Source: https://www.llccaselaw.com/may-2016-issue-67-2
Timestamp: 2019-04-19 11:11:43+00:00

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The court of appeals upheld the bankruptcy court’s contempt order against an individual lawyer. The bankruptcy court had sanctioned the individual lawyer and her firm, a professional limited liability company, for bringing a frivolous and procedurally deficient motion. When the lawyer and her firm did not pay the ordered sanctions, the court held the lawyer and her firm in civil contempt. The lawyer argued that the bankruptcy court improperly held her jointly and severally liable for actions she performed as a member of her law firm, a Texas LLC. The court stated that Texas law only protects members from being liable for the LLC’s obligations, not their own, citing the Texas LLC statute. The lawyer was held in civil contempt for her failure to pay sanctions she owed because of her own misconduct in prior bankruptcy proceedings. Thus, she was not protected by her membership in the LLC.
In analyzing the fair value of one member’s interest for purposes of the statutorily required purchase of the interest by the LLC when the member dissociated from the LLC, the court relied on certain terms agreed upon by the two members in negotiations over the operating agreement although the members were never able to agree to all of the terms of an operating agreement. The trial court had calculated the value of the member’s interest based on 50% of the value of the LLC, less the amount the member had agreed to contribute, plus the amount the LLC had contributed to an escrow account for the earnest money deposit for the purchase of property by the LLC. Because the evidence showed that the two members had agreed to a 50-50 split only after the return of their capital contributions, and the dissociating member did not make its agreed capital contribution, the court concluded that the dissociating member was only entitled to the return of the amount it had contributed to the escrow account.
Aron Puretz and Lincoln Provision, Inc. (Lincoln) formed an Illinois LLC for the purpose of acquiring and operating two Nebraska cattle-processing plants. The standard form of articles of organization filed to form the LLC stated that management was vested in the members and listed Lincoln and Puretz as the members. Puretz and Lincoln intended to include the details of the LLC’s financing and operations in an operating agreement but were never able to settle on the terms of the operating agreement. To bid on the cattle-processing plants, the LLC was required to make an initial earnest‑money deposit of $250,000 to an escrow account. Puretz contributed $150,000 and Lincoln contributed $100,000 to that amount. The LLC then submitted a successful bid of $3,900,000 for the two plants in a bankruptcy auction. Meanwhile Lincoln, Puretz, and their attorneys exchanged emails and draft operating agreements, but they could not agree on several major issues. The members met in a final attempt to resolve their differences, and notes prepared to summarize those discussions described the issues upon which the members apparently agreed, including that the members’ capital contributions would be repaid in full before the company’s profits and losses were divided equally between the members. Because the members were not able to resolve their disagreements about the financing and operations of the LLC, Lincoln refused to contribute its agreed‑upon 30% of the purchase price for the plants. Puretz thus paid the entire $3,900,000 purchase price, except for the $100,000 from Lincoln’s contribution to the escrow account that was credited to the purchase price.
About a month after the closing of the purchase of the cattle-processing plants, Lincoln’s attorney sent a letter to Puretz’s attorney stating that Lincoln was dissociating from the LLC. Under the Illinois LLC statute, if the LLC does not dissolve on the dissociation of a member, the LLC is required to repurchase the dissociating member’s interest on the terms agreed to by the members. If the LLC does not purchase the interest, the dissociating member may file suit against the LLC to have the court determine the fair value of the interest. Because Lincoln and Puretz had never executed an operating agreement that described the method for calculating the value of a member’s ownership interest in the LLC, Lincoln filed this lawsuit against the LLC (invoking diversity jurisdiction) seeking a determination of the fair value of its interest in the LLC.
After a four-day bench trial, the district court held that Lincoln and Puretz each held a 50% interest in the LLC and that the value of the LLC on Lincoln’s dissociation date was $3,900,000 and that the fair value of Lincoln’s interest was $880,00, calculated as follows: 50% of the $3,900,000 value of the LLC ($1,950,000), less the 30% of the $3,900,000 purchase price that Lincoln failed to contribute at closing ($1,170,000), plus a return of the $100,000 Lincoln contributed to the escrow account. The LLC argued the value of Lincoln’s interest was $100,000, the amount Lincoln contributed toward the acquisition of the plants. The LLC appealed.
The court of appeals agreed with the LLC that the evidence showed that the members agreed to a proportional return of capital prior to any distribution of profits and losses, even though they never finalized an operating agreement. The court reviewed testimony by Lincoln’s president, one of Lincoln’s employees, and Lincoln’s attorney supporting the conclusion that the members agreed that the 50-50 split would occur only after the members received their capital back in a 70-30 split as invested. Because Lincoln refused to make its initial 30% contribution to capital, Puretz actually contributed 100% of the capital to the LLC, less Lincoln's $100,000 payment to the escrow account. Lincoln presented no evidence indicating that Puretz agreed to contribute 70% of the capital to the LLC in exchange for the right to receive only 50% of the capital in repayment of his investment. The court rejected Lincoln’s argument that the district court correctly relied on the LLC’s articles of organization as the best evidence that each member had a “50% interest” in the LLC for all purposes, including for purposes of calculating the fair value of a member’s distributional interest. The articles merely established that the LLC was to be formed as a member‑managed LLC and that management was to be vested in its two members; the articles could not be read to establish the members’ economic interests in the LLC. The court also concluded that the district court did not err in assigning no value to Lincoln’s business plan, “sweat equity,” or unperformed promises to provide management services. The district court correctly concluded that Lincoln’s only contribution was the $100,000 paid to the escrow account.
In sum, the evidence established that Lincoln and Puretz contemplated that any capital they contributed to the LLC would be returned to them in proportion to their respective contributions before any profits or losses generated by the LLC’s operations were divided equally. Because Lincoln did not make its agreed‑upon 30% contribution to capital, it was not entitled to a 30% distribution. Lincoln’s only contribution to the LLC was its $100,000 deposit in the escrow account, and the court of appeals thus remanded with instructions to enter an order awarding Lincoln $100,000.
In this dispute regarding the ownership of an LLC Ford automobile dealership, Moultrie appealed from a judgment that determined Moultrie’s interest was reduced from 51% to 10% pursuant to an amendment of the operating agreement and that Moultrie was divested of that interest because he failed to pay a required capital contribution. The first issue addressed by the Supreme Court was whether the evidence was sufficient for the trial court to find that the members of the LLC amended an LLC operating agreement that specified the ownership interests in the LLC as Moultrie 51% and Wall 49%. The original members of the LLC were Wall and Mariner, but they approached Moultrie to help them with the dealership application process and offered him a 10% interest in the LLC. Based on Mariner’s background, Ford rejected a dealership application that reflected 45% ownership interests by Wall and Mariner and a 10% ownership interest by Moultrie. In July 2009, after rejection of the dealership application that reflected Mariner as an owner, Mariner, Wall, and Moultrie signed an amended operating agreement that specified the ownership of the LLC as Moultrie 51% and Wall 49%. An amended dealership application that specified this ownership was approved by Ford. In August 2009, Wall, Mariner, and Moultrie signed an agreement that provided that Moultrie was to retain a 10% interest in the LLC and participate in profit distributions as a 10% owner. The trial court found that the parties agreed to amend the July 2009 operating agreement based on the August 2009 agreement and other evidence, such as Moultrie’s acceptance of only 10% of the profits during a 2009 tax-planning meeting and K-1 schedules for 2009 and 2010. Under the Alabama LLC statute, the written agreement of all of the members was required to amend the operating agreement unless otherwise provided by the operating agreement, and Moultrie argued that the evidence relied on by the trial court did not satisfy the statutory requirement. Moultrie argued that the supreme court’s strict application of the phrase “agree in writing” in L.B. Whitfield, III Family LLC v. Whitfield should be applied in this case. In Whitfield, the court considered whether the statutory requirement of a written agreement by the holders of all financial rights in an LLC to the continuation of the LLC after the death of the sole member could be satisfied by implication based on the actions of the heirs of the sole member. The court agreed that Moultrie’s oral agreement to accept 10% of the profits at a tax-planning meeting and the accountant’s preparation of tax documents reflecting that agreement would not alone be sufficient to meet the statutory requirement that an amendment of the operating agreement be in writing. But the court stated that the “glaring difference” between the facts in this case and the Whitfield case was the August 2009 agreement signed by Moultrie and Wall in this case. Moultrie pointed out that the copy of the August 2009 agreement submitted into evidence was unsigned, but the court stated that it was undisputed that a signed copy was kept in Wall’s office and was stolen while the litigation was pending. Moultrie argued that it was not clear that the terms of the August 2009 agreement were intended to be an amendment of the operating agreement. The court concluded that the terms were sufficient to constitute an amendment even though the word “amendment” was not used and there was no specific reference to the operating agreement. The court also rejected Moultrie’s argument that the agreement should have been filed with the probate court to have operative effect. The Alabama LLC statute required amendments to an LLC’s certificate of formation to be delivered to the probate court but not amendments to the operating agreement.
The court next addressed Moultrie’s challenge to the trial court’s conclusion that he was divested of his membership interest in the LLC based on his failure to comply with a capital call made by Wall. The court examined the provisions of the operating agreement and concluded that the decision to make a capital call was subject to the general requirement that LLC decisions and actions be approved by a majority in interest of the members at a meeting called with notice to all members. The court rejected Wall’s argument that this general provision did not require a meeting because a provision of the operating agreement that controlled Wall’s request of capital from Moultrie did not specifically require a meeting. Wall contended that the decision to contribute capital was not a company decision but rather one left to the members. The court stated that nothing in the agreement precluded an individual member from contributing additional capital if the member desired, but a decision that the LLC needed a substantial capital contribution and that all members were required to contribute in order to maintain their ownership interest was a company decision or action that required a meeting. Although Wall argued that the urgency of the situation excused him from calling a meeting, the court pointed out that a formal meeting was not required, and Wall failed to show that in the 12-day time frame involved he did not have even a few minutes to schedule an informal meeting such as a conference call. The court also rejected Wall’s argument that no meeting was required because it would have been “fruitless.” Neither the hostility between the parties nor the fact that Wall owned the majority interest required to make the decision overrode the requirement in the operating agreement that all members had a right to a meeting before company decisions and actions were decided by a majority in interest of the members. Finally, the court could not conclude that anything in the operating agreement allowed Wall as the manager of the LLC to make a unilateral demand for capital. Because Wall did not comply with the terms of the operating agreement requiring a meeting when he made the capital call, the court reversed the trial court’s judgment insofar as it held that Moultrie was divested of his 10% interest by failing to contribute additional capital.
The court resolved a dispute about the priority of competing charging orders based on a first-in-time service rule. Charging orders that were served on a Colorado LLC after another creditors’ charging orders nevertheless took priority because the earlier served charging orders were obtained in Arizona and had not been domesticated in Colorado. Thus, the earlier served charging orders were not enforceable at the time they were served, and the later served charging orders were the first enforceable charging orders to be served on the LLC.
The court of appeals held as a matter of first impression that the priority of charging orders issued against Colorado LLCs is determined by first‑in‑time service of charging orders enforceable in Colorado. Charging orders that are enforceable in Colorado include both those issued by Colorado courts as well as foreign charging orders that have been domesticated in Colorado courts. Chase argued that its Arizona‑issued charging orders were enforceable in Colorado because the Arizona court was a “court of competent jurisdiction” under the Colorado charging order statute, and the Arizona charging orders complied with Colorado law. However, Colorado case law has established the primary methods available to foreign judgment creditors seeking to enforce foreign‑state judgments in Colorado: (1) filing a complaint in a Colorado court asserting the existence, details, and enforceability of the foreign judgment; or (2) domesticating the foreign judgment in a Colorado court under the Uniform Enforcement of Foreign Judgments Act. Unless one of these procedures is complied with, foreign charging orders are not enforceable in Colorado. To enforce a foreign charging order against a Colorado LLC based on domestication, the creditor would have to domesticate the charging order and not merely the judgment on which the charging order is based because the charging order “unlike the judgment on which it is based” requires the Colorado LLC to take action, i.e., to pay LLC distributions to the judgment creditor.
The court stated that the rule it announced in this case furthers the interest that Colorado has in LLCs organized in Colorado as demonstrated by the Colorado Limited Liability Company Act. Chase argued that the court’s rule conflicted with the first-in-time service rule applied by a division of the court of appeals in a case involving competing charging orders against a partnership interest. The court distinguished that case on the basis that both charging orders were issued by Colorado courts, and the rule as applied in this case had to take into account the rules regarding enforceability of foreign judgments. The court stated that its holding would not unfairly burden foreign judgment creditors because Colorado has a simplified procedure for rendering foreign judgments enforceable in Colorado: domestication under the Enforcement Act. The court also rejected Chase’s argument that giving the McClures’ charging order priority was a collateral attack on Chase’s Arizona charging orders in violation of the Full Faith and Credit Clause. The Full Faith and Credit Clause protects the final judgments of one state from collateral attack in another state, and application of the rule announced in this case simply determines the enforceability and priority of the competing states’ charging orders, applying the elements described in Colorado case law. Because the McClures were the first to serve charging orders that were enforceable in Colorado, the trial court was correct to declare that the McClures’ charging orders had priority over the Chase charging orders.
This dispute over the distribution of attorney’s fees from a contingent-fee case pending at the time of the dissolution of a two-member LLC law firm presented the Colorado Supreme Court with a matter of first impression in Colorado. LaFond and Sweeney formed a law firm as an LLC, and the oral profit-sharing agreement that was in effect at the time of the firm’s dissolution was that they shared equally in the profits of the firm without regard to their actual workloads. LaFond represented a client in a whistle-blower action on a contingency fee basis. After a considerable amount of work was done on the case, the firm dissolved. Once the firm dissolved, LaFond continued to represent the client in the action. At the time of the dissolution, there was no written agreement describing how the firm’s assets should be distributed, and no written agreement existed regarding how the contingent fee generated by the case would be distributed. LaFond and Sweeney were unable to reach an agreement as to the division of the fees that were potentially going to be earned from the whistle-blower case, and LaFond filed a declaratory judgment action seeking a determination by the court as to how the potential fee should be distributed. The trial court determined that the whistle-blower case had been an asset of the law firm, and the value of the case as an asset of the firm was its value at the time the firm dissolved. The oral agreement between LaFond and Sweeney required any profit from the whistle-blower case to be divided equally, so if LaFond recovered a contingent fee from the case, the trial court held that Sweeney would be entitled to one half of the recovery up to a ceiling of an amount calculated based on the work done and costs advanced as of the date of the dissolution. Sweeney appealed the trial court’s order, and the court of appeals reversed, holding that the trial court should have awarded LaFond and Sweeney each one half of the profits from the case and that LaFond was not entitled to any additional compensation for his post-dissolution work on the case. The court of appeals relied on three principles: (1) cases belong to clients, not to attorneys or law firms; (2) when attorneys handle contingent-fee cases to a successful resolution, they have enforceable rights to the contingent fee; and (3) a contingent fee may constitute an asset of a dissolved law firm organized as an LLC. Additionally, the court of appeals relied on the difference between the language of the Colorado Uniform Partnership Act of 1997 and the Colorado LLC statute to conclude that members or managers of an LLC that perform services in winding up the LLC are not entitled to additional compensation for their post-dissolution services. The supreme court affirmed the judgment of the court of appeals.
The supreme court first addressed the application of the unfinished business rule, which is based on the continued existence of a dissolved LLC law firm through the winding-up period and the fiduciary duties owed by the members and managers of the LLC. The court looked to the Colorado LLC statute to determine whether it required application of the unfinished business doctrine and concluded that it did. Here, a contingent-fee case was brought into the law firm before it dissolved, and LaFond continued to handle the case after dissolution until the case was resolved. Dissolution did not terminate the LLC law firm. Instead, the entity continued as to all existing matters for the purpose of winding up its unfinished business. The pending whistle-blower case was unfinished business to be completed in the process of winding up the LLC. The client agreed to have LaFond continue the representation, and this choice did not alter the contingent-fee agreement or the rights and duties that LaFond and Sweeney owed each other under their business arrangement. The fiduciary duties of members and mangers of an LLC continue to apply during the winding up process, and LaFond was required to hold as trustee for the LLC any profit derived in the winding up of the business. The profits from the whistle-blower case thus belonged to the firm to be distributed in accordance with the profit-sharing agreement that existed at the time of dissolution. The court relied on the California case of Jewel v. Boxer and other out-of-state cases that have held that completing an executory contract is part of winding up a firm’s business. The court rejected the argument that adopting the unfinished business rule violates a client’s right to counsel of his choice, and the court noted compelling reasons to apply the unfinished business rule over the quantum meruit approach advocated by LaFond. The court stated that the unfinished business rule prevents members and managers from competing for the most lucrative cases during the life of the LLC in hopes of retaining them if the LLC dissolves and also discourages members and managers of a dissolved LLC from scrambling to seize client files and solicit clients. The court found nothing fundamentally unfair about the effect of the unfinished business rule and pointed out that members and managers may alter the rule in the LLC operating agreement if they desire.
The court next addressed LaFond’s argument that he was entitled to additional compensation for his services in winding up even if the unfinished business rule applied. Because the Colorado LLC statute requires a member or manager to account to the LLC for the profits derived in the winding up of the LLC’s business and is silent on the issue of additional compensation in winding up, the court concluded that the statute does not provide for additional compensation. The court pointed to the legislature’s inclusion of language in the Colorado Uniform Partnership Act of 1997 expressly providing for compensation of a partner for services in winding up as well as the inclusion of similar language in the Uniform Limited Liability Company Act. The court stated that the legislature’s choice to include such language in Colorado’s partnership statute, and its choice to amend the Colorado LLC statute to include some provisions of the Uniform Limited Liability Company Act but not the provision on compensation in winding up, indicated the legislature’s intent not to provide for compensation of an LLC member or manager in winding up absent a provision in the operating agreement.
The debtor was a Delaware limited liability company formed in 1994 to develop and sell commercial real estate projects in the northeastern and mid–Atlantic states. The debtor was part of a network of real estate companies (sometimes referred to as the “Opus Group”) that originated with a construction company founded by Gerald Rauenhorst in 1953. In 1982, Gerald Rauenhorst created two trusts (the “Trusts”) for the benefit of his children and grandchildren, and the Trusts owned and controlled two holding companies: Opus Corporation (“Corp”) and Opus, LLC (“LLC”). The holding companies owned five subsidiaries that operated in different geographical areas. The debtor was an operating subsidiary of LLC. For each real estate project the debtor developed, it created a special purpose entity. The Trusts owned other subsidiaries, and Corp owned subsidiaries through which architectural and engineering services were provided to the debtor and its special purpose entities. Corp itself provided certain services directly to the operating subsidiaries, including the debtor. Those services included corporate accounting, human resources, legal, risk management, payroll, office services, and tax services (the “Shared Services”). Historically, the subsidiaries of Corp and LLC were required to make certain upstream distributions from excess income to Corp or LLC, which would then make upstream distributions to the Trusts.
The debtor successfully operated from 1994 until 2008, growing its equity from $12 to $75 million. With the failure of Lehman Brothers in 2008 and the subsequent collapse of the financial markets, the debtor was unable to sell its completed real estate projects because buyers could not obtain financing. The debtor was also unable to obtain financing to complete projects in process. The debtor was ultimately forced to file a Chapter 7 bankruptcy petition in 2009. The insolvency of the debtor was a predicate to several of the trustee’s claims in this adversary proceeding, including piercing the corporate veil, fraudulent transfers, and preferences. The trustee and defendants disagreed on the date the debtor became insolvent. After reviewing the evidence bearing on this issue, the court concluded that the debtor was solvent until February 1, 2009, under the balance-sheet, inadequate-capital, and cash-flow tests.
To prevail on an alter-ego claim under Delaware law, the court stated that the trustee had to show that the debtor, LLC, and the Trusts operated as a single economic entity that resulted in an overall element of injustice or unfairness. Respect for the corporate form is strong, and the standard of proof is greater than a preponderance of the evidence. The corporate identity of single‑member LLCs is also respected. In order to determine if the Trusts, LLC, and the debtor operated as a single economic entity, the court stated that it must consider whether: (1) the debtor was undercapitalized; (2) there was a failure to observe corporate formalities; (3) a dividend was paid; (4) the debtor was insolvent; (5) the dominant stockholder siphoned funds from the debtor; (6) there was an absence of corporate records; and (7) the debtor was a facade for the operations of its stockholder.
The trustee argued that the Opus Group, though proper in form, operated as a single economic unit. Gerald Rauenhorst described the five operating subsidiaries as battleships surrounding the Trusts who would take the torpedo (or any losses) instead of the Trusts. The trustee pointed to the interlocking directors and officers as evidence that the separate entities were mere facades for the single enterprise. The trustee pointed out that no distinction was made between the operations and financial health of one operating company versus the others during meetings of the boards of the holding companies and that the operating companies themselves could not make final decisions on projects (approval being required by Mark Rauenhorst). The court, however, was not convinced that the debtor was created only as a facade for LLC and the Trusts. The court found that the debtor was created for a legitimate business purpose and acted independently of LLC and the Trusts. No loan or contract was ever made by or with the “Opus Group,” and banks, vendors, and other business partners of the debtor were never told or misled into believing that they were doing business with any legal entity called “The Opus Group of Companies” or the “Opus Group.” Corp, LLC, and the operating companies were all separately incorporated and operated in a decentralized fashion in which each operating company had its own management, financing, and financial‑reporting department. The debtor was a separate legal entity, a Delaware limited liability company. The debtor’s executive team ran the debtor, and its officers understood that the companies were separate and that the debtor was their employer. Under the leadership of the debtor’s CEO, the debtor successfully completed a significant portfolio of projects, generating over a billion dollars in revenue and increasing equity to $75 million. Though Rauenhorst had to approve major projects, the court did not find that unusual because Rauenhorst was the chairman of the debtor’s board and major projects cost many millions of dollars and took years to complete and earn a return. The primary source of capital for the debtor was its operations, and the debtor also obtained financing from banks to operate the business, including a $20 million line of credit from Bank of America and construction financing for projects, none of which was guaranteed by LLC or the Trusts. The debtor borrowed from related entities to assist with cash flow management, and these loans were properly recorded on the books and records of the debtor and were evidenced by demand notes whose terms were similar to other lenders’ terms and were acceptable to the debtor. The debtor decided when to repay these loans from its affiliates and only made payments when it had excess cash. The debtor maintained headquarters in Maryland and offices in Philadelphia and Stamford, Connecticut, and the debtor did not share offices with LLC, Corp, any other operating subsidiary, or the Trusts. All of the debtor’s employees worked in the debtor’s offices or at its project sites, not in the offices of any other entities. No other operating subsidiary did business in the states where the debtor operated. LLC and the Trusts never did business under the debtor’s name, and the debtor did not do business under the Trusts’ or LLC’s name. Based on this record, the court found that the debtor was not a mere facade for LLC or the Trusts.
The trustee contended that the Trusts, LLC, Corp, and all the operating subsidiaries, including the debtor, comprised one operation and that corporate formalities were not observed. The trustee pointed out that the debtor, LLC, and Trusts had overlapping officers and directors and that the debtor’s “independent” directors were hand‑picked by the holding companies and were expected to support Rauenhorst’s decisions. The trustee contended that the debtor was not run as an “independent” operating company, but rather as an operating division of a single entity. For example, the trustee contended that the debtor’s board meetings were a sham. The defendants responded that Delaware law does not require limited liability companies to observe corporate formalities but contended that the debtor did observe corporate formalities in any event. The court found that the evidence supported a finding that the debtor observed corporate formalities. The debtor had a separate board of directors and had its own officers. It held periodic board meetings at which its affairs were discussed in depth, and it maintained separate corporate records. The debtor had its own accounting and finance department and personnel that kept its financial records. The debtor borrowed from banks in its own name, with no guarantors. The debtor operated in a distinct geographic region of the United States in which none of the other operating subsidiaries did business. Because the debtor observed corporate formalities and maintained its own independent books and records, the court concluded that this factor did not favor piercing the corporate veil. The court agreed with the trustee that the debtor’s observance of corporate formalities did not foreclose piercing the corporate veil if other factors weighed in favor of doing so, and the court thus considered all factors in determining whether to pierce the corporate veil.
The trustee argued that both the distribution policy and specific transfers of assets from the debtor to affiliates were examples of improper siphoning of funds from the debtor. However, the court stated that payment of dividends annually is not sufficient evidence to pierce the corporate veil, and it is usually the failure to pay dividends (while instead siphoning funds from the subsidiary through other means) that evidences a subsidiary is a mere facade of the parent. The court found that the regular payment of dividends by the debtor to its parent LLC (which paid dividends to the Trusts) was insufficient to cause the court to pierce the corporate veil, particularly when dividend payments were only made while the debtor was profitable and did not jeopardize the debtor’s ability to run or grow its business. Similarly, the policy requiring the debtor to upstream taxes based on its income did not support the trustee’s claim to pierce the corporate veil. The fact that the debtor, like many companies, was a pass‑through entity for tax purposes, did not warrant piercing the corporate veil. Further, many of the cited distributions were used to pay for Shared Services provided to the debtor by related entities. The court found that the debtor received an actual benefit from the Shared Services performed for it and concluded that the payment for Shared Services was not the siphoning of assets away from the debtor to avoid creditors that would justify piercing the corporate veil.
The trustee also asserted that the transfer of assets under the debtor’s control to other Opus entities justified piercing the corporate veil. The court found that the transfers of which the trustee complained were insufficient to show a pattern of siphoning of funds away from the debtor. In contrast, the debtor maintained bank accounts in its own name separate from all other Opus‑related entities, and the debtor’s funds were not commingled with any other entity’s funds or taken from its accounts by LLC or the Trusts. Neither Rauenhorst nor anyone else other than the debtor’s officers had signing authority for any of the debtor’s bank accounts. Neither LLC, the Trusts, nor any other related entity ever paid the debtor’s bills or any other obligation of the debtor. Funds were not taken from any of the debtor’s bank accounts against its will.
The defendants argued that the trustee’s veil-piercing claim failed even if all other factors favored piercing because the parties’ actions had no element of injustice or unfairness. Dominion or control is insufficient to hold a parent liable for a subsidiary’s obligation without proof that the corporate form was used to “defeat the ends of justice, to perpetuate fraud, to accomplish a crime, or otherwise evade the law.” The trustee argued that such injustice or unfairness existed in that the Opus Group held itself out to the world as being a single economic entity headed and financially backed by the Trusts. The trustee contended that the Trusts knew that creditors of the Opus Group believed they were a single entity backed by the Trusts. The trustee also complained that LLC made an equity contribution to the debtor in 2008 so that the debtor could make distributions required to LLC and the Trusts, but LLC refused to extend a loan to the debtor later in the year to continue its operations as the economy worsened.
The court stated that the debtor was not harmed by the 2008 equity infusion and that there was no legal obligation on the part of LLC to continue to support the debtor after the recession hit. The trustee relied on cases for the proposition that the obligation to provide sufficient capitalization is an ongoing one, which begins at the time of incorporation and continues throughout the corporation’s existence, but the court distinguished the cases relied on by the trustee from the instant case. Here the debtor had been adequately capitalized initially and had almost fifteen successful years of operation while growing its equity to $75 million. The debtor continued to operate only five months after it became insolvent, and the court found no legal obligation to continue to support the debtor when the recession hit. The court pointed out that, given the depth and length of the recession, LLC might have had to continue to prop up the debtor (and the other operating subsidiaries) for years. If the law required that, every parent of an insolvent company would have to support its subsidiary, completely blurring corporate lines. Thus, the court concluded that there was no injustice or unfairness in the treatment of the debtor by LLC or the Trusts.
Because the trustee failed to prove by a preponderance of the evidence any of the factors necessary to establish an alter-ego claim, the court entered judgment for the defendants on this claim.
An LLC member filed a direct and derivative action against the LLC’s managing member and its controllers for breach of contract, breach of the implied covenant of good faith and fair dealing, and breach of fiduciary duty. The plaintiff’s claims were based on actions that allegedly caused misappropriation of money to which the plaintiff was entitled, prohibited distributions, improper loans, and withholding of information about such actions. The defendants moved for dismissal of most of the plaintiff’s claims. The claims for breach of contract centered around the meaning of certain terms in the LLC agreement. Because the terms were ambiguous and were reasonably susceptible to different interpretations, the court denied the defendants’ motion to dismiss the breach-of-contract claims. The court denied the defendants’ motion to dismiss the plaintiff’s implied-covenant claims because the court could not foreclose, at this early stage of the litigation, the plaintiff’s reasonably conceivable claims that the managing member’s conduct went to matters so fundamental that the plaintiff’s reasonable expectations were frustrated. The court granted the defendants’ motion to dismiss the plaintiff’s fiduciary-duty claims because the claims were duplicative of the plaintiff’s breach-of-contract claims. The court acknowledged that a managing member owes equitable fiduciary duties by default unless altered by the LLC agreement and that controllers of managing members can also owe duties pursuant to In re USACafes. Nevertheless, Delaware does not allow fiduciary-duty claims to proceed in parallel with breach-of-contract claims unless there is an independent basis for the fiduciary-duty claims. An independent basis for the fiduciary-duty claims exists if the fiduciary-duty claims depend on additional facts, are broader in scope, and involve different considerations in terms of a potential remedy than the contractual claims. The facts and harms alleged by the plaintiffs in support of the fiduciary-claims appeared to be the same as those underlying the claims for breach of contract. Because the LLC agreement explicitly (or implicitly through the implied covenant) addressed the matters of loans, profits, and other distributions, and the agreement provided that its provisions restricting duties and liabilities replaced other duties and liabilities otherwise existing at law or in equity, the agreement superseded the fiduciary duties that might otherwise apply to the challenged conduct. The agreement – not some general duty of loyalty or care – governed the remedy to which the plaintiff was entitled. Thus, the court dismissed the fiduciary-duty claims. Aiding and abetting claims against the controllers were dismissed due to the lack of an underlying breach of fiduciary duty. Claims for aiding and abetting violations of contractual fiduciary duty were also dismissed because the dispute properly involved breaches of various provisions of the LLC agreement rather than breaches of fiduciary duties created by contract.
The non-managing members of Dunes Point West, LLC (“Dunes Point”), a Delaware LLC that owned an apartment complex in Kansas, sued PWA, LLC (“PWA”), a Kansas LLC that served as managing member of Dunes Point, and Katz, the managing member of PWA. The plaintiffs alleged that the actions of Katz and PWA breached Dunes Point’s operating agreement and fiduciary duties owed by PWA and Katz. PWA and Katz moved to dismiss for failure to state a claim. Katz also sought dismissal on the basis that the Delaware court lacked personal jurisdiction over him. The plaintiffs moved for summary judgment, arguing that the defendants’ actions justified removal of PWA from its position as managing member.
The court concluded that it could exercise personal jurisdiction over Katz. The court first concluded that Katz “transacted business” in Delaware within the meaning of the Delaware long-arm statute. Katz controlled and managed PWA, which managed Dunes Point, as shown by the following actions: Katz executed multiple documents relating to Dunes Point, was listed as its principal manager, had sole authority to draw checks on its bank account, mailed its Delaware partnership returns, signed checks for its Delaware franchise tax payments, and signed and filed its tax returns. The fact that neither Katz nor PWA filed the documents related to Dunes Point’s formation did not place them outside the court’s jurisdiction. Next the court found that exercising jurisdiction over Katz comported with due process. Since Katz expected a significant monetary return from his management of Dunes Point, it was reasonable to require him to answer in Delaware for alleged wrongdoing relating to his management.
The court denied the defendant’s motion to dismiss with respect to four of the plaintiffs’ claims but granted the motion on the plaintiff’s claim for waste. The court found that the complaint contained sufficient facts from which it could be inferred that PWA breached the operating agreement by allegedly paying management fees in violation of the agreement, by providing misleading financial reports, and by mismanaging Dunes Point. The complaint also contained facts supporting a claim that the defendants breached their fiduciary duties by engaging in self dealing and mismanagement. The defendants argued that the fiduciary-duty claims should be dismissed because they were essentially contract claims, but the court found that the fiduciary duty claims were broader in scope than the contract claims. The court pointed out that Katz was not a party to the operating agreement so that the claims against him could not constitute breach-of-contract claims. The court also found that PWA’s duty of loyalty could be implicated by alleged self dealing and that allegations of mismanagement could amount to gross negligence such that non-exculpated breaches of the duty of care could be implicated. The court dismissed the waste claim because the standard for waste is very high and was not satisfied by the plaintiffs’ allegation that the defendants charged somewhat lower rent than the alleged market rate for comparable apartments. The court denied the plaintiffs’ motion for summary judgment because there were genuine issues of material fact as to whether the defendants improperly commingled tenant security deposits or whether the “key person” provision was violated by Katz’s failure to remain actively involved in the management of the apartment complex.
Fläkt Woods Group SA (“FW”) moved for summary judgment on the plaintiff’s claims of aiding and abetting breach of fiduciary duties, tortious interference with contractual relations, unjust enrichment, and civil conspiracy. The plaintiff’s claims were premised upon FW’s role in the efforts of defendants Laudamiel and Capua to oust the plaintiff from Aeosphere LLC, a Delaware LLC (the “LLC”). The plaintiff’s allegations focused on the actions of Yule, who represented FW in its dealings with the LLC. The court commented that Yule’s desire for the LLC to resolve its internal disputes and to do business with Laudamiel were unobjectionable, and there was only scant evidence of wrongful conduct on Yule’s part. Nevertheless, the record suggested Yule engaged in behavior that could support an inference that he developed and implemented the strategy to force the plaintiff out of the LLC. For example, Yule created scheduling conflicts to keep Matthew from attending potentially important meetings, participated in meetings between Laudamiel and Capua allegedly to discuss how to exclude Matthew from the LLC, made statements to the effect that any contact he had with Matthew was for the sole purpose of helping Laudamiel and Capua, offered to threaten that FW would discontinue its relationship with the LLC, and took the position that DreamAir, the new entity formed by Laudamiel after the LLC was dissolved, would succeed to the agreement in place between the LLC and FW. Although these facts were not dispositive, they presented considerable obstacles to granting FW’s motion for summary judgment. In light of these facts, the court discussed the plaintiff’s claims against FW.
FW argued that the fiduciary-duty claims should be dismissed because they were based on the plaintiff’s breach-of-contract claims related to the dissolution of the LLC and were therefore duplicative. The court acknowledged that fiduciary-duty claims cannot proceed in parallel with contract claims based on the same conduct. While the plaintiff’s harm primarily arose from the dissolution and winding up of the LLC, which were topics addressed in the LLC agreement, the court found that the plaintiff presented facts that could support claims independent of the contract. For instance, the plaintiff’s allegation that FW was conducting the LLC’s business with DreamAir raised issues about the scope of FW’s violations and the resulting harm in view of the plaintiff’s contentions that Laudamiel and Capua engaged in a scheme with FW to exploit the LLC’s assets. The dissolution of the LLC was only a part of this scheme; therefore, the court denied summary judgment on the claim for aiding and abetting breach of fiduciary duty. Similarly, the court denied FW’s motion for summary judgment on the civil conspiracy claim.
The court next discussed the plaintiff’s tortious interference claims, which were based on the LLC agreement and the plaintiff’s employment agreement with the LLC. To prevail, the plaintiff was required to demonstrate there was a contract about which FW knew, that FW engaged in an intentional act that was a significant factor in causing a breach of the contract, that the act was without justification, and that it caused injury. The court found triable issues of fact existed on these elements and thus denied FW’s motion for summary judgment on the tortious interference claims. The court granted FW’s motion for summary judgment on the unjust enrichment claim, since it found FW gained no economic advantage from its conduct.
Mahalo Investments III, LLC v. First Citizens Bank & Trust Company, Inc.
The members of an LLC argued that the trial court erred by entering a charging order against their interests in several LLCs as part of the same action in which the original judgment was entered and without first establishing that venue and jurisdiction over the LLCs was proper. The court of appeals held that the LLC statute does not require that a separate action against the LLC be initiated to obtain an order charging a member’s interest in the LLC with payment of an unsatisfied judgment.
After learning in discovery conducted in post-judgment collection efforts that two judgment debtors owned interests in several LLCs, the judgment creditor filed an application seeking a charging order in the same court under the same file number as the original action in which the judgment was entered. The trial court entered the charging order, and the members argued on appeal that the Georgia LLC statute requires the judgment creditor to initiate a proceeding separate and apart from the suit in which the judgment was entered. The members relied on the statutory text and structure of the charging order statutes in the LLC and partnership contexts and a Georgia Supreme Court decision addressing the charging order remedy in the partnership context.
The court of appeals focused on the statutory requirement that an application for an order charging a membership interest must be filed with a “court of competent jurisdiction.” The court could discern no basis for not permitting the court that entered the underlying judgment to enter the charging order so long as that court is a “court of competent jurisdiction.” The members pointed to slightly different language in the Georgia Uniform Partnership Act’s charging order provision to support their argument that the judgment creditor must initiate an action in a separate court to obtain a charging order, but the court of appeals disagreed that the charging order provision in the partnership statute had any bearing on construing the plain and unambiguous language in the LLC statute. The court also did not agree with the members’ argument that the Georgia Supreme Court’s reference in another case to a judgment creditor’s initiation of a “collateral proceeding” to obtain a charging order meant that the application for a charging order must be filed in a separate action. First, the question of whether an entirely new proceeding must be initiated by a judgment creditor to obtain a charging order against a member’s interests in a limited liability entity was not at issue in that case. Second, the members’ argument contradicted its argument about the manner in which the partnership statutes were worded compared to the LLC statute. The Georgia Supreme Court’s language relied on by the members merely confirmed that a judgment creditor must, in addition to obtaining a judgment, initiate another proceeding collateral to the one establishing the debt, and request a separate order from the court to charge a debtor’s interests in an LLC or partnership. This conclusion merely leads to the question of what is meant by a “court of competent jurisdiction” in the LLC statute–more specifically, whether jurisdiction and venue over the judgment debtor and member of the LLC is sufficient or whether a court is competent to issue a charging order only if jurisdiction and venue over the LLC is proper.
The Georgia LLC statute is silent as to whether the LLC must be made a party to the proceeding initiated by the judgment creditor filing an application for a charging order. Based on the language of the charging order provision of the LLC statute, the court gleaned that the charging order is a mechanism by which a judgment creditor can attach a member’s LLC interest to satisfy an unpaid judgment, but the charging order does not permit the judgment creditor to replace the member or otherwise interfere in the governance of the LLC. It is the judgment debtor’s right to possession of distributions in the future that is essentially being levied or charged, and it is “business as usual” from the LLC’s standpoint except that any distributions to the member subject to the charging order are diverted to the judgment creditor. Because the LLC has no right or direct interest that is affected by the charging order, the court saw no reason why the LLC must be added as a party to the proceeding to obtain the charging order. Thus, the court held that the Georgia LLC statute only requires that a court have jurisdiction over the judgment debtor to have authority to enter a charging order against the judgment debtor’s interest.
A general partnership accounting firm with two partners, Ripoli and Daniel, converted to an LLC effective January 1, 1999, and a third individual, Grieco, became a member of the firm and entered into an operating agreement with the two other members a few months later. The three members approved and ratified the articles of organization and agreed to operate under the articles and the operating agreement. Several years later, the members met to discuss concerns regarding the disparity between Daniel’s profit-sharing percentage and the actual income generated from Daniel’s clients. Daniel’s profit-sharing percentage under the operating agreement was significantly higher than the income generated by his clients, and Greico’s profit-sharing percentage was significantly lower than the income produced by his clients. Eventually, in December of 2003, the members signed an agreement that they would not follow the profit-sharing percentages in the operating agreement for 2003 and would determine the profit-sharing percentages for 2003 based on the financial statements for 2003. In January of 2004, the members signed an agreement adjusting the members’ capital accounts in 2003 and specifying a method of determining Daniel’s distributions in 2004. The members abided by the 2004 agreement until Daniel died in 2006. Daniel’s estate sued Ripoli, Greico, the partnership, and the LLC seeking payment of the amount the estate claimed was owed for Daniel’s capital account under the operating agreement. The estate argued that the January 2004 agreement did not permanently change the profit-sharing percentages because it did not expressly refer to future years. The court examined the terms of the 2004 agreement and the course of conduct of the parties and concluded that the 2004 agreement amended the operating agreement and established a permanent change in Daniel’s capital account.
The court rejected an argument by Daniel’s estate on appeal that the trial court erred in determining that Ripoli and Greico had no individual liability for breach of contract. First, the court pointed out that the LLC statute at one time allowed LLC members to be held personally liable to the same extent as shareholders of a corporation. That provision was removed by the legislature effective January 1, 1998, and the statute has provided that a member or manager is not personally liable for a debt, obligation, or liability of the LLC solely by reason of being or acting as a member or manager for the entire time period since the conversion in this case of the partnership to an LLC. The LLC statute provides for an exception to the liability protection of LLC members to the extent the articles of organization provide for personal liability in a provision to which a member has consented in writing, but this exception did not apply because there was no such provision in the LLC’s articles of organization. Next the court rejected various attacks by Daniel’s estate on the validity of the conversion. The court stated that the fact that the LLC members continued to treat certain aspects of the business as a partnership (giving as an example the filing of K-1 partnership tax statements) did not change the legal status of the business as an LLC, pointing to the provision of the LLC statute that provides that an LLC’s failure to observe usual company formalities is not a ground for imposing personal liability on the members. Next the court described the conversion process. The only two partners at the time of the conversion filed a statement of conversion and articles of organization with the Illinois Secretary of State. The statement of conversion recited that each partner voted for the conversion, which satisfied the statutory requirement that all partners approve a conversion. Under the Illinois LLC statute, upon the filing of the articles of organization there is a presumption that all prerequisites to formation have been satisfied, and the LLC’s existence begins. The court stated that the estate’s argument that the partnership’s assets did not vest in the LLC was entirely refuted by the statutory conversion provisions, which provide that the converted entity is the same entity that existed before the conversion for all purposes and that the assets of a converting partnership automatically become assets of the LLC. Finally, the court rejected the estate’s argument that it could sue the other members to enforce Daniel’s rights under a provision of the LLC statute that provides a member may maintain an action against the LLC or another member to enforce the member’s rights under the operating agreement or under the statute. The court stated that the plain language of the statute expressly provides only for an action by a “member.” On a member’s death, the member becomes dissociated, and the estate cited no authority allowing a member’s estate to bring an action against individual LLC members. In sum, the court stated that the Illinois LLC statute was clear on both of the following points: (1) once a partnership converts to an LLC, it legally becomes an LLC, and inconsistent actions by the members cannot change that legal fact; and (2) LLC members have no individual liability to nonmembers. Thus, Daniel’s estate was not entitled to a judgment against the members.
A judgment creditor’s application for a charging order was found to be insufficient to establish entitlement to the charging order because it was based solely on allegations in the application, and the application was not verified nor did it support an inference that the allegations were based on personal knowledge.
The assignee of a bank payee of two promissory notes and deeds of trust was substituted for the bank as party plaintiff and obtained a judgment against the promissor and guarantor of the notes. The judgment creditor filed its “Verified Application for Charging Order” pursuant to the Missouri charging order statute. In the notarized application, the judgment creditor alleged that the trial court entered a judgment against the guarantor, the amount of the judgment, and the amount remaining unsatisfied. The judgment creditor requested that the court “issue a Charging Order requiring any limited liability company in which [the guarantor] has an interest to pay Plaintiff the amounts up to the unsatisfied amount of the above judgment with interest from [the guarantor’s] interest in said limited liability company....” The application was signed by a representative of the judgment creditor on behalf of the judgment creditor, and there were two charts (“Exhibit B”) attached showing the alleged outstanding balances on each promissory note and calculations of interest. It appeared that the trial court entered a charging order based solely on allegations contained in the application, and the court of appeals held that the record contained insufficient evidence to support the charging order.
The court explained that a charging order is a post‑judgment remedy that allows the judgment creditor of an individual debtor‑member of a limited liability company (or a partnership) to enforce a judgment by charging the individual member’s distributional interest with the unsatisfied amount of a judgment. To obtain a charging order, the LLC statute requires a judgment creditor to file an “application to a court of competent jurisdiction.” Under the rules of civil procedure, “[a]n application to the court for an order shall be by motion which ... shall be in writing, shall state with particularity the grounds therefor, and shall set forth the relief or order sought.” A motion is not self‑proving, and the movant has the burden of proving the allegations in the motion. An after‑trial motion that is based on facts not appearing in the record may be supported by proof of facts in the form of affidavits, depositions, and oral testimony, but “exhibits attached to motions filed with the trial court are not evidence and are not self‑proving.” The relief sought in the application required resolution of factual matters not appearing in the record – most importantly, the amount of the outstanding judgment and interest the guarantor owed the judgment creditor. Although the application purported to be “verified,” it failed to allege that the facts it contained were asserted on the personal knowledge of the representative of the judgment creditor that signed the application. The representative neither declared that he had personal knowledge of the facts pleaded in the application nor identified the source of the information he used to calculate the amount of the outstanding judgment. Because he did not define his relationship with the judgment creditor or provide a job title, the court could not infer personal knowledge. Exhibit B was not in the form of an affidavit, was never offered and admitted into evidence, and was not stipulated to but instead was challenged by the guarantor. In sum, the court’s review of the record revealed nothing that provided sufficient facts to determine with any degree of certainty the amount of the outstanding judgment.
The court of appeals rejected the judgment creditor’s argument that rules applying to execution applied to charging orders and did not require proof of the amount of the judgment. The court stated that the rules indicated that the charging order statute, and not the rules for execution, govern the procedure for obtaining a charging order, and the court pointed out that it had previously held that the charging order is the exclusive remedy for a judgment creditor of a partner and that the charging order has replaced levies of execution for reaching partnership interests. Based on the purpose of the charging order and the statutory requirement of judicial oversight, the court declined to extend the rules governing executions to charging orders issued under the LLC statute.
Block Communications, Inc. (“BCI”), the former employer of Pounds, sued Pounds for violating a separation agreement between Pounds and BCI. Pounds was a general manager of The Toledo Blade (“The Blade”), a newspaper owned by BCI. After Pounds left The Blade, he formed an LLC that published the Free Press, a newspaper distributed free of charge in the Toledo area. Based on a series of articles about The Blade that appeared in the Free Press, BCI sued Pounds and the LLC alleging that the articles included information that was obtained and disseminated in violation of the separation agreement. In the course of discovery, BCI requested information from the LLC, including disclosure of the identity of the members of the LLC. The LLC sought a protective order or in camera review on relevance and confidentiality grounds. The trial court rejected the LLC’s motion, and the LLC appealed. John Doe, a member of the LLC, filed an amicus curiae brief in support of the LLC.
On appeal, John Doe argued that the Ohio LLC statute implicitly shields the names of members from public disclosure because the LLC statute only mandates disclosure of the names of members and financial information to members. The court stated that the fact that the LLC statute did not mandate disclosure of this information to third parties did not establish that the statute prohibits the disclosure of that information, either expressly or by implication. Although the LLC’s operating agreement prohibited disclosure of this information, the operating agreement contained exceptions if the members agreed to the disclosure or a court ordered disclosure. The court found no support for Doe’s argument that Ohio law created an express or implied protectable interest in preserving the confidentiality of LLC members.
Doe and the LLC both argued that the information sought by BCI was not relevant to the issues in the case. The LLC had argued to the trial court that the names of the members other than Pounds were not relevant because Pounds held a 60% interest and the other members did not have a controlling interest. The court of appeals stated that the standard for relevancy during discovery is broader than at trial. While the admission or exclusion of evidence can be overturned on an abuse of discretion by the trial court, Ohio courts have held that the trial court’s determination of relevancy of discovery materials is not a final, appealable order; therefore, the court of appeals did not have to reach a determination as to relevancy or whether the trial court erred in abusing its discretion by compelling discovery.
Doe and the LLC next argued that the LLC’s business records, including the names of members, were protected trade secrets. Doe and the LLC also argued that the trial court erred in failing to consider the negative impact on the LLC’s members if BCI obtained this information. Because it was necessary to interpret and apply statutory language (the Ohio Uniform Trade Secrets Act) to determine the confidentiality of the information, the court applied a de novo standard of review as to this argument. After setting forth the definition of a trade secret under the Ohio Uniform Trade Secrets Act and the six factors used to analyze a trade-secret claim as adopted by the Ohio Supreme Court, the court of appeals concluded that the LLC had not produced any evidence to substantiate its claims that it would be irreparably harmed by disclosure of its members names. Although the operating agreement limited the members’ ability to disclose each others’ names, the agreement provided for disclosure pursuant to a court order.
The LLC further asserted that there would be a “chilling effect on business in Ohio” if the LLC had to disclose the members’ names. In support of this assertion, the LLC argued that the trial court’s ruling strips Ohio LLC members of any claim of privacy and makes it difficult or impossible for businesses to obtain investors in Ohio. The LLC argued that, as a matter of public policy, an Ohio LLC's members should not be forced to identify themselves where the members are merely “innocent bystanders” who have no direct interest in the outcome of a legal action. The court did not find these arguments convincing and pointed out that the LLC had made no effort to have the requested discovery information classified as “confidential information” or “confidential information – attorney’s eyes only,” under the parties’ existing stipulated protection order. Thus, the court could not say that the trial court abused its discretion by refusing to grant the LLC’s request for a protective order or in camera inspection, based on the LLC’s subjective belief that disclosure might cause it and its members intimidation or harassment.
Finally, the LLC argued that the trial court erroneously relied on the provision of the Ohio LLC statute recognizing LLC veil piercing to bolster its decision to require disclosure of members’ names when BCI was not attempting to pierce the veil of the LLC. The court said that the trial court’s statement regarding personal liability of an LLC’s members under the statute was part of a discussion regarding the members’ rights and responsibilities in the context of their expectation of privacy. According to the court of appeals, the trial court did not suggest or find that BCI would have to “pierce the corporate veil” in order to obtain the members’ names.
A former employee of an LLC argued that she was no longer bound by the post-termination covenant not to compete in her employment agreement with the LLC because 100% of the membership interests in the LLC had been sold by the individuals that were members of the LLC when she entered into the employment agreement. The trial court denied the LLC’s motion for a preliminary injunction enforcing the noncompetition agreement, relying on a decision of the Nevada Supreme Court in which the court held that a noncompetition agreement was not assignable in an asset sale by a corporation. The trial court also found that the LLC failed to show irreparable harm for which compensatory damages were inadequate. The Nevada Supreme Court in this case held that the sale of membership interests in an LLC is analogous to the sale of stock in a corporation rather than an asset sale; therefore, the trial court erred in relying on case law in the asset-sale context. The court agreed with the LLC that the reasoning that should be applied in this case was that applied in case law holding that the enforceability of restrictive covenants is not affected in the context of a corporate merger or a sale of 100% of the stock of a corporation because in those cases there is no new employer. In a 100% stock sale, there is no new entity because the existence of the corporate entity is not affected by changes in ownership. The supreme court agreed that the sale of 100% of the membership interests in this case was equivalent to the sale of 100% of the stock of a corporation. The former employee pointed out that the Nevada LLC statute uses the phrase “membership interest” rather than the word “stock” and that a member’s interest is defined as “a share of the economic interests in a limited-liability company, including profits, losses and distributions of assets.” But the court stated that the former employee failed to address the fact that LLCs, like corporations, have perpetual existence and are distinct from their managers and members. The court concluded that these features mandated that the court treat assignability of employment agreements in a sale of LLC membership interests like employment agreements are treated in a stock sale. Because no other entity was introduced and the LLC remained in existence after the acquisition of 100% of the membership interests, the reasoning in case law distinguishing asset sales from corporate stock sales and mergers applied to this case.
Wen, an undergraduate student from China who was enrolled at Temple University, sued Foxcode, Inc. (“Foxcode”), an investment and merchant banking firm, and Foxcode’s principal, Robert Willis, for common-law fraud, conversion, breach of fiduciary duty, and federal and state securities fraud. Wen alleged that Willis represented that the defendants would manage $4 million invested by Wen with the defendants for Wen’s benefit, deliver a return on the investment, and guarantee the full return of the $4 million principal when the investment concluded. The defendants created two Delaware LLCs to carry out the plan to invest Wen’s funds – Foxcode Far East, LLC (“FFE”), and Foxcode Capital Markets, LLC (“Foxcode Capital”). The LLC agreement of FFE (“FFE Agreement”) provided that Wen would contribute $4 million in exchange for a 99.9% membership interest in FFE, and Foxcode Capital would contribute $4,000 for a 0.1% membership interest. Foxcode would also provide all financial advisory services to generate earnings for FFE and would be paid management and performance fees. The FFE Agreement provided that the LLC was managed by its members, and both members had the ability to bind the LLC, call a meeting, demand access to the books and records, and withdraw and dissolve the LLC after 24 months. Numerous business decisions required unanimous consent of both members. Wen alleged that the defendants drained the funds from FFE’s account, transferring nearly all the funds to their own accounts. After Wen became suspicious and was not provided satisfactory reports and information, he brought this suit. In this opinion, the court addressed the defendants’ motion to dismiss the claims.
The court held that the “gist-of-the-action” doctrine barred Wen’s common-law fraud claim because the alleged misrepresentations were later incorporated into the FFE Agreement, and the gist-of-the-action doctrine forecloses a party’s pursuit of a tort action for the mere breach of contractual duties without any separate or independent event giving rise to the tort. Wen argued that the fraud claims were collateral to the investment contract and sounded in tort rather than contract. Wen relied on case law suggesting that fraudulent inducement claims tend to be collateral to, and not interwoven with, the terms of the contract itself. But the court stated that where precontractual statements that are the basis for the fraudulent inducement claim concern specific duties that the parties later include in a contract, courts have concluded that such claims sound in contract and are thus barred by the gist-of-the-action doctrine. Wen’s fraud allegations– that the defendants “would manage Wen's $4 million investment for his benefit, deliver a return on the investment, and guarantee that the $4 million principal would be returned in full when the investment concluded” involved misrepresentations that were all later included in the FFE Agreement. The FFE Agreement provided that: (1) Foxcode Capital would provide cash and all financial advisory services necessary to generate earnings for FFE; (2) Wen would receive 99.9% of the net profits of FFE; (3) when FFE was dissolved, Foxcode Capital guaranteed the return of an amount sufficient to make the total distributions to Wen equal to $4 million. Thus, the court concluded that Wen’s fraudulent inducement claims were barred by the gist-of-the-action rule and should be dismissed.
Wen’s conversion claim, which was based on the defendants’ use of his $4 million investment in the LLC for the defendants’ personal benefit, was not barred by the gist-of-the-action doctrine because the allegation implicated broader social duties imposed by the law of torts such as a prohibition of theft. The conversion claim failed, however, because money may be the subject of a claim for conversion under Pennsylvania law only where the plaintiff has a property interest in the money at the time of the alleged conversion. Under Delaware LLC law, the $4 million invested by Wen became LLC property in which Wen as a member had no specific interest once he contributed the funds to the LLC.
The court recognized that the Delaware LLC statute contemplates that equitable fiduciary duties of care and loyalty will apply by default to a manager or managing member of a Delaware LLC, but Wen’s breach-of-fiduciary-duty claim failed because Wen did not sue the other managing member of the LLC. Because the FFE Agreement vested management in the members of FFE, the court stated that the only parties owing fiduciary duties to FFE were its members–Wen and Foxcode Capital–and Wen did not sue Foxcode Capital. The court noted in a footnote that Wen alleged that the defendants owned, controlled, and dominated the affairs of FFE and Foxcode Capital, thus suggesting that Wen might be seeking to pierce the corporate veil to allege a breach of fiduciary duty claim against the named defendants, but Wen stated in his opposition to the defendants’ motion to dismiss that he was not seeking to pierce the corporate veil.
Wen’s claim for securities fraud under federal law was dismissed because the plaintiff had powers as a managing member of the LLC that precluded characterizing his interest in the LLC as a “security” under federal law. The court applied the United States Supreme Court’s definition of an investment contract in Howey as interpreted by the Third Circuit. The three elements for showing an investment contract as articulated by the Third Circuit are: (1) “an investment of money”; (2) “in a common enterprise”; (3) “with profits to come solely from the efforts of others.” The defendants did not dispute the first two elements but disagreed with Wen that his interest in FFE met the third requirement, i.e., that his profits were to come solely from the efforts of others. The court stated that the inquiry with regard to the third element began and ended with the operating agreement. The court listed the powers enjoyed by Wen as a member under the FFE Agreement and discussed case law in the Third Circuit in the partnership and LLC context, and the court concluded that the weight of authority dictated that Wen’s membership interest in FFE was not a security because Wen was granted significant control over FFE as a manager by the terms of the FFE Agreement. Wen attempted to distinguish the cases relied on by the court by arguing that the cases involved plaintiffs who had in fact been actively involved in management. Wen argued that, unlike those cases, he was not a sophisticated investor and did not in fact exercise any control over the investment. But the court concluded that “a variance, even a significant one, between the powers enjoyed by a plaintiff‑investor in an agreement and the operation of those powers in reality does not per se convert an interest from a nonsecurity into a security.” Wen tried to convince the court to adopt the Fifth Circuit’s reasoning in Williamson v. Tucker, in which the Fifth Circuit held that an investor in a partnership could have an interest that constituted an investment contract, despite the powers afforded by agreement, “if he could show he was ‘so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers.’” The court was not persuaded to adopt the Williamson rule and apply it to Wen’s case when the Third Circuit would not do so under its existing jurisprudence. The court stated that Wen enjoyed a “plethora of powers” as a managing member of FFE and had significant control over the management of the company. The fact that he did not exercise those powers, or even the fact that the defendants thwarted his attempts to exercise those powers, did not make his membership interest in FFE a security for purposes of the federal securities laws. Thus, the court granted the defendants’ motion to dismiss Wen’s federal securities fraud claim.
Because an LLC interest is presumptively a security under Pennsylvania securities law and Wen did not participate actively and completely in the management of the LLC as required for Wen’s membership interest to meet an exclusion from the definition of a security, Wen established that his membership interest was a security under the Pennsylvania Securities Act (PSA). The PSA provides that a “security” presumptively includes any membership interest in a limited liability company, but the definition does not include an LLC membership interest where all of the following conditions are satisfied: (1) the membership interest is in an LLC that is not managed by managers; (2) the purchaser of the membership interest enters into a written commitment to be engaged actively and directly in the management of the LLC; and (3) the purchaser of the membership interest, in fact, does participate actively and directly in the management of the LLC. The first condition was met because the FFE Agreement provided that FFE was managed by its members, but the parties disagreed with regard to the second and third conditions. The court noted a dearth of case law defining what exactly is meant by “engaged actively and directly” for purposes of the second condition. The affirmative responsibilities of the day‑to‑day management of FFE were assigned solely to Foxcode Capital, but both Wen and Foxcode Capital were required to devote “time and attention” to the business of FFE, and numerous transactions required unanimous consent of Foxcode Capital and Wen. The court stated that the statutory language does not require that a certain quantum of active and direct engagement in the management of the company be defined, but rather suggests that any amount will do. The court thus concluded that Wen did enter into a written commitment to be engaged actively and directly in the management of FFE so that the second condition was satisfied. However, the court concluded that the third condition was not satisfied. That condition calls for a factual inquiry – whether Wen did, in fact, participate actively and directly in the management of the FFE. Wen pointed to allegations in his complaint that the defendants transferred almost all of his $4 million investment out of the FFE account and into their own accounts and kept Wen in the dark and then froze him out when he made inquiries about the dissipation of the investment. Viewing the inferences drawn from these allegations in the light most favorable to Wen, the court found that Wen had sufficiently pleaded that this third condition did not apply. Because not all three conditions were satisfied, Wen established that his membership interest in FFE was a security for the purposes of stating a PSA securities fraud claim. The court also concluded that Wen had sufficiently pled scienter so as to survive the motion to dismiss his claim for securities fraud under the PSA.
A Delaware LLC, White Energy Partners, LLC (“WEP”), agreed to repurchase the Class B units of the Class B member, White Ventures Energy, LLC (“White Ventures”). Members of the Class A member, We Investors Group, LLC (“WEIG”), brought a derivative suit against Trey White, who was the manager of WEIG as well as the manager of White Ventures and a member of the board of managers of WEP, asserting breach-of-fiduciary and other claims against White related to WEP’s repurchase of White Venture’s Class B units. The plaintiffs also sued White Ventures for breach of contract, alleging that White Ventures violated a provision of the WEP operating agreement allowing WEIG to “tag along” with White Venture’s sale of its Class B units to WEP. The trial court concluded that the tag-along provision applied to the repurchase, but the court of appeals analyzed the tag-along provision and concluded that the provision did not entitle a Class A member to participate in a Class B member’s sale of Class B units. Even assuming the tag-along provision generally entitled a Class A member to participate in a Class B member’s sale of Class B units, the court concluded that the provision did not apply in this case because the Delaware LLC statute provided that the units repurchased by WEP were canceled on their repurchase, and the operating agreement contemplated that the purchaser in a transaction described in the tag-along provision would be capable of becoming a substituted member who would have the right to vote the units and receive distributions and allocations of profits and losses with respect to the units.
After White Ventures executed an agreement in which it agreed to transfer its Class B units to WEP, White Ventures sent WEIG a written notice of the proposed sale pursuant to a right-of-first-refusal provision in the WEP operating agreement. The right-of-first-refusal provision was one of two provisions contained in Section 10.4 of the WEP operating agreement. Section 10.4 was entitled “Sale by a Class A Member or Class B Member.” Section 10.4.1 was entitled “Right of First Refusal,” and Section 10.4.2 was entitled “Tag Along.” White decided not to have WEIG purchase any of the Class B units under the right-of-first-refusal provision. The trial court concluded that WEIG was entitled to the rights provided under the tag-along provision of the operating agreement in addition to the right-of-first-refusal provision and entered a judgment for relief based on the breach of the tag-along provision by White Ventures and related breaches of fiduciary duty by White. White and White Ventures appealed.
The court of appeals agreed with the appellants’ argument that the tag-along privileges applied only to members holding the same class of units as the class that was the subject of the third-party offer. Under the tag-along provision, a member that elected to participate in a sale of units was entitled to sell in such proposed sale, at the same price and on the same terms, “a number of Units included in [such sale of Class B Units]” determined by a formula set forth in the provision. The court stated that the emphasized language limited the type of units that could tag along to the class of units included in the purchase. Moreover, even assuming the agreement could be read to apply to both classes of units, the number of units that WEIG would be entitled to sell would be zero under the formula in the agreement because the pro rata portion was determined by dividing the number of WEIG’s Class B units, which was zero, into the total number of Class B units.
The court of appeals explained that there was another reason in this case that the language of the tag-along provision precluded WEIG from having tag-along rights in the transaction at issue. The provision described the field of buyers whose purchases could trigger tag-along rights as a “Person” who could become a substituted WEP member. Although “Person” was defined to include an LLC, WEP could not become a member of itself, and its repurchase of White Ventures’ units thus did not trigger tag-along rights. Section 10.1 stated that it applied to an offer to purchase Class A or B units from any Person, but the provision later stated that a Person who purchased a member’s interest did not become a substituted member unless the terms and conditions of another provision of the operating agreement were satisfied. A substituted member under the operating agreement was entitled to all of the rights and benefits under the agreement of the transferor of the interest. These rights would include voting and economic rights. Because the Delaware LLC statute provides that an interest in an LLC that is acquired by the LLC is deemed canceled unless otherwise provided in the LLC agreement, and the WEP agreement did not override this provision, the court concluded that White Venture’s units were canceled when repurchased by WEP, and WEP was not a Person whose offer triggered the provisions of Section 10.1.
In this dispute between a departing member of a medical practice organized as a professional limited liability company and the other members, the court of appeals held that the departing member’s membership in the LLC did not terminate when he left the medical practice, that the departing member was entitled to recover attorney’s fees from the PLLC but not from the individual members in connection with denial of his right to access the PLLC’s books and records, and the departing member’s oppression claim should be remanded for further proceedings in the interest of justice in light of the Texas Supreme Court’s decision in Ritchie v. Rupe after the trial of this case.
Jones was a founding member of Texas Ear Nose & Throat Consultants, PLLC (“TENT”), a closely held medical practice. Three basic documents governed the relationship between each member, TENT, and the other members: (1) a member agreement, (2) regulations (i.e., LLC operating agreement), and (3) a physician's employment agreement (one for each member). In November 2009, relations between Jones and the other members became strained, and the member who served as president of TENT accused Jones of undermining the practice and told Jones to leave by January 2010. Jones delivered his notice of retirement two days later on November 19, 2009, and his last day of work for TENT was December 15, 2009, after which he went to work for Baylor College of Medicine. In February 2010, Jones sued TENT and the other members alleging breach of the agreements between them, shareholder oppression, and denial of access to the practice’s books and records. TENT and the other members counterclaimed against Jones for breach of contract. Based on an extensive jury verdict, the trial court awarded each side breach-of-contract damages and related attorney’s fees, awarded Jones additional attorney’s fees on his claim seeking access to books and records, and ordered the other members to buy out Jones’s membership as a remedy for shareholder oppression. TENT (and the other members) appealed.
The first several issues addressed by the court of appeals related to the appellants’ contentions that the evidence did not support the jury's findings that TENT breached Jones's employment agreement, that Jones was entitled to $374,694.01 in “ancillary income” due to the alleged breach, and that Jones’s own breach of the agreement was excused. The court of appeals analyzed the terms of the employment agreement and the evidence and concluded that the evidence supported the jury’s findings.
The death, retirement, resignation, or dissolution of a Member, or the period for the duration of the Company [i.e., TENT] as stated in the Articles [i.e., TENT's Articles of Organization] expires, or the occurrence of any other event which terminates the continued membership of a Member in the Company (a “Dissolution Event”), dissolves the Company unless the remaining Member(s) unanimously consent in writing to the continuation of the business of the Company (“Unanimous Consent”).
The effect of retirement on a member’s interest was covered by the member agreement, which set forth numerous occurrences that could result in the involuntary transfer of a member’s ownership interest in TENT as well as procedures for handling those transfers. The occurrences listed included death of the member, termination of the member’s employment with the medical group with or without cause, termination of employment by the member with or without cause, and “Total and Permanent Retirement of the Member from the Practice of Medicine and from the Medical Group.” Another provision of the member agreement provided various methods of valuation of a member’s interest depending on the nature of the termination of membership. The appellants argued that Jones’s attempt to retire on November 19, 2009 was ineffective under the member agreement because Jones did not at that time retire from the practice of medicine. They argued that Jones instead simply terminated his employment with TENT without cause, which according to the member agreement would entitle him to $10 as payment for his interest in TENT. However, this argument glossed over the jury’s finding that the appellants improperly terminated Jones’s employment before his attempted retirement. In any event, the termination of Jones’s employment with TENT, whether a retirement, resignation, or termination, did not determine whether he retained his membership interest in TENT. Rather than being automatic on the occurrence of one of these events, specific steps had to be taken under the member agreement before a transfer could be effected. Occurrence of any of the listed events triggered successive rights of first refusal to purchase the departing member’s ownership interest. If neither the group nor individual members exercised the right of first refusal, the departing member (or his legal representative) could continue to hold the ownership interest so long as ownership did not violate laws and regulations governing medical practices. In that situation, the member had the right to demand redemption by the medical group. The appellants alternatively contended that the medical group in fact exercised its right of first refusal, pointing to testimony of TENT’s bookkeeper that Jones was given a $10 credit in TENT's books for his “stock” in January 2010. In support of the jury’s finding, Jones cited numerous external communications after January 2010 in which TENT continued to represent that he was a member, including TENT’s tax returns and his own K-1s from TENT, emails stating that Jones should be invited to board meetings, and a letter from TENT to its bank listing Jones as a “remaining partner.” Thus, there was evidence to support the jury’s finding that Jones was still a member at the time of trial.
The appellants next challenged the award of attorney’s fees to Jones for denial of access to TENT’s books and records, the only relief sought or awarded for this cause of action at trial. The trial court based the award on the jury's finding as well as provisions of the Texas Business Organizations Code. The individual physicians and not TENT as an entity were ordered to pay the attorney’s fees. Jones made his first written request for access on November 18, 2009, but he made subsequent requests as well. The appellants raised numerous sub‑issues regarding the award of attorney’s fees, including that (1) Jones failed to state a proper purpose for requesting access; (2) applicable law did not provide for the recovery; (3) Jones was not a “governing person” entitled to recovery; (4) the court erred in its jury submission on the issue; (5) the evidence was insufficient to support the finding that Jones was denied access; (6) if denial occurred, it was only after his membership was terminated; (7) the court erred in ordering the individual defendants, rather than TENT, to pay the fees; and (8) Jones failed to properly segregate his attorney’s fees. The court of appeals concluded that Jones was entitled to recover attorney’s fees against TENT but not the individual defendants and that Jones failed to segregate his attorney’s fees properly.
The appellants’ first two arguments – that Jones failed to state a proper purpose for requesting access and that applicable law did not provide for the recovery of attorney’s fees – were both based on the proposition that Jones’s rights regarding access were governed by the now-expired Texas Limited Liability Company Act (TLLCA) and not the current Texas Business Organizations Code (BOC). The TLLCA provided that a member had the right, on written request stating the purpose, to examine and copy for any proper purpose records required to be kept under that statute and other information. The BOC provides that “[a] member ... on written request and for a proper purpose, may examine and copy” the required records, and the BOC additionally provides that a “governing person ... may examine the entity's books and records ... for a purpose reasonably related to the governing person's service as a governing person.” The BOC further authorizes an award of attorney’s fees as a remedy for denial of access as to a request by a governing person. The appellants argued that the TLLCA rather than the BOC governed this case because Jones made his first request for access on November 18, 2009, prior to the expiration of the TLLCA and the BOC’s mandatory application date of January 1, 2010. On that basis, the appellants argued that the trial court erred because Jones’s written request did not state a purpose, as required by the TLLCA but not the BOC, and attorney’s fees were not an available remedy under the TLLCA. The transition provisions of the BOC provide that the BOC governs “acts, contracts, or other transactions by an entity subject to this code or its managerial officials, owners, or members that occur on or after the mandatory application date.” Prior law (i.e., the TLLCA in this case) continues to govern acts, contracts, and transactions that occurred before the mandatory application date. Although Jones made his first written request for access on November 18, 2009, the record made clear that he continued to make requests for information after the mandatory application date and never received access to all of the information sought. Thus, the trial court did not err in holding that the BOC governed.
The appellants also argued that Jones was not a “governing person” entitled to recover attorney’s fees under the BOC. (The BOC provides that “[a] court may award a governing person attorney's fees and any other proper relief in a suit to require a filing entity to open its books and records....”). The appellants relied solely on a statement in Jones’s third amended petition in which Jones referred to his right to examine books and records under certain provisions of the BOC after his retirement because he remained a member. The appellants contended that Jones admitted in this assertion that he was not a governing person. The court of appeals found nothing in this assertion that addressed whether Jones was a governing person and concluded that the appellants had waived this pleading deficiency argument in any event.
Next, the appellants complained of the trial court's refusal to submit their tendered instruction to the question on denial of access. The requested instruction read as follows: “You are instructed that John Jones was entitled to access to TENT’s books and records for a ‘proper purpose.’ You are instructed that demands for records to harass TENT, force TENT to purchase Jones' interest at an inflated price, or made in bad faith, are not ‘proper purposes.’” Based on the trial court’s discretion in determining necessary and proper jury instructions, the court of appeals concluded the trial court did not err. Explanatory instructions should be submitted when, in the discretion of the trial court, the instructions will help jurors understand the meaning and effect of the law and the presumptions the law creates. When a trial court refuses to submit a requested instruction, the ultimate question on appeal is whether the instruction was reasonably necessary to enable the jury to render a proper verdict. The appellants derived the language in their proposed instruction from a case in which the court of appeals had listed allegations that had been found sufficient to entitle a corporation to a jury trial on the issue of whether a shareholder had a proper purpose in requesting access under the Texas Business Corporation Act, which provided similar access to that provided by the BOC provisions at issue here. Assuming that analysis was applicable in this case, the court said that not every correct statement of the law belongs in the charge. The trial court here reasonably could have determined that the requested instruction was unnecessary for the jury’s understanding of the issue and that it only served to emphasize the appellants’ position.
The court next reviewed the evidence to determine if it was sufficient to support the jury’s finding that Jones was denied access to TENT’s records. The court concluded that the appellants did not properly brief this argument, which hinged on their assertion that the company was not required to keep all the information Jones requested. Accordingly, the court found no merit in the appellants’ sufficiency assertions.
The appellants’ argument that TENT was not required to furnish information to Jones because he was no longer a member failed because the court of appeals previously concluded that the evidence supported the jury’s finding that Jones was still a member of TENT at the time of trial. He was thus a member when he requested access to TENT’s books and records.
The appellants next argued that the trial court erred in ordering the individual defendants to pay Jones’s attorney’s fees instead of TENT. The BOC provides that a court may order an entity to open its books and records if the entity has improperly refused access, and the court may award attorney’s fees and other proper relief “in a suit to require a filing entity to open its books and records.” To be entitled to this relief, the requesting person must establish, among other things, that “the entity refused the person's good faith demand to inspect the books and records.” The court stated that the focus of the provision is on the actions of the entity, and the provision does not suggest that any individual connected with an entity can be ordered to open the books and records or to pay attorney's fees. Jones noted that the jury specifically found that the individual defendants acted in concert to deny Jones’s access, and Jones argued that awarding fees against TENT would punish TENT for the actions of its members. Jones also suggested that the award of fees could jeopardize the possible sale of TENT. But the court of appeals stated that the fees were awarded pursuant to the BOC, not based on shareholder oppression by the individual defendants, and the fact that the individual defendants may have caused the denial of access and that TENT might be affected by the award did not change the statutory language. The court of appeals thus concluded that the trial court should have ordered TENT and not the individual defendants to pay Jones’s attorney’s fees, and that the judgment should be modified to order TENT to pay the fees instead of the individual defendants.
The final issue addressed by the court of appeals regarding the denial of access claim was the appellants’ contention that Jones failed to properly segregate the portion of his attorney’s fees related to this claim from the fees related to other claims. The court of appeals agreed and remanded this issue for further consideration by the trial court.
The court of appeals then turned to Jones’s oppression claims. The appellants challenged the jury’s findings in favor of Jones on his “shareholder oppression” claims as well as the trial court’s buyout order requiring the appellants to pay Jones $277,500 for his interest in TENT. After the trial of the case and the original round of briefing on appeal, the Texas Supreme Court held in Ritchie v. Rupe, 443 S.W.3d 877 (Tex. 2014), that there is no common-law cause of action for shareholder oppression under Texas law and that the only available remedy under the shareholder oppression statute is the appointment of a rehabilitative receiver. The court of appeals referred to this opinion as a “sea change in the realm of shareholder oppression law.” Based on Ritchie, the trial court’s buyout order could not stand. Additionally, the court of appeals had to determine whether to render judgment on Jones’s oppression claim or remand for additional proceedings. In Ritchie, the supreme court explained that ordinarily it would consider remanding for a new trial when it announced a new legal standard, but in the case before it, remand of the shareholder oppression claims was not necessary because the plaintiff had sought only a buyout and had not requested the appointment of a rehabilitative receiver as alternate relief. Here, however, Jones did plead for appointment of a receiver under the BOC as one of the possible remedies. The appellants nevertheless urged that remand for consideration of other relief was not necessary in this case because the evidence presented at trial was legally insufficient to support the jury’s findings and the trial court’s judgment. The court of appeals said that the difficulty with this argument was that Jones prepared his case and presented his evidence without the benefit of knowing that the standard for proving shareholder oppression would change after the verdict. For example, the court said that Jones may have perceived no need to present evidence as to whether the appellants’ actions were justified under the business judgment rule, which typically was not applied in shareholder oppression cases prior to Ritchie. Thus, the court of appeals reversed the trial court’s buyout order, but, in the interest of justice, remanded Jones’s shareholder oppression claims for further proceedings in keeping with recent supreme court precedent.
In this dispute over the authority of an LLC’s operating manager to hire an attorney to assert claims on behalf of the LLC against some of its members and affiliates of the members, the court concluded that the trial court did not err in concluding that the operating manager had authority to hire the attorney on behalf of the LLC without a vote of the members.
This lawsuit started out as a suit to set aside an LLC member’s foreclosure on the LLC’s property after the LLC defaulted on a loan to the member, but the suit expanded to include additional parties and claims by the LLC against other members relating to the management of the LLC’s property before the foreclosure. The principal issue on appeal was whether the operating manager of the LLC had authority to hire an attorney for the LLC to assert claims against other members of the LLC and affiliates of those other members.
The LLC at issue was formed by several investors, including David Penny, Richard Cheroske, and Stephen Hyde, to purchase and own a hotel. Hyde was named as the LLC’s operating manager, and the LLC hired Blue Castle Property Management, LLC (“Blue Castle”) to operate and manage the motel’s day‑to‑day business. Blue Castle was owned by 190 Orange Avenue, Inc. (“190 Orange”), which was owned by Penny and Cheroske. Penny and Cheroske filed this suit as a derivative action to set aside a foreclosure on the LLC’s property, and the LLC intervened to assert several claims against Penny, Cheroske, Blue Castle, Blue Castle’s accountant, and 190 Orange for conversion, theft liability, breach of fiduciary duty, breach of contract, fraud, and other causes of action in relation to the management of the motel. After the claims relating to the foreclosure were resolved and the foreclosure was set aside, the claims against Penny, Cheroske, and the other third-party defendants remained. Penny, Cheroske, and the other third-party defendants filed a motion to require the LLC’s attorney to show the trial court that he had authority to prosecute the suit against them on the LLC’s behalf. The trial court ruled that the LLC’s attorney had authority to prosecute the suit, and Penny, Cheroske, and the other third-party defendants failed to respond to the LLC’s discovery requests and motions thereafter. The trial court eventually struck their pleadings and awarded the LLC judgment on all its claims. Penny appealed from that judgment.
On appeal, Penny challenged the trial court’s determination that the LLC’s attorney had authority to prosecute the suit. Penny argued that Hyde’s position as operating manager of the LLC did not vest him with the authority to hire an attorney to prosecute the LLC’s claim because the LLC’s operating agreement did not contain express language authorizing litigation and because Hyde lacked specific approval from a majority in interest of the members to conduct the litigation. Penny relied on Texas cases that he said stood for the proposition that the officers of a corporation do not have authority to employ counsel or initiate litigation in the absence of either approval of the board of directors or express authorization in the bylaws.
The court said it was hard to imagine a broader grant of managerial authority, and protecting the LLC’s interests by asserting the claims asserted in this case certainly fell within the purposes, business, and objectives of the company according to the court.
Even assuming the LLC’s operating agreement did not expressly grant Hyde the authority to conduct litigation on the LLC’s behalf, the court said that the cases Penny cited in support of his argument did not inform the court’s decision. The cases cited by Penny (for the proposition that Texas law requires express language in the bylaws or approval from the board of directors for an officer to litigate) involved corporations rather than LLCs and were decided under a provision of the now recodified Texas Business Corporation Act. The current version of that statutory provision is now located in Title 2 of the Texas Business Organizations Code (BOC) and is specific to for‑profit corporations. Thus, the provision does not apply to an LLC. Moreover, the court pointed out that the BOC provisions applicable in this case provide that, unless the entity’s governing documents provide otherwise, an LLC’s affairs are managed and directed by managers.
The court rejected this argument based on the agreement as a whole and harmonizing its provisions with an eye to the particular business activity sought to be served. The court concluded that the language relied on by Penny merely explained the method by which the managers reach a decision in a situation where there is more than one operating manager and they are not in complete agreement. Staying within the context of the first sentence (which provides that management of the company will be vested in operating managers, that only members can serve as operating managers, and that Hyde will be the first member to serve as operating manager), the court said the second sentence explains that the operating managers’ decisions, i.e., “decisions of the Operating Managers,” are achieved based on their membership interest. The court stated that Penny’s interpretation, which would require a majority vote on every company decision, would “render the operating agreement unreasonable, inequitable, and oppressive.” The court said that Penny’s interpretation would make the agreement’s creation of operating managers and their duties meaningless given that a member vote would be required for any and every action. In other words, there would be no need for operating managers if all decisions must be made by the members. In addition, Penny’s interpretation would render redundant the agreement’s requirement that a majority in interest of the members approve the selling or refinancing of real property.
In sum, the court determined that the operating agreement vested Hyde with authority to litigate on the LLC’s behalf, and the trial court thus did not err in holding that the LLC’s attorney satisfied his burden to show his authority by offering the LLC’s operating agreement and Hyde’s affidavit.
An LLC sued one of its members and an attorney-in-fact for breach of fiduciary duty and other causes of action and obtained a judgment. On appeal, the court held that there was evidence to support the jury’s finding that the member who caused the LLC to file suit was authorized to do so, and there was sufficient evidence to support the jury’s finding that the defendants breached their fiduciary duties to the LLC.
Jeffrey Pitsenbarger (“Jeff”), Tracy Hollister, and two other individuals formed an LLC that purchased some property, which was unexpectedly declared a Superfund site a short time after its purchase. The LLC, as an innocent owner, could pursue contribution for the clean-up costs, and Hollister introduced Jeff to Bigham, whom Hollister represented possessed expertise in managing environmental litigation. The LLC entered into a power-of-attorney agreement with Bigham. Under the power-of-attorney agreement, Bigham was to manage the litigation. The LLC alleged that Bigham and Hollister breached their fiduciary duties by sabotaging the litigation, and the LLC obtained a favorable jury verdict and judgment.
On appeal, Bigham and Hollister argued that the evidence conclusively established that Jeff lacked authority to file the suit on the LLC’s behalf, relying in part on provisions of the now-expired Texas Limited Liability Company Act that generally provide that managers may take actions on behalf of an LLC by obtaining a vote of a majority of the managers at a meeting where a quorum is present or a vote or consent of a majority of the managers without a meeting. Bigham and Hollister asserted that the evidence showed that, even if Jeff were a manager, he did not obtain the vote or consent of the majority of the managers. Because the jury was not instructed or given evidence regarding this statutory standard, however, the court did not consider it. The court measured the sufficiency of the evidence against the charge submitted. The broad question submitted to the jury asked generally whether Jeff had “authority” to file the suit. Bigham and Hollister pointed to the articles of organization of the LLC, which provided that the LLC was manager-managed. Bigham and Hollister argued that Jeff was not a manager when the suit was filed in September 2007 based on a Texas Franchise Tax Public Information Report signed by Hollister and filed by the LLC in April of 2007. The report listed Hollister as managing member and the two owners who were not involved in this case as managers or officers, but the report did not list Jeff as a manager or officer. The court disagreed that this evidence prevented a reasonable jury from finding that Jeff had authority to file the suit. That the articles of organization provided for management of the LLC by managers did not conclusively establish that only a manager could authorize a suit. There was evidence that Jeff was a member or owner of the LLC, and Jeff testified that he had authority to file the suit. Additionally, even if the authorization of a manager were required, there was conflicting evidence regarding whether Jeff was a manager. Jeff testified that the role of manager evolved to him by 2000 or 2001 and that the information in the Texas Franchise Tax Public Information Report was incorrect. In addition, Bigham referred to Jeff as the registered manager of LLC in an email in 2004. Thus, the court concluded the evidence was sufficient to support the jury’s answer to the question as submitted.
Twenty First Century Holdings, Inc. v. Precision Geothermal Drilling, L.L.C.
The court of appeals concluded that a manager of an LLC did not have authority to enter into a settlement agreement releasing the LLC’s claims against an entity owned by the manager because he was an interested governing person, and the provisions of the Texas LLC statute regarding approval of a transaction between an LLC and an entity in which a governing person has a financial interest were not met.
DeMarco and Denny formed an LLC to perform drilling work. DeMarco was 49% owner and Denny was 51% owner of the LLC, and both were managers. The LLC contracted with American Geothermal Systems, Inc. (“AGSI”), a company owned by DeMarco, and disputes arose between Denny and DeMarco over the drilling work and payment. Denny filed suit in the justice court on behalf of the LLC against AGSI seeking to recover $8,000 from AGSI. Denny and DeMarco eventually reached a settlement agreement in principle, but additional disputes arose regarding the operation of the LLC during the final settlement negotiations. DeMarco or AGSI’s counsel drafted a new settlement agreement, which DeMarco signed on behalf of both the LLC and AGSI. DeMarco then filed a nonsuit of the LLC’s case. On motion by the LLC, the justice court vacated the dismissal it had entered after DeMarco filed the nonsuit. AGSI sought to compel arbitration based on an arbitration clause in the settlement agreement. The justice court denied the motion for arbitration on the basis that the settlement agreement was invalid and also sanctioned DeMarco and the attorney for AGSI, whom the record showed represented DeMarco in virtually all matters related to the dispute and lawsuit. After unsuccessfully appealing to the county court, AGSI appealed to the court of appeals.
On appeal, AGSI contended that DeMarco had authority to execute the settlement agreement, the arbitration provision in the settlement agreement was thus valid, and the county court abused its discretion in not compelling arbitration. AGSI argued that DeMarco, as a manager of the LLC, had authority to act on behalf of the LLC in drafting and signing the settlement agreement that included the arbitration provision because the Texas LLC statute provides that the managers of an LLC are its “governing authority,” and each governing person vested with actual or apparent authority by the governing authority is an agent of the company for purposes of carrying out the company's business. The LLC argued that DeMarco's actions are controlled by a provision of the Texas LLC statute that applies to transactions involving interested governing persons. Under this provision, an otherwise valid and enforceable contract or transaction between an LLC and a governing person, or an entity in which a governing person is a managerial official or has a financial interest, is valid and enforceable, and is not void or voidable, if it is (1) known by or disclosed to and authorized by the “governing authority,” i.e., the managers, or (2) fair to the company. The LLC argued that DeMarco, as the sole owner of AGSI, was an “interested governing person” and that the settlement agreement between AGSI and the LLC thus had to be (1) known by or disclosed to and authorized by the managers, which included Denny, or (2) fair to the LLC. DeMarco did not dispute that DeMarco entered the settlement agreement without informing Denny and that Denny did not otherwise know of the agreement. The LLC contended that the settlement agreement was not fair to the LLC because it settled its breach-of-contract claim for no payment of money when the earlier settlement agreement had called for payment of $5,100 to the LLC. The court of appeals agreed with the LLC that the settlement agreement did not meet either of the requirements of the statutory provision governing conflict-of-interest transactions. It was undisputed that DeMarco acted without consulting or even informing Denny in drafting and signing the settlement agreement. Further, unbeknownst to Denny, the settlement agreement released the LLC’s claims against AGSI and DeMarco in return for no consideration other than AGSI’s release of claims against the LLC, despite a prior offer of $5,100. Thus, the settlement agreement, with the arbitration clause, could not be construed as “fair” to the LLC within the plain meaning of the term. The court cited sources defining “fair” as “characterized by honesty and justice” or “free from fraud, injustice, prejudice, or favoritism.” On the record before the court, it could not conclude that the parties entered into a valid and enforceable agreement to arbitrate.
The plaintiff sued to recover short-swing profits under Section 16(b) of the Securities and Exchange Act of 1934 based on numerous transactions involving shares in the plaintiff owned by an LLC. The court held that the “pecuniary interest” of a 50% member for purposes of determining the member’s beneficial ownership of shares sold by the LLC in a buyout of the other member was 50% even though after the transaction at issue the member owned 100% of the LLC.
An LLC and one of its members, McMillan, entered into an agreement with the other member, Pingel, under which Pingel agreed to sell all of his interest in the LLC in exchange for consideration that included 350,000 shares of stock in the plaintiff owned by the LLC. In a previous opinion, the court held that this transaction was a “sale” of the stock for purposes of short-swing profit liability under Section 16(b) of the Securities and Exchange Act. In this opinion, the court addressed a dispute as to the amount of McMillan’s beneficial ownership in the shares deemed to be sold by the LLC in the buyout of Pingel. McMillan and the LLC maintained that McMillan’s beneficial interest in the deemed sale of the shares to Pingel was limited to 175,000 shares based on McMillan’s pecuniary interest, i.e., his 50% ownership interest, in the LLC at the time of the sale. The plaintiff argued that McMillan had a pecuniary interest in all 350,000 of the shares sold in the Pingel transaction, reasoning that the pecuniary interest in the sale belonged entirely to McMillan because only he, as the sole remaining investor in the LLC, would have enjoyed the risks and rewards of owning these shares had the LLC not sold them, and only he had the opportunity to profit from the sale because he was the sole remaining investor in the LLC and stood to enjoy 100% of the benefits that it received from the transaction. The plaintiff also asserted that the 50% ownership interest of Pingel in the LLC should not be counted because he had no opportunity to profit from the sale. The court disagreed with the plaintiff’s reasoning. The plaintiff relied on a definition of “pecuniary interest” – the opportunity, directly or indirectly, to profit or share in any profit derived from a transaction – to determine the extent of that interest. However, that provision specifies what is necessary to have a pecuniary interest rather than the extent of that interest. A person has a “pecuniary interest” if he has any direct or indirect opportunity to profit or share in any profit derived from a transaction. 17 C.F.R. § 240.16a-1(a)(2)(i). The regulations contain a standard of measurement, or extent of pecuniary interest, in another context. Under 17 C.F.R. § 240.16a-1(a)(2)(ii)(B), a general partner’s indirect pecuniary interest in the portfolio securities held by a general or limited partnership is the general partner’s proportionate interest, as evidenced by the partnership agreement in effect at the time of the transaction and the partnership’s most recent financial statements. The regulations define the extent of a person’s pecuniary interest (here, an indirect pecuniary interest) based on the interest “in effect at the time of the transaction,” and there is no indication in the regulations that the interests of owners in an LLC’s portfolio securities should be treated differently. The court also disagreed with the plaintiff’s assertion that the 50% ownership interest of Pingel in the LLC should not be counted. Pingel had a pecuniary interest in the transaction, even though he was the purchaser of the shares, because they were being sold by the LLC, in which Pingel had an ownership interest at the time of the sale. Although the transaction itself extinguished that ownership interest, it did not deprive Pingel of the opportunity, directly or indirectly, to profit or share in any profit from the transaction. Thus, the court held that McMillan’s pecuniary interest in the LLC was determined according to what it was at the time of the transaction, which was 50%.
Civil Action No. 3:10-CV-0953-D, 2015 WL 1000838 (N.D. Tex. Mar. 6, 2015).
The court concluded that a statutory provision that permits a prevailing party in a breach-of-contract case to recover attorney’s fees from “an individual or corporation,” does not permit recovery of attorney’s fees from a limited liability company. The plaintiff prevailed on a breach-of-contract claim against the defendant, and the plaintiff sought to recover attorney’s fees under Section 38.001 of the Texas Civil Practice and Remedies Code. Section 38.001 provides that, if a claim is for any of eight specific categories, including a valid claim for “an oral or written contract,” “[a] person may recover reasonable attorney’s fees from an individual or corporation, in addition to the amount of a valid claim and costs.” The defendant in this case was an LLC. The Supreme Court of Texas has not yet addressed whether Section 38.001 permits the recovery of attorney's fees from an LLC; therefore, the court was required to predict how the Texas Supreme Court would resolve the issue if presented with the same case. Section 38.001 differentiates between who may recover attorney’s fees and from whom such fees may be recovered by providing that a “person” may recover attorney's fees from “an individual or corporation.” The Texas Code Construction Act broadly defines “person” to include a “corporation, organization, government or governmental subdivision or agency, business trust, estate, trust, partnership, association, and any other legal entity.” But Section 38.001provides that attorney’s fees may be recovered from “an individual or corporation” rather than a “person.” Neither the Civil Practice and Remedies Code nor the Code Construction Act defines the term “individual” or “corporation.” Thus, the court was faced with the question of whether an LLC falls within the scope of “an individual or corporation.” The court stated that an LLC clearly was not an “individual” within the ordinary meaning of the term, and Texas courts of appeals and federal courts interpreting Section 38.001 have held that the term “individual” refers to humans rather than partnerships, governmental subdivisions, or other legal entities. The plaintiff argued that the term “individual” should be construed to include LLCs because the Texas Business Organizations Code provides that “‘a domestic entity has the same powers as an individual to take action necessary or convenient to carry out its business and affairs,’ including the power to ‘sue [and] be sued,’ ‘make contracts,’ and ‘incur liabilities.’” The court was unpersuaded by this argument. Likewise, the court rejected the plaintiff’s argument that the Texas Supreme Court would interpret the term “corporation” in Section 38.001 to include an LLC. The court discussed the nature of LLCs and acknowledged that LLCs and corporations have some similarities, but the court concluded that LLCs and corporations are distinct legal entities. Further, the court concluded that the history of Section 38.001 and its predecessor statute supports the conclusion that the term “corporation” does not include an LLC. The court stated that the predecessor statute clearly distinguished between corporations, on the one hand, which could both recover attorney’s fees and from whom attorney’s fees could be awarded, and “partnerships” and “other legal entities,” on the other hand, which could themselves recover attorney’s fees but from whom such fees could not be recovered. According to the court, because the term “corporation” in the predecessor statute did not include a “partnership” or “other legal entity,” the term “corporation” in Section 38.001 likewise does not include a “partnership” or “other legal entity” such as an LLC. The court stated that cases applying the predecessor statute in which courts awarded attorney’s fees against non-corporate entities did not squarely address the question. And even if Texas courts permitted attorney’s fees to be recovered from non‑corporate business entities before the re-codification of the predecessor statute, the court stated that the current version rather than the prior, repealed statute must be given effect when “specific provisions of a ‘nonsubstantive’ codification and the code as a whole are direct, unambiguous, and cannot be reconciled with prior law.” The court was also unpersuaded by Texas cases that have awarded attorney’s fees to non‑corporate business entities under Section 38.001. In these cases, there was no indication that the question whether such an award was permitted under Section 38.001 was raised or considered.
The minority members of an LLC obtained a summary judgment against Macias, the majority member, on Macias’s claim against the minority members for breach of fiduciary duty. Macias argued on appeal that he at least raised a fact issue as to whether the minority members owed him a fiduciary duty based on their exercise of active control over the LLC. The court of appeals affirmed the trial court’s summary judgment because Macias argued in the trial court that the minority members owed him a fiduciary duty as a matter of law, comparing the LLC to a partnership in which all partners owe one another a fiduciary duty. The court of appeals concluded that Macias did not fairly apprise the trial court of his “control” argument, and the summary judgment thus could not be reversed on that basis. The court stated in a footnote that it offered no opinion as to whether an LLC’s members who control activities of the LLC owe a fiduciary duty to majority members.
The court of appeals held that there was some evidence of the existence of an informal fiduciary duty owed by the two members of an LLC who were also managers to a third member who was not involved in the day-to-day affairs of the LLC, and there was also some evidence of breach of the duty and harm suffered by the third member.
Dr. Guevara sued Mark Lackner and Robert Lackner, fellow members of an LLC in which Dr. Guevara invested, for breach of fiduciary duty. The trial court granted a no-evidence summary judgment on this claim in favor of the Lackners. Based on a provision of the company agreement vesting sole control of the LLC in the Lackners as managers, Dr. Guevara alleged that the Lackners owed fiduciary duties of loyalty, good faith, fair dealing, full disclosure, and to account for all profits and property. Dr. Guevara alleged that the Lackners breached their duties by taking his money as a loan to purchase merchandise, conspiring to keep the profits, and suppressing information related to the transaction. He also alleged that the Lackners failed to use any business judgment in their dealings related to obligations owed by another member to the LLC. Dr. Guevara asserted that he was injured by the loss of funds he provided for the purchase of merchandise for the LLC and funds provided for other expenses of the LLC. The court noted that “Dr. Guevara’s status as a co-shareholder or co-member in a closely held corporation does not automatically create a fiduciary relationship between co-shareholders or co-members.” The court stated that Texas courts have recognized that an informal fiduciary duty may exist between shareholders of a closely held corporation under particular circumstances even though Texas courts have declined to recognize a broad formal fiduciary duty between majority and minority shareholders in closely held corporations. The court concluded that there was more than a scintilla of evidence of the existence of an informal fiduciary duty between the Lackners and Dr. Guevara, the breach of that duty, and injury to Dr. Guevara. The court pointed to evidence of the Lackners’ control based on the provision of the company agreement that vested sole control of the management, business, and affairs of the LLC in the Lackners as managers. There was also evidence that the Lackners’ role as managers gave them intimate knowledge of the daily affairs of the LLC and that Dr. Guevara did not have extensive knowledge of the operations and was not involved in the day-to-day operations. The summary judgment evidence showed the Lackners did not disclose certain information to Dr. Guevara and that the Lackners’ made decisions without knowledge of relevant facts. There was also evidence that the funds provided by Dr. Guevara to the LLC were lost. According to the court of appeals, this evidence amounted to more than a scintilla of evidence of the elements of a claim for breach of an informal fiduciary duty.
A judgment creditor of Packer sought to reach the assets of several LLCs and other entities in which Packer owned most or all of the membership interests. The court rejected this reverse veil-piercing claim because alter-ego claims, including reverse-veil piercing actions, are property of the bankruptcy estate, and the plaintiff thus lacked standing to pursue such claims. Additionally, the court rejected the plaintiff’s claim that Packer should have listed the assets of his entities in his personal bankruptcy schedules. The plaintiff in essence relied on reverse veil-piercing principles as the basis for denying Packer’s discharge under Section 727(a) of the Bankruptcy Code, and the court concluded that the plaintiff did not establish that the provisions relied upon by the plaintiff had been satisfied.
The plaintiff sought to reach the assets of LLCs owned by Packer to satisfy a judgment against Packer held by the plaintiff, contending that Packer improperly disregarded corporate formalities with regard to the companies and utilized them to hinder, delay, and defraud his individual creditors. The court stated that this count was essentially a claim for reverse veil‑piercing. The court disregarded the evidence of Packer’s failure to observe corporate formalities or otherwise maintain a separate identity from the companies and dismissed this count because it is well-established in the Fifth Circuit that alter-ego claims and reverse veil-piercing actions are property of the bankruptcy estate and lie within the exclusive control of the trustee.
The plaintiff also sought denial of Packer’s discharge under various subsections of Section 727(a) of the Bankruptcy Code based on Packer’s failure to list assets of his companies on his personal bankruptcy schedules. This argument essentially relied on alter-ego/veil-piercing arguments, especially Packer’s continued use of the bank account of one of his single-member LLCs, from which he paid personal expenses. The plaintiff sought to use reverse-piercing principles to deny Packer’s discharge under Section 727(a) although the plaintiff was precluded under federal bankruptcy law (because a veil-piercing claim belonged to the bankruptcy estate) and Texas law (because the entities were not joined as parties) from obtaining a judgment against the entities. The plaintiff argued that Packer should be punished through denial of his discharge for his failure to admit and acknowledge personal ownership of corporate and LLC assets. Although the plaintiff was barred from pleading and proving any type of alter-ego claim, the plaintiff urged the court to use its equitable powers to apply the reverse veil‑piercing principles to reach a just result, even though those principles could not actually be used to disregard the legal protections that the LLCs and other entities had under applicable Texas law. The court stated that equitable principles could not be legitimately used to sidestep the clear requirements of the Bankruptcy Code and to ignore the protections of state law in order to establish an artificial evidentiary foundation upon which to deny Packer’s discharge. In light of the plaintiff's lack of standing to bring its reverse veil‑piercing claims, and the fact that the organizational integrity of Packer’s entities would not be compromised as a result of this adversary proceeding, the court stated that it must disregard any summary judgment evidence submitted by the plaintiff to establish that the assets of any independent company should be treated as the assets of the bankruptcy estate or that Packer could be sanctioned for his failure to schedule those corporate assets as his own. There was simply no legal basis upon which Packer was required to list or account for the assets of his separate entities in his personal bankruptcy schedules.
The court also concluded that Packer’s involvement with his LLCs and other entities did not present an issue for trial on the Section 727(a) claims. The summary judgment record established that Packer did not conceal material information regarding the conduct of his financial affairs within the requisite time period. He disclosed the existence of his various companies and his use of one LLC’s assets to pay personal expenses. Recognizing that single‑member LLCs and closely‑held corporations can only engage in business activity through the actions of involved individuals, Packer described his interactions with his entities, particularly the LLC that paid his personal expenses, to the trustee at the Section 341 meeting and answered all questions he was asked regarding the activities of that LLC. Nothing in the record indicated that the trustee was dissatisfied with the responses to those inquiries. Packer’s claim that his membership interests in his companies had no value could not be characterized as meritless, and there was no indication that Packer was not cooperative with the trustee throughout the bankruptcy process. The trustee had ample opportunity to examine Packer regarding his entities and to take appropriate action against the entities for the benefit of the bankruptcy estate if the trustee thought that Packer was improperly utilizing them for fraudulent or dishonest purposes. No summary judgment evidence indicated that the trustee was dissatisfied with Packer’s level of disclosure and cooperation. While a discharge may be properly denied for concealment when a debtor places assets beyond the legitimate reach of creditors or withholds vital information to which creditors are entitled, that did not occur in this case. Here there was disclosure and the opportunity for the bankruptcy estate to take appropriate action as advisable. That is the quid pro quo for a bankruptcy discharge.
There were some aspects of this dispute that troubled the court. Although Packer had the right to disregard his wholly owned LLC as a separate taxable entity for federal income tax purposes, he had no right to disregard its organizational integrity. Once Packer was owed money by his LLC for personal services, Packer was not permitted to unilaterally retain such funds in the LLC account to frustrate the collection rights of a creditor. However, because the structural integrity of the LLC was not legally compromised and in light of the summary judgment evidence that the LLC’s contracts produced LLC assets in its account, the plaintiff was required to provide specific evidence that Packer had improperly retained his funds in the LLC account during the requisite time period. By failing to present such summary judgment evidence, there was nothing in the record contradicting the legal conclusion that the funds in the LLC account constituted LLC assets. If the appropriation of LLC assets by Packer was improper, as the plaintiff alleged, it was improper as to (and perhaps avoidable by) LLC creditors, but not to creditors of Packer. With the “corporate veil” of the LLC intact, the plaintiff's unsubstantiated assertions and speculation regarding the impropriety of Packer’s use of the LLC funds were not sufficient to defeat Packer’s motion for summary judgment.
The president and sole member of an LLC asserted malpractice claims against the attorneys that advised the LLC to file bankruptcy. The plaintiff claimed that the attorneys negligently advised the plaintiff to file a Chapter 11 petition on behalf of the LLC, and the bankruptcy court analyzed whether the claims were direct or derivative. The court concluded that some of the claims were derivative and some were direct.
The bankruptcy court relied on case law in the corporate context to analyze whether the plaintiff’s claims were direct or derivative, and the court concluded that the plaintiff had asserted claims that were direct as well as claims that were derivative. The court stated that the relevant considerations in characterizing a claim as direct or derivative are which party suffered the harm and which would receive relief. The court examined the allegations in the complaint and concluded that the plaintiff asserted injuries personal to the plaintiff that formed the basis of direct claims. The complaint alleged that the plaintiff had a personal attorney‑client relationship with the defendants during which the defendants breached their fiduciary duty to the plaintiff by negligently advising him to file a Chapter 11 bankruptcy on behalf of the LLC. As a result of the alleged negligence, the plaintiff contended that he suffered losses when unpaid creditors of the LLC sued the plaintiff in his individual capacity as guarantor to recover obligations owed by the LLC. The plaintiff incurred defense costs and had judgments entered against him personally after the LLC failed to pay the debts through its bankruptcy. This harm was personal and distinct from any harm suffered by the LLC. Thus, the plaintiff’s causes of action against the defendants for negligence, breach of fiduciary duty, and violation of the Deceptive Trade Practices Act that were based on suits filed against them by LLC creditors were direct causes of action that should not be dismissed. Further, the exculpatory provision in the plan did not limit the liability of the defendants for pre-petition conduct and thus did not bar the plaintiff’s claims. To the extent the complaint alleged injury based on the loss in value of the plaintiff’s ownership in the LLC (which the court referred to as “stock” or “shares”), the claims were derivative because an individual shareholder has no separate and independent right of action for injuries suffered by the corporation that merely result in the depreciation of the shareholder’s stock. The plaintiff’s causes of action that were based merely on the devaluation of the LLC’s “stock” were derivative and belonged to the LLC’s estate.
The court first rejected the managers’ argument that Nevada law applied to their liability under the Utah Revised Uniform Limited Liability Company Act, which provides that the law of the jurisdiction of formation of a foreign LLC governs “the liability of a member as member and a manager as manager for a debt, obligation, or other liability of the company.” The managers argued that unpaid wages are like any other debt of an LLC and that Nevada law should be applied to determine the managers’ liability for the unpaid wages. The court responded that the employees were not seeking to hold the managers liable for an obligation of the LLC but were arguing that UPWA imposed direct liability on the managers. Because the employees’ theory was premised on direct liability, and the conflict-of-laws provision in the Utah LLC statute applied to liability for obligations of the LLC, the conflict provision did not apply to this case. Further, the court pointed out that the Utah LLC statute provides that registration of a foreign LLC to do business in Utah does not authorize the foreign LLC to engage in activities or exercise any power that a Utah LLC may not engage in or exercise in Utah. Because a foreign LLC that employs employees in Utah is required to follow Utah wage law, any claim of illegal wage practice by a Utah employee will be governed by Utah wage law.
The court next analyzed the UPWA and concluded that it did not impose personal liability for unpaid wages on managers of an LLC employer. Although the definition of an employer includes “any agent or officer” of the entities listed in the statute, the court stated that the phrase is qualified by the clause “employing any person in this state.” The LLC rather than the managers employed the employees, and the court stated that the conclusion that the managers were not liable was buttressed by long-accepted principles of corporate law that recognize the separate legal existence of a corporation from its officers, shareholders, and directors. Where the legislature has imposed personal liability on business officers and agents, it has done so expressly, such as in the Insurer Receivership Act and the Alcoholic Beverage Control Act. Further, the imposition of criminal liability on employers under the UPWA weighs against imposing personal liability on corporate officers and agents because “fair warning” of conduct constituting a crime is required, and the UPWA is not clear enough to meet that standard. The court rejected two alternative constructions of the UPWA raised by the employees. The employees argued that the definition of “employer” rendered the managers liable as “agents and officers” of the LLC under the language of the definition, but the court stated that this construction would lead to the absurd result that all employees would be personally liable for unpaid wages because employees are agents of their employer. The second construction argued by the employees would limit the types of agents and officers who qualify as employers to those who exercise some control over the payment of wages. This approach has been used in Pennsylvania in interpreting a wage statute that defines an employer in a manner similar to the UPWA. The court concluded that the Pennsylvania approach was arguably consistent with public policy but was not consistent with the language of the UPWA. This approach would require courts to “engage in a free-standing public policy analysis to determine precisely which agents of an employer should be held liable for unpaid wages,” and the court characterized the role of drawing such lines as one for the legislature. Since the employees’ first argument would lead to absurd results by imposing civil and criminal liability on all employees, and the second argument required drawing policy-based lines not supported by the statutory language, the court held that the LLC managers could not be held personally liable for the unpaid wages under the UPWA.
The Washington Supreme Court held that a debtor in bankruptcy did not have standing to bring a derivative action on behalf of a Washington LLC because the Washington LLC statute provides that a plaintiff in a derivative action must be a member of the LLC, the debtor was dissociated as a member pursuant to the Washington LLC statute when the debtor filed bankruptcy, and the dissociation provision of the Washington LLC statute was not preempted by Section 541 or 365 of the Bankruptcy Code.
Harold and Shirley Ostenson and Greg Holzman formed an LLC in 1998. The Ostensons and Greg Holzman, Inc. (“GHI”) became the members of the LLC, and both the Ostensons and GHI were active in the business. GHI owned a majority interest and had management responsibilities under the operating agreement. Holzman fired the Ostensons from their positions with the LLC after the LLC defaulted on its operating line of credit and lease. The Ostensons filed for bankruptcy protection under Chapter 11 in early 2007. Later in 2007, a creditor of the LLC filed this lawsuit in state court against the LLC, GHI, and the Ostensons. The Ostensons filed cross claims and a third-party complaint against Holzman, GHI, and another entity of Holzman’s. These claims were a derivative action on behalf of the LLC. After the creditor’s claims settled, the only remaining claims were the Ostensons’ responsive claims against the LLC and the derivative claims against the Holtzman defendants. This case went to trial in 2011, and the Holzman defendants moved to dismiss the Ostensons’ derivative action after the Ostensons rested their case. The Holzman defendants argued that the Ostensons were no longer members of the LLC and lacked authority to bring their derivative action. Eventually, the trial court ruled that the Ostensons relinquished their membership in the LLC when they filed bankruptcy and could not maintain a derivative action on the LLC’s behalf. The Ostensons appealed, and the court of appeals agreed with the trial court that the Ostensons did not have standing. The Ostensons appealed to the Washington Supreme Court.
The Ostensons repeated the argument that they made in the court below that Sections 541(c)(1) and 365(c)(1) invalidated or rendered unenforceable ipso facto bankruptcy clauses. Under the Washington LLC statute, a member is dissociated as a member when the member files a voluntary petition in bankruptcy unless the LLC agreement provides otherwise, and a plaintiff in a derivative action must be a member at the time of bringing the action. The Ostensons argued that the dissociation provision of the statute was preempted by federal bankruptcy law.
The court first addressed the interplay between Section 541(a) and (c)(1) and the Washington LLC statute. Under Section 541(a), a bankruptcy filing triggers the creation of a bankruptcy estate into which the debtor's property interest devolves, but the threshold question of how a debtor’s interest is determined turns on state law. Applying Ninth Circuit case law, the court concluded that the Ostensons’ bankruptcy estate took their interest as defined, determined, and encumbered according to state law, and the interest that devolved to the Ostensons’ bankruptcy estate was thus an assignee’s interest and not a member’s interest in the LLC. The court of appeals had reached the same result applying In re Garrison-Ashburn, LLC, a Virginia bankruptcy court decision applying a similar provision of the Virginia LLC statute. The Washington Supreme Court concluded that the court of appeals correctly applied In re Garrison-Ashburn, and the supreme court distinguished and declined to follow a portion of In re First Protection, Inc. because the court felt that the Ninth Circuit Bankruptcy Appellate Panel in that case did not adhere to Ninth Circuit precedent. The court also distinguished In re Daugherty Construction, Inc. and another case because those cases dealt with statutory or contractual provisions that triggered dissolution of the LLC rather than dissociation of a member on the filing of a member’s bankruptcy.
The court next addressed the Ostensons’ argument that Section 365(e)(1) invalidates or renders unenforceable ipso facto bankruptcy clauses. Section 365 applies to executory contracts. The supreme court explained that the court of appeals analyzed the obligations in the LLC operating agreement and noted that they might suffice to create an executory contract, but the court of appeals found it unnecessary to decide whether the operating agreement was an executory contract because the court concluded that Section 365(e) otherwise excused further performance under the agreement. The court of appeals relied on Washington case law in the partnership context in which the court held that a provision of state law that dissolved a general partnership upon a partner’s filing of bankruptcy was not superseded by Section 365(e)(1)’s invalidation of ipso facto provisions because the freedom of the partners to choose with whom they are associated excused the remaining partners from performance under Section 365(e)(2). The supreme court agreed with the court of appeals that the same rights of voluntary association on which the partnership case law rested applied to LLC membership. Thus, if the LLC operating agreement in this case constituted an executory contract, the associational rights of the members found in the Washington LLC statute triggered the Section 365(e)(2) exception rendering the Section 365(e)(1) prohibition on ipso facto clauses inapplicable.
Todosijevic and Vukov each owned a 50% interest in a Wyoming LLC, and after Vukov discovered he had made significantly greater capital contributions over time than Todosijevic, Vukov called a meeting and adopted resolutions increasing his ownership interest to 99.72% and decreasing Todosijevic’s interest to .28% to reflect the amounts of the members’ capital contributions. The articles of organization provided for initial contributions of $10,000 and additional contributions at such times and in such amounts as agreed by the members. Over time, Vukov became concerned that he was the only member making additional capital contributions and that Todosijevic misrepresented that he was contributing additional funds. Vukov’s investigation showed that he had contributed 1,260,00 Euros and that Todosijevic had made no additional contributions, prompting Vukov to hold a meeting at which he voted to adjust the ownership interests. Todosijevic did not attend the meeting. (Interestingly, the members were Serbian residents, and the LLC’s business was in Belgrade; the LLC had no connection with Wyoming other than being organized under Wyoming law.) Todosijevic sued the LLC and Vukov claiming that the adjustments to the members’ ownership percentages were improper. The articles of organization and written operating agreement provided that the LLC was manager-managed and named an individual who was not a member as manager, but Vukov and the LLC claimed that the LLC had no active manager and was in reality member-managed and that provisions of the Wyoming LLC statute suggested that management of a member-managed LLC is proportionate to each member’s capital contribution. The court first examined the provisions of the current LLC statute to determine whether the current or prior statute applied to the question of whether the LLC was manager-managed or member-managed. Because the LLC in this case was organized in 2007, the prior statute applied to this question. Under that statute, an LLC is member-managed unless the articles of organization provide that the LLC is manager-managed. The court rejected the argument that it should look beyond the language of the Wyoming LLC statute and the organizational documents to the realities of how the LLC was managed. The court stated that the statute did not permit the court to ignore the LLC’s designation of itself as manager-managed. Next the court addressed whether a member has the authority in a manager-managed LLC to adjust the members’ ownership interests. The current statute specifies certain provisions of the prior statute that continue to apply to LLCs formed before adoption of the new statute, but none of the specified provisions addressed this question. Thus, the court applied the current statute to this question. Under the statute, a manager in a manager-managed LLC has the exclusive authority to decide any matter relating to the activities of the LLC, and the consent of all members is required to undertake any act outside the ordinary course of the company’s activities, unless otherwise provided by the articles of organization or operating agreement. The LLC’s articles of organization stated that the manager was authorized to act for and bind the LLC by his individual signature, and the operating agreement gave broad authority to the managers and provided that members who are not managers shall take no part in the management or control of the LLC and have no power to bind the LLC. The court concluded that the changing of ownership interests was action outside the ordinary course of the LLC’s activities and required the consent of all members under the clear language of the statute. Thus, Vukov did not have the authority to unilaterally change the members’ ownership interests. The court recognized that this left the members deadlocked. Only the manager had authority to sell or transfer the LLC’s assets, but the LLC claimed there was in reality no manager. The remedy of judicial dissolution was foreclosed because the district court’s ruling granting the LLC’s motion for summary judgment on Todosijevic’s dissolution claim was not appealed. Under these circumstances, the court stated that Todosijevic’s only remedy if Vukov had illegally transferred LLC assets was to sue for monetary damages.

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