Lawsuits

Arizona Sues California Over California’s $800/Year LLC Rip Off Tax

Arizona Attorney General Mark Brnovich announced today [March 11, 2019] that his office recently filed suit in the U.S. Supreme Court against the State of California seeking to invalidate California’s extraterritorial tax assessments and seizures, which result from an unconstitutional “doing business” tax against businesses and individuals that don’t actually conduct any business in California.

Every year, California assesses an $800 “doing business” taxes against Arizona businesses that conduct no actual business in California. Instead, their only connection to California is a mere passive, non-managing investment in a California limited liability company. California continues to assess these “doing business” taxes even though both its state courts and tax appeals agency have held that the taxes are illegal under California law.

The lawsuit filed by Arizona alleges that these taxes are plainly unconstitutional under the Due Process and Commerce Clauses of the U.S. Constitution. The Supreme Court has held that passive investment in a company located in another state is not sufficient “minimum contacts” to impose taxation under the Due Process Clause (Shaffer v. Heitner, 433 U.S. 186 (1977)). The Supreme Court has also recognized four requirements for states to impose taxes on out-of-state businesses under the Commerce Clause.  California’s “doing business” assessments brazenly violate all four.

The amounts collected by these “doing business” assessments are substantial. Arizona estimates that its citizens pay over $10 million in these unconstitutional taxes to the State of California every year.

These taxes also impact Arizona’s tax collections. Since the “doing business” taxes are deductible expenses, Arizona loses an estimated $484,000 in tax revenue each year due to California’s illegal taxation.

These figures are further compounded since the tax applies to all individuals in other states who invest in California businesses.

Extraterritorial Seizures

Making matters worse, if California’s tax assessments are not paid voluntarily, California frequently further tramples on the sovereignty of other states by issuing orders to interstate banks, demanding that they transfer funds in Arizona-based accounts for back payment. Those seizure orders threaten the banks that, if they do not transfer the funds, California will take the taxes and penalties owed from the banks instead. Not surprisingly, the banks almost uniformly consent to California’s strong-arm tactics.

Exhibit G in the filing provides an example where California demanded that Wells Fargo not only transfer the $800 tax, but also a $200 “demand penalty,” a $432 “late filing penalty,” a $79 “filing enforcement fee,” and $63.40 in interest, for a “Total Tax, Penalties, Interest and Fees” of $1574.40.

The lawsuit alleges that these seizure orders violate both the Due Process Clause (by exercising jurisdiction over out-of-state funds without the requisite “minimum contacts”); and, the Fourth Amendment (by effectuating seizures without a warrant, probable cause, or involvement of any court). Those seizure orders further preclude the banks from filing any court challenge.

Arizona’s suit seeks to end California’s unconstitutional tax encroachments.

2019-07-15T11:57:42-07:00March 11th, 2019|Lawsuits, Miscellaneous, Tax Issues|0 Comments

Court Finds Visit to Asset Protection Attorney is Evidence of Intent to Hinder or Delay Creditors

The 9th Circuit Court of Appeals issued an unpublished opinion dated September 8, 2017, in a case called In re Ellison in which the Court issued a warning that consulting with an asset protection attorney can be evidence that a debtor’s actions were taken to hinder or delay creditors.  The case involves a man named Joseph Ellison who while facing the possibility of a large award for damages against him made several transfers of assets that the court found to be done to hinder or delay his creditors.

Ellison was terminated by JP Morgan.  The parties became involved in an arbitration in which JP Morgan asked the arbitration panel to award it $750,000 for a loan made to Ellison that he had not repaid.  In January of 2014 Ellison met with an asset protection attorney, but terminated the representation after the first meeting.

On June 3, 2014, the arbitration panel found that Joseph Ellison owed JP Morgan $790,000.  Ellison took the following actions:

  • In May of 2014 he transferred $18,000 to his wife’s law firm bank account.
  • Shortly after June 3, 2014, he transferred $51,000 to his wife’s law firm account and $121,000 to a corporation owned 100% by Ellison.  He later shot himself in the foot by testifying that he transferred the money to protect his family and prevent his creditors from getting it.
  • Less than a week after the negative arbitration award Ellison paid his lenders that held first and second liens on his home $41,000 and $11,000, respectively.  Again he shot himself in the other foot by testifying that he made the prepayments to protect his family and prevent his creditors from getting the money.
  • Shortly thereafter Ellison made four transfers of money to his wife’s law firm bank account.  The largest transfer was $17,000.

On July 29, 2014, Joseph Ellison did something attorney Jay Adkisson describes as follows:

“Ellison did one of the worst things that a debtor who has made transfers in defeat of his creditors can do: He filed for bankruptcy”

The reason it was a big mistake for Ellison to file for bankruptcy is because Bankruptcy Code § 727(a)(2)(A) says that a debtor cannot be discharged from debts if:

“the debtor, with intent to hinder, delay, or defraud a creditor . . . has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed . . . property of the debtor, within one year before the date of the filing of the petition”

The bankruptcy court refused to discharge Ellison’s debts and he appealed to the 9th Circuit Court of Appeals.  The 9th Circuit found that Ellison’s transfers listed above violated Bankruptcy Code § 727(a)(2)(A) and it affirmed the bankruptcy court’s decision.

The 9th Circuit’s non-published opinion contains some troubling language about the significance of a debtor in bankruptcy who consulted with an asset protection attorney before transferring assets.  The court said:

“Debtor argues that the bankruptcy court erred by relying on his meeting with attorney Woods as evidence of his intent, because the meeting preceded any of the critical transfers, and any intent he had at the time of that meeting was vitiated before he made those transfers.

But recall, bankruptcy courts may rely on a debtor’s course of conduct, or other circumstantial evidence, to infer intent to hinder or delay a creditor. * * * Here, the bankruptcy court was not relying on Debtor’s intent in meeting with Woods alone as sufficient to support a finding of his intent to hinder or delay a creditor. Rather, it found that the timing of Debtor’s meeting with Woods, together with Debtor’s knowledge and planning in doing so, was ‘additional evidence’ that supported a finding of Debtor’s intent to hinder or delay a creditor, particularly in prepaying his home loan lenders. In sum, the bankruptcy court appropriately relied on Debtor’s intent in meeting with Woods as circumstantial evidence to supports its finding of Debtor’s intent at the time he made the transfers to his creditors.”  Emphasis added.

In his article on this case attorney Jay Adkisson states the following lesson about filing for bankruptcy:

“Another lesson here is . . . that voluntarily diving into bankruptcy is usually the single-worst decision that a person who has engaged in questionable transfers can do. Yes, post-judgment proceedings in state court can be quite painful and ultimately successful for creditors. But declaring bankruptcy is not just going from the frying pan into the fryer, but if somebody has made questionable transfers . . . it is like dousing oneself with gasoline and then jumping into the fire. The difference is one between the possibility of being seriously burned to the probability of being fried to a crisp. No court has the powers of a bankruptcy court to squeeze the last drop of blood from a recalcitrant debtor . . . .

Bottom line is that if you want to protect assets, you must take appropriate action such as forming an LLC and transferring assets to the LLC or to third party BEFORE a claim arises.  Actions taken after a claim arises frequently are found to be fraudulent transfers done to hinder, delay, or defraud a creditor.

P.S.  A claim does not arise when a lawsuit is filed.  Here are some common examples of when a claim arises against you.

  • The moment you cause a traffic accident that harms people or property.
  • When you sign promissory note, contract or personal guaranty.
2017-11-18T10:42:44-07:00November 18th, 2017|Asset Protection, Lawsuits|0 Comments

Home Conveyed to LLC Caused Loss of the Homestead Exemption

Arizona Revised Statutes Sections 33-1101 – 33-1105 contain Arizona’s homestead exemption that protects up to $150,00 of equity in a person’s Arizona home.  Section 33-1101 provides:

“A. Any person the age of eighteen or over, married or single, who resides within the state may hold as a homestead exempt from attachment, execution and forced sale, not exceeding one hundred fifty thousand dollars in value, any one of the following:

1. The person’s interest in real property in one compact body upon which exists a dwelling house in which the person resides.
2. The person’s interest in one condominium or cooperative in which the person resides.
3. A mobile home in which the person resides.
4. A mobile home in which the person resides plus the land upon which that mobile home is located.

B. Only one homestead exemption may be held by a married couple or a single person under this section. The value as specified in this section refers to the equity of a single person or married couple. If a married couple lived together in a dwelling house, a condominium or cooperative, a mobile home or a mobile home plus land on which the mobile home is located and are then divorced, the total exemption allowed for that residence to either or both persons shall not exceed one hundred fifty thousand dollars in value.

C. The homestead exemption, not exceeding the value provided for in subsection A, automatically attaches to the person’s interest in identifiable cash proceeds from the voluntary or involuntary sale of the property. The homestead exemption in identifiable cash proceeds continues for eighteen months after the date of the sale of the property or until the person establishes a new homestead with the proceeds, whichever period is shorter. Only one homestead exemption at a time may be held by a person under this section.”

People sometimes ask me if they should transfer title to the home in which they live to an LLC for asset protection.  My answer is no because:

  1. There is no business purpose so a court would probably disregard the LLC.
  2. It could cause a loss of the Arizona homestead exemption that protects $150,000 of equity in a personal residence.

An August 3, 2017, decision of the Court of Appeals of Utah called “Dean White vs. Julie Dawn White” ruled that the transfer of a home into a limited liability company caused the owner of the home to lose the Utah homestead exemption.   Although the case is not an Arizona case it causes me to believe more strongly that a person who transfers his or her Arizona home into an LLC will lose the Arizona homestead exemption.

 

Does Your LLC’s Operating Agreement Say What Happens if a Member or the LLC Gets a Judgment Against a Member?

Homer Simpson and Ned Flanders owned 60% and 40%, respectively, of World Wide Widgets, LLC, an Arizona limited liability company.  WWW manufactures and sells widgets.  Without WWW’s knowledge or consent Ned began working for Arizona Widgets, LLC, a competitor of World Wide Widgets, LLC.

WWW sued Ned for breach of fiduciary duty and misappropriation of trade secrets by disclosing information to Arizona Widgets, LLC.  The Arizona court awarded WWW a judgment for $100,000 and ordered that Ned transfer his entire membership interest in the LLC to the LLC.

WWW can use the collection process to collect the money from Ned’s non-WWW assets, but can WWW acquire Ned’s membership interest in the LLC if Ned does not voluntarily transfer his membership interest to the LLC?  Arizona Revised Statutes Section 29-655 states:

“On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the member’s interest in the limited liability company with payment of the unsatisfied amount of the judgment plus interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the member’s interest. . . . This section provides the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the judgment debtor’s interest in the limited liability company.”

Emphasis added.

Section 29-655 seems to prevent WWW from forcing Ned to transfer his membership interest to the LLC because the charging order is WWW’s sole remedy.

The WWW fact pattern is similar to the facts in a recent Texas LLC case called “Gillet v. ZUPT LLC,” Houston 14th Court of Appeals, Case No. 14-15-01033-CV, 2/23/17.  In this case ZUPT, LLC, got a judgment that required its member Joel Gillet to transfer his entire membership interest to ZUPT, LLC.  Like Arizona, Texas LLC law provides that the charging order is the sole remedy of a creditor who gets a judgment against a member of a Texas LLC.

The Texas Court of Appeals ruled that the charging order exclusive remedy statute did not prevent a court order that Gillet transfer his membership interest to the LLC.  The Court stated:

“We hold that requiring turnover of a membership interest under these circumstances is proper for two reasons. First, the reasoning behind requiring a charging order as the exclusive remedy is inapposite when the judgment creditor seeking the membership interest is the entity from which the membership interest derives. Second, unlike a case in which a judgment creditor seeks to collect on its money judgment by forcing a sale of a membership interest, this case involves an explicit award of the membership interest itself from one party to the other as part of the judgment. For these reasons, we conclude that a charging order was not the exclusive remedy available to ZUPT, and the trial court did not abuse its discretion by ordering turnover of Gillet’s 45 percent interest in ZUPT.”

Unfortunately for Homer and World Wide Widgets, LLC, no Arizona appellate court has issued an opinion similar to the ZUPT, LLC, vs. Gillet opinion.  WWW will be forced to litigate the issue and hope to get an order at the appellate level requiring transfer of the membership interest to WWW.

Warning for Multi-Member Arizona LLCs

The lesson to be learned from the ZUPT, LLC, vs Gillet case is that all multi-member LLCs should have provisions in their Operating Agreements that provide appropriate remedies if a member of the LLC or the LLC get a judgment against another member.  The Operating Agreement should have language that creates remedies that allow the member or the LLC with the judgment  to get around the exclusive remedy of Section 29-655.  The remedies include a requirement that money be distributed to the creditor from funds payable to the debtor member and a requirement that the debtor member forfeit the debtor member’s membership interest in the LLC.

In an article called “Yet Another Intra-Member Dispute in ZUPT” debt collection attorney Jay Adkisson wrote:

“The decision by the Texas Court of Appeals is, in my humble opinion, right on target, but it by no means reflects (yet) anything like a majority rule or a judicial re-writing of the cold, hard language of the charging order statutes.

Practitioners who are drafting LLC and partnership agreements need to recognize this issue, and confer with the members as to what they want the outcome to be. If one member becomes indebted to the other members or the LLC, do they want to be restricted by a charging order or not? It should be relatively easy to draft around this issue, but in my experience almost nobody does so.”

As a result of ZUPT, LLC, vs Gillet and Jay Adkisson’s advice I have amended my multi-member LLC Operating Agreement to provide special remedies if a member or the LLC get a judgment against another member.

Imposter Signs & Files False Articles of Termination & ACC Terminates the LLC

This week I learned about a now defunct Arizona LLC that was terminated by the Arizona Corporation Commission (the “ACC”) without the prior knowledge or consent of the sole member and manager of the LLC.  The Articles of Organization filed with the ACC to create the LLC named Homer Simpson (not the member’s real name) as the member and manager of the manager managed LLC called World Wide Widgets, LLC (not real LLC’s name).

Sometime in 2015 somebody filed Articles of Termination to terminate World Wide Widgets, LLC.  The document was not signed by Homer Simpson.  It was signed by Bob Faker (not the real name of the signer) who signed as the manager of the LLC.  The ACC approved the filing and terminated World Wide Widgets despite the fact Bob Faker was not listed on the records of the ACC as a member or a manager of the LLC.

I notified the ACC about the fraudulent termination of the LLC and this is its response:

“We accept filings at face value, and do not request any verification of authority to act.  As you know, we are just a filing agency, not an enforcement agency.  We do not investigate or have any authority to enforce any laws with respect to allegations of fraud.  We are unable to assist with reinstating this entity.  If you were to get a court order requiring reinstatement, we would follow that order”

The fraudulent termination of an LLC could have extremely negative consequences for the members of the terminated LLC.  Here are just a few problems that the termination causes:

  • The termination would cause the IRS to take the position that the termination caused all of the assets of the terminated LLC to be distributed to the members in the year of the termination.  If the value of the distributed assets exceeds the member’s tax basis in the LLC the member has taxable income equal to the value of the distributed assets minus the tax basis.  For example, if the LLC’s only asset is a parcel of real property valued at $200,000 and the  sole member of the LLC has a tax basis of $100,000, the member has taxable income of $100,000 in the year of the fraudulent termination.
  • If the LLC owns assets that have a title, there is no document that evidences a transfer of ownership from the LLC to the member.  In the example above, the member would be the beneficial owner of the real estate, but there is no deed signed by the terminated LLC that transfers the title to the land to the member.  Because the LLC was terminated, it is not possible for it to sign a deed that transfers title.  The member will be forced to file a quiet title lawsuit to get the title changed from the LLC to the member.
  • If the terminated LLC has intellectual property such as patents or trademarks those assets will be in limbo.
  • The financial history of the terminated LLC will be lost.  The member can form a new LLC with the same name, but could not say that the new LLC has been in business since 1995.

I am sure there are many additional problems a fraudulent termination can cause.

Consequence of Filing a False Document with the ACC

Arizona LLC law provides that it is a felony to file a false document with the ACC.  Arizona Revised Statutes Section 29-613.A states:

“A person who . . . signs any articles, statement, report, application or other document filed with the [Arizona Corporation] commission that is known to the person as false in any material respect is guilty of a class 4 felony.”

Solution to the Problem

The issue becomes what, if anything, can the members of the terminated LLC do to correct the problem.  The answer alluded to by the ACC’s response above is for the members of the LLC to file a lawsuit and ask the superior court to issue an order to the ACC that the ACC reinstate the existence of the terminated LLC and correct its records to reflect that the fraudulent termination of the LLC never occurred.

This sad story reinforces something I have been telling my LLC clients for years:  YOU MUST CHECK THE ACC’S WEBSITE AT LEAST ONCE EVERY THREE MONTHS TO CONFIRM THAT ALL THE INFORMATION ABOUT YOUR LLC IS CORRECT.  If you find that your LLC was fraudulently terminated then you can file your lawsuit to correct the problem sooner rather than later.

If your LLC was fraudulently terminated, call me at 480-664-7478 or send me an email message at rickkeyt@keytlaw.com

Go the the ACC’s ecorp website to search for your LLC and confirm it exists and all information is correct.

Member Fraudulently Amends Articles of Organization to Remove Other Member

From time to time a member of an Arizona LLC calls and tells me that another member of the LLC filed an amendment to the Articles of Organization with the Arizona Corporation Commission that removed the caller as a member of the LLC without the caller’s knowledge or consent.  There was no legal basis to file the amendment.

The caller always asks “what can I do?”  The simple answer is the caller should prepare and file another amendment to the Articles of Organization to correct the removal of the caller as a member.  This solution, however, is only a temporary band aid.  It does not solve the fundamental problem which is the members cannot get along.

Unfortunately this scenario is an all too common problem.  The Arizona Corporation Commission is, in actuality, a mere filing service.  If a person submits a document for filing and it satisfies the ACC’s filing requirements, the ACC will file the document.  The ACC does not confirm or verify that the information set forth in a document is correct.  Many times when members of an Arizona LLC can not agree on the management of the LLC one of the members will file an amendment to the Articles of Organization that removes another member without any legal basis for the removal.

People who file false documents with the ACC are usually unaware that they could be committing a felony.  Arizona Revised Statutes Section 29-613.A states:

“A person who . . . signs any articles, statement, report, application or other document filed with the [Arizona Corporation] commission that is known to the person as false in any material respect is guilty of a class 4 felony.”

The bottom line is that when this happens the members need to consummate a “company divorce,” i.e., a legal termination of their relationship as members of the same LLC.  The best solution occurs if the members agree on the terms and conditions of their company divorce and they sign documents that evidence their agreement.  If the members cannot agree, they have two options:

  • Continue their relationship as members of the LLC, which means ongoing disputes, problems and stress.
  • File a lawsuit in an Arizona Superior Court and ask the court to dissolve the LLC.  This option takes time and causes both members to pay large amounts of money to their lawyers.

As a result of this latest call, I revised my multi-member Operating Agreement (yes I have a single member and husband and wife owned Operating Agreement that is about 20 pages shorter) to include a section that obligates a member who causes a fraudulent amendment to the Articles of Organization to be filed with the ACC to pay each other member liquidated damages in the amount of $10,000.  If the liquidated damages are not paid within 30 days of the filing date the unpaid amount accrues interest at the rate of 10% per annum.  If the entire amount is not paid within one year of the filing date, the offending member’s membership interest in the LLC will be forfeited on the first anniversary of the date the false amendment to the Articles of Organization was filed with the ACC and the unpaid portion of the liquidated damages will be forgiven.

For more on this topic read my blog post called “Can One Member of an Arizona LLC Expel Another Member?

Do Members of an Arizona LLC Owe Fiduciary Duties to Other Members?

Question:  “Does a member of an Arizona limited liability company owe other members of the company any fiduciary duties?

Answer:   A March 27, 2014, Arizona Court of Appeals opinion in the case of TM2008 Investments, Inc., vs. ProCon Capital Corp. says that the members of an Arizona limited liability company do not owe any fiduciary duties to the other members unless the members signed an Operating Agreement that creates and imposes contractual fiduciary duties on the members.

Since the TM2008 Investments case involves fiduciary duties we should first explain what the term means.  The Cornell University Law School Legal Information Institute says the following about fiduciary duties:

“A fiduciary duty is a legal duty to act solely in another party’s interests. Parties owing this duty are called fiduciaries. The individuals to whom they owe a duty are called principals. Fiduciaries may not profit from their relationship with their principals unless they have the principals’ express informed consent. They also have a duty to avoid any conflicts of interest between themselves and their principals or between their principals and the fiduciaries’ other clients. A fiduciary duty is the strictest duty of care recognized by the US legal system.”

If a person owes a fiduciary duty to another person it also means it is much easier for the principal to sue the fiduciary for breach of a fiduciary duty and win a judgment because there is a higher standard of care associated with the fiduciary duty than would otherwise apply.

The TM2008 Investments, Inc., vs. ProCon Capital Corp. case arises from a dispute among the two members of Doveland Developments, LLC, a company formed to buy land and develop it into homes.  Unfortunately the project was not successful.  The lender threatened to foreclose and sell the land and go after the owners of the two members (Steve Tackett and Bonnie Vanzant) of Doveland Developments, LLC, because they had personally guaranteed the payment of the loan.  The members of Doveland Developments, LLC, are TM2008 Investments, Inc., and ProCon Capital Corp.

When the lender notified the parties that the loan was in default Bonnie Vanzant paid the loan in full.  She then sued Steve Tackett under an indemnification agreement they had signed to collect from Steve one half of the money Bonnie paid to the lender under her personal guaranty of the loan.  TM2008 Investments filed a petition to dissolve and liquidate Doveland Developments due to the inability to conduct business in light of the members’ substantial disagreements. ProCon Capital filed counterclaims against TM2008 Investments for breach of the implied covenant of good faith and fair dealing (count 1) and breach of contract (count 3), and against TM2008 Investments and the Bonnie and James Vanzant personally for breach of fiduciary duty (count 2).

The lawsuits were consolidated.  The trial court granted Bonnie Vanzant’s motion for summary judgment on the indemnification claim, but denied TM2008 Investments’ motion for summary judgment on the counterclaims.  Just before trial, ProCon Capital voluntarily dismissed with prejudice counts 1 and 3.  After jury trial on the claim for breach of fiduciary duty, the jury returned a verdict in favor of ProCon Capital and against TM2008 Investments and the Vanzants personally for $1,039,754.  The losers appealed.

The primary issue before the Arizona Court of Appeals was whether or not Arizona’s limited liability company law provides that a member of an Arizona LLC owes a fiduciary duty to the other members of the LLC.  ProCon Capital argued that because Arizona corporate and partnership law create fiduciary duties on shareholders and partners, respectively, Arizona law must therefor create fiduciary duties on members of an Arizona LLC.  The appellate court disagreed.  The court said:

We decline in this case to mechanically apply fiduciary duty principles from the law of closely-held corporations or partnerships to a limited liability company created under Arizona law. The legislature did not explicitly outline any such duties for members of an LLC; instead, the LLC Act allows the members of an LLC to not only create an operating agreement, but also delineate in that agreement the duties members owe one another.”

Translation:  The court said Arizona’s LLC statutes do not subject members of Arizona LLCs to any fiduciary duties and neither do any Arizona appellate court opinions.

However, the court said that an Operating Agreement can contain language that creates one or more fiduciary duties on members.  The Operating Agreement of Doveland Developments, LLC, contained this clause that ProCon Capital aruged created a fiduciary duty on TM2008 Investments, Inc, and Bonnie and James Vanzant:

It is agreed any Member shall not be liable to the Company or any other Member for any damages or the like relating to any vote, decision, action, inaction or the like taken on behalf of the Company in accordance with these provisions and other provisions of this Agreement if such is done in good faith and with reasonable business judgment including the duty to make management decisions with the care of an ordinarily prudent person in a like position and similar circumstances and in a manner believed to be in the best interests of the Company.

The appellate court found that the above quoted language did not create a fiduciary duty on the members.

The court reversed the trial court and sent the case back to the trial court.

Lessons to Be Learned

The TM2008 Investments, Inc., vs. ProCon Capital Corp. case stands for the following:

  • Arizona’s statutes that govern Arizona limited liability companies do not create fiduciary duties on members.
  • Members of an Arizona LLC can create one or more fiduciary duties by inserting appropriate language in the LLC’s Operating Agreement.

The issue of whether the Operating Agreement of a multimember Arizona LLC should or should not contain fiduciary duty provisions is a topic for another article.  Hint:  A member in control of an Arizona LLC would not want any fiduciary duties in the Operating Agreement, but the minority member would want the opposite.

Arizona Attorney General Gets Judgment Against Arizona Corporate Minutes Scammer

The wheels of Arizona justice turn slowly, but Arizona Attorney General Terry Goddard Tom Horne finally got a judgment against the perpetrators of a 2008 corporate minutes scam.  I wrote about the scam in 2008 in an article entitled “LLC Minutes Scam Alert.”  Attorney General Goddard’s September 2009 complaint alleged:

11. From November 2008 until May 2009, Defendants disseminated at least 137,500 solicitations, using direct mail, to Arizona corporations and limited liability companies. The solicitations, under the fictitious name Arizona Corporate Headquarters, were official-looking forms which implied that a business had to complete the form and return it with an “Annual Fee” of $125 by a “REPLY BY” date to preserve its corporate status. The form is entitled “Annual Minutes Disclosure Statement.” Below this title is a date designated as the “NOTICE DATE: XIX./XX” followed by the “CORPORATE NAME:

[Name of Corporation or LLC]” and the “CORPORATION NUMBER: [#######J,” which was the corporation number of the business addressee as assigned by the Arizona Corporation Commission. The form has the format of an official-looking document and includes a citation to the Arizona Corporations Code requiring a corporation to hold annual meetings of shareholders.

12. The forms contain a warning, in boldface capital letters: “TO ENSURE APPROPRIATE PROCESSING AND FULFILLMENT, PLEASE RETURN THIS FORM WITH YOUR PAYMENT TO: ARIZONA CORPORATE HEADQUARTERS-BUSINESS DIVISION – 5025 N. CENTRAL AVENUE, SUITE 573, PHOENIX, AZ 85012.” The address is a private mail box used by Defendants and located in a UPS Store.

13. The form also contains a warning that “[fjailure to comply with certain requirements could cause your corporation to lose its limited liability status. If so, personal liability exposure to tax agencies, or other creditors could possibly be put on the directors and shareholders for failing to document formalities.” Thereafter each form states that it should be submitted “with the ANNUAL FEE OF $125.00 WITHIN 15 BUSINESS DAYS.”

14. The back of the forms utilized by Defendants states that payment should be submitted “along with the Annual Minutes Disclosure Statement for proper processing and fulfillment of the Annual Minutes for your corporation.” It directs payments be sent to the “Business Division” of Arizona Corporate Headquarters.

15. Defendants represent that in exchange for payment they will prepare corporate minutes. In fact, in the limited cases in which Defendants did provide corporate minutes, those minutes reflected meetings that never took place and actions that never occurred.

17. Defendants have received over $350,000 from the thousands of Arizona corporations and limited liability companies that completed the form and paid the $125.00.

In February of 2012 Attorney General Horne obtained a judgment for $338,225 damages plus $48,900 attorney fees against defendants Y.M.S., Inc., a Nevada corporation, Gaston Muhammad, aka Gaston Greene and Ronna Muhammad, aka Ronna Greene.

2016-11-16T08:23:46-07:00April 19th, 2012|AZ Corporation Commission, Lawsuits|0 Comments
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Court Rules LLC Member not Obligated to Contribute Money to LLC

The New York case of Duff v.Curto, 2012 NY Slip Op 30264(U) (Sup Ct Suffolk County Jan. 25, 2012), by  Suffolk County New York Justice Emily Pines involved a claim by one LLC member that the other member failed to contribute money to the company.  Duff claimed he contributed $523,000 to the capital of Fairlea Court Holding, LLC, of which Gary Duff and Peter Curto, Jr., were the only two members. Duff claimed that Curto breached the Operating Agreement because he did not contribute any money to the company and that Curto was unjustly enriched.

They signed an Operating Agreement that said:

“[u]pon the execution of this Agreement, each Member shall contribute cash and/or property to the Company as set forth opposite their names in Exhibit A”

Exhibit A stated that each member had a 50% interest in the company, but it did not show that either member was to contribute any capital to the company.  The Court said:

“The Court finds that the documentary evidence provided raises an issue of the parties intent in placing the 50% figure in the Agreement and does not definitively dispose of the plaintiff’s claim”

The Court found that Duff reported on his tax returns that he loaned $309,000 to the LLC and that Curto never agreed to contribute any money to the company.

Lesson for Arizona LLCs

Arizona LLC law provides that no member of an Arizona limited liability company is liable to contribute money or property or services to the LLC unless the member agrees to do so in writing.  Arizona Revised Statutes Section 29-702.A states:

“A promise by a member to make a capital contribution to the limited liability company is not enforceable unless set out in writing and signed by the member.”

If you have an Arizona LLC and want to create a legal obligation on the part of one or more members then the LLC must obtain a written document signed by the member(s) that states the amount of money or the description of the property or the nature and extent of the services and when the money or property or services must be contributed.  The best place for these provisions is the Operating Agreement.

2017-05-29T14:55:11-07:00March 5th, 2012|Forming LLCs, Lawsuits, Members, Operating Agreements|0 Comments

Colorado Court Pierces LLC Veil & Holds Single Member Liable for LLC’s Debt

When On February 2, 2012, the Colorado Court of Appeals issued its opinion in the case of Martin vs. Freeman, a case that is important for all limited liability company owners who want to avoid becoming liable for the debts of their LLC.

The Facts

Dean C.B. Freeman was the sole member and manager of Tradewinds Group, LLC, a Colorado limited liability company.  Tradewinds only asset was an airplane that it owed free and clear with a value of approximately $300,000.  Tradewinds hired Robert L. Martin to build an airplane hangar for its airplane. Tradewinds sued Martin in 2006 for breach of the construction  contract. In 2007 Tradewinds sold the airplane for $300,000.  After making sure that all creditors were paid Freeman caused the LLC to pay him all funds that remained in the LLC’s bank account.  Thereafter Freeman paid all of Tradewinds’ litigation expenses from his funds.

In 2008, the trial court entered a judgment in favor of Tradewinds. Martin appealed and won the appeal. The Colorado Court of Appeals found that Tradewinds’ damages were speculative and sent the case back to the trial court with directions to enter judgment in favor of Martin. The trial court ruled in 2010 that Martin was the prevailing party and awarded him $36,645.40 in costs.

 When Martin won the $36,645 judgment against Tradewinds Group, LLC, it did not have any because it had sold its only asset and paid all of the company’s funds to its sole member, Dean Freeman. Martin then sued to pierce the LLC veil and collect Tradewinds’ debt from Freeman, the sole member of the LLC.

The primary issue before the Colorado Court of Appeals was should the court allow Martin to pierce the LLC’s veil and hold its sole member liable for Martin’s judgment against Tradewinds Group, LLC? The appellate court stated:

“To pierce the LLC veil, the court must conclude

  1. the corporate entity is an alter ego or mere instrumentality;
  2. the corporate form was used to perpetrate a fraud or defeat a rightful claim; and
  3. an equitable result would be achieved by disregarding the corporate form.”

The Colorado Court of Appeals in a two to one decision ruled that all three criteria existed and that Dean C.B. Freeman was personally obligated to pay the judgment owed to Robert L. Martin.

1st Factor:  Alter Ego

The majority’s opinion says that courts consider a variety of factors in determining alter ego status, including whether:

  1. “the entity is operated as a distinct business entity;
  2. funds and assets are commingled;
  3. adequate corporate records are maintained;
  4. the nature and form of the entity’s ownership and control facilitate insider misuse;
  5. the business is thinly capitalized;
  6. the entity is used as a mere shell;
  7. legal formalities are disregarded; and
  8. entity funds or assets are used for non-entity purposes.”

The Court does not, however, tell us if alter ego status exists if a majority of the factors exist or if all all of the factors must exist or it is is merely a gut feeling determined by the court that sufficient factors exist to justify a finding that the company was the alter ego of the member.  The Court found the following facts that justified its conclusion Tradewinds was Freeman’s alter ego:

  • “Tradewinds’ assets were commingled with Freeman’s personal assets and the assets of one of his other entities, Aircraft Storage LLC;
  •  Tradewinds maintained negligible corporate records;
  •  the records concerning Tradewinds’ substantive transactions were inadequate;
  •  the fact that a single individual served as the entity’s sole member and manager facilitated misuse;
  •  the entity was thinly capitalized;
  •  undocumented infusions of cash were required to pay all of Tradewinds’ operating expenses, including its litigation expenses;
  •  Tradewinds was never operated as an active business; legal formalities were disregarded;
  •  Freeman paid Tradewinds’ debts without characterizing the transactions;
  •  Tradewinds’ assets, including the airplane, were used for non­entity purposes in that the plane was used by Aircraft Storage LLC, without agreement or compensation;
  •  Tradewinds was operated as a mere assetless shell, and the proceeds of the sale of its only significant asset, the airplane, were diverted from the entity to Freeman’s personal account.”

2nd Factor:  Defeat of a Rightful Claim

The Court stated:

“The second prong of the veil-piercing test is whether justice requires recognizing the substance of the relationship between the corporation and the person or entity sought to be held liable over the form because the corporate fiction was ‘used to perpetrate a fraud or defeat a rightful claim.”

The Court went on to make the unfortunate statement that there is no Colorado case that ruled “that a party seeking to pierce the corporate veil must show wrongful intent.”  The Court found:

“We conclude that defeating a potential creditor’s claim is sufficient to support the second prong. We further conclude, as a matter of first impression, that wrongful intent or bad faith need not be shown to pierce the LLC veil.”

The Court’s ruling effectively throws out the second prong of the three prong alter ego test and ignores 100+ years of corporate law.  If a company has assets sufficient to pay its debt, the creditor does not need to sue the owner and try to pierce the corporate/company veil.  It is only when the company cannot pay its debt that a creditor will sue the owner in an attempt to collect the company’s debt from the owner.

The corporate and LLC law of most if not all states provides that a fundamental asset protection concept is that the owners of the entity are not liable for the entity’s debts or obligations.  It may be appropriate in some cases to find that a rightful claim of a creditor should be paid by an owner of the company after a court finding that the company was the owner’s alter ego and used to perpetrate a fraud, but the mere fact that the creditor was not paid should never be considered and used to find the owner liable.  If people will be held liable for the debts of a company simply because the company has unpaid debts it will have a chilling affect on business and prevent many people from investing in businesses that would hire employees.

3rd Factor: Equitable Result

The Court did not discuss the facts that support a finding that an equitable result would be achieved by disregarding the corporate form, nor did it rule on the issue.  Apparently Colorado now has a two prong test to determine if the when a Colorado court will pierce the company veil and hold the owner of an LLC liable for its debts.

Let’s hope this case is appealed because it is bad law for the owners of LLCs, corporations, limited partnerships, limited liability partnerships and limited liability limited partnerships.

What Martin v. Freeman Means for LLC Members

Some commentators have written that this case is another reason people should shy away from the single member limited liability company.  I disagree.  The court did not discuss that the fact the LLC had only one member was significant.  What was significant to the court was the historical facts as to how the LLC operated and conducted its affairs.  The case stands for the proposition that LLC owners, both single and multiple members) must follow the formalities of operating the company or risk having the veil pierced and the owners becoming liable for the LLC’s debts.

Consider the facts that the Court found that cased it to conclude that the company was Freeman’s alter ego:

1.  Tradewinds’ assets were commingled with Freeman’s personal assets and the assets of one of his other entities, Aircraft Storage LLC:  This is a fundamental no no.  Never allow assets of a member to be commingled with the company’s assets.

 2.  Tradewinds maintained negligible corporate records:  Again this is a no brainer.

Your LLC must maintain a good set of financial books.  Use Quickbooks.  Have an experienced Quickbooks expert set it up.  It’s not too expensive.  Make sure all income and expenses are entered and properly annotated.

If you loan money to your LLC, the books must show the date and amount of the loan and the loan should be documented by a promissory note signed by the LLC and a resolution signed by all of the members that authorizes the loan.

If you transfer assets to the company, prepare a Bill of Sale signed by the transferor that lists the assets transferred as of the stated date.  If you are an employee of the company, sign an employment agreement with the company and have the members sign a resolution authorizing the LLC to enter into the employment agreement.

If the company enters into a contract with a third party have the members sign a resolution authorizing the LLC to enter into the contract.

 3.  The records concerning Tradewinds’ substantive transactions were inadequate:  The tasks listed in the prior paragraph apply here too.  In addition, one of the best things every LLC should do is routinely document all significant major actions taken by the company with minutes or resolutions signed by the members.  Here is a partial list of company actions that EVERY LLC should document with minutes or resolutions:

Contributions of money or property by a member to the LLC.

Loans of money by a member to the LLC.

Adding or removing a member.

Changing the percentage ownership of a member.

Employing a member or key employee.

Hiring an independent contractor.

Buying, selling or leasing real property or personal property with significant value.

Entering into contracts with third parties.

Purchasing insurance.

Applying for licenses such as a real estate broker’s license or a contractor’s license.

Doing business in another state.

Entering into an Operating Agreement with the members.

Entering into a Buy Sell Agreement with the members.

An annual meeting of members and managers (if manager managed).

It is imperative that the members of the company document all significant actions taken by the company with minutes or resolutions.  I know from being a business lawyer since 1980 that very few companies have the self discipline to document their actions.  Routinely documenting transactions is one of the most important things the members of an LLC should do to prevent a court from finding that the company was the alter ego of the members.

3.  Solution to the Lack of Records Problem: Prepare minutes and resolutions and have them signed by the members and managers.

 4.  The fact that a single individual served as the entity’s sole member and manager facilitated misuse:  Note the Court said that having a single member “facilitated” misuse.  It did not say that having a single member LLC is always a negative factor.  The Court recognized that doting the eyes and crossing the tees is less likely to occur with a single member LLC because it takes more self discipline to have meetings with yourself and document those meetings.  This fact of life is another reason why it is particularly important for single member LLCs to follow all of the formalities of operating the LLC and using a minutes service like Just a Minute.

 5.  The entity was thinly capitalized:  The law requires that every LLC to be adequately capitalized, but it does not give LLC owners a clue as to what that term means.  Adequate capitalization for an LLC means the company must always have sufficient assets for its needs, but the law doesn’t tell LLC owners exactly what constitutes adequate capitalization.  LLC owners only know if their company is adequately capitalized years later if they are sued and a judge or jury rules one way or the other on the issue.  Another problem is that adequate capitalization is a moving target because the number changes as the LLCs business facts and circumstances change.  If the LLC does not have sufficient assets to meet its capital needs then it is not adequately capitalized.  However, if the LLC does have sufficient assets to meet its capital needs a court could still find the company was not adequately capitalized.  Remedy:  Make sure the company has sufficient capital to pay its expenses plus a reserve of as much as you can afford and hope that if your LLC is ever challenged the judge or the jury will rule in your favor.

6.  Undocumented infusions of cash were required to pay all of Tradewinds’ operating expenses, including its litigation expenses:  This is a common problem that is easily avoided.  If your LLC needs money there are two ways to get the money: (a) one or more members make a capital contribution to the company, or (b) the company borrows money from one or more members or a third party lender.

Capital  Contributions:  A capital contribution is a gift of money or property by a member of an LLC to the company.  The company is not obligated to repay the contribution at any time except on liquidation if the contribution was not previously repaid.  The company should document all capital contributions by: (a) making a proper entry in the company’s books that the member made a contribution of $x on a specified date, and (b) having the members sign minutes or a resolution that authorizes and approves the contribution.

 Loans:  Regardless of who loans money to the LLC, the loan must always properly documented by: (a) having the LLC sign a promissory note that states the loan amount, interest rate and repayment terms, and (b) having the members sign minutes or a resolution that authorizes and approves the loan.  For more on this topic see my article called “How Do I Loan Money to My LLC?

Undocumented infusions of cash are a routine event in most LLCs, but that does not make it right.  Protect yourself by always documenting cash infusions.  It’s easy to do and could make the difference between whether a court will one day allow or refuse to allow a creditor of the company to get a judgment against you.  Undocumented cash infusions should never happen if you use a minutes service like Just a Minute, LLC, to automate the preparation of minutes on a monthly basis.

7.  Tradewinds was never operated as an active business:  Tradewinds only purpose was to own and operate Freeman’s airplane.  It did not have any customers or generate any revenue.  This factor is what other courts call the business purpose doctrine.  A concept in asset protection law is that a court may disregard the formation of an entity like an LLC or a corporation if it has  no business purpose.  For example there is no business purpose to transfer title to your home to your solely owned LLC while you continue to live in the home.  If the only reason you put property into an LLC is to protect it from the claims of your creditors, then the plan probably will not work.  Imagine what would happen if you take the witness stand and the plaintiff’s attorney asks why did you put your home in the LLC and you answer to prevent my creditors from getting it.  You lose.  Because Tradewinds did not have a business, customers or revenue, it failed the business purpose test.

 8.  Legal formalities were disregarded:  Yes the are legal formalities that apply to operating LLCs and your LLC must comply with all of them.  One of the reasons I wrote my 170 page book called the Arizona LLC Operations Manual is so I could notify my LLC clients and purchasers of the book about the legal formalities applicable to Arizona LLCs.  Every LLC must comply with the legal formalities of its formation state.

9.  Freeman paid Tradewinds’ debts without characterizing the transactions:  This is a no brainer.  Members should never pay the LLCs debt.  The LLC should never pay a member’s debt.  DO NOT DO THIS.  If your LLC needs money, write a check payable to the LLC and deposit the funds in the LLC’s bank account then pay the debt with the LLC’s money.  Don’t forget to properly document the transaction as a capital contribution or a loan.  If you need LLC money to pay your debt, have the LLC write a check to you so you can deposit the funds in your account and pay from your account.  Don’t forget to properly document the distribution of money as a loan, compensation or a return of capital (if you have a positive capital account balance).  Document the distribution with a promissory note (if a loan) and minutes or resolutions signed by the members.

 10.  Tradewinds’ assets, including the airplane, were used for non­entity purposes in that the plane was used by Aircraft Storage LLC, without agreement or compensation:  The LLC allowed another entity to use its $300,000 airplane without paying any compensation and without a written agreement.  Why?  This type of transaction is a red flag asking for trouble in more ways than one.  No person or entity should ever use LLC assets for non-LLC purposes unless the LLC enters into a written agreement with the user and the user compensates the LLC for the reasonable value of the use.

 11.  Tradewinds was operated as a mere assetless shell, and the proceeds of the sale of its only significant asset, the airplane, were diverted from the entity to Freeman’s personal account:  The Court is wrong on this factor.  The LLC was not assetless.  It owned a $300,000 asset free and clear.  It sold its assets and distributed the proceeds to its only member.  The Court calls this “diversion” of assets, but this is the common and accepted method of liquidating an LLC or a corporation.  The law does not require companies to retain cash in the company in perpetuity after the company liquidates its assets.  It is not right that the Court found this fact to be a negative factor.

Conclusion

This case is a wake up call to all LLCs that do not dot the eyes and cross the tees.  If your LLC is not religiously following the legal formalities of your state’s LLC law and properly documenting LLC transactions, especially transactions with members, then the company is setting the groundwork for a court ruling that the company veil should be pierced and the member(s) should be liable for the debts of the company.

Does your LLC properly document all significant transactions?  If not, then I have two statements for you:

  • If your LLC has not been documenting LLC transactions with minutes and resolutions, you won’t be doing it in the future.

Here are some other articles on this important topic:

“With the stripping of the requirement to prove wrongful conduct and expansion of liability for contingent claims, the ruling diminishes the limited liability protection afforded to all corporations and LLCs operating in Colorado. Incorporation in a jurisdiction with more robust liability protections seemingly provides no remedy – the Martin Court applied Colorado LLC statutes and case law without discussion of why Colorado law should apply to Tradewinds, a Delaware LLC. The ruling also highlights the renewed importance of maintaining adequate corporate records and practices as a means of avoiding ensnarement under the first prong of the veil-piercing test.”

“Update Corporate Records and Follow Required Formalities. Many closely held businesses do not keep their corporate record books up to date. In the event of a lawsuit against the company, a plaintiff’s attorney can attempt to “pierce to corporate veil”. This means the corporation will essentially be ignored and the owners (shareholders) will be personally liable for the corporate debts.  Following basic corporate formalities, including

  • Holding an annual shareholders meeting;
  • Holding regular meetings of the Board of Directors;
  • Avoiding any mixing of personal and corporate assets; and
  • Keeping corporate records up to date.

will all help to insure that the assets of the owner(s) of the business are insulated from any judgment against the business.”

For People Who Want to Form an LLC Themselves

If you think you might want to create a do-it-yourself Arizona LLC you must read Arizona LLC attorney Richard Keyt’s article called “Step by Step Guide: How to Form Arizona LLC 2019 in (6 Easy Steps).”

2019-10-26T15:25:19-07:00February 19th, 2012|Asset Protection, Lawsuits, Veil Piercing|1 Comment

Ohio LLC’s Incentive Compensation Creates Partnership With Former Employee

LLC Law Monitor:  “Business acquirors sometimes give the acquired company’s management financial incentives to enhance the acquired company’s value. These are often structured as bonus compensation for achieving defined milestones, and sometimes include equity in the acquired company or in the buyer.  In a recent Ohio case the buyer of a company’s assets provided incentive compensation to the company’s management, based on the profits of a division of the company. The employee was later terminated, and claimed the company had entered into a partnership with him and then breached its fiduciary obligations.”

KEYTLaw recommendation:  This type of provision should be in a written employment agreement that provides for a compensation bonus in an amount equal to the profits of a specific entity or division of an entity.  Be sure to define profits precisely.  The agreement should state that the provision does not create a partnership, joint venture, ownership interest in the entity or any other arrangement other that the employer / employee relationship and that it does not cause the employer (or the entity if it is not the employer) to owe any fiduciary duties to the employee.

2018-05-22T18:46:19-07:00December 19th, 2011|Lawsuits, Operating LLCs|0 Comments

Arizona Attorney General Sues Spouse Because She Owned a Community Property Interest in Husband’s LLC

Arizona Attorney General Tom Horne sued a Phoenix-area firearms dealer for consumer fraud in a lawsuit filed in Maricopa County Superior Court.  The defendants in the lawsuit are Lancaster Arms, LLC, owned by co-defendants Chester Durda and his wife Marsha.  The AG alleges that the LLC and its member Chester Durda defrauded consumers by failing to provide promised merchandise and services to dozens of customers between February of 2009 and September of 2011.

The Attorney General’s press release states:

“Protecting consumers is one of the most important jobs of this office,” Horne said. “Businesses such as the one named in this lawsuit cannot be allowed to make promises to customers and not deliver on those promises. The problem is made even worse when, as in this case, some customers made advance payments with the expectation that they would get either merchandise or services in return, and instead they got nothing. The legal action requests that the court order the business to make restitution, pay penalties, and prevent it from defrauding additional consumers.”

According to the complaint, Lancaster Arms claimed to consumers, some of whom worked in law enforcement and the military, and to some weapons dealers, on the internet and through personal contact by Chester Durda, that the company sold weapons, parts and accessories and that it provided weapon kit assembly services to consumers who sent their kits to the company. Additionally, Lancaster Arms represented that some of its weapons were subject to its “Limited Life Time Warranty”. The lawsuit alleges that Lancaster Arms failed to ship merchandise that consumers had paid for, failed to repair weapons under warranty, and failed to provide refunds. The lawsuit also alleges that Lancaster Arms failed to assemble weapons kits sent to it by consumers and failed to return the un-assembled kits to the consumers or to provide them with refunds. The complaint asks the court to enter an injunction prohibiting the defendants from engaging in any further unlawful acts, require the defendants to restore money and property to consumers, order the payment of civil penalties of up to $10,000 per violation, and to reimburse the State’s court costs and other related expenses.

The lesson to be learned from this lawsuit is that assuming that Mrs. Durda did not have any involvement with the LLC or the alleged unlawful activities she was named as a defendant because the plaintiff wants to be able to collect damages from her community property.  When spouses own an interest in an LLC as community property there always the risk that the non-active spouse could be named as a defendant in a lawsuit for this reason.  If this is a concern and the non-involved spouse wants to protect his or her assets from liabilities arising from the active spouse’s involvement with the LLC, then the active spouse should own all of the LLC as separate property and the non-active spouse would not own any of the LLC.

See my article called “How Do I Acquire an Ownership Interest in an Arizona LLC as Separate Property?

Read the Complaint.

2016-11-16T08:23:51-07:00December 15th, 2011|Asset Protection, Lawsuits, Members|0 Comments

Virginia Supreme Court Rules Death of LLC Member Transferred only Rights to Profits, Not Management or Voting Rights

Every person who is a member of an LLC will die, but few people take action while alive that will insure that the right person or people or entity inherits their membership interest in their LLC or that their heir(s) will become full members of the LLC after the LLC member dies.  A November 5, 2011, Virginia Supreme Court case illustrates the problem that arises when the deceased member failed to take action to insure that his daughter would become a member of the LLC of which he owned 80%.

The case of Ott v. Monroe involves a dispute between a 20% member and the daughter a deceased member who inherited the deceased member’s 80% interest in the LLC.  This case is an excellent teaching tool for everybody who is a member of an LLC.  The court ruled that the daughter who inherited the 80% LLC interest inherited only the right to receive 80% of the profits and distributions from the LLC and that she did not become a member of the LLC with any voting rights.  The bottom line is that after the death of the 80% member the 20% member became the sole  member of the company and the only person able to vote and control the LLC.

A member’s interest in an LLC consists of two types of interests.  The first interest is a control interest, which is the member’s right to participate with other members in the management of the LLC’s affairs. The second interest is a financial interest, which is the member’s right to a share of the LLC’s profits and losses and right to receive distributions from the LLC.  The general rule of Virginia and Arizona law is that a member may transfer only the member’s financial interest. The control interest in an LLC is personal to the member and cannot be transferred to another person or entity by the unilateral act of the member.  Arizona Revised Statutes Section 29-732.A provides:

The assignment of an interest in a limited liability company does not dissolve the limited liability company or entitle the assignee to participate in the management of the business and affairs of the limited liability company or to become or to exercise the rights of a member, unless the assignee is admitted as a member as provided in section 29-731. An assignee that has not become a member is only entitled to receive, to the extent assigned, the share of distributions, including distributions representing the return of contributions, and the allocation of profits and losses, to which the assignor would otherwise be entitled with respect to the assigned interest.”  Emphasis added.

The failure to plan caused the minority member to obtain control of the LLC when the majority member died.  This is a wake call for all people who are majority owners of an LLC.  The failure of the majority member to plan could cause the loved one(s) who inherit the majority owners interest in the LLC to lose control of the company when the majority owner dies.  Does your LLC’s Operating Agreement provide that the control interest of a deceased member transfers automatically to the member’s heirs(s)?  Should it?  The members of every multi-member LLC must decide if the control interest will or will not transfer automatically to an heir when a member dies.  If the control interest is to transfer automatically after a death, the only way to cause it to happen is by having all of the members sign a document (preferably an Operating Agreement) that provides for the automatic transfer of the control interest when a member dies.

Do you know who will inherit your membership interest in your LLCs if you were to die?  Will your heirs have to waste time and money in probate court?  For more on this topic read my article called “Who Will Inherit Your Membership Interest in Your Arizona LLC When You Die?

P.S.  The Operating Agreement I prepare for every Arizona LLC I form contains a section entitled “Transfer of a Membership Interest on Death of a Member by a Transfer of Membership Interest Testament,” which provides in part:

“Notwithstanding anything herein to the contrary, if a Member dies after making a valid Transfer of Membership Interest Testament that names one or more people or entities (“Heirs”) to inherit all or a portion of the deceased Member’s Membership Interest, the following shall occur after the death of the Member:

a. Each Heir shall inherit the portion of the deceased Member’s Membership Interest stated in the Transfer of Membership Interest Testament.

b. An Heir inherits the right to receive profits, losses and distributions attributable to the inherited Membership Interest, but shall not become a Member and have any other rights of a Member unless and until all of the requirements of Section 7.1 other than subsection (i) are satisfied.”

Do you know what your LLC’s Operating Agreement says about transfers of the financial interest and the control interest after the death of a member?  If not, do your loved ones a favor and read your Operating Agreement or if your LLC does not have an Operating Agreement, take action to have all of the members adopt an Operating Agreement that deals with what happens to a member’s interest after death.

The text of Ott v. Monroe follows.

OTT v. MONROE
Janet M. OTT v. Lou Ann MONROE, et al.
Record No. 101278.No. 101278.
November 04, 2011

PRESENT: All the Justices.

I. BACKGROUND AND MATERIAL PROCEEDINGS BELOW

Admiral Dewey Monroe, Jr. (“Dewey”) and his wife Lou Ann Monroe (“Lou Ann”) formed a Virginia limited liability company, L & J Holdings, LLC (“the Company”), which was governed by an operating agreement they executed in April 2003 (“the Agreement”). The Agreement provided that Dewey and Lou Ann were the sole members and that they held an 80% membership interest and a 20% membership interest, respectively. It also provided that Lou Ann would be the managing member and Joseph G. Monroe (“Joseph”) would serve as the successor managing member in the event of her death, disability, removal, or resignation.

Paragraph 2 of the Agreement provided that “

[e]xcept as provided herein, no Member shall transfer his membership or ownership, or any portion or interest thereof, to any non-Member person, without the written consent of all other Members, except by death, intestacy, devise, or otherwise by operation of law.” Paragraph 10(B) provided in relevant part that “[n]o Member shall, directly or indirectly, transfer, sell, give, encumber, assign, pledge, or otherwise deal with or dispose of all or any part of his Membership Interest now owned or subsequently acquired by him, other than as provided for in this Agreement.” Paragraph 10(C) provided in relevant part that, Paragraph 10(B) notwithstanding, “any Member ․ may transfer all or any portion of the Member’s Interest at any time to ․ [o]ther Members [or][t]he spouse, children or other descendants of any Member.”

Dewey died in 2004. Through a will executed prior to the formation of the Company, he bequeathed his entire estate to his daughter, Janet. After the will was admitted to probate, Janet asserted that Dewey’s bequest transferred his membership in the Company to her. She called a meeting of the Company, sending notice to Lou Ann, with the intent to remove Lou Ann and Joseph from their positions as managing member and successor managing member, respectively. Lou Ann responded that Janet had inherited only Dewey’s right to share in profits and losses of the Company and to receive distributions to which he would be entitled.

Janet proceeded with the meeting and putatively removed Lou Ann and Joseph, electing herself as the Company’s new managing member and electing Susan Shackelford as successor managing member in the event of her death, disability, removal, or resignation. Thereafter, Janet filed a complaint in the circuit court seeking declaratory judgment that she had inherited her father’s full membership in the Company and Lou Ann and Joseph had been validly removed from their positions. Lou Ann and Joseph filed a demurrer, again asserting that Janet had inherited only Dewey’s right to share in profits and losses and to receive distributions.

The court denied the demurrer and the case proceeded to a bench trial. At its conclusion, the court held that Dewey was dissociated from the Company upon his death by operation of Code § 13.1–1040.1(7)(a). Consequently, the court concluded that all his rights as a member to participate in the control of the Company’s affairs terminated and only the right to share profits and losses and to receive distributions survived to be inherited by Janet through his will. Accordingly, the court ruled that Janet was not a member of the Company and thus lacked the authority to remove Lou Ann and Joseph from their positions. We awarded Janet this appeal.

II. ANALYSIS

This appeal assigns error to the circuit court’s interpretation of the Agreement and the relevant statutes. Accordingly, we review the judgment de novo. Uniwest Constr., Inc. v. Amtech Elevator Servs., 280 Va. 428, 440, 699 S.E.2d 223, 229 (2010).

When interpreting a contract, we construe it as a whole. When its terms are clear and unambiguous, we give them their plain meaning. We harmonize its provisions and give effect to each of them when it reasonably can be done. Id. Similarly, we construe statutes as a consistent and harmonious whole to give effect to the overall statutory scheme. Virginia Electric & Power Co. v. Board of County Supervisors, 226 Va. 382, 388, 309 S.E.2d 308, 311 (1983). We apply the plain meaning of a statute unless its terms are ambiguous or doing so would lead to an absurd result. Covel v. Town of Vienna, 280 Va. 151, 158, 694 S.E.2d 609, 614 (2010).

Janet argues that the circuit court erred in ruling that Dewey was dissociated upon his death by operation of Code § 13.1–1040.1(7)(a) because that provision is preceded by the proviso, “[e]xcept as otherwise provided in the articles of organization or an operating agreement.” She asserts that Paragraph 2 of the Agreement constitutes such an exception and supersedes dissociation under the statute.  FN 1.  We disagree.

A. THE VIRGINIA LIMITED LIABILITY COMPANY ACT

We begin our analysis by examining the statutory framework governing Virginia limited liability companies, the Virginia Limited Liability Company Act, Code § 13.1–1000 et seq. (“the Act”). “The [limited liability company] is a hybrid entity, borrowing from both the corporate and partnership models” to combine a corporation’s limited liability for its owners with a partnership’s pass-through treatment for income tax purposes. S. Brian Farmer & Louis A. Mezzullo, The Virginia Limited Liability Company Act, 25 U. Rich. L.Rev. 789, 790 (1991). When the Act was enacted in 1991, federal tax regulations denied the pass-through treatment afforded partnerships if a business entity possessed three of the four principal characteristics of corporations: (1) perpetual existence, (2) central management, (3) limited liability of owners, and (4) free transferability of ownership interests. Id. at 813–15, 694 S.E.2d 609. Because limited liability was an indispensable characteristic of limited liability companies, the provisions of the Act were drafted to avoid the three remaining corporate characteristics. Id. at 815–21, 694 S.E.2d 609. Thus, the transferability of a member’s interest in a limited liability company is analogous to the transferability of a partner’s interest in a partnership.

When the Act was enacted in 1991, the Uniform Partnership Act expressly provided that

[a] conveyance by a partner of his interest in the partnership does not ․ entitle the assignee, during the continuance of the partnership, to interfere in the management or administration of the partnership business or affairs, or to require any information or account of partnership transactions, or to inspect the partnership books; but it merely entitles the assignee to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled.

Former Code § 50–27(1) (Repl.Vol.1989). FN 2.

Implicit within this language was the recognition that a partner’s interest in a partnership comprises two distinct and divisible components. The first component, the control interest, encompasses the partner’s entitlement to participate with the other partners in the administration of the partnership’s affairs. The second component, the financial interest, encompasses only the sharing of profits and losses of the partnership and receipt of distributions from its accumulated income and assets. Under the statute, only the financial interest is alienable. Thus, the control interest in a partnership is personal to the partner and cannot be bestowed on another by the unilateral act of a partner even if the words of his conveyance do not expressly limit its scope.

The division of a partner’s interest into a control interest, which may not be transferred unilaterally, and a financial interest is mirrored in the Act. Both when the Company was formed and when Janet inherited through Dewey’s will, Code § 13.1–1039 provided that

[u]nless otherwise provided in the articles of organization or an operating agreement, a membership interest in a limited liability company is assignable in whole or in part․ An assignment does not entitle the assignee to participate in the management and affairs of the limited liability company or to become or to exercise any rights of a member. Such an assignment entitles the assignee to receive, to the extent assigned, only any share of profits and losses and distributions to which the assignor would be entitled. FN 3.

Thus, an assignee of a financial interest has no control interest in a limited liability company without becoming a member. Code § 13 .1–1040(A) provides the means by which the assignee of a financial interest may become a member: “Except as otherwise provided in writing in the articles of organization or an operating agreement, an assignee of an interest in a limited liability company may become a member only by the consent of” a majority of those members exercising the direct management of the company.

In light of this statutory background, we turn to Janet’s argument.

B. DIRECT INHERITANCE OF MEMBERSHIP IN A LIMITED LIABILITY COMPANY BY DESCENT OR DEVISE

Janet argues that she inherited Dewey’s membership directly by operation of his will. She asserts the Agreement permitted her to inherit directly because Paragraph 2 superseded Code § 13.1–1040.1(7)(a). However, Paragraph 2 merely prohibits any member from transferring any part of his membership except (a) where specifically allowed under the terms of the Agreement, (b) with the consent of all the other members, or (c) upon death, intestacy, devise, or otherwise by operation of law. It does not address statutory dissociation and does not state an intent to supersede Code § 13.1–1040.1(7)(a). Consequently, it lacks specific language that would constitute an exception to the rule of dissociation set forth in Code § 13.1–1040.1. Dewey thus was dissociated from the Company upon his death and Janet became a mere assignee by operation of Code § 13.1–1040.2, entitled under Code § 13.1–1039 only to his financial interest.

Even if Paragraph 2 had superseded dissociation under Code § 13.1–1040.1, it is not possible for a member unilaterally to alienate his personal control interest in a limited liability company. Code § 13.1–1039(A). The words “[u]nless otherwise provided in the articles of organization or an operating agreement” in Code § 13.1–1039 make it possible for a limited liability company to restrict the assignment of members’ financial interests because they modify the remainder of the sentence, which continues “a membership in a limited liability company is assignable in whole or in part.” The words “[u]nless otherwise provided in the articles of organization or an operating agreement” do not make it possible for a limited liability company to allow a member to assign his control interest because they do not modify the separate sentence, which states that “[a]n assignment does not entitle the assignee to participate in the management and affairs of the limited liability company or to become or to exercise any rights of a member.” Additionally, Code § 13.1–1023(A) provides that an operating agreement may not contain provisions inconsistent with the laws of the Commonwealth. Thus it was not within Dewey’s power under the Agreement unilaterally to convey to Janet his control interest and make her a member of the Company upon his death because the Agreement could not confer that power on him.

III. CONCLUSION

For the foregoing reasons, the circuit court did not err in holding that Janet inherited only Dewey’s financial interest in the Company—the right to share in profits and losses and to receive distributions. Because she was not a member, the circuit court did not err in holding that she lacked authority to remove its managing member and successor managing member. Accordingly, we will affirm the judgment of the circuit court.

Affirmed.

FOOTNOTES

1.  Janet also asserts that statutory dissociation is preempted by Paragraph 10(A), which states that “no Member shall have any right to voluntarily resign or otherwise withdraw from the Company ․ without the prior written consent of all remaining Members of the Company. Any attempted resignation or withdrawal without the requisite consent shall be null and void and have no legal effect.” Nothing in the record of this case establishes that Dewey’s death was a voluntary attempt to resign or otherwise withdraw from the Company. Paragraph 10(A) therefore is not implicated.

2.  This limitation was preserved in Code § 50–73.106 when Chapter 1 of Title 50 was repealed and replaced upon the enactment of the Virginia Uniform Partnership Act in 1996. 1996 Acts ch. 292.

3.  Code § 13.1–1039 was subsequently amended and reenacted to add a new subdivision not relevant to this appeal. 2006 Acts ch. 912.

OPINION BY Justice WILLIAM C. MIMS.

2016-11-16T08:23:51-07:00November 22nd, 2011|Lawsuits, Members|0 Comments

Court Finds LLC Member Liable for LLC’s Debt because Member Did Not Sign Contract Correctly

If you are the manager of an Arizona manager managed LLC or a member of an Arizona member managed LLC, do you know how to sign contracts on behalf of the LLC?  If not, your ignorance could cost you big bucks.  The recent Pennsylvania case of Hazer v. Zabala, 26 A.3d 1166, 2011 Pa. Super., found that the member of a PA LLC was liable for amounts owed on a lease because the member did not properly sign the lease on behalf of the LLC.  This case is an important lesson for every LLC member and manager.

I have said many times that people who form Arizona limited  liability companies mistakenly believe that once they file the LLC’s Articles of Organization they are automatically protected from the debts and obligations of the LLC.  The primary reason people form an LLC is to shield themselves from the LLC’s activities and liabilities.  Unfortunately, owner protection is not automatic.  There are any number of ways that a member or manager of an LLC can become liable for the LLC’s debts.  For members and managers of an Arizona LLC to obtain the protection from liabilities offered by Arizona’s LLC laws, they must operate the LLC in compliance with applicable LLC law.  Most people who form an Arizona LLC do not know what Arizona LLC law is and therefore frequently cause the LLC to engage in activity that violates Arizona LLC and creates a risk that the members and managers could be found liable for the LLC’s debts.

It goes without saying that it is not likely your LLC will comply with Arizona LLC law if you do not know what the law is.  The primary reason I wrote my 170 page book called the “Arizona LLC Operations Manual” is I want to inform Arizona LLC members and managers about Arizona LLC law so they can cause their LLC to comply with the law.  One important and fundamental aspect of Arizona law is exactly how should a contract be worded so that the LLC rather than a member or manager is liable under the contract?  My Quick Start Guide has sample signature blocks that illustrate exactly how the signature of the LLC should appear in a contract.

Facts in Hazer v. Zabala

The case involved a lease that was signed by a member of Zabala Broker, LLC.  The member, Juan Zabala, signed his name on the lease and underneath is signature he printed “DBA/ZABALA BROKER, LLC.”  The court ruled that Mr. Zabala was personally liable on the lease because he signed it in his name, not as the member or manager of his LLC.

For the signer to avoid personal liability and for the LLC to be the party liable on the lease the contract should have designated the LLC as follows:

The first paragraph of the lease (or any contract) should have read:

Zabala, Broker, LLC, a Pennsylvania limited liability company

The signature block as the end of the lease (or any contract) should have read:

Example 1: For a member managed LLC:

Zabala, Broker, LLC, a Pennsylvania limited liability company

By: _______________________________
Juan Zabala, member

Example 2: For a manager managed LLC:

Zabala, Broker, LLC, a Pennsylvania limited liability company

By: _______________________________
Juan Zabala, manager

Members and managers must know how to designate their LLC properly in contracts because they may become personally liable  on the contract if it is not worded correctly.

How to Purchase the Ebook Version of the Arizona LLC Operations Manual

Click here to purchase the eBook version of our Arizona LLC Operations Manual from our internet store for the incredibly low price of $97.

Arizona Corporation Commission Sues LLCs & their Members and Managers for Securities Fraud

The Arizona Corporation Commission sued multiple related Arizona limited liability companies and their members and managers for allegedly violating Arizona securities laws and defrauding many investors.  The defendants in the Arizona Corporation Commission vs. Samuels lawsuit are Terry L. Samuels, Elizabeth Samuels, James F. Curcio, Jill L. Curcio, 3-CG, LLC, Choice Property Group, LLC, Azin Investor Group, LLC, Azin Investor Group II, LLC, Azin Investor Group III, LLC, Azin Investor Group IV, LLC, Combined Holdings IV, LLC and Combined Holdings V, LLC.

The Securities Division (“Division”) of the ACC alleged that the defendants engaged in acts, practices, and transactions that constituted violations of the Securities Act of Arizona, A.R.S. Section 44-1801 et seq.(the ‘Securities Act”).  The Division alleged that Terry L. Samuels (“Samuels”) and/or James F. Curcio (“Curcio”) directly or indirectly controlled all entities named as defendants within the meaning of A.R.S. Section 44-1999 and that Samuels and/or Curcio are each jointly and severally liable with, and to the same extent as those entities, for the entities’ violations of the anti-fraud provisions of the Securities Act.  The spouses of Samuels and Curcio were named as defendants under A.R.S. Section 44-203 1 (C) solely for purposes of determining the liability of the marital communities.

The Division alleges that Samuels and Curcio and Arizona LLCs they created and owned offered and sold securities, including membership interests in the LLCs, without complying with Arizona’s Securities Act.  The defendants allegedly misrepresented material facts and failed to disclose material facts when the solicited money from investors in connection with the entities’ fix and flip real estate business.  The Division alleges:

Although SAMUELS formed additional, shell entities for the purpose of limiting liability, SAMUELS operated the Business’s entities as if they were a single company. For example, SAMUELS and his employees held meetings for the Business as a whole, not for each separate entity. Also, there were no written agreements between the entities.

The early investors were treated as lenders who received a promissory note and a deed of trust on an Arizona home to secure repayment of the loan.  These notes were not registered as securities with the Division.  The Division alleges:

“In the spring of 2007, SAMUELS and CURCIO shifted the Business’s strategy away from having investors select, invest in and receive as collateral an interest in a specific property in the form of a DOT with the investor as the beneficiary. The new strategy consisted of creating several limited liability companies (LLCs) that served as investor pools of approximately $lM each. The investors in these LLCs received LLC memberships in exchange for their investments. SAMUELS and CURCIO then pooled the funds received from these investors (collectively referred to as the “AZIN Investors”) and transferred the funds to CPG and/or 3-CG.  Those entities then used these funds as determined by the Business’s managers, i.e. SAMUELS and CURCIO. The AZIN Investors did not participate in the selection of properties or management of the Business.”

“At or around the time they formed the first two AZIN Entities, SAMUELS and CURCIO began soliciting investors to purchase membership interests in the AZIN Entities (the “Membership Interests”). The Membership Interests were not registered as securities with the Commission to be offered or sold within or from Arizona.”

“SAMUELS and CURCIO solicited potential investors, in part, by conducting in person presentations to small groups of potential investors. These groups ranged in size from one
to about ten persons. SAMUELS and CURCIO held these presentations in several states including Arizona, Indiana and New York.”

“SAMUELS and CURCIO provided potential investors with detailed brochures and newsletters (each a “Prospectus” and collectively the “Prospectuses”) that described the benefits of
investing in the Business, current investment opportunities, and the positive opportunities available to Respondents in the Phoenix-area real estate market.”

“SAMUELS and CURCIO encouraged offerees and investors to re-direct their retirement accounts toward purchasing the Membership Interests. A Prospectus titled “3-CG News; Issue # 1 1-2008” provided by SAMUELS and CURCIO to existing and potential investors contained a section written by CURCIO titled “Jim’s Corner.” This section describes how investors could roll over their existing IRA/401(k) funds to purchase LLC memberships and that funds would be invested in a newly-formed LLC with the investor “listed on ‘Title’ to the properties as security” (quotation marks in original).”

“For all practical purposes, the AZIN Investors had no say in the management of the AZIN Entities. Under the terms of the Operating Agreement, the manager of each entity (CURCIO) had almost absolute control over the entity. Additionally, the AZIN Investors lacked experience in real estate investment and management. Thus, they could not have effectively managed the AZIN Entities even if they had any authority to do so.”

“In connection with the offer or sale of securities within or from Arizona, Respondents iirectly or indirectly: (i) employed a device, scheme, or artifice to defraud; (ii) made untrue statements if material fact or omitted to state material facts that were necessary in order to make the statements nade not misleading in light of the circumstances under which they were made; or (iii) engaged in transactions, practices, or courses of business that operated or would operate as a fraud or deceit upon offerees and investors.”

“SAMUELS and/or CURCIO directly or indirectly controlled respondents 3-CG, CPG, and the AZIN Entities within the meaning of A.R.S. 6 44-1999. As a result, SAMUELS and/or
CURCIO are jointly and severally liable with, and to the same extent as 3-CG, CPG and the AZIN Entities for their violations of the anti-fraud provisions of the Securities Act set forth above.”

The lesson to be learned from the case is that the offer and sale of membership interests in a limited liability company can be the offer and sale of securities that must be done in a way that satisfies federal and state securities laws.  If your LLC or corporation intends to take any action that solicits money from a person or entity and says to the investor in effect “sit back on your couch and we will make a profit from your investment” then your LLC will be offering to sell a security.  Before offerring or selling a membership interest in an LLC that is a security you should consult with an experienced securities law attorney and do what must be done to comply with federal securities laws and the securities laws of each state in which an investor resides.

EEOC Files Second Lawsuit against Phoenix-based Casey Jones Grill

Phoenix Business Journal:  “The U.S. Equal Employment Opportunity Commission (EEOC) today filed its second lawsuit against Phoenix bar and restaurant Casey Jones Grill, on allegations of sexual harassment of female servers.  The restaurant is operated by Los Muchachos LLC.

2018-05-31T17:09:18-07:00October 1st, 2011|Lawsuits, Why People Need an LLC|0 Comments

Arizona Jury Gives Volunteer Worker Injured in a Fall from a Ladder $5.9 Million

Phoenix Business Journal:  “A Maricopa County jury has awarded $5.9 million to a Valley man who suffered brain and severe back injuries after falling 10-feet off of a ladder while helping build a church roof in Rocky Point, Mexico.”   The plaintiff was Ronald Day who sued the Central Christian Church and Amor Ministries.  See “Valley church wants new trial after $5.9M verdict in volunteer fall case.”

This case is a perfect example of why people need to operate a business or own investment real estate in an entity that protects the owners of the entity from things that go wrong. If you are doing fix and flips without the protection of a limited liability company, you will be the defendant in the lawsuit if a worker gets hurt on the job and all of your life savings will be at risk.

This case is also a perfect example of why you should not rely solely on insurance, including an umbrella policy, as your only line of defense if something goes wrong. A lot of people acquire a $5 million dollar umbrella policy, but if the judgment is $5.9 million, you have a $900,000 problem. Insurance should be your first line of defense, but the LLC is the second line of defense.

Things happen so you need to form your LLC before the worker falls from the ladder or causes the car accident.

2011-09-23T01:19:04-07:00September 22nd, 2011|Lawsuits, Why People Need an LLC|0 Comments

EEOC Sues Outback Steakhouse over Firing of Brain-injured Waiter

In September of 2011 the Phoenix office of the Equal Employment Opportunity Commission sued a Phoenix area Outback Steakhouse restaurant for allegedly firing a waiter because of his disability, a traumatic brain injury that has slowed his thinking, impaired his speech and causes him to wear prism glasses.  The EEOC claims the employer violated the Americans with Disability Act.

A protected person who believes he or she has been the victim of an employer who violated the ADA may file a complaint with the EEOC.  The EEOC then becomes the alleged victim’s knight in shining armor who spends federal time, money and resources to take action against the employer who allegedly violated the ADA.   Even if the employer has the law and the facts on its side, the employer has to make a choice between negotiating the best settlement possible or spending $50,000 or more on attorneys fees defending a lawsuit.

The ADA is a trial lawyer’s dream and an employer’s nightmare.  It is also a perfect example of the law of unintended consequences.  This federal law was intended to protect employees who have disabilities from being fired.  The law may accomplish that purpose in some cases, but it has also had the unintended consequence of making it much more difficult for handicapped people to obtain a job.  Employers know that the risk of being sued by an employee is off the charts if they hire a handicapped person so they rarely hire the handicapped.  Read “The Unintended Consequences of the Americans with Disabilities Act,” which states:

“The employment provisions of the Americans with Disabilities Act (ADA) exemplify the law of unintended consequences because those provisions have harmed the intended beneficiaries of the Act, not helped them. ada was enacted to remove barriers to employment of people with disabilities by banning discrimination and requiring employers to accommodate disabilities (e.g., by providing a magnified computer screen for a vision-impaired person).  However, studies of the consequences of the employment provisions of ada show that the Act has led to less employment of disabled workers.

Why has ADA harmed its intended beneficiaries?  The added cost of employing disabled workers to comply with the accommodation mandate of ada has made those workers relatively unattractive to firms. Moreover, the threats of prosecution by the Equal Employment Opportunity Commission (EEOC) and litigation by disabled workers, both of which were to have deterred firms from shedding their disabled workforce, have in fact led firms to avoid hiring some disabled workers in the first place.”

The ADA prohibits discrimination on the basis of disability in employment, State and local government, public accommodations, commercial facilities, transportation, and telecommunications.  To be protected by the ADA, one must have a disability or have a relationship or association with an individual with a disability. An individual with a disability is defined by the ADA as a person who has a physical or mental impairment that substantially limits one or more major life activities, a person who has a history or record of such an impairment, or a person who is perceived by others as having such an impairment. The ADA does not specifically name all of the impairments that are covered.

Title I of the ADA requires employers with 15 or more employees to provide qualified individuals with disabilities an equal opportunity to benefit from the full range of employment-related opportunities available to others. For example, it prohibits discrimination in recruitment, hiring, promotions, training, pay, social activities, and other privileges of employment. It restricts questions that can be asked about an applicant’s disability before a job offer is made, and it requires that employers make reasonable accommodation to the known physical or mental limitations of otherwise qualified individuals with disabilities, unless it results in undue hardship.

The Obama administration’s EEOC recently filed a lawsuit that illustrates the absurdity of the ADA.  The EEOC sued Old Dominion Freight Line, Inc. because it refused to allow a recovering alcoholic to drive any of its 18 wheeled commercial trucks.  Consider the employer’s dilemma: does it take the risk and allow a recovering alcoholic to drive its vehicles and possibly drink and drive and cause an accident that kills or injures somebody or does it risk a lawsuit from the employee and the EEOC?  What would you do?  Do we really want federal law and the federal government putting drivers who drink on the road to kill and maim?

Read “Trucking Companies Told to Hire Alcoholics by Obama Administration.”  It’s only a matter of time before the EEOC sues an airline because it won’t let a recovering alcoholic fly an airliner with 300 passengers.

The ADA and the EEOC are examples of why all businesses that have employees should operate through an entity like a limited liability company that protects the owner’s life savings against debts and liabilities of the business.

For more on the ADA, read the EEOC’s “A Guide to Disability Rights Law” and “A Primer for Small Business.”

See “John Woods, Brain-Injured Former Umpire, was Wrongfully Fired by Outback Steakhouse, Says EEOC Complaint; Claims by the Disabled on Rise” and “EEOC Sues Outback Steakhouse over Firing of Brain-injured Waiter.”  For more about Mr. Woods and his injury read “Umpire making a comeback on and off the baseball field” and a lengthy story in the Arizona Republic called “Phoenix umpire perseveres after near-fatal crash.”

2019-03-21T18:52:31-07:00September 11th, 2011|Lawsuits, Why People Need an LLC|0 Comments

Stupid New Arizona Notary Law Creates a Legal Nightmare for Attorneys, Notaries & the Public

The “we are from the government and are here to help you” people in the Arizona legislature passed a terrible law that became effective in Arizona on July 20, 2011.  Arizona Senate Bill 1230 added new and outrageous notary requirements that will affect all documents notarized by an Arizona notary after July 19, 2011. The new law will invalidate tens of thousands of documents notarized by Arizona notaries because of ignorance of the law and simple mistakes.

The new law added the following provisions to Arizona Revised Statutes Section 41-313:

B.  Notaries public shall perform the notarial acts prescribed in subsection A of this section only if:

1.  The signer is in the presence of the notary at the time of notarization.

2.  The signer signs in a language that the notary understands.

3.  Subject to subsection D, the signer communicates directly with the notary in a language they both understand or indirectly through a translator who is physically present with the signer and notary at the time of the notarization and communicates directly with the signer and the notary in languages the translator understands.

4.  The notarial certificate is worded and completed using only letters, characters and a language that are read, written and understood by the notary public.

C.  If a notary attaches a notarial certificate to a document using a separate sheet of paper, the attachment must contain a description of the document that includes at a minimum the title or type of document, the document date, the number of pages of the document and any additional signers other than those named in the notarial certificate.

D.  A notary may perform a notarial act on a document that is a translation of a document that is in a language that the notary does not understand only if the person performing the translation signs an affidavit containing an oath or affirmation that the translation is accurate and complete.  The notarized translation and affidavit shall be attached to the document and shall contain all of the elements described in subsection C.

Arizona Revised Statutes Section 41-328 was amended by adding the following text:

 C.  Subject to section 41-320, a notary public shall not perform a notarization on a document if the notary is an officer of any named party, if the notary is a party to the document or if the notary will receive any direct material benefit from the transaction that is evidenced by the notarized document that exceeds in value the fees prescribed pursuant to section 41-316.

Problems Created by Revised ARS Section 41-313

What Does “a notary attaches a notarial certificate to a document” Mean?

The new law is a time bomb for anybody who creates, signs or notarizes documents that are notarized by an Arizona notary.  For example, what does “If a notary attaches a notarial certificate to a document using a separate sheet of paper” mean?  Consider the following scenarios and if the new language applies to any or all of them:

1.  Attorney, document preparer or do-it-yourself person prints a document that has a notary certificate on the same page as the page on which the signer signed.

2.  Attorney, document preparer or do-it-yourself person prints a document that has a notary certificate on a page that is not the page on which the signer signed.

3.  Attorney, document preparer or do-it-yourself person creates a document that does not contain a notary certificate so the notary prepares his/her notary certificate on a separate piece of paper and attaches it to the end of the document.

4.  Attorney, document preparer or do-it-yourself person creates a document that does not contain a notary certificate so the notary prepares his/her notary certificate on a separate piece of paper, but the attorney, document preparer or do-it-yourself person rather than the notary actually attaches the notary certificate to the end of the document.

5.  The person who creates the document in scenarios 1 & 2 is also the notary who notarizes the document.

A literal reading of the statute would seem to require compliance with the new law only in the case of scenarios 3 & 5, but we will not know for sure until an Arizona appellate court tells us what this phrase means years from now.

Practical Tip #1:  The notary certificate should contain a statement that the notary certificate was or was not attached to the document by the notary.

Practical Tip #2:  If the notary is the same person who prepared the document, the document preparer should play it safe and assume that Section 41-313.C will apply and include the required information in the notary certificate.

Mistakes & Omissions in the Notary Certificate

This new notary law is a very bad law because it demands attention to detail and creates many opportunities for the document preparer and the notary to inadvertently invalidate a notarized document.  The new law says that when it applies, the notary block must contain “the title or type of document, the document date, the number of pages of the document and any additional signers other than those named in the notarial certificate.”  This new require gives the notary a lot of ways to create an incorrect notary certificate.

The new law does not give us any guidance on the legal significance of the notarized document if one or more of the following errors occurs in the notary certificate:

1.  The title or type of document stated in the notary certificate is different from the actual title or type of document?  For example, what if the title of the document is “Promissory Note,” but the notary certificate refers to a “Note”?  What if the name or title is correct, but misspelled?

2.  The document date is incorrect?  What if the document date is off by one day, a month or the year is incorrect?

3.  The number of pages in the document is incorrect?  The new law does not tell us how we calculate the number of pages in a document.  In counting the number of pages does the notary count a cover page, the pages in a table of contents and pages in schedules or exhibits?  The document preparer, the signer and the notary should actually count all of the pages of the document because I do not recommend relying on the page numbers on the last page of the document.

4.  The name of one or more additional signers is not spelled correctly.

5. An additional signer’s name is omitted?

Does this law create new liability for lawyers, especially estate planning lawyers whose practice involves many notarized documents?  Apparently Arizona lawyers can now be sued years after a document was signed when the client or family is told the notary certificate failed to comply with Section 41-313 and therefore the document is invalid.

Practical Tip #3: In addition to stating how many pages are in the document, the notary certificate should “itemize” page numbers. For example, the notary certificate should say “The

[document name] is 25 pages consisting of a 1 page cover page, a 3 page table of contents, 19  pages of document text and a 2 page Exhibit A” or The [document name] consists of three pages and it does not have a cover page, a table of contents or any exhibits or schedules.”

The Law Should Cause all Arizona Notaries to Cease Providing Notary Services

As a practical matter, why would anybody want to be a notary in Arizona with this law?  Aren’t all notaries now liable for damages if they fail to satisfy Section 41-313?  If you are an Arizona notary, do you want to take the chance of being sued because a document you notarized fails to comply with Section 41-313.C?  Can a notary get insurance for this type of liability?  If so, what are the coverage limits?

Most notaries do not charge for their services, but they may.  Arizona Revised Statutes Section 41-316 states that “The secretary of state shall establish fees that notaries public may charge for notarial acts.”  The Arizona Secretary of State’s rule R2-12-1102 allows Arizona notaries to charge as much as $2 for each notary.  The compensation that an Arizona notary might receive for notarizing a document does not justify the risk of being sued for committing “notary malpractice.”

Tens of Thousands of Documents Will Be Invalid

Consider what this new law means for the tens of thousands of do-it-yourselfers who don’t have a clue about this law.  There are going to be a lot of estate planning documents created by 99% of the public, including Arizona notaries, who will be clueless about the requirements of revised Section 41-313.  The good news is that the vast majority of third parties who view a notarized document won’t know of Section 41-313 so they won’t question the validity of the document.

Bottom Line

This new law is a wonderful revenue generator for Arizona lawyers, especially estate planning lawyers like me.  Every document notarized by an Arizona notary should be reviewed by an Arizona attorney who is experienced with Section 41-313.  For example, nobody should ever create their own last Will & Testament without having it reviewed by an Arizona “notary law attorney” because the family will not know until after the signer dies that the Will is invalid.

Arizona Revised Statutes Section Section 41-313.C is a trial lawyers dream, but a nightmare for the unsuspecting public, lawyers and Arizona notaries.

Tell Your Arizona Legislators To Repeal or Fix This New Law

Senate Bill 1230 was sponsored by Republican Representative Michelle Reagan.  Her contact information is:  Phone Number: (602) 926-5828; Fax Number: (602) 417-3255; mreagan@azleg.gov.  I suggest you send her a letter or email  message alerting her to the problems with the new law and ask that she repeal  or fix the new law.  Do the same for your state senator or representative.  See the names and contact information for Arizona senators and house members.

2017-02-23T23:00:15-07:00August 21st, 2011|Lawsuits|0 Comments

When LLC Member May Be Held Personally Liable For Signing Loan Agreement

People form limited liability companies to limit their personal liability, but that goal will not be reached if a person signing legal documents for the LLC does not understand contracts facts of life.  The general rule of LLC law is that if an LLC signs a contract only the LLC is legally bound and the members of the LLC are not liable.  There are exceptions to this general rule and all members and managers who sign contracts for an LLC must understand the contract signature rules or they may find that by signing on the dotted line the signer becomes personally liable to satisfy the obligations of the LLC under the contract.

The case of Ubom v. Suntrust Bank, involved an attorney obtaining a line of credit for his law firm, a Maryland limited liability company.  Mr. Ubom signed a loan agreement which contained a section for a personal guaranty.  Ubom filled in the personal guaranty section with his own personal information including his social security number, personal address, employment information, and financial information.  However, Ubom left the line blank which asked for the “Legal Name of the Guarantor.”

The loan agreement contained two lines for signatures.  The agreement asked for the signature of the “applicant” and of the “guarantor.”  Mr. Ubom signed in both places and after his name he wrote “Managing Attorney.”  Unfortunately, Mr. Ubom’s law business went south and he failed to make the payments on the loan.  The bank brought suit against both Mr. Ubom and his LLC.

The bank argued Mr. Ubom had personal liability, because the language of the loan agreement clearly provided Ubon personally guaranteed the loan.  The language of the loan agreement stated:

To induce Bank to open the Account and extend credit to the applicant, or to renew or extend such other credit, each of the individuals signing this Application as a “Guarantor” (whether one or more, the “Guarantor”) hereby jointly and severally guarantee payment to Bank of all obligations and liabilities of the applicant of any nature whatsoever and whether currently existing or hereafter arising, including without limitation, all obligations and liabilities under this Application and/or the Account, and reasonable fees and expenses of Bank’s attorney(s) incurred in the collection of such obligations (collectively the “Obligations”).

Both the trial court and appellate court agreed with the bank, that this language clearly provided Ubom personally guaranteed the loan.  The court found it insignificant that Ubom left blank the section asking for the “Legal Name of the Guarantor.”  However, the court found it significant Ubom listed his personal financial information.  The court, further, found it would be pointless to have Ubom sign a guaranty in his corporate capacity when the LLC was already obligated to repay the loan.

When signing any contract, the signer must read the contract to determine if the contract obligates the signer in addition to the LLC.  If you are to sign a contract for your LLC and you are not sure if it will cause you to become personally obligated you should  seek the advice of an attorney.

We can learn another important less from this case.  According to Mr. Ubom, his banker told Ubom there was no personal guaranty on the loan.  Ubom took the banker at his word.  The court did not even take this conversation into account because of the personal guaranty found in the agreement and the clear language used to describe the guaranty.  The moral of the story is “if it is not in writing, it never happened.”