Ward on Iowa Limited Liability Company Law

Restraints on Alienation

The Bankruptcy Appellate Panel for the Sixth Circuit handed down a decision recently that at first blush might give business lawyers pause.  In re Hake, 2009 Bankr. LEXIS 3825 (November 4, 2009) holds that an agreement among shareholders requiring the consent of the other shareholders before stock can be transferred is an unreasonable restraint on alienation under Ohio law.  Curiously, the decision was rendered on the basis of a 1945 Ohio Court of Common Pleas opinion and a 1910 Ohio Supreme Court opinion without referencing the Ohio corporate law statute.  What the panel fails to point out is that this restriction was voluntarily entered into by the owners of the enterprise and was now being undone by the court.  What about freedom of contract?

 

Iowa lawyers have no reason to fear this decision, however.  We here in the Hawkeye state take a much more modern view of stock or unit transfers.  The new Iowa LLC Act only makes one reference to transfer restrictions.  In 489.502(6) the law says “A transfer of a transferable interest in violation of a restriction on transfer contained in the operating agreement or another agreement to which the transferor is a party is ineffective as to a person having notice of the restriction at the time of transfer.”  Restrictions are thus implicitly recognized in Chapter 489 and since 489.110 dictates that the operating agreement governs the relations of members as members it is safe to say that the operating agreement restrictions on transfer will control. In addition, unlike Ohio, I could not find an Iowa court opinion striking down a stock transfer restriction on the basis of restraint of alienation.  And Iowa corporate law offers strong evidence that requiring the consent of the other members/shareholders before a transfer is valid would be upheld in Iowa.

Iowa Code Section 490.627 says that the articles, bylaws or agreement among the shareholders may impose restrictions on stock transfers so long as the restriction is for a reasonable purpose and lists as one persmissable restriction requiring the corporation, the holders of shares or another person to approve the transfer “if the requirement is not manifestly unreasonable.” 

Not sure how to balance “reasonable purpose” against a restriction that is not “manifestly unreasonable” but it seems to me that a restriction recognized by statute has to be given a presumption of validity and not wanting unknown outsiders to become part owners of a company is certainly reasonable and one of the main underlying reasons for entering into such restrictive agreements.

So, what does manifestly mean?  One author has noted, although "numerous cases apply the concept they rarely explain why a provision is found manifestly unreasonable.” The Official Comments to the UCC suggest that a "manifestly unreasonable" provision might be equated to an "obviously unfair" provision. Other commentators say it is falls somewhere between "unreasonable and unconscionable" or "passing beyond the outer limits of permissiveness."  Perfectly clear, right?

 

-Marc Ward

Another Worrisome Piercing Case

This time it's the US District Court for the Southern District of Georgia that is the culprit.  Let's hope the context of this ruling is important.  The issue was one of venue, not liability.  Here are the relevant facts.

Rayonier Wood Products bought a lumber grading system from ScanWare. FinScan, a Finnish company, was not a party to the contract  and at the time was only a minority owner of ScanWare.  About 15 months later FinScan acquired 100% of the stock of ScanWare. 

As you might imagine, Rayonier was not happy with the performance of the grading system and sued ScanWare and FinScan.  Because the contract between Raynoier and ScanWare contained a choice of law provision, Rayonier filed the action in Georgia.  I'm going to skip over the procedural details to tell you simply that there was a dispute over the proper venue for the case and the question came down to whether FinScan was bound by the choice of law provision in a contract it didn't sign and at a time when it was only a minority shareholder to one of the signatories.  Of course, I wouldn't be writing this if the answer was anything but YES.

The court in Rayonier Wood Products. LLC v. ScanWare, Inc.,2009 U.S. Dist. LEXIS 110753 (Ga., 11/30/09) gave short thrift to the fact that at the time of the contract FinScan was just a minority shareholder.  What the court found dispositive instead were these facts:

1. FinScan later became the sole shareholder of ScanWare;

2. Rayonier and FinScan employees regularly communicated with each other (presumably regarding ScanWare business, but not clear);

3. FinScan's president was also ScanWare's president and he tried to resolve Rayonier's concerns with the ScanWare product;

4. The system sold by ScanWare was basically a FinScan product.

Based on these facts, the court held that "ScanWare was an instrumentality or alter ego of FinScan when the contract was signed.  Although it was not a signatory to the contract, FinScan is bound by the terms of the contract."

Keep in mind that each of these facts occurred after the contract was signed.  Like I said at the outset, let's hope the standards are lower for piercing the veil to find the proper venue than to impose monetary liability.

-Marc Ward

When Shall Doesn't Mean Shall

The courts seem to be throwing curve balls lately on the interpretation of some rather common words. In my previous post I discussed the interpretation of "if" by the Idaho Supreme Court.  TonightI am writing about the Iowa Court of Appeals ignoring the word "shall" in ruling that Wild Rose Entertainment, L.L.C. did not breach a contract with John Pavone and Signature Management Group, L.L.C. (Pavone v. Kirke, No. 9-412/08-0180, Ia. Ct. Apls., Nov. 25, 2009).

Wild Rose and SMG entered into an agreement regarding the operation of a casino in Ottumwa (the "October Agreement").  This agreement contained a provision stating that if the Ottumwa project was completed "Wild Rose shallenter into an exclusive management agreement with [Pavone]...This Management Agreement shall provide for an annual management fee equal to four percent (4%)...The terms of the Management Agreement shallbe similar to...the gaming development agreement between Wild Rose and the City of Ottumwa, Iowa."

The court's opinion notes that the parties orally agreed that this agreement would also apply to a possible casino in Emmetsburg.  Presumably then with respect to Emmetsburg the references to Ottumwa should be changed toEmmetsburg.  The Ottumwa casino was rejected by gaming authorities, but the Emmetsburg casino was approved.

The jury found for Pavone and awarded him $10 million. The district court refusedto issue a JNOV.  the court of appeals reversed the trial court and held that this section of the agreement was nothing more than an agreement to agree and was therefore unenforceable.

First, the court held that the October Agreement was a consulting agreement, not a management agreement.  It is not clear why the characterization of this contract is relevant.  Whether the October Agreement is a management agreement or a consulting agreement is not the point.  Pavone was contending that Wild Rose was required to enter into a management agreement because the Emmetsburg casino was approved.

Next, the court found that the October Agreement failed to contain many key terms regarding the management agreement including the hiring and firing of key personnel, the term of the agreement and the scope of services.  However, as the district court pointed out in its ruling, the referenced agreement with Ottumwa contained all of these terms and it was reasonable to assume that management included the hiring and firing of key personnel.

The fact that the district court and the court of appeals could come to different conclusions should have been enough to find that a jury could too, but I find it very interesting that the use of the word "shall" was never discussed.  Lawyers choose their words carefully.  What did they mean when both sides agreed to the use of the word "shall"?

Dictionary.com says it means "must or is obliged to."  Merriam-Webster's says it is used to express what is mandatory.  That is how I use the word. Apparently, the Iowa Court of Appeals thinks otherwise.  So what are lawyers now supposed to think it means?

-Marc Ward