Business Litigation

Personal Liability of LLC Members and Managers under Tennessee Law

Published on: July 19, 2020 | by J. Ross Pepper

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.

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.

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.

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

Claims for Fraudulent Concealment or Failure to Disclose in Tennessee

Published on: June 10, 2020 | by J. Ross Pepper

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.

Recovering All Commissions Owed Through Discovery Procedures in Tennessee State and Federal Courts

Published on: May 12, 2020 | by J. Ross Pepper

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

Implied General Partnerships in Tennessee: Positives and Negatives

Published on: May 3, 2020 | by J. Ross Pepper

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.

The Contemporaneous Exchange for New Value Defense

Published on: April 21, 2020 | by J. Ross Pepper

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 6^th Circuit), the case of Payless Cashways, Inc. (8^th 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

Using the Subsequent New Value Defense in a Preference Action

Published on: April 12, 2020 | by J. Ross Pepper

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.

The Ordinary Course of Business Defense to Preferential Payment Actions

Published on: April 5, 2020 | by J. Ross Pepper

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:

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.
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.
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.
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.
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.
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.

Attacking Fraudulent Transfers in Tennessee State and Federal Courts

Published on: March 29, 2020 | by J. Ross Pepper

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.

Practice Pointers: The Tennessee UCC – Sales

Published on: February 16, 2020 | by J. Ross Pepper

The “Sales” chapter of the Uniform Commercial Code (referred to as “Article 2 of the UCC”), which was adopted by Tennessee in 1963, was designed to bring uniformity and efficiency to transactions involving the sales of goods. Article 2 is thorough, to say the least. In any breach of contract case, breach of warranty case or any other case involving goods sold, it should be reviewed carefully as it has provisions that touch on every aspect of transactions involving the sales of goods, including, contract formation, price, terms, delivery, remedies, warranties, and rejection of non-conforming goods.

There is no way, in the space for a blog such as this, to cover all of the potentially important aspects of Article 2, but the following are some observations about it that are helpful to practitioners and litigants.

The UCC – Sales Only Applies to Sales of “Goods”

Article 2 only applies to transactions involving the sales of goods. If your case involves an investment, a real estate dispute, a shareholder divorce, or some type of service, you need to look to Tennessee common law or to some other statute. With some frequency, transactions will involve both the sales of goods and services. For example, the purchase and installation of computer software and hardware by a business will entail both the provision of goods and services (which the UCC refers to as “non-goods”). In such cases, the UCC will apply if the predominate assets transferred were goods. One of the leading Tennessee cases on this topic is Hudson v. Town & Country True Value Hardware, Inc., which was decided by the Supreme Court of Tennessee in 1984.

Different Rules in Article 2 May Apply If the Sale Involves a “Merchant”

A party considered a “merchant” under Article 2, in many important situations, may find that it is subject to different rules and standards under that Article. To generalize, under Article 2, you are a “merchant” if you are a professional in a business involving the type of goods involved with the transaction. (See T.C.A. § 47-2-104 for the precise definition of “merchant”). Keep in mind that, to be considered a merchant with respect to a transaction in goods, you have to be a professional with respect to the type of goods involved. If a lighting manufacturer buys a forklift, it will not be considered a merchant with respect to that transaction. If it buys filament for the bulbs it manufactures, it will be.

An LLC Member’s Obligation to Contribute to Loan Debt for Which All Members Are Personally Liable

Published on: January 14, 2020 | by J. Ross Pepper

In Thompson v. Davis, an LLC dispute case, the Court of Appeals of Tennessee issued an opinion that is informative on two different fronts: (1) An LLC member’s obligation to contribute his pro rata share to repay loans taken for the benefit of the LLC, but for which all members are personally liable; and, (2) under what circumstances a member can reduce the amount of his pro rata obligation based on alleged distributions received by the other members, but not by that member.

Before diving into the facts of, and result in, that case, it is helpful to review a couple of provisions of the Tennessee Revised Uniform Limited Liability Company Act (the “Act”) which come into play with some frequency, as well as the Tennessee statute requiring contribution by a party who is liable on a debt. First, under the Act, when an LLC is not successful, and is dissolved and liquidated, its assets must be distributed first to creditors. (Creditors, critically, includes members who have made loans to the LLC.) If there are any assets left to distribute after creditors are fully paid, which is infrequent in my experience, they must then be distributed to members who did not receive distributions to which they were entitled. If there are assets left over after those distributions are made, they must be distributed to members first for the return of contributions, and second, for their membership interests in the LLC. The statute that controls distributions upon liquidation is T.C.A. §48-249-620.

The Act also has its own fraudulent transfer provision embedded in it at T.C.A. §48-249-306. That statute provides that members may be liable for distributions which left the LLC unable to pay its debts as they became due in the ordinary course of business or which left it in the red, so to speak. (The preceding is a generalization, so review the statute for the details).

Apart from the Act, and also at issue in the Thompson v. Davis case, was the Tennessee contribution statute related to instruments, T.C.A. §47-3-116. That statute provides that a party who pays an obligation on an instrument, such as a bank note, is entitled to seek contribution from others who were also liable for the payment of the note. The statute provides that those others must contribute their pro rata share. For example, if A, B, and C borrow $750,000, interest free, and agree to be jointly and severally liable to the lender for the obligation, and A pays off the obligation, A is entitled to file suit against B and C and collect $250,000 apiece from B and C. A does not have to sue both for contribution, but A cannot collect more than $250,000 from either.