Below is a student submission by Wes Dagestad
Limited liability companies can be formed overnight, or in a matter of hours with some paperwork and filing fees. There are even do-it-yourself LLC websites that form a legal entity for you, but this can create a false sense of security for individuals who believe forming a separate legal entity rids them of all personal liability. With the sprouting of LLCs, individuals must still take precautions to properly iron out the details of their business arrangements, and must still be aware that the simple formation of an LLC does not automatically serve as a blanket shield to liability. Several former business cohorts learned this the hard way in a pending Missouri appellate case, where the sole member of an LLC allegedly had all of his assets ripped away from him by his own bookkeeper. The bookkeeper in turn attempted to transfer all of the sole member’s allegedly stolen assets to an entity known as “The Head Bitch In Charge” or H.B.I.C., LLC. Rocking H. Trucking, LLC v. H.B.I.C., LLC, 2014 WL 7211232 (Mo. App. W.D.), 23.
The basic circumstances of Rocking H. appear to be:
A trucking business was evidently started, when one guy (“Harrison”) provided a truck, and another guy (“Fenton”) provided a trailer. According to the briefs Harrison did the billing and took care of the money, while Fenton did the truck dispatching. Harrison formed a single member LLC, naming himself as the sole owner of Rocking H. Trucking, LLC. The trucking business became lucrative, and the LLC purchased more assets, titling them in the Rocking H. entity name. The LLC also hired Fenton’s daughter to fill a bookkeeper role for the entity (“Alderson”). Business relations went somewhat awry between these three and now the question is what is the legal relationship between the parties?
Before addressing the specific claims at issue, the possible legal relationships Harrison and Fenton could have created include:
1. A Partnership between Harrison and Fenton.
2. A Partnership between Harrison’s LLC (Rocking H.) and Fenton.
3. A Non-Fiduciary, independent contracting relationship between Fenton and Rocking H.
4. A type of employment relationship, which Fenton was the employee of Rocking H.
The type of legal form of the trucking business is important, because there is a fight amongst the parties over the business’ assets (trucks and trailers). Harrison claims the trucks and trailers were essentially stolen from him and his LLC, when Alderson fraudulently transferred the assets over to her own entity, H.B.I.C., LLC (“HBIC”). Alderson, HBIC, and Fenton argue that the trucks are rightfully theirs, because Harrison (a) gave away the business to Alderson, and/or (b) Harrison and Fenton operated a partnership and thus Fenton is entitled to a portion of the assets.
1. To create a partnership Harrison and Fenton could have agreed that a business would be formed in which Harrison contributed his truck and interest in the LLC, and Fenton contributed the trailer.
2. To create a differently structured partnership, Harrison, as the sole member of the LLC, could have bound the LLC to a partnership with Fenton.
3-4. To create these types of employment relationships, ordinary contractual principles would apply.
The parties among other things dispute who is the rightful owner of the assets transferred from Rocking H. to HBIC, and if damages are awarded, who is the proper party to award them to (i.e. LLC or sole member); and who must bear the burden of liability – the LLC or an individual.
Mo. Partnership Principles
At issue is whether the Rocking H. entity, or an informal partnership governed their trucking business arrangement. For two people to form a legal partnership, no formal written agreement is necessary. (Mo. Ann. Stat. § 358.060). An agreement between two people to carry on as co-owners of a business for profit can give rise to partnership rights and duties. Id. Further, under Missouri law, sharing the profits of a business is prima facie evidence that a person is a partner in a business (Mo. Ann. Stat. § 358.070). However, while the Missouri statute does not address how the allocation of losses affect the partnership relationship, the Missouri Supreme Court held long ago that while sharing profits draws the inference of an existing partnership, the inference will not follow “where the parties, although agreeing to divide profits, do not agree to share any possible losses.” Schneider v. Schneider, 146 S.W.2d 584, (Mo. 1940). A recent Missouri case re-affirmed the requirement that bearing losses is a requirement to form a legal partnership in Missouri. Clark v. Francis, 422 S.W.3d 369, at 379 (Mo. App. W.D. 2013) (quoting Van Hoose v. Smith, 355 S.W.2d 23, 27 (Mo. 1946).
Fenton at some point stated that he would work with Harrison but he was “not going to be responsible for losses.” It appears between the two briefs that no operating agreement was ever drafted, nor any ownership interest certificates issued by Rocking H. The only document Rocking H. operated under was its Articles of Organization, which listed Jack Harrison as the registered agent and organizer of the entity.
Harrison’s brief states Harrison was the sole owner, and that Fenton acted in an “informal relationship” capacity. One thing both Fenton and Harrison do agree on is that the two had operated a previous partnership engaged in the cattle ranching business. The prior cattle ranching partnership is relevant because apparently heavy losses were incurred as a result of this business. It appears from the briefs Harrison assumed the burden of those losses, and also lent money to Fenton for Fenton’s personal nonbusiness debts that were never repaid. Despite the two’s prior financial troubles, the trucking business was profitable. Rocking H. earned profits of $119,994 in 2009, and $70,533 in 2010, but neither Harrison, nor Fenton, nor Alderson drew a regular salary. Nothing is mentioned in the briefs as to how these profits were distributed.
It’s not entirely clear why none of the three was paid a salary, but the author’s suspicion is that Fenton could’ve worked under the assumption he owed Harrison for prior debts. Alderson on the other hand, likely served as Rocking H.’s bookkeeper without pay because Harrison promised her a piece of certain settlement proceeds recovered from a drug manufacturer whose product killed Harrison’s cattle in his prior business. However, it is entirely unclear why Fenton fails to argue that he is entitled to his half of the cattle ranching partnership’s settlement proceeds, given it’s one of the few things both parties actually agree on.
Potentially fed up with her and her father working for free, Alderson allegedly duped Harrison into signing a Bill of Sale transferring Rocking H.’s assets to HBIC. Upon discovering the issue Harrison demanded Alderson correct the problem; Fenton replied that Alderson now owned the business, not Harrison. No consideration was given in conjunction with the Bill of Sale, nor was there any evidence to suggest Harrison had the intention of gifting away the Rocking H. assets. Harrison’s brief also alleges that he never endorsed the titles of the trucks in connection with the transfer, but that his signature was forged. (The trial court held that this violated Mo. Rev. § 301.210 but this matter is unrelated to nature of this post)
The trial court held that Harrison and Rocking H. were the rightful owners of the trucks and awarded $270,416.67 for replevin and damages, while awarding $134,865.13 to Alderson in satisfaction of the oral promise Harrison made in connection with the defective cattle drug settlement proceeds. On appeal, Alderson, Fenton, and HBIC (“Appellants”) argue that the trial court “erroneously applied the law of corporations” because it held Fenton and Alderson individually liable without Harrison petitioning to pierce HBIC’s corporate veil. Further, Appellants argue that the trial court “misapplied the law” in awarding damages to both Rocking H. and Harrison individually, because “Rocking H was a legal entity distinct from Harrison.” Rocking H. Trucking, LLC v. H.B.I.C., LLC, 2014 WL 7211232 (Mo. App. W.D.), 23.
The first issue of this post will address the nature of how an LLC is formed in Missouri, and why upon formation it is vital for parties to properly articulate the details of their business relationship. The second portion will address what exceptions exist to an LLC’s limitation of liability, and how individual liability can follow from those exceptions.
I. Formation Issues
Fenton argues that Rocking H. operated as an informal partnership, not a sole member LLC. Fenton further argues that because Rocking H. lacked an operating agreement and certificates of membership, paired with Harrison’s inconsistent statements of ownership structure indicate this was not a sole member LLC.
Under Missouri law, an LLC is formed once the company’s articles of organization are filed and approved with the secretary of state. Mo. Ann. Stat. § 347.037.2. When the articles are marked as filed by the secretary of state, this serves as conclusive evidence that all conditions precedent have been complied with and that the limited liability company has been legally organized and formed. 25 Mo. Prac., Business Organizations § 8.4 (2d ed.). Therefore no operating agreement, or certificates of membership are required to form a valid LLC in Missouri. Rocking H. is thus a valid LLC, and no personal liability will follow “where the debts, contracts or liabilities are incurred solely on behalf of the limited liability company to the extent so disclosed or to the extent such debts, contracts or liabilities provide otherwise.” Id.
No Writing, No Problem… Yet
A question arises whether an LLC’s operating agreement falls within the Statute of Frauds. Delaware says no. § Del. Code tit. 6 § 18-101(7). Missouri doesn’t appear to force the operating agreement to be in writing either. Mo. Ann. Stat. § 432.010.
A recent Missouri case addressed a situation where an individual claimed to have a membership interest in an LLC, and the LLC lacked a written operating agreement. Birkenmeir v. Keller Biomedical, LLC, 312 S.W.3d 380, 385 (Mo. App. E.D. 2010). In Birkenmeir, the plaintiff sought to prove that he was a member of Keller Biomedical, LLC, based on prior discussions between the parties regarding the formation and future business of the LLC. Id. Additionally, the court indicated there was evidence the plaintiff generated revenue for the LLC, and even made an initial capital contribution. Id. at 391. The plaintiff’s specific claim was that despite the LLC lacking a written operating agreement, the parties’ oral arrangement should serve as the controlling operating agreement for the LLC, naming plaintiff a member. Id. Citing Missouri’s LLC statute (Mo. Ann. Stat. § 347.015), the court looked to the definition of an LLC member under the statute:
“Any person that signs in person… or otherwise is a party to the operating agreement at the time the limited liability company is formed and is identified as a member in that operating agreement and any person who is subsequently admitted as a member in a limited liability company in accordance with section 347.010 to 347.187 and the operating agreement, until such time as an event of withdrawal occurs with respect to such person.”
Id. at 390, 391 (emphasis court’s own).
The court then looked to the definition of an operating agreement in Missouri:
“An operating agreement is defined as any valid agreement or agreements, written or oral, among all members, or written declaration by the sole member concerning the conduct of the business and affairs of the limited liability company and the relative rights, duties and obligations of the members and managers, if any.”
Id. at 391 (emphasis added).
Upholding summary judgment against the plaintiff’s argument that there was an issue of material fact whether he was in fact a member of the LLC, the court held that while an operating agreement may be oral, the parties must still have a valid contractual agreement. Id. Despite the evidence of the parties’ prior discussions of the terms of the LLC, and plaintiff’s capital contribution, the court found that “there was no [valid] agreement as to the material terms between the parties to form [the LLC]. Id. Absent such an agreement, [plaintiff] could not have been a member of the LLC at the time it was formed.” Id.
This is somewhat of a curious outcome because in the absence of a written operating agreement, LLC statutes provide assorted default rules. (e.g. Sharing of Distributions – Mo. Ann. Stat. § 347.105; Promises of for Contribution to be in Writing – Mo. Ann. Stat. § 347.099; Allocation of Profits or Losses – Mo. Ann. Stat. § 347.111) Understanding how an LLC statute serves a gap-filler when certain terms of the agreement are left out, it is difficult to see how an agreement could be inadequately definitive, especially when the purported member wrote a check to the other ‘legitimate’ members that read “capital contribution,” Birkenmeier, 312 S.W.3d, at 385, although there is other authority reaching a similar conclusion under partnership law; see Cleland v. Thirion, 268 A.D.2d 842, 844 (N.Y. App. 2000).
Turning to the evidence presented in Rocking H., Rocking H. was formed as a single member LLC, and Harrison was listed as both the registered agent and organizer of the entity, paired with Fenton’s argument that Harrison (not Fenton) was the one who “gave the business to Alderson,” no such claim of a verbal operating agreement would seem to be viable. Taking the principles articulated in Birkenmeir into account, and the lack of Fenton’s evidence supporting his membership in Rocking H., Fenton likely has no right to possession in the trucks and trailers. Fenton’s best claim to any form of ownership of trucks, trailers, or Rocking H. assets would be to argue that he individually formed a partnership with Rocking H. (#2 above). Putting forth some type of evidence or oral agreement that Harrison made in his capacity as Rocking H.’s sole member, or a showing of how the two years of profits were distributed may be a start.
Alderson & Fenton’s brief hones in on the fact that Fenton contributed a trailer to the trucking business, and therefore suggests the two formed an informal partnership at the inception of Rocking H. Fenton may be able to argue that even if the court finds no legal partnership existed he is still entitled to his trailer or any assets he contributed to this business venture. (See Wittling v. Schreiber, 202 S.W. 418, at 420 (Mo. Ct. App. 1918) (no legal partnership existed, but purported partner was still entitled to equipment he contributed to the business).
As will be discussed in the remaining portion of this post – when an individual forms an LLC, the individual’s contribution of assets to that entity is not the only thing that the individual carries with it to the warm and fuzzy alleged legal promised land of limited liability.
II. Exceptions to LLC ‘Limitation’ in Liability
The second portion of this post will examine the Appellants’ (Alderson and Fenton) second and third points relied on their brief. Namely, that the court erred in entering a judgment against both H.B.I.C. in its LLC capacity, and Alderson and Fenton individually. The third point relied on relates to the second point, in that Appellants assert that the trial court “erroneously applied the law of corporations” by awarding damages to both Rocking H., and Harrison. Appellants seem unaware that LLCs do not stand as a complete legal fortress upon the formation of the entity. The term limited liability is exactly what term suggests, a mere limitation on, not a complete shield to individual liability. Please note for purposes of this section the post will not exclusively rely on Missouri law.
Outside the Limitation
First, Missouri law articulates that once an LLC is formed, and assuming no promoter liability exists (See Mo. Rev. Stat. §§347.037.2, 347.037.4 – promoters can be held jointly and severally liable), there shall be no personal liability where the debts, contracts, or liabilities are incurred solely on behalf of the LLC. 25 Mo. Prac., Business Organizations § 8.4 (2d ed.). However, there is qualifying language in the statute that disregards the limitation in personal liability for debts, contracts or liabilities that provide otherwise. (i.e. an individual’s personal guaranty debt incurred by the LLC). Id. Therefore personal liability shall still extend to an individual that incurs debts, contracts, or liabilities not on behalf of the LLC. For example, individuals can always be held individually liable for their own torts. Ltd. Liability Co. § 5:2 (2014). Each member can also still be held criminally liable if the member commits or authorizes a crime to be committed. Id. Note that this discussion does not address piercing the veil of an LLC, while still an exception to limited liability, it will not be the focus of this post and is misapplied by Appellants’ brief.
Second, there is additional authority that suggests that personal liability may extend to situations where Missouri’s limited liability statute leaves a loophole. Some courts have gone on to extend personal liability to a sole proprietor converting his business to a newly formed LLC. C & J Builders and Remodelers, LLC v. Geisenheimer, 249 Conn. 415, at 420 (Conn. 1999). Personal liability may also extend to a member who fails to indicate its principal, the LLC, on a signature line when signing a guaranty. Warren Supply Co. v. Lyle’s Plumbing, L.L.C., 74 S.W.3d 816, 819-820 (Mo. App. W.D. 2002).
Warren Supply Co. segues into a larger, often overlooked exception of limited liability. Most business folks who form an LLC will at some point need to take out a loan. In that case, many creditors will require a member to personally guaranty the LLC’s contracts or indemnify them against the LLC’s breach of its contracts. Further, as seen in Rocking H., the LLC form does not prevent a member from being liable on its own separate contracts incurred outside the scope of the LLC. Creative Resource Management, Inc. v. Soskin, 1998 WL 8134020 (Tenn. Ct. App. 1998).
Third, it is worth mentioning that at least one state has adopted a tortious conduct exception to LLC limited liability. Iowa, in Estate of Countryman v. Farmers Cooperative Association, held that member/managers would not be entitled to the protection of limited liability if they actually participated in the alleged tortious conduct even if they committed the tort while acting within the scope of their membership/managerial duties of the LLC. 679 N.W.2d 598 (Iowa 2004). Missouri has yet to adopt such a ruling, but should the H.B.I.C. ever find itself trucking up to Iowa, it may want to be careful. The court’s justification for the holding was based on agency principles, where a member’s status as an agent of the LLC should confer no immunity with respect to that member’s own tort liability. Id. The court also added that in other entity forms the “longstanding approach to liability in corporate settings…principles, corporate officers and directors can be liable for their torts even when committed in their capacity as an officer. Id. at 603.
Appellants’ brief seems to misunderstand the interplay between tort and “corporations” law. They claim that liability should not extend to individuals simply because they formed an LLC. It must be noted that Respondents’ (Rocking H. and Harrison) relevant claims against Appellants was for: (1) replevin (possession of the trucks and trailers); and (2) damages and accounting (lost profits as a result of the conversion). Therefore Appellants’ argument seems circular because in one hand they argue that replevin and damages were wrongfully awarded to Rocking H. and Harrison, but make no such argument as to their award on their counterclaim where Harrison was held personally liable for an oral promise he made to Alderson outside the scope of Rocking H.
The court found that Harrison’s promise was made in his individual capacity to Alderson and not on behalf of Rocking H. but Respondents seem perfectly fine with that application of corporate law. Respondents actually have a much better argument to go after the remainder of the cattle ranching settlement proceeds, because both parties agree that Harrison and Fenton were 50/50 partners in that line of business. However, Respondents may not be pursuing this line of legal reasoning due to the facts indicating Fenton owed a substantial amount of debt to Harrison and consequently, their cattle partnership.
Appellants also fail to realize Respondents’ claim for replevin named not only HBIC, but also Alderson and Fenton individually. If the trial court found that either Alderson or Fenton committed an individual tort against Harrison or Rocking H., it would not be “erroneously applying the law of corporations” in holding Alderson or Fenton liable for their individual tortious conduct.