New York Court Holds LLC Is Bound By Option Agreement

FUNDAMENTAL LLC v. CAMMEBY'S, 985 NE 2d 893 - NY: Court of Appeals 2013 - Google Scholar:

This is a simple breach of contract case. In 2006, the LLC granted an option to Cam Funding to allow Cam Funding "to acquire one third of Fundamental's membership units for a strike price of $1,000, provided the option was exercised on or before June 9, 2011. This agreement was signed by Forman, as manager of Fundamental, and was accepted and agreed to by Schron, as manager of Cam Funding, and Grunstein and Forman, the sole members of Fundamental."

Later the LLC amended its operating agreement in an effort to alter the terms of the option. Obviously, Cam Funding was not a member of the LLC and did not sign the operating agreement.The court explains:

"Fundamental relied on paragraph 3.3 of its operating agreement, dated December 22, 2005 and amended and restated September 3, 2009, which states that

"[a]dditional Interests shall not be issued except upon the consent of the Board of Managers [i.e., Grunstein and Forman] and the unanimous consent of the Members [i.e., Grunstein and Forman]. Upon the issuance of any additional Interests, the Person to whom such Interests are issued shall make a capital contribution to the Company in respect of such issuance in an amount equal to at least the fair market value per Interest so issued.""

The trial court held that the 2006 option agreement was binding and enforceable and that the subsequent amendment of the operating agreement did not nullify the option agreement. The trial court entered judgment in favor of the party exercising the option, Cammeby's. The appellate court affirmed the judgment.

Edward X. Clinton, Jr.

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Fraud and Proof of Reliance

In fraud cases, the plaintiff must prove, among other things, that she reasonably relied on the factual assertion made by the defendant.

All too often blue chip defendants turn around and argue that no one could ever rely on what they said because the assertions were puffery or because the plaintiff should have understood they were not telling the truth. These arguments are inconsistent and contradict the institution's claim that it is a credible institution whose word is worthy of consideration. Sometimes courts accept these arguments.

Recently, in United States v. McGraw Hill Companies and Standard and Poors Financial Services, LLC, 2013 U.S. Dist. Lexis 99961, the district judge refused to accept these arguments.

The United States sued S&P for fraud, for giving high ratings to mortgage backed securities. The issuers of those mortgage backed securities would pay S&P to rate the issue. S&P would then evaluate the creditworthiness of the issue and announce a final grade.

Why did the United States sue? Because in the recent financial crisis, the government was often left holding the bag when mortgage-backed securities proved worthless.

SP's major defense was that its statements were "puffery." The district court correctly recognizes the inconsistency in this argument. SP was paid to provide credit ratings for bond and other securities. SP is one of three companies that have the qualifications to do this work. SP opinions are relied upon by tens of thousands of market participants every day.

The district court explains: "Defendants lead off with a proposition that is deeply and unavoidably troubling when you take a moment to consider its implications. They claim that, out of all the public statements that S&P made to investors, issuers, regulators and legislators regarding the company's procedures for providing objective, data-based credit ratings that were unaffected by potential conflicts of interest, not one statement should have been relied upon by investors, issuers, regulators, or legislators who needed to be able to count on objective, data-based credit ratings."  The district court correctly rejected this argument and denied the motion to dismiss.

Under the law, subjective claims about a product are puffery. Claims like this are puffery: "Prices will never again be this low!" or "This is the best car for the money!" "When you buy a car from us, we treat you like family!"

When SP informed market participants that a certain bond issue had a AAA rating, it was not engaging in puffery. SP was giving its informed opinion as the creditworthiness of the issuer. If it was not giving an informed opinion, why was it charging so much money for "puffery?"

SP is a blue chip institution that made some bad judgments that cost the taxpayers a great deal of money. Investors and others had the right to rely on the integrity of its opinions.

Edward X. Clinton, Jr.

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Is A General Partnership Interest a Security?

CAN AN INSTRUMENT REFERRED TO AS  A GENERAL PARTNERSHIP INTEREST BE A SECURITY? 

This court answered the question with a "yes" answer?

SEC v. Louis v. Schooler and First Financial Planning Corporation, 12-cv-2164 (S.D. Cal. July 1, 2013).

The SEC filed a complaint against Schooler and the other Defendants alleging that they violated the anti fraud provisions of the Federal Securities Laws. The SEC also sought a temporary restraining order freezing assets and the appointment of a temporary receiver. The complaint alleges that defendants defrauded thousands of investors by selling 50 million dollars worth of general partnership units. The SEC alleged that the defendants sold $50 million of worth of general partnership interests "without disclosing material facts regarding the true value of the underlying land, the mortgages encumbering the properties, and when ownership of the underlying land was transferred from Defendants to the general partnerships." 

The district court granted the ex parte request for a temporary restraining order.

The SEC contended that the Schooler and the other defendants violated Section 5 of the Securities Act and Section 10(b) of the Exchange Act by failing to register the general partnership as a security.

The defendants then filed a motion to dissolve the TRO.

Over the years, there have been many attempts to avoid labeling an investment a security and therefore not subject to the remedies available to an investment under the Securities Laws.

In the Schooler case, the district court rejected Schooler’s arguments that the partnership interest was not a security.  The court ruled: 

The so called general partnership agreement leaves “so little in the hands of the investor that the investment is in fact a limited partnership interest. The court concluded that the partners are so inexperienced and unknowledgeable in the general partnership business affairs that they are incapable of intelligently exercising their partnership powers; or the partners are so dependent on some unique entrepreneurial or managerial experience of the promoter or manager that they cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.

According to the Court, the SEC pleaded  sufficient facts to establish the second and third factors, the Court reasoned that,  having already obtained a preliminary injunction, the SEC has presumptively met its burden to state a claim.

The court also noted that the SEC  alleged that the general partnership investors included a retired school teacher, a water filter salesman and a pharmacist.  The court concluded that these investors were not likely to be sophisticated investors. 

The motion to dismiss the TRO was denied. The writer predicts that there is little doubt that the SEC will prevail on the merits.

There have been numerous efforts to dodge the securities laws to avoid the  remedies that the securities laws provide. Such efforts frequently fail. The purpose of the securities law is to protect investors by requiring promoters to register the securities or to comply with one of the exceptions, such as Regulation D. 

Edward X. Clinton, Sr.

www.clintonlaw.net

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Illinois Court Affirms Decision Striking Down Noncompete Because of Inadequate Consideration

FIFIELD v. PREMIER DEALER SERVICES INC, No. 1–12–0327., June 24, 2013 - IL Court of Appeals | FindLaw:

This case deals with a noncompetition agreement between an employee and a company. The court held, consistent with long-standing Illinois precedent, that a noncompete is not binding unless the employee has been employed for at least two years.

In October 2009, Premier made an employment offer to plaintiff Fifield. The offer was conditioned upon his execution of a noncompetition agreement which provided:

“Employee agrees that for a period of two (2) years from the date Employee's employment terminates for any reason, Employee will not, directly or indirectly, within any of the 50 states of the United States, for the purposes of providing products or services in competition with the Company (i) solicit any customers, dealers, agents, reinsurers, PARCs, and/or producers to cease their relationship with the Company * * * or (ii) interfere with or damage any relationship between the Company and customers, dealers, agents, reinsurers, PARCs, and/or producers * * * or (iii) * * * accept business of any former customers, dealers, agents, reinsurers, PARCs, and/or producers with whom the Company had a business relationship within the previous twelve (12) months prior to Employee's termination.'



Fifield worked for three months and resigned. Premier sought to enforce the noncompetition agreement. The trial court ruled that the agreement was void for lack of consideration because Fifield had not worked for at least two years before he quit.


The appellate court agreed that three months employment was insufficient consideration to allow the noncompetition agreement to be enforceable.


Comment: this is a rare legal decision which announces a clear rule. Whether this is a good idea remains to be seen. Some employee may quit after 23 months to avoid the noncompetition agreement and force the court to reconsider this bright line rule.

Edward X. Clinton, Jr.

www.clintonlaw.net

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Illinois Appellate Court Affirms Enormous Award For Retaliatory Discharge

Holland v. SCHWAN'S HOME SERVICE INC., Ill: Appellate Court, 5th Dist. 2013 - Google Scholar:

This is a retaliatory discharge case in which the plaintiff claimed that he was fired for exercising his rights under the workers compensation act. After a trial, the jury awarded plaintiff about $600,000 in compensatory damages and $3.6 million in punitive damages.

The majority affirmed the jury verdict, concluding that the defendant worked an injured employee until he sustained further injuries. The court comments:

The evidence presented at the trial introduced the jury to an employer that intentionally worked an injured employee beyond his medical restrictions to the point that he suffered from severe pain from a work-related injury. When the employee's treating physician took him off work for recovery and treatment, it retaliated against the injured employee by terminating his employment. The need to deter employers from engaging in this type of reprehensible conduct is obvious and substantial. In light of the evidence considered and weighed by the jury, we will not overturn its assessment of punitive damages as being excessive or unconstitutional. 

There is also a strong dissent, filed by Justice Spomer, which argued that the employee was never fired at all, merely demoted. Thus, there was no retaliatory discharge.

In recent years, there has been much fuss over the Illinois Workers Compensation Act and some have argued that the Act is unfair to employers. This case is also controversial and, in my view, is a strong candidate to be reviewed by the Illinois Supreme Court.

Edward X. Clinton, Jr.

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National Football League's Efforts To Sue Insurers in California Are Rebuffed

National Football League v. FIREMAN'S FUND INSURANCE COMPANY, Cal: Court of Appeal, 2nd Appellate Dist., 5th Div. 2013 - Google Scholar:

The NFL has been sued by dozens of former players who allege that they were injured playing football in the 1950s, 60s and 70s. The NFL is defending the cases. As usual, the liability litigation against the league spawned an enormous cloud of coverage litigation.

The insurers sued in New York, where the league has its headquarters, for declaratory judgments that their policies do not cover the concussion lawsuits. The NFL tried to sue in California, but the California court held that the NFL is really a resident of New York and that the litigation to be fought out in the courts of New York. The order stays the California cases pending the results of the New York litigation.

Undoubtedly there was an advantage to litigating in California as opposed to New York.

Edward X. Clinton, Jr.

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Court Resolves LLC Dispute By Compelling Arbitration

RITZ-CARLTON MANAGEMENT COMPANY, LLC v. ASSOCIATION OF APARTMENT OWNERS OF KAPALUA BAY CONDOMINIUM, Dist. Court, D. Hawaii 2013 - Google Scholar:

This case does not make any new law. Rather, it holds that an arbitration clause in a limited liability company operating agreement is binding and enforceable under the Federal Arbitration Act.

Dispute resolution is an important provision in any operating agreement. That provision should be carefully considered before any members are accepted into the limited liability company.

Edward X. Clinton, Jr.

www.clintonlaw.net

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