Court Opinion

ID: 2995767
Source: CourtListenerOpinion
Date Created: 2015-09-24 19:22:17.150189+00
Date Added: 2024-06-11T15:02:49.132210
License: Public Domain

In the
 United States Court of Appeals
                 For the Seventh Circuit
                        ____________

No. 01-3768
JOHN F. VALINOTE,
                                           Plaintiff-Appellant,
                               v.

STEPHEN R. BALLIS,
                                           Defendant-Appellee.
                        ____________
       Appeal from the United States District Court for the
           Northern District of Illinois, Eastern Division.
      No. 00 C 3089—Martin C. Ashman, Magistrate Judge.
                        ____________
      ARGUED MAY 20, 2002—DECIDED JUNE 26, 2002
                    ____________

 Before EASTERBROOK, ROVNER, and EVANS, Circuit
Judges.
  EASTERBROOK, Circuit Judge. Omnibus Financial Group
L.L.C. fell short of its founders’ hopes. Formed by four in-
vestor-members in 1996, it was down to two (John Valinote
and Stephen Ballis) by mid-1997, and in 1999 Valinote
stopped participating in the firm’s management. Early
in 2000 Valinote decided to withdraw from the founder-
ing concern and asked Ballis for an “exit strategy.” This
led Ballis to initiate the buy-sell clause of Omnibus’s
operating agreement. This procedure, common in closely
held businesses, allows one investor to set a price on the
shares (for an LLC, the membership interests); next the
other investor decides whether to buy the first investor’s
2                                                No. 01-3768

interest, or sell his own, at that price. The possibility that
the person naming the price can be forced either to buy or
to sell keeps the first mover honest.
  Nothing in the operating agreement prescribes how in-
vestments are to be valued for this purpose. (A mechanical
valuation for use in the event of a member’s death or res-
ignation does not apply to voluntary transactions among
members.) Ballis named a price of -$1,581.29 for each 1%
interest in Omnibus, implying a total of -$79,064.25 for
the 50% stake that each of the two held. Valinote then
decided to sell his interest to Ballis at that price—effec-
tively paying Ballis $79,064.25 to take his 50% off his
hands. At the time (surely this was no coincidence), Omni-
bus owed Valinote exactly that sum to repay a loan that
Valinote had made to the firm. So the bottom line was
that in March 2000 Valinote surrendered his interest to
Ballis, who became the sole owner of Omnibus Financial
Group. No money changed hands. Valinote could have ac-
quired Ballis’s interest on the same terms but must have
thought that the real value was even lower than the neg-
ative price that Ballis had specified.
  Later events confirmed the dim estimate of the venture’s
prospects. In December 2000 Omnibus defaulted on a
$200,000 debt to a bank. The bank then collected on the
guarantees of this debt that Valinote and Ballis had made.
Valinote demanded that Ballis indemnify him for his
$100,000 share and for any future payments that Valinote
may be required to make. (Omnibus has at least one oth-
er bank loan of $400,000, though it may be secured by
real estate.) Ballis refused, and the district court—acting
through a magistrate judge on the parties’ consent, see 28
U.S.C. §636(c), in this suit under the diversity jurisdiction,
28 U.S.C. §1332(a)(1)—held that Ballis is under no obliga-
tion to do so. 2001 U.S. Dist. LEXIS 15339 (N.D. Ill. Sept. 24,
2001). The magistrate judge concluded that the purchaser
in a buy-sell transaction under Omnibus’s operating agree-
No. 01-3768                                                   3

ment acquires the seller’s membership interest, and that
any obligations of the seller to the firm are extinguished,
see ¶10.C.2 (the buying member must “[a]ssume and be-
come liable for all obligations of the selling Member to
the Company”), but that obligations (such as guarantees) to
third parties are unaffected. That’s the implication of lan-
guage dealing with obligations to the firm while omitting
other obligations. Paragraph 9.J of the operating agreement
requires members to indemnify each other for obligations
under guarantees, but the court held that this refers to
current members, not to former members such as Valinote.
  The operating agreement offers some succor to former
members: ¶9.E.1 requires indemnification of any “per-
son” for liability reasonably incurred while that person
was a member. That covers payment on a guarantee that
enabled Omnibus to raise operating capital. But the
indemnitor under ¶9.E.1 is “[t]he Company”, which is to
say Omnibus, and Omnibus is broke. Likewise Valinote’s
right to indemnity under the law of suretyship—by pay-
ing on the guarantee, Valinote stepped into the bank’s
shoes and acquired its $100,000 claim—is a right against
Omnibus. What Valinote wants, however, is indemnity
from Ballis, who unlike Omnibus remains solvent. That
claim lacks support in ¶9.E.1 and the law of suretyship,
and it runs up against the principle that corporate share-
holders or LLC members are not liable for the venture’s
debts. That’s the point of limited liability: people put at risk
the amounts they invest (or contract for explicitly, as by
guarantees) but not their full personal wealth. Omnibus’s
operating agreement makes this explicit: ¶9.D says that
members “shall look solely to the assets of the Company for
the return of their capital . . . [and] shall have no recourse
against the Members, or any Member . . . except as specifi-
cally provided in this Agreement.”
  Valinote does not contend that anything in the operating
agreement “specifically” requires indemnity from Ballis.
4                                                  No. 01-3768

Instead he insists that it is so strongly implicit in the buy-
sell procedure that it should be treated as if explicit. First,
he observes, the buy-sell procedure allows a member to
extricate himself from the company; that can’t be done un-
less all financial entanglements are wrapped up. Other-
wise a departing member remains at risk for things that
have passed beyond his control; the firm might be sound
at the time of withdrawal and be driven to ruin by the
remaining members, triggering the guarantees. That un-
compensated and uncontrollable risk should be eliminated
by an indemnity requirement, Valinote insists. Second,
Valinote contrasts the operation of the buy-sell procedure
with the consequences of an outright resignation. Under
¶11.C a resigning member receives the mechanically com-
puted value of each interest and “shall . . . forfeit all further
interest in the Company, but shall not be relieved of or
released from any personal guarantees or other personal
covenants”. No such provision appears in ¶10, which covers
the buy-sell procedure; this implies to Valinote that sellers
under ¶10 are relieved of guarantees. Why would he have
sold to Ballis at a negative price under ¶10 when he could
have resigned under ¶11 and demanded repayment of the
$79,000 loan, unless the ¶10 procedure shifted the financial
burden of the guarantees? Third comes the coup de grâce:
because Omnibus was a limited liability company, member-
ship interests cannot be worth less than zero. Shares of
a bankrupt corporation trade for a positive price as a re-
sult of limited liability, for shares are worth at worst the
scrap value of the paper, and the firm might recover. Yet
Ballis valued each 1% interest in Omnibus at -$1,581.29.
This must mean, Valinote insists, that Ballis was covering
in advance the risk of indemnity on any guarantees. How
else could the price go negative?
  There is some force to these observations, but not enough
to justify overriding the venerable principle of limited
liability, which may be vital to a business’s ability to raise
No. 01-3768                                                  5

capital. Especially not when the operating agreement rein-
forces that principle by proscribing personal liability “except
as specifically provided in this Agreement.” The argument
that “strongly implicit” is as good as “explicit” is equivalent
to a plea that the real explicit language of the agreement—
particularly the clause limiting personal liability—be over-
ridden. That would make all contractual language un-
reliable, and such a step would not in the long run fur-
ther the goals of investors such as Ballis and Valinote,
who draft these complex agreements in the belief that what
they have written will be enforced when push comes to
shove. Although enforcement of the agreement may have
costs—here it makes complete extrication more complex
and exposes the withdrawing investor to risk if the un-
winding is incomplete—these are not insuperable. Valinote
could have negotiated with the bank to cancel his guaran-
tee; the bank might have agreed, for a price, or Ballis
might have agreed to assume the liability (again for a
price). With so few people involved, the negotiations would
not be especially costly. Far better for Valinote and Ballis
to have resolved this issue between themselves ex ante
than to ask a court to guess ex post what that deal would
have looked like—especially when the process of guessing
would override the parties’ written agreement demanding
specificity. (Paragraph 9.D also makes it inappropriate
to turn to parol evidence about the negotiating history
and the parties’ expectations, which are even less certain
than inferences based on the difference between ¶10 and
¶11.)
  Nor is the negative price (or the contrast between buy-
out under ¶10.C.2 and resignation under ¶11.C) an enigma
that can be understood only by assuming that Ballis had
rolled into the price the risk of indemnifying Valinote. For
the operating agreement did not strictly adhere to limited
liability: there is a veil-piercing clause that appears “spe-
cifically” in the agreement. It is ¶9.J, which we now repro-
duce in full:
6                                               No. 01-3768

    The Company, or businesses and entities with
    which the Company may be associated, may from
    time to time be required to borrow funds and, to
    secure such loans, to deliver guarantees by one or
    more Members of repayment, performance, comple-
    tion, or other obligations of the Company or such
    associated venture. The Members covenant and
    agree that if any Member executes and delivers any
    such guarantee and if such guaranteeing Member
    incurs any cost or liability in connection therewith,
    then such cost shall be allocated among and shared
    by all of the Members in accordance with their re-
    spective Membership Interests.
In other words, if Member X makes good on a guarantee of
the company’s indebtedness, then Member Y must pick up
part of the cost. This is a departure from limited liability.
It also shows how the value of interests could be negative;
each carries with it some risk of liability under ¶9.J. What
is more, when one member withdraws, prospective liability
under ¶9.J becomes concentrated on those who remain, be-
cause a former member is not exposed to liability under this
clause—except to the extent that ¶11.C provides that a
resigning member retains this liability. Thus the mysteries
are resolved. Ballis set a negative interest value because
Valinote’s departure meant that he could no longer be
called on for indemnity under this clause, and Ballis’s ex-
pected net outlay on his own guarantees increased accord-
ingly. Because exposure under ¶9.J could be substantial,
something like ¶11.C is essential to prevent members
from shucking their potential liability by resigning and
walking away; but when departure is negotiated under the
buy-sell provision, a price can be attached. Here the neg-
ative price compensated Ballis for giving up any oppor-
tunity to seek relief against Valinote under ¶9.J. (On our
reading of the operating agreement, Ballis received freedom
from future indemnity claims by Valinote; whether this was
No. 01-3768                                                7

worth enough to reduce the net effect to zero depends on the
wealth of each investor, and hence the likelihood that a
demand for indemnity would be honored. The record does
not reveal this information. On Valinote’s reading, Ballis
gave up the right to indemnification while remaining liable
on his own part; the risk that Valinote might prevail in this
position would be enough by itself to generate a negative
price.) And if Valinote feared that what he was giving up in
return (the opportunity to recover from Ballis) was worth
even more, perhaps because he anticipated that under
Ballis’s management the chance of a draw on the guaran-
tees would increase, he had only to buy Ballis’s stake at the
price Ballis set rather than sell his own. Valinote’s pro-
fessed fear that as sole member Ballis could transfer all of
Omnibus’s assets to himself, leaving Valinote holding the
bag, is groundless: Such a transfer would be a fraudulent
conveyance, which Valinote, as Omnibus’s creditor following
a call on the guarantee, could rectify by reaching Ballis’s
assets. Valinote does not contend, however, that any fraud-
ulent conveyance occurred, and he does not make a claim
under the law of suretyship.
  Valinote would like to turn ¶9.J around and use it as a
source of recovery: he was a member when the guaranty
was written, even though not when he made good that
guarantee, and thus should be entitled to spread the cost
among the other members (of which Ballis is the sole re-
maining example). But if we were to treat “member” in
this language as including former members, how could
Valinote gain? He would be entitled to call on Ballis to
pick up a share—but Ballis would be entitled to call on
Valinote for reimbursement too, and it would be a wash.
Former members could not be “members” for purposes
of collection while escaping that status for purposes of
liability; the requirements are symmetric. (Recall that un-
der ¶10.C.2 Ballis acquired Valinote’s membership interest
plus Valinote’s obligations “to the Company,” but not
8                                              No. 01-3768

Valinote’s personal obligations to other members.) Like the
district court, however, we think it best to read “mem-
ber” to mean current member and exclude former member.
This is the most natural reading; it avoids circular reim-
bursements; and it also avoids questions about what each
person’s responsibility is. Membership interests change,
and Valinote’s position would leave it up in the air what
share each current (and former) member must pick up.
  The district court read the operating agreement to mean
what it says. Given ¶9.D, that was the most sensible course.
By paying on his guarantee, Valinote was subrogated to
the bank’s rights and has a claim against Omnibus; and if
Omnibus has a claim against Ballis, then Valinote can
participate. But neither Valinote nor Ballis has a direct
claim against the other; each must bear his own obliga-
tions under the guarantees. Ballis’s motion for sanctions
is denied, however; the appeal was not frivolous, and the
operating agreement does not call for fee shifting in a dis-
pute such as this.
                                                 AFFIRMED

A true Copy:
      Teste:

                        ________________________________
                        Clerk of the United States Court of
                          Appeals for the Seventh Circuit

                   USCA-97-C-006—6-26-02