What are the arguments that Stroud is not liable to National Biscuit for the value of the bread delivered to the Food Center? What are the arguments that Stroud is liable to National Biscuit for the value of the bread delivered to the Food Center? Explain which arguments should prevail.

Stroud’s Food Center

Stroud and Freeman are general partners in Stroud’s Food Center, a grocery store. Nothing in the articles of partnership restricts the power or authority of either partner to act in respect to the ordinary business of the Food Center. In November, however, Stroud informed National Biscuit that he would not be personally responsible for any more bread sold to the partnership. Then, in the following February, at the request of Freeman, National Biscuit sold and delivered more bread to the Food Center.

What are the arguments that Stroud is not liable to National Biscuit for the value of the bread delivered to the Food Center?

What are the arguments that Stroud is liable to National Biscuit for the value of the bread delivered to the Food Center?

Explain which arguments should prevail.

Limited Partnerships

The limited partnership has proved to be an attractive vehicle for a variety of investments because of its tax advantages and the limited liability it confers upon limited partners. Unlike general partnerships, limited partnerships are statutory creations. Before 1976, the governing statute in all States except Louisiana was the Uniform Limited Partnership Act (ULPA), which was promulgated in 1916. At that time, most limited partnerships were small and had only a few limited partners. But over time, limited partnerships became much larger, typically involving a small number of major investors and a relatively large group of widely distributed investors who purchase limited partnership interests. This type of organization has evolved to attract substantial amounts of investment capital. As a result, limited partnerships have been used to muster the sizable investments necessary in areas such as real estate, oil and gas, motion pictures, professional sports, and research and development. The large-scale and multistate operations of the modern limited partnership, however, have severely burdened the framework established by the ULPA.

These shortcomings prompted the Uniform Law Commission (ULC) to develop a Revised Uniform Limited Partnership Act (RULPA), which was promulgated in 1976. According to its preface, the RULPA is “intended to modernize the prior uniform law while retaining the special character of limited partnerships as compared with corporations.” In 1985, the ULC revised the RULPA “for the purpose of more effectively modernizing, improving and establishing uniformity in the law of limited partnerships.” The 1985 Act is substantially similar to the 1976 RULPA, preserving the philosophy of the older Act and making almost no change in its basic structure. All of the States except Louisiana had adopted either the 1976 Act or the 1985 Act with a large majority of these States adopting the 1985 version.

In 2001, the ULC promulgated a new revision of the 1985 Revised Uniform Limited Partnership Act (the 2001 ReRULPA). The new Act has been drafted to reflect that limited liability partnerships and limited liability companies can meet many of the needs formerly met by limited partnerships. Accordingly, the 2001 ReRULPA adopts as default rules provisions that strongly favor current management and treat limited partners as passive investors with little control over or right to exit the limited partnership. To date, at least nineteen States and the District of Columbia have adopted the 2001 ReRULPA. (In 2011 and 2013, the 2001 ReRULPA was amended as part of the Harmonization of Business Entity Acts project. These amendments brought into agreement the language in the 2001 ReRULPA with the language of similar provisions in the other uniform and model unincorporated entity acts.)

This chapter discusses the 1985 RULPA. The ULPA, the 1976 RULPA, and the 1985 RULPA are supplemented by the Uniform Partnership Act, which applies to limited partnerships in any case for which the Limited Partnership Act does not provide. The 2001 ReRULPA is a stand-alone statute and is not linked to the Uniform Partnership Act.

A limited partnership is a partnership formed by two or more persons under the laws of a State and having one or more general partners and one or more limited partners. Section 101(7). A person includes a natural person, partnership, limited partnership, trust, estate, association, or corporation. Section 101(11). A limited partnership differs from a general partnership in several respects, three of which are fundamental:

a statute providing for the formation of limited partnerships must be in effect;

the limited partnership must substantially comply with the requirements of that statute; and

the liability of a limited partner for partnership debts or obligations is limited to the extent of the capital he has contributed or has agreed to contribute.

Formation

Although the formation of a general partnership calls for no special procedures, the formation of a limited partnership requires substantial compliance with the limited partnership statute. Failure to so comply may result in the limited partners’ not obtaining limited liability.

Filing of Certificate

Section 201 of the RULPA provides that two or more persons desiring to form a limited partnership shall file in the office of the Secretary of State of the State in which the limited partnership is to have its principal office a signed certificate of limited partnership. The certificate must include the following information:

the name of the limited partnership;

the address of the office and the name and address of the agent for service of process;

the name and the business address of each general partner;

the latest date upon which the limited partnership is to dissolve; and

any other matters the general partners decide to include in the certificate.

The certificate of limited partnership must be amended if a new general partner is admitted, a general partner withdraws, or a general partner becomes aware that any statement in the certificate was or has become false. Section 202. In addition, the certificate may be amended at any time for any other purpose the general partners deem proper. As discussed later, false statements in a certificate or amendment that cause loss to third parties who rely on the statements may result in liability for the general partners.

Name

The inclusion of the surname of a limited partner in the partnership name is prohibited unless it is also the name of a general partner or unless the business had operated under that name before the admission of the limited partner. A limited partner who knowingly permits his name to be used in violation of this provision is liable to any creditor who did not know that he was a limited partner. Section 303(d). In addition, a limited partnership cannot use a name that is the same as, or deceptively similar to, the name of any corporation or other limited partnership. Section 102. Finally, the name of the limited partnership must contain the unabbreviated words “limited partnership.”

Contributions

The contribution of a partner may be cash, property, services rendered, or a promissory note or other obligation to contribute cash or property or to perform services. Section 501. A promise by a limited partner to contribute to the limited partnership is not enforceable unless it is in a signed writing. Should a partner fail to make a required capital contribution described in a signed writing, the limited partnership may hold her liable to contribute the cash value of the stated contribution.

Defective Formation

A limited partnership is formed when a certificate of limited partnership that substantially complies with the requirements of the statute is filed. Therefore, the formation is defective if no certificate is filed or if the certificate filed does not substantially meet the statutory requirements. In either case, the limited liability of limited partners is jeopardized. The RULPA provides that a person who has contributed to the capital of a business (an “equity participant”), erroneously and in good faith believing that he has become a limited partner in a limited partnership, is not liable as a general partner, provided that on ascertaining the mistake he either (1) withdraws from the business and renounces future profits or (2) files a certificate or an amendment curing the defect. Section 304. The equity participant will be liable, however, to any third party who transacted business with the enterprise before the withdrawal or amendment and who in good faith believed that the equity participant was a general partner at the time of the transaction.

The 1985 RULPA does not require that the limited partners be named in the certificate. This greatly reduces the risk that an inadvertent omission of such information will expose a limited partner to liability.

Practical Advice

To obtain limited liability as a limited partner, make sure that the limited partnership has been properly organized.

Foreign Limited Partnerships

A limited partnership is considered “foreign” in any State other than the one in which it was formed. The laws of the State in which a foreign limited partnership is organized govern its organization, its internal affairs, and the liability of its limited partners. Section 901. In addition, the RULPA requires all foreign limited partnerships to register with the Secretary of State before transacting any business in a State. Section 902. Any foreign limited partnership transacting business without so registering may not bring enforcement actions in the State’s courts until it registers, although it may defend itself in the State’s courts. Section 907.

Rights

Because limited partnerships are organized pursuant to statute, the rights of the parties are usually set forth in the certificate of limited partnership and the limited partnership agreement. Unless otherwise agreed or provided in the Act, a general partner of a limited partnership has all the rights and powers of a partner in a partnership without limited partners. Section 403. A general partner also may be a limited partner; as such, he shares in profits, losses, and distributions both as a general partner and as a limited one. Section 404.

Practical Advice

When forming a limited partnership, carefully specify the rights and duties of the general and limited partners but be sure to adhere to the statutory limitations on the powers of limited partners.

Control

The general partners of a limited partnership have almost exclusive control and management of the limited partnership. A limited partner, on the other hand, is not permitted to share in this management or control; if he does, he may forfeit his limited liability. A limited partner who participates in the control of the business is liable only to those persons who transact business with the limited partnership reasonably believing, based upon the limited partner’s conduct, that the limited partner is a general partner. Section 303(a).

In addition, Section 303(b) of the RULPA provides a “safe harbor” by enumerating activities that a limited partner may perform without being deemed to have taken part in control of the business. They are the following:

being a contractor for, or an agent or employee of, the limited partnership or of a general partner or being an officer, director, or shareholder of a general partner that is a corporation;

consulting with and advising a general partner with respect to the business of the limited partnership;

acting as surety for the limited partnership;

bringing a derivative action in the right of the limited partnership;

requesting or attending a meeting of partners;

voting on one or more of the following matters:

(a)the dissolution and winding up of the limited partnership;

(b)the sale, exchange, lease, mortgage, pledge, or other transfer of all or substantially all of the assets of the limited partnership;

(c)the incurrence of indebtedness by the limited partnership other than in the ordinary course of its business;

(d)a change in the nature of the business;

(e)the admission or removal of a general partner;

(f)the admission or removal of a limited partner;

(g)a transaction involving an actual or potential conflict of interest between a general partner and the limited partnership or the limited partners;

(h)an amendment to the partnership agreement or certificate of limited partnership; or

(i)other matters related to the business of the limited partnership which the partnership agreement states in writing may be subject to the approval or disapproval of limited partners;

winding up the limited partnership; or

exercising any other right or power permitted to limited partners under the Act.

See Case 32-1

Practical Advice

As a limited partner, exercise care not to take part in the control of the limited partnership beyond that which is legally permitted.

Voting Rights

The partnership agreement may grant to all or a specified group of general or limited partners the right to vote on any matter. Sections 302 and 405. If, however, the agreement grants limited partners voting powers beyond the safe harbor of Section 303, a court may hold that the limited partners have participated in control of the business. The RULPA does not require that limited partners have the right to vote on matters as a class separate from the general partners, although the partnership agreement may provide such a right.

Choice of Associates

After the formation of a limited partnership, the admission of additional limited partners requires the written consent of all partners, unless the partnership agreement provides otherwise. Section 301. The admission of the new limited partner is not effective until the records of the limited partnership have been amended to reflect that fact. Regarding the admission of additional general partners, the written partnership agreement determines the procedure for authorizing their admission. The written consent of all partners is required only if the partnership agreement fails to deal with this issue. Section 401.

Withdrawal

A general partner may withdraw from a limited partnership at any time by giving written notice to the other partners. Section 602. If the withdrawal violates the partnership agreement, the limited partnership may recover damages from the withdrawing general partner. A limited partner may withdraw as provided in the written partnership agreement. If the agreement does not specify when a limited partner may withdraw or a definite time for the limited partnership’s dissolution, a limited partner may withdraw upon giving at least six months’ prior written notice to each general partner. Section 603. Upon withdrawal, a withdrawing partner is entitled to receive any distribution to which she is entitled under the partnership agreement, subject to the restrictions on the amounts discussed in the section on distributions. If the partnership agreement makes no provision, the partner is entitled to receive the fair value of her interest in the limited partnership as of the date of withdrawal, based upon her right to share in distributions from the limited partnership. Section 604.

Assignment of Partnership Interest

A partnership interest is a partner’s share of the profits and losses of a limited partnership and the right to receive distributions of partnership assets. Section 101(10). A partnership interest is personal property. Section 701. Unless otherwise provided in the partnership agreement, a partner may assign his partnership interest. An assignment does not dissolve the limited partnership. The assignee, who does not become a partner, may exercise none of the rights of a partner: the assignment entitles the assignee only to receive, to the extent of the assignment, the assigning partner’s share of distributions. Except as otherwise provided in the partnership agreement, a partner ceases to be a partner upon assignment of all his partnership interest. Section 702.

An assignee of a partnership interest, including an assignee of a general partner, however, may become a limited partner if all the other partners consent or if the assigning partner, having such power provided in the partnership agreement, grants the assignee this right. Section 704. An assignee who becomes a limited partner is liable for the obligation of his assignor to make or return contributions, except for those liabilities unknown to the assignee at the time he became a limited partner. Section 704(b). Upon the death of a partner, her executor or administrator has all the rights of the partner for the purpose of settling her estate, including any power the deceased partner had to make her assignee a substituted limited partner. Section 705.

A creditor of a partner may obtain a charging order against a partner’s interest in the partnership. To the extent of the charging order, the creditor has the rights of an assignee of the partnership interest. Section 703.

Profit and Loss Sharing

Profits and losses are allocated among the partners as provided in the partnership agreement. If the agreement makes no such provision in writing, then the profits and losses are allocated on the basis of the value of the contributions each partner actually has made. Section 503. Nonetheless, limited partners usually are not liable for losses beyond their capital contribution. Section 303(a).

Distributions

The partners share distributions of cash or other assets of the limited partnership as provided in writing in the partnership agreement. The RULPA allows partners to share in distributions in a proportion different from that in which they share in profits. If the partnership agreement does not provide for allocation in writing, then distributions are based on the value of contributions each partner actually made. Section 504. Unless otherwise provided in writing, a partner has no right to demand a distribution in any form other than cash. Once a partner becomes entitled to a distribution, he has the status of a creditor with respect to that distribution. Section 606. A partner may not receive a distribution from a limited partnership unless the assets remaining after the distribution are sufficient to pay all partnership liabilities other than liabilities to partners on account of their partnership interests. Section 607.

Loans

Both general and limited partners may be secured or unsecured creditors of the partnership with the same rights as a person who is not a partner, subject to applicable State and Federal bankruptcy and fraudulent conveyance statutes. Section 107.

Information

The partnership must continuously maintain within the State an office at which it keeps basic organizational and financial records. Section 105. Each partner has the right to inspect and copy any of the partnership records. Each limited partner may obtain from the general partners upon reasonable demand (1) complete and accurate information regarding the business and financial condition of the limited partnership; (2) copies of the limited partnership’s Federal, State, and local income tax returns for each year; and (3) any other reasonable information regarding the affairs of the limited partnership. Section 305.

Derivative Actions

A limited partner has the right to bring an action on behalf of a limited partnership to recover a judgment in its favor if the general partners having authority to bring the action have refused to do so. Section 1001. The Act also establishes standing and pleading requirements similar to those imposed in shareholder’s derivative actions and permits the court to award reasonable expenses, including attorneys’ fees, to a successful plaintiff. Section 1002.

Rights

Practical Advice

When forming a limited partnership, carefully specify the rights and duties of the general and limited partners but be sure to adhere to the statutory limitations on the powers of limited partners.

Control

being a contractor for, or an agent or employee of, the limited partnership or of a general partner or being an officer, director, or shareholder of a general partner that is a corporation;

consulting with and advising a general partner with respect to the business of the limited partnership;

acting as surety for the limited partnership;

bringing a derivative action in the right of the limited partnership;

requesting or attending a meeting of partners;

voting on one or more of the following matters:

(a)the dissolution and winding up of the limited partnership;

(b)the sale, exchange, lease, mortgage, pledge, or other transfer of all or substantially all of the assets of the limited partnership;

(c)the incurrence of indebtedness by the limited partnership other than in the ordinary course of its business;

(d)a change in the nature of the business;

(e)the admission or removal of a general partner;

(f)the admission or removal of a limited partner;

(g)a transaction involving an actual or potential conflict of interest between a general partner and the limited partnership or the limited partners;

(h)an amendment to the partnership agreement or certificate of limited partnership; or

(i)other matters related to the business of the limited partnership which the partnership agreement states in writing may be subject to the approval or disapproval of limited partners;

winding up the limited partnership; or

exercising any other right or power permitted to limited partners under the Act.

See Case 32-1

Practical Advice

As a limited partner, exercise care not to take part in the control of the limited partnership beyond that which is legally permitted.

Voting Rights

Choice of Associates

Withdrawal

Assignment of Partnership Interest

Profit and Loss Sharing

Distributions

Loans

Information

Derivative Actions

Limited Liability Companies

A limited liability company (LLC) is another form of unincorporated business association. Prior to 1990, only two States had statutes permitting LLCs. By 1996, all States had enacted LLC statutes. Since then, many States have amended or revised their LLC statutes. Until 1995, there was no uniform statute on which States might base their LLC legislation, and since its promulgation, twelve States have adopted the Uniform Limited Liability Company Act (ULLCA), which was amended in 1996. In 2006, the Revised ULLCA was completed and at least fourteen States have adopted it. (In 2011 and 2013, the 2006 Revised ULLCA was amended as part of the Harmonization of Business Entity Acts project. These amendments coordinate the language in the 2006 Revised ULLCA with the language of similar provisions in the other uniform and model unincorporated entity acts.) Therefore, LLC statutes vary from State to State with respect to such matters as LLC management, admission and withdrawal of members, power of members and managers to bind the LLC, duties imposed on managers and members, and the LLC’s right to merge with other business entities. Nevertheless, the LLC statutes generally share certain characteristics.

A limited liability company is a noncorporate business organization that provides limited liability to all of its owners (members) and permits all of its members to participate in management of the business. It may elect not to be a separate taxable entity, in which case only the members are taxed. (Publicly traded LLCs, however, are subject to corporate income taxation.) If an LLC has only one member, then it will be taxed as a sole proprietorship, unless separate entity tax treatment is elected. Thus, the LLC provides many of the advantages of a general partnership plus limited liability for all its members. Its benefits outweigh those of a limited partnership in that all members of an LLC not only enjoy limited liability but also may participate in management and control of the business. LLCs have become the most popular and widely used unincorporated business form. The most frequent use of LLCs has been in real estate transactions, professional services, construction, finance, and retail. Ownership interests in an LLC may be considered to be securities, especially interests in those LLCs operated by managers. If a particular LLC interest is considered a security, its sale will be subject to State and Federal securities regulation, as discussed in Chapter 43.

Formation

The formation of an LLC requires substantial compliance with a State’s LLC statute. All States permit an LLC to have only one member. Once formed, an LLC is a separate legal entity that is distinct from its members, who are normally not liable for its debts and obligations. An LLC can contract in its own name and is generally permitted to carry on any lawful purpose, although some statutes restrict the permissible activities of LLCs.

Members

LLC statutes permit members to include individuals, corporations, general partnerships, limited partnerships, limited liability companies, trusts, estates, and other associations. LLC statutes differ concerning the procedure for adding members after an LLC has been formed.

Filing

The LLC statutes generally require the central public filing of articles of organization in a designated State office. The States vary regarding the information they require the articles to include, but all require at least the following: (1) the name of the firm, (2) the address of the principal place of business or registered office, and (3) the name and address of the agent for service of process. The articles may also include any provision consistent with law for regulating internal LLC matters.

Most LLC statutes provide that the acceptance for filing is conclusive evidence that the LLC has been properly formed, except against the State in an involuntary dissolution or certificate revocation proceeding. Most LLC statutes require the articles to state whether the LLC will be managed by managers. Most States provide that LLCs have perpetual existence unless the members agree otherwise. The articles of organization may be amended by filing articles of amendment. In most States, LLCs must file annual reports with the State.

Name

LLC statutes generally require the name of the LLC to include the words limited liability company or the abbreviation LLC. The name of each LLC must be distinguishable from other firms doing business within the State.

Contribution

In most States, the contribution of a member to an LLC may be cash, property, services rendered, a promissory note, or other obligation to contribute cash or property or to perform services. Most LLC statutes require both a written agreement to make a contribution and a written record of contributions. Members are liable to the LLC for failing to make an agreed contribution.

Operating Agreement

The members of most LLCs adopt an operating agreement, which is the basic contract among the members governing the affairs of an LLC and stating the various rights and duties of the members and any managers. The operating agreement is subordinate to Federal and State law. LLC statutes generally do not require the operating agreement to be in writing, although some statutes permit modification of certain statutory rules to be only by written provision in an operating agreement. Unless the operating agreement provides otherwise, the members may amend it only by unanimous consent.

Foreign Limited Liability Companies

An LLC is considered “foreign” in any State other than that in which it was formed. LLC statutes provide that the laws of the State in which a foreign LLC is organized govern its organization, its internal affairs, and the liability of its members and managers. Foreign LLCs, however, generally are not permitted to transact business that domestic LLCs may not transact. Foreign LLCs must register with the Secretary of State before transacting any business in a State. Any foreign LLC transacting business without so registering may not bring enforcement actions in the State’s courts until it registers, although it may defend itself in the State’s courts. Moreover, States generally impose fines and penalties on unregistered foreign LLCs that transact business in the State.

Practical Advice

To obtain limited liability as a member of a limited liability company, make sure that the LLC has been properly organized.

Rights of Members

A member has no property interest in property owned by the LLC. On the other hand, a member does have an interest in the LLC, which is personal property. A member’s interest in the LLC includes two components:

the financial interest, which is the right to share profits and losses and to receive distributions, and

the management interest, which consists of all other rights granted to a member by the LLC operating agreement and the LLC statute. The management interest typically includes the right to manage, vote, obtain information, and bring enforcement actions.

Profit and Loss Sharing

The LLC’s operating agreement determines how the partners allocate the profits and losses. If the LLC’s operating agreement makes no such provision, in most States, the profits and losses are allocated on the basis of the value of the members’ contributions. A few States follow the partnership model under which profits are divided equally. Section 405.

Distributions

LLC statutes do not provide LLC members the right to distributions before withdrawal from the LLC. Therefore, the members share distributions of cash or other assets of an LLC as provided in the operating agreement. If the LLC’s operating agreement does not allocate distributions, in most States, they are made on the basis of the contributions each member made. All LLC statutes impose liability on members who receive wrongful distributions; some statutes also impose liability on members and managers who approved the wrongful distributions. The statutes vary in defining what constitutes a wrongful distribution, but most make a distribution wrongful if the LLC is insolvent or if the distribution would make the LLC insolvent. In most States, members are liable whether or not they knew that the distribution was wrongful.

Withdrawal

Some statutes permit a member to withdraw and demand payment of her interest upon giving the notice specified in the statute or the LLC’s operating agreement. Some of the statutes permit the operating agreement to deny members the right to withdraw from the LLC.

Management

Nearly all LLC statutes provide that in the absence of a contrary agreement, each member has equal rights in the management of the LLC. All LLC statutes permit LLCs to be managed by one or more managers who may, but need not, be members. LLC statutes generally provide that the members select the managers. In a member-managed LLC, the members have actual and apparent authority to bind the LLC. In a manager-managed LLC, the managers have this authority, while the members have no actual or apparent authority to bind the manager-managed LLC. Most statutes require a publicly filed document to elect a manager-managed structure; a few statutes permit the operating agreement to make that election.

See Case 32-3

Voting

Most of the LLC statutes specify the voting rights of members, subject to a contrary provision in an LLC’s operating agreement. In most States, the default rule for voting follows a corporate approach (voting is based on the financial interests of members), while a few States take a partnership approach (each member has equal voting rights). Typically, members have the right to vote on proposals to (1) adopt or amend the operating agreement, (2) admit any person as a member, (3) sell all or substantially all of the LLC’s assets prior to dissolution, and (4) merge the LLC with another LLC or other business entity. Some LLC statutes authorize voting by proxy. A proxy is a member’s authorization to an agent to vote for the member.

Information

The LLC must keep basic organizational and financial records. Each member has the right to inspect and copy the LLC records.

Derivative Actions

A member has the right to bring an action on behalf of an LLC to recover a judgment in its favor if the managers or members with authority to bring the action have refused to do so.

Assignment of LLC Interest

Unless otherwise provided in the LLC’s operating agreement, a member may assign his financial interest in the LLC. An assignment does not dissolve the LLC. The assignment only entitles the assignee to receive, to the extent of the assignment, the assigning member’s share of distributions. A judgment creditor of a member may obtain a charging order against the member’s financial interest in the LLC. The charging order gives the creditor the same rights as an assignee to the extent of the interest charged.

The assignee does not become a member and may not exercise any management rights of a member. However, an assignee of a financial interest in an LLC may acquire the other rights by being admitted as a member of the company by all the remaining members. (Some States allow admission by majority vote.) In most States, this unanimous acceptance rule is now a default rule, and the operating agreement may eliminate or modify it.

Applying the Law

Limited Partnerships and Limited Liability Companies

Facts

Rustin was a member of a limited liability company (LLC) called Global Trade, LLC, which refurbished and exported used construction equipment to foreign buyers. When Rustin and his wife divorced, they entered into a property settlement agreement, which divided up their assets and liabilities in a mutually acceptable manner. As part of this contract, Rustin assigned his membership in Global Trade to his ex-wife, Fanning. Rustin’s divorce lawyer notified Global Trade of the assignment to Fanning and provided a copy of the court order approving the property settlement to Global Trade’s manager. The LLC’s operating agreement is silent with respect to transfers of a member’s interest.

Fanning subsequently declared herself a member of Global Trade. As such, she requested detailed information about a proposed merger of Global Trade with one of its primary suppliers and demanded permission to attend a meeting of Global Trade’s members, at which they anticipated discussing and voting on the proposed merger. Global Trade’s members declined to give her the requested information and denied her access to the meeting at which they approved the merger.

Issue

Did Rustin’s assignment to Fanning make her a member of the LLC?

Rule of Law

Members of an LLC own an interest in the entity, which is personal property. A member’s interest in the LLC consists of two components: a financial interest and a management interest. The financial interest is a right to share profits and to receive distributions only. The management interest is the bundle of remaining member rights, including the right to manage, right to be informed, and right to vote. Members may assign their financial interest unless the operating agreement provides otherwise. On the other hand, members may assign their management interest only if the operating agreement expressly provides members that right. Otherwise, an assignee of an interest in an LLC will become a member only if the remaining members consent to admit her.

Application

As a member of Global Trade, LLC, Rustin had two distinct membership interests—the financial interest and the management interest. Because of the nature of LLCs, both of these membership rights are necessarily shaped and constrained by the terms of the relevant operating agreement and state LLC statute. In this case, the operating agreement said nothing about transfers of members’ interests. Therefore, by default, Rustin’s assignment is only of his financial interest.

This result is reinforced by the fact that, with notice of Rustin’s assignment to her, the members denied Fanning access to their meeting. An assignee of a financial interest in an LLC, like Fanning, can acquire a management interest if the other members of the LLC consent to her membership. Here, it is unclear whether the members formally voted on the question of whether Fanning should be admitted to the LLC. Nonetheless, because they denied her request for information and excluded her from the merger meeting, it is apparent that they are unwilling to consent to her admission as a member.

Conclusion

Fanning did not become a member of Global Trade, LLC, by virtue of Rustin’s assignment. Instead, she gained only the right to Rustin’s share of distributions from the LLC.

Duties

As with general partnerships and limited partnerships, the duties of care and loyalty also apply to LLCs. In most States, the LLC statute expressly imposes these duties. In other States, the common law imposes these duties. Many statutes also expressly impose an obligation of good faith and fair dealing. Who has these duties in an LLC depends upon whether the LLC is a manager-managed LLC (analogous to a limited partnership) or a member-managed LLC (analogous to a partnership).

Manager-Managed LLCs

All LLC statutes either permit or require LLCs to be managed by one or more managers selected by the members. Most LLC statutes impose upon the managers of an LLC a duty of care. In some States, this is a duty to refrain from grossly negligent, reckless, or intentional tortious conduct; in other States, it is a duty to act in good faith and as a prudent person would in similar circumstances. Managers also have a fiduciary duty, although the statutes vary in how they specify that duty. Usually, members of manager-managed LLCs have no duties to the LLC or its members by reason of being a member.

Member-Managed LLCs

Members of member-managed LLCs have the same duties of care and loyalty that managers have in manager-managed LLCs.

See Figure 32-2: Comparison of Member-Managed and Manager-Managed LLCs

Figure

32-2.

Comparison of Member-Managed and Manager-Managed LLCs

Member of Member-Managed LLC Manager of Manager-Managed LLC Member of Manager-Managed LLC

Control Full None

Liability Limited Limited

Agency Is an agent of the LLC Is not an agent of the LLC

Fiduciary Duty Yes No

Duty of Care Yes No

Note: LLC = limited liability company.

Practical Advice

Recognize that your rights and duties as a member of a limited liability company depend on whether the LLC is member managed or manager managed.

Dissolution

Ending an LLC involves three steps: (1) dissolution, (2) winding up or liquidation, and (3) termination. LLC statutes require a public filing in connection with dissolution. For example, after winding up the company, some LLC statutes provide for the filing of articles of dissolution stating (1) the name of the company, (2) the date of the dissolution, and (3) that the company’s business has been wound up and the legal existence of the company has been terminated. Other statutes require either (1) a public filing of the intent to dissolve at the time of dissolution or (2) filings at both the time of dissolution and after winding up.

Causes

Most LLC statutes no longer require that LLCs dissolve at the end of a stated term. Moreover, LLC statutes either (1) provide that a member’s dissociation does not cause dissolution or (2) permit the remaining members, by either unanimous or majority vote, to avoid dissolution upon a member’s disassociation. LLC statutes generally provide that an LLC will automatically dissolve upon the following:

the expiring of the LLC’s agreed duration, if any, or the happening of any of the events specified in the articles;

the written consent of all the members; or

a decree of judicial dissolution typically on the grounds that “it is not reasonably practicable to carry on the LLC’s activities in conformity with the articles of organization and the operating agreement” or, under some statutes, the members or managers have acted illegally, fraudulently, or oppressively.

LLC statutes require a public filing in connection with dissolution. For example, after winding up the company, the ULLCA and some LLC statutes provide for the filing of articles of termination stating (1) the name of the company, (2) the date of the dissolution, and (3) that the company’s business has been wound up and the legal existence of the company has been terminated. Other statutes require either (1) a public filing of the intent to dissolve at the time of dissolution or (2) filings at both the time of dissolution and after winding up.

See Case 32-5

Dissociation

Dissociation means that a member has ceased to be associated with the company through voluntary withdrawal, death, incompetence, expulsion, or bankruptcy. Some LLC states have eliminated a member’s dissociation as a mandatory cause of dissolution. Other LLC statutes permit the remaining members, by either unanimous or majority vote, to avoid dissolution upon a member’s disassociation.

Winding Up

An LLC continues after dissolution only for the purpose of winding up its business, which involves completing unfinished business, collecting debts, disposing of inventory, reducing assets to cash, paying creditors, and distributing the remaining assets to the members. During this period, the fiduciary duties of members and managers continue.

Authority

Upon dissolution, the actual authority of a member or manager to act for the LLC terminates, except so far as is appropriate to wind up LLC business. Actual authority to wind up includes the authority to complete existing contracts, to collect debts, to sell LLC assets, and to pay LLC obligations. In addition, some statutes expressly provide that after dissolution, members and managers continue to have apparent authority to bind the company they had prior to dissolution provided that the third party did not have notice of the dissolution.

Distribution of Assets

Most statutes provide default rules for distributing the assets of an LLC as follows:

to creditors, including members and managers who are creditors, except with respect to liabilities or distributions;

to members and former members in satisfaction of liabilities for unpaid distributions, except as otherwise agreed;

to members for the return of their contributions, except as otherwise agreed; and

to members for their LLC interests in the proportions in which members share in distributions, except as otherwise agreed.

Protection of Creditors

Many LLC statutes establish procedures to safeguard the interests of the LLC’s creditors. Such procedures typically include the required mailing of notice of dissolution to known creditors, a general publication of notice, and the preservation of claims against the LLC for a specified time.

Mergers and Conversions

Most LLC statutes expressly provide for mergers. A merger of two or more entities is the combination of all of their assets. One of the entities, known as the surviving entity, receives title to all the assets. The other party or parties to the merger, known as the merged entity or entities, is merged into the surviving entity and ceases to exist as a separate entity. Thus, if Alpha LLC and Beta LLC combine into the Alpha LLC, Alpha is the surviving LLC and Beta is the merged LLC.

The LLC statutes vary with respect to the voting rights of the members regarding approval of a merger. Some provide for a majority or unanimous vote; others leave it to the operating agreement. Some statutes require the filing of articles of merger; others require a merged LLC to file articles of dissolution. Upon the required filing, the merger is effective, and the separate existence of each merged entity terminates. All property and assets owned by each of the merged entities vests in the surviving entity, and all debts, liabilities, and other obligations of each merged entity become the obligations of the surviving entity.

Many LLC statutes provide for the conversion of another business entity into an LLC. LLC statutes and other business association statutes also provide for an LLC to be converted into another business entity. The converted entity remains the same entity that existed before the conversion.

Other Types of Unincorporated Business Associations

32-3a.

Limited Liability Partnerships

All of the States have enacted statutes enabling the formation of limited liability partnerships (LLPs). Until 1997, there was no uniform LLP statute, so the enabling statutes vary from State to State. In 1997, the Revised Uniform Partnership Act (RUPA) was amended to add provisions enabling general partnerships to elect to become LLPs, and more than thirty States have adopted this version of the RUPA. A registered limited liability partnership is a general partnership that, by making the statutorily required filing, limits the liability of its partners for some or all of the partnership’s obligations.

Formalities

To become an LLP, a general partnership must file with the Secretary of State an application containing specified information. The RUPA requires the partnership to file a statement of qualification. RUPA Section 1001(c). Most of the statutes require only a majority of the partners to authorize registration as an LLP; others require unanimous approval. The RUPA requires unanimity unless the partnership agreement provides otherwise. RUPA Section 1001(b). Some statutes require renewal of registrations annually, other statutes require periodic reports, and a few require no renewal. The RUPA requires filing annual reports. RUPA Section 1003. Some statutes require a new filing after any change in membership of the partnership, but a few of the statutes do not. The RUPA does not.

Designation

All statutes require LLPs to designate themselves as such. Most statutes require the name of the LLP to include the words limited liability partnership or registered limited liability partnership (or the abbreviation LLP or RLLP). Most statutes provide that the laws of the jurisdiction under which a foreign LLP is registered shall govern its organization, internal affairs, and the liability and authority of its partners. Many, but not all, of the statutes require a foreign LLP to register or obtain a certificate of authenticity. The RUPA requires a foreign LLP to qualify and file annual reports. RUPA Sections 1102 and 1003.

Liability Limitation

LLP statutes have taken three different approaches to limiting the liability of partners for the partnership’s obligations. The earliest statutes limited liability for negligent acts only; they retained unlimited liability for all other obligations. The next generation of statutes extended limited liability to any partnership tort or contract obligation that arose from negligence, malpractice, wrongful acts, or misconduct committed by any partner, employee, or agent of the partnership. Unlimited liability remained for ordinary contract obligations, such as those owed to suppliers, lenders, and landlords. The first two generations of LLP statutes are called “partial shield” statutes. Many of the more recent statutes (called “full shield” statutes) have provided limited liability for all debts and obligations of the partnership, including Section 306(c) of the RUPA. Most States have now adopted full shield statutes although some States still provide only a partial shield.

The statutes, however, generally provide that the limitation on liability will not affect the liability of (1) a partner who committed the wrongful act giving rise to the liability and (2) a partner who supervised the partner, employee, or agent of the partnership who committed the wrongful act. A partner is also personally liable for any partnership obligations guaranteed by the partner. The statutes also provide that the limitations on liability will apply only to claims that arise while the partnership was a registered LLP. Accordingly, partners would have unlimited liability for obligations that arose either before registration or after registration lapses.

See Figure 32-3: Liability Limitations in LLPs

Figure

32-3.

Liability Limitations in LLPs

LLP Statutes Limited Liability Unlimited Liability

First Generation Negligent acts • All other obligations

Wrongful partner
Supervising partner

Second Generation Tort and contract obligations arising • All other obligations

from wrongful acts • Wrongful partner

Supervising partner

Third Generation All obligations • Wrongful partner

Supervising partner

Note: LLP = limited liability partnership.

Practical Advice

Professionals should consider registering their partnerships as limited liability partnerships or organizing their firms as LLPs.

CHAPTER SUMMARY

Limited Partnerships

Definition of a Limited Partnership a partnership formed by two or more persons under the laws of a State and having one or more general partners and one or more limited partners

Formation a limited partnership can be formed only by substantial compliance with a State-limited partnership statute

Filing of Certificate two or more persons must file a signed certificate of limited partnership

Name inclusion of a limited partner’s surname in the partnership name in most instances will result in the loss of the limited partner’s limited liability

Contributions may be cash, property, or services or may be a promise to contribute cash, property, or services

Defective Formation if no certificate is filed or if the one filed does not substantially meet the statutory requirements, the formation is defective and the limited liability of the limited partners is jeopardized

Foreign Limited Partnerships a limited partnership is considered “foreign” in any State other than that in which it was formed

Rights a general partner in a limited partnership has all the rights and powers of a partner in a general partnership

Control the general partners have almost exclusive control and management of the limited partnerships; a limited partner who participates in the control of the limited partnership may lose limited liability

Voting Rights the partnership agreement may grant to all or a specified group of general or limited partners the right to vote on any matter

Choice of Associates no person may be added as a general partner or a limited partner without the consent of all partners

Withdrawal a general partner may withdraw from a limited partnership at any time by giving written notice to the other partners; a limited partner may withdraw as provided in the limited partnership certificate

Assignment of Partnership Interest unless otherwise provided in the partnership agreement, a partner may assign his partnership interest; an assignee may become a substituted limited partner if all other partners consent

Profit and Loss Sharing profits and losses are allocated among the partners as provided in the partnership agreement; if the partnership agreement has no such provision, then profits and losses are allocated on the basis of the contributions each partner actually made

Distributions the partners share distributions of cash or other assets of a limited partnership as provided in the partnership agreement

Loans both general and limited partners may be secured or unsecured creditors of the partnership

Information each partner has the right to inspect and copy the partnership records

Derivative Actions a limited partner may sue on behalf of a limited partnership if the general partners refuse to bring the action

Duties and Liabilities

Duties general partners owe a duty of care and loyalty (fiduciary duty) to the general partners, the limited partners, and the limited partnership; limited partners do not

Liabilities the general partners have unlimited liability; the limited partners have limited liability (liability for partnership obligations only to the extent of the capital that they contributed or agreed to contribute)

Dissolution

Causes the limited partners have neither the right nor the power to dissolve the partnership, except by decree of the court; the following events trigger a dissolution: (1) the expiration of the time period; (2) the withdrawal of a general partner, unless all partners agree to continue the business; or (3) a decree of judicial dissolution

Winding Up unless otherwise provided in the partnership agreement, the general partners who have not wrongfully dissolved the partnership may wind up its affairs

Distribution of Assets the priorities for distribution are as follows: (1) creditors, including partners who are creditors; (2) partners and ex-partners in satisfaction of liabilities for unpaid distributions; (3) partners for the return of contributions, except as otherwise agreed; and (4) partners for their partnership interests in the proportions in which they share in distributions, except as otherwise agreed

Limited Liability Companies

Definition a limited liability company (LLC) is a noncorporate business organization that provides limited liability to all of its owners (members) and permits all of its members to participate in management of the business

Formation the formation of an LLC requires substantial compliance with a State’s LLC statute

Members LLC statutes permit members to include individuals, corporations, general partnerships, limited partnerships, limited liability companies, trusts, estates, and other associations

Filing LLC statutes generally require the central filing of articles of organization in a designated State office

Name LLC statutes generally require the name of the LLC to include the words limited liability company or the abbreviation LLC

Contribution the contribution of a member to an LLC may be cash, property, services rendered, or a promissory note or other obligation to contribute cash, property, or to perform services

Operating Agreement the basic contract governing the affairs of an LLC and stating the various rights and duties of the members

Foreign Limited Liability Companies an LLC is considered “foreign” in any State other than that in which it was formed

Rights of Members a member’s interest in the LLC includes the financial interest (the right to distributions) and the management interest (which consists of all other rights granted to a member by the LLC operating agreement and the LLC statute)

Profit and Loss Sharing the LLC’s operating agreement determines how the partners allocate the profits and losses; if the LLC’s operating agreement makes no such provision, in most States, the profits and losses are allocated on the basis of the value of the members’ contributions

Distributions the members share distributions of cash or other assets of an LLC as provided in the operating agreement; if the LLC’s operating agreement does not allocate distributions, in most States, they are made on the basis of the contributions each member made

Withdrawal a member may withdraw and demand payment of her interest upon giving the notice specified in the statute or the LLC’s operating agreement

Management in the absence of a contrary agreement, each member has equal rights in the management of the LLC, but LLCs may be managed by one or more managers who may be members

Voting LLC statutes usually specify the voting rights of members, subject to a contrary provision in an LLC’s operating agreement

Information LLCs must keep basic organizational and financial records; each member has the right to inspect and copy the LLC records

Derivative Actions a member has the right to bring an action on behalf of an LLC to recover a judgment in its favor if the managers or members with authority to bring the action have refused to do so

Assignment of LLC Interest Unless otherwise provided in the LLC’s operating agreement, a member may assign his financial interest in the LLC; an assignee of a financial interest in an LLC may acquire the other rights by being admitted as a member of the company if all the remaining members consent or the operating agreement so provides

Duties

Manager-Managed LLCs The managers of a manager-managed LLC have a duty of care and loyalty; usually, members of a manager-managed LLC have no duties to the LLC or its members by reason of being members

Member-Managed LLCs members of member-managed LLCs have the same duties of care and loyalty that managers have in manager-managed LLCs

Liabilities subject to certain exceptions, no member or manager of an LLC is obligated personally for any debt, obligation, or liability of the LLC solely by reason of being a member or acting as a manager of the LLC

Dissolution

Causes an LLC will automatically dissolve upon (1) in some States, the dissociation of a member if the remaining members do not choose to continue the LLC, (2) the expiration of the LLC’s agreed duration or the happening of any of the events specified in the articles, (3) the written consent of all the members, or (4) a decree of judicial dissolution

Dissociation means that a member has ceased to be associated with the company through voluntary withdrawal, death, incompetence, expulsion, or bankruptcy

Winding Up completing unfinished business, collecting debts, and distributing assets to creditors and members; also called liquidation

Authority the actual authority of a member or manager to act for the LLC terminates, except so far as may be appropriate to wind up LLC affairs; apparent authority continues unless notice of the dissolution is given to a third party

Distribution of Assets the default rules for distributing the assets of an LLC are (1) to creditors, including members and managers who are creditors, except with respect to liabilities for distributions; (2) to members and former members in satisfaction of liabilities for unpaid distributions, except as otherwise agreed; (3) to members for the return of their contributions, except as otherwise agreed; and (4) to members for their LLC interests in the proportions in which members share in distributions, except as otherwise agreed

Protection of Creditors many LLC statutes establish procedures to safeguard the interests of the LLC’s creditors, including (1) mailing notice of dissolution to known creditors, (2) publishing of notice, and (3) preserving claims against the LLC for a specified time

Mergers

Definition the combination of the assets of two or more business entities into one of the entities

Effect the surviving entity receives title to all of the assets of the merged entities and assumes all of their liabilities; the merged entities cease to exist

Other Types of Unincorporated Business Associations

Limited Liability Partnership (LLP) a general partnership that, by making the statutorily required filing, limits the liability of its partners for some or all of the partnership’s obligations

Formalities most statutes require only a majority of the partners to authorize registration as an LLP; others require unanimous approval

Designation the name of the LLP must include the words limited liability partnership or registered limited liability partnership or the abbreviation LLP

Liability Limitation some statutes limit liability only for negligent acts; others limit liability to any partnership tort or contract obligation that arose from negligence, malpractice, wrongful acts, or misconduct committed by any partner, employee, or agent of the partnership; most provide limited liability for all debts and obligations of the partnership

Limited Liability Limited Partnership (LLLP) a limited partnership in which the liability of the general partners has been limited to the same extent as in an LLP

CASES

Control in Limited Partnerships: Alzado v. Blinder, Robinson & Company, Inc.

Supreme Court of Colorado, 1988 752 P.2d 544

Kirshbaum, J.

[In 1979, Lyle Alzado, a former professional football player, and two business associates formed Combat Promotions, Inc., to promote an eight-round exhibition boxing match in Denver, Colorado, between Alzado and Muhammad Ali, a former world champion boxer.] Ali had agreed to engage in the match on the condition that prior to the event his attorneys would receive an irrevocable letter of credit guaranteeing payment of $250,000 to Ali.

Combat Promotions, Inc. initially encountered difficulties in obtaining the letter of credit. Ultimately, however, Meyer Blinder (Blinder), President of Blinder-Robinson, expressed an interest in the event. Blinder anticipated that his company’s participation would result in a positive public relations image for its recently opened Denver office. Blinder-Robinson ultimately agreed to provide the $250,000 letter of credit.

Blinder-Robinson insisted on several conditions to protect its investment. It required the formation of a limited partnership with specific provisions governing repayment to Blinder-Robinson of any sums drawn against the letter of credit. It also required Alzado’s personal secured guarantee to reimburse Blinder-Robinson for any losses it might suffer. Alzado and Combat Promotions, Inc. accepted these conditions.

On June 25, 1979, an agreement was executed by Combat Promotions, Inc. and Blinder-Robinson creating a limited partnership, Combat Associates. Under the terms of the agreement, Combat Promotions, Inc. was the general partner and Blinder-Robinson was the sole limited partner. Blinder-Robinson contributed a $250,000 letter of credit to Combat Associates, and the partnership agreement provided expressly that the letter of credit was to be paid off as a partnership expense.

On the same day, June 25, 1979, Alzado executed a separate guaranty agreement with Blinder-Robinson. This agreement provided that if Ali drew the letter of credit, Alzado personally would reimburse Blinder-Robinson for any amount Blinder-Robinson was unable to recover from Combat Associates under the terms of the limited partnership agreement. As security for his agreement, Alzado placed a general warranty deed to his residence, an assignment of an investment account and a confession of judgment in escrow for the benefit of Blinder-Robinson. Thereafter, a separate agreement was apparently executed by Alzado and Combat Associates providing that Alzado would receive $100,000 in compensation for the exhibition match but subordinating any payment of that sum to the payment of expenses of the match, including, if drawn, the letter of credit.

Approximately one week before the date of the match, Alzado announced that he might not participate because he feared he might lose the assets he had pledged as security for the guaranty agreement. Alzado informed Blinder of this concern, and the two met the next day in Blinder-Robinson’s Denver office. Tinter, Kauffman and Ali’s representative, Greg Campbell, were also present. Subsequently, on July 14, 1979, the event occurred as scheduled.

Few tickets were sold, and the match proved to be a financial debacle. Ali drew the letter of credit and collected the $250,000 to which he was entitled. Combat Associates paid Blinder-Robinson only $65,000; it did not pay anything to Alzado or, apparently, to other creditors.

In January of 1980, Blinder-Robinson filed this civil action seeking $185,000 in damages plus costs and attorney fees from Alzado pursuant to the terms of the June 25, 1979, guaranty agreement. Alzado denied any liability to Blinder-Robinson and * * * also filed two counterclaims against Blinder-Robinson. The first alleged that because of its conduct Blinder-Robinson must be deemed a general partner of Combat Associates and, therefore, liable to Alzado under the agreement between Alzado and the partnership for Alzado’s participation in the match. * * * [The jury returned a verdict of $92,500 in favor of Alzado on this counterclaim. The court of appeals reversed.]

* * *

Alzado next contends that the Court of Appeals erred in concluding that Blinder-Robinson’s conduct in promoting the match did not constitute sufficient control of Combat Associates to justify the conclusion that the company must be deemed a general rather than a limited partner. We disagree.

A limited partner may become liable to partnership creditors as a general partner if the limited partner assumes control of partnership business. [Citations]; see also [RULPA] §303, which provides that a limited partner does not participate in the control of partnership business solely by doing one or more of the following:

(a)Being a contractor for or an agent or employee of the limited partnership or of a general partner;

(b)Being an officer, director, or shareholder of a corporate general partner;

(c)Consulting with and advising a general partner with respect to the business of the limited partnership;

* * *

* * * Any determination of whether a limited partner’s conduct amounts to control over the business affairs of the partnership must be determined by consideration of several factors, including the purpose of the partnership, the administrative activities undertaken, the manner in which the entity actually functioned, and the nature and frequency of the limited partner’s purported activities.

* * * The record here reflects that Blinder-Robinson used its Denver office as a ticket outlet, gave two parties to promote the exhibition match and provided a meeting room for many of Combat Associates’ meetings. Blinder personally appeared on a television talk show and gave television interviews to promote the match. Blinder-Robinson made no investment, accounting or other financial decisions for the partnership; all such fiscal decisions were made by officers or employees of Combat Promotions, Inc., the general partner. The evidence established at most that Blinder-Robinson engaged in a few promotional activities. It does not establish that it took part in the management or control of the business affairs of the partnership. Accordingly, we agree with the Court of Appeals that the trial court erred in denying Blinder-Robinson’s motion for judgment notwithstanding the verdict with respect to Alzado’s first counterclaim.

* * *

We * * * affirm the judgment of the Court of Appeals insofar as it reverses the judgments entered at trial in favor of Alzado on his first counterclaim against Blinder-Robinson.

Case 32-2.Duties of General Partner in Limited Partnerships: Wyler v. Feuer

California Court of Appeal, Second District, Division 2, 1978 85 Cal.App.3d 392, 149 Cal.Rptr. 626

Fleming, J.

Defendants Cy Feuer and Ernest Martin, associated as Feuer and Martin Productions, Inc. (FMPI), have been successful producers of Broadway musical comedies since 1948. Their first motion picture, “Cabaret,” produced by Feuer in conjunction with Allied Artists and American Broadcasting Company, received eight Academy Awards in 1973. Plaintiff Wyler is president and largest shareholder of Tool Research and Engineering Corporation, a New York Stock Exchange Company based in Beverly Hills. Prior to 1972 Wyler had had no experience in the entertainment industry.

[In 1972, FMPI bought the motion picture and television rights to Simone Berteaut’s best-selling books about her life with her half-sister Edith Piaf. To finance a movie based on this novel, FMPI sought a substantial private investment from Wyler. In July 1973, Wyler signed a final limited partnership agreement with FMPI. The agreement stated that Wyler would provide, interest free, 100 percent financing for the proposed $1.6 million project, in return for a certain portion of the profits, not to exceed 50 percent. In addition, FMPI would obtain $850,000 in production financing by September 30, 1973. The contract specifically provided that FMPI’s failure to raise this amount by September 30, 1973, “shall not be deemed a breach of this agreement” and that Wyler’s sole remedy would be a reduction in the producer’s fee.]

Despite their acclaimed success in “Cabaret,” defendants at the time of execution of the limited partnership agreement were experiencing difficulties in obtaining distributor commitments and knew it would be unlikely they could obtain any production financing by the September 30 deadline. Their difficulties arose from their overestimation of the attractiveness of the Piaf subject-matter, from the unknown leading actress, and from the scheduling of photography during the summer months when most Europeans go on vacation.

Filming of the motion picture began July 23 and ended October 9. By that time Wyler had advanced $1.25 million and defendants had failed to obtain any production financing. The completed cost of the picture was $1,512,000.

Early in October, Feuer met Wyler in Paris and requested an extension of the deadline for production financing to December 30, so that defendants could take advantage of distributor negotiations in process and recoup their profit percentage and their producer’s fee. Wyler said he had already financed the picture and refused to extend the deadline, thereby maintaining his profit percentage at 50 percent.

[A year after its release in 1974, the motion picture proved less than an overwhelming success—costing $1.5 million but making only $478,000 in total receipts. From the receipts, Wyler received $313,500 for his investment. FMPI had failed to obtain an amount even close to the $850,000 required for production financing. Wyler then sued Feuer, Martin, and FMPI for mismanagement of the business of the limited partnership and to recover his $1.5 million as damages.]

A limited partnership affords a vehicle for capital investment whereby the limited partner restricts his liability to the amount of his investment in return for surrender of any right to manage and control the partnership business. [Citation.] In a limited partnership the general partner manages and controls the partnership business. [Citation.] In exercising his management functions the general partner comes under a fiduciary duty of good faith and fair dealing toward other members of the partnership. [Citations.]

These characteristics—limited investor liability, delegation of authority to management, and fiduciary duty owed by management to investors—are similar to those existing in corporate investment, where it has long been the rule that directors are not liable to stockholders for mistakes made in the exercise of honest business judgment [citations], or for losses incurred in the good faith performance of their duties when they have used such care as an ordinarily prudent person would use. [Citation.] By this standard a general partner may not be held liable for mistakes made or losses incurred in the good faith exercise of reasonable business judgment.

According all due inferences to plaintiff’s evidence, as we do on review of a nonsuit, we agree with the trial court that plaintiff did not produce sufficient evidence to hold defendants liable for bad business management. Plaintiff’s evidence showed that the Piaf picture did not make money, was not sought after by distributors, and did not live up to its producers’ expectations. The same could be said of the majority of motion pictures made since the invention of cinematography. No evidence showed that defendants’ decisions and efforts failed to conform to the general duty of care demanded of an ordinarily prudent person in like position under similar circumstances. The good faith business judgment and management of a general partner need only satisfy the standard of care demanded of an ordinarily prudent person, and will not be scrutinized by the courts with the cold clarity of hindsight.

[Judgment for Feuer, Martin, and FMPI affirmed.]

Case 32-3.Management of Limited Liability Companies: Montana Food, LLC v. Todosijevic

Supreme Court of Wyoming, 2015 2015 WY 26, 344 P.3d 751

Kite, J.

[Montana Food,] LLC is a limited liability company organized under the laws of the State of Wyoming and listing its principal place of business in Laramie County, Wyoming. During 2010, Mr. Todosijevic and Mr. Vukov, who are residents of Belgrade, Serbia, each held a 50% membership interest in the LLC. The LLC organized several subsidiaries in Belgrade, including Delbin Investments, MD, LTD (Delbin). The LLC and its subsidiaries invested in buildings located in Belgrade with an eye toward developing them.

The LLC’s articles of organization provided that the LLC was manager-managed and named Maksim Stajcer, who was not a member of the LLC, as the manager. The articles of organization also provided that after the initial capital contribution of $10,000, “[a]dditional contributions shall be made at such times and in such amounts as may be agreed upon by the Members as provided in the Operating Agreement.” In late 2010, Mr. Vukov became concerned that he was the only member making additional contributions. He retained counsel in Serbia to investigate. The investigation apparently showed that Mr. Vukov had contributed 1,260,600 Euros while Mr. Todosijevic had made no additional contributions. Mr. Vukov issued a notice of meeting indicating that he wished to address the issue of capital contributions by the members as provided in the articles of organization and propose that any member who did not contribute to the LLC’s capital would be subject to a reduction of his ownership interest. Mr. Todosijevic claimed he did not receive the notice. In any event, he did not attend. At the meeting, Mr. Vukov adopted and approved resolutions showing his capital contribution of 1,260,600 Euros, increasing his ownership interest to 99.72% and reducing Mr. Todosijevic’s interest to 0.28%. Thereafter, Mr. Vukov amended the articles of organization by naming himself and his wife as the new managers of the LLC.

[In 2011, Mr. Todosijevic filed an action against Mr. Vukov and the LLC, claiming, among other things, that Mr. Vukov did not have the authority to adjust the members’ ownership interests. The district court granted Mr. Todosijevic’s motion for summary judgment. The LLC appealed.]

The narrow issue before us is whether Mr. Vukov on behalf of the LLC had the contractual or statutory authority to adjust the members’ capital contributions. In deciding that issue, we must determine whether provisions of Wyoming’s current LLC Act are controlling or whether provisions of the earlier Act apply. [Section 17-29-1103 of the current Act provides that four sections of the former Act applied at the time this action arose, including the management provision.]

The effective date of the current Act was July 1, 2010. The LLC we are concerned with here was organized in June of 2007. Therefore, we look to the former provisions * * * for guidance. We begin with §17-15-116:

17-15-116. Management.

Management of the limited liability company shall be vested in its members, which unless otherwise provided in the operating agreement, shall be in proportion to their contribution to the capital of the limited liability company, as adjusted from time to time to properly reflect any additional contributions or withdrawals by the members; however, if provision is made for it in the articles of organization, management of the limited liability company may be vested in a manager or managers who shall be elected by the members in the manner prescribed by the operating agreement of the limited liability company. If the articles of organization provide for the management of the limited liability company by a manager or managers, unless the operating agreement expressly dispenses with or substitutes for the requirement of annual elections, the manager or managers shall be elected annually by the members in the manner provided in the operating agreements. The manager or managers, or persons appointed by the manager or managers, shall also hold the offices and have the responsibilities accorded to them by the members and set out in the operating agreement of the limited liability company.

(Emphasis added.)

In the present case, the articles of organization received by the Wyoming Secretary of State on June 1, 2007, provided as follows:

IX: Management: The Company is to be managed by a manager. The name and address of the manager who is to serve as manager until the first annual meeting of Members or until its successor or successors is or are elected and qualify, and who shall have authority to act and bind the Company upon his individual signature, is:

Maksim Stajcer, CPA S.A. 76 Dean Street Belize City Belize, C. America

The LLC operating agreement, also dated June 1, 2007, provided:

3.1 MANAGEMENT OF THE BUSINESS. The name and place of residence of each Manager is attached as Exhibit 1 of this Agreement. By a vote of Member(s) holding a majority of capital interests in the Company, as set forth in Exhibit 2 as amended from time to time, shall elect so many Managers as the Members determine, but no fewer than one.

Exhibit 1 to the operating agreement stated that by a majority vote of the members, Maksim Stajcer was elected to serve as manager of the LLC until removed by a majority vote of the members or his voluntary resignation. There is no evidence in the record that Mr. Stajcer had been removed or voluntarily resigned prior to Mr. Vukov’s unilateral amendment of the articles of organization in 2011. * * *

* * *

The next question for our determination is whether, in a manager-managed LLC, a member has the authority to adjust the members’ ownership interests. Again, we begin by considering which version of Wyoming’s LLC Act applies. Section 17-29-1103 * * * states that four sections of the former Act applied at the time this action arose * * *. None of those provisions address the authority of a member of a manager-managed LLC to adjust ownership interests. We, therefore, look to the new Act to resolve the issue.

Section 17-29-407(c) * * * addresses LLC management. Subsection (c)(i) provides that in a manager-managed LLC, unless the articles of organization or the operating agreement provide otherwise, any matter relating to the activities of the company is decided exclusively by the manager. Subsection (c)(iv)(C) further provides that the consent of all members is required to undertake any act outside the ordinary course of the company’s activities. Pursuant to the plain language of subsection (c)(i), unless the articles of organization and operating agreement provide otherwise, Mr. Vukov, as a member of the LLC, did not have the authority to decide matters relating to company activities. Pursuant to subsection (c)(iv)(C), Mr. Vukov also had no authority to take action outside the ordinary course of the LLC’s activities without Mr. Todosijevic’s consent unless the organizational documents provide otherwise.

The articles of organization at issue here provided that the manager “shall have the authority to act for and bind the Company upon his individual signature.” The operating agreement further provided:

* * * Members that are not Managers shall take no part whatever in the control, management, direction, or operation of the Company’s affairs and shall have no power to bind the Company …

* * *

Pursuant to these provisions, LLC members were not authorized to control, manage, direct or operate LLC affairs; rather, the manager was to control ordinary LLC operations. The manager was not authorized, however, to change members’ ownership interests. Nothing in the articles of organization or operating agreement gave anyone the authority to change ownership interests. We conclude, as the district court did, that changing ownership interests was action outside the ordinary course of the LLC’s activities. Applying the clear language of §17-29-407(c)(iv)(C), the consent of all members was required. The district court correctly concluded Mr. Vukov did not have the statutory or contractual authority to unilaterally change the members’ ownership interests.

Case 32-4.Liabilities in Limited Liability Companies: Estate of Countryman v. Farmers Coop. Ass’n

Supreme Court of Iowa, 2004 679 N.W.2d 598

Cady, J.

In the afternoon of September 6, 1999, an explosion leveled the home of Jerry Usovsky (Usovsky) in Richland, Iowa. Tragically, seven people who had gathered in the home to celebrate the Labor Day holiday died from the explosion. Six others were injured, some seriously. The likely cause of the explosion was stray propane gas. The survivors and executors of the estates of those who died eventually filed a lawsuit seeking monetary damages against a host of defendants. The legal theories of recovery included negligence, breach of warranty, and strict liability. The defendants included Iowa Double Circle, L.C. (Double Circle) and Farmers Cooperative Association of Keota (Keota).

Double Circle is an Iowa limited liability company. It is a supplier of propane, and delivered propane to Usovsky’s home prior to the explosion. Keota is one of two members in Double Circle. It owns a ninety-five percent interest in the company. The other member is Farmland Industries, Inc. (Farmland Industries), a regional cooperative. Keota and Farmland Industries formed Double Circle in 1996 from an existing operation.

Keota is a farm cooperative that provides a variety of farm products and services to area farmers. It is a member of Farmland Industries and is managed by Dave Hopscheidt (Hopscheidt). The executive committee of Keota’s board of directors serves as the board of directors of Double Circle, along with a representative of Farmland Industries. Keota provides managerial services to Double Circle, pursuant to a management agreement between Keota and Double Circle. Keota’s duties under the agreement include “human resource and safety management.” Hopscheidt oversees the daily operations of both Keota and Double Circle. However, Keota and Double Circle operate as separate entities and maintain separate finances. Keota moved for summary judgment. * * *

The plaintiffs resisted the motion by pointing to allegations in their petition indicating Keota participated in the claims of wrongdoing through the management decisions it made in consumer safety matters. For example, plaintiffs claimed Keota, through Hopscheidt, was negligent in failing to provide proper warnings to propane users, including the failure to warn users to install a gas detector, and to properly design the odorant added to the propane. * * *

The district court granted summary judgment for Keota. It found plaintiffs failed to produce any facts to show that Keota engaged in conduct separate from its duties as director or manager of Double Circle. Consequently, it concluded Keota was protected as a matter of law from personal liability for claims of wrongful conduct attributable to Double Circle. * * *

* * *

Plaintiffs filed their notice of appeal from the summary judgment. * * * They claimed the district court erred by finding that Keota was insulated from liability as a matter of law. * * *

* * *

The limited liability company, “LLC” as it is now known, is a hybrid business entity that is considered to have the attributes of a partnership for federal income tax purposes and the limited liability protections of a corporation. [Citation.] As such, it provides for the operational advantages of a partnership by allowing the owners, called members, to participate in the management of the business. [Citation.] Yet, the members and managers are protected from liability in the same manner shareholders, officers, and directors of a corporation are protected. [Citation.]

The LLC * * * has now been adopted by statute in every state in the nation. [Citation.] Iowa joined the trend in 1992 with the passage of the Iowa Limited Liability Company Act (ILLCA). [Citation.] The ILLCA, among other features, permits the owners or members to centralize management in one or more managers or reserve all management powers to themselves. [Citations.]

Although the tax treatment of an LLC has been largely resolved, the contours of the limited liability of an LLC are less certain. [Citation.] Only a few courts have specifically addressed the issue of tort liability. * * *

* * *

The[se] rules of liability derived from [the ILLCA] have been summarized as follows:

Sections * * * of the Act generally provide that a member or manager of a limited liability company is not personally liable for acts or debts of the company solely by reason of being a member or manager, except in the following situations: (1) the ILLCA expressly provides for the person’s liability; (2) the articles of organization provide for the person’s liability; (3) the person has agreed in writing to be personally liable; (4) the person participates in tortious conduct; or (5) a shareholder of a corporation would be personally liable in the same situation, except that the failure to hold meetings and related formalities shall not be considered.

[Citation.]

* * * While liability of members and managers is limited, the statute clearly imposes liability when they participate in tortious conduct. [Citation.] This approach is compatible with the longstanding approach to liability in corporate settings, where, under general agency principles, corporate officers and directors can be liable for their torts even when committed in their capacity as an officer. [Citations.] * * *.

Keota suggests that liability of an LLC member or manager for tortious conduct is limited to conduct committed outside the member or manager role. Yet, this approach is contrary to the corporate model and agency principles upon which the liability of LLC members and managers is based, and cannot be found in the language of the statute. We acknowledge that the “participation in tortious conduct” standard would not impose tort liability on a manager for merely performing a general administrative duty. [Citations.] There must be some participation. [Citation.] The participation standard is consistent with the principle that members or managers are not liable based only on their status as members or managers. [Citation.] Instead, liability is derived from individual activities. Yet, a manager who takes part in the commission of a tort is liable even when the manager acts on behalf of a corporation. [Citation.] The ILLCA does not insulate a manager from liability for participation in tortious conduct merely because the conduct occurs within the scope and role as a manager. * * * The limit on liability created for members and managers of LLCs in [citation] means members and managers are not liable for company torts “solely by reason of being a member or manager” of an LLC. [Citation.] The phrase “solely by reason of” refers to liability based upon membership or management status. It does not distinguish between conduct of a member or manager that may be separate and independent from the member or management role. Thus, it is not inconsistent to protect a member or manager from vicarious liability, while imposing liability when the member or manager participates in a tort. Liability of members of an LLC is limited, but not to the extent claimed by Keota.

* * *

We conclude that Keota is not protected from liability if it participated in tortious conduct in performing its duties as manager of Double Circle. Consequently, the district court improperly granted summary judgment based on the limited liability provisions of [citation]. A trial is necessary to develop the facts relating to allegations of Keota’s participation in the alleged torts.

We reverse the summary judgment ruling of the district court on the issue of liability under [citation], and remand for further proceedings.

Case 32-5.Judicial Dissolution of Limited Liability Companies: In the Matter of 1545 Ocean Ave., LLC

Appellate Division of the Supreme Court of New York, Second Department, 2010 72 A.D.3d 121, 893 N.Y.S.2d 590

Austin, J.

[1545 LLC was formed in November 2006 by its two members Crown Royal Ventures, LLC (Crown Royal) and Ocean Suffolk Properties, LLC (Ocean Suffolk) that executed an operating agreement that provided for two managers: Walter T. Van Houten (Van Houten), who was a member of Ocean Suffolk, and John J. King, who was a member of Crown Royal. Each member of 1545 LLC contributed 50 percent of the capital, which was used to purchase premises known as 1545 Ocean Avenue in Bohemia, New York, on January 5, 2007. 1545 LLC was formed to purchase the property, rehabilitate an existing building, and build a second building for commercial rental. Van Houten, who owns his own construction company, Van Houten Construction (VHC), was permitted to submit bids for the project, subject to the approval of the managers.

Article 4.1 of the operating agreement provides that “[a]t any time when there is more than one Manager, any one Manager may take any action permitted under the Agreement, unless the approval of more than one of the Managers is expressly required pursuant to the [operating agreement] or the [Limited Liability Company Law].”

Article 4.12 of the operating agreement entitled, “Regular Meetings,” does not require meetings of the managers with any particular regularity. Meetings may be called without notice as the managers may “from time to time determine.”

The managers disagreed about various aspects of the construction work performed on the LLC property by VHC, which billed 1545 LLC the sum of $97,322.27 for this work. King claims that he agreed 1545 LLC would pay VHC’s invoice on the condition that VHC would no longer unilaterally do work on the site. Notwithstanding King’s demand, VHC continued working on the site. Despite his earlier protests, King did nothing to stop it. The managers also disagreed about which company to hire to perform environmental remediation work on the site.

King contended that thereafter tensions between King and Van Houten escalated and that Van Houten refused to meet on a regular basis, proclaiming himself to be a “cowboy” and would “just get it done.” Nevertheless, King acknowledged that the construction work undertaken by VHC was “awesome.” By April 2007, King announced that he wanted to withdraw his investment from 1545 LLC. He proposed to have all vendors so notified, telling them that Van Houten was taking over the management of 1545 LLC. As a result, Van Houten viewed King as having resigned as a manager of 1545 LLC.

Ultimately, King sought to have Ocean Suffolk buy out Crown Royal’s membership in 1545 LLC or, alternatively, to have Crown Royal buy out Ocean Suffolk. Despite discussions regarding competing proposals for the buyout of the interest of each member by the other member, no satisfactory resolution was realized. During this period of disagreements, VHC continued to work unilaterally on the site so that the project was within weeks of completion when Crown Royal filed a petition to dissolve 1545 LLC. The sole ground for dissolution cited by Crown Royal was deadlock between the managing members arising from Van Houten’s alleged violations of various provisions of article 4 of the operating agreement. The trial court granted the petition of Crown Royal to dissolve 1545 Ocean Avenue, LLC. Ocean Suffolk appealed.]

Limited Liability Company Law §702 provides for judicial dissolution as follows:

On application by or for a member, the supreme court in the judicial district in which the office of the limited liability company is located may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement (emphasis added).

* * *

* * * Limited Liability Company Law §702 is clear that * * * the court must first examine the limited liability company’s operating agreement, [citation], to determine, in light of the circumstances presented, whether it is or is not “reasonably practicable” for the limited liability company to continue to carry on its business in conformity with the operating agreement [citation]. * * *

* * * Where an operating agreement, such as that of 1545 LLC, does not address certain topics, a limited liability company is bound by the default requirements set forth in the Limited Liability Company Law [citations].

The operating agreement of 1545 LLC does not contain any specific provisions relating to dissolution. * * *

Crown Royal argues for dissolution based on the parties’ failure to hold regular meetings, failure to achieve quorums, and deadlock. The operating agreement, however, does not require regular meetings or quorums [citation]. It only provides, in article 4.12, for meetings to be held at such times as the managers may “from time to time determine.” The record demonstrates that the managers, King and Van Houten, communicated with each other on a regular basis without the formality of a noticed meeting which appears to conform with the spirit and letter of the operating agreement and the continued ability of 1545 LLC to function in that context.

King and Van Houten did not always agree as to the construction work to be performed on the 1545 LLC property. King claims that this forced the parties into a “deadlock.” “Deadlock” is a basis, in and of itself, for judicial dissolution under Business Corporation Law §1104. However, no such independent ground for dissolution is available under Limited Liability Company Law §702. Instead, the court must consider the managers’ disagreement in light of the operating agreement and the continued ability of 1545 LLC to function in that context.

It has been suggested that judicial dissolution is only available when the petitioning member can show that the limited liability company is unable to function as intended or that it is failing financially [citation]. Neither circumstance is demonstrated by the petitioner here. On the contrary, the purpose of 1545 LLC was feasibly and reasonably being met.

* * *

* * * Thus, the only basis for dissolution can be if 1545 LLC cannot effectively operate under the operating agreement to meet and achieve the purpose for which it was created. In this case, that is the development of the property which purpose, despite the disagreements between the managing members, was being met. As the Delaware Chancery Court noted in Matter of Arrow Inv. Advisors, LLC,

The court will not dissolve an LLC merely because the LLC has not experienced a smooth glide to profitability or because events have not turned out exactly as the LLC’s owners originally envisioned; such events are, of course, common in the risk-laden process of birthing new entities in the hope that they will become mature, profitable ventures. In part because a hair-trigger dissolution standard would ignore this market reality and thwart the expectations of reasonable investors that entities will not be judicially terminated simply because of some market turbulence, dissolution is reserved for situations in which the LLC’s management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business, such as in the case of a voting deadlock or where the defined purpose of the entity has become impossible to fulfill * * * [citation].

Here, the operating agreement avoids the possibility of “deadlock” by permitting each managing member to operate unilaterally in furtherance of 1545 LLC’s purpose.

After careful examination of the various factors considered in applying the “not reasonably practicable” standard, we hold that for dissolution of a limited liability company pursuant to Limited Liability Company Law §702, the petitioning member must establish, in the context of the terms of the operating agreement or articles of incorporation, that (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible.

Dissolution is a drastic remedy [citation]. * * * [T]he petitioner has failed to meet the standard for dissolution enunciated here * * *.

[Order of the trial court is reversed, the petition is denied, and the proceeding is dismissed.]

CASE TO RESPOND:

A limited partnership was formed consisting of Webster as general partner and Stevens and Stewart as the limited partners. The limited partnership was organized in strict compliance with the limited partnership statute. Stevens was employed by the partnership as a purchasing agent. Stewart personally guaranteed a loan made to the partnership. Both Stevens and Stewart consulted with Webster with respect to partnership business, voted on a change in the nature of the partnership business, and disapproved an amendment to the partnership agreement proposed by Webster. The partnership experienced serious financial difficulties, and its creditors seek to hold Webster, Stevens, and Stewart personally liable for the debts of the partnership. Who, if anyone, is personally liable?

What are the arguments that Stroud is not liable to National Biscuit for the value of the bread delivered to the Food Center? What are the arguments that Stroud is liable to National Biscuit for the value of the bread delivered to the Food Center? Explain which arguments should prevail.

Stroud’s Food Center

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