Florida Series: Charging Order that Gives Receiver Management Control over LLC Finances Too Broad – Fla Appeals Court

A creditor’s exclusive remedy against a debtor who is a member or manager of a limited liability company (LLC) is a charging order on the debtor’s distributional interest.

McClandon v. Dakem & Associates, LLC, (see here), a recent Florida appellate case, illustrates that while the charging order remedy is flexible enough to allow for some creative lawyering, it still has limits.

McClandon’s facts are straightforward: the plaintiff obtained a money judgment against an individual who had an interest in several limited liability companies.   In post-judgment proceedings, the plaintiff sought a charging order against the debtor’s LLC interests.  The court granted the charging order and appointed a receiver to take control of the LLCs’ finances.

The debtor appealed.

Partially reversing the charging order’s terms, the appeals court found the trial court exceeded its authority and encroached on the legislature by giving the receiver managerial control over the LLCs.

Section 605.0503 of the Florida LLC statute permits a court to enter a charging order as a creditor’s exclusive remedy to attach a debtor’s interest in a multi-member LLC.  The statute further provides that a court can apply broad equitable principles (i.e., alter ego, equitable lien, constructive trust, etc.) when it fashions a charging order.  Florida’s LLC act is based on the Revised Uniform Limited Liability Company Act of 2006 which specifically provides that a court can appoint a receiver to assist in collection of a debtor’s LLC distributions.  See RULLCA Section 503(b)(1).

The court had discretion to appoint a receiver to help the creditor foreclose on the charging order against the debtor’s LLC interests.  But the court exceeded its boundaries by giving the Receiver expansive management authority over the LLC’s finances.

Since there was no statutory predicate for the court to allow the Receiver to exert managerial control over the LLCs, the trial court’s charging order was overly broad.

Afterwords:

The charging order remedy lends itself to flexibility and creative lawyering.  While a creditor can have a receiver appointed to assist in collecting LLC distributions, the receiver cannot – at least in Florida and other states following the Uniform LLC Act – exert control over the LLC’s financial inner workings.  When petitioning for a receiver, creditor’s counsel should make sure the receiver does not engage in the management of the LLC’s business operations.

 

IL Supreme Court Expands on Shareholder Derivative Suits and Standing Doctrine in Att”y Malpractice Suit

Some minority shareholders in an LLC sued their former counsel for legal malpractice alleging the firm failed to file “obvious” breach of fiduciary claims against the LLC’s corporate counsel.

Affirming summary judgment for the defendant law firm in Stevens v. McGuirreWoods, LLP, 2015 IL 118652, the Illinois Supreme Court gives content to the quantum of proof needed to sustain a legal malpractice claim and discusses the type of legal interest that will confer legal standing for a corporate shareholder to sue in his individual capacity.

The plaintiffs’ central claim was that McGuirreWoods (MW) botched the underlying case by not timely suing Sidley Austin, LLP (Sidley) after the LLC’s majority shareholders allegedly looted the company.  Sidley got the underlying case tossed on statute of limitations grounds and because the plaintiffs lacked standing. minority shareholder plaintiffs lacked standing to individually sue Sidley since Sidley’s obligations ran squarely

The trial court in the legal malpractice suit granted summary judgment for MW due to plaintiffs’ lack of standing.  The court held that even if MW had timely sued Sidley, the claim still would have failed because they could not bring claims in their individual capacity when those claims belonged exclusively to the LLC. After the First District appeals court partially reversed on a procedural issue, MW appealed to the Illinois Supreme Court.

Result: Plaintiffs’ lacked standing to assert individual claims against Sidley.  Judgment for MW.

Rules/Reasons:

Some cases describe the legal malpractice suit as a “case-within-a-case.”  This is because the thrust of a legal malpractice claim is that if it wasn’t for an attorney’s negligence in an underlying case, the plaintiff would have won that case and awarded damages.

The legal malpractice plaintiff must prove (1) defendant attorney owed the plaintiff a duty of care arising from the attorney-client relationship, (2) the defendant’s breached that duty, and (3) as a direct and proximate result of the breach, the plaintiff suffered injury.

Injury in the legal malpractice setting means the plaintiff suffered a loss which entitles him to money damages.  Without proof the plaintiff sustained a monetary loss as a result of the lawyer defendant’s negligence, the legal malpractice suit can’t succeed.

The plaintiff must establish that he would have prevailed in the underlying lawsuit had it not been for the lawyer’s negligence.  The plaintiff’s recoverable damages in the legal malpractice case are the damages plaintiff would have recovered in the underlying case. [¶ 12]

Here, the plaintiffs sued Sidley in their individual capacities.  Since Sidley’s obligations flowed strictly to the LLC, the plaintiff’s lacked standing to sue Sidley in their individual capacity.

Under the law, derivative claims belong solely to a corporation on whose behalf the derivative suit is brought.  A plaintiff must have been a shareholder at the time of the transaction of which he complains and must maintain his shareholder status throughout the entire lawsuit.  [¶ 23]

Illinois’ LLC Act codifies this common law derivative suit recovery rule by making clear that any derivative action recovery goes to the LLC.  By contrast, the nominal plaintiff can only recover his attorneys’ fees and expenses.  805 ILCS 180/40-15.

A nominal plaintiff in a derivative suit only benefits indirectly from a successful suit through an increase in share value. The Court held that the plaintiffs’ missing out on increased share value was not something they could sue for individually in a legal malpractice suit.  Had MW timely sued Sidley, any recovery would have gone to the LLC, not to the plaintiffs – even though they were the named plaintiffs.  Since the plaintiffs could not have recovered money damages against Sidley in the earlier lawsuit, they cannot now recover those same damages under the guise of a legal malpractice action.

An added basis for the Court’s decision was that plaintiffs lacked standing to sue by divesting themselves of their LLC interests.  Standing means one has a real interest in the outcome of a controversy and may suffer injury to a legally recognized interest.

Since plaintiffs relinquished their LLC membership interests before suing MW, they lacked standing to pursue derivative claims for the LLC.

Afterwords:

This case illustrates in vivid relief the harsh results flowing from statute of limitations and the standing doctrine as it applies to aggrieved shareholder suits.

The case turned on the nature of the plaintiff’s claims.  Clearly, they were suing derivatively (as opposed to individually) to “champion” the LLC’s rights.  As a result, any recovery in the case against Sidley would flow to the LLC – the entity of which plaintiffs were no longer members.

And while the plaintiffs did maintain their shareholder status for the duration of the underlying Sidley case, their decision to terminate their LLC membership interests before suing MW proved fatal to their legal malpractice claims.

 

General Contractor Insolvency, Not Owner Recourse, is Key Implied Warranty of Habitability Test – IL First Dist.

In Sienna Court Condominium Association v. Champion Aluminum Corporation, 2017 IL App (1st) 143364, the First District addressed two important issues of common law and statutory corporate law.  It first considered when a property owner could sue the subcontractor of a defunct general contractor where there was no contractual relationship between the owner and subcontractor and then examined when a defunct limited liability company (LLC) could file a lawsuit in the LLC’s name.

The plaintiff condo association sued the developer, general contractor (“GC”) and subcontractors for various building defects.  The subcontractors moved to dismiss the association’s claims on the ground that they couldn’t be liable for breaching the implied warranty of habitability if the plaintiff has possible recourse from the defunct GC’s insurer.

The trial court denied the subcontractors’ motion and they appealed.

Affirming denial of the subcontractors’ motions, the First District considered whether a homeowner’s implied warranty claim could proceed against the subcontractors of an insolvent GC where (1) the plaintiff had a potential source of recovery from the GC’s insurer or (2) the plaintiff had already recovered monies from a warranty fund specifically earmarked for warranty claims.

The court answered “yes” (plaintiff’s suit can go forward against the subs) on both counts. It held that when deciding whether a plaintiff can sue a subcontractor for breach of implied warranty of habitability, the focus is whether or not the GC is insolvent; not whether plaintiff can possibly recover (or even has recovered) from an alternate source (like a dissolved GC’s insurer).

For precedential support, the Court looked to 1324 W. Pratt Condominium Ass’n v. Platt Construction Group,   2013 IL App (1st) 130744 where the First District allowed a property buyer’s warranty claims versus a subcontractor where the general contractor was in good corporate standing and had some assets.  The court held that an innocent purchaser can sue a sub where the builder-seller is insolvent.

In the implied warranty of habitability context, insolvency means a party’s liabilities exceed its assets and the party has stopped paying debts in the ordinary course of its business. (¶¶ 89-90).  And under Pratt’s “emphatic language,” the relevant inquiry is GC’s insolvency, not plaintiff’s “recourse”.¶ 94

Sienna Court noted that assessing the viability of an owner’s implied warranty claim against a subcontractor under the “recourse” standard is difficult since there are conceivably numerous factual settings and arguments that could suggest plaintiff has “recourse.”  The court found the insolvency test more workable and more easily applied then the amorphous recourse standard. (¶ 96).

Next, the Court considered the chronological outer limit for a dissolved LLC to file a civil lawsuit.  The GC dissolved in 2010 and filed counterclaims in 2014.  The trial court ruled that the 2014 counterclaims were too late and time-barred them.

The appeals court affirmed.  It noted that Section 35-1 of the Illinois LLC Act (805 ILCS 180/1-1 et seq.) provides that an LLC which “is dissolved, and, unless continued pursuant to subsection (b) of Section 35-3, its business must be wound up,” upon the occurrence of certain events, including “Administrative dissolution under Section 35-25.” 805 ILCS 180/35-1

While Illinois’ Business Corporation Act of 1993 specifies that a dissolved corporation may pursue civil remedies only up to five years after the date of dissolution (805 ILCS 5/12.80 (West 2014)), the LLC Act is silent on when a dissolved LLC’s right to sue expires.  Section 35-4(c) only says “a person winding up a limited liability company’s business may preserve the company’s business or property as a going concern for a reasonable time”

The Court opted for a cramped reading of Section 35-4’s reasonable time language.  In viewing the LLC Act holistically, the Court found that the legislature contemplated LLC’s having a finite period of time to wind up its affairs including bringing any lawsuits.  Based on its restrictive interpretation of Section 35-4, the Court held the almost four-year gap between the GC’s dissolution (2010) and counterclaim filing (2014) did not constitute a reasonable time.

Afterwords:

Sienna Court emphasizes that a general contractor’s insolvency – not potential recourse – is the dominant inquiry in considering a property owner’s implied warranty of habitability claim against a subcontractor where the general contractor is out of business and there is no privity of contract between the owner and subcontractor.

The case also gives some definition to Section 35-4 of the LLC Act’s “reasonable time” standard for a dissolved LLC to sue on pre-dissolution claims.  In this case, the Court found that waiting four years after dissolution to file counterclaims was too long.