Articles Posted in Business Litigation

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Many Tennessee Limited Liability Companies (“LLCs”) are set up, for whatever reason, so that their operating agreements do not provide for the buying out or expulsion of a member, whether pursuant to a mandatory buy-sell clause or pursuant to a clause that sets forth conduct which is grounds for expulsion. In fact, quite a few Tennessee LLC’s have members who have never executed an operating agreement.

If there is no mandatory buy-sell provision in an operating agreement for an LLC pursuant to which a member can be forced to sell his or her interest (or to buy out someone else’s), members looking to get rid of another member must look to the provisions of the Tennessee Revised Limited Liability Company Act (the “Act”). The Act, T.C.A. §48-249-503(6), provides the limited circumstances which permit a court to expel involuntarily an LLC member.  They are:

  • Where the member has engaged in wrongful conduct that has adversely and materially affected the LLC’s business
  • Where the member has willfully and persistently committed a material breach of the LLC documents
  • Where the member has willfully and persistently committed a material breach of the duties owed by the member to the LLC or to the other members, as set forth in T.C.A. §48-249-403
  • Where the member has engaged in conduct relating to the LLC’s business that makes it not reasonably practicable to carry on business with the member

As of this blog, there is no opinion from any Tennessee appellate court which applies, or further explains, the above statute. Some conduct would obviously warrant expulsion under the above statute, e.g. stealing from other members, a criminal conviction for a felony involving dishonest conduct, or repeated and intentional usurpation of opportunities available to the LLC.  There is, however, quite a bit of gray area when it comes to what a Tennessee court could determine amounts to circumstances justifying an expulsion under the above statute.  The case law from other states which interprets the above statute (which has been adopted uniformly by many other states) is also rather limited.

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When a Tennessee company attempts to enforce a non-compete or non-solicitation agreement against a former employee or independent contractor who served in a sales or marketing capacity, it is almost certain that the company will allege that the former representative had become the “face of the company” to that company’s customers. If the company can prove that argument, it is highly likely that its non-compete or non-solicitation agreement will be upheld.

Not all non-competition and non-solicitation agreements are enforceable in Tennessee, and many have been held to be unenforceable. In order to be able to enforce such agreements, a company must be able to show that it has a “protectable interest.”  To have a protectable interest, a company must show that the former employee’s or contractor’s relationship and work with the company puts the person in the position to do more than just engage in ordinary competition against the company.  The company for whom the former salesperson worked must prove that the relationship put the former salesperson in a position that gives that person an unfair competitive advantage over the company.

Under Tennessee law, a court must look to several factors to determine whether the former employer has a protectable interest such that a non-compete or non-solicitation agreement is enforceable. One of those factors is whether the former employee, by virtue of the goodwill of the former employer, had developed “special relationships” with the former employer’s customers such that the former salesperson was so closely associated with the former employer that he or she had become the “face of the company” to those customers.

To understand how Tennessee courts analyze the “face of the company” factor, it is helpful to look at a few Tennessee non-compete cases.

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Sales representatives, whether they are employees or independent contractors, are too frequently faced with situations where the businesses which owe them commissions refuse to pay them or refuse to pay them the full amounts owed. While, unfortunately, sales representatives do sometimes get beaten out of commissions which they are rightfully owed, sales representatives should take a hard look at their situations before giving up on receiving payment for sales commissions.

Here are some legal points for sales reps to consider when faced with a refusal to pay:

A VERBAL CONTRACT TO PAY COMMISSIONS IS ENFORCEABLE

We have had several cases over the years where a sales representative was not paid and where the refusal to pay was on the basis that there was no written agreement to pay or to pay the percentage which was claimed to be owed. In such cases, sales reps should bear in mind that an agreement to pay commissions does not have to be in writing. Under Tennessee law, oral or verbal agreements to pay commissions are just as enforceable as written ones.  The problem with oral contracts is that people lie or, to be more euphemistic, they remember things differently.

The problem of the party who owes the commission remembering the parties’ agreement differently can sometimes be overcome by evidence of the parties’ course of conduct. For example, we had a case where a manufacturer claimed that it did not have a written agreement to pay its manufacturer’s representative commissions on pre-fabricated metal building materials. The manufacturer’s defense fell apart because our client had information on the total value of each sale he had made and he had copies of checks from the manufacturer which showed that, for over two years, he had been paid the percentage he claimed he was owed on all of the projects he sold. While most defenses don’t fall apart that easily, that case demonstrates how a course of conduct can make it difficult for a manufacturer, employer or other business to renege on the payment of sales commissions.

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Anecdotally, the defense of novation to a breach of contract claim under Tennessee law seems to do about as well as the multitude of other defenses which are often pled, but much less frequently successful. In a nutshell, a novation occurs when a prior contract between the same parties is replaced and extinguished by a new contract. The defense is often used by defendants who claim that, because of a novation, they were let off the hook and are no longer responsible for the obligations to which they agreed.

In a recent breach of contract case before the Court of Appeals of Tennessee, Premier Imaging/Medical Systems, Inc. v. Coffey Family Medical Clinic, P.C., that court affirmed the decision of the trial court that the defendant had failed to prove the defense of novation.  Here are the key facts:

  • The defendant, CFMC, was a medical practice
  • CFMC entered into a contract (the “Contract”) with Premier whereby Premier was to service a medical scanner used by CFMC
  • The Contract had a five-year term and required CFMC to pay about $4,500 per month
  • The effective date of the Contract was January 1, 2011
  • In 2013, the principal of CFMC, Dr. Coffey, entered into a separate contract with a company called Pioneer (the “Pioneer Contract”)
  • Under the Pioneer Contract, Pioneer assumed contractual obligations of CFMC including CFMC’s contractual obligations to Premier under the Contract
  • Premier was not a party to the Pioneer Contract and did not agree that CFMC was no longer obligated pursuant to the Contract
  • CFMC requested that Premier begin sending its monthly invoices to Pioneer
  • Premier, thereafter, did send the monthly invoices to Pioneer
  • Pioneer made monthly payments to Premier for only four months after which its relationship with Dr. Coffey and CFMC deteriorated

Since the Court of Appeals affirmed the decision and reasoning of the trial court, the appellate court’s reasoning will be discussed here. The court started its analysis by laying out the four elements that have to be proven for a novation: (1) a prior valid obligation; (2) an agreement supported by evidence of intention; (3) the extinguishment of the old contract; and (4) a valid new contract. It also noted a couple of other key points about the defense of novation. First, the party asserting it has the burden of proving it. Second, while a novation may be implied and does not have to be established by evidence that it was expressed, it is never presumed and must be established by a clear and definite intention.

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Sometimes in a breach of contract case, or other commercial litigation matter, a party will be met with the defense that it is not entitled to recover because a condition precedent to the parties’ contract was not fulfilled. Under Tennessee law, a party is not required to perform under a contract unless and until a condition precedent agreed upon by both parties has been satisfied.  However, and very importantly, to rely successfully on the defense that a condition precedent was not satisfied, a party must first prove that there was a condition precedent.

Because conditions precedent have a tendency to result in harsh and unfair outcomes, Tennessee courts disfavor finding the existence of conditions precedent. Sometimes, even when they do find a condition precedent which was indisputably not satisfied, nevertheless, they do not allow that fact to permit a party to avoid performance.

A leading case on conditions precedent in Tennessee was decided by the Supreme Court of Tennessee in 1996. In that case, Koch v. Construction Technology, Inc., a subcontractor filed a breach of contract case alleging that the general contractor had failed to pay it for the entire amount due for work done on a project owned by the Memphis Housing Authority (“MHA”).  In defense, the general contractor claimed that it was not required to pay the entire balance it owed to the subcontractor because a condition precedent to its performance had not been fulfilled.

The written contract between the contractor and subcontractor in the Koch case contained a provision referred to as a “pay when paid” clause.  It stated: “Partial payments subject to all applicable provisions of the Contract shall be made when and as payments are received by the Contractor.”  The general contractor argued that the only amount for which it had not paid the subcontractor was the amount MHA had not paid it.  It also argued that the above language created a condition precedent.

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Under Tennessee law (T.C.A. §48-25-102), a foreign business entity which is transacting, or has transacted, business in Tennessee without obtaining a certificate of authority from the Secretary of State of Tennessee cannot maintain an action in a Tennessee court. This rule applies to lawsuits filed in Tennessee state courts, as well as to those filed in federal district courts located in Tennessee. See, e.g., In Re Meyer & Judd, 1 F. 2d 513, 526 (W.D. Tenn. 1924); G.M.L., Inc. v. Mayhew, 188 F. Supp. 2d 891, 893-94 (M.D. Tenn. 2002).

The process of obtaining a certificate of authority is also referred to as registering to do business in Tennessee. When a business entity registers to do business in Tennessee, it may be referred to as having been “domesticated” in Tennessee.

Any action filed in a Tennessee state court or a federal court located in Tennessee by a business entity transacting business in Tennessee without registering to do business in the state is subject to dismissal. Importantly, it is never too late to register to do business in Tennessee, and Tennessee law expressly allows an entity to register to do business and, thereafter, to continue its lawsuit. However, registering, after having failed to register for a number of years, can become expensive.

What does it mean to “transact business” in Tennessee such that a business must register to do business in Tennessee? The general rule is that a foreign business entity is transacting business in Tennessee when it transacts some substantial part of its ordinary business in Tennessee and its operations in Tennessee do not consist of mere casual or occasional transactions.  There is a Tennessee statute (T.C.A. §48-25-101) which delineates a number of things that do not constitute the transaction of business in Tennessee.  Perhaps a few of the most relevant are:

  • Holding meetings related to internal governance
  • Owning real estate
  • Maintaining bank accounts
  • Selling through independent contractors
  • Soliciting orders by mail which require acceptance outside of Tennessee
  • Creating or acquiring loans, security interests and deeds of trust
  • Conducting isolated transactions that are completed in one month
  • Transacting business in interstate commerce

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A recent opinion of the Court of Appeals of Tennessee in a fraudulent transfer case provides an excellent summary and roadmap of what it takes to prove a fraudulent transfer under Tennessee law. The Uniform Fraudulent Transfer Act, which has been adopted in Tennessee, can be a bit much to get one’s head around, at least without a good bit of review and study.  The recent opinion is useful because the facts of it are tailor-made to demonstrate how the provisions of the Act are applied and the result.

Here are the key facts of the case:

  • Father owned an LLC, the business of which was installing drywall
  • Father owed a Drywall Supplier about $350,000
  • In October of 2007, Father signed a note to the Drywall Supplier for the amount he owed
  • In March of 2009, Father sold the LLC to his Son for $12,000
  • Drywall Supplier filed a lawsuit to set aside the transfer of the LLC to Son, alleging it was a fraudulent transfer

In its fraudulent transfer case, Drywall Supplier alleged that the transfer of the LLC to Son was a fraudulent transfer under the actual fraud statute and, also, under the constructive fraud statute, both of which are part of the Uniform Fraudulent Transfer Act. The trial court found that the transfer was not fraudulent under either provision of the Act. The Court of Appeals affirmed the trial court in all respects.

Under the actual fraud statute, a plaintiff must prove that the transfer was made “with actual intent to hinder, delay, or defraud” a creditor. Since proving fraudulent intent almost always requires circumstantial evidence, the statute lists eleven (11) factors that are to be considered in determining whether there was intent to defraud.  If a plaintiff is able to prove the existence of one or more of those factors (often called “badges of fraud”), a presumption of fraud arises.  Once that presumption has arisen, the burden shifts to the defendant to prove that there was no fraudulent intent.

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In many Tennessee cases involving written contracts, the contracts will contain provisions whereby the parties agreed that the substantive law of a state other than Tennessee would apply in any litigation between them. (In the absence of such a provision, Tennessee follows the rule of lex loci contractus whereby it is presumed that the law of the state where the contract was signed applies).  Since there is substantial similarity between the laws of the States, especially the common law of breach of contract, which State’s law applies may not make a big difference in most cases. It can, however, make a big difference in some cases.

Where the parties have agreed that the law of a particular state will govern any litigation, a Tennessee court will enforce that agreement unless the jurisdiction whose law is chosen does not bear a material connection to the transaction or unless the law of the jurisdiction chosen is contrary to the fundamental policies of Tennessee. This blog focuses on the issue of when a Tennessee court might not enforce a choice of law provision because the law of the state chosen by the parties does not bear a material connection to the transaction.

There is scant published Tennessee case law that addresses this issue. In a 1931 opinion, Manufacturers Finance Co. v. B. L. Johnson & Co., 15 Tenn. App. 236, the Court of Appeals of Tennessee refused to apply the law of Delaware, which the parties had agreed would govern any dispute between them. In that case, the plaintiff was a finance company organized under Delaware law, but which had a principal place of business in Maryland.  The defendant was a Tennessee corporation with a principal place of business in Knoxville.  No part of the disputed transaction touched Delaware.  The court held that it would not apply Delaware law under those circumstances.

In a 2012 breach of contract case, the Tennessee Court of Appeals enforced a contractual provision whereby the law of Kentucky was to govern any litigation between the parties. In that case, the prospective buyer claimed that it was entitled to a refund of an earnest money deposit it had made to purchase land located in Kentucky from the seller. In that case, the buyer was from Tennessee, but the sellers were from Kentucky and the land being sold was in Kentucky.  Under those facts, the court held that there was a material connection between Kentucky and the transaction being litigated.

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In 1977, the Tennessee Consumer Protection Act was enacted. In 2011, the legislature of Tennessee modified it significantly. Here are some basic points to remember with respect to potential Tennessee Consumer Protection Act lawsuits:

  1. Since 2011, a party cannot bring a private cause of action for acts and practices which fall under the catch-all provision of T.C.A. §47-18-104(27).  The TCPA contains a laundry list of fairly specific acts or practices which are per se unfair and deceptive.  It also contains a catch-all subdivision which declares that “any other act or practice which is deceptive” is actionable.  In many cases, in my experience, it is difficult to shoe horn the conduct at issue into one of the defined unfair acts and practices.  In such cases, the catch-all provision may be the only avenue for a client to achieve the relief provided by the TCPA.  In 2011, however, the TCPA was revised to prohibit a private cause of action under the catch-all provision.  There are still other provisions for which a private cause of action is available, which are somewhat broad and which may fit a client’s case, particularly, T.C.A. §47-18-104(5)(7) and (19).
  2. The statute of limitations for lawsuits under the Tennessee Consumer Protection Act is one year. The one year period begins running from “a person’s discovery of the unlawful act or practice.”  Beware that a defendant can argue that the statute began running when a person had constructive knowledge of the act or practice. A plaintiff has constructive knowledge when the plaintiff is aware of facts which would put a reasonable person on notice that the plaintiff has suffered an injury because of the wrongful conduct and knows the identity of the entity or person who engaged in that conduct.  When a plaintiff had constructive knowledge is a question of fact to be decided by the jury, if a jury has been demanded.  There is an absolute outer limit, or statute of repose, for the filing of TCPA claims of 5 years after the date of the transaction which is the basis of the lawsuit.
  3. To recover under the Tennessee Consumer Act, a plaintiff has to show more than just an unfair or deceptive act or practice: A plaintiff must show that he or she suffered an ascertainable loss as the result of the act or practice. In other words, consistent with the common law tort claims for fraud and negligent misrepresentation, a plaintiff in a consumer protection lawsuit must show that the conduct at issue caused him or her damages.  The question of whether or not there has been an ascertainable loss, and the amount thereof, is a question of fact for the jury where a jury has been demanded.
  4. The Tennessee Consumer Protection Act can no longer be used as a cause of action against an insurance company.  In 2011, T.C.A. §56-8-113 became effective and it prohibits the use of the TCPA against insurance companies.
  5. A plaintiff cannot recover both treble damages under the TCPA and punitive damages for a common law claim which relates to the same conduct. Plaintiffs typically combine a TCPA cause of action with a common law cause of action like fraud.  Punitive damages are not available under the TCPA, but a court may treble the amount of any damages awarded by the jury under the TCPA.  If a plaintiff recovers punitive damages under a common law claim and treble damages under the TCPA, the plaintiff must then elect which award to take (which is a no brainer decision).
  6. The TCPA cannot be used against someone who has been engaged in the isolated sale of real estate. If you buy a home or other real estate from someone who you believe made a misrepresentation or who failed to disclose a material defect, and that person is not in the real estate business and does not frequently sell real estate, you may have common law causes of action and other statutory causes of action against that person, but it is unlikely you have a viable TCPA claim against them.  (The same cannot be said for real estate agents and agencies.)
  7. The TCPA applies to acts or practices in connection with the marketing or sale of securities.
  8. Under the TCPA, a court may award a successful plaintiff attorney’s fees.  

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The Tennessee Statute of Frauds requires several types of contracts to be memorialized in a writing (or combination of writings) and signed in order to be enforceable. The three most important types of contracts covered by the Statute of Frauds, at least from a commercial standpoint, are contracts for the sale of land and leases longer than one year; agreements to pay the debts of another; and contracts that cannot possibly be performed within one year.

If a contract is covered by the Statute, does a modification of that contract also have to meet the requirements of the Statute? There is Tennessee case law to support that argument.  The case of Davidson v. Wilson is such a case, and one that demonstrates the ability of the Statute of Frauds to cause what many would describe as an inequitable result in a breach of contract case.

Here are the key facts of that case:

  • Buyer and Seller entered into a written contract providing that Seller would sell a specific 50 acre tract to Buyers for $124,750
  • The closing date for the sale in the written contract was December 5, 2005
  • On the closing date of December 5, the Seller sent, by U.S. mail, a warranty deed to the Buyers
  • The warranty deed recited that the tract was 50 acres “more or less”
  • The warranty deed also provided that the legal description of the tract was provided “without the benefit of a survey”
  • Buyers were concerned, as they should have been, about the deed
  • According to Buyers, after they received the deed, they had numerous conversations with the Seller which resulted in an oral modification of the terms of the written contract
  • According to Buyers, the oral modification was an agreement to extend the closing date until the Buyers had obtained a survey
  • The Seller denied that any such agreement modifying the written contract had been reached
  • The facts of the case strongly compelled the conclusion reached by the trial court: That the Seller’s version of events was not credible and that he had taken the position that the Buyers had breached by not closing on time only after he was able to obtain a contract for a significantly higher price for the tract from a third party

The Court of Appeals of Tennessee reversed the trial court. It did not challenge the trial court’s findings about the respective testimony of the litigants. It held that, since the alleged oral agreement changed the “essential terms” of the contract, it had to be in a writing which complied with the Statute of Frauds.

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