MARCH 10, 2015
LLC LAW TODAY
& BEYOND – 2015
PRESENTED BY:
TAMARA KLING, ESQ.
OVERVIEW OF SEMINAR
•Part I – An Overview of LLC Law
•Part II – LLC Statutory Law Today
•Part III – LLC Case Law Today
1
AN OVERVIEW OF LLC LAW
2
WHAT DO WE MEAN BY LLC LAW?
•State LLC statutes
– Laws authorizing formation of LLC and governing LLCs
formed there under
•LLC case law
– Cases involving LLC’s internal governance
– Cases involving rights, duties, liabilities of owners and
managers
3
WHY EXAMINE LLC LAW NOW?
• It has been over 35 years since 1st LLC statute was enacted and
15 years since the last LLC statute was enacted
•Most LLC statutes were enacted between 1992 and 1997
•Legislatures have had a chance to reassess and amend statutes
•Courts have had a chance to interpret LLC statutes and decide
cases involving LLC’s internal affairs and members’ rights and
duties
4
WHAT IS AN LLC?
•Statutory business entity
•Formed by filing document with entity filing office of one state
•Owners are called members
•May be managed by members or managers
•Main governing document is operating agreement
– Governs regulation of LLC’s affairs and conduct of business
– Governs relations among members, between members and LLC,
between members and managers
•LLC statutes consist mainly of default provisions
– Apply only in absence of OA provision
5
WHAT IS AN LLC?
•Exists as an entity separate and apart from owners
– Sue or be sued in own name
– Buy, own, use property
– Make own contracts
– Have own rights, responsibilities, liabilities
•Members have limited liability
– Member’s assets generally not available to satisfy LLC debts
•Pass-through tax entity
– LLC does not have to pay income tax
– Income, losses pass-through to members
– May choose to pay income tax
6
HOW ARE LLCS BEING USED?
•To own property
•To operate commercial businesses
•To do anything a privately held corporation is used for
– Not that many publicly traded LLCs
•Have also replaced GPs, LPs, business trusts for many purposes
7
POLLING QUESTION NO. 1
In your practice do you form more?
A. Corporations
B. LLCs
8
FIVE KEY FEATURES OF THE LLC
•These features affect both LLC statutes and case law
•An LLC is hybrid entity
•An LLC is, in most cases, a closely held entity
•An LLC is, in most cases, a “pick your partner” entity
•An LLC is a contractual entity
•An LLC is a flexible entity
9
AN LLC IS A HYBRID ENTITY
•LLC has features of corporation, GP, LP
• In enacting and amending statutes legislatures borrow from
corporation law and partnership law
•Courts, in interpreting LLC statutes look to comparable provision
in corporation, GP, LP statute
•Courts also look to case law precedent involving corporations,
GPs, LPs
10
AN LLC IS MOSTLY A CLOSELY HELD ENTITY
•What is a closely held entity?
– Not publicly traded
– No established market for ownership interests
– Small number of owners
– Owners generally manage
– Owners often work together
•Have different concerns and problems than public or large private entity
•Unique concerns of closely-held entity affects statutes and cases
11
AN LLC IS A “PICK YOUR PARTNER” ENTITY
•Members often run business together and have significant
personal interaction
•Success of LLC often depends upon unique skills of each member
•Thus, members do not want to have co-members not of their
choosing
•Legislatures and courts recognize this and it impacts LLC law
12
AN LLC IS A CONTRACTUAL ENTITY
•LLC is considered more of a contractual entity than a statutory
entity
•Legislatures anticipate that members will provide for
management in OA
•Legislatures anticipate that members will set forth their rights,
duties, liabilities in OA
•This anticipation results in statutes that do not contain many
protections for members
•Courts do not seek to rewrite agreements to protect members
but seek to enforce what parties agreed to
•Can cause problems if members do not have well drafted OA
13
AN LLC IS A FLEXIBLE ENTITY
•LLC was created, in part, to provide business entity with
flexibility of a partnership
•Leads to statutes with few restrictions on management
•Leads to statutes with few restrictions on allocation of rights
•Can lead to litigation if there are gaps in statute and OA
14
EVENTS INFLUENCING LLC LAW
•These events had significant impact on LLC statutes and case law
•Hamilton Bros. Oil Co. lobbies for LLC Act
•Revenue Ruling 88-76 is issued
•First flexible LLC statute is adopted
•Check-the-box is enacted
15
LLC STATUTORY LAW TODAY
16
THREE GENERATIONS OF LLC STATUTES
•First generation = bulletproof statutes
– Contained unalterable provisions designed to avoid corporate
taxation
•Second generation = flexible statutes
– Allowed members to opt out of statutory provisions
•Third generation = first and second as amended
17
WHY WERE STATUTES AMENDED?
•The check-the-box rule
– Provisions no longer had to be designed to avoid corporate
characteristics
– Allowed states to amend provisions governing dissolution,
dissociation, number of members, transferability
•The need to fill in gaps
– Over the years it became apparent where LLC statutes failed to
address necessary issues
• C.V. Properties v. State, 295 P.3d 1136 (Okla. 2013) – LLC
refused to pay annual certificate filing fee on grounds that OK
LLC Act did not specifically provide for it. OK leg amends LLC
Act to include fee
•The need to clarify ambiguities
– Over the years ambiguities in the original statutes became
apparent and were cleared up
• nonprofit purpose specified 18
WHY WERE STATUTES AMENDED?
•Legislative anticipation vs. realities
– In original statutes legislators guessed at needs, concerns and
problems LLCs and members would face in future
– Amendments address unanticipated needs, concerns
• Granting third parties rights in OA
•The need for consistency among the state’s entity statutes
– Name conflict
– Inter-entity merger
– Registered agent
•Reaction to court decisions
– Court may interpret statute or fill in gaps in manner legislature did
not intend
19
WHY WERE STATUTES AMENDED?
•Ott v. Monroe, 719 S.E.2d 309 (Va. 2011)
– Va SCt rules that a member’s control interest is not transferable on
the member’s death without the consent of the other members
even though OA seemed to allow the transfer
– According to Ct, Sec. 13.1-1040.1 provides that member’s death
causes dissociation unless OA provides otherwise. Here OA did not
state an intent to supersede the section and lacked specific
language that would constitute an exception to statutory rule
•S.B. 779, eff. 7/1/2013
– Amends Sec. 13.1-1039 to clarify that an OA can allow an assignee
of a member’s interest to also receive management rights and be
admitted as member
– Legislative history indicates intention to overturn Ott case
20
IS THERE A “TYPICAL” LLC STATUTE?
•Current LLC statutes are not uniform
•But some generalizations can be made
•Will look at “typical” provisions governing:
– Formation
– Members and management
– Mergers and conversions
– Compliance requirements
– Foreign LLCs
– Dissolution
•Will discuss how they have changed from original statutes, why
they changed and how they may change in future
21
FORMATION
•Form LLC by filing formation document
•Formation documents – current law
– Most often called articles of organization
– “Notice” filing – intended to notify the public of formation of
entity with limited liability
– Not intended to provide information on entity’s finances,
ownership or management structure
– Typical content
• LLC name
• Principal office address
• Name and address of registered agent
22
FORMATION
•Formation document – early statutes
– Generally required more information
– Latest date of dissolution, management structure, names of
members/managers, purposes
•Reasons for change
– Became unnecessary due to check-the-box
– Increased flexibility by allowing change in management structure,
dissolution date, etc. without needing amendment
•Organizers
– Current law - one or more authorized persons
– Early laws - two or more; some required member
23
FORMATION
•Purposes
– Current law
• Few restrictions
• For profit or not for profit
• Professional service
– Early laws
• Not for profit not specified
• Restrictions on banking or insurance
• Restrictions on professional service as purpose
24
FORMATION
•Operating agreement
– May be required or optional
– Generally may be written or oral
– Few restrictions on what members may set forth
•Amendments re operating agreement
– Expanded what OA may provide
– Clarified certain issues
•When OA may be entered to
•Whether required or optional
•Who is bound
25
POLLING QUESTION NO. 2
Operating Agreement – when forming an LLC is your operating
agreement?
A. Individually drafted to accommodate the needs of the
members or managers, the type of industry and matters
particular to those initially forming the LLC
B. Mostly boilerplate from the LLC operating agreement on file
with my firm
C. The boilerplate form my firm uses is drafted so that it can
accommodate the individual needs of the users
26
MEMBERS
•Most provisions dealing with members are default provisions
•Number of members
– Current – one or more
– Early laws – two or more (to avoid corporate tax)
– Change made after check-the–box
•Single Member LLC
– Allowing SMLLC increased LLC’s usefulness
– SMLLC currently governed by same provisions as multi-
member
– May see amendments to clarify SMLLC treatment
•Future change? – Shelf LLC
– No members at formation
– Useful for certain business deals
27
MEMBERS
•Membership interest
– Financial rights – share in profit & losses and distributions
– Non-financial rights – participate in management, inspect records
•Springing member
– Member without economic interest
– Main purpose to take over management from last member of LLC
28
MEMBERS
•Allocating rights
– Statutes have default provisions
– States differ
• Some allocate equally, others based on capital contribution
• Legislatures have not found that one default rule is better than the
other
• Amendments may be made if it turns out that one formula works
better and is used more often than other
29
MEMBERS
•Transferability of interest
– Default rule allows members to transfer financial rights without
restriction
– Default rule provides that members may not transfer non-financial
rights without consent of other members
– Early statutes restricted transfer of non-financial rights to negate
corporate characteristic of free transferability
– Current statutes retained this rule because it reflects the desires of
members to control who their co-members will be
30
MEMBERS
•Withdrawal
– Early statutes gave members default right to withdraw and demand
payment of interests
• To avoid corporate characteristic of continuity of life
– Current statutes
• In some states default rule is members may not voluntarily withdraw
from LLC
• In others members may withdraw but will be treated like assignees (with
no right to demand payment of interests)
– Reasons for change
• Give LLC liquidity and stability
• Provide estate tax planning advantages for family LLCs
31
MEMBERS
•Withdrawal
– Consequences of not having right to withdraw and obtain payment
of membership interest
• Member is “locked in”
• Minority member becomes vulnerable to will of majority
32
MEMBERS
•Charging order
– Judgment creditor’s rights against debtor member’s interest
generally limited by statute to charging order
– Charging order entitles creditor to receive distributions only
– Creditor has status of assignee and does not become member unless
other members consent
– Part of “pick your partner” protection
• Prevent creditor from becoming unwanted co-member
– Future changes?
• Clarify exclusivity of remedy
• Clarify applicability to single member LLC
– Ex. – proposed 2013 DE amendment – “attachment, garnishment, foreclosure
or other legal or equitable remedies are not available to the judgment
creditor, whether the LLC has 1 member or more than 1 member”
33
MANAGEMENT
•Vested in members
– Current default rule is management by members
– Early statutes had this as default rule to negate corporate characteristic
of centralized management
– Legislatures did not change default rule because most LLCs are member
managed
– May be vested in managers if members so choose
•Formalities
– Few restrictions in statutes
– Members may decide what actions LLC will take, and how, as they wish
34
MANAGEMENT
•Fiduciary duties
– Duties owed by managing members or managers to members and
LLC
– Generally include a duty of loyalty and a duty of care
•Statutes differ significantly
– Some include exclusive list of duties owed
– Some include non-exclusive list of duties owed
– Some have no provisions, leaving it to members in OA
– Some adopt partnership law approach, some corporate law
•Source of litigation
– Future amendments may be made based on outcome
– Amendments may be made to specifically deal with public LLCs
35
POLLING QUESTION NO. 3
Are the LLCs you form?
A. Usually member-managed
B. Usually manager- managed
C. Close to an even split
36
MERGERS AND CONVERSIONS
•Mergers
– Current LLC laws
• Permit LLCs to merge with or into other LLCs or any other type of entity
• Default rule generally is majority member approval
– Early laws
• Some limited merger to other LLCs or to only a few different types of entities
• Default rule was unanimous member approval
– Reason for amendments
• Expansion of entity constituents - Entities sought to change forms and acquire businesses operating in other forms
• Amendments to “mechanics” – Facilitate inter-entity merger
• Change in default rule – increase management flexibility
– Future changes?
• allow short form merger of LLC parent and corp sub
37
MERGERS AND CONVERSIONS
•Conversions
– Current LLC statutes
• Permit a domestic LLC to convert to any other form of domestic or
foreign entity
• Permit any other form of entity to convert to a domestic LLC
– Early statutes
• Permitted conversion of LP or GP to domestic LLC
• Did not permit domestic LLC to convert
– Conversions allowed now to meet needs of businesses that want to
change forms
– Amendments have been made to make provisions more consistent
with other entity statutes
38
COMPLIANCE REQUIREMENTS
•LLC acts are “enabling” not “regulatory”
•LLC acts do not have many compliance requirements
•Compliance requirements in business entity laws often there to protect owners
• In LLC it is thought members can protect themselves in their OA
•Three main compliance requirements
– Annual report
– Registered agent
– Recordkeeping
39
COMPLIANCE REQUIREMENTS
•Annual Report
– Furthers legislative purpose of helping public and state locate LLC
– Some states have biennial requirement
– Contains current information about LLC
• Name
• Principal place of business
• Name and address of registered agent
– Failure to file grounds for dissolution/revocation
– Amendments made over the years to adjust filing fees or due dates
or permit/require e-filing
40
COMPLIANCE REQUIREMENTS
•Registered agent
– Agent who receives and forwards SOP
– Furthers legislative purpose of helping public find and serve
process on business entities
– LLC must appoint at time of formation/qualification and
continually maintain in state
– Statutes also prescribe how appointment and change of agent are
made; impose penalties for non-compliance
– Provisions are changing
• Distinguish between commercial and non-commercial agent
• Movement to make provisions consistent from state to state and within
a state from entity to entity
• MoRAA – model act dealing with registered agent requirement
41
COMPLIANCE REQUIREMENTS
•Recordkeeping requirement
– Many statutes require LLC to maintain certain records
– Varies by state but generally includes
• List of names and addresses of members and managers
• Articles of organization, OA, amendments thereto
• Tax returns and reports for last three years
• Financial statements for last three years
• Members’ capital contributions (if not in OA or articles of org)
42
FOREIGN LLCS
•Every LLC statute has an article dealing with foreign LLCs
•Defined in statutes as an LLC formed under a jurisdiction other
than that state
•Foreign article deals with limited issues
– Governing law
– Applying for authority (qualifying)
– Amendment/Cancellation
– Penalties for doing business with authority
•Foreign provisions have not changed much over years
•Future changes?
– Provide for qualification of series LLCs, L3Cs
43
FOREIGN LLCS
•Formation state governs internal affairs, liability of members and
managers
•Foreign LLC must qualify to do business in the state
– File application for authority
• Legal name; fictitious name if legal name unavailable
• Principal office address
• Name and address of registered agent
• Certificate of existence generally required
• Some states require information such as statement as to
member/manager management, purposes, date business to begin
44
FOREIGN LLCS
•LLC doing business in state without authority
– May not bring action in state courts until qualified
– Fines may be imposed
– LLC may defend suit
– Failure to qualify does not void contracts or make members or
managers liable for LLC’s obligations
•LLC acts do not define “doing business” in state
– List activities that do not constitute doing business in state
– Include suing or being sued, holding member or manager meetings,
maintaining bank account, creating or collecting debts
– Much of law of “doing business” found in court decisions where
defendant asserts plaintiff’s failure to qualify as defense
45
FOREIGN LLCS
•Foreign LLCs subject to annual report and registered agent requirements
•Not subject to recordkeeping
46
DISSOLUTION
•Current LLC statutes
– LLC is dissolved upon consent of members or event or time set forth in
OA or formation document
– Default rule - LLC is not dissolved upon member’s death, resignation,
bankruptcy, incompetence
•Early statutes
– Sought to negate corporate characteristic of continuity of life
– Limited term of duration to 30 years
– Default rule – LLC dissolved upon member’s death, resignation, etc.
– LLC dissolved upon member’s voluntary withdrawal unless members
consent to continue
47
DISSOLUTION
•Amendments made after check-the-box
– Legislatures recognize most owners want continuity of life
– Easily dissolved entities are unstable and can have trouble
attracting business partners and financing
•Further changes?
– Allow member to apply for judicial dissolution upon oppression or
deadlock?
– Allow revocation of dissolution before cancellation document is
filed
48
DELAWARE’S LLC STATUTE
•Popular LLC formation state
•Why is DE popular?
– Flexible statute
– Statute amended annually
– Chancery court
– Case law precedent
– Division of Corporations
49
DELAWARE’S LLC STATUTE
•What does the statute provide?
– LLC is formed by filing certificate of formation
• Only requires LLC name and registered agent and office
– May carry on any business, profit or NP, except banking
– Must have at least one member
– Members must enter into LLC agreement
– Series LLCs allowed
•Sec. 18-1101
– States that it is policy of Act to give maximum effect to principle of
freedom of contract and enforceability of LLC agreements
– Directs courts to apply contract law principles
50
POLLING QUESTION NO. 4
Do you form the most of your LLCs
A. In Delaware
B. In the state where I practice
C. Almost an even split
D. Varies, choose state of jurisdiction based on the needs of the owners
51
SERIES LLC
•Series LLC is an LLC that is divided into separate series
•Each series functions like a separate LLC
– Can have its own members, managers, assets, liabilities, purpose
• If properly formed and maintained, debts of a series can be
satisfied from that series only
– Formation document must state that it is a series LLC with series
having limited liability
– OA must establish series
– Separate and distinct records must be maintained for each series
– Assets associated with each series must be held separately
52
SERIES LLC
•Delaware was first state to authorize
•Other states include IL, NV, IA, OK, TN,TX, UT, DC, MT (10/13), KS
•Main advantage – segregate liabilities without costs of forming and
maintaining separate LLCs
•Suggested uses for Series LLC
– Ownership of real estate
– Ownership of multiple business ventures
– Hold securities
– Use for short term projects
•Main disadvantage – advantage is largely theoretical because of lack of
guidance from courts, legislatures, gov’t agencies
53
SERIES LLC
•Questions surrounding Series LLCs
– How will Series LLC and series be taxed?
• PLR 200803004 – IRS treated each series separately
– Will foreign state that does not provide for Series LLC respect
separation of liabilities?
– Can series, in its own name, enter into contracts, sue or be sued,
own legal title to real estate?
• DE and some other states specify they can
– Can series file for bankruptcy or register under securities laws?
54
LLC CASE LAW TODAY
55
SOME GENERAL OBSERVATIONS
•LLC law is also made by judges
•Steady increase in number of cases nationwide
– Not evenly distributed however; some states hearing more LLC related litigation than others
– Not a great deal of decisions from high courts
– Cases involving single member LLC
56
SOME GENERAL OBSERVATIONS
•Some issues seen in LLC cases today
– Cases requiring court to interpret LLC statute
– Cases requiring court to interpret OA
– Cases involving attempts to impose liability on member
– Cases seeking to hold manager liable for breaching fiduciary duties
– Cases questioning authority of member or manager to act for LLC
– Cases involving LLC treatment under statute not specifically
applicable to LLCs
57
INTERPRETING A STATE LLC STATUTE
•Goal of court is to give effect to legislative intent
•Begin with ordinary meaning of words
•Read words in context so that they are consistent with rest of
provision and statute
•Court may look to analogous provision of corporation, LP, GP law
•Court may look at what other state courts have done
58
DAVIS V. WINNING STREAK SPORTS, LLC
•2013 Kan. App. LEXIS 16
•Sec. 17-7670 of KS LLC act – To the extent that a member has been
successful on the merits or otherwise or in the defense of any
action that member shall be indemnified against expenses actually
and reasonably incurred
•Member sought a declaratory judgment that he owned a 49%
interest in an LLC
•LLC claimed he owned 0%
•Jury found plaintiff owned 0.96%
•Pl sought mandatory indemnification under Sec. 17-7670
59
DAVIS V. WINNING STREAK SPORTS, LLC
•Trial court found for LLC because Pl was only nominally
successful and not prevailing party
•KS Ct of App reversed
– Statute does not require complete success
– Pl was successful in obtaining a declaration that he was member
even though it was for less of an interest than he sought
– Pl was thus entitled to indemnification
60
NY DERIVATIVE SUIT CASES
•NY LLC Law does not have provision stating that member may bring
derivative suit
•Early draft of LLC law had a derivative suit provision; Provision
removed before enactment
•Lower state courts and federal district courts had split on whether
member had common law right
•Courts denying right found that removal of provision = legislative
intent not to allow derivative suits
•Courts granting right based it on fact shareholders and limited
partners have right and that removal of provision from draft is not
clear legislative intent to deny right
61
NY DERIVATIVE SUIT CASES
•Tzolis v. Wolff, 884 N.E.2d 1005 (N.Y. 2008)
– Court of Appeals upholds member’s right to bring derivative suit
– Courts have repeatedly recognized derivative suits in absence of
express statutory authorization
– Shareholders and limited partners have both statutory and common
law right to bring derivative suit; no reason to treat members
differently
– Reason for derivative suit - so that victims of faithless fiduciaries
have a remedy – still valid
– No evidence legislature intended to take radical step of abolishing
derivative suit
62
INTERPRETING OA
•Courts apply principles of contractual interpretation
•Function of court is to ascertain shared intentions of parties
•First give words ordinary meaning
•Avoid result parties could not have intended
63
MAJKOWSKI V. AMERICAN IMAGING MGMT SERVICES, LLC
•913 A.2d 572 (Del. Ch. 2006)
•Was plaintiff entitled to advancement of legal expenses?
•LLC agreement did not mention advancement
•LLC agreement stated that LLC would “indemnify and hold
harmless”
•Plaintiff claimed “hold harmless” included advancement
– Had to have meaning other than indemnify or phrase would be
surplusage
– Claimed harm by having to pay litigation expenses
64
MAJKOWSKI V. AMERICAN IMAGING MGMT SERVICES, LLC
•Ch Ct held that phrase “indemnify and hold harmless” had long
history of usage and was second nature to many drafters
•Held that plaintiff’s argument would bend contractual language
to read a meaning parties did not intend
65
FUNDAMENTAL LONG TERM CARE HOLDINGS, LLC V. CAMMEBY’S FUNDING LLC
• 2013 NY Slip Op 951
•OA required capital contribution of at least fmv of interests before new member admitted
• LLC entered into option agreement entitling holder to one-third interest for $1,000 upon exercise
• LLC refused to issue membership interest to option holder; sought declaration that holder had to provide capital contribution pursuant to OA
•NY Ct of App held option holder was entitled to one-third interest
– OA and option agreement were not intertwined
– Option agreement unambiguously granted holder right to acquire interest for $1,000
– Parties were sophisticated and if they meant for OA fmv provision to apply they would have so provided
66
MEMBER LIABILITY CASES
•Many LLC cases involve attempts to impose liability on member
•Third party seeking to hold member liable for LLC debts
•Third party seeking to hold member liable based on member’s
participation in LLC’s wrongful conduct
•Member, manager, LLC seeking to hold member liable for breach
of fiduciary duty
•Member seeking to hold member liable for breach of OA
67
3RD PARTY SUIT TO RECOVER LLC DEBTS
•LLC statutes provide that member is not liable for LLC’s debts based on status as member
•But member may be held liable if court “pierces veil”
•Court may pierce if plaintiff establishes:
– Member completely controlled LLC including policies and practices with respect to transaction complained of
– Control used to commit fraud, wrong, breach of duty
– Control and breach caused plaintiff’s injury
68
ORX RESOURCES V. MBW EXPLORATION, LLC
•32 So.3d 931 (La. App. 4 Cir. 2010)
•Pl was drilling an oil well. Contracted with LLC to share expenses
and profits
•Oil well failed. Pl sued LLC’s managing member for breach of
contract to recover LLC’s share of expenses
•Trial ct – veil piercing applies to LLCs; member was LLC’s alter ego
and liable for its debts
69
ORX RESOURCES V. MBW EXPLORATION, LLC
•Appellate court affirmed
– Piercing justified when LLC is used to defraud creditors
– Def member used LLC as a shell to avoid paying debts
– Evidence showed LLC was undercapitalized, funds were commingled,
formalities not followed
• All factors that support piercing the veil
– LLC had no bank account; LLC’s fees were paid from member’s personal
account or account of another company of his
– LLC had not yet been formed when member signed contract on its behalf
– No meetings had been held in over a year
70
SERIO V. BAYSTATE PROPERTIES, LLC
• 60 A.3d 475 (Md. App. 2013)
• Pl contracts with Md LLC
• Pl is to build homes on land owned by LLC’s member and be paid upon sales of
homes
• Pl is not paid for sales on two lots and files suit, seeking to pierce LLC veil to
hold member liable
•Md law – Cts will pierce only when necessary to (a) prevent fraud or (b) enforce
a paramount equity
• Trial Ct pierces LLC veil to hold member liable
– Finds no fraud
– But piercing necessary for equitable purposes
• Member misled Pl about sales
• LLC failed to create escrow account as agreed upon
• Member’s conduct left LLC insolvent
71
SERIO V. BAYSTATE PROPERTIES, LLC
•Md Ct of Special Appeals reversed
– Looks to corporate law cases
– Cts find no equitable interest more paramount than state’s interest
in limiting shareholder liability
– Therefore a finding of fraud is required to pierce
– Conduct trial court relied on – misleading Pl, rendering LLC
insolvent, trying to evade a legal responsibility – have not been
held as enough to pierce in the corporate cases
– Here, Pl knew it was contracting with LLC and was not expecting
member to make payments
– Thus, trial court erred in piercing the LLC’s veil in this case
72
LIABILITY BASED ON MEMBER’S CONDUCT
•Statutes do not insulate members from liability for their own
actions
• If plaintiff can establish that member participated in LLC’s
wrongful conduct, member can be held liable
73
MBAHABA V. MORGAN
•44 A.3d 472 (N.H. 2012)
•Tenant in building owned by LLC brought suit ag LLC and member
after tenant’s daughter was poisoned by lead paint
•Trial Ct dismissed claims ag member
•NH SCt reversed
•Under NH LLC Act member is not vicariously liable for LLC’s
obligations
•Here, Pl was attempting to hold member liable for his own
negligence in managing the building and breaching his duty to avoid
exposing tenants to unreasonable risk of harm
•Pl claim should survive motion to dismiss 74
MEMBER BREACH OF FIDUCIARY DUTY CASES
•Member may be sued for breaching a fiduciary duty
•Fiduciary duty may be based on LLC statute, OA provision,
common law
75
GOTTSACKER V. MONNIER
•2007 Wisc. App. Lexis 68
•LLC had 3 members – Gregory, Paul, Julie; no OA
•LLC’s asset was a piece of real estate
•Paul and Julie formed a new LLC. Without telling Gregory, they
voted to sell LLC’s real estate to their new LLC
•Gregory sued. Ct applied WI LLC law Sec. 183.0402
– No member or manager shall act in a manner that constitutes a
willful failure to deal fairly with LLC or members in connection with a
matter in which member or manager has a conflict of interest
•WI S Ct - Sec. 183.0402 forbids willful unfairness
76
GOTTSACKER V. MONNIER
•Court held willful unfairness requires both unfair conduct and
resulting injury
•On remand, trial court found Paul and Julie did not violate Sec. 183.0402; appellate court affirmed
•Certain actions of Paul and Julie could be construed as unfair
– No notice of meeting or opportunity to vote on sale
– No effort to find other buyers
– Sale left LLC without assets
•However result was not unfair
– Even if allowed to vote Gregory could not have prevented sale
– Purchase price was fair, it eliminated LLC’s debts and Gregory was paid his fair share
77
SUITS FOR BREACH OF OA
•One issue is whether breach occurred
•Another issue is if member breached OA, what is remedy?
•Court can use equitable powers to fashion remedy
78
EUREKA VIII LLC V. NIAGARA FALLS HOLDINGS LLC
•899 A.2d 95 (Del. Ch. 2006)
– Decision affirmed by DE Supreme Ct (Niagara Falls Holding, LLC v.
Eureka VIII LLC, No. 413, 2006 (Del. Supr. 2007)
•LLC formed to develop property
•2 members; Milstein provided financing, Cogan provided skills to
operate business and licensing rights
•Milstein invested based on Cogan’s know how and did not intend to
be partners with anyone else
•LLC agreement contained restrictions on transferability
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EUREKA VIII LLC V. NIAGARA FALLS HOLDINGS LLC
•Cogan went bankrupt and died, resulting in creditor taking over
Cogan’s interest in LLC
•Milstein sued for breach of LLC agreement’s transferability
restrictions
•Milstein sought a declaratory judgment that it was sole member -
a remedy not provided for by LLC agreement or statute
•Ch Ct found breaches occurred and declared that creditor had
rights of assignee only and that Milstein was sole member
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EUREKA VIII LLC V. NIAGARA FALLS HOLDINGS LLC
•Court’s remedy based on Sec. 18-702
– Provides that member ceases to have rights and powers of member
upon assignment
– Policy – it is far more tolerable to suffer a new passive investor than a
new co-manager
– Although no assignment here, it was analogous situation
– Breach of LLC agreement had same affect as if Cogan had assigned
interest to creditor
– Milstein should not be bound to manage and operate LLC with a co-
member it did not choose
– Creditor limited to financial interest
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MANAGER BREACH OF FIDUCIARY DUTY CASES
•May be brought by LLC or member
•May be direct or derivative suit
•Fiduciary duties may be imposed by OA, statute, or common law
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WOOD V. BAUM
•953 A.2d 136 (Del. Supr. 2008)
•Derivative suit alleging directors of public LLC breached fiduciary duties
– Caused LLC to issue false financial statements, failed to institute controls over reporting
•Plaintiff alleged demand futility based on directors’ substantial risk of liability
•OA exempted directors from liability except in cases of fraud or illegal conduct
•Del. S.Ct – directors’ exposure to liability was limited to claims that they knowingly engaged in fraudulent or illegal conduct or bad faith violation of implied contractual covenant of good faith and fair dealing
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WOOD V. BAUM
•Court ruled plaintiff did not allege particularized facts that, if proven, would show that majority of directors faced liability
•Complaint alleged directors engaged in following acts
– Executed LLC’s publicly filed financial reports
– Authorized certain transactions
– Served on audit committee
– Ignored red flags
•Court ruled none of those acts established knowing participation in illegal conduct
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GATZ PROPERTIES, LLC V. AURIGA CAPITAL CORP.
•2012 Del. LEXIS 577
•Minority members sued manager alleging breach of fiduciary duties
after he bought them out for price well below market value
•Ch Ct holds that managers owe default fiduciary duties of care and
loyalty
•Ch Ct holds manager breached contractual and default fiduciary duties
– Refused to explore strategic options
– Refused to consider credible offer to buy LLC from 3rd party
– Made low ball offer to members
– Conducted a sham auction for the LLC
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GATZ PROPERTIES V. AURIGA CAPITAL
•De S Ct affirms ruling that manager breached his contractual fiduciary
duties
– LLC agreement imposed fiduciary duty on manager to obtain fair price in
conflict of interest transaction
– Manager acted in bad faith so statutory exculpation provision did not
excuse breach
•De S Ct states that Ch Ct’s ruling that managers owe default fiduciary
duties was dicta and had no precedential value
– Where there is a contractual provision imposing fiduciary duties there is
no need to decide if there are default duties
– No party asked the Ch Ct to decide the issue
– Reasonable minds can differ so it is up to General Assembly to clarify
•Legislative reaction – 2013 proposed amendment to LLC Act would
clarify that default fiduciary duties will apply in absence of LLC
agreement provision
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INTERNAL MEDICINE ALLIANCE LLC V. BUDELL
•659 S.E.2d 668 (Ga. App 2008)
•Passive member sued managing member
•Alleged manager breached fiduciary duties by failing to have his accounts receivable processed and collected
•Court applied statutory standard
– Manager shall act in manner he/she believes in good faith is in LLC’s best interests and with care ordinarily prudent person would exercise
•Judgment for plaintiff - Evidence showed manager acted in bad faith in not collecting on plaintiff’s accounts
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AUTHORITY TO ACT CASES
• Informal manner in which LLC may be operated, combined with few
statutory provisions …
•Can lead to litigation over whether members or managers acting on
behalf of LLC had authority to do so
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MAITLAND V. INT’L REGISTRIES, LLC
•C.A. No. 3669-CC (Del. Ch. 2008)
•LLC had 2 equal managing members (Maitland and Guida)
•Maitland sued LLC to enforce inspection rights
•Guida retained counsel for LLC, answer was filed
•Maitland moved to strike answer and disqualify counsel on grounds
that Guida lacked authority to retain counsel and file answer for
LLC without Maitland’s assent
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MAITLAND V. INT’L REGISTRIES, LLC
•Chancery Court granted motion
– LLC agreement stated that decision of majority of interests
controlled
– Statement in LLC agreement that members are granted all rights,
powers, authority to manage LLC means that one member may
manage when other is silent; does not give one member power to
manage when other is opposed
– Neither can unilaterally agree to retain counsel and file answer
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CROUSE V. MINEO
•658 S.E.2d 33(N.C. App. 2008)
•LLC sues member-manager to recover assets allegedly
misappropriated
•Suit filed on LLC’s behalf by other member-manager
• Issue – did member-manager have authority to file suit on LLC’s
behalf?
•LLC relies on section of LLC law stating that every manager is an
agent of LLC for purpose of carrying on in usual way LLC’s business
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CROUSE V. MINEO
•Defendant relies on section of LLC law stating that management
decisions require approval of majority of managers
•Court agrees with defendant. Holds filing of lawsuit against
member/manager is a management decision and not the carrying
on in usual way of LLC’s business
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STATUTORY TREATMENT OF LLCS
•Early question about LLCs – how would they be treated under
statutes/regulations specifically dealing with corporations and/or
partnerships but not LLCs?
•Over the years some amendments have been made to clarify LLC
treatment
93
CHAMPLUVIER V. MISSISSIPPI
•942 So.2d 145 (Miss. 2006)
•Example of how some statutes were amended after a court case
alerted legislature to need
•Champluvier was convicted of embezzling money from LLC she
formed
•Section of law she was convicted under applied to agents,
officers, etc. of “incorporated company”
•Mississippi Supreme Court overturned conviction because LLC is
not an incorporated company
•Section of law amended shortly thereafter to broaden
application
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LLC DIVERSITY CASES
•Federal diversity jurisdiction requires plaintiffs and defendants to be citizens of different states
•28 USC 1332(c)(1) – corporations are citizens of state of incorporation and state where principal place of business is located
• Issue – does Sec. 1332 (c)(1) apply to LLCs?
•Nearly all US Courts of Appeal have dealt with the issue. Every one held that Sec. 1332 (c)(1) does not apply to LLCs
– Congress chose to include corporations only
– Up to Congress to amend to include LLCs
• Current law – LLC is citizen of all states in which its members are citizens
•Future – Will Congress or US SCt make a change?
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CASES INVOLVING SINGLE MEMBER LLCS
•LLC acts generally written with multi-member LLCs in mind
•Concept of SMLLC does not fit neatly in all provisions, especially
those protecting members from actions of co-members
• In some cases courts have declined to apply certain sections of
LLC act to SMLLC
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IN RE MODANLO
•2008 US App LEXIS (4th Cir.), affirming, In re Modanlo, 2006 Bankr. LEXIS 4524 (D.Md)
•Member of DE SMLLC filed for bankruptcy
•Bankruptcy trustee sought to manage LLC
•Member argued trustee had, at best, rights of assignee, but no governance rights
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IN RE MODANLO
•Court held for trustee. Ruled three sections of DE LLC Act did not apply to SMLLC
– Sec. 18-304 – default rule that member ceases to be member upon filing for bankruptcy
– 18-702, 18-704 – default rules that assignee has no right to participate in management and may become member upon consent of all members
– These sections are intended to protect member from actions of co-member. Not applicable when there is no co-member.
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OLMSTEAD V. FTC
• 44 So.3d 76 (Fla. 2010)
• FTC obtained $10 million judgment against individuals who owned FL SMLLCs
• 8th Cir certified question to FL SCt asking whether charging order provision
of FL LLC act permits court to order a judgment debtor to surrender all
rights, title, interest in debtor’s SMLLC to satisfy judgment
• FL SCt ruled that FL law permits court to order surrender of full interest in
SMLLC; court not limited to charging order
– Charging order provision is part of section on assignee rights; requires consent
of “all members other than member assigning interest” for assignee to take full
interest. In SMLLC – no other members
– Charging order is special remedy for creditor when debtor’s LLC interest is not
fully transferable but subject to right of other members to object to transferee
becoming member
– LLC act provision does not state that charging order is exclusive remedy; in
contrast, LP and GP provisions state remedy is exclusive
• Aftermath – FL and other states amended LLC acts to specify that charging
order provision applies to SMLLC
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