Ward on Iowa Limited Liability Company Law

Another Eerie SMLLC Piercing Case

Fortunately, most piercing the veil cases include a member/shareholder who deserves to be punished.  As a matter of fact I think most piercing cases are decided based on how badly the court wants to nail the SOB.

Alan Kosinski operated a night club on Salisbury Beach in Massachusetts called "Boston Waves."  He used greatly exaggerated projections of profit and misrepresented the term of the night club lease as 20 years instead of two in order to con $75,000 out of poor Mr. Douglas.  Needless to say "Boston Waves" didn't do so well.  Troubles with keeping a liquor license and a disastrous non-appearance by Snoop Dogg (but a SWAT team showed up) did the club in.  Mr. Douglas sued in Bankruptcy court to hold Kosinski personally liable on his loan to Boston Waves, LLC.

Now it was evident that Kosinski could be seen as a con artist.  He ran some of the dubious real estate seminars where everybody is told they can make a fortune.  His financial projections were probably fantasy, although in his defense the club did not take off as anticipated and the term of the lease turned out to be irrelevant because the club folded within a single summer season.

Nevertheless, after citing the usual litany of factors a court will consider in deciding whether to pierce the veil of an LLC (including the rather frightening "insolvency at the time of the litigated transaction") the court held Kosinski personally liable for the debt to Douglas.

The court stated as reasons for piercing the veil "Kosinski's persuasive control of Boston Waves, the absence of corporate [sic] record, and thin capitalization or insolvency, as well as use of the limited liability company to promote fraud."  In re Alan D. Kosinski, 2009 Bankr. LEXIS 192 (US Bankr. Ct. Mass. 2/4/09).

Here is the rub.  There was no evidence presented in the opinion to suggest that there was an absence of business records or thin capitalization or insolvency.  It is not even clear that Kosinski was the only member of the LLC. The court's conclusion turned on, albeit, a rather dubious set of profit & loss statements and the misrepresentation of the term of the lease.  However, P&L statements don't reflect the capitalization of the company, particularly ones that are projections not a reflection of past or current performance.

This case seems to have been decided purely on the basis of the judge wanting to stick it to a perceived con man.  That is not to say the outcome is wrong, but the reasoning is shaky.

-Marc Ward

Expediency Kills

One of my three rules of life is the little things get you down (the other two will have to wait for another day).  Kwok v. Transnation Title Insurance Company (Los Angeles County Super. Ct. No. EC044350, filed 2/10/09) is a case on point.

The plaintiffs, a husband and wife, each owned a 50 percent interest in an LLC that in turn owned real property on which a house was constructed for investment purposes.  At the time of the purchase the the defendant issued a standard title insurance policy.  The LLC was the only insured.  The definition of "insured" included those who succeeded to the interest of the named insured "by operation of law."

A dispute arose with the owners of an adjacent property over access to an easement for sewer and drainage.  Construction was delayed, the real estate market tanked, and the plaintiffs decided to move into the residence constructed on the property and rent their existing home until the market improved.

On September 21, 2005, the LLC transferred the property to the plaintiffs as trustees of a revocable trust.  On December 15 of that year a certificate of dissolution was filed stating that the LLC had been dissolved.

Because the easement dispute could not be resolved the plaintiffs filed a claim with the title insurance company under the policy.  Defendant denied coverage on the grounds that the property had been transferred by a voluntary act to a separate legal entity and not by operation of law.  The letter of denial noted that plaintiffs had not purchased an additional endorsement covering transfers to a separate legal entity.  The trial court granted the title company's motion for summary judgment and the appellate court affirmed holding that the transfer was a voluntary act to a separate legal entity and not one arising by operation of law.

Had the property been transferred to the members qua members by virtue of the dissolution of the company it would have been a transfer by operation of law. The plaintiffs skipped a step.  They should have transferred their LLC interest to themselves as trustees of the revocable trust and then dissolved the LLC.  The property would have been distributed to the trust by operation of law and the title insurance would have remained available.

A similar Maryland case had the same result.  Gebhardt v. Family Inv., LLC v. Nations Title Ins. of N.Y., Inc., 132 Md. App. 457 (2000).

Watch out for the little things.

-Marc Ward

Be Careful What You Wish For!

In Fuiaxis v. 111 Huron Street, LLC, 2009 WL 203625 (N.Y. A.D. 2 Dept. 2009) the plaintiff got hoisted on the operating agreement.

Fuiaxis withdrew from an LLC and then brought an action against the LLC and the three remaining members for among other things judicial dissolution.  The LLC and the three defendants turned around and made a demand on the plaintiff for $10,000 to defend the litigation and to pay for fines imposed by the City of New York for boiler violations.

The demand was based on paragraph 17 of the operating agreement which permitted the LLC to make a capital call on the members and allowed the membership interest of a defaulting member to be purchased by the other members.  The court refused the plaintiff's request that the demand not be enforced because the New York LLC Act authorized such a demand.  Ouch!

My thanks to Professor Dan Kleinberger for bringing this case to my attention via the lnet-llc list serve.

-Marc Ward

Is it a Partnership or a Joint Venture?

The Idaho Supreme Court handed down a decision distinguishing a partnership from a joint venture.  In Costa v. Borges, 179 P.3d 316 (Idaho 2008) the court dealt with a dispute between two real estate developers who had an oral agreement to develop some property.  The Court followed the general rule that a partnership is formed to carry on a business generally and a joint venture has but a single business purpose.

The upshot of the holding is a joint venture cannot avail itself of the portion of the Revised Uniform Partnership Act that views a partnership to be an entity distinct from its partners and permits a partnership to continue after dissociation of a partner.  The Court also confusingly notes that RUPA should be applied to resolve the case, but then pointedly does not.

Iowa law is similarly confusing.

In Fitzhugh v. Thode, 265 N.W. 893 (Iowa 1936)  the Iowa Supreme Court, said  that "although courts in modern times do not treat a joint venture as identical with a partnership, it is so similar in its nature and in the contractual relationships created by such adventure that the rights as between themselves are governed practically by the same rules that govern partnerships. As some of the courts hold, while a partnership is ordinarily formed for the transaction of general business of a particular kind, a joint adventure, as a rule, relates to the single transaction, although it may comprehend a business to be continued for a period of years."

In Beck v. Rounds, 332 NW 2d 109 (1982)  the Iowa Court of  Appeals said "We also agree with the agency's finding that petitioners were engaged in a partnership and/or joint venture. The district court noted that petitioners had an agreement in which they pooled their money, their farm equipment, their labor and skill in the farming  operation, and that they agreed to divide the profits and share the losses....A joint venture is characterized as a business enterprise carried on for profit, and as a common undertaking in which the parties combine their property, money, efforts, skill or knowledge. A joint venture relates to a single transaction, whereas a partnership, having the above characteristics, relates to a continuing business [cite omitted].... The business relationship of Glenn and William Beck can be characterized as either a joint venture or a partnership...."

The obvious point is avoid oral agreements!

-Marc Ward

Florida Charging Order Decision Expected Soon

Readers under the age of 50 might remember when I wrote about FTC v. Olmstead, et al, 2008 US App LEXIS 11393 (May 29, 2008)  back on June 2, 2008.  This is the case to decide whether under Florida law the charging order provisions of the Florida LLC Act could deflect a creditor's attempt to get voting control of a single member LLC.  The charging order provision of the Florida act is identical to the charging order provisions under Iowa Code Chapter 490A, but much different than Chapter 489.

The Florida Supreme Court heard oral arguments on the case on January 8, 2009.  Here is a link to a summary of those arguments.  http://tinyurl.com/cylz7h

-Marc Ward

Errant Section of Chapter 489 to be Deleted

Section 489.407(2)(f) of the new Iowa LLC Act will be stricken from the law by the Legislature this session.  This section was added by the Iowa LLC Committee in an attempt to cover what was perceived to be a gap in the uniform law dealing with those events that required the unanimous consent of the members to undertake (unless, of course, the operating agreement provided otherwise).

We had added (f) as a new provision that read as follows "Approve a merger, conversion, or domestication under article 10."

Upon reflection it was concluded that Article 10 and 407(2)(d) adequately addressed this matter and we had forgotten to state the approval required in any event.  Our bad.

-Marc Ward

Walker, Ward and Nelson to Write Sample Forms

David Walker and I have been tapped to write sample forms for the Iowa State Bar Association's Business Law Manual.  Chris Nelson of the Belin law firm will also assist.  We expect to have the samples ready this Spring and include a form for the Statement of Authority.

Updated Operating Agreement Available

Thanks to Dell Richard of Coralville a couple of erroneous cross-references in my sample operating agreement have been corrected.  They appeared in Section 4.03.  The revised operating agreement is available here.

-Marc Ward