Source: http://kentuckybusinessentitylaw.blogspot.com/2011/
Timestamp: 2017-11-18 23:35:34
Document Index: 574834810

Matched Legal Cases: ['§ 271', '§ 8113', '§ 271', '§ 271', '§ 271', '§ 14', '§ 271', '§ 271', '§ 3', '§ 6']

Kentucky Business Entity Law: 2011
In a recent decision, the Federal District Court for the Eastern District of Kentucky confirmed that an unincorporated syndicate is not, as a default matter, governed by the rules set forth in the Kentucky Business Corporation Act. KNC Investments, LLC v. Lane’s End Stallions, Inc., 2011 WL 5507395 (E.D. Ky. 2011). In this instance, in a suit arising out of the interpretation of a stallion syndicate agreement, the plaintiff argued that the provisions of the Kentucky Business Corporation Act governing the inspection of corporate books and records should be referenced with respect to the interpretation of the books and records inspection right that existed under a syndicate agreement. The court dismissed this argument, noting that:
No justification exists to extend Kentucky law that by its own terms is strictly limited to corporations to non-corporate entities such as the LDK Syndicate. Id. at *4.
The November/December 2011 issue of The Journal of Passthrough Entities includes my article Vampires and the Law of Business Organizations: The Fruitless Search for Authenticity. This piece compares the various constructs used for the vampire in various books and movies, analogizing that to the various laws governing business organizations. What is a vampire in a particular book or movie is determined by the author. In the same way, what are the rights, duties and responsibilities of individuals within a particular organization are determined by the controlling statute and the governing documents. Ultimately, each must be assessed on its individual terms, and assumptions that one characteristic applies in other contexts are often erroneous.
Martin v. Pack’s Inc.: The Court of Appeals
Adds Uncertainty and Risk to Dissolution
Martin v. Pack’s Inc. involved a claim for construction services rendered by Pack’s prior to the administrative dissolution of Southeastern Construction, Inc. After the administrative dissolution of Southeastern, Ed Martin, on the corporation’s behalf, entered into two agreements with Pack’s, Southeastern’s creditor, for resolution of that debt. Southeastern failed to perform. Pack’s then sought to enforce the debt against not only Southeastern but also Ed Martin and Jeff Collinsworth, Southeastern’s shareholders. Granting summary judgment to Pack’s, the trial court held, and the Court of Appeals affirmed, that each of Martin and Collinsworth are personally liable on the debt. Martin v. Pack’s Inc., 2011 WL 3207947 (Ky. App. 2011) (To Be Published).
IMHO, the grounds for that determination were erroneous.
The (Flawed) Understanding of the Effect of Dissolution on Shareholder Limited Liability
One basis upon which the Court of Appeals affirmed holding Martin liable on the obligation to Pack’s was that the agreement for the resolution of the corporation’s debt was entered into after the corporation’s administrative dissolution, the court reasoning that after dissolution there was neither a corporation nor the consequent limited liability. Id. at *5. “To reiterate, Martin cannot be shielded from personal liability by virtue of the statute, (sic) because his corporation was dissolved at the time of his actions.” The Court said, in effect, that dissolution abrogates the rule of limited liability.
It appears there was not identified to the Court, and that its own research did not unearth, the 2007 amendment to the Business Corporation Act enacted in response to and legislatively overruling the Forleo decision (2006 WL 2788429 (Ky. App. 2006)). That amendment expressly provides that a corporation’s dissolution does not “abate or suspend” the shareholder’s limited liability. See Ky. Rev. Stat. Ann. § 271B.14-050(2)(i); see also Thomas E. Rutledge, The 2007 Amendments to the Kentucky Business Entity Statutes, 97 Ky. L.J. 229, 243 (2008-09).
To the extent that the Court of Appeal’s affirmation of the trial court’s ruling was based upon the notion that, subsequent to dissolution, shareholders do not enjoy limited liability, that ruling was directly contrary to the controlling statute.
A (Flawed) Understanding of the Effect of Dissolution on Corporate Status
The second substantive failure of the decision is its assumption that upon dissolution a corporation ceases to exist. Simply put, that is not the law.
In a prior age it was the rule that upon dissolution a corporation simply ceased to exist – its property became vested in the shareholders, its debts were extinguished and suits by or against it were terminated. See, e.g., 16A William Meade Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 8113; II Stewart Kyd, A Treatise on The Law of Corporations 516 (1794) (“The effect of the dissolution of a corporation is, that all its lands revert to the donor; its privileges and franchises are extinguished; and the members can neither recover debts which were due to the corporation, nor be charged with debts contracted by it, in their natural capacities.”) Those rules have been long repealed. See, e.g., Greene v. Stevenson, 175 S.W.2d 519, 523-24 (Ky. 1943). Under the formula currently employed, a corporation, after dissolution, continues to exist as a corporation. See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation shall continue its corporate existence….”). A dissolved corporation is restricted to activities “appropriate to wind up and liquidate its business and affairs.” Ky. Rev. Stat. Ann. § 271B.14-050(1).
At one time a corporation’s dissolution caused it to cease to exist. Under the modern system as enacted by the General Assembly, a dissolved corporation continues to exist as a corporation. See KRS § 271B.14-050(1); id. § 14A.7-020(3). Ergo, any conclusion based upon the premise “a dissolved corporation no longer exists as a corporation” must fail as the premise is false.
The (Flawed) Understanding of the Winding Up Process
Dissolution effects a limitation upon the proper activities of the dissolved organization, restricting it to those that are appropriate for its winding up and termination. See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation … may not carry on any business except that appropriate to wind up and liquidate its business and affairs….”). Whether any particular activity is appropriate for the winding up and termination of a particulate venture is a fact dependent issue. For example, in the winding up and termination of a retail store, it is difficult to contemplate a situation in which the acquisition of additional inventory would be appropriate. Conversely, in the winding up and termination of a landscaping business, the purchase of additional materials with which to complete a job that is under contract and partially completed likely would be appropriate. The open and fact dependent nature of this assessment is implicit in the statute’s use of “including” in the description of activities that are appropriate after dissolution. Id.
The Martin court makes much of the fact that the agreement with Pack’s was created subsequent to the dissolution. 2011 WL 3207947 at *2-3. Even accepting that characterization as true, it is not determinative of the outcome. Rather, nothing in the law of dissolution precludes a dissolved corporation from entering into entirely new obligations.
In the resolution of claims with creditors, whether they are known or unknown, there will often need to be a new agreement entered into pursuant to which the amount and manner of resolution are agreed upon. While some of these agreements may constitute only a modification of existing agreements, a claim arising, for example, in quasi-contract will not. Were the rule espoused in Martin v. Pack’s, Inc. to be correct, then the post-dissolution sale of assets sanctioned in Greene v. Stevenson would have exposed whoever signed the sale agreement to personal liability thereon. Assume a creditor initiates an action against a dissolved corporation. Is the corporation precluded from entering into an engagement with an attorney for the purpose of making a defense or even asserting a counter-claim? That engagement letter with the attorney will be a new post-dissolution obligation.
Curiously, neither the Court of Appeals nor the trial court explained how the post-dissolution agreement between Southeastern and Pack’s did not fall within KRS § 271B.14-050(i)(c) and its express authorization for a dissolved corporation to “mak[e] provision for discharging its obligations.”
The suggestion that a corporation, after dissolution, cannot in its own name and on its behalf enter into agreements in settlement of its debts and obligations is without analytic support and is contrary to the statute.
A (Flawed) Understanding of the Effort of Dissolution Upon Agency
A corporation “is an artificial being, invisible, intangible, and existing only in contemplation of law.”, Trustees of Dartmouth Coll. v. Woodward, 17 U.S. (4 Wheat.) 518, 636 (1819), able to act only through those natural persons who are its agents. Restatement (Third) of Agency § 3.04, comment d. As noted above, a corporation continues to exist after dissolution for the purpose of its winding up and liquidation. During the dissolution process the corporation must act through agents. Presuming appropriate identification of the principal and that the action is within the agent’s authority, the agent is not a party to and is not personally liable on the agreement at issue. Restatement (Third) of Agency § 6.01.
There is currently pending before the Supreme Court a petition for discretionary review.
While Tom Petty tells us "Its good to be king," at many levels Mary's refrain might have been "Its not good to be a king's daughter or to be queen."
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A recent case from a North Carolina Court of Appeals highlights how easy it may be to waive limited liability. Consolidated Electrical Distributors, Inc. v. Wieltech Electric Co., LLC, No. COA 11-96 (N.C.) (Ct. App. Oct. 18, 2011).
In September, 2006, Wieltech Electric Company was reorganized into an LLC; the opinion is silent as to its earlier form of organization. In connection therewith, a letter was sent to Wieltech’s vendors and customers advising them as to the change and stating in part that the debts and obligations of the predecessor organization “shall be transferred wholly into the newly formed LLC and the two individual organizers.” Slip op. at 2, emphasis added. Jennifer Fortenberry and Benjamin Wieland had been identified as the organizers of the LLC. When the claim of Consolidated Electrical Distributors, Inc. against the LLC was not satisfied, it initiated suit, including against Fortenberry and Wieland, the suit against the individuals being based upon the letter stating that the obligations were “transferred” to them.
Fortenberry’s defense focused on the Statute of Frauds, asserting that the letter was insufficient to constitute an agreement to be responsible for the LLC’s debt. Distinguishing the writing from that in a prior dispute to the effect that the individual would “try” to pay off an obligation, which was found to be insufficient under the Statute of Frauds to create a binding obligation, in this instance the letter stated that the accounts would be transferred to the LLC’s organizers including Fortenberry. On that basis, the court found that the letter was sufficiently detailed to satisfy the Statute of Frauds and on that basis the trial court’s grant of summary judgment to the plaintiff was affirmed.
Under the reasoning of this decision, it is obviously not going to require much in the way of formality for an individual to waive the limited liability they otherwise enjoy from the debts and obligations of an LLC. Whether it reflects, however, the law that would be applied in Kentucky is open to question. See Racing Investment Fund 2000, LLC v. Clay Ward Agency, Inc., 320 S.W.3d 654, 659 (Ky. 2010) (“To reiterate, assumption of personal liability by a member of an LLC is so antithetical to the purpose of a [LLC] that any such assumption must be stated in unequivocal terms leaving no doubt that the member or members intended to forego a principal advantage of this form of business entity.”)
The Delaware Court of Chancery Ranks the Beatles Versus the Rolling Stones (and Also Talks About the Obligation of Good Faith and Fair Dealing)
Last Thursday (Nov. 10, 2011), the Delaware Court of Chancery (Chancellor Strine) issued the opinion in Winshall v. Viacom International, Inc., 2011 WL 5506084. It is quite possible this opinion will be most remembered for the conclusion of Chancellor Strine that the Beatles were a better group than were the Rolling Stones. See id. at footnote 44 and accompanying text. Still, this decision is a furthering interesting stage in the definition of the parameters of the obligation of good faith and fair dealing.
The Plaintiffs had sold Harmonix Music Systems, Inc. to Viacom by means of a merger agreement including a contingent right to receive certain payments based upon Harmonix’s financial performance in the two years following the merger. Harmonix was itself a developer of video games. A year after the closure on the merger and during the earn-out period, Harmonix released the “Rock Band” game. In light of the success of Rock Band, Electronic Arts (“EA”) sought to renegotiate its distribution agreement with Harmonix for the purpose of acquiring greater distribution rights to both Rock Band and any sequels that might be issued. As renegotiated, in return for the right to distribute certain Rock Band sequels and as well the right to expand its distribution channels to include hand-held devices, distribution fees being paid by Harmonix were reduced for future years, all after the expiration of the earn-out for Harmonix’s original shareholders. Had the reduced distribution fees applied during the earn-out period, the payments to the former Harmonix shareholders under the earn-out would have been increased. Those shareholders sued Viacom alleging that the amendment distribution agreement was “purposefully renegotiated to reduce the earn-out payments, thereby breaching the covenant of good faith and fair dealing.” In effect, Harmonix’s former shareholders asserted that the obligation of good faith and fair dealing should be applied to capture for them the benefit of any renegotiated distribution agreement. This assertion was squarely rejected by Chancellor Strine, he writing:
Even assuming that Viacom and Harmonix intentionally forewent possible opportunity to increase Harmonix’s profits during the earn-out period and structured the amended contract with EA so that Viacom and Harmonix could enjoy all the benefits for themselves, Viacom and Harmonix took no steps to reduce any reasonable contractual expectation of the Selling Shareholders. It would be inequitable for this Court to imply a duty on Viacom and Harmonix’s part to share with the Selling Shareholders the benefits of a renegotiated contract addressing EA’s right to distribute Harmonix products after the expiration of the earn-out period. The implied covenant of good faith and fair dealing is not a license for a court to make stuff up, which is what [the Plaintiffs] seeks to have me do.
The Court reiterated the rule that the implied obligation of good faith and fair dealing is not a mechanism by which, after the fact, parties to an agreement may secure for themselves benefits that they failed to negotiate. Focusing upon the situation as it existed at the time the merger agreement was entered into, that preceding the resounding success of the Rock Band game and the consequent shift in bargaining position to Viacom with respect to the renegotiation of the distribution agreement:
I find that Winshall has failed to allege facts that support a reasonable inference that the Selling Stockholders did not get the benefit of their bargain under the Merger Agreement. On these facts, even viewed in the light most favorable to Winshall, the Selling Shareholders could not conceivably have a reasonable expectation that Viacom and Harmonix had a duty to renegotiate the [original distribution agreement] to increase the amount of earn-out payments the Selling Stockholders would receive.
Contrasting these facts with the situation in which the acquirer manipulates the finances of the acquired company in order to reduce the amount of the earn-out, the Chancery Court was not willing to impose a reciprocal obligation that the benefits of any future events must be allocated in such a manner as to increase the earn-out amount.