Ward on Iowa Limited Liability Company Law

It Depends on the Meaning of "If"

Consider a partnership or LLC Agreement that says a partner/member may withdraw from the partnership/LLC "at any time if" (a), (b), (c) or (d) occur and if a partner/member withdrew for one of the four reasons, then specific consequences would result (termination of the partnership/LLC interest, etc.) Would you consider the four events to be the only reasons a partner/member could withdraw? Or does it just describe what happens if one of these four events occurs, leaving open the possibility that a partner/member may withdraw for other reasons without violating the partnership/LLC agreement?

In St. Alphonsus Diversified Care, Inc. v. MRI Associates, LLP, 2009 Ida. LEXIS 198 (Idaho Supreme Court, October 21, 2009), the court held the latter.  The court concluded that "if" was not exclusive, but really meant "in the event that."  With this meaning the pertinent provision of the partnership agreement merely described what happened under four circumstances resulting in a withdraw.  It did not prohibit other reasons for withdrawal.  The court went on to conclude that the partner's withdraw was not wrongful under the RULPA because it did not violate an "express provision" of the partnership agreement (same language can be found in the Iowa RULPA and the Iowa LLC Act, Section 489.601(2)(a)).

Based on this decision, to write an ironclad operating agreement provision limiting the right of a member to withdraw from an LLC do not use "if" but instead use something like this "A member shall not withdraw from the LLC except...." or "A member may only withdraw from the LLC under the following circumstances..."

-Marc Ward

Series LLCs, Better than Parent-Subsidiary?

There is a line of thought circulating among LLC commentators suggesting that Series LLC formed under the Delaware LLC Act not only creates a liability shield for the LLC against claims against a series (like a traditional parent-subsidiary corporate/LLC format) but also shields each series against claims against the LLC (not available to parent-subsidiary).

Take a look at Delaware LLC Act Section 18-215(b) and see what the fuss is about:

"...none of the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to the limited liability company generally or any other series thereof shall be enforceable against the assets of such series."

Fortunately or unfortunately, Iowa's new LLC Act does not have this language.  And of course, there is no case law on the subject.

-Marc Ward 

When Duties Shift - Cash Out Mergers

Shenker v. Laureate Education, Inc., (2009 Md. LEXIS 837, November 12, 2009) provides an interesting example of when the duties of a board shift from the corporation to the shareholders.  Most of the recent case law regarding the duties owed by boards of directors is derived from the Delaware business corporation act.  This case is an interpretation of the Maryland business corporation act which is very similar to the Model Business Corporation Act.  Therefore helpful in interpreting the Iowa Business Corporation Act.  Due to the sparsity of Iowa case law interpreting Chapter 490, we can use the help.

In Shenker the Board chair proposed that he would acquire the company by means of a cash out merger.  The Board established a committee of independent directors with the power to retain independent advisors to assess the offer.  After rejecting an initial offer and some further jousting between the offerors and several large institutional shareholders, the final offer was found to be fair by the independent advisors, Merrill Lynch and Morgan Stanley.  The special committee and the Board approved the offer.

A shareholder lawsuit ensued but was dismissed because it was filed as a direct action, not as a derivative action.  The lower courts held that the Board's statutory fiduciary duty ran only to the company and not the shareholders; any claims for breach of fiduciary duties must be brought derivatively.

The Maryland Court of Appeals disagreed. With the Delaware decisions in Revlon and Paramount Communications as a back drop, the court held that there are common law shareholder duties that are triggered once the decision to sell the corporation has been made.  The statutory duty of care regards the Board's duties in managing the corporation and is not exclusive of other duties.  In the case of a cash-out merger the Board assumes responsibilities to the shareholders and assume the duties of candor and maximizing the consideration paid for the stock. 

Important in the court's decision, as it points out, is the fact that because success in a derivative claim would benefit the corporation and hence all of the shareholders, the majority shareholders who were the alleged transgressors would have benefited as well.  This apparently didn't sit well with the court.

Of course in Iowa we have 490.202(2)(d) which, if properly reflected in the articles of incorporation precludes monetary liability on the part of directors for any of their actions or inactions unless the conduct (1) resulted in the directors receiving an improper financial benefit, (2) was an intentional infliction of harm, (3) resulted in an improper distribution or (4) was an intentional violation of criminal law.  Unless this section of the Code is found to be limited to the duty of care or only to statutory duties, Shenker will have little purchase in Iowa.

-Marc Ward

Derivative versus Direct Action

Imagine you are a 13% owner of an LLC.  The other two members own 60% and 27% of the LLC interests, respectively.  Your LLC owns and operates a restaurant.  You learn much to your dismay that two new restaurants open in surrounding communities.  Curious, you drop in for a meal at these establishments.  Lo and behold, the menus look surprisingly similar to your restaurant.  You dig a little further and discover that the owners of these new restaurants are also the members of your LLC.  Not only do the menu ideas appear derivative, you believe some of the assets and trade secrets from your restaurant are being used by the new ones.  Not happy, you bring a direct claim against your business colleagues.  They in turn move to dismiss because you lack standing to sue them directly.  Will their motion be successful?

In Ward v. Gamble, (2009 Conn. Super. LEXIS 2091) the court faced with these facts (I indulged in a little artistic license in my recounting of them) granted the motion to dismiss.  Unlike Iowa law, which I will get to in a minute, the Connecticut LLC Act does not address derivative actions so the court had to rely on a statute regarding corporate and unincorporated associations derivative actions. The court recited well-settled Connecticut law that in order to have standing the plaintiff must "demonstrate a specific, personal and legal interest in [the subject matter of the challenged action], as distinguished from a general interest" and this interest has been adversely affected by the actions of the defendants.

It then applied the general derivative statute to conclude that the plaintiff must bring a derivative action because the alleged injuries are not separate and distinct from those suffered by the LLC and its other members, even though the only other members of the LLC were the alleged wrong-doers.

Iowa Code 489.901 addresses direct actions by LLC members.  A member may bring a direct action against another member, manager or LLC "to enforce the member's rights and otherwise protect the member's interests.  The member must plead and prove injury that is not solely the result of an injury suffered by the LLC.

-Marc Ward

Special Merger Protections for Minority Shareholders

In 2005 John Q. Hammons Hotels, Inc. was sold to a private company.  The minority shareholders received $24 per share for their 24% interest and John Q. himself received different consideration for his 76% stake.  Hammond's consideration included a small stake in the buyer with a preferential buyout, a line of credit and other consideration.  The parties disagreed on whether his consideration was worth more or less than $24 per share.

The plaintiffs brought a class action alleging that Hammons and the board of directors breached their fiduciary duties by negotiating different consideration and allowing the merger to be approved through a deficient process, respectively.  In re John Q. Hammons Hotels, Inc. Shareholder Litigation (Del. Ch. October 2, 2009).

The plaintiffs argue that Kahn v. Lynch Communication Systems, Inc. is the controlling case.  In Lynch the Delaware court held that when a controlling shareholder makes a cash out merger offer to the minority the standard of review is entire fairness of the transaction and the burden is on the controlling shareholder.  The burden shifts to the plaintiff when the approval of the cash-out merger is required of (1) an independent committee of directors or (2) an informed majority of minority shareholders.  The defendants countered that the business judgment rule should apply because of the safeguards built into the deal.

The court in Hammons declined to find Lynch controlling because John Q was not the purchaser (i.e. not on both sides of the transaction. But it did find that the business judgment rule could not be invoked because the merger process was deficient. 

To make a long story short, in merger transactions involving a controlling shareholder (but not as buyer)the business judgment rule will not be available and instead entire fairness (fair dealing and fair price) will be applied unless (1) an independent committee of disinterested directors approve the deal and (2) a majority of the minority shareholders (not just those voting) approve the merger in a vote that is not waivable by the independent directors.  The court made clear that it was not enough that the committee did not waive even though they could have or a majority of all minority shareholders approved the merger even though only those attending the meeting were required to.  The form controls the substance in this regard.

-Marc Ward

Vermont's Virtual Farce: Corporate Law Changes Are No Improvement

The state of Vermont is getting some undeserved credit for adopting amendments to its corporate statute that permit so-called virtual corporations.  It is much ado about nothing.

A visiting law professor at New York Law School who doesn't know much about corporate law, David Johnson, is touting the changes as unique in the country.  They are not.  He makes a big deal out of the fact that Vermont corporations will no longer be required to hold face-to-face annual meetings (I can't help but think of the Town Hall meeting episode from "Newhart").  Iowa has permitted telephonic and video conference meetings for years, and written actions without a meeting have been around even longer.

Iowa, and many other states I am sure, is also ahead of Vermont when it comes to filing annual reports online and permitting electronic signatures.

There are unique aspects to the Vermont law.  Start with the name of the legislation, H.0888 Miscellaneous Tax Documents.  Yep. That is the name of the act.  In Iowa it would be unconstitutional.

But it gets better.  Vermont goes off the deep end in a number of places.  Notice to a shareholder can now be delivered by voice mail. (Is it delivered if not listened to?) And, get this, and I quote: "terms of shares may be made dependent upon facts objectively ascertainable outside the articles of incorporation."  Say What?  Are they serious or did the maple syrup ferment?

If anyone wants to read this zany bill you can get it here.

-Marc Ward