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LLC Law Today and Beyond

The document provides an overview of Limited Liability Company (LLC) law, covering its statutory framework, case law, and recent developments. It highlights the characteristics of LLCs, amendments to statutes, the implications of series LLCs, and the role of case law in shaping LLC governance. Additionally, the document discusses compliance requirements, member and manager responsibilities, and various litigation scenarios relevant to LLC structures.

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LLC LAW TODAY & BEYOND 2016 PRESENTED BY: LORI ANN FOX, ESQ.
Overview of Seminar • Part I – An Overview of LLC Law • Part II – LLC Statutory Law Today • Part III – LLC Case Law Today • Part IV – LLC Law Beyond Today 1
AN OVERVIEW OF LLC LAW 2
What Do We Mean By LLC Law? • State LLC statutes – Laws authorizing formation of LLC and governing LLCs formed there under • LLC case law – Cases involving LLC’s internal governance – Cases involving rights, duties, liabilities of owners and managers 3
Five Key Features of the LLC These features affect both LLC statutes and case law: – An LLC is hybrid entity – An LLC is, in most cases, a closely held entity – An LLC is, in most cases, a “pick your partner” entity – An LLC is a contractual entity – An LLC is a flexible entity 4
Events Influencing LLC Law • Hamilton Bros. Oil Co. lobbies for LLC Act • Revenue Ruling 88-76 is issued • First flexible LLC statute is adopted • Check-the-box is enacted 5
LLC STATUTORY LAW TODAY 6
Three Generations of LLC Statutes • First generation = bulletproof statutes – Contained unalterable provisions designed to avoid corporate taxation • Second generation = flexible statutes – Allowed members to opt out of statutory provisions • Third generation = first and second as amended 7
Why Were Statutes Amended? • The check-the-box rule • The need to fill in gaps • The need to clarify ambiguities • Legislative anticipation vs. realities • The need for consistency • Reaction to court decisions 8
Is There A “Typical” LLC Statute? • Current LLC statutes are not uniform • But some generalizations can be made • Will look at “typical” provisions governing: – Formation – Members and management – Mergers and conversions – Compliance requirements – Foreign LLCs – Dissolution • Will discuss how they have changed from original statutes, why they changed and how they may change in future 9
Formation • Formation document • Organizers • Purposes • Operating agreement 10
POLLING QUESTION # 1 How many members does the typical LLC you form have? A. One B. More than one but less than ten C. Ten or more 11
Members & Managers • Members – Membership interest – Springing member – Allocating rights – Transferability of interest – Withdrawal – Charging order • Managers – Formalities – Fiduciary duties – Statutes differ significantly – Source of litigation 12
Mergers and Conversions • Mergers – LLC laws – Now and Then – Reason for amendments – Future changes? • Conversions – LLC laws – Now and Then – Current statutes meet the needs of businesses that want to change forms – Amendments have been made to make provisions more consistent with other entity statutes 13
Compliance Requirements • LLC acts are “enabling” not “regulatory” • LLC acts do not have many compliance requirements • Compliance requirements in business entity laws often there to protect owners • In LLC it is thought members can protect themselves in their OA • Three main compliance requirements – Annual report – Registered agent – Recordkeeping 14
Foreign LLCs • Statutes deal with limited issues • Not many changes over years • Formation state governs – internal affairs – liability of members and managers • Qualification/registration required 15
Dissolution • LLC laws – Now and Then • Amendments • Further changes? 16
POLLING QUESTION # 2 Are you familiar with the Series LLC? A. Yes B. No 17
Series LLC - Diagram Series A (Hotel) Series D (Apt) Series C (Mall) Series B (Land) Series E (Gas Station) 18
Series LLC • An LLC that is divided into separate series • Each series functions like a separate LLC • If properly formed and maintained, debts of a series can be satisfied from that series only • Delaware was first state to authorize • Other states include AL, DC, IL, IA, IN (1/17), KS, MO, MT, NV, OK, TN, TX, UT 19
Series LLC Questions surrounding Series LLCs – How will Series LLC and series be taxed? • PLR 200803004 – IRS treated each series separately – Will foreign state that does not provide for Series LLC respect separation of liabilities? – Can series, in its own name, enter into contracts, sue or be sued, own legal title to real estate? – Can series file for bankruptcy or register under securities laws? 20
LLC CASE LAW TODAY 21
Some General Observations • LLC law is also made by judges • Steady increase in number of cases nationwide – Not evenly distributed however; some states hearing more LLC related litigation than others – Not a great deal of decisions from high courts – Cases involving single member LLC 22
Some General Observations Some issues seen in LLC cases today – Cases requiring court to interpret LLC statute – Cases requiring court to interpret OA – Cases involving attempts to impose liability on member – Cases seeking to hold manager liable for breaching fiduciary duties – Cases questioning authority of member or manager to act for LLC – Cases involving LLC treatment under statute not specifically applicable to LLCs 23
Interpreting a State LLC Statute • Goal of court is to give effect to legislative intent • Begin with ordinary meaning of words • Read words in context so that they are consistent with rest of provision and statute • Court may look to analogous provision of corporation, LP, GP law • Court may look at what other state courts have done 24
Davis v. Winning Streak Sports, LLC • 2013 Kan. App. LEXIS 16 • Sec. 17-7670 of KS LLC act – To the extent that a member has been successful on the merits or otherwise or in the defense of any action that member shall be indemnified against expenses actually and reasonably incurred • Member sought a declaratory judgment that he owned a 49% interest in an LLC • LLC claimed he owned 0% • Jury found plaintiff owned 0.96% • Pl sought mandatory indemnification under Sec. 17-7670 25
Davis v. Winning Streak Sports, LLC • Trial court found for LLC because Pl was only nominally successful and not prevailing party • KS Ct of App reversed – Statute does not require complete success – Pl was successful in obtaining a declaration that he was member even though it was for less of an interest than he sought – Pl was thus entitled to indemnification 26
NY Derivative Suit Cases • NY LLC Law does not have provision stating that member may bring derivative suit • Early draft of LLC law had a derivative suit provision; Provision removed before enactment • Lower state courts and federal district courts had split on whether member had common law right • Courts denying right found that removal of provision = legislative intent not to allow derivative suits • Courts granting right based it on fact shareholders and limited partners have right and that removal of provision from draft is not clear legislative intent to deny right 27
NY Derivative Suit Cases • Tzolis v. Wolff, 884 N.E.2d 1005 (N.Y. 2008) – Court of Appeals upholds member’s right to bring derivative suit – Courts have repeatedly recognized derivative suits in absence of express statutory authorization – Shareholders and limited partners have both statutory and common law right to bring derivative suit; no reason to treat members differently – Reason for derivative suit - so that victims of faithless fiduciaries have a remedy – still valid – No evidence legislature intended to take radical step of abolishing derivative suit 28
Interpreting OA • Courts apply principles of contractual interpretation • Function of court is to ascertain shared intentions of parties • First give words ordinary meaning • Avoid result parties could not have intended 29
Majkowski v. American Imaging Mgmt Services, LLC 913 A.2d 572 (Del. Ch. 2006) Background: – LLC agreement did not mention advancement – LLC agreement stated that LLC would “indemnify and hold harmless” – Plaintiff claimed “hold harmless” included advancement • Had to have meaning other than indemnify or phrase would be surplusage • Claimed harm by having to pay litigation expenses Court: – Ch Ct held that phrase “indemnify and hold harmless” had long history of usage and was second nature to many drafters – Held that plaintiff’s argument would bend contractual language to read a meaning parties did not intend 30
Fundamental Long Term Care Holdings, LLC v. Cammeby’s Funding LLC 2013 NY Slip Op 951 Background: – OA required capital contribution of at least fmv of interests before new member admitted – LLC entered into option agreement entitling holder to one-third interest for $1,000 upon exercise – LLC refused to issue membership interest to option holder; sought declaration that holder had to provide capital contribution pursuant to OA Court: – NY Ct of App held option holder was entitled to one-third interest – OA and option agreement were not intertwined – Option agreement unambiguously granted holder right to acquire interest for $1,000 – Parties were sophisticated and if they meant for OA fmv provision to apply they would have so provided 31
Member Liability Cases • Many LLC cases involve attempts to impose liability on member • Third party seeking to hold member liable for LLC debts • Third party seeking to hold member liable based on member’s participation in LLC’s wrongful conduct • Member, manager, LLC seeking to hold member liable for breach of fiduciary duty • Member seeking to hold member liable for breach of OA 32
AT&T Advertising L.P. v. Winningham 2012 Ok. Civ. App. 51 Background: – Example of member being held liable LLC debts – Member sued for money owed on contract entered into by LLC Courts: – Trial court – summary judgment to plaintiff; LLC was cancelled by SOS at time of signing contract so no liability shield – Court of Civil Appeals affirmed • LLC cancelled for non-payment of fees for three years does not provide shield for its agents • OK LLC Act distinguishes between LLC in good standing and one that has been cancelled, which does not exist and cannot provide shield 33
3rd Party Suit to Recover LLC Debts • LLC statutes provide that member is not liable for LLC’s debts based on status as member • But member may be held liable if court “pierces veil” • Court may pierce if plaintiff establishes: – Member completely controlled LLC including policies and practices with respect to transaction complained of – Control used to commit fraud, wrong, breach of duty – Control and breach caused plaintiff’s injury 34
ORX Resources v. MBW Exploration, LLC 32 So.3d 931 (La. App. 4 Cir. 2010) Background: – Pl was drilling an oil well – Contracted with LLC to share expenses and profits – Oil well failed – Pl sued LLC’s managing member for breach of contract to recover LLC’s share of expenses Courts: – Trial ct – veil piercing applies to LLCs; member was LLC’s alter ego and liable for its debts – Appellate court affirmed • Piercing justified when LLC is used to defraud creditors • Def member used LLC as a shell to avoid paying debts • Evidence showed LLC was undercapitalized, funds were commingled, formalities not followed (All factors that support piercing the veil) • LLC had no bank account; LLC’s fees were paid from member’s personal account or account of another company of his • LLC had not yet been formed when member signed contract on its behalf • No meetings had been held in over a year 35
Martin v. Freeman • 272 P.3d 1182 (Colo. App. 2012) • Facts: – Pl obtained judgment against SMLLC – While suit pending LLC sold airplane that was only significant asset • Court pierced veil to hold member liable for judgment – Main factor – proceeds from airplane sale were diverted to member’s personal account – Courts do not have to consider that LLCs have fewer restrictions than corporations in observing formalities – Wrongful intent or bad faith need not be shown 36
Serio v. Baystate Properties, LLC • 60 A.3d 475 (Md. App. 2013) • Pl contracts with Md LLC • Pl is to build homes on land owned by LLC’s member and be paid upon sales of homes • Pl is not paid for sales on two lots and files suit, seeking to pierce LLC veil to hold member liable • Md law – Cts will pierce only when necessary to (a) prevent fraud or (b) enforce a paramount equity • Trial Ct pierces LLC veil to hold member liable – Finds no fraud – But piercing necessary for equitable purposes • Member misled Pl about sales • LLC failed to create escrow account as agreed upon • Member’s conduct left LLC insolvent 37
Serio v. Baystate Properties, LLC • Md Ct of Special Appeals reversed – Looks to corporate law cases – Cts find no equitable interest more paramount than state’s interest in limiting shareholder liability – Therefore a finding of fraud is required to pierce – Conduct trial court relied on – misleading Pl, rendering LLC insolvent, trying to evade a legal responsibility – have not been held as enough to pierce in the corporate cases – Here, Pl knew it was contracting with LLC and was not expecting member to make payments – Thus, trial court erred in piercing the LLC’s veil in this case 38
Liability Based on Member’s Conduct • Statutes do not insulate members from liability for their own actions • If plaintiff can establish that member participated in LLC’s wrongful conduct, member can be held liable 39
Mbahaba v. Morgan • 44 A.3d 472 (N.H. 2012) • Tenant in building owned by LLC brought suit ag LLC and member after tenant’s daughter was poisoned by lead paint • Trial Ct dismissed claims ag member • NH SCt reversed • Under NH LLC Act member is not vicariously liable for LLC’s obligations • Here, Pl was attempting to hold member liable for his own negligence in managing the building and breaching his duty to avoid exposing tenants to unreasonable risk of harm • Pl claim should survive motion to dismiss 40
Member Breach of Fiduciary Duty Cases • Member may be sued for breaching a fiduciary duty • Fiduciary duty may be based on LLC statute, OA provision, common law 41
Gottsacker v. Monnier 2007 Wisc. App. Lexis 68 • Background: – LLC had 3 members – Gregory, Paul, Julie; no OA; asset was a piece of real estate – Paul and Julie formed a new LLC w/o telling Gregory, voted to sell LLC’s real estate to new LLC – Gregory sued • Courts: – Trial court held willful unfairness requires both unfair conduct and resulting injury – WI S Ct - Sec. 183.0402 forbids willful unfairness • No member or manager shall act in a manner that constitutes a willful failure to deal fairly with LLC or members in connection with a matter in which member or manager has a conflict of interest – On remand, trial court found Paul and Julie did not violate Sec. 183.0402; appellate court affirmed – Certain actions of Paul and Julie could be construed as unfair • No notice of meeting or opportunity to vote on sale • No effort to find other buyers • Sale left LLC without assets – However result was not unfair • Even if allowed to vote Gregory could not have prevented sale • Purchase price was fair, it eliminated LLC’s debts and Gregory was paid his fair share 42
Suits for Breach of OA • One issue is whether breach occurred • Another issue is if member breached OA, what is remedy? • Court can use equitable powers to fashion remedy 43
Eureka VIII LLC v. Niagara Falls Holdings LLC 899 A.2d 95 (Del. Ch. 2006) – Decision affirmed by DE Supreme Ct (Niagara Falls Holding, LLC v. Eureka VIII LLC, No. 413, 2006 (Del. Supr. 2007) Background: – LLC formed to develop property – 2 members; Milstein provided financing, Cogan provided skills to operate business and licensing rights – Milstein invested based on Cogan’s know how and did not intend to be partners with anyone else – LLC agreement contained restrictions on transferability – Cogan went bankrupt and died, resulting in creditor taking over Cogan’s interest in LLC – Milstein sued for breach of LLC agreement’s transferability restrictions – Milstein sought a declaratory judgment that it was sole member - a remedy not provided for by LLC agreement or statute 44
Eureka VIII LLC v. Niagara Falls Holdings LLC • Court: – Ch Ct found breaches occurred and declared that creditor had rights of assignee only and that Milstein was sole member – Court’s remedy based on Sec. 18-702 • Provides that member ceases to have rights and powers of member upon assignment • Policy – it is far more tolerable to suffer a new passive investor than a new co- manager • Although no assignment here, it was analogous situation • Breach of LLC agreement had same affect as if Cogan had assigned interest to creditor • Milstein should not be bound to manage and operate LLC with a co-member it did not choose • Creditor limited to financial interest 45
Manager Breach of Fiduciary Duty Cases • May be brought by LLC or member • May be direct or derivative suit • Fiduciary duties may be imposed by OA, statute, or common law 46
Wood v. Baum • 953 A.2d 136 (Del. Supr. 2008) • Derivative suit alleging directors of public LLC breached fiduciary duties – Caused LLC to issue false financial statements, failed to institute controls over reporting • Plaintiff alleged demand futility based on directors’ substantial risk of liability • OA exempted directors from liability except in cases of fraud or illegal conduct • Del. S.Ct – directors’ exposure to liability was limited to claims that they knowingly engaged in fraudulent or illegal conduct or bad faith violation of implied contractual covenant of good faith and fair dealing 47
Wood v. Baum • Court ruled plaintiff did not allege particularized facts that, if proven, would show that majority of directors faced liability • Complaint alleged directors engaged in following acts – Executed LLC’s publicly filed financial reports – Authorized certain transactions – Served on audit committee – Ignored red flags • Court ruled none of those acts established knowing participation in illegal conduct 48
POLLING QUESTION # 3 Are you familiar with the Delaware LLC fiduciary duties standards? A. Yes B. No 49
Gatz Properties, LLC v. Auriga Capital Corp. 59 A.3d 1206 (Del Supr. 2012) • Case creating split over default fiduciary duties • Minority members sued manager alleging breach of fiduciary duties after he bought them out for price well below market value • Courts – Ch Ct holds that managers owe default fiduciary duties of care and loyalty – S Ct states that Ch Ct’s ruling that managers owe default fiduciary duties was dicta and had no precedential value • Where there is a contractual provision imposing fiduciary duties there is no need to decide if there are default duties • No party asked the Ch Ct to decide the issue • Reasonable minds can differ so it is up to General Assembly to clarify • Legislative reaction – Amendment to 18-1104 – In any case not provided for in this chapter, the rules of law and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern 50
Authority to Act Cases • Informal manner in which LLC may be operated, combined with few statutory provisions … • Can lead to litigation over whether members or managers acting on behalf of LLC had authority to do so 51
Maitland v. Int’l Registries, LLC C.A. No. 3669-CC (Del. Ch. 2008) • Background: – LLC had 2 equal managing members (Maitland and Guida) – Maitland sued LLC to enforce inspection rights – Guida retained counsel for LLC, answer was filed – Maitland moved to strike answer and disqualify counsel on grounds that Guida lacked authority to retain counsel and file answer for LLC without Maitland’s assent • Chancery Court granted motion – LLC agreement stated that decision of majority of interests controlled – Statement in LLC agreement that members are granted all rights, powers, authority to manage LLC means that one member may manage when other is silent; does not give one member power to manage when other is opposed – Neither can unilaterally agree to retain counsel and file answer 52
Statutory Treatment of LLCs • Early question about LLCs – how would they be treated under statutes/regulations specifically dealing with corporations and/or partnerships but not LLCs? • Over the years some amendments have been made to clarify LLC treatment 53
Champluvier v. Mississippi • 942 So.2d 145 (Miss. 2006) • Example of how some statutes were amended after a court case alerted legislature to need • Champluvier was convicted of embezzling money from LLC she formed • Section of law she was convicted under applied to agents, officers, etc. of “incorporated company” • Mississippi Supreme Court overturned conviction because LLC is not an incorporated company • Section of law amended shortly thereafter to broaden application 54
LLC Diversity Cases • Federal diversity jurisdiction requires plaintiffs and defendants to be citizens of different states • 28 USC 1332(c)(1) – corporations are citizens of state of incorporation and state where principal place of business is located • Issue – does Sec. 1332 (c)(1) apply to LLCs? • Nearly all US Courts of Appeal have dealt with the issue. Every one held that Sec. 1332 (c)(1) does not apply to LLCs – Congress chose to include corporations only – Up to Congress to amend to include LLCs • Current law – LLC is citizen of all states in which its members are citizens • Future – Will Congress or US SCt make a change? 55
Cases Involving Single Member LLCs • LLC acts generally written with multi-member LLCs in mind • Concept of SMLLC does not fit neatly in all provisions, especially those protecting members from actions of co-members • In some cases courts have declined to apply certain sections of LLC act to SMLLC 56
In re Modanlo • 2008 US App LEXIS (4th Cir.), affirming, In re Modanlo, 2006 Bankr. LEXIS 4524 (D.Md) • Member of DE SMLLC filed for bankruptcy • Bankruptcy trustee sought to manage LLC • Member argued trustee had, at best, rights of assignee, but no governance rights • Court held for trustee. Ruled three sections of DE LLC Act did not apply to SMLLC – Sec. 18-304 – default rule that member ceases to be member upon filing for bankruptcy – 18-702, 18-704 – default rules that assignee has no right to participate in management and may become member upon consent of all members – These sections are intended to protect member from actions of co-member. Not applicable when there is no co-member 57
Olmstead v. FTC • 44 So.3d 76 (Fla. 2010) • FTC obtained $10 million judgment against individuals who owned FL SMLLCs • 8th Cir certified question to FL SCt asking whether charging order provision of FL LLC act permits court to order a judgment debtor to surrender all rights, title, interest in debtor’s SMLLC to satisfy judgment • FL SCt ruled that FL law permits court to order surrender of full interest in SMLLC; court not limited to charging order – Charging order provision is part of section on assignee rights; requires consent of “all members other than member assigning interest” for assignee to take full interest. In SMLLC – no other members – Charging order is special remedy for creditor when debtor’s LLC interest is not fully transferable but subject to right of other members to object to transferee becoming member – LLC act provision does not state that charging order is exclusive remedy; in contrast, LP and GP provisions state remedy is exclusive • Aftermath – FL and other states amended LLC acts to specify that charging order provision applies to SMLLC 58
LLC LAW BEYOND TODAY 59
The Uniformity Movement • LLC statutes may change if states adopt uniform and model acts • Uniformity movement – Began at end of 19th century because different and conflicting laws were creating confusion and hindering trade – Main drafting groups – NCCUSL and ABA • Model vs. uniform law – Model – template expected to be modified by each state rather than adopted in whole – Uniform – intended to be adopted without revision 60
Revised Uniform LLC Act (RULLCA) • ULLCA adopted by NCCUSL in 1995 – Only nine states adopted • RULLCA adopted by NCCUSL in July 2006 – Drafters claim it reflects current LLC needs, goals, uses better than ULLCA – If drafters are correct, RULLCA may prove more popular with states than ULLCA – As of March 29, 2016 adopted by AL, CA, DC, FL, ID, IA, MN, NE, NJ, ND, SD, UT, VT, WA, WY (as per uniformlaws.org) – 2016 introductions: CT, IL, PA, SC • Formation document called certificate of organization – Signal that document reflects existence of LLC rather than location of governance rules 61
RULLCA • Some of the innovations (according to the co-reporters) include the following • Emphasis on OA as foundational document • “Uncabining” of fiduciary duties – Instead of exhaustively codifying as in RUPA, ULPA, ULLCA, RULLCA partially codifies and increases power of OA to define • Restates duty of care – From gross negligence to simple negligence, subject to business judgment rule 62
RULLCA • Eliminates statutory apparent authority – Member of member managed LLC not an agent solely by being member – Power to bind based on agency principles • Permits filing of statement of authority – States authority or limitation of authority of person holding position to which statement relates • Creates statutory remedy for oppressive conduct by controlling member – Minority member may apply for dissolution – Court may grant other remedy • Does not include Series LLC provision 63
Model Entity Transactions Act (META) • Model act approved by NCCUSL and ABA in 2005 and amended in 2007 • Response to problems involving inter-entity mergers, conversions and other transactions involving different types of entities • Inter-entity transactions require compliance with statutes that differ in areas such as – Whether transaction is authorized – What entities may participate – What document is filed – Whether delayed effective date is allowed – Effect of transaction – Ability to abandon or amend plan 64
META • Provides single set of procedures for all entity types for – Multi-entity mergers – Multi-entity interest exchanges – Conversion – Domestication • States adopting would repeal provisions in LLC act and META would govern – As of March 29, 2016 adopted by AK, AZ, CT, DC, ID, KS, PA (as per uniformlaws.org) 65
Model Registered Agents Act (MoRAA) • Joint project of NCCUSL and ABA; approved in 2006 • Deals with registered agent issues • Applies to all forms of entities • As of March 29, 2016 adopted by AR, DC, ID, ME, MS, MT, NV, ND, SD, UT, WY (as per uniformlaws.org) 66
Model Registered Agents Act (MoRAA) • Provisions deal with – Addresses in filings – Content of filings appointing registered agent – How to change registered agent – Resignation of agent – Duties of registered agent – Eliminates publication and venue functions of registered office – Permits listing of commercial registered agent • Adopting state would repeal conflicting provisions from LLC statutes and MoRAA would govern 67
Recap • Overview of LLC law – Key features & events • LLC statutes today – “Typical” provisions governing formation, members, management, merger and conversion, compliance requirements, foreign LLC, dissolution, Delaware LLCs, Series LLCs – How and why they changed over the years • LLC case law today – Interpreting LLC statute and OA – Member and manager liability and authority to act – Treatment under certain statutes – Single member LLC • LLC law beyond today – RULLCA, META, MoRRA 68
THANK YOU FOR ATTENDING LLC LAW TODAY & BEYOND - 2016 69

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LLC Law Today and Beyond

  • 1.
    LLC LAW TODAY &BEYOND 2016 PRESENTED BY: LORI ANN FOX, ESQ.
  • 2.
    Overview of Seminar •Part I – An Overview of LLC Law • Part II – LLC Statutory Law Today • Part III – LLC Case Law Today • Part IV – LLC Law Beyond Today 1
  • 3.
    AN OVERVIEW OFLLC LAW 2
  • 4.
    What Do WeMean By LLC Law? • State LLC statutes – Laws authorizing formation of LLC and governing LLCs formed there under • LLC case law – Cases involving LLC’s internal governance – Cases involving rights, duties, liabilities of owners and managers 3
  • 5.
    Five Key Featuresof the LLC These features affect both LLC statutes and case law: – An LLC is hybrid entity – An LLC is, in most cases, a closely held entity – An LLC is, in most cases, a “pick your partner” entity – An LLC is a contractual entity – An LLC is a flexible entity 4
  • 6.
    Events Influencing LLCLaw • Hamilton Bros. Oil Co. lobbies for LLC Act • Revenue Ruling 88-76 is issued • First flexible LLC statute is adopted • Check-the-box is enacted 5
  • 7.
  • 8.
    Three Generations ofLLC Statutes • First generation = bulletproof statutes – Contained unalterable provisions designed to avoid corporate taxation • Second generation = flexible statutes – Allowed members to opt out of statutory provisions • Third generation = first and second as amended 7
  • 9.
    Why Were StatutesAmended? • The check-the-box rule • The need to fill in gaps • The need to clarify ambiguities • Legislative anticipation vs. realities • The need for consistency • Reaction to court decisions 8
  • 10.
    Is There A“Typical” LLC Statute? • Current LLC statutes are not uniform • But some generalizations can be made • Will look at “typical” provisions governing: – Formation – Members and management – Mergers and conversions – Compliance requirements – Foreign LLCs – Dissolution • Will discuss how they have changed from original statutes, why they changed and how they may change in future 9
  • 11.
    Formation • Formation document •Organizers • Purposes • Operating agreement 10
  • 12.
    POLLING QUESTION #1 How many members does the typical LLC you form have? A. One B. More than one but less than ten C. Ten or more 11
  • 13.
    Members & Managers •Members – Membership interest – Springing member – Allocating rights – Transferability of interest – Withdrawal – Charging order • Managers – Formalities – Fiduciary duties – Statutes differ significantly – Source of litigation 12
  • 14.
    Mergers and Conversions •Mergers – LLC laws – Now and Then – Reason for amendments – Future changes? • Conversions – LLC laws – Now and Then – Current statutes meet the needs of businesses that want to change forms – Amendments have been made to make provisions more consistent with other entity statutes 13
  • 15.
    Compliance Requirements • LLCacts are “enabling” not “regulatory” • LLC acts do not have many compliance requirements • Compliance requirements in business entity laws often there to protect owners • In LLC it is thought members can protect themselves in their OA • Three main compliance requirements – Annual report – Registered agent – Recordkeeping 14
  • 16.
    Foreign LLCs • Statutesdeal with limited issues • Not many changes over years • Formation state governs – internal affairs – liability of members and managers • Qualification/registration required 15
  • 17.
    Dissolution • LLC laws– Now and Then • Amendments • Further changes? 16
  • 18.
    POLLING QUESTION #2 Are you familiar with the Series LLC? A. Yes B. No 17
  • 19.
    Series LLC -Diagram Series A (Hotel) Series D (Apt) Series C (Mall) Series B (Land) Series E (Gas Station) 18
  • 20.
    Series LLC • AnLLC that is divided into separate series • Each series functions like a separate LLC • If properly formed and maintained, debts of a series can be satisfied from that series only • Delaware was first state to authorize • Other states include AL, DC, IL, IA, IN (1/17), KS, MO, MT, NV, OK, TN, TX, UT 19
  • 21.
    Series LLC Questions surroundingSeries LLCs – How will Series LLC and series be taxed? • PLR 200803004 – IRS treated each series separately – Will foreign state that does not provide for Series LLC respect separation of liabilities? – Can series, in its own name, enter into contracts, sue or be sued, own legal title to real estate? – Can series file for bankruptcy or register under securities laws? 20
  • 22.
    LLC CASE LAWTODAY 21
  • 23.
    Some General Observations •LLC law is also made by judges • Steady increase in number of cases nationwide – Not evenly distributed however; some states hearing more LLC related litigation than others – Not a great deal of decisions from high courts – Cases involving single member LLC 22
  • 24.
    Some General Observations Someissues seen in LLC cases today – Cases requiring court to interpret LLC statute – Cases requiring court to interpret OA – Cases involving attempts to impose liability on member – Cases seeking to hold manager liable for breaching fiduciary duties – Cases questioning authority of member or manager to act for LLC – Cases involving LLC treatment under statute not specifically applicable to LLCs 23
  • 25.
    Interpreting a StateLLC Statute • Goal of court is to give effect to legislative intent • Begin with ordinary meaning of words • Read words in context so that they are consistent with rest of provision and statute • Court may look to analogous provision of corporation, LP, GP law • Court may look at what other state courts have done 24
  • 26.
    Davis v. WinningStreak Sports, LLC • 2013 Kan. App. LEXIS 16 • Sec. 17-7670 of KS LLC act – To the extent that a member has been successful on the merits or otherwise or in the defense of any action that member shall be indemnified against expenses actually and reasonably incurred • Member sought a declaratory judgment that he owned a 49% interest in an LLC • LLC claimed he owned 0% • Jury found plaintiff owned 0.96% • Pl sought mandatory indemnification under Sec. 17-7670 25
  • 27.
    Davis v. WinningStreak Sports, LLC • Trial court found for LLC because Pl was only nominally successful and not prevailing party • KS Ct of App reversed – Statute does not require complete success – Pl was successful in obtaining a declaration that he was member even though it was for less of an interest than he sought – Pl was thus entitled to indemnification 26
  • 28.
    NY Derivative SuitCases • NY LLC Law does not have provision stating that member may bring derivative suit • Early draft of LLC law had a derivative suit provision; Provision removed before enactment • Lower state courts and federal district courts had split on whether member had common law right • Courts denying right found that removal of provision = legislative intent not to allow derivative suits • Courts granting right based it on fact shareholders and limited partners have right and that removal of provision from draft is not clear legislative intent to deny right 27
  • 29.
    NY Derivative SuitCases • Tzolis v. Wolff, 884 N.E.2d 1005 (N.Y. 2008) – Court of Appeals upholds member’s right to bring derivative suit – Courts have repeatedly recognized derivative suits in absence of express statutory authorization – Shareholders and limited partners have both statutory and common law right to bring derivative suit; no reason to treat members differently – Reason for derivative suit - so that victims of faithless fiduciaries have a remedy – still valid – No evidence legislature intended to take radical step of abolishing derivative suit 28
  • 30.
    Interpreting OA • Courtsapply principles of contractual interpretation • Function of court is to ascertain shared intentions of parties • First give words ordinary meaning • Avoid result parties could not have intended 29
  • 31.
    Majkowski v. AmericanImaging Mgmt Services, LLC 913 A.2d 572 (Del. Ch. 2006) Background: – LLC agreement did not mention advancement – LLC agreement stated that LLC would “indemnify and hold harmless” – Plaintiff claimed “hold harmless” included advancement • Had to have meaning other than indemnify or phrase would be surplusage • Claimed harm by having to pay litigation expenses Court: – Ch Ct held that phrase “indemnify and hold harmless” had long history of usage and was second nature to many drafters – Held that plaintiff’s argument would bend contractual language to read a meaning parties did not intend 30
  • 32.
    Fundamental Long TermCare Holdings, LLC v. Cammeby’s Funding LLC 2013 NY Slip Op 951 Background: – OA required capital contribution of at least fmv of interests before new member admitted – LLC entered into option agreement entitling holder to one-third interest for $1,000 upon exercise – LLC refused to issue membership interest to option holder; sought declaration that holder had to provide capital contribution pursuant to OA Court: – NY Ct of App held option holder was entitled to one-third interest – OA and option agreement were not intertwined – Option agreement unambiguously granted holder right to acquire interest for $1,000 – Parties were sophisticated and if they meant for OA fmv provision to apply they would have so provided 31
  • 33.
    Member Liability Cases •Many LLC cases involve attempts to impose liability on member • Third party seeking to hold member liable for LLC debts • Third party seeking to hold member liable based on member’s participation in LLC’s wrongful conduct • Member, manager, LLC seeking to hold member liable for breach of fiduciary duty • Member seeking to hold member liable for breach of OA 32
  • 34.
    AT&T Advertising L.P.v. Winningham 2012 Ok. Civ. App. 51 Background: – Example of member being held liable LLC debts – Member sued for money owed on contract entered into by LLC Courts: – Trial court – summary judgment to plaintiff; LLC was cancelled by SOS at time of signing contract so no liability shield – Court of Civil Appeals affirmed • LLC cancelled for non-payment of fees for three years does not provide shield for its agents • OK LLC Act distinguishes between LLC in good standing and one that has been cancelled, which does not exist and cannot provide shield 33
  • 35.
    3rd Party Suitto Recover LLC Debts • LLC statutes provide that member is not liable for LLC’s debts based on status as member • But member may be held liable if court “pierces veil” • Court may pierce if plaintiff establishes: – Member completely controlled LLC including policies and practices with respect to transaction complained of – Control used to commit fraud, wrong, breach of duty – Control and breach caused plaintiff’s injury 34
  • 36.
    ORX Resources v.MBW Exploration, LLC 32 So.3d 931 (La. App. 4 Cir. 2010) Background: – Pl was drilling an oil well – Contracted with LLC to share expenses and profits – Oil well failed – Pl sued LLC’s managing member for breach of contract to recover LLC’s share of expenses Courts: – Trial ct – veil piercing applies to LLCs; member was LLC’s alter ego and liable for its debts – Appellate court affirmed • Piercing justified when LLC is used to defraud creditors • Def member used LLC as a shell to avoid paying debts • Evidence showed LLC was undercapitalized, funds were commingled, formalities not followed (All factors that support piercing the veil) • LLC had no bank account; LLC’s fees were paid from member’s personal account or account of another company of his • LLC had not yet been formed when member signed contract on its behalf • No meetings had been held in over a year 35
  • 37.
    Martin v. Freeman •272 P.3d 1182 (Colo. App. 2012) • Facts: – Pl obtained judgment against SMLLC – While suit pending LLC sold airplane that was only significant asset • Court pierced veil to hold member liable for judgment – Main factor – proceeds from airplane sale were diverted to member’s personal account – Courts do not have to consider that LLCs have fewer restrictions than corporations in observing formalities – Wrongful intent or bad faith need not be shown 36
  • 38.
    Serio v. BaystateProperties, LLC • 60 A.3d 475 (Md. App. 2013) • Pl contracts with Md LLC • Pl is to build homes on land owned by LLC’s member and be paid upon sales of homes • Pl is not paid for sales on two lots and files suit, seeking to pierce LLC veil to hold member liable • Md law – Cts will pierce only when necessary to (a) prevent fraud or (b) enforce a paramount equity • Trial Ct pierces LLC veil to hold member liable – Finds no fraud – But piercing necessary for equitable purposes • Member misled Pl about sales • LLC failed to create escrow account as agreed upon • Member’s conduct left LLC insolvent 37
  • 39.
    Serio v. BaystateProperties, LLC • Md Ct of Special Appeals reversed – Looks to corporate law cases – Cts find no equitable interest more paramount than state’s interest in limiting shareholder liability – Therefore a finding of fraud is required to pierce – Conduct trial court relied on – misleading Pl, rendering LLC insolvent, trying to evade a legal responsibility – have not been held as enough to pierce in the corporate cases – Here, Pl knew it was contracting with LLC and was not expecting member to make payments – Thus, trial court erred in piercing the LLC’s veil in this case 38
  • 40.
    Liability Based onMember’s Conduct • Statutes do not insulate members from liability for their own actions • If plaintiff can establish that member participated in LLC’s wrongful conduct, member can be held liable 39
  • 41.
    Mbahaba v. Morgan •44 A.3d 472 (N.H. 2012) • Tenant in building owned by LLC brought suit ag LLC and member after tenant’s daughter was poisoned by lead paint • Trial Ct dismissed claims ag member • NH SCt reversed • Under NH LLC Act member is not vicariously liable for LLC’s obligations • Here, Pl was attempting to hold member liable for his own negligence in managing the building and breaching his duty to avoid exposing tenants to unreasonable risk of harm • Pl claim should survive motion to dismiss 40
  • 42.
    Member Breach ofFiduciary Duty Cases • Member may be sued for breaching a fiduciary duty • Fiduciary duty may be based on LLC statute, OA provision, common law 41
  • 43.
    Gottsacker v. Monnier 2007Wisc. App. Lexis 68 • Background: – LLC had 3 members – Gregory, Paul, Julie; no OA; asset was a piece of real estate – Paul and Julie formed a new LLC w/o telling Gregory, voted to sell LLC’s real estate to new LLC – Gregory sued • Courts: – Trial court held willful unfairness requires both unfair conduct and resulting injury – WI S Ct - Sec. 183.0402 forbids willful unfairness • No member or manager shall act in a manner that constitutes a willful failure to deal fairly with LLC or members in connection with a matter in which member or manager has a conflict of interest – On remand, trial court found Paul and Julie did not violate Sec. 183.0402; appellate court affirmed – Certain actions of Paul and Julie could be construed as unfair • No notice of meeting or opportunity to vote on sale • No effort to find other buyers • Sale left LLC without assets – However result was not unfair • Even if allowed to vote Gregory could not have prevented sale • Purchase price was fair, it eliminated LLC’s debts and Gregory was paid his fair share 42
  • 44.
    Suits for Breachof OA • One issue is whether breach occurred • Another issue is if member breached OA, what is remedy? • Court can use equitable powers to fashion remedy 43
  • 45.
    Eureka VIII LLCv. Niagara Falls Holdings LLC 899 A.2d 95 (Del. Ch. 2006) – Decision affirmed by DE Supreme Ct (Niagara Falls Holding, LLC v. Eureka VIII LLC, No. 413, 2006 (Del. Supr. 2007) Background: – LLC formed to develop property – 2 members; Milstein provided financing, Cogan provided skills to operate business and licensing rights – Milstein invested based on Cogan’s know how and did not intend to be partners with anyone else – LLC agreement contained restrictions on transferability – Cogan went bankrupt and died, resulting in creditor taking over Cogan’s interest in LLC – Milstein sued for breach of LLC agreement’s transferability restrictions – Milstein sought a declaratory judgment that it was sole member - a remedy not provided for by LLC agreement or statute 44
  • 46.
    Eureka VIII LLCv. Niagara Falls Holdings LLC • Court: – Ch Ct found breaches occurred and declared that creditor had rights of assignee only and that Milstein was sole member – Court’s remedy based on Sec. 18-702 • Provides that member ceases to have rights and powers of member upon assignment • Policy – it is far more tolerable to suffer a new passive investor than a new co- manager • Although no assignment here, it was analogous situation • Breach of LLC agreement had same affect as if Cogan had assigned interest to creditor • Milstein should not be bound to manage and operate LLC with a co-member it did not choose • Creditor limited to financial interest 45
  • 47.
    Manager Breach ofFiduciary Duty Cases • May be brought by LLC or member • May be direct or derivative suit • Fiduciary duties may be imposed by OA, statute, or common law 46
  • 48.
    Wood v. Baum •953 A.2d 136 (Del. Supr. 2008) • Derivative suit alleging directors of public LLC breached fiduciary duties – Caused LLC to issue false financial statements, failed to institute controls over reporting • Plaintiff alleged demand futility based on directors’ substantial risk of liability • OA exempted directors from liability except in cases of fraud or illegal conduct • Del. S.Ct – directors’ exposure to liability was limited to claims that they knowingly engaged in fraudulent or illegal conduct or bad faith violation of implied contractual covenant of good faith and fair dealing 47
  • 49.
    Wood v. Baum •Court ruled plaintiff did not allege particularized facts that, if proven, would show that majority of directors faced liability • Complaint alleged directors engaged in following acts – Executed LLC’s publicly filed financial reports – Authorized certain transactions – Served on audit committee – Ignored red flags • Court ruled none of those acts established knowing participation in illegal conduct 48
  • 50.
    POLLING QUESTION #3 Are you familiar with the Delaware LLC fiduciary duties standards? A. Yes B. No 49
  • 51.
    Gatz Properties, LLCv. Auriga Capital Corp. 59 A.3d 1206 (Del Supr. 2012) • Case creating split over default fiduciary duties • Minority members sued manager alleging breach of fiduciary duties after he bought them out for price well below market value • Courts – Ch Ct holds that managers owe default fiduciary duties of care and loyalty – S Ct states that Ch Ct’s ruling that managers owe default fiduciary duties was dicta and had no precedential value • Where there is a contractual provision imposing fiduciary duties there is no need to decide if there are default duties • No party asked the Ch Ct to decide the issue • Reasonable minds can differ so it is up to General Assembly to clarify • Legislative reaction – Amendment to 18-1104 – In any case not provided for in this chapter, the rules of law and equity, including the rules of law and equity relating to fiduciary duties and the law merchant, shall govern 50
  • 52.
    Authority to ActCases • Informal manner in which LLC may be operated, combined with few statutory provisions … • Can lead to litigation over whether members or managers acting on behalf of LLC had authority to do so 51
  • 53.
    Maitland v. Int’lRegistries, LLC C.A. No. 3669-CC (Del. Ch. 2008) • Background: – LLC had 2 equal managing members (Maitland and Guida) – Maitland sued LLC to enforce inspection rights – Guida retained counsel for LLC, answer was filed – Maitland moved to strike answer and disqualify counsel on grounds that Guida lacked authority to retain counsel and file answer for LLC without Maitland’s assent • Chancery Court granted motion – LLC agreement stated that decision of majority of interests controlled – Statement in LLC agreement that members are granted all rights, powers, authority to manage LLC means that one member may manage when other is silent; does not give one member power to manage when other is opposed – Neither can unilaterally agree to retain counsel and file answer 52
  • 54.
    Statutory Treatment ofLLCs • Early question about LLCs – how would they be treated under statutes/regulations specifically dealing with corporations and/or partnerships but not LLCs? • Over the years some amendments have been made to clarify LLC treatment 53
  • 55.
    Champluvier v. Mississippi •942 So.2d 145 (Miss. 2006) • Example of how some statutes were amended after a court case alerted legislature to need • Champluvier was convicted of embezzling money from LLC she formed • Section of law she was convicted under applied to agents, officers, etc. of “incorporated company” • Mississippi Supreme Court overturned conviction because LLC is not an incorporated company • Section of law amended shortly thereafter to broaden application 54
  • 56.
    LLC Diversity Cases •Federal diversity jurisdiction requires plaintiffs and defendants to be citizens of different states • 28 USC 1332(c)(1) – corporations are citizens of state of incorporation and state where principal place of business is located • Issue – does Sec. 1332 (c)(1) apply to LLCs? • Nearly all US Courts of Appeal have dealt with the issue. Every one held that Sec. 1332 (c)(1) does not apply to LLCs – Congress chose to include corporations only – Up to Congress to amend to include LLCs • Current law – LLC is citizen of all states in which its members are citizens • Future – Will Congress or US SCt make a change? 55
  • 57.
    Cases Involving SingleMember LLCs • LLC acts generally written with multi-member LLCs in mind • Concept of SMLLC does not fit neatly in all provisions, especially those protecting members from actions of co-members • In some cases courts have declined to apply certain sections of LLC act to SMLLC 56
  • 58.
    In re Modanlo •2008 US App LEXIS (4th Cir.), affirming, In re Modanlo, 2006 Bankr. LEXIS 4524 (D.Md) • Member of DE SMLLC filed for bankruptcy • Bankruptcy trustee sought to manage LLC • Member argued trustee had, at best, rights of assignee, but no governance rights • Court held for trustee. Ruled three sections of DE LLC Act did not apply to SMLLC – Sec. 18-304 – default rule that member ceases to be member upon filing for bankruptcy – 18-702, 18-704 – default rules that assignee has no right to participate in management and may become member upon consent of all members – These sections are intended to protect member from actions of co-member. Not applicable when there is no co-member 57
  • 59.
    Olmstead v. FTC •44 So.3d 76 (Fla. 2010) • FTC obtained $10 million judgment against individuals who owned FL SMLLCs • 8th Cir certified question to FL SCt asking whether charging order provision of FL LLC act permits court to order a judgment debtor to surrender all rights, title, interest in debtor’s SMLLC to satisfy judgment • FL SCt ruled that FL law permits court to order surrender of full interest in SMLLC; court not limited to charging order – Charging order provision is part of section on assignee rights; requires consent of “all members other than member assigning interest” for assignee to take full interest. In SMLLC – no other members – Charging order is special remedy for creditor when debtor’s LLC interest is not fully transferable but subject to right of other members to object to transferee becoming member – LLC act provision does not state that charging order is exclusive remedy; in contrast, LP and GP provisions state remedy is exclusive • Aftermath – FL and other states amended LLC acts to specify that charging order provision applies to SMLLC 58
  • 60.
  • 61.
    The Uniformity Movement •LLC statutes may change if states adopt uniform and model acts • Uniformity movement – Began at end of 19th century because different and conflicting laws were creating confusion and hindering trade – Main drafting groups – NCCUSL and ABA • Model vs. uniform law – Model – template expected to be modified by each state rather than adopted in whole – Uniform – intended to be adopted without revision 60
  • 62.
    Revised Uniform LLCAct (RULLCA) • ULLCA adopted by NCCUSL in 1995 – Only nine states adopted • RULLCA adopted by NCCUSL in July 2006 – Drafters claim it reflects current LLC needs, goals, uses better than ULLCA – If drafters are correct, RULLCA may prove more popular with states than ULLCA – As of March 29, 2016 adopted by AL, CA, DC, FL, ID, IA, MN, NE, NJ, ND, SD, UT, VT, WA, WY (as per uniformlaws.org) – 2016 introductions: CT, IL, PA, SC • Formation document called certificate of organization – Signal that document reflects existence of LLC rather than location of governance rules 61
  • 63.
    RULLCA • Some ofthe innovations (according to the co-reporters) include the following • Emphasis on OA as foundational document • “Uncabining” of fiduciary duties – Instead of exhaustively codifying as in RUPA, ULPA, ULLCA, RULLCA partially codifies and increases power of OA to define • Restates duty of care – From gross negligence to simple negligence, subject to business judgment rule 62
  • 64.
    RULLCA • Eliminates statutoryapparent authority – Member of member managed LLC not an agent solely by being member – Power to bind based on agency principles • Permits filing of statement of authority – States authority or limitation of authority of person holding position to which statement relates • Creates statutory remedy for oppressive conduct by controlling member – Minority member may apply for dissolution – Court may grant other remedy • Does not include Series LLC provision 63
  • 65.
    Model Entity TransactionsAct (META) • Model act approved by NCCUSL and ABA in 2005 and amended in 2007 • Response to problems involving inter-entity mergers, conversions and other transactions involving different types of entities • Inter-entity transactions require compliance with statutes that differ in areas such as – Whether transaction is authorized – What entities may participate – What document is filed – Whether delayed effective date is allowed – Effect of transaction – Ability to abandon or amend plan 64
  • 66.
    META • Provides singleset of procedures for all entity types for – Multi-entity mergers – Multi-entity interest exchanges – Conversion – Domestication • States adopting would repeal provisions in LLC act and META would govern – As of March 29, 2016 adopted by AK, AZ, CT, DC, ID, KS, PA (as per uniformlaws.org) 65
  • 67.
    Model Registered AgentsAct (MoRAA) • Joint project of NCCUSL and ABA; approved in 2006 • Deals with registered agent issues • Applies to all forms of entities • As of March 29, 2016 adopted by AR, DC, ID, ME, MS, MT, NV, ND, SD, UT, WY (as per uniformlaws.org) 66
  • 68.
    Model Registered AgentsAct (MoRAA) • Provisions deal with – Addresses in filings – Content of filings appointing registered agent – How to change registered agent – Resignation of agent – Duties of registered agent – Eliminates publication and venue functions of registered office – Permits listing of commercial registered agent • Adopting state would repeal conflicting provisions from LLC statutes and MoRAA would govern 67
  • 69.
    Recap • Overview ofLLC law – Key features & events • LLC statutes today – “Typical” provisions governing formation, members, management, merger and conversion, compliance requirements, foreign LLC, dissolution, Delaware LLCs, Series LLCs – How and why they changed over the years • LLC case law today – Interpreting LLC statute and OA – Member and manager liability and authority to act – Treatment under certain statutes – Single member LLC • LLC law beyond today – RULLCA, META, MoRRA 68
  • 70.
    THANK YOU FORATTENDING LLC LAW TODAY & BEYOND - 2016 69