LLCs allow investors to invest in businesses without fear of liability for harms caused by the LLCs’ activities, but there are exceptions. Case in point: the Montana Supreme Court recently had to decide whether to allow a claim that an LLC member should be liable for the LLC’s obligations on two vehicle service contracts. The Supreme Court held that the member was not liable, even though the member had benefited from the LLC’s contracts, had made some payments on the contracts on behalf of the LLC, and had brought suit in his own name to recover the vehicle being serviced. Weaver v. Tri-County Implement, Inc., 311 P.3d 808 (Mont. Oct. 22, 2013).
C.R. Weaver was one of two members of Mikart Transport, LLC, a Montana member-managed LLC. Mikart entered into agreements with Tri-County Implement, Inc. for service on a Freightliner truck and a Volvo semi-truck. Tri-County carried out the work but was not fully paid, so it asserted a lien and refused to release the Volvo.
Weaver sued Tri-County in his own name for fraud and for return of the Volvo. Tri-County counterclaimed against Weaver and asserted third-party complaints against Mikart and the other member, demanding payment for the work on the two vehicles. Tri-County moved for summary judgment on its claims and the trial court found in its favor on all counts. Judgment for the amount due to Tri-County and for an additional $21,180 in attorneys’ fees was entered against Mikart, the other member, and Weaver. Weaver appealed the trial court’s imposition of personal liability. Id. at 810.
All state LLC statutes provide that LLC members and managers are not liable for the debts and obligations of their LLC simply because they are members or managers, and that is where the Weaver court began. The court quoted Section 35-8-304(1) of the Montana LLC Act:
[A] person who is a member or manager, or both, of a limited liability company is not liable, solely by reason of being a member or manager, or both, under a judgment, decree or order of a court, or in any other manner, for a debt, obligation, or liability of the limited liability company, whether arising in contract, tort, or otherwise or for the acts or omissions of any other member, manager, agent, or employee of the limited liability company.
The court recognized that an LLC’s liability shield is a corollary of its status as a separate legal entity, distinct from its members and with obligations separate from those of its members. Weaver, 311 P.3d at 811. But the liability shield for members and managers is status-based, and certain acts or omissions of a member may go beyond the shield. “[T]his liability shield is not absolute and does not provide immunity to a member for his own wrongful conduct.” Id.
Applying those rules to Weaver’s appeal, the court found that Weaver’s liability would depend on whether he personally breached a contract obligation or committed a tort with regard to Tri-County. Id. at 812. The trial court had relied on the facts that (a) the Volvo that Mikart had hired Tri-County to service was owned by Weaver, (b) Weaver had personally made some payments to Tri-County but had failed to make others, and (c) Weaver personally brought the legal action against Tri-County to recover the Volvo. The Supreme Court, however, found those facts insufficient.
On the contract prong of the analysis, the agreements for the work performed on the two trucks were solely between Tri-County and Mikart. Weaver never guaranteed payment or made any other promises to Tri-County. Without an agreement between Weaver and Tri-County, Weaver could not be liable for breach of contract. Against that bedrock principle, it was immaterial that Weaver owned the Volvo, sued Tri-County personally, or made some partial payments on the amount Mikart owed to Tri-County. To conflate Mikart’s failure to pay its debts with Weaver’s failure to pay Mikart’s debts “would eviscerate the protection afforded by Montana’s Limited Liability Company Act and render the LLC business form superfluous.” Id.
On the tort analysis, the court found that the allegation that Mikart may be unable to pay its debts did not, by itself, establish wrongful conduct that would impose liability on Weaver. There was no fraud or other tortious conduct. (A tort is an actionable, civil wrong, such as fraud, breach of a fiduciary duty, or negligently causing an auto accident.)
The court concluded that there was no basis for holding Weaver liable for Mikart’s obligations to Tri-County, and reversed the judgment against Weaver. Id.
Comment. If hard cases sometimes result in bad law, then Weaver must be the inverse, an example of an easy case making good law. It’s satisfying to see a court march through a weak argument and systematically deconstruct it to reach the right result.
Tri-County’s argument in its brief to the Supreme Court focused mainly on Weaver’s close connection to Mikart, and on the litany of facts: Weaver paid part of what Mikart owed to Tri-County, Weaver owned the Volvo that Mikart contracted with Tri-County to repair, and Weaver personally filed the lawsuit to recover the Volvo. Appellees’ Brief at 10-13. But no legal argument was asserted to show how the facts led to a cause of action: not a promise by Weaver, not wrongdoing on Weaver’s part, not unjust enrichment to Weaver, not piercing the veil.
Although the opinion does not discuss it, one other well-recognized route by which claimants against an LLC can sometimes also pursue their claim against an LLC’s members or managers is by piercing the veil of the LLC. I have written about LLC veil-piercing cases several times; a collection of those posts is available here. (The Montana courts apparently have not ruled definitively on the applicability of veil-piercing to LLCs. See White v. Longley, 244 P.3d 753, 280 n.2 (Mont. 2010).)
Illinois Says LLC Is Not a Joint Venture, So Contractor/Member Can File a Mechanic's Lien Against Its Own LLC
An Illinois contractor cannot file a mechanic’s lien against property it owns or co-owns, including ownership through a joint venture. Is an LLC a joint venture? That was the question before the Illinois Appellate Court last month. A contractor that was a member of an LLC and had worked on the LLC’s property filed a mechanic’s lien against the property for its unpaid fee. The LLC’s lender contended that the mechanic’s lien was invalid because the contractor was a joint venturer and would in effect be placing a lien on its own property. Peabody-Waterside Dev., LLC v. Islands of Waterside, LLC, No. 5-12-0490, 2013 WL 4736714 (Ill. App. Ct. Sept. 3, 2013).
The facts of the case are straightforward. The contractor was one of two 50% members of the LLC, which was attempting to develop real estate in Illinois. The LLC hired the contractor for site preparation and grading work at the property. The contractor performed the work and billed the LLC for $4.5 million. The contractor was unpaid, filed its mechanic’s lien, and later sued the LLC for breach of contract and to foreclose its mechanic’s lien.
At trial the LLC’s bank lender filed a motion to invalidate the contractor’s mechanic’s lien, on grounds the lien was invalid because the contractor had performed the work for its own benefit as a co-owner of the property. (If the bank could not invalidate the contractor’s lien, then the contractor’s claim would have priority over the bank’s secured loan.) The trial court agreed with the bank’s argument and invalidated the lien, although it did enter judgment against the LLC in favor of the contractor for its breach of contract claim. Id. at *2.
The trial court based its lien ruling on Fitzgerald v. Van Buskirk, 306 N.E.2d 76 (Ill. App. Ct. 1974), which had held that a building contractor “acted in the capacity of a joint venturer with the defendants and in such capacity was not a person entitled to a mechanic’s lien.” Id. at 78. The Appellate Court agreed with the Fitzgerald rule, noting that “an owner or co-owner of property may not claim a lien against his or her own property.” Peabody-Waterside, 2013 WL 4736714, at *2 (citing Bonhiver v. State Bank of Clearing, 331 N.E.2d 390, 398 (Ill. App. Ct. 1975)).
But the Appellate Court disagreed with the trial court’s conclusion. The court pointed out that:
- an Illinois LLC is a legal entity distinct from its members (805 Ill. Comp. Stat. 180/5-1(c));
- an LLC member is not a co-owner of the LLC’s property (805 Ill. Comp. Stat. 180/30-1(a));
- a member of an LLC owns only its membership interest in the LLC; and
- sharing in the profits and losses of an LLC does not make the LLC’s members jointly interested or co-owners of the LLC’s property.
Id. at *3. The court differentiated LLCs from joint ventures, which it said are not distinct legal entities. Id.
The court concluded: “Given that [the contractor], as a member of [the LLC], is not jointly interested in the property, nor is it a co-owner of the property, its mechanic’s lien must, therefore, be valid.” Id.
The bank also argued that the contractor, as an LLC member, had waived the LLC’s defenses to its own lien claim and should therefore be ineligible to assert the mechanic’s lien. The court dismissed that argument because the contractor did not control the LLC’s actions alone. The other member’s consent was needed for any action by the LLC, the other member was also the LLC’s managing member, and the two members were separate and unaffiliated. Id. at *4.
The Appellate Court never defined joint ventures, only characterizing them as not being distinct legal entities. Id. at *3. Many lawyers are no better – the term “joint venture” is often used loosely to cover a range of commercial relationships, from strategic alliances to LLCs to short-term or limited-purpose partnerships. One treatise provides a useful characterization:
A “joint venture” is an association of two or more persons to carry on a single enterprise for profit. The legal principles that govern partnerships generally govern joint ventures, because a joint venture essentially is a partnership carried on for a single enterprise.
1 William Meade Fletcher, Fletcher Cyclopedia of the Law of Corporations § 23, at 40 (Carol A. Jones, ed. 2006) (footnote omitted).
Partners are co-owners of partnership property, so Fletcher’s definition is consistent with the court’s assertion in Peabody-Waterside that the parties to a joint venture are co-owners of a joint venture’s property.
Peabody-Waterside very likely would have come out the other way if the contractor had been the LLC’s sole member. The LLC would still be a legal entity distinct from its sole member, and the LLC and not its member would still own the property. But a sole member’s complete control over the LLC would probably be fatal to the member’s mechanic’s lien, given the court’s discussion in Peabody-Waterside of the importance of the two members’ shared control.
An LLC is a legal entity that is separate and distinct from its members, and an injury to an LLC is not the same as an injury to its members. Failure to take that distinction into account when commencing a lawsuit can lead to the dismissal of claims. An example of this unfortunate (at least from the plaintiff’s point of view) result is O’Reilly v. Valletta, 55 A.3d 583 (Conn. App. Ct. Nov. 20, 2012).
Background. HUB Associates, LLC and its sole member, John O’Reilly, sued Robert Pformer for violations of the Connecticut Unfair Trade Practices Act (CUTPA). HUB had leased real estate for a restaurant, and Pformer was a board member of the condominium association that managed the leased premises. The suit claimed that Pformer interfered with HUB’s efforts to advertise its business on the leased premises.
The trial court dismissed the CUTPA claims against Pformer on grounds that Pformer’s alleged conduct involved the management of a condominium and did not constitute “acts or practices in the conduct of any trade or commerce,” as is required to prove a violation of CUTPA. Id. at 586. O’Reilly appealed, but HUB did not appeal. Id. at 584 n.1.
The Appeal. Pformer argued on appeal that the trial court’s ruling in his favor was correct. But he went further and argued on appeal, for the first time, that O’Reilly lacked standing to bring the claim against him and that O’Reilly’s claim should therefore be dismissed for lack of subject matter jurisdiction.
Standing and subject matter jurisdiction sound technical, but they address fundamental issues of the court’s power and who may bring a lawsuit. Subject matter jurisdiction is the authority of a court to adjudicate the type of controversy presented. Courts have no power to decide cases over which they lack jurisdiction. Subject matter jurisdiction may not be waived by a party, and it may be raised by any party or by the court at any stage of the proceedings, including on appeal. Id. at 586.
One aspect of subject matter jurisdiction is standing. A court has no jurisdiction over a claim if the claimant does not have standing to assert the claim. Normally a party will have standing if it alleges direct injury to itself – the claimant’s injury must not be indirect or remote. Id. at 587.
The court considered O’Reilly’s claim and his status as the sole member of HUB. (HUB’s claim was not before the Appellate Court because the trial court had ruled against it and it had not appealed.) The court noted that an LLC is a distinct legal entity, with separate existence from its members. Therefore, “[a] member or manager … may not sue in an individual capacity to recover for an injury based on a wrong to the limited liability company.” Id.
O’Reilly’s CUTPA claim against Pformer was based entirely on allegations of Pformer’s violations of HUB’s rights and expectations that arose from HUB’s status as lessee of the premises and operator of the restaurant. Id. As sole owner of HUB, O’Reilly may have been harmed indirectly by Pformer’s alleged injuries to HUB, but the only direct harm was to HUB. The court therefore concluded that O’Reilly lacked standing, that the trial court lacked subject matter jurisdiction over the claim, and that the trial court improperly rendered judgment for Pformer on the merits of O’Reilly’s CUTPA claim. The case was remanded to the trial court to dismiss for lack of subject matter jurisdiction.
Comment. O’Reilly addresses basic issues that are sometimes taken for granted. The key to the court’s ruling is the separate nature of LLCs, their status as distinct legal entities. They can sue and be sued, own property, and enter into binding contracts. If an LLC is injured by a breach of contract, for example, it can sue the other party for breach of that contract. But its members, even a sole member, would not have standing to sue for breach of the contract because only the LLC was directly injured.
O’Reilly is also instructive about the power in litigation of the issue of subject matter jurisdiction. New legal issues cannot generally be brought up on appeal, but subject matter jurisdiction cannot be waived and can be brought up at any stage of litigation, including on appeal. If there is no subject matter jurisdiction, the claim is dismissed.
Corporate Parent's Attempt to Disregard the Separate Nature of Its Wholly Owned LLC In Order to Support Insurance Claim Is Rejected by Federal Court
Businesses with wholly owned subsidiaries usually take care to treat them as separate entities, in order to maintain each subsidiary’s liability shield. But in a Sixth Circuit case last month, the parent company argued the opposite – that the separate nature of its wholly owned LLC should be disregarded. In order to recover on an insurance policy that did not list the LLC as a named insured, the parent contended that the LLC’s loss was actually a direct loss to the parent. The court disagreed. Tooling, Mfg. & Techs. Ass’n v. Hartford Fire Ins. Co., No. 10-2480, 2012 WL 3931802 (6th Cir. Sept. 11, 2012).
Background. The Tooling, Manufacturing & Technologies Association is a Michigan trade association, and is the sole member of TMTA Insurance Agency, LLC, a Michigan LLC. The Agency sells insurance policies to the Association’s members. The Association’s principal revenue source is insurance commissions paid to the Agency, and the Association receives the entire benefit or loss from the Agency’s operations.
The Association hired Mark Tyler to be the Agency’s general manager. The Agency has no employees, and Tyler was paid and employed by the Association. Id. at *1.
In 2003 the Association purchased an employee fidelity insurance policy from Hartford Fire Insurance Company. The policy covered the Association and six other named insureds, but not the Agency. Shortly thereafter Tyler began diverting commission payments that were due to the Agency.
The thefts, totaling $715,000, came to light in 2007. The Association notified Hartford and filed a claim against the policy. Hartford refused to pay and the Association brought an action in state court seeking a declaratory judgment and damages. Hartford removed the case to federal district court on the basis of diversity jurisdiction. The trial court found for Hartford, and the Association appealed.
Under the policy, Hartford promised to pay for loss or damages resulting directly from theft by an employee of the insured. There was no dispute that there was a theft or that Tyler was an employee of the Association, but Hartford refused to pay the claim on the grounds that (1) the Agency is a separate entity under Michigan law, (2) the Agency was not a named insured under the policy, and (3) the policy only applied to direct losses by an insured, and any loss to the Association was indirect. Id. at *3.
The Court’s Analysis. The court’s first question was whether the Agency was covered by the policy. If so, the Association would be entitled to recover under the policy. The policy did not name the Agency as an insured, but the Association argued that the close relationship between the Association and the Agency essentially erased any difference between the two for purposes of the insurance policy. In short, the Association claimed that the injury to the Agency was equivalent to an injury to the Association. The Association also pointed out that the only reason the Agency was created as a separate entity was to satisfy Michigan’s state insurance licensing requirements. Id. at *4.
The court looked first to the language of the policy, which stated that it was for the benefit only of the named insureds. The Agency was not a named insured (although six other related entities were listed as named insureds). The Agency was treated as a separate legal entity under the policy and for the purpose of being licensed to receive insurance commissions.
The court also reviewed the history of a separate lawsuit in state court, in which the Association had sought recovery of the commissions from Tyler and in which Tyler had counterclaimed for unpaid commissions. Tyler’s counterclaim did not include the Agency, and the Association argued in state court that the Agency was a separate entity and that there were no grounds for Tyler’s claim against the Association. The Association’s separate treatment of the Agency in that lawsuit supported the conclusion that the Association and the Agency should be treated separately under the Hartford policy. The court also recognized that Michigan’s LLC statute treats LLCs as separate from their members. Id. at *5 n.6; see Mich. Comp. Laws § 450.4504(2).
The court therefore held that the Agency had no rights or benefits under the policy and that the policy did not cover any of the Agency’s losses due to the theft. Tooling, Mfg. & Techs. Ass’n, 2012 WL 3931802, at *5. But that conclusion did not resolve the case, because the court still had to determine whether the Association’s theft-related loss of income from the Agency resulted directly from Tyler’s theft. If so, the Association’s loss would be covered by the policy.
The court reviewed the two contending interpretations used by courts in various jurisdictions: (a) “direct” means immediate or without anything intervening; or (b) “direct” means proximately caused by the originating action, which the court saw as a more flexible standard.
The Court of Appeals rejected an unpublished opinion from the Michigan Court of Appeals which held that in the context of a property damage insurance policy, the word “direct” means “immediate” or “proximate.” Acorn Inv. Co. v. Mich. Basic Prop. Ins. Ass’n, No. 284234, 2009 WL 2952677, at *2 (Mich. Ct. App. 2009). Because it was an unpublished opinion, the Acorn opinion would have no precedential value in Michigan courts, but courts in the Sixth Circuit will follow unpublished state court opinions on points of state law unless the court is convinced that the highest court of the state would decide otherwise. Tooling, Mfg. & Techs. Ass’n, 2012 WL 3931802, at *8. The Tooling court determined that the Michigan Supreme Court would not follow Acorn, ruled that “direct” in the policy means immediate or without anything intervening, and concluded that the Association’s loss of income from the Agency was not a direct result of Tyler’s theft, under the policy.
The court therefore affirmed the district court’s ruling that Hartford’s insurance policy did not cover the Association’s loss from Tyler’s thievery.
Comment. The Association’s attempt to disregard the separate nature of the Agency and treat the Agency’s loss as a direct loss of the Association was doomed by the Association’s own actions. The Association formed the Agency under state law as a separate entity, licensed the Agency under the state insurance authority as a separate entity, and claimed the benefit of the Agency’s separate existence as a defense against Tyler’s counterclaim in the state court lawsuit.
Those are all normal and reasonable actions, and only worked against the Association because of its attempt to assert an inconsistent position in its suit against Hartford.
An LLC member ordinarily is not liable for the debts and liabilities of an LLC simply by virtue of being a member. E.g., Wash. Rev. Code § 25.15.125; Or. Rev. Stat. § 63.165. Many states, however, impose personal liability for unpaid taxes on those within a business who have authority for paying taxes withheld from employee wages, or for paying sales taxes collected from customers. If one of those statutes applies, being a member of the LLC will not shield the employee, manager or officer from the statute’s reach.
Kelly Haugen, a 10% member of an Oregon LLC, was assessed liability by the Oregon Department of Revenue for the LLC’s failure to pay Oregon income taxes withheld from employee wages. Haugen v. Dep’t of Revenue, No. TC-MD 100052C, 2011 Ore. Tax LEXIS 187 (Or. T.C. Apr. 26, 2011). The LLC was manager-managed, and Haugen was not the LLC’s manager. Haugen occasionally signed checks for the LLC, and a form filed by the LLC with the state indicated that Haugen was responsible for hiring and firing employees. Id., at *2-3. The Department of Revenue asserted liability against Haugen because of his part ownership of the LLC and because he signed checks for the business. Id. at *6.
Oregon requires employers to withhold and pay Oregon income taxes from wages paid to employees. Or. Rev. Stat. § 316.167. Personal liability for unpaid tax withholdings is imposed on “[a]n officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee or member is under a duty to perform the acts required of employers by ORS 316.167 ….” Or. Rev. Stat. § 316.162(3)(b).
Finding a paucity of case law on the liability of LLC members, the Haugen court analogized Haugen’s status to that of a corporate officer for the purpose of determining liability. Haugen, 2011 Ore. Tax LEXIS 187, at *6. The court applied prior Oregon case law involving corporate officers, and found that Haugen would be liable if he had the actual authority and control to pay or direct payment of the tax withholdings. Id. at *7. The evidence indicated that Haugen did not have authority to unilaterally sign checks or make important financial decisions – he had authority to sign checks only under the direction of the 90% owner and manager, after obtaining specific consent to sign each check. Also, Haugen did not have general authority as a member, because the LLC was manager-managed, and Haugen was not a manager.
The court concluded that because Haugen “was not in a position to pay the withholdings or direct the payment of the withholdings at the time the duty arose to withhold or pay over the taxes,” he was not an “employer” under Or. Rev. Stat. § 316.162. Haugen, 2011 Ore. Tax LEXIS 187, at *11-12. The court therefore canceled the Department of Revenue’s Notice of Liability against Haugen.
Kelly Haugen escaped liability for the unpaid taxes because of his lack of authority. Had his been a member-managed LLC, or if he had had discretion to sign checks without prior approval, the court presumably would have upheld the tax assessment against him.
Many of the comparable statutes from other states are at least as strict in finding managers and check signers to be personally liable for failure to pay tax withholdings and sales taxes over to the state. The strict approach is not surprising, given that in these cases the business has in effect been a tax collector for the state and (at least in the state’s view) is holding the state’s money. The Haugen case should be a wake-up call for LLC managers and check signers to avoid the temptation of financing the business in troubled times by holding on to tax withholdings or sales taxes.
A recent New York case dealt with one of the most fundamental characteristic of LLCs – the LLC as a legal entity. Sealy v. Clifton, LLC, 890 N.Y.S.2d 598, 2009 N.Y.App. Div. LEXIS 9020 (N.Y.App.Div. 2009). One of two LLC members, each owning a 50% interest, asked the trial court to partition the LLC’s real estate. In a partition action, real estate held by joint tenants or tenants in common is divided into portions so that each co-owner is awarded full, individual ownership of a portion of the real estate. The trial court refused to dismiss the partition action, but the Appellate Division reversed and required dismissal by the trial court.
Under state LLC laws, an LLC is a legal entity, in effect a legal person. An LLC can sue and be sued, own property, enter into contracts, and do many of the things that an individual human being can do. E.g. N.Y. Ltd. Liab. Co. Law §§ 203(d), 202.
Since an LLC is a legal person, the property it owns is the property of the LLC, not of the members. The New York LLC Act is clear: “A membership interest in the limited liability company is personal property. A member has no interest in specific property of the limited liability company.” N.Y. Ltd. Liab. Co. Law § 601. Other state LLC laws have similar provisions.
Relying on Section 601, the Sealy court held that the LLC, not its members, owned the real estate. Because the members were not co-owners of the real estate, the partition action had to be dismissed. Sealy, 2009 N.Y.App. Div. LEXIS 9020, at *1. Prior New York law allowed partition actions to be brought only by co-owners.
Perhaps the reasoning of the Sealy plaintiff was: “I am a part owner of the LLC; the LLC owns the real estate, therefore I am a part owner of the real estate.” In other words, something like “I own the box, ergo I own what’s inside the box.” The analogy is not apt, but perhaps it convinced the trial judge, since he refused to throw out the partition request.
That theory breaks down because an LLC is a legal entity, a legal person. The real estate in Sealy was owned by the LLC, not by the members. The only way a member could reach the real estate would be to cause the dissolution and winding up of the LLC. In that process either the real estate would be liquidated and its proceeds distributed to the members, or the real estate could be divided by the LLC and the individual parcels of the real estate distributed in kind to the members. But the member apparently had not pursued dissolution.
The legal personhood of LLCs, like that of corporations, partnerships and other entities, is a legal doctrine thoroughly woven into our legal, business, financial and political systems. It allows the law to treat LLCs as persons for many purposes – but not all. For example, LLCs cannot marry, adopt children, hold public office, or vote in public elections.
Some constitutional rights apply to legal entities. For example, the U.S. Supreme Court last month invalidated a federal ban on corporate expenditures for public communications intended to affect federal elections. The Court held that the First Amendment’s mandate that “Congress shall make no law … abridging the freedom of speech” applies to corporations. Citizens United v. Fed. Election Comm’n, 175 L. Ed. 2d 753 (2010). The Court’s opinion saw corporations as entitled to be heard in the political arena, like individuals. This was a controversial five-to-four decision that overruled prior Supreme Court precedent.
The boundaries of the legal doctrine that treats corporations and LLCs as persons will continue to be mapped and delineated. And as in Citizens United, the boundary may shift from time to time.