New Developments

South Dakota Supreme Court on LLC dissolution

The Supreme Court of South Dakota has held that an LLC may be dissolved when two of four members refuse to renegotiate the terms of an agreement between the LLC and those two members.

 

In Kirksey v. Grohmann, four sisters were left equal ownership interests in a ranch when their mother died in 2001. The ranch had been in the family for over 100 years. They formed an LLC the next year to hold title to the ranch. They did so for tax advantages, to keep the land within the family, and to keep the land out of the hands of the sisters’ spouses. Ms. Grohmann, the eldest, lived on the land and was named manager. Ms. Randell, the next oldest, lived on the land, as well. All four decided that the LLC would lease the land to Grohmann, Randell, and Ms. Kirksey (a third sister), who owned grazing livestock on the land. The fourth sister, Ms. Ruby, neither lived on the land nor grazed livestock on it. The lease was for about $14,000 per year and netted about $4,000 after taxes and insurance. Grohmann and Randell quickly fell out with Kirksey and Ruby and Kirksey sold her livestock to Grohmann and Randell in 2003. Apparently, the land increased in value by a factor of six but the lease payments were fixed. The operating agreement required a majority vote to take action and the sisters were deadlocked as to any action that would change the status quo either by changing the lease terms or by dissolving. Kirksey and Ruby sued for dissolution, which the trial court denied.

 

Justice Konenkamp held that dissolution was warranted under the South Dakota LLC Act, which in pertinent part is identical to the 1996 ULLCA. That act provides for court ordered dissolution when, inter alia, “the economic purpose of the company is likely to be unreasonably frustrated” or “it is not otherwise reasonably practicable to carry on the company’s business in conformity with the articles of organization and the operating agreement”. The complaint apparently did not seek dissolution on the ground of illegal, oppressive, fraudulent, or unfairly prejudicial conduct, though it seems clear from the briefs that such a claim could at least have been made, if not ultimately proven. Nor did the complaint seek damages for breach of fiduciary duty.

 

After canvassing a number of states’ interpretation of the “not reasonably practical” standard, the court held that the economic entity of the ranch could be continued but that leaving de facto control in Grohmann and Randell, who refuse to change the terms of the lease favorable to them, is not reasonably practical in light of the operating agreement. The court suggested that Kirksey and Ruby knew of the favorable terms when they entered into the original lease and surely knew the terms of the operating agreement. Justice Konenkamp also held that that the economic purpose of the LLC is likely to be unreasonably frustrated, essentially for the same reasons.

 

Although the court does not speak in terms of fiduciary duties, the subtext seems to be that Grohmann and Randell had some sort of obligation to renegotiate the terms of the lease so that the other two sisters could share equitably (perhaps equally?) in the economics of the enterprise. It seems not to matter that Kirksey and Ruby willingly agreed both to the LLC operating agreement and to the lease terms. A deal isn’t a deal if it turns out to be too good a deal.

North Carolina Court of Appeals on director conflict of interest safe harbor

The North Carolina Court of Appeals has erroneously held that directors do not face conflicts of interest when they elect a family member as an officer, approve compensation for officer-family members, and approve “matters related to” those family members. The court also erroneously focused on the directors’ voting (rather than on the underlying transaction) to determine that election of a family member as an officer and compensation paid to officer-family members are not transactions “with the corporation”. The court erroneously held that those transactions are not subject to the North Carolina conflict of interest safe harbor statute.

In Geitner v. Mullins, a corporation was owned equally by Ms. Geitner and Ms. Mullins, two daughters of the founder. The six person board was not equally divided between the sisters. The board consisted of Ms. Geitner and her husband, on the one hand and Ms. Mullins, her husband (Mr. Mullins), her daughter (Ms. Shehan), and her son on the other hand. The Mullins branch controlled the corporation.

The board approved bonuses for Mr. Mullins, who was the president, and, after his death, voted to appoint Ms. Shehan as president and to give her a substantial raise. Mr. Mullins abstained from voting on his bonuses and Ms. Shehan abstained from voting on her appointment as president and concomitant raise. Each vote was approved by the remaining three Mullins directors (a non-family member replaced Mr. Mullins on the board and voted with the Mullins family); the two Geitner family directors voted against each transaction. The Geitners brought suit seeking a declaration that the Mullins directors’ votes were invalid and that any future votes “on matters related to” Mr. Mullins and Ms. Shehan would be invalid because they were not in conformity with the North Carolina conflict of interest statute. That statute is substantially identical to pre-1990 MBCA § 8.31, which is in effect in about a dozen states. It is comparable to Delaware’s approach in DGCL § 144.

Judge Tyson held that the family relationships, vel non, are insufficient to trigger the conflict of interest statute because the statute does not explicitly state that family relationships are conflicts of interest. He also held that the statute is not triggered because voting is not a transaction with the corporation. Thus the court affirmed entry of summary judgment for defendants.

Judge Geer, in her concurrence, disagreed with both of Judge Tyson’s assertions, and she is exactly right. She looked to both the standard treatise on North Carolina corporate law and, more pertinently, to the MBCA Official Comments for guidance. Both sources make salient the intuitive notion that a transaction between a corporation and a director’s immediate family member is a conflict of interest for the director. She then moved to a more central point, which Judge Tyson did not address at all: the operative effect of the conflict of interest statute. The statute does not invalidate director votes; it provides a safe harbor for transactions that might otherwise be voidable. Because the statute does not invalidate director votes, plaintiff’s declaratory relief request failed. Judge Geer mercifully declined to deal with Judge Tyson’s second ground. Had she done so, she doubtless would have pointed out that voting is obviously not the statute’s concern. The statute speaks to transactions with the corporation such as, oh, I don’t know, contracting with officers and agreeing to compensate them.

Nebraska Supreme Court on partnership buyout and partnership property

The Supreme Court of Nebraska has held that a partnership agreement’s buyout option is triggered by service of process of a lawsuit for dissolution rather than by the court’s judgment in that lawsuit. The supreme court also applied the presumptions in the UPA to determine whether two pieces of real estate were partnership property. In Mogensen v. Mogensen, three brothers formed a partnership to operate a family farm. After a falling out, Steven Morgensen sued for dissolution. The court entered summary judgment for the defendants on the ground that the partnership agreement provided an avenue for withdrawal and therefore the UPA’s provisions for dissolution were inapplicable. The partnership agreement permitted the other partners to purchase a withdrawing partner’s interest if they gave notice within 90 days of receiving notice of the intent to withdraw. About a month after the court’s judgment, Keith Morgensen gave notice of his intent to purchase Steven’s partnership interest. Steven refused. Keith brought suit for specific performance and Steven counterclaimed for declaratory relief as to whether two parcels were partnership property.

Justice Connolly held that the 90 day window began when Keith received service of process rather than when the court granted summary judgment. This holding was based on caselaw from other jurisdictions. The court determined that one of the disputed parcels was partnership property because it was purchased in part with partnership funds, but that the other disputed property was not partnership property because it was not acquired with partnership property. These holdings are quite straightforward but the discussions of the two parcels make a very nice contrast with one another. That part of the opinion would teach well because the facts are readily apprehended, the statutory provisions clear, and the application reasonable.

Delaware Court of Chancery on Caremark duty of loyalty

The Delaware Court of Chancery has held that two directors breached their duty of loyalty by failing to meet their Caremark obligations. In ATR-Kim Eng Financial Corp. v. Araneta, Araneta controlled 90% of a corporation and was one of the three directors. After a falling out with his childhood friend Arnaiz, who’s ATR owned the remaining 10%, Araneta transferred the corporation’s assets to his own children for no consideration.

Vice Chancellor Strine had no difficulty finding Araneta liable. The interesting part of the opinion concerns the other two directors, Berenguer (Araneta’s niece and the CFO) and Bonilla. They were completely overborne by Araneta and readily admitted that they did nothing as directors. It appears that no board meetings were held. Vice Chancellor Strine found that they violated their duty of loyalty by failing to implement a reporting or monitoring system as required by Caremark. It has several characteristically Strinian phrases.

Pedagogically, this case and Stone v. Ritter will probably replace Caremark (casebook pp. 410, 426-27, 443-44). Between them they show that the duty to monitor is a loyalty issue and they also discuss the standard of review. The facts of Araneta are more accessible and interesting than those of Caremark. Since Stone v. Ritter torques Caremark rather considerably, it would be hard to keep Caremark itself as a teaching case. Perhaps it will be less confusing to students if we refer to the duty to monitor as the Loyaltymark duty.

Francis Pileggi (here), Steve Bainbridge (here), and Gordon Smith (here) all have discussions of Araneta.

Wyoming Supreme Court on minority discount in determining “fair value”

The Wyoming Supreme Court has held that a minority discount is impermissible in calculating the fair value of a dissenting shareholder’s shares. In Brown v. Arp and Hammond Hardware Co., four cousins owned a corporation. The four agreed to sell a large portion of the corporation’s assets to an entity owned by one of the cousins. They then decided to sell their stock instead of the assets, but one cousin, Brown, disapproved. She desired to sell the assets but was unwilling to sell her entire ownership interest. The other three cousins sold their shares and the purchasing entity then effected a reverse stock split to cash out Brown. Brown perfected her right to appraisal and the primary issue was whether a minority discount should be applied.

Justice Burke held that a minority discount should not be applied. The Wyoming statute is substantially equivalent to § 13.01(4) of the MBCA before the 1999 amendments and does not speak to whether a minority discount is appropriate. After a decent discussion of the background of appraisal rights, Justice Burke noted that states were split on the issue of minority discount at the time Wyoming adopted the MBCA. Later, however, the Delaware Supreme Court decided Cavalier Oil Corp. v. Harnett, which held that minority discounts are inappropriate and most other states have since followed that decision. Justice Burke cited Matthew G. Norton v. Smyth, casebook pate 664, for the proposition that rejecting minority discounts is consonant with the pre-1999 MBCA.

One of the corporation’s arguments in favor of applying a minority discount was that ascertaining fair value is fact-intensive and that the facts here suggest that the objecting shareholder’s mother (who gave her shares to Brown shortly before the reverse stock split) was “troublesome, meddling, [and] difficult”. Justice Burke held that these facts are not “extraordinary circumstances” warranting a discount and noting that the “extraordinary circumstances” exception permits a marketability discount, not a minority discount.

Delaware Court of Chancery on entire fairness

The Delaware Court of Chancery has held that the entire fairness standard applied to a cash out merger but not because the directors and their families owned over half of the shares. Rather, the entire fairness standard applied because the directors were to remain shareholders after the merger, thus incentivizing the board to pay as little as possible to the cashed out shareholders, rendering the directors “interested”. In In re PNB Holding Co., a small rural bank holding company believed that converting to Subchapter S status would increase the returns to shareholders. To reduce the 360 shareholders to seventy-five or fewer, to meet Subchapter S requirements, the bank effected a merger with a wholly-owned Subchapter S corporation in which only shareholders with more than 2,000 shares would remain shareholders. The others would be cashed out. All of the officers and directors (and 27 of their family members) qualified to remain shareholders, as did about 9% of the other shareholders. Some shareholders perfected appraisal rights. Others asserted a claim for breach of fiduciary duties.

Vice Chancellor Strine found that the fair value of the shares was about 28% greater than the merger consideration. He also found that the defendants did not demonstrate that the merger was entirely fair and awarded identical relief to those shareholders who did not vote yes on the merger and who did not dissent. He denied recovery to shareholders who voted yes on the merger, and therefore acquiesced.

The family aspects of this case are of particular interest. Vice Chancellor Strine rejected the argument that the directors and their families constituted a controlling bloc because they owned about 60% of the stock. The Vice Chancellor declined to aggregate the officers’ and directors’ 33% of the shares with those of their family members.

“[T]he idea that children and parents always see eye-to-eye is not a premise of our law. One can have a healthy family relationship and still feel free to vote one’s stock differently than a parent.”

“[W]hat is critical is whether there is a reason to believe that the familial relationship, coupled with other important facts, is so thick that the stockholders should be treated as essentially a voting group.”

He then held that familial relationships were relevant to whether the directors were interested. Vice Chancellor Strine held that the economic benefits of remaining a shareholder were material to the directors because several directors made efforts to increase the shareholdings of their family members so that they could remain shareholders.

Quaere whether the fact that Vice Chancellor Strine is dubitant about the wisdom of Lynch might have made him inclined, subconsciously, to discount the power of family when deciding whether to find “control”.

Block that metaphor quote:

“Glomming share-owning directors together into one undifferentiated mass with a single hypothetical brain would result in an unprincipled Frankensteinian version of the already debatable 800-pound gorilla theory of the controlling shareholder that animates the Lynch line of reasoning.”

Nebraska court on the internal affairs doctrine

The Supreme Court of Nebraska has held that the internal affairs doctrine, as embodied in the Nebraska corporations act, requires that Delaware law apply to the Delaware holding company of a Nebraska operating company and that the facts alleged do not state a claim under Delaware law. In Johnson v. Johnson, the father owned 75% of the Delaware parent company and five children owned the remaining 25%. Richard, the favored son, owned 10% of the parent and was to succeed the father as head of the Nebraska subsidiary. Michael, who owned 6% of the parent, was to succeed Richard. The three were the directors of both the parent and the subsidiary. The parent’s only asset was subsidiary stock and the subsidiary did business only in Nebraska. The father died with Richard named as personal representative. Richard terminated Michael from his employment with the subsidiary, filled his father’s director slot with a long time employee, and gave himself a large raise. The parent has never paid dividends. Richard convened a parent shareholder meeting at which he voted all of the father’s stock in favor of ratification of Richard’s actions. Michael sued alleging that Richard’s actions constituted oppression and were a breach of fiduciary duties. He requested equitable relief that, in essence, sought the appointment of a receiver, dissolution, and an accounting.

The court, per Gerrard, J., held that the Nebraska corporations act, substantively equivalent to MBCA § 15.05(c), required the application of the internal affairs doctrine and the factors in Section 6 of the Restatement (Second) of Conflict of Laws that warrant overriding that application do not apply. Michael did not challenge the trial court’s holding that Delaware law did not permit the dissolution of the parent or the appointing of a receiver by a foreign forum on these facts. Thus, once it is clear that Delaware law applies, Michael’s complaint does not state a claim upon which relief can be granted.

The court is certainly correct. The nub of the complaint is that Michael has been wronged as a shareholder of the Delaware parent, not as an employee of the Nebraska subsidiary. Thus his only redress is against his brother as controller of the Delaware parent. This highlights a danger of suggesting that a local corporation incorporate out of state.

Missouri court on apparent authority

The Missouri Court of Appeals has held that an officer of a corporation created apparent authority in her son when she signed a credit application as “Secretary-Owner” of the corporation, left a section requiring the names of all owners blank, her son later listed himself, falsely, as an owner, and submitted the application to a third party that extended credit to its detriment. In Motorsport Marketing, Inc. v. Wiedmaier, Inc.(Mo. Ct. App. 2006), Motorsport sold NASCAR merchandise on credit based upon a credit application submitted by Wiedmaier, Inc., owner and operator of a truck stop. Motorsport dealt exclusively with Michael Wiedmaier, son of the only two Wiedmaier, Inc. shareholders and officers. The merchandise was shipped to an L.L.C. owned by Michael, which sold NASCAR merchandise over the internet. Payments were made to Motorsport by the L.L.C., which Michael falsely represented to Motorsport as being a division of Wiedmaier, Inc. Some of the merchandise was displayed for sale at the truck stop, apparently acquired by Wiedmaier Inc. from the L.L.C. When the account exceeded $90,000 in unpaid charges, Motorsport finally contacted Michael’s mom who denied corporate liability on the ground that Michael had not been authorized to act on the corporation’s behalf. Quaere whether the credit application in fact did not create apparent authority because it listed Michael only as an owner, not as an officer, employee, or agent? Quaere whether the corporate Secretary’s execution of the credit application, presumably knowing its purpose, was sufficient to endue Michael with actual authority or whether her subsequent actions were ratification by acquiescence thereby binding the corporation?

Texas case on DGCL §§ 218 and 253

The Texas Court of Appeals has held that the board of a Delaware corporation (“parent”) may effect a short form merger of a second Delaware corporation (“sub”) into itself even though the parent is not the shareholder of record of any sub shares. In Warren v. Warren Equipment Co., (Tex. App. 2006), the parent (a family corporation) put the stock of a wholly owned sub into a voting trust with two parent board members as trustees. One trustee died and the remaining trustee (“Rick”) had a falling out with the other parent directors. The parent board purported to remove Rick from its board (an obvious violation of DGCL 141(k), which the court does not discuss. Possibly the court misspoke and it was a majority of the parent company shareholders – doubtless also members of the board – that actual amoved Rick) and then effected a short form merger, thus ending the voting trust and ending Rick’s power over the sub.

Neither the court’s result nor its reasoning is intuitively correct. The court found that the parent, as the beneficial owner of sub shares, “owned” the sub for purposes of DGCL 253. However, a parent controls its sub only through its power to elect the sub’s board (and otherwise vote the sub’s shares). Where the economic and managerial powers of the sub are separated, it is not immediately apparent why the economic power should control over the managerial. Overlaying all of this is another issue the court did not reach: whether the Schnell doctrine should be invoked to invalidate statutorily authorized action (short form merger) used for inequitable purposes (ending Rick’s power to vote the sub’s shares).