The Minnesota Court of Appeals has held that the de facto LLC doctrine does not exist in Minnesota and that the LLC-by-estoppel doctrine is inapplicable where a party’s intention to deal solely with an LLC is induced by fraud.
In Stone v. Jetmar Properties, LLC, Ortega gave Hammond an unsecured $200,000 loan to develop property that Ortega had planned to sell to Jetmar, Hammond’s LLC. The sale was not completed because Hammond could not obtain sufficient funds. Although the loan was to be repaid in three days, Hammond never repaid it. A few months later, Hammond met Stone and convinced him to invest more than $50,000 in Jetmar projects. Hammond convinced Stone to quitclaim a rented duplex to Jetmar so that Jetmar’s balance sheet would show sufficient assets to obtain further financing. Hammond promised to reconvey the property in sixty days and told Stone he could continue to keep the rent from the tenants.
Hammond recorded the deed the next day and mortgaged the duplex to Ortega the day after that in exchange for Ortega’s agreement to extend the $200,000 loan. Ortega recorded the mortgage a few days later after confirming that Jetmar had title. Ortega foreclosed on the duplex about seven months later, sending notice to the tenants who forwarded it to Stone. Relying on Hammond’s assurances that all would be well, Stone did not contact Ortega to assert his interest in the duplex. A couple of months later Ortega conducted a foreclosure sale at which he purchased the duplex in return for his $200,000 loan to Jetmar. About a week later, Hammond filed Jetmar’s articles of organization. Apparently neither Ortega nor Stone knew that Jetmar had not been formed. Stone filed suit against Jetmar, Hammond, and Ortega seeking damages and a declaratory judgment that he owned the duplex. Jetmar and Hammond defaulted.
Judge Lansing held that Stone’s quitclaim dean to Jetmar was void because Jetmar did not exist at the time. Neither the de facto entity doctrine nor the entity-by-estoppel doctrine prevented Stone from reclaiming title to the duplex. Judge Lansing held that an element of the de facto doctrine was not met because Hammond made no colorable attempt to form the LLC at the time Stone conveyed the duplex. She further held that the de facto entity doctrine cannot apply to LLCs. Minnesota’s corporations act, which is based, in pertinent part, on the MBCA of 1950, abolished the de facto corporation doctrine. The reporter’s notes to the Minnesota LLC statute state that corporate law should apply to analogous portions of the LLC statute. Because the LLC statute’s section stating that an LLC’s existence begins at filing is based on a similar corporations act section, the de facto entity doctrine cannot apply to LLCs.
The entity-by-estoppel doctrine was not abolished by statute but does not allow Ortega to retain the duplex. Although Stone intended to deal only with Jetmar, not Hammond, that intention was induced by fraud, which allows the court to decline to apply the entity-by-estoppel doctrine. Thus Stone cannot be estopped from seeking to recover the duplex.
As a policy matter, it makes sense to be consistent in applying the defective formation doctrines of de facto entity and entity-by-estoppel. The drafters of the current MBCA concluded that the 1950 MBCA’s attempt to end the de facto corporation doctrine was misguided; courts continued to provide equitable relief despite the statute. Whether the drafters were right in that conclusion is less than obvious and the survival of the 1950 MBCA provisions in a few states, such as Minnesota, suggests that the appropriate policy choice is not obvious. The entity-by-estoppel doctrine is so amorphous that perhaps the best one can say is that, if their courts are consistent, then they’ve made an appropriate choice in terms of defining the doctrine.
This case could be taught in Chapter 19 either right before or just after P.D. 2000, L.L.C. v. First Financial Planners, Inc., on casebook page 745. It would make a good contrast with P.D. 2000, L.L.C. on the entity-by-estoppel question.
One other aspect of this case caught my eye. Jetmar’s counsel was Alex W. Russell, Esq. Mr. Russell practices with, and, in fact, seems to be the only lawyer at, the firm called, “Evening & Weekend Law Offices”. This is an interesting marketing technique and I wonder whether Mr. Russell’s practice is helped or hurt on the whole by his choice of firm name.