLCs. Any partnership lawyer will also recognize the centrality of the language omitted by the court, especially the portion in bold italics. As written, Section 14-11-301 conditions a manager’s power to bind the LLC by an unauthorized act to acts “apparently carrying on the the usual way the business and affairs of the LLC.” As subsection (c) makes clear, unauthorized acts that are not apparently carrying on in the usual way the business and affairs of the LLC do not bind the LLC. The result of the misquotation–the ellipsis–is a radical expansion of the apparent authority of LLC’s manager: not just usual acts, but any act, without regard to its nature.

This seems to me to be a particularly pernicious use of the ellipsis; one that changes the character of the quotation. Even non-lawyers recognize that intentionally omitting important information is unethical. Thanks to Seinfeld, we even have an expression that describes an elision made in bad faith: “yada, yada.”

The question here is whether the justices on the Court knew that a key part of the statute had been dropped out. One might attribute the misquotation to the not-uncommon phenomenon of unfamiliarity with agency principles, and unincorporated business entity law, or, instead, to an overcrowded docket. Still, it is hard to imagine that none of the justices read Section 14-11-301 closely, or that, on close reading, none noticed its limits on apparent authority.

That said, the result–overturning the summary judgment–is probably correct. Whether borrowing money is apparently carrying on in the usual way the LLC’s business is a question of fact that turns on the nature of the LLC’s business. Jimmy Carter Commons, LLC seems to have been a real estate development 0company. Such companies are more likely to be customary frequent borrowers than, say, a company selling advertising slots on a border radio station. See, Burns v. Gonzalez, 439 S.W.2d 128 (Tex Civ. App. 1969).

But, as I suggested in my earlier post, Conflating Tests for Agents and Servants, there is no such thing as a “harmless” misstatement of the law by a court. Given that the misstatement here is by the Georgia Supreme Court, only a later opinion of that court can put Georgia law back on the right course.

Gary Rosin

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Gatz Properties, LLC. v. Auriga Capital Corp. (Del. 2012): Strine Affirmed on other Grounds and Chastised

Thursday, November 8th, 2012

Yesterday, the Delaware Supreme Court handed down its opinion in  Gatz Properties, LLC v. Auriga Capital Corp., C.A. No. 4390 (Del. Nov. 7, 2012). As expected form oral argument,  the Court affirmed Chancelllor Strine’s holding of earlier this year, but on other grounds.

In Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d  839 (Del. Ch. Ct. 2012) (slip opinion), Chancellor Strine held that a controlling owner of the manager of an LLC violated its duty of loyalty in connection with a  self-interested merger of the LLC. Chancellor Strine reasoned that, unless clearly eliminated by agreement, the managing and controlling persons of a Delaware LLC owe traditional “default fiduciary duties.”

The Delaware Supreme Court affirmed on the grounds that the LLC Agreement directly imposed a contractual duty of loyalty, and thus, entire fairness review.  Slip Op, at 12-20. The Court reserved the question of default fiduciary duties, but noted that

whether the LLC statute does—or does not— impose default fiduciary duties is one about which reasonable minds could differ. Indeed, reasonable minds arguably could conclude that the statute—which begins with the phrase, “[t]o the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties)”—is consciously ambiguous. That possibility suggests that the “organs of the Bar” (to use the trial court’s phrase) may be well advised to consider urging the General Assembly to resolve any statutory ambiguity on this issue.

Slip. Op., at 626-27.  The Court then criticized Chancellor Strine for addressing an issue that, in the view of the Court, was not properly before him:

We remind Delaware judges that the obligation to write judicial opinions on the issues presented is not a license to use those opinions as a platform from which to propagate their individual world views on issues not presented. A judge’s duty is to resolve the issues that the parties present in a clear and concise manner. To the extent Delaware judges wish to stray beyond those issues and, without making any definitive pronouncements, ruminate on what the proper direction of Delaware law should be, there are appropriate platforms, such as law review articles, the classroom, continuing legal education presentations, and keynote speeches.

Slip. Op., at 27 (emphasis added).

Gary Rosin

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Doubling Down on Olmstead: Rossignol v. Rossignol (NY App. Div. 2011)

Monday, March 7th, 2011

In Court Decision Weds Business Divorce with Matrimonial Divorce, on New York Business Divorce Blog, Peter Mahler reports on Rossignol v. Rossignol, 2011 NY Slip Op 01560 (3d Dept Mar. 3, 2011).  In Rossignol, husband and wife were members of an LLC.  After wife filed for divorce, the court entered a restraining order against the husband preventing him from accessing funds in both their personal and the LLC’s banking accounts.  When husband then brought a separate action for involuntary dissolution of the LLC, the trial court dismissed the action because the proceeding for the divorce and the division of marital property involved the “same parties for the same cause of action.”  The appellate court affirmed, reasoning as follows:

Inasmuch as the husband and wife are the only owners of the LLC, and both are parties to the divorce action, we see no reason why any issues should be left for resolution after equitable distribution of the parties’ property. Given the availability of complete relief pursuant to Domestic Relations Law § 234 and our public policy of resolving equitable distribution within the context of a divorce action, we conclude that dismissal of the second action was within Supreme Court’s broad discretion….

Slip Op., at 3-4 (citations omitted).

Mahler is rightly concerned about the apparent disregard of the difference between the LLC and its members.  After the Florida Supreme Court’s opinion Olmstead v. FTC, expanding the rights of personal creditors of the single-member on an LLC (see Charging Orders and Two Kinds of Exclusivity), the Court in Rossignol at least opens the door to a similar result in marital dissolution actions where the spouses are the sole members of the LLC.

posted by Gary Rosin

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

Friday, 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.

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2010 Amendments to Delaware LLC Act

Monday, 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)

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

Monday, 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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