Ward on Iowa Limited Liability Company Law

Does 489 or 490A Apply to Foreign LLCs?

If you read the transition provisions of Iowa Code 489.1304 regarding the move from 490A (it still applies to LLCs formed before January 1, 2009 until January 1, 2011) to 489 you will not see the word "foreign." 

So let's say you have a client that is a foreign LLC.  It was formed in its home state several years ago and wants to come into the state for the first time.  It asks if it is required to register to do business in this state. 

Do you consult 490A or 489?  It matters because the rules for registering foreign LLCs are different under the two statutes.  For example, owning real property "without more" does not require registration under 490A but owning "income-producing" real property does under 489.

Iowa Code 489.1304 is of no help on its face, but I think it is reasonable to conclude that foreign LLCs coming into this state for the first time in 2009 and 2010 should be treated like newly formed domestic LLCs and 489 should apply.  Foreign LLCs that were in the state before 2009 should be able to continue to rely on 490A until January 1, 2011. 

Of course on January 1, 2011, 490A disappears and a lot of foreign LLCs will be required to register with the state.  An obligation that will probably be honored in the breach.

-Marc Ward

A Troubling Development out of Delaware re Operating Agreements

In Mickman v. Am. Int'l Processing, LLC, 2009 Del. LEXIS 43 (April 1, 2009) the Delaware Chancery Court drew this conclusion in a comparison to corporations: "Based on the flexible and less formal nature of LLCs, it is reasonable to consider evidence beyond the four corners of the operating agreement, where, as here, the plaintiff has presented admissible evidence that, notwithstanding the language of the operating agreement, suggests the parties to that agreement intended to make, and believed they had made, the plaintiff a member of the LLC."

At first blush I thought an integration/merger clause in the operating agreement would solve this or a provision requiring all amendments to be in writing.  The opinion is silent as to whether the operating agreement in this case contained such provisions.  But I am not so sure.  Then I remembered something from law school called the parol evidence rule and thought that should clear things up.  Nope.

In Iowa the parol evidence rule "forbids the use of extrinsic evidence to vary, add to, or subtract from a written agreement." Montgomery Props. Corp. v. Econ. Forms Corp, 305 NW 2d 470, 476 (Iowa 1981).  But this is limited to negotiations or agreements that are prior to or contemporaneous with the written instrument. Garland v. Brandstad, 648 NW 2d 65, 69 (Iowa 2002).

In this case you have an operating agreement that presumably identified two persons as the members of an LLC and extrinsic evidence after the fact (i.e. a tax return) showing three. 

I take exception with the Chancery Court that LLCs are less formal than corporations, less rigid, yes, and certainly more flexible, but in any case no less entitled to application of the same contract rules as apply to corporations.

The reason the Iowa LLC Committee adopted 489.111(4) (there is no comparable provision in the Uniform Act) was to avoid this situation.  Section 111(4) says "An operating agreement in a signed record that excludes modification or rescission except by a signed record cannot be otherwise modified or rescinded."

Is this court saying that such a limitation can be ignored because LLCs are informal organizations and members don't mean what they say in a contract?  I hope not.  It does reinforce in my mind the absolute necessity of restricting amendments to those that are in writing and agreed to by (usually) all of the members.

-Marc Ward

Another Reason to Stay Off the High Seas

Federal Maritime law appears to take an expansive view of the piercing the corporate veil doctrine.  The standard is to pierce the veil when to do so would "achieve an equitable result." Williamson v. Recovery Ltd. P'ship, 542 F.3d 43, 53 (2d Cir. 2008).  Ugh.  So its all about fairness?

In In re Rickmers Genoa Litigation, 2009 LEXIS 30430 (SDNY Mrch 31, 2009), the court applied a very inclusive and loose 15-factor test to determine whether to pierce the veil.  See if you recognize any of your clients here:

"(1) common or overlapping stock ownership between parent and subsidiary; (2) common or overlapping directors and officers; (3) use of same corporate office; (4) inadequate capitalization of subsidiary; (5) financing of subsidiary by parent; (6) parent exists solely as holding company of subsidiaries; (7) parent's use of subsidiaries' property and assets as its own; (8) informal intercorporate loan transactions; (9) incorporation of subsidiary caused by parent; (10) parent and subsidiary's filing of consolidated income tax returns; (11) decision-making for subsidiary by parent and principals; (12) subsidiary's directors do not act independently in interest of subsidiary but in interest of parent; (13) contracts between parent and subsidiary that are more favorable to parent; (14) non-observance of formal legal requirements; (15) existence of fraud, wrongdoing or injustice to third parties."

Ten out of 15 can easily apply to the most innocent of corporate structures.

Now watch how the court applies these factors.  The parentheticals are my commentary:

"Here, the evidence presented raises triable issues as to whether piercing the corporate veil is warranted. The Non-Moving Parties have pointed to the facts that: ESMT is a wholly-owned subsidiary of ESM Group and may have been created to circumvent U.S. import laws or obtain lower prices for certain materials previously imported by ESM Group ("circumvent" is a loaded term, how about minimize impact?  And lower prices are bad?); ESM Group directors sit on ESMT's board, sometimes constituting the entire ESMT board (not uncommon in small companies, particularly Iowa bank holding companies); ESM Group provides substantial financing to ESMT (a common reason to create a holding company is to raise capital); ESM Group designed ESMT's plant to manufacture SS-89 and supplied the capital, machinery, and expertise necessary to start the operation (sharing resouces); ESM Group developed the specifications for SS-89, gave that formula to ESMT (capital contribution), and instructed ESMT personnel on how to make SS-89; ESM Group conducts oversight of ESMT production facilities and procedures (sharing resources again); a significant majority of ESMT's output is sold to ESM Group, and ESM Group fulfills its SS-89 needs from ESMT (division of labor); although apparently sufficiently capitalized, ESMT's net profits were comparatively small in 2004 and 2005 (bad times?  poor management?). This evidence tends to show that ESMT was transacting ESM Group's business rather than its own business. Taking this evidence as a whole, it is sufficient to create a triable issue as to whether veil piercing is warranted in this case."

These cases give me the willies.

-Marc Ward

Delaware Refines the Breach of the Duty of Loyalty

In Lyondell Chemical Company v. Ryan, 2009 Del. LEXIS 152 (March 25, 2009) the Delaware Supreme Court clarified what it means for directors to breach their duty of loyalty by failing to act in good faith.  Recent decisions on this issue include In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del. 2006) and Stone v. Ritter, 911 A2d 362 (Del. 2006).

Lyondell concerns the sale of the company, at the time the third largest independent publicly traded chemical company in North America, to Basell AF, a private Luxembourg company.  Basell first made an overture to the Lyondell in April 2006; an overture that was rebuffed by the Lyondell CEO out of hand.  About a year later, in May 2007, Basell made a 13D filing with the SEC indicating its interest in acquiring Lyondell.

The Lyondell board immediately held a meeting to discuss the 13D filing and decided that although the company appeared to be "in play" to adopt a "wait and see" approach.  Two months went by with the Lyondell board doing nothing further regarding the company's potential sale.

On July 9, 2007 discussions between the two CEOs heated up resulting in an offer of $48 per share, no financing contingency, a $400 million break up fee and a requirement to sign a merger agreement by July 16.

On July 10 and 11 the Lyondell board met twice for no more than an hour each time to review the proposal, the possibility that others might be interested in buying the company, and to retain a financial advisor.

On July 12 the board met again to instruct the CEO to seek a higher price, a go-shop clause, and a reduction in the break-up fee.  These negotiations resulted in only the break-up fee being reduced to $385 million.

On July 16 the board met again, this time to review the financial advisor's opinion that the $48 per share offer was fair as well as its belief that no other entities would top this offer.  The board approved the merger and recommended it to the shareholders.

Because Lyondell's charter contained a section 102(b)(7) exculpatory provision protecting the directors from personal liability for breaches of the duty of care, the plaintiff alleged a breach of the duty of loyalty.  Since the board was found to be independent and not motivated by self-interest or ill will, the breach of the duty of loyalty claim was further narrowed to whether the directors failed to act in good faith.  The Chancery Court concluded they had.  The Supreme Court reversed.

Applying Walt Disney and Stone, the question, according to the Supreme Court, was whether the board's actions were an "intentional dereliction of duty, a conscious disregard for one's responsibilities" (quoting Walt Disney).  Under this standard the court could only impose liability if there is "a showing that the directors knew that they were not discharging their fiduciary obligations" (quoting Stone).

The Delaware Supreme Court also noted that the Chancery Court misapplied Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A2d 173 (Del. 1986).  It did this by applying the Revlon duties (maximize shareholder value) before the board had decided to sell the company or the sale had become inevitable.  Further, the Chancery Court wrongly concluded that Revlon imposed a set of requirements on a board that must be met during the sale process.  And third, the court had wrongly concluded that failure to meet the Revlon standard was the equivalent of "a knowing disregard of one's duties that constitutes bad faith."  (It is a breach of the duty of care.)

The Chancery Court had determinedthat the inaction of the Lyondell board between May and July was the key to the finding of a breach of the duty of loyalty.  The Supreme Court disagreed.  The Revlon duties to find the best price do not kick in when a company is "in play" but when a sale becomes inevitable.  In this case, the Revlon duties did not begin until July 10.  The Supreme Court noted that it was possible that the Revlon duties might not have been met since the board did not conduct an auction or a market check to get the best price, but these were due care considerations when the only legal issue was whether the board failed to act in good faith.

The Supreme Court found a "vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties."   It takes "an extreme set of facts" to make a claim of disloyalty stick.  In this case the failure of the directors to do all they should have done might be a breach of the duty of care, but they would have had to "knowingly and completely failed to undertake their responsibilities" in order to have breached their duty of loyalty.

This case is a very important explanation of Walt Disney and Stone (as well as In re Lear Corp Shareholder Litig., 2008 LEXIS 121).  It seems the Court realized it had not been clear enough or had left the impression in those earlier cases that the standard for finding a breach of the duty of loyalty for failure to act in good faith was not as high as it clearly is in Lyondell.

-Marc Ward

Default Language that Didn't Go Away

Both the Iowa Uniform Limited Partnership Act (Iowa Code Chapter 488) and the new LLC Act (Iowa Code Chapter 489) provide statutory default language that a partnership agreement or LLC operating agreement can only be amended by the unanimous consent of the partners or members.  The unanimity requirement can be overridden by the terms of the respective agreements.  Oh, really?

Not so held the In re: LJM2 Co-Investment, L.P. Limited Partners Litigation court.  The opinion of the Delaware Chancery Court can be found at 866 A. 2d 762 (2004).

The limited partners of LJM2 tried to weasel out of their obligation to heed a capital call by amending the limited partnership agreement to eliminate the obligation (after the general partner had properly made the call!).  They also canned the general partner, replacing it with a more friendly one.

A majority of the limited partners, but not all of the limited partners approved the amendments.  The limited partners relied on a provision of the agreement that authorized amendments "in any respect" upon the agreement of a majority of the limited partners.  However, this provision contained the proviso, and possible boilerplate term, that no amendment could change the percentage necessary for any consent unless the amendment was approved by the same percentage.  So what is the catch?

The Delaware RULPA contained a default provision that an obligation of a limited partner to make a contribution may be compromised only by the consent of all partners.  Iowa has a similar provision at Iowa Code Section 488.502.  The Delaware Court read this default provision into the partnership agreement notwithstanding the "in any respect" language.

This decision should be a concern for Iowa limited partnerships since the Delaware and Iowa RULPAs are very similar.  It is not an issue for Iowa LLCs because there is no similar provision regarding obligations to make agreed to capital contributions.

-Marc Ward

Court: Deferred Comp Plan Can Be Forfeited if Non-Compete Violated

In Lindsay vs. Cottingham & Butler Insurance Services, Inc., (Iowa Supreme Court, March 27, 2009), Lindsay had worked for C&B as an account executive from 1987 until 2001.  During in his employment, C&B provided Lindsay with a deferred compensation plan that was “in consideration of (his past) and future services.”  The plan provided for 120 months of deferred compensation, dependent upon Lindsay’s years of service.  The plan also contained a ten (10) year non-compete agreement which provided in part that he would be available to advise the company after his retirement from active service and must represent the company well to clients and the community.  It also stated that Lindsay was not to compete with the company during the retirement period in any manner in order to be eligible to receive deferred compensation benefits.  Although the plan provided that C&B’s Board could decide to suspend or terminate payments under the plan, the Board’s decision would be final.

 

            At the time Lindsay left C&B, he declined to take the deferred compensation payments immediately; he preferred to wait until he was 55 in order to avoid the early payment discount.  During the “exit” meeting, C&B representatives explained that they expected Lindsay to comply with the non-compete provisions of the deferred compensation plan.  Instead, after leaving C&B, Lindsay worked with another insurance sales agency and was advised by C&B that he could be in violation of the deferred compensation agreement.  Later, Lindsay went to yet another benefits and insurance brokerage firm which was in direct competition with C&B.  At that firm, Lindsay worked with two clients with whom he had contact with while he was with C&B. 

 

            The lower court found that Lindsay had violated the deferred compensation plan by soliciting and accepting C&B clients while with his new employer.  Lindsay argued that the non-compete provisions that were contained in the plan were unconscionable and unenforceable under Iowa law because it does not contain reasonable limits as to time and area.  Lindsay appealed to the Iowa Supreme Court.  The Court found that ERISA covered the plan and, therefore, federal law rather than state law determines whether the plan’s non-compete forfeiture provisions can be enforced. 

 

-Rebecca Dublinske

rdublinske@dickinsonlaw.com

8th Circuit Makes General Contractors their "Brother's Keeper"

On February 26, 2009, in Secretary of Labor v. Summit Contractors, Inc., 2009 U.S. App. LEXIS 3755, the United States Court of Appeals for the Eighth Circuit overturned the decision of the Occupational Safety and Health Review Commission (“OSHRC”) and held that a controlling employer can be cited for OSHA violations even when it did not create the hazard and none of its employees were even exposed to the hazard giving rise to the citation. 
 
Summit Contractors (Summit) was the general contractor for a construction project in Little Rock, Arkansas.  It subcontracted the entire project, and therefore had only 4 employees on the site:  a project superintendent and three assistant superintendents.  All Phase Construction (All Phase) was the subcontractor responsible for the exterior brick masonry work.  On two or three occasions Summit’s project superintendent observed All Phase employees operating without personal fall protection on scaffolds lacking guard rails.  The superintendent advised All Phase to correct the problems; however, when the All Phase employees moved the scaffold to another location, they would again work without fall protection and guardrails.  None of Summit’s employees were exposed to the hazard. 
 
An OSHA Compliance Safety and Health Officer observed All Phase employees working on scaffolds over ten feet above ground without fall protection or guardrails.  In addition to citing All Phase, the officer issued a citation to Summit, based on OSHA’s controlling employer citation policy.   That policy provides that OSHA may issue citations to general contractors at construction sites who have the ability to prevent or abate hazardous conditions created by subcontractors through the reasonable exercise of supervisory authority, regardless of whether the general contractor created the hazard or whether the general contractor’s own employees were exposed to the hazard.
 
The OSHRC had held that the multi-employer policy violated 29 C.F.R. §1910.12(a), which provides:
The standards prescribed in part 1926 of this chapter are adopted as occupational safety and health standards under section 6 of the Act and shall apply, according to the provisions thereof, to every employment and place of employment of every employee engaged in construction work.  Each employer shall protect the employment and places of employment of each of his employees engaged in construction work by complying with the appropriate standards prescribed in this paragraph.
 
The Eighth Circuit concluded that the plain language of the regulation does not preclude the Secretary of Labor’s controlling employer citation policy and therefore the Commission abused its discretion in determining that the controlling employer citation policy conflicted with § 1910.12(a). 
 
As the Eighth Circuit acknowledged, the controlling employer citation policy places an enormous responsibility on a general contractor to monitor all employees and all aspects of the worksite.   “Control” resulting to exposure to a citation under the policy can be established by contract, or by the exercise of control in practice.  Even in the absence of explicit contract provisions granting the right to control safety, or where the contract says the employer does not have such a right, an employer may still be found to be a controlling employer, based on a combination of contractual rights that give it broad responsibility at the site involving almost all aspects of the job.  Responsibilities of key significance in this analysis include the authority to resolve disputes between subcontractors and  set schedules and determine construction sequencing, because of the likelihood that these matters may affect safety. 
 
It is of small consolation that the standard OSHA will use to determine if the controlling employer exercised reasonable care to prevent and detect violations on the site is a lower one than that required of an employer with respect to protecting its own employees. How frequently and closely a controlling employer must inspect to meet its standard of reasonable care will depend upon the scale of the project, the nature and pace of the work, and how much the controlling employer knows about the safety history and practices of the employer it controls.  More frequent inspections are needed if the controlling employer knows that the other employer has a history of non-compliance, or, at the beginning of a project if the controlling employer has no knowledge of the other employer’s compliance history. 
 
Challenges to OSHA’s controlling employer citation policy can be expected to continue.  The two to one decision in Summit was a narrow one and it included a vigorous dissenting opinion.  The decision did not evaluate OSHA’s overall multi-employer citation policy and, although the issue was not raised by the parties, the Court suggested that OSHA may need to submit the policy to the informal rulemaking process for continued use in enforcement.  Nevertheless, at the present time, general contractors and construction managers must be vigilant in their supervision of the worksite to avoid liability for the safety infractions of other employers. 

-Joan Fletcher

jfletcher@dickinsonlaw.com