Source: https://www.professorbainbridge.com/professorbainbridgecom/agency-law/page/2/
Timestamp: 2019-04-24 18:28:39+00:00

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Might Nevada avoid the mistake of extending alter ego liability to LLCs?
The Nevada Supreme Court has not expressly held that the laws for piercing the corporate veil under the alter-ego doctrine apply to LLCs, but it has applied those rules in the LLC context, “assum[ing] without deciding that” the corporate analysis applies.
Pharmaplast S.A.E. v. Zeus Medical Holdings, LLC, et al. Case No. 2:15-cv-002432-JAD-PAL. (D. Nevada, March 14, 2017) (footnote omitted citing Webb v. Shull, 270 P.3d 1266, 1271 n.3 (Nev. 2012) and JSA, LLC v. Golden Gaming, Inc., 2013 Nev. Unpub. LEXIS 1449 (Nev. 2013)). Judge Dorsey could have, but did not mention, that the Ninth Circuit Court of Appeals has similarly assumed, but not decided, that members of a Nevada LLC at risk of alter ego liability. Volvo Constr. Equip. Rents, Inc. v. NRL Rentals, LLC, 614 Fed. Appx. 876, 878 n. 1 (9th Cir. Nev. 2015). Nonetheless, the legislative history to Nevada’s LLC law supports the proposition that members may be liable under the alter ego doctrine as noted in Bishop and Zucker on Nevada Corporations and Limited Liability Companies § 16.4[A].
Of course, I have argued against extending veil piercing and alter ego to the LLC setting, most recently in Todd Henderson's and my book Limited Liability: A Legal and Economic Analysis .
The familiarity with corporate boards may prompt some business owners and their advisors to consider creating board-managed LLCs. Business owners who adopt such structures may be sorry for doing so for a number of reasons. Generally speaking, such structures are too complicated for closely held LLCs, which would benefit from simpler member-managed or manager-managed structures. Because LLC statutes generally do not provide for board-managed LLCs, boards of LLCs generally are the product of management provisions in LLC operating agreements. The lack of a statutory framework provides flexibility but also creates more room for adopting unwanted agreements. Terms such as “board of managers” and “board of directors” could, for instance, have different meanings, and could either grant authority to the board as a whole or to members of the board as managers. Finally, recent case law also indicates that courts will use corporate law to decide disputes that arise among members and managers of board-managed LLCs, corporifying the management structure of those LLCs. Thus, business owners and their advisors must use caution when considering whether to create board-managed LLCs. If they decide that such structures are a must, perhaps they will benefit from forming the LLC in one of three states that have statutory board structures. This brief article introduces these matters.
I think the authors are correct. The whole point of the LLC is to combine partnership-like governance structures with corporate-like limited liability, while also adding a degree of flexibility that neither corporations nor partnerships possess by also allowing manager-managed LLCs and substantial freedom of contract. But this is a good example of situations in which having freedom of contract doesn't;t necessarily mean you should exercise it.
Of all the duties a law student encounters in the study of law, few will prove as bewildering as fiduciary duties. Whilst their core is supposed to be “relatively clear”,1 the wider content of fiduciary obligations continue to elude us. Whilst we know that fiduciaries are expected to avoid unauthorised profits and conflicts of interests, whether any fiduciary duties exist beyond this core remains controversial. Beyond a few established categories of fiduciary relationships such as trustee and beneficiary, 2 director and company,3 agent and principal,4 partners, 5 and solicitor and client,6 it remains a mystery as to when fiduciary duties arise. This is problematic because “[i]t is not because a person is a ‘fiduciary’ … that a rule applies to him. It is because a particular rule applies to him that he is a fiduciary … for its purposes.” 7 Whilst the latter problem of who is a fiduciary is a very real one, the former problem surrounding its content is by far the more acute of the two. Until we know what fiduciary duties the law subjects fiduciaries to, it should not be surprising that the courts will remain circumspect in determining who is a fiduciary outside the established categories.
The most contentious dispute surrounding the content of the fiduciary obligation in recent years lies in its proscriptive or prescriptive nature. Despite case law suggesting that the fiduciary obligation may be prescriptive,8 some courts9 and commentators10 fiercely defend the exclusively proscriptive nature of fiduciary duties. This article proposes that fiduciary duties operate at two levels. The most commonly encountered fiduciary duties are the proscriptive duties preventing conflicts and unauthorised profits. These duties are prophylactic in nature, operate at a subsidiary level and are sometimes said to be better characterised as disabilities.11 At the primary level, the search for peculiarly fiduciary duties is an exercise in futility as fiduciary accountability is invariably and inextricably associated with duties of a nominate or even particular character that apply differently to various categories of fiduciaries. Rather, if at all desirable, it is perhaps more sensible to distinguish fiduciary breaches from non-fiduciary breaches of these complex duties. It is fiduciary accountability at the primary level that the subsidiary proscriptive duties seek to support rather than any non-fiduciary form of accountability. In this sense, at the primary level, fiduciary accountability can be prescriptive. However, in its prescriptive form, as it is inextricably embedded within a complex and compound nominate duty, it is pointless to search for an independent prescriptive fiduciary duty.
I addressed that debate in my article, The Parable of the Talents (August 15, 2016). UCLA School of Law, Law-Econ Research Paper No. 16-10. Available at SSRN: https://ssrn.com/abstract=2787452, in which I come down on the prescriptive side.
Why not just abolish LLC veil piercing?
(6) absence of corporate records, and (7) the fact that the corporation was a mere facade for the operations of the [parent company].
ACKISON SURVEYING, LLC, Plaintiff, v. FOCUS FIBER SOLUTIONS, LLC, et al., Defendants., No. 2:15-CV-2044, 2017 WL 958620, at *3 (S.D. Ohio Mar. 13, 2017) (alterations in original).
The opinion ultimately find that the complaint made only legal conclusions and failed to provide any facts to support the allegations of the LLC as an alter ego of its parent corporation, and further determined that a proposed amended claim was equally lacking. As such, the court dismissed FTE from the case. This conclusion appears correct, but it still suggests that, in another case, one could support a veil piercing claim against an LLC by showing that the LLC's "failure to observe corporate formalities," formalities it may have no legal obligation to follow.
This remains my crusade. When courts get cases like this, they should (at a minimum) provide a clear veil piercing law for LLCs that accounts for the differences between LLCs and corporations.
I was pleased to go out to Pepperdine today to give a talk based on my essay on The Parable of the Talents at their annual Nootbaar Conference on Law and Religion.
Corporate Officers as Agents, 74 Wash. & Lee L. Rev. __ (no. 2, 2017).
Understanding that officers are agents also brings into focus the often overlooked question of what law governs an officer’s performance of his or her duties. Remarkably, the Delaware Supreme Court made no mention in Gantler v. Stephens of the law of agency or the possible application of Ohio law, where the corporation was headquartered and operated a bank. In my view, the Court should have analyzed the actions of the defendants qua officers under agency law and determined under applicable choice of law principles whether to apply Delaware or Ohio law. ... Because officers typically exercise authority over corporate employees, the title of officer has come to imply authority.
First question, if officers are agents--pure and simple--why did the drafters of the Model Business Corporation Act feel it necessary to lay out both standards of conduct and standards of liability for officer? The MBCA had to do so for directors, who are fiduciaries but not agents, so as to define the directors' duties because agency law was not applicable. The decision to do so for officers therefore implies that even if officers are agents, they are a special sort of agent.
The local law of the state of incorporation will be applied to determine the existence and extent of a director's or officer's liability to the corporation, its creditors and shareholders, except where, with respect to the particular issue, some other state has a more significant relationship under the principles stated in § 6 to the parties and the transaction, in which event the local law of the other state will be applied.
Issues relating to the liability of the directors and officers for acts such as these can practicably be decided differently in different states. It would be practicable, for example, for a director to be held liable for a given act in one state and to be held not liable for an identical act in another state. Nevertheless, in the absence of an applicable local statute, the local law of the state of incorporation has usually been applied to determine the liability of the directors or officers for acts such as these to the corporation, its creditors and shareholders. This law has usually been applied even in a situation where it might be thought that some other state had a greater interest than the state of incorporation in the issue to be determined. The local law rule of a state other than the state of incorporation is most likely to be applied in a situation where this rule embodies an important policy of the other state and where the corporation has little contact with the state of its incorporation.
Restatement (Second) of Conflict of Laws § 309 cmt c. (1971).
The Restatement thus tees up a case in which the forum state is not the state of incorporation. In that instance, we are told, the forum state should apply the law of the state of incorporation except in rare instances in which the forum state has an applicable rule reflecting an important local policy and the corporation has weak contacts with the state of incorporation.
VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108, 1113 (Del. 2005) (footnotes omitted). In other words, Delaware takes the position (again, not surprisingly) that the internal affairs doctrine amounts to a constitutional principle. As such, why would we expect a Delaware court to spend time dithering (in an opinion as opposed to perhaps a bench ruling) over choice of law in such a case?
Did you notice my qualifying remark "If someone had raised the choice of law issue"? It is a general rule that a "court is not obligated to analyze a choice of law issue sua sponte. Kearl v. Rausser, 293 F. App'x 592, 599 n. 2 (10th Cir.2008) (“ ‘[U]nlike jurisdictional issues, courts need not address choice of law issues sua sponte.’ ”) (quoting Flying J Inc. v. Comdata Network, Inc., 405 F.3d 821, 831 n. 4 (10th Cir.2005))." Patterson v. Williams, No. 10-CV-4094-CM, 2012 WL 138606, at *2 (D. Kan. Jan. 18, 2012). The court may. But it doesn't have to.
Second, Keith is perturbed by the court's failure to deal with the choice of law issue. But (1) maybe nobody brought it up, in which case the court had no duty to do so sua sponte and (2) the result would have been a foregone conclusion in favor of applying Delaware law.
Personally, I'm okay with it.
It seems to me necessary to state your facts more clearly to avoid the distinction between capital losses and operating losses, which to my mind only confuses matters.
Suppose Abel contributes $20,000 to the initial partnership checking account. During a year of operations expenses exceed revenue by $30,000. The initial $20,000 was used to reduce the remaining amount owed for expenses to $10,000. Baker does not take a salary.
In this situation, which the Kovocik opinion does not explicitly address, is Abel required to pay the entire $10,000—for which, presumably, both partners are liable (jointly and severally)?
I would suppose not, and if Abel in fact pays the entire $10,000, Baker owes him $5,000. That seems fair enough.
These facts, and those in Kovacik, suggest the need for agreement at the time of formation of the partnership. Lots of luck with that, but to my mind the problem is largely attributable to the failure to pay a salary to Baker for his services or at least to accrue a salary. If, for example, the parties had agreed that Baker was entitled to a salary of $20,000, and if that amount had been owed rather than paid to him, then on my facts that amount would have been part of the expenses (but let’s leave the total the same); Baker would, on liquidation, be entitled to $20,000 as a creditor (maybe subordinated?); Able and Baker are on the hook for a total of $30,000 including $20,000 owed to Baker and $10,000 owed to others; Baker can treat his accrued salary as a capital contribution so Able and Baker are even on that score; each has lost the $20,000 capital contribution and each must contribute $5,000 to pay off the other creditors. That might be more of a burden on Baker than the parties might have wanted at the outset, so a simpler approach might be simply to provide at the outset that Baker would not be liable for any additional contributions to the partnership during its operation or on liquidation.
This suggests that there is another problem that “should” be addressed at the formation stage—namely, the need for additional capital during operation. Again, lots of luck with that, at least with a small operation.
In Kovacik v. Reed, the California Supreme Court carved out an exception to the statutory scheme of dividing up losses in a partnership for the important class of firms known as service partnerships. Kovacik and Reed entered into a general partnership to operate a kitchen remodeling business. Kovacik made an initial capital contribution of $10,000. Reed made no capital contribution, but did contribute a promise of future services by agreeing to superintend the partnership’s work and to estimate the jobs on which the partnership bid. Kovacik and Reed agreed to share profits equally, but made no provision for allocating losses. Reed apparently took no salary. Unfortunately, things did not go as planned and Kovacik dissolved the partnership, after only ten months, on grounds that it was unprofitable. Kovacik claimed that the partnership had lost $8,680 and brought a proceeding for an accounting in which he sought to recover one half of the partnership’s capital loss from Reed.
On the face of the statutes, Kovacik had a strong claim. It appears that the partnership had no liabilities falling under UPA (1914) §§ 40(b)(I) or (II). Accordingly, the next set of liabilities to be satisfied were those “owing to partners in respect of capital”; in other words, return of capital was the senior remaining claim on the partnership’s assets. Assuming for the sake of simplicity that there had been no adjustments to the initial capital accounts (there being no facts to the contrary), the partnership owed $10,000 to Kovacik “in respect of capital” and nothing to Reed. Kovacik therefore was entitled to the entire $1,320 apparently realized upon the liquidation of the partnership, leaving a capital loss of $8,680. Per § 40(d) both partners were required to contribute to satisfaction of that liability in accordance with the rules laid out in § 18(a). In turn, § 18(a) provides that the $8,680 loss was to be shared among the partners “according to [their] share in the profits,” which it will be recalled were shared equally.
On dissolution, the partnership thus had suffered a capital loss, in the form of a capital deficit, of $8,680. Equal sharing of that loss required a debit to each partner of $4,340. Because Reed made no capital contribution, however, he would not bear any share of the capital loss unless he was required to pay in $4,340. Likewise, unless Reed paid him $4,340, Kovacik would bear the entire $8,680 loss. On the face of the statute, Reed is therefore obliged to equalize the losses by paying Kovacik the demanded sum of $4,340.
Courts have strictly applied the UPA provisions in most situations, except those involving a so-called “service partnership,” of the sort present in Kovacik, in which some partners contribute only services. Although none of the relevant UPA sections make any distinction between general partnerships in which all partners make capital contributions and a service partnership, many courts have refused to apply the statute to firms of the latter type if doing so would mean that the service-only partner would be required to make a cash contribution out of personal assets towards his share of any capital losses.
The rationale of this rule . . . is that where one party contributes money and the other contributes services, . . . in the event of a loss each would lose his own capital—the one his money and the other his labor. Another view would be that in such a situation the parties have, by their agreement to share equally in profits, agreed that the value of their contributions—the money on one hand and the labor on the other—were likewise equal; it would follow that upon the loss . . . of both money and labor, the parties have shared equally in the losses.
Whatever one makes of this rationale, it has been widely accepted by the courts.
But how would the rule apply where there was both a capital and an operating loss? After all, the court in Kovacik too some pains to note that "Actually, of course, plaintiff here lost only some $8,680 or somewhat less than the $10,000 which he originally proposed and agreed to invest."
Suppose you had the following facts: Abel and Baker are partners. Abel contributed $10,000 cash to the partnership and provides no services to the partnership. Baker contributed to cash to the partnership and did all of the labor of the partnership business. Profits were divided 50-50. After two years in business, they have decided to dissolve the partnership. After liquidating the partnerships assets, the firm owes its outside creditors $100,000 but has paying off the partnership’s creditors, the business has suffered a loss of 20,000. In a state that follows the rule of Kovacik v. Reed, how much money—if any—must Baker pay to settle the losses? My assumption is that he has to pay $10,000 (50%) of the operating loss but none of the capital loss. After all, while it is true that his labor in the court's view is equivalent to Kovacik's capital, that logically should only extend to a capital loss. Right?
Now suppose you were in a UPA (1997) jurisdiction. Section 8.06 makes no distinction between capital and operating losses. And the commentary thereto makes clear that the drafters intended the statute to overturn Kovacik. So you have a net loss of $30,000 and Baker should have to pay $10,000 to the creditors and make good half of Abel's capital loss. Right?
 315 P.2d 314 (Cal. 1957). See generally Stephen M. Bainbridge, Contractarianism in the Business Associations Classroom: Kovacik v. Reed and the Allocation of Capital Losses in Service Partnerships, 34 Ga. L. Rev. 631 (2000).
 See, e.g., Kovacik v. Reed, 315 P.2d 314 (Cal. 1957); Becker v. Killarney, 532 N.E.2d 931 (Ill. App. 1988); Snellbaker v. Herrmann, 462 A.2d 713 (Pa. Super. Ct. 1983). The leading precedent to the contrary is Richert v. Handly, 330 P.2d 1079, 1081 (Wash. 1958), in which the Washington Supreme Court (without any analysis) held that where the parties had not agreed upon or specified the basis upon which losses were to be shared, the UPA provisions controlled. Each partner, including the service-only partner, therefore was required to contribute toward the capital loss sustained by the partnership according to his share of the profits. Richert perhaps can be reconciled with Kovacik by invoking the limitation set forth in the latter that service-only partners who are compensated for their services can be held liable for their share of capital losses. Although this fact did not assume any prominence in the opinion, it appears that the service-only partner in Richert was compensated for at least a portion of his services, 330 P.2d at 1080–81, and, therefore, perhaps could be held liable even under Kovacik and its progeny.
 A later decision made clear that the dispositive fact is that one partner was to provide only services. The Kovacik rule therefore still applies even if the partner who contributed the firm’s capital also contributes some services, so long as the other partner contributes only services. De Witte v. Calhoun, 34 Cal. Rptr. 491, 494–95 (Cal. App. 1963).
 See Snellbaker v. Herrmann, 462 A.2d 713, 716 (Pa. Supr. 1983) (collecting cases); David B. Sweet, Annotation, Joint Venturers’ Comparative Liability for Losses, Absence of Express Agreement, 51 A.L.R.4th 371 (same).
This Article argues that USACafes is a needless doctrine that stands in conflict with other, more fundamental precepts of law and equity. Accordingly, when presented with the opportunity, the courts of Delaware and other jurisdictions should reject its holding. Instead, the law ought to respect the fiduciary entity for what it is: a legal person separate and apart from its owners and controllers. If the limited liability veil of a fiduciary entity is to be pierced, then it should be under the more rigorous legal standard that courts have traditionally applied in veil piercing cases.
It is frequently observed that LLCs “are creatures of contract,” which they primarily are. The Delaware Limited Liability Company Act (the “LLC Act”) provides that “[i]t is the policy of this chapter to give maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.” 6 Del. C. § 18–110(b). Because of this freedom, “the parties have broad discretion to use an LLC agreement to define the character of the company and the rights and obligations of its members.” Kuroda, 971 A.2d at 880. One “attraction of the LLC form of entity is the statutory freedom granted to members to shape, by contract, their own approach to common business ‘relationship’ problems.” Haley v. Talcott, 864 A.2d 86, 88 (Del. Ch.2004) (Strine, V.C.). “Virtually any management structure may be implemented through the company's governing instrument.” Robert L. Symonds, Jr. & Matthew J. O'Toole, Delaware Limited Liability Companies § 9.01[B], at 9–9 (2015).
Using the contractual freedom that the LLC Act bestows, the drafters of an LLC agreement can create an LLC with bespoke governance features or design an LLC that mimics the governance features of another familiar type of entity. The choices that the drafters make have consequences. If the drafters have embraced the statutory default rule of a member-managed governance arrangement, which has strong functional and historical ties to the general partnership (albeit with limited liability for the members), then the parties should expect a court to draw on analogies to partnership law. If the drafters have opted for a single managing member with other generally passive, non-managing members, a structure closely resembling and often used as an alternative to a limited partnership, then the parties should expect a court to draw on analogies to limited partnership law. If the drafters have opted for a manager-managed entity, created a board of directors, and adopted other corporate features, then the parties to the agreement should expect a court to draw on analogies to corporate law. Depending on the terms of the agreement, analogies to other legal relationships may also be informative. See JAKKS Pac., Inc. v. THQ/JAKKS Pac., LLC, 2009 WL 1228706, at *2 (Del. Ch. May 6, 2009) (explaining that although a party to the LLC agreement at issue is “technically a member of the LLC,” its economic interest “is less that of an equity owner and more akin to a licensor with rights to royalties based on sales”).
This suggests an important wrinkle on freedom of contract. If you opt into a corporate-like LLC governance structure and you don’t want corporate law rules to apply by analogy presumably you will have to say so very explicitly in your governing documents. It also suggests that you’re going to have to be very careful about adopting some corporate-like features. How many are enough to trigger this rule? This decision is likely to result in a lot more transactional lawyering expenses for LLCs.
Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. June 10, 2016), will be cited often as a reference guide for fundamental principles of Delaware corporate law including the following: (1) even in derivative litigation when a stockholder has survived a motion to dismiss under Rule 23.1, for example, in which demand futility is an issue, pursuant to DGCL Section 141, the board still retains authority over the “litigation assets” of the corporation, and if truly independent board members exist, or can be appointed, to create a special litigation committee (SLC), it is still possible for the SLC, under certain circumstances, to seek to have the litigation dismissed; (2) if an LLC Operating Agreement adopts a form of management and governance that mirrors the corporate form, one should expect the court to use the cases and reasoning that apply in the corporate context; (3) even though most readers will be familiar with the cliché that LLCs are creatures of contract, the Court of Chancery underscores the truism that it may still apply equitable principles to LLC disputes; (4) a bedrock principle that always applies to corporate actions is that they will be “twice-tested,” based not only on compliance with the law, such as a statute, but also based on equitable principles.
In closing, we are happy to note that the scholarship of a very good friend of this blog, and nationally recognized corporate law scholar, Professor Stephen Bainbridge, was cited in this court opinion at footnote 16. It is not uncommon for Professor Bainbridge’s scholarship on corporate law issues to be cited by the Delaware courts, but it is still worth noting.
My blushes. Go read the whole thing for more detailed analysis.
The Court’s opinion in Obeid confirms that Delaware courts may review the provisions of limited liability company agreements to determine the governance structure the parties intended and, absent other factors, may view that as evidence of an intent to have aspects of the entity law of similarly-managed entities apply to the limited liability company. In drafting limited liability company agreements, transaction planners and their counsel should give careful consideration to the provisions authorizing or restricting the delegation of authority to various parties and whether the governance structure may impact the ability to delegate certain authority to third parties.
The opinion in Obeid v. Hogan, CA. No. 11900-VCL (Del. Ch. Jun. 10, 2016), illustrates the importance of careful drafting in alternative entity governance documents. Particularly, drafters should consider (1) whether they intend to incorporate corporate governance principles into their limited liability company or limited partnership agreements and (2) the intended scope of delegation to non-managers, non-members and non-general partners.

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