Ward on Iowa Limited Liability Company Law

Begin the New Year by Reading a Sample Operating Agreement!

As you know, tomorrow brings significant changes to Iowa limited liability companies.  All LLCs formed after today will be subject to new Iowa Code Chapter 489.  Existing LLCs will need to start transitioning to Chapter 489 effective January 1, 2011.  All operating agreements of LLCs formed prior to 2009 should be reviewed and necessary amendments made prior to December 31, 2010.

To assist in the process I have prepared a sample operating agreement based on the default provisions of Iowa Code Chapter 489.  You can find the form here.  It should be used as a guide only, modified to fit the needs of each particular situation.  Non-lawyers should not use it without consulting with a lawyer.

Have a happy New Year!

-Marc Ward

Yes, You Can Eliminate/Alter Fiduciary Duties of Officers

As you had better know in 8 days, Iowa Code Section 489.110(4) permits an operating agreement, so long as it is not manifestly unreasonable, to restrict or eliminate the duty of loyalty and "alter" the duty of care or any other fiduciary duty.  "Alter" means to make different, to change or modify, but implicitly not to eliminate.  Section 489.110(7) permits an operating agreement to eliminate a manager's liability to the LLC and the members for a breach of the duty of care (with certain exceptions).

The Delaware LLC law (18-1101(e)), similarly, also permits an operating agreement to eliminate any and all liability for a breach of any  fiduciary duty of a member, manager or other person.

This provision was put to the test recently in In re Heritage Organization, L.L.C., 2008 Bankr. LEXIS 3230 (N.D. Tex December 12, 2008).  The bankruptcy trustee attempted to hold two officers of the debtor liable for breach of their fiduciary duties to the company.  However, taking its cue from 18-1101(e), the Delaware LLC's operating agreement contained a shield from liability for its manager which said "The Manager shall not be required to exercise any particular standard of care, nor shall he owe any fiduciary duties to the Company or the other Members."  Several fiduciary duties were identified in a non-exhaustive list including the duty of care and the duty of loyalty.

The officers argued that because they acted as agents of the Manager (a corporation), the exculpatory language applied to them.  The trustee, naturally, argued that the exculpatory clause only applied to the manager, not the officers.  The court noted that it found the officers' agency theory "unpersuasive at this juncture" because from the record it was not clear if the individuals acted as agents of the manager "and thus protected pursuant to the terms of the exculpation clause itself" or as officers.

The court then went on to exam the operating agreement in terms of the duties owed by officers of the LLC.   The operating agreement permitted the Manager to appoint a president, one or more vice presidents, etc., and such "officers shall have such authority and perform such duties" as provided in the operating agreement.  Later, the operating agreement described the president to be "subject to the same duties and powers granted to the Manager."  The manager was also empowered to delegate any duties or powers upon such terms as may be designated in a written instrument."

As the court saw it, any duties imposed on the officers had to pass down from the manager.  Because there was no evidence that the manager had granted, prescribed or delegated any duties to the officers, the court was left with the provisions of the operating agreement.  The court concluded that the Heritage operating agreement "clearly contemplates that Heritage officers only owed those duties to Heritage that were either delegated or prescribed by Heritage's Manager or president."  Since no such delegation existed, there was no duty to breach.

It is also important to point out that the court dismissed the trustee's argument that there were common law fiduciary duties owed by the officers.  As "a creature of contract" the court noted, the operating agreement was controlling.

The lesson here is to consider officers when contemplating whether or not to impose fiduciary duties, including liability for breach, on the management of LLCs.

-Marc Ward

Information Rights Under the New Iowa LLC Law

Under Iowa Code 490A.709 the information obligation of Iowa LLCs and the rights to information of its members is straightforward and not unlike the corporate provisions (although probably honored in the breach).  That is about to change.

Pursuant to Iowa Code 489.410 there will no longer be any requirement to maintain any certain information at the principal offices of an LLC, but it is still a good idea to do so.

The bigger change, however, is the obligation, nay, the burden placed on LLCs.  The new law provides that "the company shall furnish to each member...without demand, any information concerning the company's activities, financial condition, and other circumstances which the company knows and is material to the proper exercise of the member's rights and duties under the operating agreement or this chapter."

In a manager-managed LLC the obligation is imposed on the managers. 

To put it differently, LLCs will have an affirmative duty to disclose all known information material to the member as a member. 

Of course, this duty is probably always present when an entity communicates with its owners.  The bigger question may be about the timing.  Is the duty applicable only when an LLC communicates with its member, only when it asks the members to vote or otherwise take some action, or must an LLC communicate with its members each time it becomes aware of a material piece of information? 

Section 489.110 permits LLCs to "reasonably restrict" information rights. It might make sense to restrict this duty of disclosure to those times when an LLC communicates with its members.

Members also have rights to seek information from the LLC subject to standards of reasonableness.

-Marc Ward

Ahhh, to be in Wilmington Now that Winter is Here

If you are a lawyer who represents a corporation located in Iowa but incorporated in Delaware and you have sent a document to CT Corporation or CSC in Delaware to be filed with the Delaware Secretary of State, you and your firm are subject to the jurisdiction of the Delaware courts.

In Sample v. Morgan, 935 A. 2d 1046 (Del. Ch. 2007), the court ruled that general outside counsel for an Ohio-based Delaware corporation, even though the law firm was based in Columbus, Ohio, was subject to Delaware's long-arm statute.  The law firm had prepared a certificate of amendment in Ohio and sent it to the Delaware office of CSC with instructions to file it with the Delaware Secretary of State.  The court concluded that this constituted transacting business in Delaware.  The law firm also provided general corporate advice to its client which naturally included interpretation of Delaware law, but the deciding factor seems to be the preparation and delivery of the certificate.

The court also concluded that this exercise of personal jurisdiction was consistent with the due process clause of the 14th Amendment to the US Constitution because the law firm should have "reasonably anticipated" that its actions might result in personal jurisdiction.

-Marc Ward

Finally, Some Piercing Sanity

In Aekyung Co., Ltd. v. Intra & Company, Inc, et al, 2008 U.S. Dist. LEXIS 96942 (SDNY Nov. 19, 2008), the federal district court considered piercing the corporate veil of corporation owned by a single shareholder.  In his decision, which is applicable to single member LLCs, Judge McKenna brought some sanity to the unpredictable world of veil piercing.

A judgment had been entered against Intra & Company, Inc., a corporation with only one shareholder.  Apparently, Intra did not have $1.8 million in its bank account so the plaintiff sought to pierce the corporate veil and obligate the sole shareholder to pay the judgment.

Under New York law to pierce the corporate veil there must be a showing that (1) the owner exercised complete domination of the corporation and (2) such domination was used to commit a fraud or wrong against the plaintiff resulting in injury to the plaintiff.

To show dominance of Intra by the sole shareholder the plaintiff alleged, among other things, (1) the rent on the shareholder's residence was paid from a corporate account, (2) Intra was administratively dissolved for over a year, (3) the corporation had no officers other than the sole shareholder and no minutes of shareholder or board meetings, (4) a single person was the sole shareholder, director and officer, and (5) this person was the only person who had the authority to bind the corporation or represent Intra.

Judge McKenna was dismissive of these claims noting that given the fact that this was a single shareholder corporation "it comes as no surprise that [he] was the only person with authority and the capacity to bind Intra...."

The fact that "a corporation is 'controlled or dominated by a single shareholder' cannot, by itself, cause veil piercing." (cite omitted).  More importantly, domination and fraud is not enough to pierce the corporate veil unless "the corporate form was itself used to effectuate the fraud." 

The court also noted that points (1) through (3) listed above were an insufficient basis to grant summary judgment.  This is important because it means that sloppy bookkeeping, inattention to corporate filings and formalities should not lead to personal liability.  To conclude otherwise would render the ability of a single person to own a corporation (or an LLC) for purposes of limiting liability a nullity.  While not to be condoned, the conduct must be connected to the fraud alleged in order to lead to a veil piercing.

-Marc Ward