22 CH 4 LLCs (1)
docx
keyboard_arrow_up
School
University of Florida *
*We aren’t endorsed by this school
Course
7804
Subject
Business
Date
Feb 20, 2024
Type
docx
Pages
52
Uploaded by GeneralStrawFinch41
BUSINESS ORGANIZATIONS—Chapter 4 LLCs
Chapter 4
The LLC
1
History, 2.
Formation 3.
Documentation (The Operating Agreement)
4.
Promoter Liability & Defective Formation 5
Becoming a Member & Membership Interests
6.
Members’ Liability including Piercing the Veil
7.
Management 8.
Fiduciary Duties in an LLC
9.
Sharing of Distributions 10. Dissociation, Winding Up, and Termination 11. Sample Essay questions based on the bar exam *****************************************************************************
C
HAPTER
4.
T
HE
LLC
1
H
ISTORY
OF
THE
LLC
Although we have not yet discussed business taxation, some general understanding of the history
of how businesses have been taxed in this country is relevant to an understanding of how this
form of business came to be. As we will discuss in a little more detail shortly, the U.S. Tax Code is divided into multiple
chapters, each of which govern different kinds of taxation. When the Code was written, there
were limited business options, and so the Code addresses partnership taxation in subchapter K,
and corporate taxation in either subchapter C (for most corporations) or subchapter S (for eligible
corporations that file a special election to be taxed sort of like partnerships). The reality is that
under state law, there are options other than the corporation and the general partnership, and
there have been other options (such as limited partnerships) for a very long time. Historically
speaking, one of the complicated issues under the Code was making sure that a business not
organized as a corporation or traditional general partnership was taxed under the appropriate
subchapter.
The traditional IRS approach to figuring out how a for-profit business should be classified for tax
purposes was to ask whether the business more closely resembled a traditional corporation or a
traditional partnership. In utilizing this approach, there were four primary factors used to
distinguish between corporations and partnerships: (1) existence of centralized management like
a board of directors; (2) continuity of life apart from the participation of owners; (3) free
transferability of ownership interests; and (4) limited liability for owners. The presence of each
of those four characteristics tended to show the existence of an association taxable as a
1
corporation. Absence made it more likely that a particular business would be taxed as a
partnership. Under this “corporate resemblance test,” unless the business had MORE corporate
characteristics (which meant 3 of the 4), it was taxed as a partnership.
Given this tax regime, it is not surprising that some enterprising entrepreneur (actually an
international mining concern) wanted to obtain the benefit of partnership taxation while
obtaining limited liability for its owners. After all, that was only one corporate characteristic, so
the business should still be taxed as a partnership. After extensive lobbying, Wyoming passed the
first LLC Act, and the IRS eventually conceded that it would be taxed as a partnership. Within 7
years of when the IRS agreed that LLCs would be tax partnerships, every state had an LLC Act.
In fact, states acted so quickly, there was no uniform act to help them out. There were two efforts
to promulgate uniform acts, one by the Uniform Law Commission which was working on a
ULLCA (Uniform Limited Liability Company Act), and one by a Working Group of the
Committee on Partnerships and Unincorporated Business Organizations in the Section of
Business Law of the American Bar Association, which produced a draft Prototype LLC Act in
1992. Although the draft Prototype LLC Act was never revised or finalized, it became the model
for a number of states laws, including Arkansas. To put it bluntly, that statute was a mess. Unfortunately, by the time that the ULLCA was finally promulgated it was too late, since most
states (including Arkansas) already had LLC statutes. Therefore, LLC Acts have been among the
least uniform of business statutes. However, a new version of ULLCA (ULLCA (2013)) has
been issued, and is now being adopted in an increasing number of states. In 2021, Arkansas
became the 22
nd
state to adopt the Uniform act with very minor changes. The old LLC Act
(known as the Small Business Entity Tax Pass Through Act) which was codified at 4-32-101 et
seq was repealed effective September 2021. As we go through our new statute, remember that
the LLC was designed to work like a general partnership that gave all members limited liability.
As the tax laws changed to allow businesses greater flexibility, so did the statutes. The ULLCA
tries to stay true to the goals of an informal business with limited liability and maximum
flexibility, while having as many default rules as possible that make sense for small businesses. 2.
F
ORMATION
OF
AN
LLC
The first substantive topic is formation of LLCs. In this section, some statutory sections are out
of order because I thought it made sense to start with the definition and description of the
Certificate of Organization. Note that this is a change from Articles of Organization, which is
what the document was formerly called in Arkansas. The next section describes the effective
date of the certificate. Other sections explain various provisions applicable to the filing or
contents of the certificate of organization.
Ark. Code Ann. Title 4 Business and Commercial Law
Chapter 38 Uniform Limited Liability Company Act
§ 4-38-101. Short title
2
This chapter may be cited as the Uniform Limited Liability Company Act.
§ 4-38-102. Definitions
In this chapter:
(1) “Certificate of organization” means the certificate required by § 4-38-201. The term includes
the certificate as amended or restated. ….
§ 4-38-201. Formation of limited liability company--Certificate of organization
(a) One or more persons may act as organizers to form a limited liability company by delivering
to the Secretary of State for filing a certificate of organization.
(b) A certificate of organization must state:
(1) the name of the limited liability company, which must comply with § 4-38-112;
(2) the street and mailing addresses of the company's principal office; and
(3) the information required by § 4-20-105(a).
(c) A certificate of organization may contain statements as to matters other than those required
by subsection (b), but may not vary or otherwise affect the provisions specified in § 4-38-105(e)
and (f) in a manner inconsistent with that section. However, a statement in a certificate of
organization is not effective as a statement of authority.
(d) A limited liability company is formed when the certificate of organization becomes effective
and at least one person has become a member or manager.
§ 4-38-207. Effective date and time
Except as otherwise provided in § 4-38-208 and subject to § 4-38-209(d), a record filed under
this chapter is effective:
(1) on the date and at the time of its filing by the Secretary of State, as provided in § 4-38-
210(b);
(2) on the date of filing and at the time specified in the record as its effective time, if later
than the time under paragraph (1);
(3) at a specified delayed effective date and time, which may not be more than 90 days after
the date of filing; or
(4) if a delayed effective date is specified, but no time is specified, at 12:01 a.m. on the date
specified, which may not be more than 90 days after the date of filing.
§ 4-38-203. Signing of records to be delivered for filing to Secretary of State
(a) A record delivered to the Secretary of State for filing pursuant to this chapter must be signed
as follows:
(1) Except as otherwise provided in paragraphs (2) and (3), a record signed by a limited
liability company must be signed by a person authorized by the company.
(2) A company's initial certificate of organization must be signed by at least one person
acting as an organizer.
(3) A record delivered on behalf of a dissolved company that has no member must be signed
by the person winding up the company's activities and affairs under § 4-38-702(c) or a person
appointed under § 4-38-702(d) to wind up the activities and affairs.
3
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(4) A statement of denial by a person under § 4-38-303 must be signed by that person.
(5) Any other record delivered on behalf of a person to the Secretary of State for filing must
be signed by that person.
(b) A record delivered for filing under this chapter may be signed by an agent. Whenever this
chapter requires a particular individual to sign a record and the individual is deceased or
incompetent, the record may be signed by a legal representative of the individual.
(c) A person that signs a record as an agent or legal representative affirms as a fact that the
person is authorized to sign the record.
§ 4-38-206. Filing requirements
(a) To be filed by the Secretary of State pursuant to this chapter, a record must be received by the
Secretary of State, comply with this chapter, and satisfy the following:
(1) The filing of the record must be required or permitted by this chapter.
(2) The record must be physically delivered in written form unless and to the extent the
Secretary of State permits electronic delivery of records.
(3) The words in the record must be in English, and numbers must be in Arabic or Roman
numerals, but the name of an entity need not be in English if written in English letters or
Arabic or Roman numerals.
(4) The record must be signed by a person authorized or required under this chapter to sign
the record.
(5) The record must state the name and capacity, if any, of each individual who signed it,
either on behalf of the individual or the person authorized or required to sign the record, but
need not contain a seal, attestation, acknowledgment, or verification.
(b) If law other than this chapter prohibits the disclosure by the Secretary of State of information
contained in a record delivered to the Secretary of State for filing, the Secretary of State shall file
the record if the record otherwise complies with this chapter but may redact the information.
(c) When a record is delivered to the Secretary of State for filing, any fee required under this
chapter and any fee, tax, interest, or penalty required to be paid under this chapter or law other
than this chapter must be paid in a manner permitted by the Secretary of State or by that law.
(d) The Secretary of State may require that a record delivered in written form be accompanied by
an identical or conformed copy.
(e) The Secretary of State may provide forms for filings required or permitted to be made by this
chapter, but, except as otherwise provided in subsection (f), their use is not required.
(f) The Secretary of State may require that a cover sheet for a filing be on a form prescribed by
the Secretary of State.
§ 4-38-112. Permitted names
(a) The name of a limited liability company must contain the phrase “limited liability company”
or “limited company” or the abbreviation “L.L.C.”, “LLC”, “L.C.”, or “LC”. “Limited” may be
abbreviated as “Ltd.”, and “company” may be abbreviated as “Co.”.
(b) Except as otherwise provided in subsection (d), the name of a limited liability company, and
the name under which a foreign limited liability company may register to do business in this
4
state, must be distinguishable on the records of the Secretary of State from any [other recorded
names] ….
§ 4-38-115. Registered agent
(a) Each limited liability company and each registered foreign limited liability company shall
designate and maintain a registered agent in this state in compliance with the Model Registered
Agents Act, § 4-20-101 et seq.
(b) The designation of a registered agent is an affirmation of fact by the limited liability company
or registered foreign limited liability company that the agent has consented to serve.
(c) A registered agent for a limited liability company or registered foreign limited liability
company must have a place of business in this state.
(d) The only duties under this chapter of a registered agent that has complied with this chapter
are as described in § 4-20-114.
QUESTION:
Probably the best way to check to see if you understand these rules is to see if you
can find the errors that would prevent the document that appears on the following page
(assuming it is properly filled out, signed, mail in with the required fee) from complying with the
new statutory provisions. Note that the form itself was downloaded from the Arkansas Secretary
of State’s website on April 17, 2021. What portions of the following form ask for information
that is no longer required? What information that is required is missing from this form?
NOTE: This exercise is designed to illustrate why it is critical that you understand where a form
you are using came from and what statute was in effect or applicable when that document was
drafted.
5
6
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
So you do not go away thinking our Secretary of State is hopelessly out of date, here is the
current PDF of the form to form an LLC (or current as of May 2022 at any rate).
Note the special provisions for professional service LLCs. We will not be covering those in this
course, but there are some special rules for LLCs organized to provide professional services (like
law firms, medical and accounting firms.)
7
3.
D
OCUMENTATION
(T
HE
O
PERATING
A
GREEMENT
)
The Certificate of Organization is not the only document that an LLC may need. Under our old
LLC Act a written operating agreement was required. The ULLCA makes such an agreement
optional, but just as was true in the case of partnership agreements, a written operating
agreement will be a good idea in most cases. The following provisions in the new act relate to
operating agreements.
******************************************************************************
§ 4-38-102. Definitions
In this chapter: …
(13) “Operating agreement” means the agreement, whether or not referred to as an operating
agreement and whether oral, implied, in a record, or in any combination thereof, of all the
members of a limited liability company, including a sole member, concerning the matters
described in § 4-38-105(a). The term includes the agreement as amended or restated. ….
§ 4-38-105. Operating agreement--Scope, function, and limitations
(a) Except as otherwise provided in subsections (e) and (f), the operating agreement governs the
following:
(1) relations among the members as members and between the members and the limited
liability company;
(2) relations between the members and any manager or managers, and the rights and duties
under this chapter of a person in the capacity of manager;
(3) the activities and affairs of the limited liability company and the conduct of such
activities and affairs, including without limitation the requisite votes or consents from
members and any managers required under this chapter; and
(4) the means and conditions for amending the operating agreement, including without
limitation the votes or consents required from members and any managers with respect to any
matters under this chapter.
(b) Except as provided in subsections (e) and (f), the operating agreement may vary the terms
and provisions of this chapter.
(c) For purposes of this chapter, activities include without limitation all business and financial
matters.
(d) To the extent the operating agreement does not provide for a matter described in subsection
(a), this chapter governs the matter.
(e) An operating agreement may not:
(1) vary the law applicable under § 4-38-104;
(2) vary a limited liability company's capacity under § 4-38-109 to sue and be sued in its own
name;
(3) vary any requirement, procedure, or other provision of this chapter pertaining to:
(A) registered agents under the Model Registered Agents Act, § 4-20-101 et seq.; or
(B) the Secretary of State, including provisions pertaining to records authorized or
required to be delivered to the Secretary of State for filing under this chapter;
8
(4) vary the provisions of § 4-38-204;
(5) alter or eliminate the duty of loyalty or the duty of care, except as otherwise provided in
subsection (f);
(6) eliminate the contractual obligation of good faith and fair dealing under § 4-38-409(d),
but the operating agreement may prescribe the standards, if not manifestly unreasonable, by
which the performance of the obligation is to be measured;
(7) relieve or exonerate a person from liability for conduct involving bad faith, willful or
intentional misconduct, or knowing violation of law;
(8) unreasonably restrict the duties and rights under § 4-38-410, but the operating agreement
may impose reasonable restrictions on the availability and use of information obtained under
that section and may define appropriate remedies, including liquidated damages, for a breach
of any reasonable restriction on use;
(9) vary the causes of dissolution specified in § 4-38-701(a)(4);
(10) vary the requirement to wind up the company's activities and affairs as specified in § 4-
38-702(a), (b)(1), and (e);
(11) unreasonably restrict the right of a member to maintain an action under § 4-38-801 et
seq.;
(12) vary the provisions of § 4-38-805, but the operating agreement may provide that the
company may not have a special litigation committee;
(13) vary the right of a member to approve a merger, interest exchange, conversion, or
domestication under § 4-38-1023(a)(2), § 4-38-1033(a)(2), § 4-38-1043(a)(2), or § 4-38-
1053(a)(2);
(14) vary the required contents of a plan of merger under § 4-38-1022(a), plan of interest
exchange under § 4-38-1032(a), plan of conversion under § 4-38-1042(a), or plan of
domestication under § 4-38-1052(a); or
(15) except as otherwise provided in § 4-38-106 and § 4-38-107(b), restrict the rights under
this chapter of a person other than a member or manager.
(f) Subject to subsection (e)(7), without limiting other terms that may be included in an operating
agreement, the following rules apply:
(1) The operating agreement may:
(A) specify the method by which a specific act or transaction that would otherwise violate
the duty of loyalty may be authorized or ratified by one or more disinterested and
independent persons after full disclosure of all material facts; and
(B) alter the prohibition in § 4-38-405(a)(2) so that the prohibition requires only that the
company's total assets not be less than the sum of its total liabilities.
(2) To the extent the operating agreement of a member-managed limited liability company
expressly relieves a member of a responsibility that the member otherwise would have under
this chapter and imposes the responsibility on one or more other members, the agreement
also may eliminate or limit any fiduciary duty of the member relieved of the responsibility
which would have pertained to the responsibility.
(3) If not manifestly unreasonable, the operating agreement may:
(A) alter or eliminate the aspects of the duty of loyalty stated in § 4-38-409(b) and (i);
9
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(B) identify specific types or categories of activities that do not violate the duty of
loyalty;
(C) alter the duty of care, but may not authorize conduct involving bad faith, willful or
intentional misconduct, or knowing violation of law; and
(D) alter or eliminate any other fiduciary duty.
(g) The court shall decide as a matter of law whether a term of an operating agreement is
manifestly unreasonable under subsection (e)(6) or (f)(3). The court:
(1) shall make its determination as of the time the challenged term became part of the
operating agreement and by considering only circumstances existing at that time; and
(2) may invalidate the term only if, in light of the purposes, activities, and affairs of the
limited liability company, it is readily apparent that:
(A) the objective of the term is unreasonable; or
(B) the term is an unreasonable means to achieve the term's objective.
§ 4-38-106. Operating agreement--Effect on limited liability company and person becoming
member--Preformation agreements
(a) A limited liability company is bound by and may enforce the operating agreement, whether or
not the company has itself manifested assent to the operating agreement.
(b) A person that becomes a member is deemed to assent to the operating agreement.
(c) Two or more persons intending to become the initial members of a limited liability company
may make an agreement providing that upon the formation of the company the agreement will
become the operating agreement. One person intending to become the initial member of a limited
liability company may assent to terms providing that upon the formation of the company the
terms will become the operating agreement.
§ 4-38-107. Operating agreement--Effect on third parties and relationship to records
effective on behalf of limited liability company
(a) An operating agreement may specify that its amendment requires the approval of a person
that is not a party to the agreement or the satisfaction of a condition. An amendment is
ineffective if its adoption does not include the required approval or satisfy the specified
condition.
(b) The obligations of a limited liability company and its members to a person in the person's
capacity as a transferee or a person dissociated as a member are governed by the operating
agreement. Subject only to a court order issued under § 4-38-503(b)(2) to effectuate a charging
order, an amendment to the operating agreement made after a person becomes a transferee or is
dissociated as a member:
(1) is effective with regard to any debt, obligation, or other liability of the limited liability
company or its members to the person in the person's capacity as a transferee or person
dissociated as a member; and
(2) is not effective to the extent the amendment imposes a new debt, obligation, or other
liability on the transferee or person dissociated as a member.
10
(c) If a record delivered by a limited liability company to the Secretary of State for filing
becomes effective and contains a provision that would be ineffective under § 4-38-105(e) or § 4-
38-105(f)(3) if contained in the operating agreement, the provision is ineffective in the record.
(d) Subject to subsection (c), if a record delivered by a limited liability company to the Secretary
of State for filing becomes effective and conflicts with a provision of the operating agreement:
(1) the agreement prevails as to members, persons dissociated as members, transferees, and
managers; and
(2) the record prevails as to other persons to the extent they reasonably rely on the record.
******************************************************************************
If you read through the preceding statutory sections, you will see that an operating agreement can
not only be oral, it can be established by implication through conduct, or it could even consist of
a combination of these. In the absence of such an agreement, the statutory rules control, but the
members may agree otherwise on the vast majority of issues relative to the business and affairs
of an LLC. As for the issues that an operating agreement may not affect, those are listed in
section 105(e), and they mimic the kinds of things that cannot be changed in a partnership’s
partnership agreement.
The law of the state of organization controls; the LLC has the legal capacity to sue and be sued;
it must have a registered agent; and the members cannot change the obligation to sign documents
if compelled by court order. An operating agreement cannot eliminate the duties or loyalty or
care except as specifically allowed; eliminate the duty of good faith and fair dealing; eliminate
the potential for liability for bad faith or willful misconduct; unreasonably limit members’ right
to information; vary causes of dissolution by court order; change the rights of parties to wind up;
restrict rights to bring derivative actions; vary rights to approve structural changes via merger,
conversion, etc.; or affect the rights of third parties.
The statute also provides that the operating agreement can be enforced by the LLC even if it is
not a party and can bind subsequent members to the terms of the agreement as a condition of
their joining as members.
Take note of section 4-38-107(d) which says that if a record filed with the Secretary of State is
effective and conflicts with the operating agreement, the agreement prevails as to members,
former members, transferees, and managers, but the record prevails to other persons who
reasonably rely on it.
4.
P
ROMOTER
L
IABILITY
IN
THE
LLC CONTEXT
Once an LLC is formed, members are no longer liable for acts of the business:
§ 4-38-304. Liability of members and managers
(a) A debt, obligation, or other liability of a limited liability company is solely the debt,
obligation, or other liability of the company. A member or manager is not personally liable,
11
directly or indirectly, by way of contribution or otherwise, for a debt, obligation, or other liability
of the company solely by reason of being or acting as a member or manager. This subsection
applies regardless of the dissolution of the company.
(b) The failure of a limited liability company to observe formalities relating to the exercise of its
powers or management of its activities and affairs is not a ground for imposing liability on a
member or manager for a debt, obligation, or other liability of the company.
******************************************************************************
However, what happens if the LLC is not properly formed? What if organizers fail to mail in an
appropriate certificate of organizations, or neglect to pay appropriate fees, or if the articles are
rejected by the Secretary of State for another reason? It might well be that the participants, either
assuming that the LLC has been formed, or unconcerned about whether it has been formed at a
particular point of time, act before the company is validly existing under state law. What is their
potential liability? In essence there are multiple possibilities: (1) persons who act on behalf of an LLC before it has been formed may be liable as promoters (i.e., those who act for a non-existent principal); (2) there may be a real principal (such as a partnership or other person) but it is not fully disclosed, making the agent liable for contracts entered into for an unidentified or undisclosed principal; (3)
there may have been no principal to give authority, meaning the ostensible agent is liable for breaching a warranty of authority; (4) if there are multiple owners, there may have been a general partnership formed and it might be liable; (5) restitution might be required if the agent accepts a benefit meant for the LLC; or (6) there might be some theory on which the underlying entity (even if not properly formed at the time might be held liable) on a theory of enterprise liability. Most theories of enterprise liability are based on and arise out of corporate law but could apply
to limited liability businesses such as LLCs as well. For example, theories such as estoppel to
deny existence of the LLC or a “de facto” doctrine which would treat the LLC as having been
formed in fact even though the legal or de jure requirements were not met (also a doctrine that
would be borrowed primarily from corporate law) are possible alternatives. In addition, there
might be a new contract agreed to by both the LLC once it is formed and the third party,
resulting in the release of any promoters or ostensible agents. This would involve “novation.”
The LLC could also accept the contract by adoption, but in this case the agents or promoters
could also be liable. This theory would be “adoption.” Note that ratification is NOT a possibility.
Finally, if the LLC accepts the benefits of the bargain, it might be liable for restitution, for the
value of the benefit received.
The following case looks at and applies some of these theories.
*****************************************************************************
Questions based on Duray Dev., LLC
:
1.
Why does Duray claim that Perrin was liable?
2.
Under ordinary agency rules, would Duray’s arguments prevail? Why?
3.
What are Perrin’s defenses to his personal liability?
12
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
4.
What does it take for there to be a de facto corporation?
5.
What does it take for there to be a corporation by estoppel?
6.
Why do those corporate law doctrines apply to LLCs?
7.
Who winds up being liable and is the result fair to Duray?
Duray Dev., LLC v. Perrin
, 792 N.W.2d 749 (Mich App. 2010)
...[Basic facts: Carl Perrin signed a contract with Duray Development before validly forming
Outlaw LLC. He signed on behalf of Outlaw only. Duray sued Outlaw for unsatisfactory
performance, and found out that it had not been in existence at the time the contract was signed.
The complaint was then amended to add Perrin. At trial, the court rules in favor of Duray.] ...In a posttrial memorandum, Perrin argued that he was not personally liable for Duray
Development's damages. He asserted that, although Outlaw was not a valid limited liability
company at the time of the execution of the second contract, Outlaw was nevertheless liable to
Duray Development under the doctrine of de facto corporation. The trial court opined that if
Outlaw were a corporation, then the de facto corporation doctrine most likely would have
applied. However, the trial court concluded that the Limited Liability Company Act “clearly and
specifically provides for the time that a limited liability company comes into existence and has
powers to contract” and therefore superseded the de facto corporation doctrine and made it
inapplicable to limited liability companies altogether. Perrin now appeals.
... Perrin argues that he was not personally liable because he signed the second contract on behalf
of Outlaw. According to Perrin, even though Outlaw was not yet a properly formed limited
liability company, the parties all treated the contract as though Outlaw was a properly formed
limited liability company and, therefore, the doctrine of de facto corporation shielded Perrin
from personal liability. He further argues that the doctrine of corporation by estoppel precluded
Duray Development from arguing that he is personally liable. ....
The Limited Liability Company Act provides precisely when a limited liability company comes
into existence. ...Once a limited liability company comes into existence, limited liability applies,
and a member or manager is not liable for the acts, debts, or obligations of the company. In
contrast, a person who signs a contract on behalf of a company that is not yet in existence
generally becomes personally liable on that contract. However, a company can become liable if,
(1) after the company comes into existence, it either ratifies or adopts that contract, (2) a court
determines that a de facto corporation existed at the time of the contract, or (3) a court orders that
corporation by estoppel prevented the opposing party from arguing against the existence of a
corporation.
In this case, Perrin signed the articles of organization for Outlaw on the same day as the second
contract, October 27, 2004. Perrin then signed the October 27, 2004 contract on behalf of
Outlaw. However, the DELEG administrator did not endorse the articles of organization until
November 29, 2004. Therefore, pursuant to the Limited Liability Company Act, Outlaw was not
13
in existence on October 27, 2004. And Outlaw did not adopt or ratify the second contract.
Therefore, Perrin became personally liable for Outlaw's obligations unless a de facto limited
liability company existed or limited liability company by estoppel applied.
...De facto corporation and corporation by estoppel are separate and distinct doctrines that
warrant individual treatment. The de facto corporation doctrine provides that a defectively
formed corporation—that is, one that fails to meet the technical requirements for forming a de
jure corporation—may attain the legal status of a de facto corporation if certain requirements are
met, as discussed later in this opinion. The most important aspect of a de facto corporation is that
courts perceive and treat it in all respects as if it were a properly formed de jure corporation. For
example, it can sue and be sued. Often, as in this case, the status of the company is crucial to
determine whether the parties forming the corporation are individually liable. Corporation by estoppel, on the other hand, is an equitable remedy and does not concern legal
status. The general rule is: “Where a body assumes to be a corporation and acts under a particular
name, a third party dealing with it under such assumed name is estopped to deny its corporate
existence.” Like the de facto corporation doctrine, corporation by estoppel often arises in the
context of assessing individual versus corporate liability. The purpose of the doctrine is so “that
one who contracts with an association as a corporation is estopped to deny its corporate existence
... so as to prevent one from maintaining an action on the contract against the associates, or
against the officers making the contract, as individuals or partners.”
In sum, the de facto corporation doctrine allows a defectively formed corporation to attain the
legal status of a corporation. The corporation by estoppel doctrine prevents a party who dealt
with an association as though it were a corporation from denying its existence. Stated another
way, the de facto corporation doctrine establishes the legal existence of the corporation. By
contrast, the corporation by estoppel doctrine merely prevents one from arguing against it, and
does nothing to establish its actual existence in the eyes of the rest of the world.
Despite their differences, the two doctrines are often discussed in tandem and the Supreme Court
tends to collapse discussion of the two into a single blended analysis. One reason that the two
doctrines are often blended together is because a common fact pattern continually emerges in the
caselaw: a party conducts business with an association that it believes to be a de jure corporation,
but which was defective in some way and never truly incorporated. In that situation, both
corporation by estoppel and de facto corporation naturally become relevant.
....
The Michigan Supreme Court established the four elements for a de facto corporation long
ago: “When incorporators have [1] proceeded in good faith, [2] under a valid statute, [3] for an
authorized purpose, and [4] have executed and acknowledged articles of association pursuant to
that purpose, a corporation de facto instantly comes into being. A de facto corporation is an
actual corporation. As to all the world, except the State, it enjoys the status and powers of a de
jure corporation.”
14
Here, there is no question that elements (2), (3), and (4) were satisfied. ....
It is less obvious
whether the first element of the doctrine—good faith—was satisfied. There is little guidance in
Michigan caselaw for a definition, or application, of this specific element. But...the Michigan
Supreme Court, although applying a different set of elements, did state that in the absence of a
claim or evidence of fraud or false representation on the part of the incorporators, and in light of
a bona fide attempt to incorporate, there was no reason to deny a company... [de facto status.]
Here, Duray Development does not allege that Perrin set up the corporation through fraud or
false representations; that is, Duray Development does not allege that Perrin set up the
corporation as a sham, for fraudulent purposes, or as a mere instrumentality under a theory of
piercing the corporate veil. Rather, as the record indicates, Duray Development did not learn
until after filing the complaint in this case that Outlaw was not a valid limited liability company
on October 27, 2004. Duray Development at all times dealt with Outlaw as a valid corporation
with which it contracted. Duray Development's sole member, Munger, testified that once the
second contract took effect, Duray Development no longer considered Perrin or Perrin
Excavating as parties to the contract, but instead considered Outlaw to be the new “ contractor.”
There is no evidence whatsoever to suggest that Perrin formed Outlaw in anything other than
good faith. Accordingly, the trial court was correct to conclude that, had Outlaw been formed as
a corporation instead of a limited liability company, it would have been a de facto corporation
for purposes of liability on the October 27, 2004 contract. Thus, all elements of a de facto
corporation were present in this case.
The trial court, however, concluded that the de facto corporation doctrine does not apply to
limited liability companies and therefore did not apply to Outlaw. It reasoned that the plain
reading of the Limited Liability Company Act “clearly and specifically provides for the time that
a limited liability company comes into existence and has powers to contract.” ....
Neither this
Court nor the Supreme Court has addressed whether the de facto corporation doctrine can be
extended or applied to a limited liability company. That is not to say, however, that the doctrine
cannot be applied to a limited liability company. ...[A 1911 case] is similar to the facts here and
suggests that the plain language of the Limited Liability Company Act and the Business
Corporation Act should not supplant the de facto corporation doctrine. ....
Accordingly, we
conclude that the de facto corporation doctrine applies to Outlaw, a limited liability company. As
a result, Outlaw, and not Perrin, individually, is liable for the breach of the October 27, 2004
contract.
....
As stated previously, generally, a person who signs a contract on behalf of a company that is
not yet in existence becomes personally liable on that contract. However, a court can order that
the company is instead liable if it finds that corporation by estoppel prevented the opposing party
from arguing against the existence of a corporation. ....
“Where a body assumes to be a
corporation and acts under a particular name, a third party dealing with it under such assumed
name is estopped to deny its corporate existence.”
15
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
...[C]orporation by estoppel is an equitable remedy, and its purpose is to prevent one who
contracts with a corporation from later denying its existence in order to hold the individual
officers or partners liable. The doctrine has come up on numerous occasions in conjunction with
de facto corporations. In that setting, the rule is:
In the case of the associates in the corporation de facto, and those who have had dealings
with it, there is a mutual estoppel, resting upon broad grounds of right, justice and equity.
The first class are not suffered to deny their incorporation, nor the second to dispute the
validity of their assertions of corporate powers.
With this in mind, and in light of the purpose of corporation by estoppel, the corporate structure
has little impact on the equitable principles at stake. In other words, there is no reason or purpose
to draw a distinction on the basis of corporate form. Furthermore, like de facto corporation,
because corporation by estoppel coexists with the Business Corporation Act, so too can it coexist
with the Limited Liability Company Act.
....
[T]he record clearly supports a finding of “limited liability company by estoppel” through the
extension of the corporation by estoppel doctrine. ...[A]ll parties dealt with the ... contract as
though Outlaw were a party. ... Duray Development received billings from Outlaw, and not from
Perrin. Duray Development also received a certificate of liability insurance for Outlaw. Munger
testified that he ... only dealt with Outlaw after. Duray Development continued to assume Outlaw
was a valid limited liability company after filing the lawsuit and only learned of the filing and
contract discrepancies once litigation began in July 2006. ....
[Reversed]
***************************************************************************** You can see from this opinion that the issue of when a business is deemed to come into existence
is not as black and white as statutes might make it appear. We will consider the doctrine of
business de facto and business by estoppel in greater detail when we consider it in the context of
corporations. Also recall that if there had been more than one person working for the as-yet-
unformed business, you might then have two or more persons, associating as co-owners in a
business for profit (that has not been formed under another statute). Hopefully you recall that is
the precise definition of the general partnership, so that it is entirely possible that promoters
acting in concert for a business in formation might find themselves liable as general partners.
And, although there is no intent to make this course cumulative, it is also impossible to avoid the
potential application of agency rules. When Perrin was entering into transactions on behalf of the
company, he presumably signed on behalf of the LLC. In reality, there was no LLC. Do you
recall the rule as to what happens when an agent fails to fully and accurately disclose the identity
of his or her principal? (Hopefully, you remember that an agent for an unidentified principal is
also a party to any contract.) Moreover, a non-existent principal cannot authorize an agent to act.
Do you recall what happens when a purported agents enters into a contract without authority?
(At the very least there is a breach of the implied warranty of authority.) All of these theories
will be considered again, in more detail, in the materials relating to corporations.
16
5.
B
ECOMING
A
M
EMBER
& M
EMBERSHIP
I
NTERESTS
So what does it take to be a member in an LLC? Article 4 of the ULLCA deals with relations of
members to each other and to the company; it also includes provisions explaining how to become
a member. The most important provisions are as follows.
§ 4-38-401. Becoming a member
(a) If a limited liability company is to have only one member upon formation, the person
becomes a member as agreed by that person and the organizer of the company. That person and
the organizer may be, but need not be, different persons. If different, the organizer acts on behalf
of the initial member.
(b) If a limited liability company is to have more than one member upon formation, those
persons become members as agreed by the persons before the formation of the company. The
organizer acts on behalf of the persons in forming the company and may be, but need not be, one
of the persons.
(c) After formation of a limited liability company, a person becomes a member:
(1) as provided in the operating agreement;
(2) as the result of a transaction effective under § 4-38-1001 et seq.;
(3) with the affirmative vote or consent of all the members; or
(4) as provided in § 4-38-701(a)(3).***
(d) A person may become a member without:
(1) acquiring a transferable interest; or
(2) making or being obligated to make a contribution to the limited liability company.
[***Professor’s note: 4-38-701(a)(3) says that if the LLC has no more members, the heir or
representative of the last member has 90 days in which to select a new member]
§ 4-38-402. Form of contribution
A contribution may consist of property transferred to, services performed for, or another benefit
provided to the limited liability company or an agreement to transfer property to, perform
services for, or provide another benefit to the company.
§ 4-38-403. Liability for contributions
(a) A person's obligation to make a contribution to a limited liability company is not excused by
the person's death, disability, termination, or other inability to perform personally.
(b) If a person does not fulfill an obligation to make a contribution other than money, the person
is obligated at the option of the limited liability company to contribute money equal to the value
of the part of the contribution which has not been made.
(c) The obligation of a person to make a contribution may be compromised only by the
affirmative vote or consent of all the members. If a creditor of a limited liability company
extends credit or otherwise acts in reliance on an obligation described in subsection (a) without
knowledge or notice of a compromise under this subsection, the creditor may enforce the
obligation.
17
******************************************************************************
A limited liability company membership interest may be issued in exchange for property,
services rendered, or a promissory note or other obligation to contribute cash or property or to
perform services. If an enforceable promise to contribute property or perform services is made,
the member is obligated to contribute cash equal to that portion of the value of the agreed upon
contribution which is not made, even if the member is unable to perform because of death,
disability, or other reason. It takes the unanimous vote of all members to waive any such
obligation. Creditors who extend credit to the company in reliance on an obligation to contribute
or otherwise acts in reliance on that obligation may enforce any obligation to contribute. Note also that there is no minimum capital requirement for the LLC, either in total or on a per-
member basis. Membership interests do not need to be documented by certificates. You can call
them anything you want, and operating agreements which refer to units or percentage interests or
even shares are not uncommon. In essence, the operating agreement can provide any
requirements or restrictions that members in a particular LLC desire; otherwise the statue allows
virtually unlimited freedom to choose the type and amount of contributions that are acceptable
for membership in any given LLC.
Because the LLC was originally designed to mimic most partnership rules, what are the rules
governing transferability of interests? As you review these provisions, consider how they
resemble the rules for transfer of partnership interests.
§ 4-38-501. Nature of transferable interest
A transferable interest is personal property.
§ 4-38-502. Transfer of transferable interest
(a) Subject to § 4-38-503(f), a transfer, in whole or in part, of a transferable interest:
(1) is permissible;
(2) does not by itself cause a person's dissociation as a member or a dissolution and winding
up of the limited liability company's activities and affairs; and
(3) subject to § 4-38-504, does not entitle the transferee to:
(A) participate in the management or conduct of the company's activities and affairs; or
(B) except as otherwise provided in subsection (c), have access to records or other
information concerning the company's activities and affairs.
(b) A transferee has the right to receive, in accordance with the transfer, distributions to which
the transferor would otherwise be entitled.
(c) In a dissolution and winding up of a limited liability company, a transferee is entitled to an
account of the company's transactions only from the date of dissolution.
(d) A transferable interest may be evidenced by a certificate of the interest issued by a limited
liability company in a record, and, subject to this section, the interest represented by the
certificate may be transferred by a transfer of the certificate.
18
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(e) A limited liability company need not give effect to a transferee's rights under this section until
the company knows or has notice of the transfer.
(f) A transfer of a transferable interest in violation of a restriction on transfer contained in the
operating agreement is ineffective if the intended transferee has knowledge or notice of the
restriction at the time of transfer.
(g) Except as otherwise provided in § 4-38-602(5)(B), if a member transfers a transferable
interest, the transferor retains the rights of a member other than the transferable interest
transferred and retains all the duties and obligations of a member.
(h) If a member transfers a transferable interest to a person that becomes a member with respect
to the transferred interest, the transferee is liable for the member's obligations under §§ 4-38-403
and 4-38-406 known to the transferee when the transferee becomes a member.
******************************************************************************
Section 4-38-503 (not excerpted here) provides that a judgment creditor of a member or
transferee may obtain a charging order against the transferable interest, and explains how the
interest may be foreclosed. In neither event does the creditor become a member unless the
member is the sole member of the LLC.
******************************************************************************
6.
M
EMBERS
’ L
IABILITY
INCLUDING
P
IERCING
THE
V
EIL
The default rule for members in an LLC is that they are not liable for debts of the business.
(Section 4-38-304, excerpted in the section 4 of this chapter.) This model of limited liability is
essentially the same as that which exists for shareholders in corporations (and for limited
partners in a limited partnership, or any partner in an LLP or LLLP). Note that while the statute
purports to be absolute, providing that a member “is not liable” for debts of the business, there
are actually a number of exceptions to the rule of non-liability. That is why they have “limited”
liability and not “no” liability. Here are the general circumstances under which a member in an
LLC can still be “liable”:
(1) A member stands to lose his or her promised investment if the business fails. So long as an
agreed-upon contribution is promised in a signed writing, creditors who rely on the promise can
enforce the obligation. Moreover, once the contribution is made, the value of such contributions
can certainly be lost if the business fails.
(2) A member will always be liable for his or her own misconduct. In the case of torts, this is true
regardless of whether the tortfeasor is a member or manager or other employee of an LLC, and
regardless of whether the tort was in the scope of employment. Note that liability can also exist
as a result of failure to abide by fiduciary duties, including the duty to obey limitations on
authority. (3) A member will be personally liable if he or she is otherwise contractually obligated to accept
19
such liability. This would be the case if the member personally guarantees the LLC’s debt, or
signs anything like an indemnification agreement to hold the LLC’s creditor harmless. (4) A member can be held liable if the veil of limited liability of the entity is pierced by the
courts for equitable reasons. While most “piercing” cases have been decided in the corporate
context, in recent years, there have been a growing number of instances where parties have
sought to pierce the veil of other limited liability entities. I have excerpted the first reported Arkansas case that allowed piercing of the veil in the context
of an LLC. Note that the court consistently and incorrectly refers to the LLC as a corporation and
to its owners as shareholders. However, despite the inaccuracy in terminology, the basic rules
announced by the court seem consistent with cases from other states. For the most part, the same
analysis that is used to pierce the veil of corporate liability will apply to LLCs. I am well aware
that you have not yet studied cases dealing with piercing of the veil in corporations, but rest
assured, those materials will be covered shortly.
******************************************************************************
Questions based on Anderson v. Stewart
:
1.
What is the doctrine of piercing?
2.
When will a court “pierce the veil”?
3.
Why do they pierce the veil in this case?
Anderson v. Stewart
, 366 Ark. 203, 234 S.W.3d 295 (2006)
This appeal, certified to us by the court of appeals, poses the issue as to whether the trial court
erred in applying the doctrine of “piercing the corporate veil” and holding shareholders in a
limited liability company individually liable. We find no error, and affirm. *** [There was an
initial case against Check Mart of Hot Springs LLC, which was owned by appellants Jerry
Anderson and Mike Stout. In that case, in January of 2003, Appellee Charles Stewart won a
judgment against the LLC on the basis that the fees charged by Check Mart constituted illegal
usury.] On November 14, 2003, Stewart filed his second amended class action complaint, naming as
defendants Stout and Anderson, the “sole owners of Check Mart of Hot Springs, LLC,” and
Dunn, who formerly owned Check Mart and who sold the business to Stout and Anderson.
Stewart's complaint alleged that Check Mart, LLC, was the alter ego of Stout, Anderson, and
Dunn, who all received financial gain from their operation of the business. Stewart asserted that
the trial court had already determined that the plaintiffs were entitled to judgment as a matter of
law on the usury claim. In addition, Stewart raised a further cause of action under the Arkansas
Deceptive Trade Practices Act (DTPA), Ark.Code Ann. § 4–88–101 to-503 (Repl.2001), alleging
that Stout, Anderson, and Dunn were, as controlling and supervising persons, individually liable
for the damages caused by Check Mart. Stewart also asked the trial court to pierce the corporate
20
veil, asserting that the defendants operated Check Mart “for the sole purpose of engaging in
activities [that] violated the Arkansas usury protections in the Arkansas Constitution,” and that
Check Mart lacked sufficient assets to satisfy any judgment against it and was inadequately
capitalized.
The case was presented at a bench trial on November 9, 2004, and following the trial, the parties
agreed to submit briefs on the issue of the liability of the individual defendants. On April 19,
2005, the trial court entered an order finding that the plaintiff class was entitled to damages of
$122,027.50, attorneys' fees of $36,878.25, and costs of litigation of $908.42, for a total
judgment in favor of the class in the amount of $159,814.17. The court further found that the
individual defendants were liable under the Deceptive Trade Practices Act, and apportioned the
damages among the individual defendants based on the amount of time they had owned stock in
the company. Anderson, Stout, and Dunn filed timely notices of appeal, and now argue that the
trial court erred in piercing the corporate veil and holding them each individually liable under §
4–88–101, the DTPA. ***
The ... appellants' argument is that there was insufficient evidence to support the trial court's
decision to pierce the corporate veil. It is a nearly universal rule that a corporation and its
stockholders are separate and distinct entities, even though a stockholder may own the majority
of the stock. In special circumstances, the court will disregard the corporate facade when the
corporate form has been illegally abused to the injury of a third party. The conditions under
which the corporate entity may be disregarded or looked upon as the alter ego of the principal
stockholder vary according to the circumstances of each case. The doctrine of piercing the
corporate veil is founded in equity and is applied when the facts warrant its application to
prevent an injustice. Piercing the fiction of a corporate entity should be applied with great
caution. The issue of whether the corporate entity has been fraudulently abused is a question for
the trier of fact, and the one seeking to pierce the corporate veil and disregard the corporate
entity has the burden of proving that the corporate form was abused to his injury.
Legal treatises have noted that common instances in which the separate corporate identity has
been disregarded are when the corporation attempted to 1) evade the payment of income taxes, 2)
hinder, delay, and defraud creditors, 3) evade a contract or tort obligation, 4) evade the
obligations of a federal or state statute, and 5) perpetrate fraud and injustice generally.
Arkansas cases in which the corporate veil has been pierced have generally involved some fraud
or deception. *** On the other hand, in cases where the courts refused to pierce the corporate
veil, the evidence failed to make a showing of illegality or fraudulent behavior.
In the instant case, appellant Stout testified that he became a stockholder of Check Mart in early
2001 when he and appellant Jerry Anderson bought out appellant Dunn's interest; prior to
becoming a stockholder, when Dunn owned the company, Stout had been the registered agent for
the business. Dunn had been running the business for over a year at several different locations in
Hot Springs when Stout and Anderson bought it. Stout testified that Check Mart closed in
21
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
December of 2001; he could not recall whether the company continued to collect fees after that
time. After Check Mart closed, Stout formed D & L Service Company, which Stout described as
a “service company for a loan company out of South Dakota” that serviced loans and collected a
fee from the South Dakota loan company. When asked whether a number of Check Mart's
customers became customers of D & L Service Company, Stout said that he “would assume so,
yes,” although he stated that he did not work in the day-to-day operations, so he couldn't testify
that he “knew it for a fact.”
Stout denied knowing about any of Check Mart's business or customer records, acknowledging
that his attorney handled the records and had furnished any and all documents relating to fees
paid to Check Mart. Stout further acknowledged that Check Mart did not maintain any customer
records or any other documents that would reflect the amount of fees that Check Mart received
from its customers. He also agreed that, to his knowledge, D & L did not have any of Check
Mart's customer records. Stout stated that the only person who would have knowledge of the
company's day-to-day business records would be the manager, Bonnie Berg, who was not
present at the trial to testify.
Stout agreed that, in order to have a check cashing business in Arkansas, one has to post a surety
bond. In addition, he agreed that a party wishing to obtain a license to operate a check cashing
operation must have proof of liquid assets in a certain amount. Stout sought a letter of credit
from First State Bank to satisfy the statutory cash-on-hand requirements, but cancelled the letter
of credit on February 5, 2002, some three months after Stewart's lawsuit was filed. Stewart
introduced the surety bond, naming Dunn as principal, that was posted by Check Mart when the
company was started in March of 2000, and Stout agreed that the bond was the only bond ever
posted for Check Mart. However, he did not recognize any other related documents, and he could
not state positively whether the bond was ever canceled. Stout could also not be “absolutely
positive” about whether Check Mart had surrendered its check cashing license to the State,
although Check Mart's bond was canceled on February 6, 2002.
Stout testified that, other than Bonnie Berg, Check Mart had no other full-time employees, and
that no one else besides himself, Dunn, or Anderson had ever been owners of the company. He
also stated that he and his wife operated Check Mart of Conway, Inc., another “servicer” for the
South Dakota loan company. He said that the way the Conway Check Mart operated was that a
customer would come in and make a loan application, which was transmitted to South Dakota; if
the loan was approved, a check was printed from the South Dakota office, and the customer
could cash the check in the Conway office or take it to the customer's bank. The customer would
leave a check at the Conway office as collateral for that loan. If the customer did not come back
when the loan was due, Check Mart of Conway would deposit the customer's check “as a
servicer for the loan company.”
Stout said that he believed the State revoked the license for Check Mart of Hot Springs, and he
agreed that after the instant lawsuit was filed, Check Mart had no assets. However, tax records
22
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
introduced at trial showed that Stout reported $33,397 in gross receipts from Check Mart on his
personal tax return in 2001.
Stewart also introduced copies of “dun letters” sent by Check Mart to customers who failed to
make payments on their transactions with Check Mart and whose checks were dishonored by
their banks. Stout “assumed” that Check Mart would maintain copies of any such letters sent to
customers, but did not know for a fact. Stout denied having any knowledge of the amounts of
fees paid to Check Mart by customers, and denied knowing whether Check Mart ever sued any
of its customers, despite the introduction into evidence of a small claims complaint filed in the
name of Check Mart and signed by Bonnie Berg, the store's manager. Further, Stout denied
knowing anything about whether Check Mart maintained copies of checks written to the
company. Stout professed that it was his intent for Check Mart to comply with the Arkansas
Check Casher's Act, but did not know whether, or for how long, the Act required him to retain
any records.
When asked whether Check Mart ever had an accountant, Stout stated that the company did not
have an accountant, although he personally had one. Stout was unsure whether Berg kept the
books for Check Mart “or if the accountant posted [them],” and did not know who prepared the
company's profit-and-loss statement. That profit-and-loss statement for the period from January
through November of 2001 reflected a loss of $7,078; Stout could not explain why the entire
amount of that same loss was reported on his personal tax returns for 2001. ***
On these facts, the trial court's decision to pierce the corporate veil and hold the individual
defendants liable was not clearly erroneous. The evidence demonstrated that Check Mart and its
owners failed to properly maintain business records, thereby failing to comply with the Check
Casher's Act. In addition, Stout withdrew Check Mart's letters of credit and canceled the bond
Check Mart had posted shortly after this lawsuit was filed, an act which Stewart contends was
designed to ensure that Check Mart would not have the appropriate assets to satisfy any
judgment that might be entered against the company. Further, ... even after Check Mart closed,
the same individuals were operating the same kind of business in the form of D & L Service
Company.
***Given the evidence before it, we hold that the trial court did not err in piercing the corporate
veil and holding the individual defendants personally liable.
******************************************************************************
7.
M
ANAGEMENT
One major issue with LLCs concerns how they are managed. This is one area where the ULLCA
differs both from partnership law and the prior Arkansas LLC statute. In a partnership, general
partners have statutory apparent authority; this rule was also in the old Arkansas act. Consider
how the following provisions treat authority and management power:
23
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
§ 4-38-301. No agency power of member as member
(a) A member is not an agent of a limited liability company solely by reason of being a member.
(b) A person's status as a member does not prevent or restrict law other than this chapter from
imposing liability on a limited liability company because of the person's conduct.
§ 4-38-407. Management of limited liability company
(a) A limited liability company is a member-managed limited liability company unless the
operating agreement:
(1) expressly provides that:
(A) the company is or will be “manager-managed”;
(B) the company is or will be “managed by managers”; or
(C) management of the company is or will be “vested in managers”; or
(2) includes words of similar import.
(b) In a member-managed limited liability company, the following rules apply:
(1) Except as expressly provided in this chapter, the management and conduct of the
company are vested in the members.
(2) Each member has equal rights in the management and conduct of the company's activities
and affairs.
(3) A difference arising among members as to a matter in the ordinary course of the activities
and affairs of the company may be decided by a majority of the members.
(4) The affirmative vote or consent of all the members is required to:
(A) undertake an act outside the ordinary course of the activities and affairs of the
company; or
(B) amend the operating agreement.
(c) In a manager-managed limited liability company, the following rules apply:
(1) Except as expressly provided in this chapter, any matter relating to the activities and
affairs of the company is decided exclusively by the manager, or, if there is more than one
manager, by a majority of the managers.
(2) Each manager has equal rights in the management and conduct of the company's activities
and affairs.
(3) The affirmative vote or consent of all members is required to:
(A) undertake an act outside the ordinary course of the company's activities and affairs;
or
(B) amend the operating agreement.
(4) A manager may be chosen at any time by the affirmative vote or consent of a majority of
the members and remains a manager until a successor has been chosen, unless the manager at
an earlier time resigns, is removed, or dies, or, in the case of a manager that is not an
individual, terminates. A manager may be removed at any time by the affirmative vote or
consent of a majority of the members without notice or cause.
(5) A person need not be a member to be a manager, but the dissociation of a member that is
also a manager removes the person as a manager. If a person that is both a manager and a
member ceases to be a manager, that cessation does not by itself dissociate the person as a
member.
24
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(6) A person's ceasing to be a manager does not discharge any debt, obligation, or other
liability to the limited liability company or members which the person incurred while a
manager.
(d) An action requiring the vote or consent of members under this chapter may be taken without
a meeting, and a member may appoint a proxy or other agent to vote, consent, or otherwise act
for the member by signing an appointing record, personally or by the member's agent.
(e) The dissolution of a limited liability company does not affect the applicability of this section.
However, a person that wrongfully causes dissolution of the company loses the right to
participate in management as a member and a manager.
(f) A limited liability company shall reimburse a member for an advance to the company beyond
the amount of capital the member agreed to contribute.
(g) A payment or advance made by a member which gives rise to a limited liability company
obligation under subsection (f) or § 4-38-408(a) constitutes a loan to the company which accrues
interest from the date of the payment or advance.
(h) A member is not entitled to remuneration for services performed for a member-managed
limited liability company, except for reasonable compensation for services rendered in winding
up the activities of the company.
*************************************************************************
The best way to test your understanding of the rules set out in these provisions is to see if you
can answer these questions.
Problems on sections 4-38-301 and 4-38-407:
1.
Khaleel and Carlita form an LLC. They are the only members. They do not mention
management in their certificate. They do not mention management in their operating agreement.
Carlita wants the LLC to buy new computers, which would be within the scope of the usual
operations of a business like their LLC. Carlita knows that Khaleel would object. Is Carlita an
agent of the LLC? Does she have the authority to bind the LLC? Why?
2.
Same as problem 1, but now Carlita wants to buy a $55,000 luxury car for the LLC. Khaleel
would really object to this, and it is not even the kind of thing that a business like theirs would
usually do. Can she bind the LLC by signing a contract to buy the car?
3.
What if the operating agreement provides that Carlita will have exclusive day to day
authority over all business decisions. Does this change your answer to problem 2?
4.
Suppose instead that the certificate of organization says that the LLC will be manager
managed, but they do not mention managers in the operating agreement. Same facts as problem
1. Now can Carlita bind the LLC to by signing on a contract for the computers when she knows
that Khaleel would not vote for that purchase?
25
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
5.
Suppose that both Khaleel and Carlita agree to buy that luxury car that is outside the usual
way that this kind of LLC would operate. The LLC’s certificate says it is manager-managed. The
operating agreement is silent. Carlita signs the contract to buy the car, and now Khaleel wants to
back out of the deal. Is the LLC bound? Is Carlita liable for anything?
******************************************************************************
8.
F
IDUCIARY
D
UTIES
IN
AN
LLC
In addition to management power, it is important to understand the rights and responsibilities of
members and managers of LLCs. The next two statutory sections deal with those concerns.
§ 4-38-409. Standards of conduct for members and managers
(a) A member of a member-managed limited liability company owes to the company and, subject
to § 4-38-801, the other members the duties of loyalty and care stated in subsections (b) and (c).
(b) The fiduciary duty of loyalty of a member in a member-managed limited liability company
includes the duties:
(1) to account to the company and hold as trustee for it any property, profit, or benefit
derived by the member:
(A) in the conduct or winding up of the company's activities and affairs;
(B) from a use by the member of the company's property; or
(C) from the appropriation of a company opportunity;
(2) to refrain from dealing with the company in the conduct or winding up of the company's
activities and affairs as or on behalf of a person having an interest adverse to the company;
and
(3) to refrain from competing with the company in the conduct of the company's activities
and affairs before the dissolution of the company.
(c) The duty of care of a member of a member-managed limited liability company in the conduct
or winding up of the company's activities and affairs is to refrain from engaging in grossly
negligent or reckless conduct, willful or intentional misconduct, or knowing violation of law.
(d) A member shall discharge the duties and obligations under this chapter or under the operating
agreement and exercise any rights consistently with the contractual obligation of good faith and
fair dealing.
(e) A member does not violate a duty or obligation under this chapter or under the operating
agreement solely because the member's conduct furthers the member's own interest.
(f) All the members of a member-managed limited liability company or a manager-managed
limited liability company may authorize or ratify, after full disclosure of all material facts, a
specific act or transaction that otherwise would violate the duty of loyalty.
(g) It is a defense to a claim under subsection (b)(2) and any comparable claim in equity or at
common law that the transaction was fair to the limited liability company.
(h) If, as permitted by subsection (f) or (i)(6) or the operating agreement, a member enters into a
transaction with the limited liability company which otherwise would be prohibited by
subsection (b)(2), the member's rights and obligations arising from the transaction are the same
as those of a person that is not a member.
26
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(i) In a manager-managed limited liability company, the following rules apply:
(1) Subsections (a), (b), (c), and (g) apply to the manager or managers and not the members.
(2) The duty stated under subsection (b)(3) continues until winding up is completed.
(3) Subsection (d) applies to managers and members.
(4) Subsection (e) applies only to members.
(5) The power to ratify under subsection (f) applies only to the members.
(6) Subject to subsection (d), a member does not have any duty to the company or to any
other member solely by reason of being a member.
§ 4-38-410. Rights to information of member, manager, and person dissociated as member
(a) In a member-managed limited liability company, the following rules apply:
(1) On reasonable notice, a member may inspect and copy during regular business hours, at a
reasonable location specified by the company, any record maintained by the company
regarding the company's activities, affairs, financial condition, and other circumstances, to
the extent the information is material to the member's rights and duties under the operating
agreement or this chapter.
(2) The company shall furnish to each member:
(A) without demand, any information concerning the company's activities, affairs,
financial condition, and other circumstances which the company knows and is material to
the proper exercise of the member's rights and duties under the operating agreement or
this chapter, except to the extent the company can establish that it reasonably believes the
member already knows the information; and
(B) on demand, any other information concerning the company's activities, affairs,
financial condition, and other circumstances, except to the extent the demand for the
information demanded is unreasonable or otherwise improper under the circumstances.
(3) The duty to furnish information under paragraph (2) also applies to each member to the
extent the member knows any of the information described in paragraph (2).
(b) In a manager-managed limited liability company, the following rules apply:
(1) The informational rights stated in subsection (a) and the duty stated in subsection (a)(3)
apply to the managers and not the members.
(2) During regular business hours and at a reasonable location specified by the company, a
member may inspect and copy information regarding the activities, affairs, financial
condition, and other circumstances of the company as is just and reasonable if:
(A) the member seeks the information for a purpose reasonably related to the member's
interest as a member;
(B) the member makes a demand in a record received by the company, describing with
reasonable particularity the information sought and the purpose for seeking the
information; and
(C) the information sought is directly connected to the member's purpose.
(3) Not later than 10 days after receiving a demand pursuant to paragraph (2)(B), the
company shall inform in a record the member that made the demand of:
(A) what information the company will provide in response to the demand and when and
where the company will provide the information; and
27
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(B) the company's reasons for declining, if the company declines to provide any
demanded information.
(4) Whenever this chapter or an operating agreement provides for a member to vote on or
give or withhold consent to a matter, before the vote is cast or consent is given or withheld,
the company shall, without demand, provide the member with all information that is known
to the company and is material to the member's decision.
(c) Subject to subsection (h), on 10 days' demand made in a record received by a limited liability
company, a person dissociated as a member may have access to the information to which the
person was entitled while a member if:
(1) the information pertains to the period during which the person was a member;
(2) the person seeks the information in good faith; and
(3) the person satisfies the requirements imposed on a member by subsection (b)(2).
(d) A limited liability company shall respond to a demand made pursuant to subsection (c) in the
manner provided in subsection (b)(3).
(e) A limited liability company may charge a person that makes a demand under this section the
reasonable costs of copying, limited to the costs of labor and material.
(f) A member or person dissociated as a member may exercise the rights under this section
through an agent or, in the case of an individual under legal disability, a legal representative.
Any restriction or condition imposed by the operating agreement or under subsection (h) applies
both to the agent or legal representative and to the member or person dissociated as a member.
(g) Subject to § 4-38-504, the rights under this section do not extend to a person as transferee.
(h) In addition to any restriction or condition stated in its operating agreement, a limited liability
company, as a matter within the ordinary course of its activities and affairs, may impose
reasonable restrictions and conditions on access to and use of information to be furnished under
this section, including designating information confidential and imposing nondisclosure and
safeguarding obligations on the recipient. In a dispute concerning the reasonableness of a
restriction under this subsection, the company has the burden of proving reasonableness.
******************************************************************************
There are some points worth making about this language. First, members are not completely free
to eliminate these standards of care set out here or to narrow the rights to information. The
operating agreement can set standards by which compliance with the duties may be judged, and
the agreement can apply heightened duties of care. This does not hold members and managers to a particularly high standard of care since they are
directed under the statute to avoid “gross negligence or willful misconduct.” The duty of loyalty
is to hold as trustee profits derived from transactions connected with the business of the LLC,
and to refrain from dealing on behalf of an adverse party or from competing with the LLC prior
to dissolution. The statute also specifically gives other member or managers the ability to
authorize or ratify transactions that would violate the duty of loyalty after full disclosure, and
also says that it is a defence to any claim that the transaction was fair to the LLC. In manager-
managed LLCs the obligations apply to managers not members. Finally, note also that the statute
says there is no violation of a duty just because the interests of a member are also furthered. 28
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
Questions based on McConnell
:
1.
Who was the member alleged to have breached his duty of loyalty and what did he do?
2.
What is his argument that he was allowed to do this?
3.
How does the court rule, and why?
4. If the case came up in Arkansas under the ULLCA (2013) how should the agreement be
analyzed, and what result should be reached?
McConnell v. Hunt Sports Enterprises
, 725 N.E.2d 1193 (Ohio App. 1999)
On June 17, 1997, John H. McConnell and Wolfe Enterprises, Inc. filed a complaint for
declaratory judgment ... against Hunt Sports Enterprises, Hunt Sports Enterprises, L.L.C., Hunt
Sports Group, L.L.C. ("Hunt Sports Group"), and Columbus Hockey Limited ("CHL"). CHL was
a limited liability company ....
A brief background of the events leading up to the formation of
CHL and the subsequent discord among certain of its members follows.
In 1996, the National Hockey League ("NHL") determined it would be accepting applications for
new hockey franchises. ....
In April 1996 ... Ronald A. Pizzuti and McConnell [were contacted
about starting an NHL franchise in Columbus]….
Pizzuti began efforts to recruit investors in a possible franchise. Pizzuti approached Lamar Hunt,
principal of Hunt Sports Group, as to Hunt's interest in investing in such a franchise for
Columbus. Hunt was already the operating member of the Columbus Crew, a professional soccer
team whose investors included Hunt Sports Group, Pizzuti, McConnell, and Wolfe Enterprises,
Inc. Hunt expressed an interest in participating in a possible franchise. The deadline for applying
for an NHL expansion franchise was November 1, 1996.
On October 31, 1996, CHL was formed when its articles of organization were filed with the
secretary of state pursuant to R.C. 1705.04. The members of CHL were McConnell, Wolfe
Enterprises, Inc., Hunt Sports Group, Pizzuti Sports Limited, and Buckeye Hockey, L.L.C. Each
member made an initial capital contribution of $25,000. CHL was subject to an operating
agreement that set forth the terms between the members. Pursuant to section 2.1 of CHL's
operating agreement, the general character of the business of CHL was to invest in and operate a
franchise in the NHL.
On or about November 1, 1996, an application was filed with the NHL on behalf of the city of
Columbus. In the application, the ownership group was identified as CHL …. There was no
facility at the time, and the proposal was to build a facility that would be financed, in large part,
by a three-year countywide one-half percent sales tax. The sales tax issue would be on the May
1997 ballot.
[On May 7, after the sales tax failed] ..., Dimon McPherson, chairman and chief executive officer
of Nationwide Insurance Enterprise ("Nationwide"), met with Hunt, and they discussed the
29
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
possibility of building the arena despite the failure of the sales tax issue. McPherson testified that
he chose Hunt because: "Well, he was the visible, obvious, only person that was involved in
trying to bring NHL hockey to Columbus. There was really no one else to turn to." Hunt was
interested, and Nationwide began working on an arena plan. ….
By May 28, 1997, Nationwide had come up with a plan to finance an arena privately and on such
date, Nationwide representatives met with representatives of Hunt Sports Group. Hunt Sports
Group did not accept Nationwide's lease proposal [and continued negotiations were not
successful]
.....
The June 4, 1997 NHL deadline was discussed. Hunt Sports Group stated that it
would continue to evaluate the proposal, and it wanted the weekend to do so. Nationwide
informed appellant that it needed an answer by close of business Friday, May 30.
On May 30, 1997, McPherson called McConnell and requested that they meet and discuss
"where [they] were on the arena." McPherson "could see that the situation now was slipping
away, and [he] just didn't want that to happen," so he went to see McConnell for advice and
counsel. …. McConnell stated that if Hunt would not step up and lease the arena and, therefore, get the
franchise, McConnell would. Hunt Sports Group did not contact Nationwide on May 30, 1997.
On Saturday, May 31, McPherson told Nationwide's board of directors that there was not yet a
lease commitment but that if Hunt Sports Group did not lease the arena, McConnell would. On
Monday, June 2, 1997, City Council passed the resolution that set forth the terms for Nationwide
to build an arena downtown. … [On June 3] Hunt Sports Group told Nationwide that it still
found the terms of the lease to be unacceptable. On June 3 or June 4, McConnell, in a
conversation with the NHL, orally agreed to apply for a hockey franchise for Columbus. …
On June 4, 1997, the NHL franchise expansion committee met. …. The expansion committee
recommended Columbus to the NHL board of governors as one of four cities to be granted a
franchise.
On June 5, 1997, the NHL sent Hunt a letter requesting that he let the NHL know by Monday,
June 9, 1997 whether he was going forward with his franchise application. In a June 6, 1997
letter to the NHL, Hunt responded that CHL intended to pursue the franchise application. Hunt
informed the NHL that he had arranged a meeting with the members of CHL to be held on June
9, 1997. Hunt indicated that the application was contingent upon entering into an appropriate
lease for a hockey facility.
On June 9, 1997, … [t]he NHL required that the ownership group be identified and that such
ownership group sign a lease term sheet by June 9, 1997. … Hunt indicated the lease was
unacceptable. ....
Pizzuti and Wolfe agreed to participate along with McConnell. ....
Christie
informed Ellis that McConnell had accepted the term sheet and was signing it in his individual
capacity. The term sheet contained a signature line for "Columbus Hockey Limited" as the
30
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
franchise owner. Ellis phoned his secretary and had her omit the name "Columbus Hockey
Limited" on her computer from under the signature line …. McConnell then signed the term
sheet as the owner of the franchise. ….
On June 17, 1997, the NHL expansion committee recommended to the NHL board of governors
that Columbus be awarded a franchise with McConnell's group as owner of the franchise. On the
same date, the complaint ... was filed. On or about June 25, 1997, the NHL board of governors
awarded Columbus a franchise with McConnell's group as owner. ….
In their complaint, McConnell and Wolfe Enterprises, Inc. requested a declaration that section
3.3 of the CHL operating agreement allowed members of CHL to compete with CHL.
Specifically, McConnell and Wolfe Enterprises, Inc. sought a declaration that under the
operating agreement, they were permitted to participate in COLHOC and obtain the franchise. On June 23, 1997, Hunt Sports Group filed an answer and counterclaim on its behalf and on
behalf on CHL. The counterclaim was asserted against McConnell and alleged breach of
contract, breach of fiduciary duty, and interference with prospective business relationships.
…. On October 31, 1997, the trial court rendered a decision, granting summary judgment in
favor of McConnell and Wolfe Enterprises, Inc. on count one of the... complaint and on counts
one and three of the counterclaim. Specifically, the trial court found that section 3.3 of the
operating agreement was clear and unambiguous and allowed McConnell and Wolfe Enterprises,
Inc. to compete against CHL and obtain the NHL franchise. In addition, the trial court found
McConnell did not breach the operating agreement by competing against CHL. The trial court
denied the motion for summary judgment as to counts two, four, and five of the counterclaim.
Therefore, the claims that remained were
....
breach of fiduciary duty and interference with
prospective business relationships
....
Section 3.3 of the operating agreement states:
"Members May Compete. Members shall not in any way be prohibited from or restricted in
engaging or owning an interest in any other business venture of any nature, including any
venture which might be competitive with the business of the Company."
Appellant emphasizes the word "other" in the above language and states, in essence, that it
means any business venture that is different from the business of the company. Appellant points
out that under section 2.1 of the operating agreement, the general character of the business is "to
invest in and operate a franchise in the National Hockey League." Hence, appellant contends that
members may only engage in or own an interest in a venture that is not in the business of
investing in and operating a franchise with the NHL.
Appellant's interpretation of section 3.3 goes beyond the plain language of the agreement and
adds words or meanings not stated in the provision. Section 3.3, for example, does not state
"[m]embers shall not be prohibited from or restricted in engaging or owning an interest in any
31
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
other business venture that is different from the business of the company." Rather, section 3.3
states: "any other business venture of any nature." (Emphasis added.) It then adds to this
statement: "including any venture which might be competitive with the business of the
Company." The words "any nature" could not be broader, and the inclusion of the words "any
venture which might be competitive with the business of the Company" makes it clear that
members were not prohibited from engaging in a venture that was competitive with CHL's
investing in and operating an NHL franchise. Contrary to appellant's contention, the word
"other" simply means a business venture other than CHL. The word "other" does not limit the
type of business venture in which members may engage.
Hence, section 3.3 did not prohibit appellees from engaging in activities that may have been
competitive with CHL, including appellees' participation in COLHOC. Accordingly, summary
judgment in favor of appellees was appropriate, and appellees were entitled to a declaration that
section 3.3 of the operating agreement permitted appellees to request and obtain an NHL hockey
franchise to the exclusion of CHL. ….
... [T]he trial court was correct in stating that it could not be considered a breach of fiduciary
duty, in and of itself, to compete against CHL because the operating agreement allowed such
competition. Contract provisions may affect the scope of fiduciary duties, and as such, the trial
court was correct to indicate that the method of competing, not the competing itself, may
constitute a breach of fiduciary duty...
... In the case at bar, a limited liability company is involved which, like a partnership, involves a
fiduciary relationship. Normally, the presence of such a relationship would preclude direct
competition between members of the company. However, here we have an operating agreement
that by its very terms allows members to compete with the business of the company. Hence, the
question we are presented with is whether an operating agreement of a limited liability company
may, in essence, limit or define the scope of the fiduciary duties imposed upon its members. We
answer this question in the affirmative
....
Here, the injury complained of by appellant was, essentially, appellees' competing with CHL and
obtaining the NHL franchise. The operating agreement constitutes the undertaking of the parties
herein. In becoming members of CHL, appellant and appellees agreed to abide by the terms of
the operating agreement, and such agreement specifically allowed competition with the company
by its members. As such, the duties created pursuant to such undertaking did not include a duty
not to compete. Therefore, there was no duty on the part of appellees to refrain from subjecting
appellant to the injury complained of herein
....
In conclusion, there was not sufficient material evidence presented at trial so as to create a
factual question for the jury on the issues of breach of fiduciary duty and tortious interference
with business relationships. Therefore, a directed verdict in favor of appellees ... was appropriate.
....
*****************************************************************************
32
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
It is worth looking at how the facts of this case should be analyzed under the ULLCA (2013)
(and the current Arkansas statutes) in a little more detail.
1. CHL had an operating agreement setting out its purpose (in section 2.1) to invest in and
operate an NHL franchise. Section 3.3 read: "Members May Compete. Members shall not in any
way be prohibited from or restricted in engaging or owning an interest in any other business
venture of any nature, including any venture which might be competitive with the business of the
Company." McConnell was a member of CHL, but formed another business that took the NHL
License.
2.
The statutory default duty of loyalty under section 4-38-409(b)(3) of the LLC Act is that a
member in a member-managed LLC is supposed “to refrain from competing with the company in
the conduct of the company’s activities and affairs before the dissolution of the company.” While
section 4-38-107(c)(5) says that an operating agreement may not “alter or eliminate the duty of
loyalty or the duty of care, except as otherwise provided in subsection (d);” section 4-38-107(d)
(3) provides that:
If not manifestly unreasonable, the operating agreement may: (A) alter or eliminate the aspects of the duty of loyalty stated in Section 4-38-409(b)
[and]
(B) identify specific types or categories of activities that do not violate the duty of
loyalty
….
3. Absent the operating agreement, it would not have been permissible for McConnell to
compete with his LLC. In the case, the operating agreement changed the result. What should be
the result under the ULLCA provisions? If you go back to the previously described tenants of
§4-38-107(d)(3), the members of an LLC can agree to eliminate aspects of the duty of loyalty so
long as they are not being “manifestly unreasonable.” In the case, Hunt’s refusal to accept
available financing options for the arena were jeopardizing the entire NHL franchise. The ability
to take the opportunity after fully disclosing everything to the other members does not seem to be
“manifestly unreasonable.” 9.
S
HARING
OF
D
ISTRIBUTIONS
From an individual member's standpoint, the economic claims of the member against the LLC
may have paramount importance among all the issues with which the member will be concerned.
Therefore, a legal adviser/drafter will likely want to ensure that these economic claims, above all
other matters, are clearly defined and understood.
Arkansas’ new LLC Act talks about members’ and transferees’ rights in terms of their right to
share in distributions. The right to interim distributions (i.e., distributions while the LLC is still
operating, rather than the final liquidating distributions) is set out in the following sections:
33
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
§ 4-38-404. Sharing of and right to distributions before dissolution
(a) Any distribution made by a limited liability company before its dissolution and winding up
must be in equal shares among members and persons dissociated as members, except to the
extent necessary to comply with a transfer effective under § 4-38-502 or charging order in effect
under § 4-38-503.
(b) A person has a right to a distribution before the dissolution and winding up of a limited
liability company only if the company decides to make an interim distribution. A person's
dissociation does not entitle the person to a distribution.
(c) A person does not have a right to demand or receive a distribution from a limited liability
company in any form other than money. Except as otherwise provided in § 4-38-707(d), a
company may distribute an asset in kind only if each part of the asset is fungible with each other
part and each person receives a percentage of the asset equal in value to the person's share of
distributions.
(d) If a member or transferee becomes entitled to receive a distribution, the member or transferee
has the status of, and is entitled to all remedies available to, a creditor of the limited liability
company with respect to the distribution. However, the company's obligation to make a
distribution is subject to offset for any amount owed to the company by the member or a person
dissociated as a member on whose account the distribution is made.
§ 4-38-405. Limitations on distributions
(a) A limited liability company may not make a distribution, including a distribution under § 4-
38-707, if after the distribution:
(1) the company would not be able to pay its debts as they become due in the ordinary course
of the company's activities and affairs; or
(2) the company's total assets would be less than the sum of its total liabilities ….
(b) A limited liability company may base a determination that a distribution is not prohibited
under subsection (a) on:
(1) financial statements prepared on the basis of accounting practices and principles that are
reasonable in the circumstances; or
(2) a fair valuation or other method that is reasonable under the circumstances.
….
(d) A limited liability company's indebtedness to a member or transferee incurred by reason of a
distribution made in accordance with this section is at parity with the company's indebtedness to
its general, unsecured creditors, except to the extent subordinated by agreement.
….
(f) In measuring the effect of a distribution under § 4-38-707, the liabilities of a dissolved limited
liability company do not include any claim that has been disposed of under § 4-38-704, § 4-38-
705, or § 4-38-706.
§ 4-38-406. Liability for improper distributions
(a) Except as otherwise provided in subsection (b), if a member of a member-managed limited
liability company or manager of a manager-managed limited liability company consents to a
distribution made in violation of § 4-38-405 and in consenting to the distribution fails to comply
34
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
with § 4-38-409, the member or manager is personally liable to the company for the amount of
the distribution which exceeds the amount that could have been distributed without the violation
of § 4-38-405.
(b) To the extent the operating agreement of a member-managed limited liability company
expressly relieves a member of the authority and responsibility to consent to distributions and
imposes that authority and responsibility on one or more other members, the liability stated in
subsection (a) applies to the other members and not the member that the operating agreement
relieves of the authority and responsibility.
(c) A person that receives a distribution knowing that the distribution violated § 4-38-405 is
personally liable to the limited liability company but only to the extent that the distribution
received by the person exceeded the amount that could have been properly paid under § 4-38-
405.
….
(e) An action under this section is barred unless commenced not later than two years after the
distribution.
*****************************************************************************
While the equal sharing of distributions should be familiar given that it is the same approach
taken in the general partnership statute, the rules in sections 4-38-405 and 406 are new. There is
nothing like them in the partnership act. Why are these provisions necessary here when they
were note needed in the partnership act?
Remember that in the traditional partnership, partners had unlimited liability for partnership
debts. If there were insufficient assets in the business to cover its obligations, the partners were
already obligated to repay them. That is not the rule for members in LLCs. These provisions,
making LLC members personally liable for distributions that leave the business insolvent or
made when the business is already unable to pay its debts, is therefore needed to protect
creditors. It is modeled after the language that is found in corporate statutes.
For those of you who are trying to put all the pieces together, considering the difference between
the varied forms of business enterprise, you might be thinking of the LLP, which is a general
partnership where the partners do NOT have personal liability for the debts of the business. Why
do LLP statutes not have provisions like these? That is a very good question, and probably the
answer is that in the rush to adopt LLP provisions it was not well thought out. On the other hand,
there are other statutes that fill this void. Bankruptcy rules will kick in, and they may void
transactions that leave the company insolvent when made to insiders without a reasonably
equivalent exchange of value. (This means the company can still buy essential supplies, services,
and pay bills, but could not distribute earnings to owners.) Similarly, most states (including
Arkansas) have fraudulent conveyances laws. That particular statute will be covered in the
material dealing with corporate distributions.
Returning to the rule governing how distributions are to be made in an LLC, the default rule in
Arkansas mirrors the traditional default rule for general partnerships–members share in
35
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
distributions equally no matter the value of their contribution or the efforts that the make in
ensuring the business’ profitability. This is probably one of the issues addressed most frequently
in operating agreements. The members in an LLC are generally free to divide up the economic
pie of the LLC in whatever manner they choose, and the flexibility afforded here (a characteristic
carried over from the partnership form of business) is one of the more attractive features of the
LLC. However, any variation from the default rules needs to be expressed in the operating
agreement. One common variation is to provide that profits are to be based on the agreed-value of
contributions. A problem with this is that it does not recognize that contributors may have
different levels of risk based on when they buy into the LLC. Another common approach is to
design a payout based on the number of ownership interests (or units, or rights, or even shares)
that a member acquires, regardless of the amount paid. Of course, this requires careful thought
by the members and the person charged with drafting the operating agreement.
Unless the members are happy with equal shares, the LLC’s operating agreement should provide:
(1) how the LLC is to determine the total amount available for distribution on an interim basis;
(2) how much of what is available for distribution in any given year may or must be distributed;
(3) how the total amount to be distributed is to be shared; (4) the mechanism for determining
when these distributions will be made. With regard to item (3), there are a number of options. (1) Overall distribution rights may be
determined in some manner other than equally; (2) Some members may have preferred
distribution rights; or (3) Particular items (e.g., the profit on the sale of a particular property)
may be distributed in a manner that is different from the general distribution rights. With regard to item (4), the timing of distributions is also essential. The LLC Act says there is no
specific "default" rule concerning the timing of interim distributions. Only if the LLC decides to
make a distribution will it occur. The most informal way of handling the timing issue is to say
nothing about it in the operating agreement. In that event, those in charge of management of the
LLC, either members or managers, will decide when distributions will be made. On the other
hand, the operating agreement may mandate that distributions be made when available cash flow
will permit it. The availability of the cash flow could be assessed on whatever schedule the
operating agreement provides, such as monthly, quarterly, etc. The choice of whether to specify
in the operating agreement when distributions are to be made will probably depend primarily on
whether the LLC is member-managed or manager-managed. If the LLC is being managed by
representatives of the members rather than the members themselves, the members may want the
operating agreement to provide greater assurances that distributions will in fact be made with
some regularity. Minority members may have similar desires when it comes to the drafting of an
operating agreement.
All of the preceding information has dealt with interim distributions. What about distributions on
liquidation?
36
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
§ 4-38-707. Disposition of assets in the winding up
(a) In winding up its activities and affairs, a limited liability company shall apply its assets to
discharge the company's obligations to creditors, including members that are creditors.
(b) After a limited liability company complies with subsection (a), any surplus must be
distributed in the following order, subject to any charging order in effect under § 4-38-503:
(1) to each person owning a transferable interest that reflects contributions made and not
previously returned, an amount equal to the value of the unreturned contributions; and
(2) among persons owning transferable interests in proportion to their respective rights to share
in distributions immediately before the dissolution of the company.
(c) If a limited liability company does not have sufficient surplus to comply with subsection (b)
(1), any surplus must be distributed among the owners of transferable interests in proportion to
the value of the respective unreturned contributions.
(d) All distributions made under subsections (b) and (c) must be paid in money.
******************************************************************************
In the case of liquidating distributions by an LLC, the LLC Act protects the rights of creditors by
giving them a higher claim to the LLC assets than members have and generally providing that
creditors’ claims will not be discharged before they are notified (actually or constructively) and
given an opportunity to present their claims to the LLC. More will be said about this in the next
set of readings.
10.
D
ISSOCIATION
, W
INDING
U
P
, AND
T
ERMINATION
Here are the relevant provisions regarding how a member ceases to be a member in an LLC
(dissociation as a member) and the consequences of dissociation:
§ 4-38-601. Power to dissociate as member--Wrongful dissociation
(a) A person has the power to dissociate as a member at any time, rightfully or wrongfully, by
withdrawing as a member by express will under § 4-38-602(1).
(b) A person's dissociation as a member is wrongful only if the dissociation:
(1) is in breach of an express provision of the operating agreement; or
(2) occurs before the completion of the winding up of the limited liability company and:
(A) the person withdraws as a member by express will;
(B) the person is expelled as a member by judicial order under § 4-38-602(6);
(C) the person is dissociated under § 4-38-602(8) [Prof’s note: bankruptcy]; or
(D) in the case of a person that is not a trust other than a business trust, an estate, or an
individual, the person is expelled or otherwise dissociated as a member because it
willfully dissolved or terminated.
(c) A person that wrongfully dissociates as a member is liable to the limited liability company
and, subject to § 4-38-801, to the other members for damages caused by the dissociation. The
liability is in addition to any debt, obligation, or other liability of the member to the company or
the other members.
37
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
§ 4-38-602. Events causing dissociation
A person is dissociated as a member when:
(1) the limited liability company knows or has notice of the person's express will to withdraw as
a member, but, if the person has specified a withdrawal date later than the date the company
knew or had notice, on that later date;
(2) an event stated in the operating agreement as causing the person's dissociation occurs;
(3) the person's entire interest is transferred in a foreclosure sale under § 4-38-503(f);
(4) the person is expelled as a member pursuant to the operating agreement;
(5) the person is expelled as a member by the affirmative vote or consent of all the other
members if:
(A) it is unlawful to carry on the limited liability company's activities and affairs with the
person as a member;
(B) there has been a transfer of all the person's transferable interest in the company, other
than:
(i) a transfer for security purposes; or
(ii) a charging order in effect under § 4-38-503 which has not been foreclosed;
(C) the person is an entity and:
(i) the company notifies the person that it will be expelled as a member because the
person has filed a statement of dissolution or the equivalent, the person has been
administratively dissolved, the person's charter or the equivalent has been revoked, or the
person's right to conduct business has been suspended by the person's jurisdiction of
formation; and
(ii) not later than 90 days after the notification, the statement of dissolution or the
equivalent has not been withdrawn, rescinded, or revoked, the person has not been
reinstated, or the person's charter or the equivalent or right to conduct business has not
been reinstated; or
(D) the person is an unincorporated entity that has been dissolved and whose activities and
affairs are being wound up;
(6) on application by the limited liability company or a member in a direct action under § 4-38-
801, the person is expelled as a member by judicial order because the person:
(A) has engaged or is engaging in wrongful conduct that has affected adversely and
materially, or will affect adversely and materially, the company's activities and affairs;
(B) has committed willfully or persistently, or is committing willfully or persistently, a
material breach of the operating agreement or a duty or obligation under § 4-38-409; or
(C) has engaged or is engaging in conduct relating to the company's activities and affairs
which makes it not reasonably practicable to carry on the activities and affairs with the
person as a member;
(7) in the case of an individual:
(A) the individual dies; or
(B) in a member-managed limited liability company:
(i) a guardian or general conservator for the individual is appointed; or
38
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(ii) a court orders that the individual has otherwise become incapable of performing the
individual's duties as a member under this chapter or the operating agreement;
(8) in a member-managed limited liability company, the person:
(A) becomes a debtor in bankruptcy;
(B) signs an assignment for the benefit of creditors; or
(C) seeks, consents to, or acquiesces in the appointment of a trustee, receiver, or liquidator of
the person or of all or substantially all the person's property;
(9) in the case of a person that is a testamentary or inter vivos trust or is acting as a member by
virtue of being a trustee of such a trust, the trust's entire transferable interest in the limited
liability company is distributed;
(10) in the case of a person that is an estate or is acting as a member by virtue of being a personal
representative of an estate, the estate's entire transferable interest in the limited liability company
is distributed;
(11) in the case of a person that is not an individual, the existence of the person terminates;
(12) the limited liability company participates in a merger under § 4-38-1001 et seq. and:
(A) the company is not the surviving entity; or
(B) otherwise as a result of the merger, the person ceases to be a member;
(13) the limited liability company participates in an interest exchange under § 4-38-1001 et seq.
and, as a result of the interest exchange, the person ceases to be a member;
(14) the limited liability company participates in a conversion under § 4-38-1001 et seq.;
(15) the limited liability company participates in a domestication under § 4-38-1001 et seq. and,
as a result of the domestication, the person ceases to be a member; or
(16) the limited liability company dissolves and completes winding up.
§ 4-38-603. Effect of dissociation
(a) If a person is dissociated as a member:
(1) the person's right to participate as a member in the management and conduct of the
limited liability company's activities and affairs terminates;
(2) the person's duties and obligations under § 4-38-409 as a member end with regard to
matters arising and events occurring after the person's dissociation; and
(3) subject to § 4-38-504 and § 4-38-1001 et seq., any transferable interest owned by the
person in the person's capacity as a member immediately before dissociation is owned by the
person solely as a transferee.
(b) A person's dissociation as a member does not of itself discharge the person from any debt,
obligation, or other liability to the limited liability company or the other members which the
person incurred while a member.
******************************************************************************
Section 4-38-601 explains when withdrawal is wrongful and explains that the wrongfully
withdrawing member is liable for damages to the LLC and potentially other members. While this
looks a lot like the partnership model, there is a very significant difference. In the Arkansas
General Partnership Act it is impossible to remove a general partnership’s power to withdraw,
although it can be made wrongful. (See ACA 4-46-103 for the list of provisions in the Arkansas
39
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
UPA that cannot be changed by agreement.) There is no such limitation in the ULLCA (Go back
and check Arkansas Code § 4-38-107 for the list of provisions that cannot be modified by the
operating agreement) meaning that it is entirely possible to remove the right AND the power of
an LLC member to withdraw.
Section 4-38-602 sets out the default events of dissociation, meaning that the operating
agreement or members can agree that they will not cause dissociation. Under the default rules,
members cease to be members (or in other words dissociate) if any of the following happen:
(1) a member gives notice of intent to withdraw
(2) an event stated in the operating agreement as causing the person’s dissociation occurs;
(3) the person’s entire interest is transferred in a foreclosure sale;
(4) the person is expelled as a member pursuant to the operating agreement;
(5) the person is expelled as a member by unanimous vote of all other members if: (A) it is unlawful to keep the person as a member (B) that members entire transferable interest has been sold
(C) the member is an entity that has filed a statement of dissolution or has been dissolved for 90 or more days
(D) the person is an unincorporated entity that is being being wound up;
(6) the person is expelled by court order because they have (A) engaged in material wrongful conduct (B) willfully or persistently materially breached the operating agreement; or
(C) it is not reasonably practicable to carry on the activities with the person as a member;
(7) in the case of an individual:
(A) the individual dies; or
(B) in a member-managed limited liability company the person is not legally competent
(8) in a member-managed limited liability company, the person becomes bankrupt:
(9) – (11) non individual members terminate
a trustee, receiver, or liquidator of the person or of all or substantially all the person’s property;
(12) – (15) the LLC reorganizes and does not survive or the member is bought out
(16) the LLC dissolves and completes winding up.
There is nothing in the LLC Act that prevents the operating agreement from adding additional
events of dissociation if the members so desire. Section 4-38-603 lists the consequences of dissociation. The primary effect is that the member
loses their right to participate in management and that their transferable interest becomes held by
such person as a transferee. This means that there is no obligation on the part of the LLC to buy
out the member upon such dissociation. Again, the most effective way of making sure that you understand these rules is to try your hands
at some problems. 40
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
Questions about Dissociation
1.
Abby, Baker, and Carla form an Arkansas LLC. They have no operating agreement so the
default rules control. Abby tells Baker and Carla that she has changed her mind and that she
quits. Baker and Carla say fine, she can quit. Now Abby wants her contribution back. What
result?
2.
Same as problem 1, but both Abby and Carla would vote to give Abby her contribution back.
Does this change your analysis?
3. Suppose that Destiny, Elijah and Frank form an LLC. They do not have an operating
agreement. Elijah sells what purports to be his membership interest to Gia. Can Destiny and
Frank vote Elijah out of the LLC? If they do, what happens to his voting rights?
4. Suppose Austin, Brooklyn, and Chandler all pass the Arkansas bar exam and decide to form
an Arkansas LLC in which to practice law. Regrettably, they did not take my course, as they all
plan on being litigators. This is important because they wind up forming a valid LLC but they do
not change any of the statutory default rules aside from agreeing to be a law firm. It turns out that
Austin and Brooklyn are great lawyers, but Chandler turns out to be absolutely awful. He is
making it impossible for the others to continue to represent their clients effectively. Can Austin
and Brooklyn force Chandler out? Can they go to court and get a court to order his removal?
5.
Same as question 4 but suppose instead that Chandler is disbarred. Do the other partners have
to go to court to get a court to order his removal if he will not voluntarily leave? Would his
dissociation be considered wrongful?
******************************************************************************
Let us turn our attention away from dissociation of members to dissolution of the entire business.
Note that dissolution is the starting point of the winding up process, as the introductory language
of § 4-38-701 makes clear.
§ 4-38-701. Events causing dissolution
(a) A limited liability company is dissolved, and its activities and affairs must be wound up, upon
the occurrence of any of the following:
(1) an event or circumstance that the operating agreement states causes dissolution;
(2) the affirmative vote or consent of all the members;
(3) the passage of 90 consecutive days during which the company has no members unless
before the end of the period:
(A) consent to admit at least one specified person as a member is given by transferees
owning the rights to receive a majority of distributions as transferees at the time the
consent is to be effective; and
(B) at least one person becomes a member in accordance with the consent;
41
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(4) on application by a member, the entry by the circuit court of an order dissolving the
company on the grounds that:
(A) the conduct of all or substantially all the company's activities and affairs is unlawful;
(B) it is not reasonably practicable to carry on the company's activities and affairs in
conformity with the certificate of organization and the operating agreement; or
(C) the managers or those members in control of the company:
(i) have acted, are acting, or will act in a manner that is illegal or fraudulent; or
(ii) have acted or are acting in a manner that is oppressive and was, is, or will be
directly harmful to the applicant; or
(5) the signing and filing of a statement of administrative dissolution by the Secretary of
State under § 4-38-708.
(b) In a proceeding brought under subsection (a)(4)(C), the court may order a remedy other than
dissolution.
§ 4-38-702. Winding up
(a) A dissolved limited liability company shall wind up its activities and affairs and, except as
otherwise provided in § 4-38-703, the company continues after dissolution only for the purpose
of winding up.
(b) In winding up its activities and affairs, a limited liability company:
(1) shall discharge the company's debts, obligations, and other liabilities, settle and close the
company's activities and affairs, and marshal and distribute the assets of the company; and
(2) may:
(A) deliver to the Secretary of State for filing a statement of dissolution stating the name
of the company and that the company is dissolved;
(B) preserve the company activities, affairs, and property as a going concern for a
reasonable time;
(C) prosecute and defend actions and proceedings, whether civil, criminal, or
administrative;
(D) transfer the company's property;
(E) settle disputes by mediation or arbitration;
(F) deliver to the Secretary of State for filing a statement of termination stating the name
of the company and that the company is terminated; and
(G) perform other acts necessary or appropriate to the winding up.
(c) If a dissolved limited liability company has no members, the legal representative of the
last person to have been a member may wind up the activities and affairs of the company. If
the person does so, the person has the powers of a sole manager under § 4-38-407(c) and is
deemed to be a manager for the purposes of § 4-38-304(a).
(d) If the legal representative under subsection (c) declines or fails to wind up the limited
liability company's activities and affairs, a person may be appointed to do so by the consent
of transferees owning a majority of the rights to receive distributions as transferees at the
time the consent is to be effective. ….
42
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
(e) The circuit court may order judicial supervision of the winding up of a dissolved limited
liability company, including the appointment of a person to wind up the company's activities
and affairs:
(1) on the application of a member, if the applicant establishes good cause;
(2) on the application of a transferee, if:
(A) the company does not have any members;
(B) the legal representative of the last person to have been a member declines or fails
to wind up the company's activities; and
(C) within a reasonable time following the dissolution a person has not been
appointed pursuant to subsection (c); or
(3) in connection with a proceeding under § 4-38-701(a)(4).
§ 4-38-703. Rescinding dissolution
(a) A limited liability company may rescind its dissolution within 120 days after the election
to dissolve unless:
(1) termination has become effective;
(2) a court has entered an order dissolving the limited liability company; or
(3) the Secretary of State has dissolved the limited liability company under § 4-38-708.
….
(c) If a limited liability company rescinds its dissolution:
(1) the company resumes carrying on its activities and affairs as if dissolution had never
occurred;
(2) subject to paragraph (3), any liability incurred by the company after the dissolution
and before the rescission has become effective is determined as if dissolution had never
occurred; and
(3) the rights of a third party arising out of conduct in reliance on the dissolution before
the third party knew or had notice of the rescission may not be adversely affected.
§ 4-38-707. Disposition of assets in the winding up
(a) In winding up its activities and affairs, a limited liability company shall apply its assets to
discharge the company's obligations to creditors, including members that are creditors.
(b) After a limited liability company complies with subsection (a), any surplus must be
distributed in the following order, subject to any charging order in effect under § 4-38-503:
(1) to each person owning a transferable interest that reflects contributions made and not
previously returned, an amount equal to the value of the unreturned contributions; and
(2) among persons owning transferable interests in proportion to their respective rights to
share in distributions immediately before the dissolution of the company.
(c) If a limited liability company does not have sufficient surplus to comply with subsection (b)
(1), any surplus must be distributed among the owners of transferable interests in proportion to
the value of the respective unreturned contributions.
(d) All distributions made under subsections (b) and (c) must be paid in money.
43
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
You should also be aware of the following provisions, although I have not excerpted their terms
here. In each of the following cases, the relevant language is drawn directly from corporate law,
so when we cover corporate dissolution at the end of the course, those provisions will also have
applicability (through the language in the LLC Act) in Arkansas LLCs. Note that these
provisions did NOT exist in the prior Arkansas LLC statute, so there is no case law that is
relevant to date involving LLCs. Since the statutory language is identical (aside from applying to
LLCs rather than corporations), however, the general approach taken corporate cases should
apply here too.
4-38-704. KNOWN CLAIMS AGAINST DISSOLVED LIMITED LIABILITY
COMPANY.
4-38-705. OTHER CLAIMS AGAINST DISSOLVED LIMITED LIABILITY COMPANY.
4-38-708. ADMINISTRATIVE DISSOLUTION.
4-38-709. REINSTATEMENT.
******************************************************************************
As you review the preceding provisions, you should note that there is a shorter list of default
triggers for winding up than exists for general partnerships. For example, death, incapacity, or
withdrawal of a member does not trigger dissolution unless there are no members remaining.
Bankruptcy or insolvency is also not listed as a trigger. Here is a shorthand list of the events that
do cause dissolution of an LLC under the statute:
1. anything provided in the operating agreement
2. unanimous consent of all members
3. expiration of 90 days with no members
4.
judicial dissolution because:
-substantially all of the LLC’s activities are unlawful
-it is not reasonably practical to carry on the business in conformity with the agreements
-those in control of the company are acting illegally, fraudulently, oppressively
5.
the LLC is administratively dissolved
The statutory process of winding up is actually borrowed primarily from corporate law rather
than partnership law. The members or managers who are left at the time the business starts the
dissolution process have the responsibility for winding up the business. (Dissociated members
have no lingering power to manage, pursuant to section 4-38-603(a)(1)). Members who have
authority to wind up the business have only the legal authority to take acts consistent with the
winding up of the business. (4-38-702(a))
Essentially, under § 4-38-707, persons conducting the winding up are supposed to liquidate
everything and pay out the proceeds in the following order of priority: (1) first to creditors, including members and former members;
(2) to persons owning a transferable interest for amounts equal to unreturned contributions;
(3) to persons with a transferable interest in accordance with their interest in distributions
44
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
If there is not enough money to fully return contributions, the amount available shall be returned
in proportion to the unreturned contributions. Everything is to be paid out in money, not in-kind.
In order to give notice of the dissolution to creditors and other parties, the LLC Actallows for the
filing of a statement of dissolution, much like those that are expected when a corporation
dissolves (which will be talked about later in this course). (§ 4-38-702(b)(2)(A)). In addition, in
provisions that I did not fully excerpt for you, there are provisions providing that the LLC may
(the statute is not mandatory) give notice to known creditors by sending them a mailed notice of
the dissolution. From the LLC’s standpoint, if the business still has assets, this sets in motion a
very short period of time in which to file claims against the LLC. (§ 4-38-704). Publication
notice takes care of unknown or contingent creditors, and they have a significantly longer (3
years) statute of limitations period within which they can bring claims. (§ 4-38-705). This is very
similar to the process set out in the corporate code, although the statute of limitations for claims
by unknown creditors is 3 years rather than the 5 years provided in the corporate code.
The final liquidating distribution that concludes the winding up does not have to wait for the
passage of this much time, however. Those in charge of the winding up can make a final
liquidating distribution, and if a subsequent claim is successful, the judgement creditor can
recover from members in proportion to their interest, but not in excess of amounts distributed to
them. (§ 4-38-705(d)(2)).
The importance of following statutory procedures is highlighted in the following opinion. Questions based on New Horizons
:
1.
Who was Allison Haack and what was her role in Kickapoo Valley Freight LLC?
2.
Who was New Horizons and what was its role in this lawsuit?
3.
If Allison was a member or manager, why was her personal liability not limited by the LLC
statute?
4.
What did Allison do that resulted in personal liability?
5.
What could she have done instead?
New Horizons Supply Coop v. Haack
590 N.W.2d 282 (Wis. App. 1999)
(not designated for publication)
Allison Haack appeals a small claims judgment in the amount of $1,009.99 plus costs entered
against her in favor of New Horizons Supply Cooperative. Haack contends the trial court erred in
denying her defense that because the debt was incurred by Kickapoo Valley Freight LLC, a
limited liability company under ch. 183, Stats., she was not personally liable for the cooperative's
claim. We conclude, however, that Haack did not establish at trial that the amount of New
Horizons' claim exceeded the value of any liquidation distribution she may have received from
the dissolved company. See § 183.0909(2), Stats. (quoted below in text). Accordingly, we affirm
the appealed judgment.
45
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
BACKGROUND
On May 30, 1995, Haack signed a "CARDTROL AGREEMENT" whereby the "Patron" agreed
"to be responsible for payment of all fuel purchased with" the "Cardtrol Card" issued under the
agreement by a predecessor to New Horizons. "Kickapoo Valley Freight, LLC" is shown as the
"Patron" in the first paragraph of the form agreement, and it is signed by "Allison Haack," with
no designation indicating whether her signature was given individually or in a representative
capacity on behalf of Kickapoo Valley.
An employee of New Horizons testified at trial that in September 1997, when the Kickapoo
Valley account was in arrears, she contacted Robert Koch about the bill. Koch referred her to his
sister, Haack, who apparently took care of paying the bills for the company. When contacted,
Haack told the New Horizons employee that she would start paying $100 per month on the
account. When no payment was received in October, Haack was contacted again, and she then
informed New Horizons that Kickapoo Valley had dissolved, "that she was ... a partner, that
Robert had moved out of state, and that she planned to assume responsibility and would again
start to make a hundred dollars per month beginning in October." The employee also testified
that during the October telephone conversation, Haack told her she had the assets of the business:
a truck, which was secured by the bank; and some accounts receivable "that they were trying to
collect." When contacted in November, Haack again promised a payment, but in December,
Haack told the New Horizons employee "not to call her at work anymore."
When attempts to contact Haack at her home phone number proved unsuccessful, New Horizons
commenced this action to collect the account balance, $1,009.99, from Haack "DBA
KICKAPOO VALLEY FREIGHT." Haack testified that Kickapoo Valley had been organized as
a limited liability company, but she did not introduce articles of organization or an operating
agreement into evidence. Haack did offer as exhibits a Wisconsin Department of Revenue
registration certificate, as well as some correspondence from the department, showing the
enterprise identified as "Kickapoo Valley Freight LLC." Haack stated her defense to New
Horizons' claim was that the account was in the business name, that she was not personally liable
for debts of the limited liability company, and that she had not personally guaranteed the
obligation.
According to Haack, her brother, Robert Koch, had suffered a nervous breakdown and left the
state; the truck was sold, with all proceeds going to the bank who held the lien on it; and there
were "no additional assets," but that she was "left with quite a lot of debt that I had signed for."
She acknowledged that she told New Horizons that she "would try to take care" of the account
"several times" after the business ceased operations. Finally, Haack testified that she had not
filed articles of dissolution or notified creditors of the termination of the business when it ceased
operations in the fall of 1997.
46
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
In response to questions from the court regarding her investment in the company, and the limits
of her liability and that of Mr. Koch, Haack answered that both of them had "lost" their
investments in the company. She also testified that the company was taxed as a partnership, and
that she had with her copies of a sale agreement whereby "the assets" of the company were sold
and the proceeds were given to the bank in order to release the lien on the truck. None of those
documents were introduced as exhibits, however, and they are not a part of the record. Haack
later testified that the assets that were sold consisted of a "truck, a pallet jack and the customer
list." She did not testify as to the disposition of any cash or accounts receivable remaining at the
time the business was dissolved.
The trial court began its oral decision by noting that "the problem the court has, nobody's filed
with this court any documents to show what the limited liability agreement stated. I don't
know ...
who bore what responsibilities." The court went on to conclude that "the rules of dissolution
apparently were not followed" because articles of dissolution had not been filed nor creditors
notified. It awarded judgment to New Horizons in the amount claimed, on the following basis:
Haack signed ... an agreement for Kickapoo Valley Freight LLC, but it would appear to me that
the corporation was just a shell around which there were no real intentions to operate like a
corporation because there was no intent even to dissolve the corporation, and the court's going to
find that the corporate veil is pierced by the fact that the people were acting like a partnership,
being taxed like a partnership, and haven't even dissolved the-- ...I'm treating this as a partnership and assessing liability to the remaining partner
....
That's the
evidence that's before me, and unless I would have some other evidence that was not presented, I
have to treat this matter as a partnership and assume that the limited liability agreement did not
alter the normal partnership liability situation.
Haack appeals the judgment entered against her for $1,009.99 plus costs.
ANALYSIS
Although Haack argues on appeal that New Horizons provided "incorrect testimony to the court"
regarding Wisconsin's limited liability company law, and that the cooperative did not meet its
burden of proof in establishing her personal liability for the debt, the gravamen of Haack's appeal
is that the court erred in applying the law to the largely undisputed facts of record. Thus, we are
called upon to decide a legal question: Were Haack's testimony and exhibits sufficient to
establish a defense under § 183.0304, STATS., which provides that "a member or manager of a
limited liability company is not personally liable for any debt, obligation or liability of the
limited liability company"? The application of a statute to a particular set of facts is a question of
law which this court reviews de novo, owing no deference to the trial court's reasoning.
However, we will not overturn a judgment where the record reveals that the trial court's decision
was right, although for the wrong reason
47
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
New Horizons seeks to defend the trial court's judgment, and its rationale of "piercing the
corporate veil," by noting that ch. 183, Stats., expressly permits the importation of concepts such
as "piercing the veil" from business corporation law….
The cooperative argues that the court properly applied the concept of "piercing the veil" to the
facts adduced at the trial of this matter. We disagree, and conclude, as Haack contends, that the
court's comments imply that it erroneously deemed Kickapoo Valley's treatment as a partnership
for tax purposes to be conclusive. There is little in the record, moreover, to support a conclusion
that Haack "organized, controlled and conducted" company affairs to the extent that it had "no
separate existence of its own and [was Haack's] mere instrumentality," which she "used to evade
an obligation, to gain an unjust advantage or to commit an injustice."
Rather, we conclude that entry of judgment against Haack on the New Horizons' claim was
proper because she failed to establish that she took appropriate steps to shield herself from
liability for the company's debts following its dissolution and the distribution of its assets.
[The applicable statute] provides that "[o]ne or more persons may organize a limited liability
company by signing and delivering articles of organization to the [Department of Financial
Institutions] for filing." The filing of articles by the department constitutes "conclusive proof that
the limited liability company is organized and formed under this chapter." As we have noted,
Haack testified that an attorney had drafted and filed the necessary paperwork to establish
Kickapoo Valley Freight LLC, but no direct evidence of the filing of articles with the department
was presented to the court. Be that as it may, a fact-finder could have inferred from Haack's
testimony and from her exhibits showing that the Department of Revenue apparently recognized
Kickapoo Valley as a "LLC," that Haack and her brother had properly formed a limited liability
company.
The record is devoid, however, of any evidence showing that appropriate steps were taken upon
the dissolution of the company to shield its members from liability for the entity's obligations.
Although it appears that filing articles of dissolution is optional, the order for distributing the
company's assets following dissolution is fixed by statute, and the company's creditors enjoy first
priority, see § 183.0905, STATS. A dissolved limited liability company may "dispose of known
claims against it" by filing articles of dissolution, and then providing written notice to its known
creditors containing information regarding the filing of claims. The testimony at trial indicates
that Haack knew of New Horizons' claim at the time Kickapoo Valley was dissolved. It is also
clear from the record that articles of dissolution for Kickapoo Valley Freight LLC were not filed,
nor was the cooperative formally notified of a claim filing procedure or deadline.
….
It appears from the record that certain of Kickapoo Valley's assets were sold, and that the
proceeds from that sale were remitted to the bank which held a lien on the company's truck.
There is nothing in the record, however, showing the disposition of other company assets, such
as cash and accounts receivable. New Horizons' witness testified that, in October 1997, Haack
48
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
had claimed to be attempting to collect the accounts of the dissolved company and hoped to pay
the instant debt from those proceeds. We do not know the value of the accounts receivable in
question, however, or the amounts of any other company debts to which the proceeds of the
accounts may have been applied, because Haack presented no testimony on the issue.
In this regard, we agree with the trial court's comments regarding the lack of evidence in the
record to show that Kickapoo Valley's affairs were properly wound up following its dissolution
occasioned by Robert Koch's dissociation from the enterprise. Although Kickapoo Valley
Freight LLC may have been properly formed and operated as an entity separate and distinct from
its owners, Haack did not establish that she distributed the entity's assets in accordance with [the
statutes]… following Kickapoo's dissolution. Her failure to employ the procedures outlined in
[the statutes] … left her vulnerable to New Horizons' claim ... absent proof that the value of any
assets of the dissolved company she received were exceeded by the cooperative's claim.
Thus, although Haack correctly contends that the judgment cannot be sustained on the ground
relied upon by the trial court, we “nevertheless ... look to facts in the record ‘in favor of
respondent which [seem] to be insurmountable.’” [Affirmed]*** ******************************************************************************
One final point about LLCs. Article 8 of the LLC Act sets out the right of members to bring
actions either against members, managers or the LLC itself to enforce both direct claims and
derivative claims. There was no parallel to most of these provisions in prior Arkansas LLC law,
but the provisions essentially mirror the rights of shareholders to bring derivative claims under
corporate law. We will not cover direct and derivative claims here, but when we cover the rules
in the context of corporations and corporate shareholders, you should be aware that there will be
similar procedures for LLC members explicitly set out in the Arkansas code.
49
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
11. R
EVIEW
Q
UESTION
N
UMBER
1 – B
ASED
ON
THE
J
ULY
2016 B
AR
E
XAM
Q
UESTION
.
Two siblings, Billy and Sue, decided to open a candy shop with a close friend, Carol. They filed
a certificate of organization to form a limited liability company. Billy and Sue paid for their LLC
member interests by each contributing $50,000 in cash to the LLC. Carol paid for her LLC
member interest by conveying to the LLC five acres of undeveloped land valued at $50,000; the
LLC then recorded the deed. Neither the certificate of organization nor the members' operating agreement specifies whether
the LLC is member-managed or manager-managed. However, the operating agreement provides
that the LLC's land may not be sold without the approval of all three members. Following formation of the LLC, the company rented a storefront commercial space for the
candy shop and opened for business. Three months ago, purporting to act on behalf of the LLC, Billy entered into a written and signed
contract to purchase 100 pounds of swiss chocolate for $3,000. When the chocolate delivered,
Sue said that it was too expensive and told her brother to return it. Billy was surprised by his
sister's objection because twice before he had purchased the same amount of this chocolate for
the LLC at the same price from this supplier, and neither his sister nor their friend had objected.
Billy refused to return the chocolate, pointing out that it is "perfect for our customer base.” Sue
responded, “You pay for it then. You bought it all without my permission.” Billy replied, “You
are crazy. I don’t need your permission. The LLC will pay for them." To date, however, the
$3,000 has not been paid. One month ago, purporting to act on behalf of the LLC, the friend sold the LLC's acreage to a
third-party buyer. The buyer paid $75,000, which was well above the land's fair market value.
Only after the friend deposited the sale proceeds into the LLC bank account did Billy and sister
learn of the sale. Both of them objected. One week ago, Billy wrote in an email to his sister, "I want out of our business. I don't want to
have anything to do with the candy shop anymore. Please send me a check for my share."
1. What type of LLC was created -- member-managed or manager-managed? Explain.
2.
Is the LLC bound under the contract for the swiss chocolate contract ? Explain.
3.
Is the LLC bound by the sale of the land? Explain.
4.
What is the legal effect of Billy's email? Explain.
50
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
R
EVIEW
Q
UESTION
N
UMBER
2 – B
ASED
ON
THE
J
ULY
2013 B
AR
E
XAM
Q
UESTION
On April 1, Rose, Sam, and Tracie form RST Fitness LLC (RST), a member-managed LLC, for
the purpose of building, owning, and running an upscale fitness center in their hometown. RST
soon began to experience unexpected financial problems, prompting Sam to look for other
investment opportunities. On May 2, Sam told Rose and Tracie that, although he would remain as a member of RST, he
would no longer contribute any capital to RST, and he was also becoming a co-owner of Pro Fit
Elite, an existing deluxe fitness center in the same town near the RST project. Rose and Tracie
objected to Sam's plan, fearing that he might put the interests of Pro Fit Elite ahead of his
existing obligations to RST. In response, Sam cited § 5.1 of RST's Operating Agreement, which
states as follows:
Members of RST shall not in any way be prohibited from or restricted in managing, owning,
or otherwise having an interest in any other business venture that may be competitive with
the business of RST.
Shortly after Sam became a co-owner of Pro Fit Elite, RST's financial situation worsened. Rose
and Tracie worried that RST would not be able to pay a bill it owed to its building contractor.
Rose proposed to pay the contractor’s bill from her own personal funds and then obtain
reimbursement from RST once the hotel project was completed. Rose wanted to do this so that
she could file a personal financial statement which underreported her assets and so enable her
son to qualify for student financial aid. Tracie agreed to this proposal. Rose and Tracie also
agreed to alter RST's financial records so that it would appear as if RST had paid the contractor’s
bill out of its own accounts, without showing the obligation to reimburse Rose for that amount.
In the next few weeks, several other of RST's bills came due. Rose tried to pay these bills using
her personal funds, but it soon became clear that RST was approaching insolvency. On
September 3, the fitness center’s contractor left a message for Tracie seeking payment of an
overdue bill. Rose and Tracie were concerned about the solvency of the company. Without responding to the
contractor, Rose and Tracie, acting with Sam's consent, sold all of RST's property and remaining
assets. Rose and Tracie each kept one-third of the sale proceeds and gave the remaining one-third
to Sam. They did not file articles of dissolution with the state. When the contractor later called
Tracie again about the bill, she responded that RST had been "dissolved" and that no payment
would be forthcoming.
1.
Do Rose and Tracie have any legal basis to object to Sam's co-ownership of Pro Fit Elite?
Explain.
51
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
2.
Under what theory or theories could Rose, Sam, or Tracie be personally liable to the
contractor? Explain
.
52
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
Related Documents
Recommended textbooks for you
BUSN 11 Introduction to Business Student Edition
Business
ISBN:9781337407137
Author:Kelly
Publisher:Cengage Learning
Essentials of Business Communication (MindTap Cou...
Business
ISBN:9781337386494
Author:Mary Ellen Guffey, Dana Loewy
Publisher:Cengage Learning
Accounting Information Systems (14th Edition)
Business
ISBN:9780134474021
Author:Marshall B. Romney, Paul J. Steinbart
Publisher:PEARSON
International Business: Competing in the Global M...
Business
ISBN:9781259929441
Author:Charles W. L. Hill Dr, G. Tomas M. Hult
Publisher:McGraw-Hill Education
Recommended textbooks for you
- BUSN 11 Introduction to Business Student EditionBusinessISBN:9781337407137Author:KellyPublisher:Cengage LearningEssentials of Business Communication (MindTap Cou...BusinessISBN:9781337386494Author:Mary Ellen Guffey, Dana LoewyPublisher:Cengage LearningAccounting Information Systems (14th Edition)BusinessISBN:9780134474021Author:Marshall B. Romney, Paul J. SteinbartPublisher:PEARSON
- International Business: Competing in the Global M...BusinessISBN:9781259929441Author:Charles W. L. Hill Dr, G. Tomas M. HultPublisher:McGraw-Hill Education
BUSN 11 Introduction to Business Student Edition
Business
ISBN:9781337407137
Author:Kelly
Publisher:Cengage Learning
Essentials of Business Communication (MindTap Cou...
Business
ISBN:9781337386494
Author:Mary Ellen Guffey, Dana Loewy
Publisher:Cengage Learning
Accounting Information Systems (14th Edition)
Business
ISBN:9780134474021
Author:Marshall B. Romney, Paul J. Steinbart
Publisher:PEARSON
International Business: Competing in the Global M...
Business
ISBN:9781259929441
Author:Charles W. L. Hill Dr, G. Tomas M. Hult
Publisher:McGraw-Hill Education