Unincorporated Business Entities Law

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