Ward on Iowa Limited Liability Company Law

Iowa Supreme Court Applies Business Judgment Rule to Non-Profit Corporations

We don’t often see a business judgment rule case emanate from the Iowa Supreme Court, so when one comes along, even in the context of a nonprofit condominium owners’ association I am compelled to comment on it. Oberbillig v. West Grand Towers Condominium Ass'n, 807 N.W.2d 143, 2011 WL 6270701, Iowa, December 16, 2011 (NO. 09-1097).                

The crux of the case was whether the board of directors of the condominium association was correct in approving nonemergency repairs to the association’s parking garage.  The pertinent provision of the bylaws declares that “the board shall not approve any expenditure in excess of Twenty-five Thousand Dollars ($25,000), unless required for emergency repair, protection or operation of the Common Elements or Limited Common Element….” 

The plaintiffs, two residents at West Grand Towers, contend that “emergency” modifies repair and protection and operation.  The Association believes that “emergency” modifies only repair.  The trial court held for the plaintiffs and the Association appealed. 

The Iowa Supreme Court reversed.  The reversal is not based on the Court believing that “emergency” only modifies “repair” although I suspect it does believe that, but upon application of principles that are far more useful.  In essence, the Court concluded that when a bylaw provision is ambiguous, the organizational documents (in this case, the Declaration) grant the board the authority to interpret the bylaws, and the board’s interpretation is reasonable, then the Court will defer to the board’s “interpretation if doing so is consistent with the business judgment rule.” 

Here are a couple of takeaways from this case.  First, the court applied the “doctrine of the last preceding antecedent” in finding that the bylaw provision quoted above was ambiguous.  As the Court has observed in prior cases, qualifying words usually only apply to the immediately preceding antecedent. In this case, emergency only applies to repair.  The trial court on the other hand interpreted the clause to actually read “emergency repair, emergency protection or emergency operation of the Common Elements or Limited Common Element” and was castigated by the Court for it (“We should not rewrite bylaws in the guise of interpretation.”).  Second, the Court refused to construe the ambiguous language against the Association because the developers, not the Association, drafted the Declaration and bylaws.  Third, should non-profit and for-profit bylaws now include a provision that grants the board of directors the authority to interpret the bylaws?

-Marc Ward

Single Member LLCs and the Risk of Veil Piercing

With good fortune this unpublished opinion by the Colorado Court of Appeals will be reversed on appeal.  Until then, lawyers need to take notice of this case because it is indicative of the risk inherent in operating a single member LLC.  Call it limited liability light, but some courts seem to give less deference to the limited liability protections of LLCs compared to corporations. 

Dean Freeman owned and managed Tradewinds Group, LLC as a single member LLC.  Tradewinds contracted with Robert Martin to build an airplane hangar.  Now, follow the dates.  In 2006 Tradewinds sues Martin for breach of contract.  In 2007 Tradewinds sold its only “meaningful” asset, an airplane, for $300,000 (the court apparently didn’t think the claim against Martin was meaningful).  The proceeds of the sale went directly to Freeman, the only member of the LLC.  In 2008 a judgment was entered in favor of Tradewinds.  In 2009 this judgment was reversed, Martin was declared the winner and awarded costs of $36,645.40.  In 2010, following a bench trial, the trial court pierced the limited liability veil and found Freeman personally liable. 

The court of appeals decision was split 2-1.  The majority apparently didn’t find it significant that Tradewinds sold its only significant tangible asset one year before judgment was entered in its favor against Martin, two years before the judgment was reversed, and three years before the bench trial that led to the eventual piercing of the veil. See Martin v. Freeman, 2012 WL 311660 (Colo. App. 2/2/12).

Instead, the court relied on (1) Tradewinds assets were commingled with Freeman’s and another of his companies, Aircraft Storage LLC (it is not explained how one commingles an aircraft with other assets); (2) the LLC had negligible corporate records (Colorado law declares that the failure of an LLC to observe formalities and requirements is not in itself grounds to impose personal liability); (3) Tradewinds had inadequate records of its substantive transactions; (4) a single person was the LLC’s only member and manager (!?); (5) the entity was thinly capitalized (with an airplane!); (6) cash infusions to pay bills were undocumented; (7) Tradewinds never operated as an active business (never seen this one before); (8) legal formalities were ignored (see above); (9) Freeman paid the LLCs debts without characterizing the transactions; (10) the airplane was used for “nonentity purposes”; and (11) Tradewinds was operated as “a mere assetless shell” and the proceeds from the sale of this assetless shell’s asset went directly to its only member.   

The majority overlooks, but the dissent reminds them, that the trial court found the plane was sold in an arm’s length transaction, the proceeds were a lawful distribution to Freeman under Colorado law, he was unaware of any impropriety with respect to the sale, and to his knowledge all debts of the entity were provided for at the time of the distribution. 

The court also found that showing that the LLC form was used to defeat a creditor’s rightful claim is all that needs to be shown and “further proof of wrongful intent or bad faith is not required.” 

The dissenting judge came to an opposite conclusion, finding that the sale of the airplane and distribution of the proceeds two years before Martin had a claim against Freeman could not be construed to be a use of the LLC form to defeat a creditor’s rightful claim.  The dissent cites a host of cases involving corporations where attempts to pierce the veil were thwarted because no wrongful conduct was proven. 

As the dissent reasonable explains, two years before Martin had a claim against the LLC, Tradewinds sold its primary asset, “it made sense that the business would be closed…and its funds taken by its sole member.” 

What this case says to SMLLCs is simple.  You need to document your transactions, keep your funds separate and mind your p’s and q’s to a much greater extent than if you were a corporation.  I wish this wasn’t the case, but this opinion and a host of others suggest to me that some courts have yet to grasp the fact that LLCs and corporations should be treated the same when it comes to limited liability protections.

-Marc Ward

Delaware Court Issues Key Opinion on Fiduciary Duties Owed to LLC Members

On January 27, 2012, the Delaware Chancery Court (Chancellor Strine) issued what one commentator has called a magnum opus in the case of Auriga Capital Corp. v. Gatz Properties LLC.  This 75-page opinion explains how fiduciary duties are owed by a manager to a LLCs members absent an expressed limitation or elimination in the operating agreement.

 For Iowa LLCs the take away is to be aware of the default statutory fiduciary duties In Iowa Code Section 489.409 and the ability to limit or eliminate these duties per Section 489.110 (but only if such limitations or eliminations are not “manifestly unreasonable”, whatever that might be found to mean).  Delaware does not have default statutory fiduciary duties, relying on the common law instead.

 -Marc Ward