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So far Jon Brinkman has created 10 blog entries.

Missouri Court Holds Minority Member can Pierce LLC’s Veil

Recently, in Hibbs v. Berger, the Missouri Court of Appeals ruled that a 5% minority member can pierce the veil of the LLC.  This case shows how extensive the court’s power is in determining these types of cases.  All LLCs should be knowledgeable about veil piercing, and also what can be one to prevent it.

In Hibbs v. Berger, the plaintiff (Hibbs) was an ex-employee of Tavern Creek, an LLC.  The plaintiff had no voting or management rights in this LLC, which were split on a 50-50 basis between Tavern Creek and Wood Nuts, another LLC.  Tavern Creek and Wood Nuts appointed Taylor and Berger, respectively, as co-managers of Tavern Creek.  Though Hibbs had no voting rights or management rights, he did acquire 5% of economic interests when his employment agreement was revised (once Wood Nuts became 50% owner).

Soon after the new employment agreement in 2007, Tavern Creek experienced financial troubles.  Wood Nuts would assist Tavern Creek during these times by loaning Tavern Creek money.  Despite this, Tavern Creek was unable to recover, and defaulted on these loans.  Wood Nuts exercised its rights under the agreement of these loans, and  obtained all collateral as satisfaction in 2009.  During this time, Hibbs was working for Tavern Nuts.  He was not fully paid for his commission earned in 2007, and never paid for the commission in 2008.  In late August of 2008, Hibbs was terminated and then re-hired as an employee-at-will.  Hibbs then left Tavern Creek two months later.

In January 2010, Hibbs filed a claim against Berger and Taylor, in an attempt to pierce the corporate veil.  The defendants motioned for summary judgment, which was granted, but Hibbs appealed.  The Missouri Court of Appeals began by acknowledging that members of an LLC usually are not responsible for debts of the LLC.  Then, however, the court acknowledged a three-prong test that determines if the court will piece the business entity’s veil.  The parts of this test include:

“(1) Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and

(2) Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal

(3) The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of.”

After establishing the rule for veil piercing, the Missouri Court of Appeals specifically discussed if an LLC’s minority member can pierce the entity’s veil.  The court mentioned that this was a case of first impression, meaning that the Court of Appeals has not dealt with this type of case.  Because of this, the court looked to a case in which the District of Columbia Court of Appeals held that a minority shareholder is not prohibited from piercing the veil of the business entity.  The Missouri Court also stated that precluding a minority member from piercing the corporate veil would be unfair to those members.  For these reasons, the Missouri Court of Appeals held that the minority member of an LLC can pierce the entity’s veil, if the plaintiff meets the requirements set by the three-prong test.

Although it was eventually determined that this plaintiff did not meet the requirements to overcome summary judgment, the case provides an important lesson.  LLCs and other business entities should not assume that a member is unable to pierce their entity’s veil.  These managers must know the veil-piercing standard of their formation state, and take steps to ensure that a disgruntled member cannot hold the majority member(s) personally liable.

 

 

By |2016-12-13T21:20:14-07:00February 25th, 2015|Categories: Lawsuits, Members, Operating LLCs, Veil Piercing|0 Comments

LLC Lawsuits- Direct or Derivative

Prior to the creation of the first limited liability company (LLC), shareholders were able to sue the corporation through a direct or derivative lawsuit.  Classifying the claim as direct or derivative would determine the procedure of the complaint, in addition to determining the remedy and likely outcome.  Now, with the popularity of the LLC, the derivative and direct classifications are applying to members’ complaints about the operation of the LLC.  Since LLC law does not have too many of these cases, it is beneficial to look at the corporate law (especially because LLC law often borrows from corporate law).  In fact, as seen in several states, it is often corporate case law which determines the outcome of LLC disputes between a member and the LLC itself.  For these reasons, a brief description of the differences between a direct and derivative lawsuit would be beneficial not only to a shareholder, but also to a member or manager of an LLC.

Direct

A direct claim allows the member or members to pursue the lawsuit in their own name(s).  This is allowed only if the member or group of members were injured by the actions of the LLC, and it is those members (not the LLC) who would receive the benefit of recovery.  However, if the entire LLC was injured by the action of a manager, the claim does not classify as direct.  An example of a direct claim would be if the voting rights or interests of a certain member were lost.  Here, it is not the entire LLC that is harmed, but only that member.

Furthermore, for a direct claim, the remedy sought is usually equitable, or non-monetary.  In the example above, the proper remedy would not be money damages, but an injunction to prevent the LLC from harming the voting interest of the particular member.  Overall, if a member is injured (not the LLC), and the remedy is equitable, then the claim is direct.

Derivative

A derivative claim is much more complicated than a direct claim.  A derivative lawsuit is one in which the entire LLC is harmed (by the LLC), rather than a specific member bring injured.  In other words, the lawsuit is brought by a member on behalf of the entire LLC, against the LLC itself.  An example of a derivative law suit would be if the LLC engaged in an agreement to pay an extraordinary amount of money to an individual who is not performing.  Here, a law suit would benefit the entire LLC, and the remedy would be the money lost on the violated agreement.

A key difference between a derivative and direct lawsuit is that the concept of “demand.”  Under a derivative lawsuit, the plaintiff is required to either make demand of the company, or prove that demand of the company is futile.  Demand refers to demanding the LLC take on the case.  Since the lawsuit is meant to benefit the entire LLC, courts have mentioned that the LLC should have the ability to investigate and determine the validity of the case itself.  However, it is apparent that if an LLC hears about the complaint and chooses to investigate, a conflict of interest could result in the LLC dismissing a valid claim, rather than bringing the suit.  Furthermore, since courts often defer to the business judgment of business entities like the LLC, there is a low likelihood that a plaintiff will be able to show that the LLC wrongfully dismissed the suit.

For all of the problems associated with making demand of the company, the plaintiff in this type of suit usually chooses to show demand futility.  To show demand futility, the plaintiff usually has to show that there is reasonable doubt that the managers and directors are independent, or that there is doubt that the agreement/transaction was a valid business decision.  In California, however, there is not a specific test to show demand futility.  If demand futility is shown, then the suit proceeds.  If not, then the suit is dismissed because demand should have been made.

The next step in a derivative lawsuit is based on whether the LLC has hired a special litigation committee (SLC).  An SLC is a committee often employed by the LLC to settle these types of disputes.  A court will defer to the decision of the SLC, as long as the SLC is independent.  To test this, courts analyze how the SLC came to it’s conclusion, evaluating whether the SLC used good faith in it’s reasonable investigation.  If the SLC was not independent, the court could apply it’s own business judgment to determine the value of the suit.  After this, the derivative suit has taken all possible steps, and the suit either proceeds, settles, or has been dismissed along the way.

As one can easily imagine, the direct law suit is much easier for a plaintiff to bring than the derivative suit.  On the other hand, the LLC would prefer a suit to be classified as derivative, because of the multiple opportunities to dismiss the suit, through the demand doctrine or an SLC.  Therefore, if an issue arises in your LLC, be sure to investigate the complaint to determine what steps can and should be taken to protect yourself and the LLC.

 

 

By |2016-12-13T21:20:14-07:00February 25th, 2015|Categories: Lawsuits, Member Disputes, Miscellaneous|0 Comments

Administrative Dissolution for Failing to File a Statement of Information

Administrative dissolution of an LLC occurs when an LLC fails to follow the state’s requirements, resulting in the state agency penalizing or dissolving the LLC.  In California, these requirements include payment of the annual tax and fee, in addition to filing the initial and biennial Statement of Information.  When an administrative dissolution occurs, the LLC must act in a timely manner to correct the deficiency.

There are many instances when an LLC is administratively dissolved, yet it continues to operate.  This often occurs when the LLC is not aware of the administrative dissolution.  An issue then arises as to who is liable for acts when an administratively dissolved LLC enters into a contract and subsequently is unable to pay or perform.  This issue was dealt with in Pannell v. Shannon, when a single-member Kentucky LLC was dissolved, but continued to enter into a lease agreement.  When the dissolved LLC defaulted on the lease, the other party sued not only the dissolved LLC, but also the single member.  The LLC responded by immediately taking steps for reinstatement, which was granted by the Kentucky Secretary of State.  Still, the issue remained whether or not the single member was personally liable.

The Supreme Court of Kentucky affirmed the lower courts’ decision in holding that the member was not personally liable for the administratively dissolved LLC’s lease.  By relying on the Kentucky LLC Act, the court determined that since the reinstatement related back to the date of the dissolution,  the LLC was essentially never dissolved in the first place.  The court emphasized the absurdity of limiting an unintentionally dissolved LLC to only winding-up activities.  This limit on activities, if taken literally, would prevent the LLC from filing the necessary paperwork to be reinstated.  Also, the court highlighted the purpose of the LLC Act: to limit personal liability.  A missed LLC fee or tax payment does not justify disregarding the most important principle behind why people form LLCs.

The opinion reveals that despite a complicated scenario, an understanding of the basic reason behind a limited liability company is not to be ignored: An LLC is meant to protect owners and members from personal liability.  The opinion also shows that the normal requirements for a winding-up LLC do not apply for LLCs which are unintentionally dissolved.  By protecting managers and remembering the purpose of an LLC, this ruling should be regarded as a victory.

 

 

 

By |2016-12-13T21:20:14-07:00September 25th, 2014|Categories: Lawsuits, LLCs & Corporations, Miscellaneous, Operating LLCs|0 Comments

Florida Determines Charging Order is Exclusive Remedy

Florida’s Fourth District Court of Appeals recently published an important LLC opinion in Young v. Levy.  The issue in this case was whether a writ of garnishment could be used against distributions by the limited liability company.  Specifically, this case interpreted “exclusive remedy” within the charging order provisions to decide the outcome.  This opinion is not only relevant to Florida LLC members and managers, but also to the LLC members and managers in 15 states that have similar charging order “exclusive remedy” language in their state’s LLC statutes.  FYI:  California LLC law is not one of the states that has the charging as the exclusive remedy for a creditor who gets a judgment against a member of a California LLC.  It is undetermined if other states will follow in Florida’s footsteps, but an understanding of the Young v. Levy decision would benefit LLCs who are looking to determine what remedies are available in a cases similar to Young v. Levy.

In this case, Levy owned 51% of the LLC, while Young owned the other 49%.  Due to business-management differences, Levy removed Young from the business.  This led Young to sue Levy for injunctive relief and damages.  Initially, the trial court granted Young’s requests.  However, Levy soon after filed a motion to dissolve the injunction, which was granted.  Then Levy moved for damages regarding attorneys’ fees.  These fees were awarded to Levy, totaling $41,409.45.

To obtain this money, Levy looked to use a writ of garnishment on distributions by the LLC.  The garnishee (LLC) owed over $44,000 to Young.  Young claimed that he was exempt from the garnishment, while Levy filed objections, stating that the garnishment was proper.  This was the key issue analyzed by Florida’s Fourth District Court of Appeals.

Young asserted that the language in Section 608.433 (5) in Florida Statues (2011) did not allow garnishments as a proper remedy.  This section states:

“Except as provided in subsections (6) and (7), a charging order is the sole and exclusive remedy by which a judgment creditor of a member or member’s assignee may satisfy a judgment from the judgment debtor’s interest in a limited liability company or rights to distributions from the limited liability company.”

Levy argued that the distributions owed to Young were “profits” or “dividends”; and thus, a writ of garnishment would be an acceptable remedy.  The Fourth District Court of Appeals did not accept this argument, because the term “interest” is defined as share of profits and the right to receive distributions.  This led the court to hold that a garnishment of distributions is not a proper remedy to satisfy judgment.  The court reiterated the importance of the plain language of Florida Statues which emphasized that “

[A] charging order is the sole and exclusive remedy by which a judgment creditor of a member . . . may satisfy a judgment from the judgment debtor’s interest in a limited liability company or rights to distributions.”

The interpretation of “exclusive remedy” only allows plaintiffs to obtain charging orders on the members’ distributions by the LLC.  Plaintiffs cannot obtain a garnishment on these distributions.  As stated earlier, a similar “exclusive remedy” provision exists in 15 states, besides Florida.  If these other states rule similarly, it will be more difficult for the LLC to collect judgment from a member.

By |2016-12-13T21:20:14-07:00June 28th, 2014|Categories: Charging Orders, Lawsuits|0 Comments

Single Member’s Death Could Cause Dissolution of LLC

Some states require that a limited liability company (LLC) have at least two members.  Many states, including California, allow for single member LLCs.  Another jurisdiction that permits a single member LLC is Alabama.  The LLC law of California and Alabama provide that when the single member dies, the LLC must be dissolved, subject to two exceptions.  First, the single member LLC can continue if the operating agreement provides for the continuation and a method for determining the successor(s) to the deceased member.  Second, the LLC can continue if the assignee(s) of the interest of the deceased members elect to continue the business within 90 days of the death.  Recently, in L.B. Whitfield III, Family LLC v. Whitfield, the Supreme Court of Alabama dealt with the dissolution of the single member LLC.

In this case, the single member of an Alabama LLC died, and left his interest in the LLC to his four children.  There was no vote to continue the LLC, and no special provisions in the operating agreement.  Still, the children operated the business for 10 years after their father’s death.  The four children began to have business disputes and one child (the manager) filed a lawsuit against the other three children.  The three defendants discovered the Alabama law that dissolves a single member LLC unless the majority of the heirs agree to continue the business within 90 days.  The three children then sued for a court order that the LLC distribute its assets to the members because the LLC was statutorily dissolved 90 days after the father’s death.

Despite the defenses offered by the plaintiff, the court held that the three children were correct, and that the LLC was dissolved when the children failed to continue the business within 90 days after the father’s death.  The Supreme Court of Alabama said it did not matter that the LLC continued to operate for 10 years.  The court highlighted that the fundamental principles of an LLC include membership admission through a written agreement that is signed.  Since this new agreement was never established, the LLC was dissolved.

Caution:  If a California resident dies his or her membership interest may be subject to an expensive and time-consuming California probate.  To learn about nasty California probates and how to avoid a California probate and save your loved ones mega-bucks read “Trusts Should Own Valuable LLCs to Avoid Probate.”

For more on this topic see “What Happens If the Sole Member of a CA LLC Dies?“

By |2016-12-13T21:20:15-07:00June 22nd, 2014|Categories: CA Law, Lawsuits, Member Disputes|0 Comments

RULLCA Continues to Gain Momentum

On April 11th, Minnesota signed into law the “New Act,” replacing the Minnesota Limited Liability Company Act.  This New Act was largely based the Revised Uniform Limited Liability Company Act (RULLCA) provided by the National Conference of Commissioners on Uniform State Laws (NCCUSL).  By passing the New Act, many of the default rules which governed Minnesota LLCs were modified or changed completely.  These changes are to take place on August 1, 2015, but do not affect LLCs formed prior to that date, unless the LLC requests otherwise.  For access to the entire text of the New Act, visit the Minnesota State Legislature’s website.

With Minnesota’s enactment, RULLCA has now been adopted in 9 states (including California) and the District of Columbia.  Additionally, South Carolina introduced their version of RULLCA this year.  When first passed in 2006, RULLCA was criticized for having awkward phrasing, in addition to creating uncertainty regarding fiduciary duties and remedies.  However, after  a slow start, RULLCA seems to be picking up steam.  In the past two years, four states have enacted RULLCA, and other states, like South Carolina, may not be far behind.

For information on California’s Revised Uniform Limited Liability Company Act, click here.  The article provides access to all provisions of California’s version of RULLCA.

By |2019-03-17T14:39:53-07:00May 16th, 2014|Categories: LLCs & Corporations, Miscellaneous|0 Comments

Arkansas Rules that Member v Member Claims Are Direct

When one member of a limited liability company has a claim against another member or a manager of the limited liability company (LLC), it can be classified as direct or derivative.  A direct claim is one where the individual member is negatively affected by an action of the LLC, but the whole LLC is not injured.  A derivative suit is one in which the entire LLC is affected by a decision of one of it’s managers or members.  In these derivative cases, a member usually brings suit on behalf of the LLC.  Determining the classification is important, because it reveals how the procedure of the claim will be handled

For the LLC, a derivative suit is preferable because there are many opportunities in the procedure which allow for the claim to be dismissed.  However, the plaintiff (LLC member) would rather the claim be direct, so they can avoid procedural obstacles and take have their claim proceed much easier.  For more detail, including implications of both cases, see direct and derivative suits.

Though the differences between direct and derivative claims may be clear, which category the claim falls under might be difficult to discern.  This is especially true for LLCs, because they do not have a long history of these types of cases.  The Arkansas Supreme Court dealt with this issue in Muccio v. Hunt.  Here, minority members of an LLC sued the other members and managers.  They alleged that these majority members committed fraud, breached their duty to disclose information, and converted their membership interests.

The trial court found that the claim was derivative.  This meant that the minority members of the LLC had no standing because the LLC itself was the proper party to bring this complaint.  However, the Supreme Court of Arkansas reversed, holding that the claim may proceed in the members’ names, stating that the members themselves were injured; and therefore, the claim was direct.  The court addressed the fraud, breach of duty to disclose, and conversion separately.

Regarding fraud, the court first noted these types of suits are normally derivative.  The  court noted that direct suits are appropriate, however, when the member shows an injury that is unique to the member, and not applicable only to the LLC.  In applying this rule to the present situation, the court found that the minority members suffered loss of their ownership.  The court further noted that the fraud being alleged by plaintiffs was not fraud that harmed only the LLC.  This resulted in the claim of fraud to be classified as direct, not derivative.

When analyzing the duty to disclose, the Arkansas Supreme Court noted their LLC statute.  This requires the LLC managing members to make available full and true information that reasonably affects any member.  The court later stated that these statutory rights of members supported individual claims, not claims made by the LLC.  This led the court to rule that this claim was also direct.

Finally, the court addressed the claim of conversion (wrongful possession of another person’s property).  In this case, the plaintiffs contended that the LLC converted the minority member’s interests.  In their complaint, the plaintiffs stated the the managing members did this through fraudulent misrepresentation.  The court agreed that the conversion was tied to the fraud; since the fraud claim was direct, then the conversion claim was also direct.

Throughout the opinion, the Arkansas Supreme Court constantly compared LLC and corporate law.  The court even mentioned corporate case law and applied it to the LLC case at hand. This was a surprise to many, and appeared to blur the line between the two business entities.  By ruling that these types of claims were direct, the Arkansas Supreme Court made it easier for a disgruntled LLC member to bring a suit against the other members.  If this type of ruling becomes a trend for other states, it means that the LLC may have to take more steps to protect themselves from liability.

 

 

By |2019-03-17T14:05:51-07:00April 18th, 2014|Categories: Lawsuits, LLCs & Corporations, Member Disputes|0 Comments

Lack of Business Records Leads Massachusetts to Pierce LLC’s Veil

In Kosanovich v. 80 Worcester Street Associates, LLC, the Massachusetts Appellate Division ruled that a single-member LLC’s veil should be pierced because of poor record keeping.  This case is particularly interesting because it seems inconsistent with previous rules and cases.

Here, the plaintiff bought a condominium from the single-member LLC.  In the agreement between the parties, the LLC was to repair any defects of the condominium within one year of the purchase date.  The LLC then failed to repair some of the defects, and the plaintiff sued for breach of contract and breach of an implied warranty.  The judge not only sided with the plaintiff, but also pierced the veil, holding the member of the LLC personally liable.  On appeal, the court started with the veil-piercing rule which states that the veil should only be pierced to defeat fraud or injustice.  Then, the court listed 12 factors that determine if piercing the LLC’s veil was justified.  These factors include:

  • (1) common ownership,
  • (2) pervasive control,
  • (3) confused intermingling of business assets,
  • (4) thin capitalization,
  • (5) nonobservance of corporate formalities,
  • (6) absence of corporate or LLC records,
  • (7) no payment of dividends or distributions,
  • (8) insolvency at the time of the litigated transaction,
  • (9) siphoning away of corporation’s funds by dominant shareholder or member,
  • (10) nonfunctioning of managers, or officers and directors,
  • (11) use of the corporation or LLC for transactions of the dominant shareholders or members, and
  • (12) use of the corporation or LLC in promoting fraud.

The court noted that when analyzing these factors, the veil-piercing was justified.  In particular, the court looked to the pervasive control and poor record keeping to support the trial court’s decision.  The court suggested that the poor record keeping applied to the other factors, since the LLC member could not provide documents convincing the court otherwise.

This decision seems odd because this case was not regarding fraud or injustice (the reason the court stated that veil-piercing should exist).  Also, the burden of proof in this case seemed to have shifted to the LLC member by suggesting that it was this duty to keep good records to show that the 12 factors weighed in his favor.  Still, one of the ways to prevent a veil piercing is to formally treat the LLC as a business.  This means keeping good books and records, and following the formalities of ordinary businesses.

By |2016-12-13T21:20:16-07:00February 25th, 2014|Categories: Operating LLCs|0 Comments

Do I Need to Reserve a Name for My New California LLC?

Question:  I intend to file Articles of Organization with the California Secretary of State to create a new California LLC.  Should I reserve the LLC’s name with the California Secretary of State?

Answer:  Almost always no because:

  • If the name is available for the LLC it has been available from the beginning of time up to the moment the California Secretary of State grants the reservation.
  • The fact the California Secretary of State reserves the name of a to be formed LLC does not mean the name can actually be used by the to be formed LLC.  Although nobody else can use the reserved name for a California entity while the reservation is active you won’t know if the Secretary of State will actually allow the LLC to be formed with the name until you file the Articles of Organization and the Secretary of State approves it.
  • The reservation is expires after 60 days.
  • Its a waste of $10.

If you do want to reserve a name for your new California limited liability company just follow the instructions on and file the California Secretary of State’s Name Reservation Request form.

By |2015-02-19T20:43:40-07:00February 25th, 2014|Categories: CA LLC Formation, FAQs|0 Comments

Amended Indemnification Provision does not Eliminate Previous Obligation

An LLC’s Operating Agreement can modify basic functions of LLC members or managers.  This includes indemnification clauses which may require the LLC to indemnify members or managers against lawsuits.  In Branin v. Stein Roe Inv. Counsel, a disagreement arose when the LLC amended the indemnification provision.  Unlike the old provision, the new indemnification rules prevented an employee from being indemnified in certain circumstances.  That employee, Francis Branin, filed suit arguing that his original indemnification rights should not be replaced by the new amendment.  The Delaware Court of Chancery agreed.

In this case, Branin was being sued by his former employer for soliciting former clients.  After 10 years of litigation, the charges were eventually dismissed.  In this interim period, the LLC which Branin worked for changed their indemnification clause in the operating agreement.  This second version of the indemnification clause was much more stringent, and would not cover Branin’s $3million legal fees.  The question then became the following: Does the second version of the indemnification preclude the indemnification allowed under the original clause?

The court decided that the first agreement included an enforceable indemnification clause.  Also, after looking to previous cases involving indemnification clauses, the Delaware Court of Chancery ruled that the right to be indemnified vests when the initial lawsuit was filed.  Due to Branin’s right being vested under the first version of the indemnification provision, the second version had no effect.  This shows that LLCs cannot rid their responsibility to indemnify once the provision has been triggered.  Therefore, LLCs should design these types of clauses carefully and not blindly accept a boilerplate indemnification clause which may expose the LLC to more liability than desired.

 

By |2016-12-13T21:20:16-07:00January 25th, 2014|Categories: Operating LLCs|0 Comments
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