Archives for March 2015

Piercing the LLC Corporate Veil: Publicly-Traded Parent Corp. Is Responsible for Controlled LLC’s Debts – Wyoming Court

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An ill-fated wind turbine project in Southeast Wyoming sets the unlikely stage for a court’s encyclopedic corporate liability history lesson.  In Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc., 2014 WY 144, 337 P.3d 454 (Wyo. 2014), the Wyoming Supreme Court traces the evolution of the corporate form (and later, the equitable piercing the corporate veil remedy), from its pre-Biblical origins through the modern day where the limited liability company is the business vehicle of choice for start-ups and entrepreneurs across the country.

The plaintiff got about a $44K judgment against an LLC defendant  for consulting work the plaintiff did as part of a wind turbine development.  In post-judgment discovery, the plaintiff learned that the LLC was controlled in every way by its parent company – a publicly-traded entity – who decided what LLC creditors would and wouldn’t be paid.

The plaintiff then added the corporate parent as a defendant and the lower court pierced the LLC’s veil of protection and found the parent company responsible for the judgment.  Affirming the piercing judgment, the Wyoming Supreme Court held:

the cardinal features of an LLC are limited liability and flexibility.  LLC’s have the personal liability protections of a corporation with the taxation benefits of a partnership (no “double taxation” at entity and personal levels, e.g.);

– Wyoming’s LLC Act provides that a failure of an LLC to observe corporate formalities isn’t enough to impose liability on LLC members or managers for LLC obligations (Wyo. Stat. Ann. s. 17-29-304).

– although Wyoming’s LLC Act provides that LLC members aren’t responsible for an LLC’s debts, an LLC’s veil of limited liability can be pierced where there is a unity of interest between the LLC and a dominating person or entity, and where recognizing corporate existence will lead to injustice or sanction a fraud;

– A Wyoming LLC can be pierced not only where there is actual fraud (misrepresentation of fact, scienter, reliance, damages, e.g.) but also where there is constructive fraud – conduct that doesn’t rise to the level of (intentional) fraud but is treated the same because of its similar harmful consequences;

– Two key factors involved in the piercing equation include undercapitalization and commingling: the degree to which a business is intermixed with the affairs of its member;

– No single factor is determinative on its own and the court’s piercing calculus is fact-driven.

(¶¶ 12-33)

The defendant and the LLC were separate entities and had separate bank accounts. Still the court upheld the lower court’s piercing of the LLC’s corporate veil to bind the defendant.

The undercapitalization factor weighed heaviest in the court’s analysis.  There is no magic capital infusion number that equals adequate capitalization.  The court noted that over a several-month period during the time plaintiff was submitting bills to the LLC, that it (the LLC) had a zero bank balance and that the defendant dictated what bills the LLC would and wouldn’t pay.

Since the LLC was continually unfunded by choice instead of by external market forces, the LLC was inadequately capitalized.  (¶¶ 40-43).

The court also found that the LLC and its corporate parent intermingled their business and finances.  Key facts cited by the court included: (i) the same accountants managed both the LLC’s and the defendant’s finances; (ii) the LLC didn’t have any employees.  Instead, defendant’s employees negotiated and inked contracts for the LLC; (iii) the LLC had no revenue separate from the defendant and the defendant used the LLC to “pass through” funds for bill payment; and (iv) the defendant claimed tax deductions for the LLC’s business without assuming responsibility for any of the LLC’s debts.  

In short, the defendant enjoyed all the benefits of an LLC without also shouldering the responsibility for its operation.  (¶¶ 44-45).

Q: But Shouldn’t the Plaintiff Have Gotten A Guaranty?

The defendant’s last argument was that the plaintiff should have protected itself by insisting on a guaranty from the corporate defendant.  The court rejected this, noting that the “reality of the marketplace” is that companies like the plaintiff are often in a competitively vulnerable position compared to large corporations like the defendant and lack the leverage to require a guaranty from the corporation.

Taken together, these factors led the to find the conditions ripe for piercing and held the defendant responsible for the judgment.

Afterwords:

A significant opinion for its exhaustive analysis of piercing litigation with a special focus on piercing an LLC.;

Piercing was allowed here even though there was no finding of actual or constructive fraud and where Wyoming’s LLC Act specifically provides that LLC members are not liable for LLC debts;

Time will tell whether this case and others like it will embody a major change in corporate liability law making it easier to pierce the veil of limited liability where a dominant entity controls a weaker, affiliated one.

A special thanks to Robert Ansell of Silverman Acampora (Jericho, NY) for alerting me to this
[email protected]

 

Attorneys’ Liens, Contingency Fee Agreements and Quantum Meruit Recovery – An Illinois Case Note

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In a prior post (http://paulporvaznik.com/tag/retaining-lien), I discussed the common law retaining lien, which allows an attorney to keep a client’s papers and property as security for the payment of past due fees.  Another legal device at a lawyer’s disposal to encourage payment is the statutory attorneys’ lien, codified in Illinois at 770 ILCS 5/1.

Grane v. Methodist Medical Center of Central Illinois, 2015 IL App (3d) 130003-U, considers the attorneys’ lien remedy where a client fires his attorney, hires someone else and later rakes in big bucks in a settlement.

The personal injury plaintiff entered a written contingency fee agreement with a law firm (Law Firm 1) whom he (the plaintiff) later fired before hiring new counsel (Law Firm 2).  Law Firm 1 served a written notice of its attorneys’ lien on the defendant hospital while it still represented plaintiff.

When the suit settled for several million dollars, Law Firm 1 sought to recover pursuant to the 30% recovery contingency fee contract.  The trial court agreed and awarded Law Firm 1 nearly $600K: 30% of the total fee award.  Law Firm 2 and plaintiff appealed.

Held: Reversed.

Q: Why?

A: To collect fees under the Illinois Attorney Lien Act, 770 ILCS 5/1, the attorney must file a petition to adjudicate her lien.  A prerequisite to filing a lien petition is that the attorney must have been hired by the client to assert a claim and the lien must have been “perfected.”

To perfect an attorney lien, the claimant must serve notice in writing of his lien upon the party against whom her client has a claim.  The lien may be served by registered or certified mail.

The lien attaches on the date of service of the statutory notice.  An attorneys’ lien must also be perfected during the time there is an attorney-client relationship. (If the attorney waits until after she’s fired to serve the notice, it’s too late.)

When a client fires a lawyer, the fee agreement signed pre-firing is extinguished and no longer exists.  Once that happens, the lawyer’s recourse is to try and recover under a quantum meruit theory: to seek the reasonable value of her services before she was fired.

The quantum meruit factors an Illinois court considers when deciding a fee award include: (1) the skill and standing of the attorney employed, (2) the nature of the case and difficulty of the questions at issue, (3) the amount and importance of the subject matter, (4) the degree of responsibility involved in the management of the case, (5) the time and labor required, (6) the usual, customary fee in the community, and (7) the benefit flowing to the client.  (¶¶ 19-22).

Since the court awarded fees based on a cancelled contingency fee agreement, the appeals court reversed so that the trial court could award the plaintiff’s its fees under the quantum meruit factors.

Takeaway:

The case’s obvious lesson for lawyers is to Track Your Time.  Even in cases where a client isn’t paying by the hour or where it seems unlikely that a fee dispute is likely to ever crystallize.

By keeping diligent time records, the attorney who is fired before a client gets a hefty settlement can show tangible proof of her services and can quantify the dollar value of them.

Lost Profits and the ‘New Business Rule’ – A Short and Sweet One

Aside from delving into some unique issues that crop up in corporate guaranty suits, Williamson Co. v. Ill-Eagle Enterprises, Ltd., 2015 WL 802250, the case I featured yesterday (http://paulporvaznik.com/business-compulsion-duress-and-guaranties-signed-after-the-underlying-contract/7667) also provides some lost profits essentials adapted to a new(ish) business relationship.

In the case, the home decor designer who vends to large retailers (think Bed Bath & Beyond) countersued against the plaintiff foreign manufacturer for lost profits resulting from defective merchandise shipped by the manufacturer.

The manufacturer moved to dismiss the counterclaim on the basis that the designer’s claimed lost profits were speculative since the designer was a “new business” with a sparse profit history.  The court disagreed and posited some key lost profit rules:

lost profits can be recovered when they’re proven with reasonable certainty – mathematical certainty is not required;

– the plaintiff seeking lost profits must show a reasonable basis for the computation of the claimed damages;

– damages must be shown with reasonable certainty and shown to have been contemplated of the defaulting party at the time the contract was entered into;

– expert testimony is sometimes considered in a lost profits claim but isn’t required;

– the “New Business Rule” (NBR) precludes lost profits recovery for a new or unestablished business since it lacks a financial track record with which to gauge future profits;

– Illinois extends the NBR to both new businesses and new products;

– courts generally permit discovery on lost profits damages before deeming them too speculative;

– If after discovery, the plaintiff can’t show an established market for a given product or business, a lost profits claim will fail.

Here, the plaintiff designer established enough of a track record to permit discovery on the issue of lost profits.  There was a five-year relationship between the wall furnishings  manufacturer and designer wall furnishings as well as a multi-year history of contracts the designer had with “big box” retailers.

As a consequence, the court held it was premature to dismiss the designer’s counterclaim without allowing the designer to take oral and written discovery to support the damages claim.

Afterwords:

The case presents a useful summary of Illinois lost profits basics in the context of a high-dollar/high-sophistication dispute between two commercial entities.

The New Business Rule (NBR) applies to new businesses as well as new products.  However, despite the newness of a given company or enterprise, courts will allow discovery on the lost profits question.  The longer the parties’ contractual relationship, the less likely the NBR will defeat a lost profits claim.