Tag: conversion

LLC Members Not Liable to Deceased Member’s Estate; Partnership’s Assets Become LLC’s Upon Conversion

The First District recently examined the nature of a limited liability company (LLC) member’s personal liability and the requirements for converting a general partnership to an LLC.

In Daniel v. Ripoli, 2015 IL App (1st) 122607, a case with a labyrinthine fact pattern, an LLC member’s estate sued an accounting company LLC to recover distributions the estate claimed was owed the deceased member under the LLC operating agreement.

The LLC defended by asserting that the deceased’s distribution amount was permanently reduced before he died by an amendment to the operating agreement.  The trial court entered a money judgment of about $200,000 for the plaintiff and the LLC appealed.

Held: reversed.  The operating agreement’s amendment lessened the deceased member’s distribution amounts from the amendment date forward.

Rules/Reasons:

1/ In Illinois a contract can be modified by express agreement or by conduct.  A contractual modification that’s not expressly agreed to can be ratified by acquiescence in a course of conduct consistent with recognizing the modification;

2/ An LLC provides more insulation from liability for its members than does a corporation for its shareholders;

3/ Under Section 10-10(a) of Illinois’ LLC Act, 805 ILCS 180/10-10(a), LLC members aren’t liable for debts of the LLC unless (1) the articles of organization provide for personal liability; and (2) the member has consented in writing to the adoption of a personal liability provision;

3/ The failure of an LLC to observe usual corporate formalities in connection with the operation of its business is not a basis for imposing personal liability on LLC members or managers;

4/ When a general partnership converts to an LLC, all that’s required is each partner vote for the conversion.  The partnership does not need to also transfer all of its assets to the newly formed LLC;

5/ Once the conversion from partnership to LLC is complete, all debts and assets of the partnership automatically become those of the LLC;

7/ An LLC member can sue the LLC or another member for legal or equitable relief with or without an accounting to enforce the member’s rights under the LLC Act, the operating agreement or any other rights of the member;

8/ The death of an LLC member results in the member’s disassociation from the LLC;

9/ The LLC Act does not allow for a deceased member’s estate to sue the LLC or other LLC members on the deceased member’s behalf;

805 ILCS 180/10-10(a), (c), 180/15-20.

The court held that here, once the accounting general partnership converted to an LLC, the LLC members (who were the erstwhile partners) had no liability to non-members like the plaintiff.

Additionally, the parties’ conduct indicated a mutual recognition that the deceased’s distributions were reduced by the deceased member accepting lesser distributions for several years before he died.  The court then reversed the judgment against the LLC.

Afterwords:

A former LLC member’s estate has no standing to sue an LLC absent legislative decision to the contrary;

A partnership’s assets and liabilities become those of an LLC upon conversion to the LLC form;

Basic contract formation principles apply when determining LLC members’ rights and duties under an operating agreement.

 

 

No Punitive Damages For Breach of Contract; Conversion of ‘Intangible’ Property = An Open Question – IL ND

Sometimes in breach of contract suits, I see clients (and attorneys, too!) let visceral considerations cloud their judgment.  They let emotions factor into a litigation equation that should purely be about “dollars and cents.”  What’s to an objective observer a simple monetary dispute, becomes a complex psychological event when a breach of contract plaintiff views the defendant’s breach as a personal affront – one calling out for revenge.  Usually though, a breaching defendant isn’t trying to make the plaintiff’s life miserable.  Instead, the defendant typically can’t meet his financial obligations under the agreement or he lets his performance lapse for purely strategic reasons. 

One way the law puts a check on emotions dominating a business dispute is by preventing plaintiffs from bootstrapping a breach of contract claim into a fraud claim.  Another way is through the firmly entrenched legal principle that punitive damages cannot be recovered for a breach of contract.

The latter rule is at play in David Mizer Enterprises, Inc. v. Nexstar Broadcasting, Inc., 2015 WL 469423 (N.D.Ill. 2015), where a business consultant sued a television broadcasting firm under various legal and equitable theories for wrongfully disclosing plaintiff’s proprietary software and business model to third parties in violation of a written licensing agreement.

The plaintiff alleged that after a three-year license period expired, defendant continued using plaintiff’s secret software and business model without permission.

The plaintiff sought over $330K in damages in its breach of contract suit and sought an award of punitive damages premised on the defendant’s bad faith.  The plaintiff also joined a conversion count based on the defendant’s unauthorized use of plaintiff’s software after the license lapsed.  Defendant moved to dismiss and to strike plaintiff’s punitive damages allegation.

Result: motion to dismiss denied; motion to strike punitive damages claim granted

Reasons:

Under Illinois law, punitive damages are generally not available for a breach of contract.  An exception to this rule applies where the contract breach amounts to an independent tort is done with “malice, wantonness or oppression.”  The court looks to a defendant’s motive for its breach in determining whether punitive damages are warranted.

The court struck the plaintiff’s punitive damages claim.  The plaintiff failed to allege malice or bad faith conduct by the defendant.  Instead, plaintiff’s allegations were consonant with a basic breach of contract action.  As a result, punitive damages weren’t warranted.

Next, the court sustained the plaintiff’s conversion claim. Under Illinois law, a conversion plaintiff must establish that he (1) has a right to certain property; (2) has an absolute and unconditional right to the immediate possession of the property; (3) made a demand for possession; and (4) the defendant wrongfully and without authorization assumed control, dominion, or ownership over the property.

Typically, conversion must involve tangible, personal property like computer hardware or a car, for example.  Whether conversion applies to intangible property is an open question with cases going each way.

The defendant argued that plaintiff was suing to recover damages based on defendant’s interference with its intangible electronic data.  Rejecting this argument, the court found that since the licensing contract specifically mentioned plaintiff’s software and related writings, the lifted property was tangible enough to underpin a conversion claim.

The court held that the plaintiff’s allegation that the defendant deprived Plaintiff of the exclusive benefit of its software and information, stated a valid conversion claim sufficient to survive a motion to dismiss.

Take-aways:

Punitive damages aren’t recoverable in breach of contract suits.  The only exception is where the plaintiff can show the defendant’s breach was done with malice: for the sole purpose of harming the plaintiff;

Whether intangible property (like computer data) can underlie a conversion action is an open question.  The more “hard” or concrete property the plaintiff can point to, the better his chances of making out a civil conversion suit. 

 

The IL Fiduciary Obligations Act: Added Protection Against Bank Liability

ATMProfessional Business Automation Technology, LLC v. Old Plank Trail Community Bank, 2014 IL App (3d) 130044-U presents a recent illustration of the Fiduciary Obligations Act, 760 ILCS 65/7 (the “Fiduciary Act”) – a statute that immunizes banks from liability to a corporate customer that gets fleeced by a high-ranking employees.

The only exceptions are where the bank (1) has actual knowledge of a fiduciary’s breach or (2)  exhibits bad faith in allowing a questionable transaction to take place.  An example would be where a business’s accountant endorses checks payable to the business to herself and the bank sees this and allows it to happen.

In Professional Business, a former member of the plaintiff LLC deposited about $45K over a five-month period in an account he set up under a fictitious but similarly worded (to the plaintiff) entity about 10 days after he resigned as member of the plaintiff LLC.  All funds deposited were intended for the plaintiff – the rightful payee.

When plaintiff found out about the ex-member’s scheme, it sued the bank for negligence and conversion on the theory that the bank shouldn’t have allowed the ex-member to open the sham account or to deposit monies in it.  The plaintiff also argued that the bank should have been more diligent in verifying the corporate status of the account holder before opening the account.  The trial court granted the bank’s summary judgment motion.

Affirming, the court held that the plaintiff failed to show bad faith by the bank or that it had actual knowledge that the former LLC member was breaching obligations owed to his principal.

Actual knowledge means “awareness at the moment of the transaction” that a fiduciary is defrauding the principal or using funds for private purposes in violation of a fiduciary relationship.  (¶  13).

Bad faith  means the bank was commercially unreasonable by remaining passive in a dubious situation and refusing to learn readily available facts surrounding the questionable transaction (like a corporate employee endorsing corporate checks to herself).

Here, the plaintiff failed to present any evidence that the bank had actual knowledge that the individual opening the dummy account was violating any fiduciary duties to a corporate principal.  The Court also found that the bank followed normal procedures when opening the account and there was nothing to alert the bank that the member was defrauding the plaintiff.

The bank offered sworn testimony (via affidavit) that it adhered to all internal protocols for opening a corporate account as it required the account opener to supply a corporate resolution and a FEIN number.

The bank officer also testified that she looked at the Secretary of State website and didn’t see anything suspicious – even though there was no mention of the account holder entity’s name as a valid corporation.

The Court also found that the bank defeated plaintiff under UCC Section 3-404 and 3-420.  The former section relieves a bank from liability where it pays out in good faith to an imposter or fictitious payee.  The latter statute (3-420) controls conversion of instruments and only allows actions by parties who actually receive an instrument (i.e., a check).  Here, since the plaintiff never actually received the deposited checks, the bank had no conversion liability under the UCC.  (¶ 15).

Take-away:

It’s difficult to sue and win against a bank.  Not only can the bank rely on the Fiduciary Act, but various sections of UCC Article 3 also provide safe harbors from liability to a bilked bank customer.  Business account holders should be vigilant and keep tabs on corporate employees who have broad money depositing and withdrawal authority.

As this case shows, the hurdles a plaintiff must clear to successfully hold a bank responsible for a corporate employee’s misdeeds make it all the more important for a company to have a system of checks and balances: no single employee should have free reign over a firm’s bank deposits and withdrawals.  The temptation to cheat is probably too great.