Articles Posted in Business Litigation

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What damages can a plaintiff recover under Tennessee law for construction defects? The answer is that a plaintiff can recover either the amount it will take to remedy or repair the defects or the difference in value between the structure had the work been done correctly and its value considering the defective work. The later method of damages is sometimes referred to as “diminution in value” or “diminution” damages.

Construction defect cases almost always are breach of contract cases where a project owner or homeowner has sued a contractor with which it had a written or verbal contract. Thus, although there are some unique considerations in construction defect cases, basic principles of Tennessee contract law apply to them. The purpose of breach of contract damages is, first and foremost, to attempt to put the plaintiff, as near as possible, in the same position in which he or she would have been had the defendant not breached.  The plaintiff should not receive a windfall nor should the plaintiff receive less than what it will take to be made whole.

A plaintiff in a breach of contract case with a contractor must be mindful that, under Tennessee law, the plaintiff bears the burden of proving damages. Practically speaking, lawyers representing plaintiffs in construction defect cases must be strategic and proactive from the very beginning of the case about the proof needed to ensure that their client receives a recovery.  More than a few construction defects cases have foundered at the damages stage after a plaintiff has proven liability.

Who determines, in a construction defect case, which of the above two methods of calculating damages applies? In Tennessee, the judge does. How does the judge decide which method to apply? Probably, the seminal and most informative Tennessee case addressing that question is GSB Contractors, Inc. v. Hess (Tenn. Ct. App. 2005).

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A member of a Tennessee Limited Liability Company (“LLC”) may, at some point, lose his or her membership interest, either voluntarily or involuntarily.  An Operating Agreement of an LLC may have provisions which address the conditions under which a member’s interest may be terminated. If the LLC does not have an Operating Agreement, or the Operating Agreement which it does have does not contain provisions dealing with the termination of a member’s interest, then, the provisions of Tennessee Revised Limited Liability Company (the “Act”) will apply by default. (The Act’s provisions always apply, by default, where an LLC does not have an Operating Agreement). Frequently, Operating Agreements contain provisions related to the voluntary and involuntary termination of a member’s interest in the LLC.

Under the Act, an LLC member may voluntarily terminate his or her interest in the LLC. (If the member does so in contravention of the terms of the LLC’s Operating Agreement, the member may be held liable for any damages caused by such voluntary termination).  As well, under the Act, a member’s interest may be terminated involuntarily by a Tennessee court under certain circumstances set forth in the Act at T.C.A § 48-249-503.

What does a member of an LLC receive under Tennessee law when his or her membership interest has been terminated, whether voluntarily or involuntarily?  If the Operating Agreement provides how the valuation and payment is to be made, then its terms will control. If the Operating Agreement does not provide for how a terminated member’s interest is to be valued, then the provisions of the Act, specifically T.C.A §48-249-505, will apply.

Under §505, a member is entitled to be paid “fair value” for his or her membership interest. That term, as explained by the Court of Appeals of Tennessee in a recent decision, is not the same as “market value.”  In Raley v. Brinkman (Tenn. Ct. App. 2020), two members, Raley and Brinkman, owned 50% of the membership interests of the LLC at issue. Among several rulings arising from the dispute between the two, the trial court ruled that Raley’s interest should be involuntarily terminated because of his conduct.

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In evaluating the potential for personal liability of members or managers of limited liability companies under Tennessee law, it is first helpful to determine into which of two broad categories the conduct at issue falls. The first category is conduct of a member or manager that has harmed members of the LLC or the LLC, but not third parties. The second category is conduct of a member or manager that has harmed a third party who is not a member of the LLC.

  1. Conduct Affecting the LLC or LLC Members

If the manager’s or member’s conduct affected members of the LLC or the LLC, the liability of that manager or member will be determined by §48-249-403 of the Tennessee Revised Limited Liability Company Act (the “Act”) (this assumes the LLC in question was formed after January 1, 2006 and is, thus, governed by that Act). §48-249-403 limits the liability of managers and members by expressly limiting their duties to the LLC and to other members to the duties of care and loyalty.

  1. Duty of Care

The duty of care set forth in §48-249-403 incorporates the “Business Judgment Rule.” The Business Judgment Rule allows managers and members of LLCs to make decisions about the operation of the business without having to face liability if the decisions turn out to be bad.   That Rule, as reflected in §48-249-403, provides that managers and members are not liable for their conduct in operating the business except where it amounts to “grossly negligent or reckless conduct, intentional misconduct or knowing violation of law.” If a manager or member makes a risky investment that turns out poorly, but had some possibility of an upside, he or she will probably not be liable. On the other hand, if he or she wired all of the LLCs’ funds to an alleged Nigerian prince or paid a bribe to a government official, he or she will probably face liability.

  1. Duty of Loyalty

Broadly speaking, the duty of loyalty prohibits a member or manager from competing with the LLC or usurping an opportunity of the LLC. It also prohibits a manager or member from using LLC assets for his or her own benefit and from otherwise misappropriating LLC funds or assets. Continue reading →

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Under Tennessee law, when a defendant has affirmatively made an untrue statement of material fact, a plaintiff may well be able to recover for intentional misrepresentation (also called “fraud”) or for negligent misrepresentation.  What if, instead of making an untrue statement of fact, the defendant failed to disclose an important fact or facts? In Tennessee, in proper cases, a plaintiff can recover for the defendant’s failure to disclose a material fact (sometimes called “fraudulent concealment”).

When considering a cause of action because a party has failed to disclose important facts, a good place to start your analysis is to recognize that, under Tennessee law, in most all transactions, a party does not have a duty to disclose material facts to the other party.  For that reason, among others, this cause of action is not at all easy to prove. However, in some cases, it can be successful.

There are four categories of exceptions to the rule that a party to a transaction generally does not have a duty to disclose facts to the other party to the transaction. The first exception exists where a “previous definite” fiduciary relationship existed between the parties.  Examples of definitive fiduciary relationships are attorneys and clients, and trustees and beneficiaries.

The second exception exists “where it appears one or each of the parties to the contract expressly reposes trust and confidence in the other.” I have not been able to find an example, in Tennessee case law, where this exception has been found to apply.  This exception would necessarily be very difficult to prove and would require something more than is present in almost all transactions, in my opinion. It might apply to a situation where, by the express language of the contract, one party acknowledged that it was in a superior position of knowledge and recognized that the other party was relying upon it and trusting it to fully disclose all relevant facts.

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When sales representatives, brokers, agencies, or other businesses are owed commissions, but are not paid, sometimes they have to retain an attorney to file a lawsuit to recover the unpaid commissions.  Our firm, over the years, has represented many commissioned sales representatives in such lawsuits.  Many times, not only have we had to prove that the defendant was contractually liable for unpaid commissions, but also, we have had to establish and to prove the amount of the commissions owed.

Defendants which owe commissions often deny that they owe the amount of commissions which they, in fact, owe.  Furthermore, they also often do not reveal, at least until they must, the full amount of revenue received or all of the sales on which the commissions are to be based.  By doing this, they attempt to reduce the amount of their liability.

Before a lawsuit is filed, which is when discovery procedures can be used to compel parties to produce information on pain of being sanctioned, parties who owe commissions may refuse to produce information to former sales representatives or agents which is needed to determine the exact amount of commissions owed.  Once a lawsuit is filed in a Tennessee state or federal court, however, a plaintiff can use the discovery procedures in the Tennessee Rules of Civil Procedure or the Federal Rules of Civil Procedure, as the case may be, to compel a defendant to produce information about sales, revenues, customer accounts, or claimed charge backs or refunds. For all practical purposes for this blog, the federal discovery rules and Tennessee discovery rules are the same. This blog gives an overview of the particular discovery rules that can be employed to determine the amount of commissions owed to a sales representative.

RULE 33:  INTERROGATORIES

Rule 33 allows a party to send interrogatories, or questions, to another party.  Unless an interrogatory is objectionable, a party must answer it and must do so under oath.  Interrogatories are a helpful method of obtaining information about sales, dates of sales, amounts of sales, and the status of customer accounts. They are also helpful in forcing a business to identify the persons with the most knowledge about matters that bear directly on the amount of commissions owed so that those persons may be deposed. Continue reading →

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A partnership can be created under Tennessee law without the partners ever having a written partnership agreement.  Even where parties have not expressly agreed, verbally, to operate a partnership, an implied partnership can be formed under Tennessee law where the parties involved intended the acts that give rise to a partnership.  The consequences, good and bad, of being in an implied partnership can be financially significant.

If you are in an implied partnership, that may be a good thing to establish in a Tennessee court as it may allow you successfully to recover money, property or profits another partner owes you or is withholding.  Being a partner in an implied partnership, however, can also result in your personal liability, not just to other partners, but to third parties. To boot, it can result in your being liable to a third party based on an act or omission of the person or persons with whom you are determined to be in an implied partnership.

This blog discusses two general topics about implied partnerships in Tennessee: (1) How Tennessee courts determine whether an implied partnership exists; and (2) the resulting advantages and disadvantages to partners in implied partnerships.

DOES AN IMPLIED PARTNERSHIP EXIST?

Under the Tennessee Revised Uniform Partnership Act (“TRUPA”), a partnership is formed “by the association of two or more persons to carry on as co-owners of a business for profit … whether or not the persons intend to form a partnership.” Under TRUPA, a “person” includes business entities such as limited liability companies and corporations. Significantly, TRUPA provides that owning property together, in and of itself, even where profits from it are shared, does not establish a partnership.

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The contemporaneous exchange for new value defense, 11 U.S.C. §547(c)(1), is one of several defenses in the Bankruptcy Code that a creditor may be able to use successfully to defeat the claim of a bankruptcy trustee, or other plaintiff, that the creditor should have to repay money paid to it by the now bankrupt debtor before that debtor filed for bankruptcy.  This defense is applicable to all actions filed in bankruptcy courts located in Nashville or other cities in Tennessee.

This defense allows a creditor, which supplied goods or services, at or near the same time that the debtor paid for those services, to avoid liability for what would otherwise be a preferential payment. The purpose of the contemporaneous exchange for new value defense is to encourage a creditor to keep doing business with a customer which is having financial issues.

Although it is not a case decided by the federal circuit in which bankruptcy courts in Nashville and other parts of Tennessee are located (the 6th Circuit), the case of Payless Cashways, Inc. (8th Cir. 2004) provides a helpful analysis of the defense, and one that any Tennessee bankruptcy court would be expected to apply.

Here are the basic facts of the case:

  • The debtor which had filed bankruptcy (“Debtor”) was a business which sold home improvement products at retail
  • The creditor which was sued by the trustee for the recovery of preference payments (“Creditor”) was a lumber supplier
  • Creditor had supplied lumber to Debtor before it filed its first bankruptcy
  • After Debtor filed its first bankruptcy, Creditor required Debtor to pay for lumber on a cash-in-advance basis by Electronic Fund Transfer (“EFT”)
  • After a while, Creditor somewhat loosened its payment policy
  • Debtor filed a second bankruptcy
  • At the time of the preferential payments at issue, Creditor had agreed to ship all lumber via destination contracts, F.O.B. the Debtor’s facilities. The lumber was shipped via truck or rail, and Creditor’s invoice dates were always the date of shipment.
  • At the time of the preference payments at issue, the Creditor and Debtor had agreed to attempt to match the date the lumber shipments would arrive at Debtor’s facilities with its obligation to pay, and had agreed that all payments would be by EFT.
  • Payment terms were based on whether the lumber would be shipped by truck or rail. Lumber shipped by rail generally took 12-14 days, while lumber shipped by truck generally took 3-5 days.
  • During the relevant period, Debtor paid Creditor for rail shipments within 10.9 days after the date of the invoice, on average, and within 3.2 days, on average, for rail shipments
  • For all shipments, with minor exceptions, Debtor paid Creditor for specific shipments before, or at, the time they arrived at Debtor’s facilities
  • Neither Creditor nor Debtor kept regular records of when shipments arrived at Debtor’s facilities
  • The trustee brought a preference action seeking to recover four transfers made by Debtor

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If you, or your company, is facing a claim in a bankruptcy court in Tennessee, or facing a demand letter from a bankruptcy trustee, or other party, for the return of payments made to you by a company or individual now in bankruptcy, you might be able to use what is referred to as the “subsequent new value” defense. This defense, just one defense in the Bankruptcy Code available to a creditor which is the subject of a preferential payment lawsuit, is particularly useful for creditors which maintained open accounts for now bankrupt debtors.

In concept, the defense is fairly easy to understand. In many cases, its successful application will require complex and tedious analysis of the statutory elements in light of the particular facts of the case.  Assuming that the trustee, or other party which has filed the adversary proceeding, meets his or her burden of proof that the payments to the creditor by the debtor were preferential payments under 11 U.S.C.A. §547(b), a creditor which can prove the elements of the subsequent new value defense (11 U.S.C.A § 547(c)(4)) can avoid repaying the preference payments, or some portion thereof.

To succeed under the subsequent new value defense, a creditor must, to paraphrase the statute, prove three elements: (1) That it gave new value to the creditor after a preferential transfer (a transfer with respect to which the trustee has proven all of the elements of §547(b));  (2) that the new value given was not secured by a security interest which the trustee cannot avoid; and (3) that the debtor did not repay the debt for the new value with a transfer that the trustee cannot avoid.

Like all statutes and laws, understanding the reason for it is helpful in the analysis of particular factual scenarios.  First, it is intended to promote creditors’ willingness to continue to do business with financially troubled accounts, which, ideally, will prevent bankruptcies. Second, when a creditor provides new value to a debtor, the same increases the value of the bankruptcy estate of the debtor, which increases the amount of assets available for distribution to other creditors. Thus, the defense recognizes that it is fair to allow that creditor to offset the value of the new value provided against the amount of the preferential transfers to it.

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If you are the subject of demand by a trustee or other party, whether in a pre-suit demand letter or in a filed adversary proceeding, for the return of money paid to you by an individual or business which is now in bankruptcy, you may be able to keep the money if you can prove that the payments at issue fall within the ordinary course of business exception for preference payments. This is one of the most, if not the most, widely used defense in preference cases, and defendants are successful with it with some frequency. (There are other defenses to preference actions in the Bankruptcy Code, which are not discussed in this post).

Unless the payments at issue are to an “insider,” as defined by the Bankruptcy Code, only payments made within the 90-day period before a debtor files bankruptcy can be attacked as preferences.  In addition to proving that the payments were made within the 90-day period, the trustee, or other party making the claim, has the burden of proving a few other elements in order to establish that the payments at issue were preferences.  Once that burden is met, the creditor who received the payments can avoid having to disgorge the money at issue if it carries its burden of proof that the payments, though preferences, fall within the ordinary course of business exception in the Bankruptcy Code (11 U.S.C.A. §547(c)(2)).

To help readers better understand this exception, this blog discusses two cases — one in which the defense was successful, and the other in which it was not. Before discussing those cases, it is helpful to understand some basic rules about this exception. Here they are:

  1. The exception can be met by a creditor (who received a preferential payment) proving either the subjective component of the exception or the objective component of the exception.
  2. The subjective component of the exception considers whether the transfer, and the debt for which it was transferred, were made in the ordinary course of business of the debtor and creditor. Like the American Camshaft case discussed below, in many cases, there will be no dispute that the debt incurred by the debtor was incurred in the ordinary course of business, but there will be a dispute about whether the payment for that debt was in the ordinary course of business of the debtor and creditor.
  3. The objective component of the exception considers whether the debt was incurred in the ordinary course of the business of the debtor and creditor and whether the transfer that was the payment for the debt was made “according to ordinary business terms,” meaning ordinary business terms in the industry of the debtor and creditor.
  4. The Bankruptcy Code does not define “ordinary course of business” or “ordinary business terms” and the Sixth Circuit (which is the Circuit in which Tennessee bankruptcy courts are located) has said that there is no “precise legal test” to apply to determine whether either term has been satisfied. Instead, each preference case in which the ordinary course of business defense is raised turns on its own, unique facts.
  5. For the subjective component of the exception, in many cases, the most important factor that a Tennessee bankruptcy court will look at is the timing of the payments made by the debtor to the creditor that occurred within the 90-day preference period compared to the timing of the payments that occurred more than 90 days before the debtor filed bankruptcy.
  6. Under the subjective component of the exception, a creditor’s chances of success will be diminished, if not foreclosed, if it engaged in collection activity during the 90-day preference window that it did not engage in prior to 90 days before the debtor filed for bankruptcy.

In American Camshaft Specialties, Inc. (Bankr. E.D. Mich. 2011), the creditor (“Creditor”) was able to avoid repayment of preferential payments under both the subjective and objective components of the ordinary course of business defense.  In that case, the Creditor supplied steel to the debtor (“Debtor”). The trustee for the Debtor filed suit against Creditor to recover a number of payments which had been made to the Creditor during the 90-day preference window.  The payments had been made for steel supplied to the Debtor by Creditor.  There was no dispute that the debt for the steel was incurred in the ordinary course of the business of the Debtor and Creditor.

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It happens sometimes that someone, or some company, which owes a debt will transfer assets that could have been used to pay the debt in order to avoid paying it. Such transfers are often to family members, related or successor businesses, or preferred creditors, and often, when the asset transferred is not cash, are made so that the debtor/transferor receives well below the value of the asset transferred.

Fraudulent transfers can come in an endless variety of forms. Some are obvious and easy to spot. (One of the first ones I ran into involved a defendant which had transferred a piece of real estate to another entity just after my client obtained a judgment against it.) Often, however, they cannot be spotted absent access to the transferor’s financial records, and perhaps even, a deposition or two or a review of financial records by a forensic accountant.

Tennessee has adopted the Uniform Fraudulent Transfer Act (the “Act”) to allow creditors to set aside fraudulent conveyances. If the debtor/transferor transferred the asset to a bona-fide purchaser who paid a value reasonably equivalent to the asset, a court may not set aside the transfer, but, in such a situation, it may well be possible to obtain a judgment against the entities or individuals responsible for the transfer, if they are different from the transferor.

Under the Act, it is important to remember that you do not have to have obtained a court judgment for the amount owed to you before a transfer can be considered fraudulent and set aside. A transfer can be fraudulent as to any creditor who has a “claim” against the transferor. Under the Act, “claim” has a broad definition, and odds are, if you were owed money by the transferor, you can avail yourself of the Act.  Moreover, the definition of “claim” includes unliquidated debts, meaning debts the exact amount of which are not known, but which, at some point, can be reduced to a dollar value.

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