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|Posted: Sun Mar 01, 2015 6:42 pm Post subject: LECTURE OUTLINE FOR 3/5/15 PART TWO UPDATED
|BELOW IS THE OUTLINE FOR CHAPTER 39. YOU MAY OMIT READING PROFESSOR CHESEMAN'S CHAPTER 39 AND SUBSTITUTE THIS POSTING.
WE WILL PLAY A Q & A GAME WHEREIN POINTS TOWARD YOUR FIRST TEST WILL BE CREDITED BY YOU SUPPLYING THE CORRECT ANSWERS TO MY QUESTIONS. WE WILL GO IN ORDER OF THIS POSTING AND YOU MUST/SHOULD BRING IT WITH YOU.
Caveat: This download is based on my personal notes for the presentation of Chapter 39. It is provided for my students personal use and is not intended for distribution to others. It is protected by all applicable federal laws. As, until now, it’s been for my personal use it does contain grammatical errors and some spelling mistakes. I have not corrected all of these errors. SW
WITH THE EXCEPTION OF CASE INDICATED AS WITHIN THE BODY OF THE TEXTBOOK ALL CASES APPEAR IN THE BACK OF CHAPTER 39, PAGES 669-671
INTRODUCTION TO LLC’S
Use of LLCs as a form of conducting business in the United States is of rather recent origin. In 1977, Wyoming was the first state to enact legislation creating an LLC as a legal form for conducting business. This form of business received little attention until early 1990s, when several more states enacted legislation allowing creation of LLCs. Then use of LLCs grew at blinding speed, w/all states enacting LLC statutes by 1998. Most LLC laws are quite similar, although some differences do exist between these state statutes.
LLC unincorporated business entity combines the most favorable attributes of general partnerships, limited partnerships, and corporations. An LLC may elect to be taxed as a partnership, the owners can manage the business, and the owners have limited liability for debts and obligations of the partnership. Many entrepreneurs who begin new businesses choose the LLC as their legal form for conducting business.
LIMITED LIABILITY COMPANY (LLC)
“New form of business entity.” Creatures of state law and can only be created pursuant to the laws of the state in which the LLC is being organized, i.e.: they regulate formation, operation, and dissolution of LLCs and the state legislature may amend its LLC statute at any time. The courts interpret state LLC statutes to decide LLC and member disputes.
Unincorporated business entity combines most favorable attributes of general partnerships, limited partnerships, and corporations.
May elect to be taxed as a partnership, the owners can manage the business, and the owners have limited liability. Many entrepreneurs who begin new businesses choose LLC as their legal form for conducting business.
A limited liability company is a separate legal entity (or legal person) distinct from its members [ULLCA § 201]. Limited liability companies are treated as artificial persons who can sue or be sued, enter into and enforce contracts, hold title to and transfer property, and be found civilly and criminally liable for violations of law.
MEMBERS' LIMITED LIABILITY
OWNERS OF LLCS USUALLY CALLED MEMBERS. General rule members not personally liable to third parties for the debts, obligations, and liabilities of an LLC beyond their capital contribution. Members are said to have limited liability The debts, obligations, and liabilities of an LLC, whether arising from contracts, torts, or otherwise, are solely those of the LLC
SEE: 39.1 “Silva” P.661 BODY OF TEXT NOT BACK OF CHAPTER
NON TEXTBOOK EXAMPLE
J, S, and V form an LLC and each contributes $25K in capital. The LLC operates for a period of time during which it borrows money from banks and purchases goods on credit. After some time, the LLC experiences financial difficulty and goes out of business. If the LLC fails with $500,000 in debts. How much will each of the members lose?
THE UNIFORM LIMITED LIABILITY COMPANY ACT IN 1995 (ULLCA) REVISED 2006.
A model provides comprehensive and uniform laws for the formation, operation, and dissolution of LLCs.
DEFINITION OF LLC
COMBINES TAX BENEFITS OF A PARTNERSHIP WITH THE LIMITED PERSONAL LIABILITY ATTRIBUTES OF A CORPORATION.
NON TEXT EXAMPLE: T. D, and E, form a limited liability company called "Real Estate Developers, LLC." Each contributes $50,000 capital, and LLC then purchases a 400-acre parcel of vacant land 75 miles from Chicago. The LLC, wants to build tracts of homes on site. The owners of the LLC, go to Bank asking to borrow $100M to complete development and construction. Bank agrees to make loan, only if D agrees to personally guarantee LLCs loan and give security by pledging his 12-story penthouse in Manhattan, worth $100M, as collateral. D agrees signs personal guarantee pledges penthouse as collateral; Bank makes loan to LLC. LLC, makes regular interest payments on loan for one year then defaults with $100M still owed. Time of default, LLCs, only asset is 400-acre parcel of land that still worth $150,000. City Bank sues LLC, T, D, and E to recover the amount of the unpaid loan. Who is liable to City Bank?
Member Personally liable for the debts of an LLC only if agrees to be in either articles of organization or other writing, or if personally guarantees repayment of LLCs debts.
CASE 39.1 P. 669 DALE C. BONE
NON TEXT EXAMPLE: Patricia, Arnold, and Emory form a new LLC. Go to bank to have the LLC borrow funds, bank refuses unless members personally guarantee the loan. They all sign personal guarantees w/bank agreeing to repay loan if the LLC does not. If LLC fails to repay, bank may enforce personal guarantees and recover the amount of the loan from members.
FACTS: Nashville Pro Hockey LLC was a limited liability company in Tennessee that owned and operated the Nashville Nighthawks. Nashville Pro Hockey contracted with Creative Resource Management to provide employee leasing services to Nashville Pro Hockey. The contract was signed by Barry Soskin, president. The following language was in the contract: By affixing my hand and seal to this, I personally guarantee any/all payments payable. Nashville Pro Hockey failed, owing CRM about $30,000. CRM sued Nashville Pro Hockey and Barry Soskin. Soskin defended, alleging that his signature on the contract was in his representative capacity only and not in his individual capacity as a guarantor. The trial court agreed.
ISSUE: Did Soskin's signature on the contract constitute a personal guarantee for the payment of the debt of Nashville Pro Hockey, LLC, to CRM?
"CHECK-THE-BOX" REGULATIONS FOR PARTNERSHIP TAXATION OF LLCS
LLC) unincorporated business entity formed under state law. Neither partnership nor corporation, SO how taxed for federal income tax purposes.
INTERNAL REVENUE CODE
Not taxed at entity level: Income/losses "flow through" to the partners' individual income tax returns. Avoids double taxation.
Generally taxed once at entity level; then again if they pay dividends to shareholders, who must pay tax on these dividends when they file personal income tax returns. EQUALS: Double taxation.
OLDER IRS RULE REGARDING TAXING OF LLC's
Regulations LLC could be taxed as a partnership if it gave up two of following corporate attributes: (1) associates, (2) objective to carry on the business for a profit, (3) centralized management, (4) limited liability, (5) continuity of life, and (6) free ability for the transfer of interests.
To obtain partnership taxation, in most instances LLCs gave up continuity of life by stating a term for the LLC (e.g., 50 years) and free transferability of interests by agreeing to buy-and-sell agreements and other restrictions on the sale or transfer of their ownership interests.
IRS REGULATIONS EFFECTIVE JANUARY 1,1997,"CHECK-THE-BOX"
Easier LLCs taxed as partnerships. These regulations provide that a business entity falls into one of the following categories:
PER SE CORPORATIONS
Corporations incorporated under state law and taxed as corporations for federal income tax purposes.
Entities other than per se corporations. Eligible entities include unincorporated businesses with two or more owners, such as LLCs, LLPs, limited partnerships, and general partnerships. Taxed as a partnership unless it elects to be taxed as a corporation.
Taxed as a sole proprietorship unless owner elects to be taxed as a corporation.
Default rules provide eligible entities, such as an LLC, are treated as partnerships with flow-through taxation unless an election is made to be taxed as a corporation. This election is made by filing Form 8832 with the IRS and must be signed by all owners or a manager who is given authority to sign such an election. The Check-the-Box Regulations make it easier for LLCs to obtain partnership taxation status for federal income tax purposes. Most states automatically apply the federal classification rules for state income tax purposes, although a few do not.
By state statute with certain formalities
May be organized for any lawful purpose. Most organized to operate businesses, real estate developments, and such.
LLCs cannot conduct business in certain regulated industries, such as banking and insurance, unless they meet special requirements and obtain required licenses.
LLCs cannot operate the practice of certain professionals such as accountants, lawyers, and doctors. (Most states allow such as a limited liability partnership - discussed in Chapter 39).
SELECTING A STATE FOR ORGANIZATION
Organized in only one state; can conduct business in all other states. For convenience most, particularly smaller ones, choose the state in which the LLC will be doing most of its business.
SELECTING AN LLC'S NAME VERY STRICT RULE!!
Must ensure meets the states LLC code and is not already being used by another business. So organizers should take the following steps:
Name must contains the words "limited liability company" or "limited company" or the abbreviation "L.L.C," "LLC," "L.C.," or «LC." "Limited" may be abbreviated as "Ltd.," and "company" may be abbreviated as "Co."
Determine whether name federally trademarked by another company or business and therefore unavailable. (Trademark lawyers and specialized firms will conduct trademark searches for a fee.)
Determine whether similar to other nontrademarked names used by other businesses and therefore unavailable for use. (Lawyers and specialized firms wii conduct such searches for a fee.)
When name selected determined to be available, reserve name by filing application w/secretary of state of the state of organization. The name may be reserved for a nonrenewable period (e.g., 120 days). During this time, the organizers should complete the process of organization.
COMPARISON OF LLC AND S CORPORATIONS, PARTNERSHIPS
Why instead of an S Corporation or a partnership? S Corporations and partnerships are subject to many restrictions and adverse consequences that do not exist with an LLC. Some differences:
S Corporations cannot have shareholders other than estates, certain trusts, and individuals (who cannot be nonresident aliens)
S Corporations can have no more than 100 shareholders and one class of stock and may not own more than 80 percent of another corporation. LLCs have no such restrictions.
General partnership, partners personally liable for the obligations of partnership. CF.: Members of LLCs have limited liability.
Limited partnerships must have at least one general partner who is personally liable for obligations of partnership (although this partner can be a corporation) CF.: Limited partners precluded from participating in the management of the business. CF.: An LLC provides limited liability to all members, even though they participate in management of the business.
FILING THE ARTICLES OF ORGANIZATION
May be organized by one/more persons. (Ca. Corp. Code Section 17001) Sole proprietors can obtain the benefit of the limited liability shield of an LLC.
NON TEXT EXAMPLE: A, L, and R want to form limited liability company called "iToys.com, LLC,": sell toys over Internet. Hire Laura, a licensed practicing attorney, to do legal work to prepare and file articles of organization. Laura drafts articles and other required legal documents; has A, L, and R come to her office; they sign documents. Laura tells owners she will file articles w/secty of state that afternoon. Relying on this statement, next day A, L, and R obtain $500,000 bank loan in the name of the LLC. Laura, became busy doing other things, forgets to file Articles. One year later iToys.com goes bankrupt still owing $500,000 to Bank who sues iToys.com, LLC, A, L, and R to recover amount of the unpaid loan. Who is liable?
Formed by delivering articles of organization to the office of the secretary of state of the state of organization for filing. If in proper form, secretary of state will file the articles. Existence of LLC begins when articles of organization are filed. Filing of articles of organization by secretary of state is conclusive proof organizers have satisfied all conditions necessary to create the LLC.
Under ULLCA, Articles of organization of LLC must set forth:
Name;address of the LLC initial office;
Name and address of initial agent for service of process;
Name and address of each organizer;
Whether LLC is a term LLC and, if so, the term specified;
Whether the LLC is to be a manager-managed LLC, and, if so, the name and address of each manager;
Whether one or more of the members of the LLC are to be personally liable for the LLCs debts and obligations.
Articles of organization may set forth provisions from the members' operating agreement and any other matter not inconsistent with law.
A sample articles of organization: Exhibit 39.1 P. 657.
Articles of organization may be amended any time by filing articles of amendment w/Secretary of state.
Any person may request the secretary of state to furnish a certificate of existence for an LLC.
Anyone who suffers loss because of any false statement made in the articles of organization or amendments thereto may recover damages from the person who signed the document and knew that the statement was false [ULLCA § 209].
At-will unless designated a term LLC and the duration of the term is specified in the articles of organization. The duration of a term LLC may be specified in any manner that sets forth a specific and final date for the dissolution. EXAMPLE: Periods specified "50 years from date of filing of articles of organizations" or "the period ending January 1,2050" are valid to create a term LLC. An at-will LLC has no specified term.
Member's capital contribution may be form of money, personal property, real property, other tangible property, intangible property (e.g., a patent), services performed, contracts for services to be performed, promissory notes, or other agreements to contribute cash or property.
Member's obligation to contribute capital not excused by member's death, disability, or other inability to perform. If member cannot make required contribution of property/services then obligated to contribute money equal to the value of promised contribution. The LLC or any creditor who extended credit to LLC in reliance on the promised contribution may enforce the promised obligation.
AGENT FOR SERVICE OF PROCESS
Must designate to receive service of process, notices, and demands if the LLC is sued or involved in an administrative proceeding. Often the LLC's lawyer, although other persons may act. LLC must notify secretary of state if there is a change of the agent or if the agent's address changes.
CERTIFICATE OF INTEREST
Operating agreement may provide members ownership interest may be evidenced by a certificate of interest issued by the LLC, acts the same as a stock certificate issued by a corporation.
AN INTERESTING READ:
DreamWorks SKG, LLC: Script for a Movie Company
In 1995, Steven Spielberg, Jeffrey Katzenberg, and David Geffen formed DreamWorks SKG, major movie and recording production company. Spielberg's fame and money came from directing such films as E. T., Katzenberg was a leading executive at Disney, and Geffen built and sold Geffen Records. These multimillionaire, multimedia giants combined their talents to form a formidable entertainment company. Interestingly, DreamWorks was hatched as a Delaware limited liability company, or LLC. The organizers chose an LLC because it is taxed as a partnership and the profits (or losses) flow directly to the owners, but like a
corporation, owners are protected from personal beyond their capital contributions. DreamWorks issued several classes of stock, or interests. The three principals put up $100 million ($33.3 million each) for "SKG" stock, which grants the principals 100 percent voting control and 67 percent of the firm's profits. In addition, each principal has a seven-year employment contract that pays him $1 million annually,
plus other fringe benefits and perquisites on terms that are customary for similarly situated executives in the entertainment industry. DreamWorks raised the other $900 million of its $1 billion capital from other investors, who received a third of future profits. The other investors were issued the following classes of stock:
Class Investment A Outside investors. Class A stock was sold to big investors with over $20 million to invest. Microsoft's cofounder, Paul Alien, purchased $500 million of Class A stock.
Class A investors got seats on the board of directors.
Class S Outside investors.
Class S stock was issued for smallish, "strategic" investments with other companies for cross-marketing purposes.
Class E Employees. Employees were granted the right to participate in an employee stock purchase plan.
CONVERSION OF AN EXISTING BUSINESS TO AN LLC
Many LLCs formed by entrepreneurs to start new businesses. Additionally, many existing businesses may want to convert to obtain tax benefits and limited liability shield. Partnerships, limited partnerships, and corporations may be converted if the following requirements are met
1. An agreement of conversion drafted sets forth the terms of conversion 2. Terms of conversion approved by all parties or number or percentage of owners required for conversion.
Articles of organization filed w/Secretary of state, which must state the LLC previously another form of business and prior business's name.
Conversion takes effect when articles filed w/Secty. of state or at any later date specified in the articles of organization. When conversion takes effect all property owned by prior business vests in the LLC, and all debts obligations, and liabilities of prior business become those of the LLC.
LIABILITY FOR OBLIGATIONS OF PARTNERS WHEN CONVERSION TAKES PLACE
NON TEXT EXAMPLE: Gregory and Carol, general partners of a limited partnership called "Wash Me.": it owns/operates chain of car washes (in Memphis, Tennessee.) General partnership owes $65K to M.Bank for loan took out in 1998 to start business. In 2000, due to tax consequences and limited liability shield offered limited liability companies, Gregory and Carol convert general partnership to a limited liability company called "Wash Me, LLC.": $65K still owed M.Bank on partnership's loan. After conversion: LLC borrows $100K from C. Bank to expand. After one year, business fails w/$65K still owed M. Bank and $100K still owed C Bank. M. Bank and C. Bank sue Wash Me, LLC, Gregory, and Carol. Who is liable?
FOREIGN LIMITED LIABILITY COMPANY
Organized in one state may conduct business in another state. Called domestic LLC in state of organization. LLC is called foreign LLC in all other states which it conducts business To conduct business in another state, must obtain certificate of authority from Secty. of state. Requires foreign LLC file application. Alien LLC organized in a foreign country and doing business in the United States. In most states, alien LLCs are treated as foreign LLCs.
OPERATING A LIMITED LIABILITY COMPANY
POWERS OF AN LLC
Same powers as individual to do all things necessary or convenient to carry on its business or affairs. Include: Own and transfer personal property; sell, lease, and mortgage real property; make contracts and guarantees; borrow and lend money; issue notes and bonds; sue and be sued; and take other actions to conduct the affairs and business of the LLC.
Members may enter into operating agreement that regulates affairs of the company and conduct of its business and governs relations among the members, managers, and company. The operating agreement may be amended by the approval of all members unless otherwise provided in the agreement. The operating agreement and amendments may be oral but are usually written.
LIABILITY OF THE LLC
LLC liable for any loss/injury caused to anyone as result of wrongful act/omission by member/manager/agent/emloyee who commits wrongful act while acting in ordinary course of LLC business or w/authority of LCC. EXAMPLE Sable Silvia, and Samantha form SSS, LLC: owns and operates business. Each member contributes $10K capital. On LLC business, Sable drives her auto; accidently hits and injures Damon. Damon can recover damages for his injuries from Sable personally because she committed the negligent act and recover damages from SSS, LCC because Sable acting w/in course and scope of ordinary business. Silva and Samantha limited liability only up to the amount of their capital contribution. LLC Managers not personally liable for debts, obligations, and liabilities of LCC they manage.
EXAMPLE Real Estate Development LLC hires Sarah Goldstein, a non-member, to be its president. Acting w/in scope of LLC's authority, Sarah signs loan agreement, borrows $1M from bank (to complete construction of office building.) Subsequently LLC suffers financial difficulty and defaults. Sarah not personally responsible for the loan because she is the manager of the LLC. LLC liable for loan.
SEE: HYPOTHETICALS 39.2 and 39.3
Failure of LLC to observe usual company formalities not ground for imposing personal liability on the members. Example if LCC doesn't keep minutes of company's meetings, the members don't become personally liable for LCC's debts.
MEMBER-MANAGED LLC AND MANAGER-MANAGED LLC
SEE HYPOTHETICALS 39.4 AND 39.5
Member Managed LLC unless designated as manager-managed LLC in articles of organization.
Designation as member-managed or manager-managed is important in determining who has authority to bind LLC to contracts.
Member managed: All members have agency authority to bind. CF.:
Manager-managed: Only designated managers authority to bind; non-manager members not have such authority.
LLC only bound to contracts that are in the ordinary course of business or that the LLC has authorized.
Entrepreneur and the Law
MANAGEMENT OF A LIMITED LIABILITY COMPANY
Each member equal rights in management of business of the LLC, irrespective of the size of capital contribution. Any matter relating to business of LLC is decided by majority vote of members EXAMPLE A,J S, Lan-Wei, and I form NorthWest.com, LLC. A contributes $100K capital; other four members each $25K capital. Deciding whether/not add another line of products to business, S,Lan-Wei, I vote to add, A, and J vote against. The line is added to because the vote of members was 3-2. Immaterial two members who voted no contributed $125K in capital collectively versus $75K in capital by three members who voted yes.
Members and non members designated as managers control management. Members not managers no rights to manage LLC unless otherwise provided in operating agreement. Manager must be appointed by vote of majority of members; Managers may also be removed by vote of majority of members. In Manager-managed LLC, each manager equal rights in management and conduct of company's business. Any matter relating to business of LLC may be exclusively decided by managers by a majority vote of the managers.
Certain actions cannot be delegated to managers; must be voted on by all members. Include
Amending articles of organization
Amending the operating agreement,
Admitting new members
Consenting to dissolve the LLC
Consenting to merge the LLC with another entity, and
Selling, leasing, or disposing of all or substantially all of LLC's property
A member or manager may appoint a proxy to vote/otherwise act for them by signing an appropriate proxy card
RESTRICTIONS ON CONTRACTING AUTHORITY
SEE HYPOTHETICAL 39.6
Members/managers authority to bind LLC to contracts maybe restricted in either articles of organization or operating agreement, but restrictions on authority do not affect apparent authority to third parties who do not have notice of restriction. Restrictions in articles of organization that are filed w/ Secty of state are public and therefore considered proper notice; restrictions in an operating agreement do not give proper notice unless third party is directly notified of the restriction. EXAMPLE M, T, and S form Hampton, LLC. The operating agreement among members states S does not have power to bind contracts. Restriction not appear in articles of organization. S signs lease on behalf of the LLC with Xerox Corp. to lease copier. Xerox not made aware of restriction on authority; LLC is bound to lease.
ENTREPRENEUR AND THE LAW
DIVIDING LLC'S PROFITS AND LOSSES
SEE HYPOTHETICAL 39.7
Unless otherwise agreed member right to equal share in LLC's profits. Default rule and members can override by agreement by a provision in operating agreement. EXAMPLE Members may not want profits shared equally This would normally occur if capital contributions of members were unequal. If the members want the profits divided in same proportion as capital contributions, should be specified in operating agreement. EXAMPLE: L and H form LLC. L contributes $75K capital and Harrison $25K. No agreement how profits shared. LLC makes $100K in profits, L and H share profits equally $50K. To avoid: L and Harrison agree in operating agreement how want divided.
Losses shared equally unless otherwise agreed. Members who not want divide losses equally and maybe not even in same way as capital contributions. If LLC chosen to be taxed as partnership, losses from an LLC flow to members' individual income tax returns. Losses from LLC can sometimes be offset against members gains from other sources. Therefore, members may want to agree to divide losses so members who can use them to offset other income will receive greater share of the losses. Profits and losses from LLC do not have to be distributed in same proportion. EXAMPLE: Member right to a 10% share of profits may be given right to receive 25% of losses.
COMPENSATION AND REIMBURSEMENT OF LCC
Nonmanager member not entitled to remuneration for services performed, except for winding up the business.
Managers whether members or not are paid compensation and benefits as specified in employment agreements.
LLC obligated reimburse members and managers for payments made on behalf of the LLC (e.g., business expenses) and to indemnify members and managers for liabilities incurred in ordinary course of LLC business or in preservation of the LLC's business or property.
MEMBERS' DISTRIBUTION INTEREST
Member's ownership interest called a distributional interest. Member's distributional interest in an LLC is personal property and may be transferred in whole or part. Generally, transfer of an interest does not entitle transferee to become member of LLC or exercise any right of a member. Transfer entitles transferee to receive only distributions from the LLC to which the transferor would have been entitled. EXAMPLE C, H, and A are members of Boston Tea Party, LLC; each owns one-third interest members agree to divide distributions equally in one-third portions. C sells interest to T. LLC makes $99,999 in profits. T entitled to receive one-third of distributions ($33,333). T not a member of LLC.
HOWEVER: Transferee of distributional interest becomes member if provided in operating agreement or if all other members of LLC consent.
Transferee who transfers his or her distributional interest not released from liability for debts, obligations, and liabilities of the LLC .
A member has no interest in property of the LLC, however. Therefore, member has no transferable interest in property of the LLC. Consider EXAMPLE E, M, and H each own a one-third interest in New York Construction, LLC, The LLC owns 20 pieces of heavy construction equipment valued at $10 million. M transfers interest to V. V receives J's one-third interest in distributions of profits; V NOT receive
one-third ownership interest in individual pieces of equipment, however.
FIDUCIARY DUTIES OF LOYALTY AND CARE OWED TO LLC
Member of member-managed and manager of manager-managed LLC owe two fiduciary duties:
Duty of loyalty;
Duty of care
DUTY OF LOYALTY
SEE HYPOTHETICALS 39.6 AND 39.7
Must act honestly in dealings with the LLC. Includes duty not to usurp LLC's opportunities, make secret profits, secretly deal with the LLC, secretly compete with the LLC, or represent any interest adverse to that of the LLC. EXAMPLE: Making secret kickbacks on the purchase of goods; and transacting business with LLC w/o first disclosing position and obtaining approval from LLC are breaches of the duty of loyalty. EXAMPLE Viola is member of member-managed LLC, business of operating online auctions over Internet. Owner of Dolls & Toys.corn., LLC, a company that conducts online auctions over the Internet to sell Beanie Babies, Pokemon cards, and such, approaches Viola to inquire whether LLC, would interested in purchasing Dolls & Toys.com. Instead of disclosing this opportunity to her LLC, Viola pays asking price and personally purchases Dolls &Toys.com. Viola has breached duty of loyalty by usurping (stealing) an LLC opportunity. To legally purchases would have first had to offer opportunity to her LCC and give it reasonable time to accept or reject. Only if offer rejected or reasonable time passed is Viola free to purchase
Advanced Orthopedics, L.L.C. v. Moon
FACTS: Byron Heath and John Moon organized LLC called Advanced Orthopedics, LLC, in Louisiana. Supplied orthopedic devices to public. Two could not manage business together. Year later, Moon set up competing business and resigned from Advanced. Advanced filed petition for permanent injunction and damages against Moon, alleging Moon violated fiduciary duty of loyalty to Advanced by setting up his competing business while still a member-manager of Advanced. Moon claimed Advanced Orthopedics, LLC wasn't a legally formed LLC because he didn't have subjective intent to form LLC.
HISTORY: Trial Court granted injunction against Moon.
ISSUE: Was limited liability company formed by Heath and Moon, thereby justifying the trial court's finding Moon had violated his fiduciary duty of loyalty to Advanced?
LIMITED DUTY OF CARE OWED TO LLC
Member of member-managed LLC and manager of manager-managed LLC owe duty of care not to engage in:
Known violation of law.
Intentional, reckless or grossly negligent conduct that injures LLC.
This is limited duty of care because it does not include ordinary negligence, if not grossly negligent not liable to the LLC.
THIRD PARTY INJURY
SEE HYPOTHETICAL 39.7
LLC liable if third party injured by member of member-managed LLC or manager of manager-managed LLC acting on LLC business whether injury caused by known violation of law, intentional or reckless conduct, or gross or ordinary negligence. Member/manager also personally liable for injuries caused by ordinary negligence. EXAMPLE Charlene member of member-managed LLC. While engaging in LLC business driving an auto accidently hits Zubin, a pedestrian, and severely injures him. Under agency theory, Zubin sues the LLC and recovers $1 million in damages. If court determines that Charlene was ordinarily negligent when she caused accident, for example: she was driving the speed limit and did not see Zubin because the sun was in her eyes; she will not be liable to the LLC for any losses caused to the LLC by her negligence. If instead the court determines Charlene driving 65 mph in a 35 mph zone and thus grossly negligent, Charlene liable to LLC for the $1 million it was ordered to pay Zubin.
Duty of Good Faith and Fair Dealing
Obligation good faith and fair dealing on member of a
membermanaged LLC in discharging his or her duties to the LLC and other members. Members of member-managed LLC not only are held to express terms of LLC's articles of organization and operating agreement, but also required act in "good faith" and deal fairly all respects in achieving objectives of LLC. EXAMPLE: Edward, Elvira, and Estonia members:Book Publishers, LLC, a member-managed LLC. Business: 20 years old, originally formed to engage in hardcover book publishing. Business converted to LLC seven years ago w/stated purpose: engaging in book publishing. Today, Elvira sees opportunity for online publishing over Internet would like to do this herself. However, under doctrine of good faith and fair dealing, Elvira should take her idea for electronic online publishing to Edward and Estonia to see if they want to consider having Book Publishers, LLC, engage in this business. Even though the original business of the LLC is hardcover book publishing.
SEE HYPOTHETICAL 39.6
NO FIDUCIARY DUTY OWED BY A NONMANAGER-MEMBER
Member of manager-managed LLC not a manager owes no fiduciary duty of good faith and fair dealing to the LLC or its other members. Basically, nonmanager member of manager-managed LLC treated equally to a shareholder in a corporation. EXAMPLE Felicia member of 30-person manager-managed LLC engaged in buying, developing, and selling real estate. Felicia not manager, is just a member-owner. If third party approaches Felicia with opportunity to purchase large and valuable piece of real estate ripe for development, and price is below fair market value, Felicia owes no duty to offer opportunity to the LLC. May purchase for herself w/o violating any duty to the LLC.
DISSOLUTION AND WINDING-UP
Member of LLC power to disassociate from the LLC. Could cause dissolution of LLC. Other events also may cause dissolution of an LLC.
MEMBER'S DISASSOCIATION FROM AN LLC
If operating agreement does not provide otherwise, member has power to w/draw from both at-will LLC and term LLC by express will. The effects of w/drawyl remarkably different in each circumstance.
Disassociation from term LLC before expiration of specified term is wrongful.
Disassociation from at-will LLC not wrongful unless power to w/draw is eliminated in operating agreement.
Member who wrongfully disassociates liable to the LLC and to other members for any damages caused.
Member's disassociation terminates right to participate in management, acting as agent, or conducting business.
Disassociation also terminates disassociating members duties of loyalty and care to the LLC.
Member disassociates from at-will LLC w/o causing wrongful
disassociation, LLC must purchase the disassociated member's distributional interest. The price and terms may be fixed in the operating agreement. If the price not agreed upon in operating agreement, LLC must pay fair market value. LLC must make offer w/in 30 days after distributional interest vested. If parties not reach agreement w/in another 90 days, Member can bring action to have court determine fair market value.
Member disassociates from a term LLC, the LLC must only purchase the disassociating member's distributional interest on the expiration of the specified term.
Any damages caused by wrongful w/drawal must be offset against purchase price.
EXAMPLE: W, J, and G form LLC develop and produce new documentary film. Term three years. Each member contributes $100K capital and agrees, as member-managers, to work full-time on production of film. After one year, G decides to quit and disassociates. Several things happen: First, G has power to disassociate and may do so; thus, she is no longer member of the LLC. Second: Not have right to disassociate prior to expiration of term; so G liable for any damages caused by wrongful disassociation. Third: G not due any payment for distributional interest until end of term, and any damages caused by wrongful disassociation may be deducted from her distributional interest at that time.
NOTICE OF DISASSOCIATION
For two years after member disassociates from LLC that continues in business, disassociating member has apparent authority to bind LLC to contracts in the ordinary course of business except to parties who either (1) know of the disassociation or (2) are given notice. LLC can give constructive notice of member's disassociation by filing a statement of disassociation w/Secty. of state stating name of the LLC and name of member disassociated from LLC. Notice effective against any person who later deals with disassociated member, whether person aware of notice or not. EXAMPLE: W, J, and S members of member-managed LLC: operates auto dealership. J disassociates. LLC fails to file statement of disassociation w/Secty. of state. Jesse has no express agency authority to bind LLC to contracts because no longer member, J does have apparent authority to bind contracts in ordinary course of business for two years after disassociation or until files a statement.
CONTINUATION OF AN LLC
At expiration of the term some members may want to continue the LLC. Can be continued in two situations: First, Members may vote prior to the expiration date to continue for an additional specified term. Requires unanimous vote of all members and filing of amendment to articles of organization w/Secty of state stating this fact. Second, absent the unanimous vote maybe continued as at-will LLC by simple majority vote.
WINDING-UP AN LLC'S BUSINESS
If LLC is not continued, an LLC is wound up. Process of preserving and selling assets and distributing money and property to creditors and members.
After dissolution, any member not wrongfully disassociated may participate in winding-up. Member winding-up may preserve the LLC's business and property as a going concern for a reasonable time, dispose of and transfer LLC property, discharge the LLC's debt, settle and close the business, and distribute the assets of the LLC.
Assets must be applied to first pay off the creditors; thereafter the surplus amount distributed to members in equal shares unless the operating agreement provides otherwise. Good practice for members to specify in the operating agreement how distributions will be made to members.
After dissolution and winding-up, LLC may terminate existence by filing articles of termination w/Stay of state. The existence of the LLC is terminated upon the filing or upon a later effective date specified in the articles of termination.
SEE HYPOTHETICAL 39.8 (YOU MAY DISREGARD THE ETHICS PART OF THE QUESTION)