Ward on Iowa Limited Liability Company Law

Pay Me Now or Pay Me Later

The Iowa Court of Appeals opinion in Builders Kitchen and Supply Co. v. Moyer, N0. 0-655/09-0194 (September 2, 2009) is a deceptively simple case.  On the one hand it represents the folly of not having even run of the mill contracts reviewed by lawyers before they are signed.  And on the other hand, it is a warning to lawyers that things aren't as simple as they appear.

Frank Moyer signed a contract with Builders Kitchen for the purchase and installation of some kitchen cabinets and countertops.  The contract was just two pages long.  On the first page there was a place for the name of the business and a little later a space to indicate the type of entity.  Moyer filled in the name of his business, Crystal Creek Development, but neglected to indicate that it was a corporation.  He signed the contract as "Frank Moyer, Pres."  The second signature line, presumably for the guarantor, was left blank.

Unfortunately for Moyer the contract contained a clause that said "I hereby personally guarantee to pay on demand any and all sums due that my/our company shall fail to pay."  Of course, I wouldn't be writing this post if Crystal Creek Development had paid the amount due.

Because it didn't Builders Kitchen sued the company and Moyer personally.  The district court found Moyer to be personally liable and the Court of Appeals affirmed finding that Moyer's signature was both in his representative capacity and personally.  To find otherwise, both courts said, would negate the language of the contract. 

This raises some interesting questions.  First, is this also true if a document is signed as ABC, Inc. by John Doe, President and the other signature line for the guarantor is left blank?  What if a lower level officer, not the owner of the company, had signed the contract?  Would that poor son of a gun be personally liable?  Does this mean that signatories to contracts are also parties to the contracts, unless "party" is defined to exclude the signatories? (thus, references to "the parties agree/represent/warrant/ etc." now bind the individuals signing the contract?)  And how does this ruling jive with Iowa Code 554.3402(2) which says:

2.  If a representative signs the name of the representative to an
  instrument and the signature is an authorized signature of the
  represented person, the following rules apply:
a.  If the form of the signature shows unambiguously that the
  signature is made on behalf of the represented person who is
  identified in the instrument, the representative is not liable on the
  instrument.

Maybe this case is not so simple after all.

-Marc Ward

Was Time or Price Really "Of the Essence"?

Forgive me for being cynical, but in the case that follows it seems to me that price was the issue, not timely performance.

In High Development Corp. v. Star of the West Company, 2009 Iowa App. LEXIS 561 (June 17, 2009) the Iowa Court of Appeals held that "time is of the essence" provisions in real estate contracts must be read literally and restrictively.  High Development agreed to buy from Star of the West property located at 1101 Old Marion Road in Cedar Rapids.  The closing was scheduled for August 30.  High Development was not able to close on the 30th, but did tender payment the following day.  Star of the West refused to close on the 31st and kept the $5,000 down payment.  Within two weeks it had entered into another contract to sell the property to someone else.

High Development sued for specific performance and attorney fees.  The real estate contract provided that if the buyer failed to perform the seller may forfeit the contract under Iowa Code Chapter 656 or proceed by an action at law or equity.  Star of the West did neither.

The trial court concluded that the forfeiture clause in the contract was controlling and the sole remedy of the seller.  Because the buyer tendered the consideration the next day the ability of the seller to forfeit the contract was cut off.  The lower court granted the request for specific performance and awarded attorney fees to the buyer.  The court of appeals reversed.

The appellate court first concluded that Iowa Code Section 656.1 does not mean what it says when it states that the buyer's rights under a real estate contract if it fails to perform shall "not be forfeited or canceled except as provided in this chapter."  Statutory forfeiture is not the only remedy available to the seller.  The court interpreted Chapter 656 to apply to real estate installment contracts where the buyer has an equitable interest in the property as a result of having made several installment payments. In the case of a "one-time closing," according to the court of appeals, Chapter 656 is just one of several remedies available to a seller notwithstanding the language of 656.1.  The court fails to explain the difference between several installment payments and one down payment. 

In support of this conclusion the appellate court cites just one Iowa Supreme Court case.  However, in Passehl Estate v. Passehl, 712 NW 2d 408, 414 (Iowa 2006) the supreme court referred to Chapter 656 as "irrelevant" to the case and in the related footnote said the forfeiture provision "is inapplicable because the arguments in this case do not center on this provision and do not call for a forfeiture of the subject property."  To cite this case as authority for the proposition that statutory real estate foreclosure is just one of several remedies available to a seller in the event the buyer fails to perform is just simply wrong.

After interpreting one provision of the contract and the related Iowa Code provision loosely, the court of appeals shifts gears and interprets "time is of the essence" strictly and narrowly.  The closing date was August 30.  Period.  If buyer missed the date by even a day, which it did, the contract was breached because time was of the essence.  Recall that payment was tendered the very next day.  Seller refused and a couple of weeks later sold to someone else.  If time really was "of the essence" wouldn't seller have taken the money the very next day?  Or did it get wind of a better offer and was happy to "forfeit" the contract on a technical breach?  "Essence" according to my well-worn American Heritage dictionary means "the intrinsic or indispensable properties that identify something."  Subsequent events seem to prove that time was neither intrinsic nor indispensable to this deal.

The trial court should have been affirmed.

-Marc Ward

Attorney-Client Privilege and the Independent Contractor

In a case more interesting for its facts than the law, the US District Court for the Middle District of  Alabama recently considered whether the attorney-client privilege extended to an independent contractor of the client.  Hope for Families v. Warren, 2009 US Dist. LEXIS 46009 (April 21, 2009).  It's a good refresher and relies particularly on an Eight Circuit case for its ruling.  In re Bieter Co., 16 F.3d 929 (8th Cir. 1994).  The general answer is yes it can.

Now for the facts.  The independent contractor was a former state senator and lieutenant governor hired by a bingo parlor to (1) secure a document signed by the county sheriff authorizing Lukcy Palace to operate a bingo parlor (2) find an opponent to run against the sheriff and (3) run the campaign.  Apparently the lawsuit involved claims that the sheriff was conspiring with others to create a bingo monopoly in the county.  Think big Macon.  Sheriff Warren was re-elected.

-Marc Ward

A Pint is a Pound the World Around...

... and so is a deal.  That old saw was taught to me by a client years ago.  I haven't forgotten it, but sometimes businesspersons do.  If you ever have a client that feels he or she has been slighted by another party when the apparent "gentlemen's agreement" turns to nothing does your client have legal recourse?  In Iowa, maybe not.  But in Maryland, yes.

Take the case of Giant Food, Inc. v. Ice King,Inc., 536 A. 2d 1182 (Md. App. 1988).  The court held that despite the lack of a contract between the parties Ice King could recover damages for negligent misrepresentation by Giant Food.  For several months Ice King and Giant Food discussed the possibility of Ice King supplying ice to Giant Food.  All along, unbeknownst to Ice King, Giant Food was planning to build its own ice plant.  Ice Food believed it had a commitment to supply ice based on 30 or 40 communications between the parties, including authorization by Giant for Ice King to inform its bank of their "deal."

The court concluded that in light of the more than casual response of Giant Food "a businessman in [the Ice King representative's] shoes might have reasonably relied on the informal 'deal or gentlemen's agreement.'" In fact, Ice King had "the right to rely upon Giant, and Giant owed a duty to give the correct information."  When Ice King learned about the possibility of a new Giant ice plant and attempted to learn the truth the court held that it was incumbent on Giant to provide the "true facts."  When instead the Giant representative said "everything was all right" the assurance "was, at the very minimum, negligent."

So the next time a client believes he had a deal and was double-crossed, remember this case and supporting cases from New York and Prosser and Keeton on the Law of Torts, Section 107 (1984) and the Restatement (Second) of Torts, Section 552 (1977).*

-Marc Ward

*The research of Allison Miller, a second year law student at the University of Iowa and Dickinson summer associate, is the source of this case and analysis.

If it Quacks like a Duck, it must be a Duck

It is typical of acquisition agreements to provide for an earn out clause that captures that part of the value of a company that cannot be readily ascertained at the time a deal is consummated.  A standard provision would call for a formula to determine future profits and then pay that amount or a portion thereof to the seller.

In Harker's Distribution, Inc. v. Reinhart FoodService, LLC, 2009 U.S. Dist. LEXIS 3623 (Jan. 20, 2009), the United States District Court for the Northern District of Iowa was called upon to determine if such a clause was an arbitration agreement under Illinois law.  Like most such earnout clauses the final calculation of the purchase price called for the buyer to submit its calculation of the Preliminary Intangible Value to the seller.  The seller had 30 days to raise any objections to the calculation.  The parties then had another 30 days to resolve the objections.  If that could not be done, then the matter of the objections was to be submitted to a national accounting firm for resolution.

Needless to say, a dispute arose over the calculation.  Before the end of the 30 day period to resolve the dispute Harker's file a declaratory action seeking the court to determine that there was a unilateral mistake over the calculation of customers used to determine the intangible value.  Reinhart countered that the matter should be arbitrated pursuant to the earn-out provisions of the asset purchase agreement.

Applying the principles of Fit Tech, Inc. v. Bally Total Fitness Holding Corp., 374 F. 3rd 1 (1st Cir. 2004), the District Court held that the "accountant remedy" was an arbitration clause under Illinois law (the law chosen by the parties to apply to the agreement) and the matter of the accounting issues only should be determined by application of the provision, and not the other legal issues related to a mutual or unilateral mistake and the effect such a mistake might have on the enforceability or rescission of the agreement.

The key is the Fit Tech analysis that a provision can be an arbitration clause, regardless of whether the word "arbitration" is used, if application of the provision serves the purpose of arbitration, provides for a final remedy, by an independent arbitrator, applying substantive standards, with an opportunity for both sides to present its case.

-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

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

Ahhh, to be in Wilmington Now that Winter is Here

If you are a lawyer who represents a corporation located in Iowa but incorporated in Delaware and you have sent a document to CT Corporation or CSC in Delaware to be filed with the Delaware Secretary of State, you and your firm are subject to the jurisdiction of the Delaware courts.

In Sample v. Morgan, 935 A. 2d 1046 (Del. Ch. 2007), the court ruled that general outside counsel for an Ohio-based Delaware corporation, even though the law firm was based in Columbus, Ohio, was subject to Delaware's long-arm statute.  The law firm had prepared a certificate of amendment in Ohio and sent it to the Delaware office of CSC with instructions to file it with the Delaware Secretary of State.  The court concluded that this constituted transacting business in Delaware.  The law firm also provided general corporate advice to its client which naturally included interpretation of Delaware law, but the deciding factor seems to be the preparation and delivery of the certificate.

The court also concluded that this exercise of personal jurisdiction was consistent with the due process clause of the 14th Amendment to the US Constitution because the law firm should have "reasonably anticipated" that its actions might result in personal jurisdiction.

-Marc Ward

Chancellor Chandler Blows One: HDS Investment v. The Home Depot

I usually like to read opinions by Chancellor Chandler of Delaware's Chancery Court.  He is an insightful jurist, at least he was until  HDS Investment Holding, Inc.v.The Home Depot, Inc.,Civ. Action 3968-CC (October 17, 2008).

The case revolves around a purchase price adjustment clause in the agreement spinning HD Supply off from Home Depot to a group of private investors.  The clause is a common one in such transactions calling for a post-closing adjustment for the working capital (current assets minus current liabilities) of the sold entity as of the day before the closing date. 

In this case current assets excluded cash and cash equivalents because Home Depot was entitled under another provision of the agreement to take the cash and equivalents out of its affiliate before closing.  Current liabilities included accrued compensation and benefits even though another provision of the agreement called for Home Depot to reimburse the acquiror for certain bonuses and retention payments made to employees of HD Supply for a certain period prior to closing.

Home Depot did not remove the cash before closing and became concerned that the agreement could be read to call for the certain bonuses and retention payments to be reimbursed by it and included in the calculation of current liabilities, a double payment.

The issue before the Chancellor was whether the arbitration clause included in the purchase price adjustment provision should be interpreted to mean that the cash and bonus/retention issues should be arbitrated or adjudicated.  The court concluded that because these subjects were covered directly by provisions of the agreement that were outside the purchase price adjustment provision containing the arbitration clause, he would decide those issues, not the arbitrator.

The problem with this conclusion is there is no way the Chancellor can solve the issueswithout reference to the purchase price adjustment clause.  There is no question that Home Depot is to reimburse HDS for the bonus and retention payments.  The question is whether the liability is within the meaning of "accrued compensation and benefits."  There is no question that Home Depot is entitled to the cash and cash equivalents.  The question is whether it is entitled to deem them "accounts receivable" if in fact it did not take the cash.  Both of the real questions at issue concern the purchase price adjustment clause to which the arbitration clause applies.  It does not require adjudication of the other provisions of the agreement.  The good Chancellor blew this one.

The broader lesson is the care in which post-closing adjustment clauses must be drafted.  Both parties were represented by top-of-the-line law firms, yet they still drafted a key clause of an agreement with ambiguity.  There but for the grace of God....

-Marc Ward

NOLs and Bank Acquisitions

When the market gives you lemons, the IRS sometimes hands you sugar; at least for banks.

Bad debts and loan losses held by a bank never looked so good.  The Internal Revenue Service issued Notice 2008-83, dated today, which permits an acquiring company to deduct losses on loans or bad debts when purchasing a “bank”, as defined in section 581.  After an ownership change (defined in section 382(g)), a proper deduction relating to losses on loans or bad debts is not treated as a built-in loss or attributed to the period before the change.  The result is a tax deduction that is not subject to the limitation rules of Section 382 when purchasing a bank.

With many banks sour with loan losses and bad debts, this Notice apparently hopes to increase the acquisitions of banks by providing tax benefits to sweeten the deal.  Not knowing the future of the debts and loans, the deal keeps getting sweeter as those items become deductible losses in the future.  And with limited restrictions, a potential 3 year retroactive applicability, and no end date in sight, this Notice may help stir up acquisitions.

Before you can sit on your porch and enjoy your IRS lemonade, you should know that there are serious questions being raised as to whether this change is within the authority of the Internal Revenue Service.  Others are still calculating the financial impact of this change and some estimate the loss of tax revenue to be in the billions.  The impact of this Notice has yet to be fully recognized, but the IRS may have found the secret ingredient to stimulate the banking acquisition market.

IRS Circular 230 Disclosure:  Although this written communication may address certain tax issues, it is not intended to constitute a reliance opinion as described in IRS Circular 230 and, therefore, it cannot be relied upon by itself to avoid any tax penalties.

Contact Christine Halbrook at chalbrook@dickinsonlaw.com or at 515.246.4544 with further questions.

SMLLCs: Beware of Minnesota!

As Joe Kristan points out in his blog, www.taxupdateblog.com, the Minnesota Department of Revenue has adopted a new rule that will tax transfers of tangible personal property between a single member limited liability company (SMLCC) and its member, if the SMLLC does not elect to be treated as a corporation for federal income tax purposes.  It is the only state to make this distinction and tax such transfers.

The rule may be technically consistent with the Minnesota Tax Code (which on this issue is also unique) but it does not make a lot of sense to treat SMLCCs differently for state sales tax purposes based on an election for federal income tax.  The substance of the transaction is not different.  The intent of the exemption is to exclude from taxation the transfer of assets when there is only a change in legal title and not a change in beneficial ownership.  This intention is thwarted by this new rule.

And as Joe points out, it is a real trap for the unwary.  Who would think a SMLLC which is disregarded for tax purposes at the federal income tax level would have to pay sales tax on transfers between the owner and the "disregarded entity."

-Marc Ward

Save the Dates!

Joe Kristan, noted accountant and blogger, and I will be conducting four seminars on the new Iowa LLC Act in December. 

Under the auspices of the National Business Institute (NBI) Joe and I will be holding two half-day seminars in Cedar Rapids on December 8 and two half-day seminars in Des Moines on December 9.

The new law takes effect on January 1, 2009.  We look forward to seeing you at one of the seminars.

-Marc Ward

Throwing a Hail Mary

While some people know of a Hail Mary in the religious sense, for those of you who are football fans, you know a Hail Mary is an attempt to throw a long pass down the field, in the few remaining seconds of a game, in a last-ditched effort to win the game and beat the reigning champions (anyone else thinking of Flutie right now?).  In a recent Montana case, a process server threw a Hail Mary of sorts when he served the summons and complaint to an officer manager. In Montana Professional Sports, LLC v. National Indoor Football League, LLC, 180 p. 3d 1142 (Mont. 2008), the process server attempted to serve the summons and complaint to the National Indoor Football League (NIFL) using the address on record at the secretary of state’s office.  A woman in the office claimed to be the office manager and told the process server she could deliver the papers to the intended recipients.  As it turns out, this office manager was not employed by the NIFL - she was employed by a company owned by the president of the NIFL.  The court found that the process server’s inadvertent Hail Mary gave adequate notice and thus constitutes proper service.

 

-Christine F. Halbrook

Approach Third-Party LLC Opinions with Care

The current newsletter of the ABA's Third-Party Legal Opinion Committee highlights some of the challenges LLCs present for third-party legal opinion givers. 

One of the biggest gotcha's with Delaware LLCs is the fact that a "duly formed"opinion cannot be given with respect to a shelf LLC because Delaware LLCs are required to have an LLC agreement.  A similar problem exists with Iowa LLCs under the current law because Iowa LLCs must have members in order to exist.

Another problem with rendering an opinion regarding Delaware and Iowa LLCs has to do with opining that a contract has been duly authorized by the LLC.  This is generally a problem with interpreting the operating agreement vis a vis the statute.  Both must be read and compared carefully, bearing in mind that the operating agreement will control. But is it clear?  Are you sure?

By the way, a good place to start when confronted with an LLC opinion is the TriBar Opinion Committee's Third-Party Closing Opinions: Limited Liability Companies, 61 Bus. Law 679 (2006).

-Marc Ward

Lawyer Liability for Third-Party Legal Opinions

Court opinions regarding third-party legal opinions are rare, so when one is released it is worth taking a look at it.

The Ohio law firm of Purcell & Scott was accused of fraudulently inducing the plaintiff to invest in its client's securities because of an opinion letter the firm issued in connection with the stock offering.  Needless to say, the company tanked soon after the securities offering.

The letter broadly opined that the execution of the stock purchase agreement and the issuance of preferred stock would not violate "any statute, law, ordinance, rule or regulation of the United States of America or the State of Ohio...." (a "no violation of law" opinion).  Nevertheless the court found that this opinion did not include federal or state securities laws for two reasons.  First, the opinion letter incorporated the ABA Legal Opinion Accord (which excludes federal securities and state Blue Sky laws from the "no violation of law" opinion unless explicitly included).

The second reason is more intriguing.  The court concluded that the "no violation of law" opinion like the one in this case, even one given in a legal opinion letter that does not incorporate the Accord, was limited to the execution of the stock purchase agreement and the issuance of the preferred stock, and was not a guarantee of overall compliance with the law.  The misleading statements were in the offering materials and the financial statements, not the signing of the agreement or the ministerial act of issuing the stock.

I do not often run across legal opinions based on the Accord, and we do not use the Accord in our firm, but we always specifically exclude state and federal securities laws.  Based on In re National Century Financial Enterprises, Inc., 2008 U.S. Dist. LEXIS 39931 (May 5, 2008), maybe that is overkill.

-Marc Ward

Anheuser-Busch Sues InBev NV/SA

Alleging an illegal plan and deceptive conduct on the part of InBev, Anheuser-Busch upped the ante in the struggle for its future by filing a lawsuit yesterday in the United States District Court for the Eastern Division of Missouri.  You can read the complaint here.

The complaint seeks an injunction against InBev and its officers, agents, servants, employees and attorneys for violating Section 14(a) of the Securities and Exchange Act of 1934 and SEC Rule 14a-9.

-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

Do Stock Restrictions Belong in the Articles or Bylaws?

This has nothing to do with LLCs, but then I don't limit my practice to just LLCs.

The Iowa Business Corporation Act, like most corporate statutes, permits the articles of incorporation, bylaws or an agreement among shareholders to "impose restrictions on the transfer" of shares.  Iowa Code 490.627.

But Iowa Code 490.601 and 490.602 require certain stock rights and limitations to be exclusively in the articles of incorporation.

How do you know when a provision must be in the articles and not the bylaws?  Kansas Heart Hospital, LLC v. Duick, et al, 184 P 3rd 866 (May 16, 2008) offers a helpful rule of thumb.  In that case, which has little to do with an LLC despite the lead plaintiff, the Kansas Supreme Court concluded that a restriction that affects an entire class of stock instead of certain shareholders of the stock, must be in the articles.  Put another way, if a restriction operates against the holder of the stock, but not the stock itself, it can appear in the bylaws.

In this case, the court upheld a bylaw restriction that permitted the corporation to redeem the stock of stockholders who invested in a competing health care facility.

The case is also worth reading (a) for an explanation of the difference (or lack of difference) between "purchase" and "redeem" (b) as an application of the business judgment rule to what appears to be a situation not requiring "judgment" and (c) as an example where shareholder-directors are independent for purposes of applying the business judgment rule.

-Marc Ward

Beer Bust: InBev takes on Anheuser-Busch

As part of its battle to acquire Anheuser-Busch (AB), InBev filed a declaratory action in Delaware Chancery Court yesterday seeking the court's judgment that InBev could remove all AB directors from the board without cause by obtaining the written consent of a majority of the shareholders to do so.  You might think they would wait for the annual meeting to wage a proxy battle, but the terms of 5 of the 13 directors are not up until 2009.

This issue arises from the fact that prior to 2007 AB's directors were divided into three classes so they could be elected to 3-year staggered terms.  Such "classified" directors could not be removed except for cause under Delaware law.  See 8 Del. C. 141(k).  Unclassified directors can be removed without cause.  Id.

In 2006 the AB shareholders approved an amendment to its certificate of incorporation that declassified the directors beginning in 2007.  Directors elected to 3-year terms in 2006 still have a year to go in their terms. 

The question for the court seems to be whether declassified directors serving out their classified terms can be removed without cause.  You can access the complaint here.

Fascinating question, but it is curious that InBev isn't willing to assert a cause for removal since it implies in paragraph 4 of its complaint that the current directors have not complied with their fiduciary duties.

-Marc Ward

The No Successor Liability Rule and LLCs

Corporate doctrines continue to be applied to limited liability companies.  A recent example is application of the no successor liability rule to an LLC in Milliken v. Duro Textiles, LLC, 887 NE 2d 244 (Mass. May 30, 2008).

The traditional corporate law principle followed by most courts, including Iowa, holds that the liabilities of a selling corporation (LLC) are not imposed upon the successor corporation (LLC) which purchased its assets.

There are four exceptions to this rule:  (1) the successor entity agrees to assume the liabilities of the predecessor; (2) the transaction is a de facto merger (Iowa doesn't recognize this exception); (3) the successor is a "mere continuation" of the predecessor; or (4) the transaction is fraudulent.

The Milliken case dealt with the mere continuation exception.  The court also noted that many courts consider the de facto merger and mere continuation exceptions interchangeably, which may be the reason Iowa doesn't bother with the de facto merger exception.

Under both exceptions the courts compare the owners, management, assets, operations and physical locations of the predecessor and the successor.  No single factor is dispositive and the facts must be considered on a case-by-case basis.  It is a classic substance over form test or as one court put it, is the buyer "merely a 'new hat' for the seller?"

In Milliken the court concluded that New Duro, as the successor was called, was merely a new hat for Old Duro. The secured lenders owned 51% of Old Duro and all of New Duro, which they created to acquire the assets of Old Duro (but not the unsecured liabilities).  Management was the same between the old and new companies, operations were the same, and the physical location was the same.  Old Duro ceased its old line of business and became the landlord to, you guessed it, New Duro.  The court imposed Old Duro's unsecured obligations on New Duro.

The lesson here, particularly for lenders, is not to assume that form will prevail over substance and secured lenders are not impervious to the equitable power of the courts.

The most recent Iowa case on successor liability is Pancratz v. Monsanto, 547 NW 2d 198 (Iowa 1996).  In that case the Iowa Supreme Court reaffirmed its commitment to the majority rule that "a corporation that purchases the assets of another corporation assumes no liability for the transferring corporation's debts and liabilities."  The Iowa Supreme Court also recognized the exceptions noted in Milliken (other than de facto merger).

The Pancratz case is also significant for the fact that the Iowa Supreme Court refused to create another exception for no successor liability to product liability cases.

-Marc Ward

Diversity of Citizenship and LLCs for Federal Jurisdiction

A Federal district court recently reaffirmed a long-standing rule with respect to the determination of diversity jurisdiction in cases involving artificial entities other than corporations.  In Provini v. Paradigm Global Advisors, LLC, 2008 U.S. Dist LEXIS 40500 (N.J. May 19, 2008) a rather exasperated court declared that a petition alleging for purposes of diversity jurisdiction the fact that the defendant was a New York LLC with its principal office in New York was "meaningless."  Unlike corporations, where such an allegation would be meaningful, LLCs are unincorporated associations deemed citizens of each state in which their members are citizens. 

In fact, it may be necessary to go deeper than the first layer of ownership to determine diversity if the LLC has members who are LLCs (Belleville Catering Co. v. Champaign Mkt. Place, 350 F. 3d 691 (7th Cir. 2003) or limited partnerships (Hart v. Terminex Int'l, 336 F. 3d 541 (7th Cir 2003).

Provini is an excellent case for learning what will not suffice as sufficient allegations of diversity of citizenship.  For a terrific review of the history of diveristy jurisdiction and artificial entities, see C.T. Carden v. Arkoma Associates, 494 U.S. 185, 110 S. Ct. 1015, 108 L. Ed. 157 (1990).

-Marc Ward

Employers Basic Guide with Forms

Being an employer is a very complex undertaking.  My law firm has for a number of years published a Basic Guide for Employers including forms to help with such things as regulatory reporting requirements, immigration law, employee benefits, wage/hour notices, and the like.  Today I posted the guide with the forms on this blog.

Please remember that the guide is designed for general informational purposes only and is not intended as legal advice.  Although every effort has been made to ensure the accuracy and completeness of the information, my firm cannot be responsible for any errors or omissions or changes to the regulations described in the guide.

You can find the guide here.

-Marc Ward

Don't Sit on Your Rights!

In Roemmich v. Eagle Eye Development, LLC, 2008 U.S. App. LEXIS 10239 (8th Cir. 2008), we have yet another case of a family business venture leading to family litigation. Leland and Jane Bertsch (husband and wife) formed Eagle Eye Development, LLC, on June 12, 1995, to construct and lease post office buildings to the U.S. Postal Service. They brought in Jane’s brother, Bruce Roemmich, to oversee construction and development of two such projects in Florida. Eventually, the deal matured (or devolved, depending on how you look at it) into Roemmich getting a 30 percent ownership interest in Eagle Eye and a salary of $400 per week. Leland Bertsch owned the other 70 percent. Jane Bertsch originally owned a 5 percent interest, but she signed it over to her brother early on—perhaps she sensed trouble coming.

Roemmich became Secretary, Treasurer, and Governor of Eagle Eye. Jon Wagner later replaced him as Secretary. The opinion doesn’t really identify Wagner’s relationship to the endeavor. He just kind of lurks throughout like that guy on your college campus who graduated a long time ago but never left… Anyway, financial difficulties plagued the Florida projects and Reommich decided to walk out during June 1996. Leland Bertsch hired someone else to complete the work. Not surprisingly, the relationship between Roemmich and the rest of the Eagle Eye team deteriorated to the tune of physical and verbal threats. When Leland called the next meeting of the LLC, he was the only member in attendance, but he got a lot done. He removed Roemmich as Governor and Treasurer and appointed his wife Governor. As Executive Vice President and 30 percent owner, Roemmich continued to receive financial statements. By November, he suspected fraud, tax violations, and criminal conduct. He did not, however, exercise his right to call a meeting or request detailed financial information.

In 2004, he brought suit against Eagle Eye, Leland, Jane, and that Wagner guy. Roemmich claimed their actions were unfairly prejudicial, breached fiduciary duty, and the duty to act in good faith owed to him as a member and minority shareholder. He also said he was denied his right to vote as a member and mom always liked Jane better. Defendants counterclaimed based on Roemmich’s untimely departure from Florida back in 1996.

The essence of Reommich’s claim was self-dealing. In April 1997, Eagle Eye received $152,247.35 from the Postal Service and turned around and paid it to Bertsch Construction as reimbursement for “expenses.” Bertsch Construction also got 3 percent of project costs for support services but the fee was never approved by Eagle Eye governors or members. Eagle Eye also granted Bertsch Construction a contract (with really nice profit margins) to do repair work on Eagle Eye properties in Florida after hurricanes hit. Oh what a tangled web we weave when our family corporation is paid by our family LLC… The LLC also paid Leland $400 per week for services for two years, and made payments on behalf of the Bertsch’s for non-LLC related expenses.

The problem, of course, is that Roemmich let his anger boil for too long. The district court applied North Dakota’s six-year statute of limitations for tort, contract, and statutory causes of action and barred claims accruing prior to April 13, 1998. Pretty much everything happened before April 13, 1998, and Roemmich had notice before then, too. Roemmich argued that the defendants’ acts were a continuing violation that continued into the last six years because the conduct, when cumulative, froze him out of the LLC. This argument failed because he didn’t need cumulative activity to have notice of his claims. He had enough information about significant and distinct actions to do something within the limitations period. He just didn’t do it.

He also argued that the six year period did not apply to this violation. He preferred the ten year statute of limitations for violations not provided for in the Code, and argued that North Dakota’s LLC Act did not specifically address the freezing out of LLC members. The Court didn’t buy the argument, and said the LLC statute covered freeze-outs quite sufficiently, thank you very much, and the six year period for statutory violations applied.

Roemmich made some arguments about events that took place after April 13, 1998, but he did not provide enough evidence to support the allegations or did not provide enough evidence as to when the events occurred. Roemmich was beaten not only because he slept on his rights, but because his case was not well presented.

The 8th Circuit also concurred with the district court’s findings that Roemmich had no reasonable expectation of employment by Eagle Eye, especially after he walked out on the Florida projects; that the Bertsch’s did not engage in improper self-dealing; and that Reommich never had a reasonable expectation that he would be a decision-maker for Eagle Eye, especially given his own “inequitable” conduct.

Adding insult to injury, the 8th Circuit made Roemmich pay for the Defendants’ reasonable expenses, including attorney fees, because of his arbitrary, vexatious, or bad faith conduct. The district court found that Roemmich made baseless accusations of fraud and illegality, and attempted to disrupt Eagle Eye’s business relationships, and the 8th Circuit did not find anything to the contrary. Seems Roemmich would have been better off sleeping on his rights for a little while longer.

-Emily Pontius

Ms. Pontius is an associate at Dickinson, Mackaman, Tyler & Hagen, P.C. and a contributor to this blog.

LLCs and the Attorney-Client Privilege

LLCs are commonly referred to as hybrid business entities.  So when it comes to the attorney-client privilege, are they more like corporations or partnerships?  What is the difference, you ask?  The difference is in defining who is the client.

There is a split among the courts regarding corporations.  At the federal level and in some states, the corporation is the client and the privilege belongs to current management.  When control goes over to new management, the corporation's attorney-client privilege moves with them.  The seminal case on this topic is CFTC v. Weintraub, 471 US 343 (1985). 

Other courts apply the "collective corporate client" rule (this seems more likely to be the case in closely held corporations) holding that directors (including former directors) and the corporation hold the privilege allowing them access to documents that might otherwise be privileged under the Weintraub analysis.  See e.g. Kirby v. Kirby, 1987 WL 14862 (Del. Ch. 1987).

The courts are also split when it comes to partnerships, some apply the same rule as applied to corporations, but some cases have found that the "client" is not just the partnership, but also the partners because they owe fiduciary duties to one another and have broader powers than shareholders.  Wortham & Van Liew v. Superior Court, 188 Cal. App. 3d 927 (1987).

Which leads us to today's case, Montgomery v. eTreppid Technologies, LLC, 2008 U.S. Dist. Nev. LEXIS 35561 (April 18, 2008), one of only three cases that analyze the attorney-client privilege with respect to LLCs.  Montgomery and the other two cases apply the law of corporations to LLCs.  Montgomery is a well-reasoned case that rejects the joint client theory for corporations and follows the single client theory of Weintraub and Milroy v. Hanson, 875 F.Supp 646 (D. Neb. 1995).

The other two LLC attorney-client cases are Moore v. Commissioner of Internal Revenue, T.C. Memo 2004-259 (2004) and In re Tri-River Trading, LLC, 329 B.R. 252 (8th Cir. 2005).  The Tri-River decision is troubling because it applies the collective or joint client theory without any analysis.  Under this  theory, since there is no expectation of privacy between joint clients (in this case a member and her LLC) otherwise privileged communications were not prohibited from disclosure at trial. 

Because this is an Eighth Circuit decision Iowa lawyers should realize that the joint client theory could be applied to them and their LLC clients.  This is particularly true for member-managed LLCs under Iowa Code 489.409(1) of the New Iowa LLC Act.

-Marc Ward

Welcome to the Iowa LLC Law Blog

In 2008, Iowa became one of the first states to adopt the Revised Uniform Limited Liability Company Act.  The new Iowa LLC Act is the result of months of hard work by the LLC Committee of the Iowa State Bar Association.  I was honored to chair the committee (just as I chaired the 1992 committee that wrote the original Iowa LLC Act).  There will be a lot of questions about the new law in the coming months and this blog is intended to be a place to look for answers. 

Effective January 1, 2009, new Iowa Code Chapter 489 will take effect.  All LLCs formed on and after that date will be covered by the new law.  On January 1, 2011, the current LLC statute (490A) will be repealed and all LLCs will be subject to Iowa Code Chapter 489.  During the period between January 1, 2009, and January 1, 2011, LLCs existing prior to January 1, 2009, can elect to be covered by the new law.  Here is a link to Iowa's Revised Uniform Limited Liability Company Act

During the coming weeks, check this site for a comprehensive analysis of the new Iowa LLC Act.  As we count down to January 1, 2009, this is the place to find out about important LLC cases handed down by the courts around the country, key IRS rulings, and the occasional business law case that will impact LLCs.

I welcome comments, corrections, and alternative points of view, so don’t hesitate  to engage in respectful debate with me and others who comment on this blog.

-Marc Ward