Tag Archives: LLC

Why Do We Still Encounter Issues of Promoter Liability? Menard, Inc. v. Dial-Columbus, LLC

The normal treatment where a promoter purports to enter into a contract on behalf of a corporation that has not yet been formed is that the promoter is personally liable. Here is a summary of the normal treatment:

  • The promoter is personally liable for pre-incorporation contracts.
  • The corporation becomes liable not merely upon formation but upon adoption. This is sometimes referenced as “ratification”. A somewhat tedious observation is that one formally cannot ratify a contract where the person purporting to ratify the contract was not in existence as of the time of the contract. Hence, avoiding tedious distraction is facilitated by referencing this as an “adoption”.
  • Acceptance of benefits constitutes adoption.
  • The promoter is not discharged upon corporation becoming bound, unless creditor assents to substitution (novation).
  • A novation exists where the newly-formed entity accept benefits “if performance is made with the understanding that a complete novation is proposed”.

More after the break …

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Has Someone Been Severed from an Understanding of Contracts?

STT Holdings, LLC v. Wren, No. ED99763 (Mo. Ct. App., E.D.), involves a spicy dispute arising from an LLC member’s withdrawal from the firm, alleging breach of the withdrawing member’s terms of employment.  The alleged facts referenced in the withdrawing member’s brief involve circumstances I might dream-up for an exam:

some spicy ones:

allegations concerning a former executive indictment (note:  to be clear, this author is not expressing a view on veracity of allegations)

allegations a control person “cheated on an important technical certification test by having one of [a company’s] employees complete the certification test under his name”  (note:  to be clear, this author is not expressing a view on veracity of allegations)

one that is beyond what I might have imagined;

a former member, who had been bought-out, was thought evidently to have been bought-out by another member but that member, as reported in the brief, “during the trial, … gratuitously volunteered that he did not own 51% of SpearTip because on March 31, 2006, SpearTip, not [that member], acquired [a former member’s] equity shares….  [The testifying member] further used his position as SpearTip’s CEO to assign ownership of the shares to himself personally.”  (again, this author is not stating a view on veracity of allegations)

There are many interesting circumstances to address in the briefs.  We may perhaps return to this case at a later date.  For now, we will turn to one aspect of one brief that succinctly addresses a matter.  The mind boggles:

Section 14.11, “Severability of Provisions,” of SpearTip’s Operating Agreement, Exhibit 1, provides that: “Each provision of this Agreement is severable… .” SLF039.  Appellant’s contention that Wren forfeited his right to redeem his equity interest pursuant to Operating Agreement Section 11.6 because he breached the provisions of Section 12.1 is without merit in light of the express provision that all provisions of the operating agreement are severable or divisible.

“Severable or divisible contracts are, in legal effect, independent agreements about different subjects though made at the same time.”  Grease Monkey Intern, Inc. v. Godat, 916 S.W.2d 257,261 (Mo. App. E. Dist. 1995); Sanfillipo v. Oehler, 869 S.W.2d 159, 161 (Mo. App. E.D. 1994).  The question of divisibility is primarily a question of the intent of the parties determined by the language used and the subject matter of the agreements.  Grease Monkey Intern, 916 S.W.2d at 261.  SpearTip’s operating agreement is a severable contract that embraces separate distinct promises that admit to separate execution, Id, and the alleged breach of the non-compete clause has no effect on the enforceability of the redemption clause.

Brief of Respondent/Cross-Appellant David Wren, STT Holdings, LLC v. Wren, No. ED99763 (Mo. Ct. App., E.D. 12-13.

Why is this analysis of concern?  It is certainly possible that an employment agreement, including an associated non-compete, could end up being an entirely separate agreement from the arrangements governing ownership of an entity.  Rudman v. Cowles Communications, 280 N.E.2d 867 (N.Y. 1972) is a somewhat analogous case, where an employer’s breach of an employment agreement with an executive of an acquired firm is treated as a separate agreement from the acquisition agreement itself.  So, there may be a severable pair of undertakings, but, if so, the brief’s author will have stumbled into the correct conclusion.

“Severable” can be used in multiple ways.  For one of the contracts folks, It can be used to direct a court that, if the court finds some provision in a contract unenforceable, that provision can be severed.  One might also use that language in connection with describing the consequences of a determination that a contract involves multiple pairs of performance where “the parts of each pair are properly regarded as agreed equivalents”.  Restatement 2d § 240.  So, for example, Allstate Indem. Co. v. Rice, 2013 WL 1314195 (W.D. Mo. 2013) (annotating prior authority as “discussing the general rule when a policy may be divisible and severable where it covers several different kinds of risks or property at different locations).

What, do we suppose, is the intent of the contractual language quoted, albeit only in part?  It is implausible that an operating agreement is drafted so as to make each duty severable in the sense of giving rise to a divisible obligation.  It simply does not make sense.  To be severable in the form of divisible requires pairs of performance that are viewed as equivalents.  It cannot be the case that each promise in an operating agreement has some other paired equivalent.

Operating Agreement Drafted “with Minimal Input from Legal Counsel”

“The operating agreement that governed the Company (the ‘Operating Agreement’) was drafted by the members of the Company themselves with minimal input from legal counsel.” Brief of Respondents at 7. From this we can expect the participation of litigators will follow. Magruder v. Pauley, 2013 WL 5525832 (Mo. App. W.D. 2013) does not disappoint.

An operating agreement for an LLC, awkwardly referencing the parties as “partners”, provides for a buy-out of a withdrawing member, based on “an appraisal of the business … commissioned and paid by the company and/or remaining partners.” The trial court orders an appraisal and a buy-out on the indicated terms.

The Court hereby orders said Defendants to commission and pay for an appraisal of the company, either jointly or by causing the Company to do so, and thereafter to purchase Magruder’s share in the Company for 1/4 the appraisal value.

So, the appraiser makes a number of errors in the appraisal. The withdrawing member seeks to have them corrected; the appraiser won’t unless the withdrawing member pays. The remaining members inexplicably fail to pay. So, we have a mess.

On appeal, the withdrawing member seeks, and gets, a determination of the value of the firm and a buy-out order.

The LLC agreement contemplates recovery of attorneys’ fees. What do the remaining LLC members say about that (on p. 14 of their brief):

That provision of the Operating Agreement applies if any member of the Company obtains a judgment against another party that is a member of the Company “by reason of breach of” the Operating Agreement. … The trial court’s judgment on Appellant’s specific performance claim made no finding that the Operating Agreement was breached. The actual breach of contract claim was dismissed.

Come on. Is it plausible that an award of specific performance is not “by reason of breach of” the governing contract? Time to open the checkbook some more.

The brief also makes reference to the operating agreement not stating the time-frame in which the appraisal or the payment to the withdrawing member are to be made.  OK; fine; not drafted by counsel; whatever; a reasonable time.  Let’s move on.

The remaining members’ brief is not entirely devoid of cogent analysis.  It notes trial testimony that defendants made all required  capital contributions to the LLC, but the withdrawing member did not.  Of course, a well-drafted operating agreement would explicitly address the consequences of failure to meet a capital call.