Denise Potter, et al. v. Ruby Potter (Md. Ct. of Spec. Appeals)

Filed: September 13, 2021.

Opinion: Christopher Kehoe

Holding: 

Decedent’s membership interest in a limited liability company (LLC) was “property” under Maryland estate law that passed to decedent’s estate where LLC’s operating agreement which required the membership interest to pass to named successor was not a valid will under Maryland law. 

Facts: 

James Potter (“James”) owned an interest in a Maryland LLC. The members executed an operating agreement and a members’ agreement. The LLC’s operating agreement distinguished between a member’s “interest,” which was defined as that member’s right to share in the profits and losses of the LLC, and the member’s “rights,” which was the right of a member to participate in the management of the LLC. The members’ agreement stated that, upon a member’s death, that member’s interest and right in the LLC shall be transferred to the individual identified in the members’ agreement. 

According to the members’ agreement, James’s membership interest was to be transferred to Ruby Potter, and James’s membership rights were to be transferred to two other members of the company. Although James signed both the operating agreement and the members’ agreement, the record showed that the signing of operating agreement was not witnessed and the members’ agreement was witnessed by only one individual. 

James acquired his LLC interest after his marriage to Ruby Potter (“Ruby”) in 1984. However, James and Ruby separated in 2016. Subsequently, James married Denise Potter (“Denise”). Despite his divorce and subsequent re-marriage, James did not amend the members’ agreement to remove Ruby as his successor.  In 2017, James died intestate. 

Denise opened a small estate and was appointed as personal representative of James' estate. In a document filed with the orphans’ court, Denise identified James’s membership interest in the LLC as an asset of the estate. Thereafter, Ruby filed a complaint for declaratory judgement seeking a declaration that she was entitled to James’s membership interest as she was listed as his successor in the members’ agreement. 

The Circuit Court held that Ruby was entitled the interest because the members’ agreement was a contract which controlled the passing of James’s membership interest. The Court of Special Appeals reversed, for the reasons stated below. 

Analysis:

The Court held that the membership interest was “property” as defined by the Estates and Trusts code which passed to James’s estate because the operating agreement and members’ agreement were not valid testamentary instruments under Maryland law. The Court reached its holding after considering three questions: (1) whether the operating agreement and the members’ agreement are testamentary in nature; (2) whether Maryland law permits an LLC to agree that a member’s interest can transfer by means of an agreement that does not satisfy the statute of wills; and (3) whether there is any conflict between the Estates and Trusts code and the article governing limited liability companies. 

(1) The operating agreement and members’ agreement are not testamentary instruments that control disposition of the membership interest.

As the operating agreement and members’ agreement were not witnessed in accordance with the Estates and Trust code, the Court held that such documents were not testamentary instruments under Maryland law. However, the Court also had to decide whether James’s membership interest was “property” that fell within the scope of the Estates and Trusts code. The Estates and Trust Code provides that all “property” of a decedent is subject to the estates and decedents law, and thus may only pass via will or intestacy absent other statutory exception. See Md. Code Ann., Est. & Trusts §1-301. “Property” is defined as any interest that a decedent has in real or personal property except for property “which does not pass, at the time of the decedent’s death, to another person by the terms of the instrument under which it is held, or by operation of law.” Id. §1-201(r). 

Ruby argued that the operating agreement and members’ agreements were “instruments” under which the membership interest was held that required the interest to pass to another person. The conclusion being that, as a result, the interest was not “property” subject to the provisions of the Estates and Trusts code. The Court rejected this argument on the basis that “the relevant legislative history and caselaw indicate that the General Assembly did not intend for the definition of ‘property’” to mean what Ruby asserted. 

Legislative history revealed that “property” was intended to include “those assets which traditionally constituted what is sometimes called in Maryland the probate estate.” Potter v. Potter, 252 A.3d 17, 32 (Md. Spec. App. 2021), cert. granted, 259 A.3d 787 (Md. 2021). The Court looked to case law that established what constituted a testamentary instrument at the time the Estates and Trust code was enacted. The court concluded that “a writing that purports to transfer the maker’s property at death is testamentary in nature unless it is both irrevocable and based on an otherwise enforceable legal obligation whose performance is deferred during the maker’s lifetime.” Id. As a result, the Court held that the membership interest was subject to the Estates and Trusts code because the designation in the members' agreement was not irrevocable. Id. Indeed, the Court observed that James could have changed his designation at any time, but simply failed to do so. Id. As the interest was not irrevocable during James's lifetime, the court concluded that it fell within what would have been considered the "probate estate," and was accordingly "property" as defined by the Estates and Trusts code.    

(2) The Limited Liability Act did not Subvert the Estates and Trusts Code

Ruby argued that the limited liability act authorized companies to agree that Maryland’s testamentary laws do not apply to membership interests. This argument was based on section 4A-606 of the Corporations and Associations article which provides that, unless otherwise agreed, a member’s membership in an LLC terminates at death. Ruby argued that this provision allows LLCs to alter the default provisions and to agree to the disposition of membership interests upon the death of a member. 

The Court rejected this argument based on the clear wording of the LLC Act. The LLC Act allows an LLC to make operating agreements that are “not inconsistent” with “the laws of this State.” Md. Code Ann., Corps & Ass’ns, §4A-203(15). As discussed above, Maryland law imposes strict requirements on the disposition of property that falls within the Estates and Trusts code. As an LLC cannot make agreements inconsistent with Maryland law, the provisions of the operating agreement and members’ agreement which sought to disposed of James’s property were invalid as testamentary interests due to their non-compliance with the Estates and Trusts code. 

Finally, the court held that there was no conflict between the Estates and Trusts article and the Corporations and Associations article based on its holding that, under Corps & Ass’ns, §4A-203(15), an LLC operating agreement cannot be inconsistent with other state law.  

The full opinion is available here.

Mas Associates, LLC, et al. v. Harry S. Korotki (Ct. of Appeals)

Filed: August 8, 2019

Opinion by: J. Adkins

Holding: The evidence cannot sustain the simultaneous intent to form both an LLC and a partnership where the parties engaged in negotiations to become members of an existing LLC and never abandoned that intention; they governed the entity and made capital contributions to it consistent with the terms of the existing LLC operating agreement; and in the interim period before becoming members, they agreed to be employees rather than partners, and treated payments made to them as salary rather than shared profits.

Facts:

In 2009, Appellee and two defendants, one of whom was a member of the Appellant LLC, began discussing the possibility of merging their companies to increase profitability. The parties held discussions about what form the merger would take and eventually agreed to dissolve the other companies and join the Appellant LLC.

The parties agreed during a business planning meeting that the parties should own Appellant LLC at approximately a third each (plus a minority) and, to achieve this, planned a transfer of interests under the Appellant LLC's existing 2004 operating agreement. They also agreed during the meeting to divide their affairs into an interim and post-interim period. During the interim period, the parties agreed that they would be employees who would receive compensation equal to one-third of the profits. Appellee and the non-owner defendant would also liquidate their companies and surrender their licenses. The parties' attorneys circulated a draft interim agreement and a draft operating agreement, which were extensively negotiated but never signed. For years, the parties engaged in the business and eventually began turning a profit. Other relevant details are discussed in the analysis section.

In 2011, Appellee resigned from his position and attempted to negotiate his departure. The defendants refused to meet with him, and Appellee filed a claim in the Circuit Court for Baltimore County. Among other claims, he pleaded for a determination of the buyout price of his partnership interest. The trial court found in favor of Appellee on all but one of his claims. The trial court found that a partnership had existed because the parties made management decisions together and contributed money equally during the course of the business and awarded damages accordingly. The question presented here is whether competent material evidence exists in the record to support the trial court’s conclusion that the parties intended to form a partnership.

Analysis:

In Ramone v. Lang, No. Civ.A. 1592-N, 2006 WL 905347 (Del. Ch. Apr. 3, 2006), the Ramone court held that there was no partnership between two parties who had discussed buying a swimming center by forming an LLC. When negotiations failed, and one party went on to form an LLC with other individuals, the other party claimed they had formed a partnership in the course of their negotiations. The Ramone court held that the failure to form an LLC without more did not make them partners given the reality that they had never agreed on their obligations to one another.

The Court also cited other case law and sources for the proposition that “it would be inequitable to construe arms-length negotiations between sophisticated parties to form an LLC concurrently as intent to form a partnership when those negotiations fail.” See Grunstein v. Silva, C.A. No. 3932-VCN, 2011 WL 378782 (Del. Ch. Jan. 31, 2011); Christine Hurt, D. Gordon Smith, Alan R. Bromberg & Larry E. Ribstein, on Partnership sec. 204[B]; and Garner v. Garner, 31 Md. App. 641 (1976). The Court concluded that these principles are applicable here.

Here, the parties’ initial goal, which remained consistent throughout the negotiations, was to each obtain a membership interest in the Appellant LLC. To govern their relations until they could reach that goal, the parties entered an interim agreement whereby they would be employees and not partners. Critically, the parties never abandoned their efforts to become members of the Appellant LLC.

As for other factors that courts commonly look toward to evaluate partnership intent, the Court also found in favor of the Appellants. In terms of the management and control factor, the Court held that the parties were acting in accordance with the terms of the existing 2004 operating agreement and that their joint decision-making is consistent with the typical duties of an LLC manager. Also, casual use of the word “partner” is not determinative, particularly when the parties did business under the registered tradename of the Appellant LLC.

As for the capital contributions factor, the parties made payments first to another member of the Appellant LLC who then transferred them to the Appellant LLC because such was the procedure demanded under the existing 2004 operating agreement. Such elaborate steps would have been unnecessary if the parties intended to contribute to a partnership. Finally, the Revised Uniform Partnership Act prohibits blurring the lines between partnerships and other entities. To treat the contribution to an LLC as a contribution to a partnership would be to treat the entities as one in the same in contravention of the express terms of the law.

As for the sharing of profits and losses factor, the Court cited Ingram v. Deere, 288 S.W.3d 898-99 in support of the contention that salary can be a share of gross revenue. Here, the payments to the parties were denoted as salary on the payroll journal, their wages were calculated on W-2 forms--which included typical wage withholdings--they reported wages on their Form 1040 tax returns, and no one filed a K-1 schedule reporting profits. The business paperwork also reflected their titles as managers and officers. Also, Appellee never intended to be equally liable for the debts of the alleged partnership, as evidenced by his unwillingness to be held jointly and severally liable for loans or execute any indemnity agreements to that effect.

As a result, the Court of Appeals reversed the lower court, determining that the trial court was clearly erroneous in finding an intention to form a partnership by the parties to the litigation.

The full opinion is available in PDF.

Willow Grove Citizens Assoc. v. County Council of Prince George's County, Maryland (Ct. of Special Appeals)

Filed:  December 20, 2017

Opinion by:  Stuart R. Berger

Holding:  A Maryland LLC’s participation in an administrative proceeding by filing for a zoning special exception was valid even though the LLC had forfeited its right to do business in Maryland.  A foreign unregistered corporation's participation in the proceedings as agent or co-applicant did not invalidate the application because the isolated action did not constitute doing business in Maryland.

Facts:  Appellee (“LLC”) in 2001 purchased a parcel in Bowie, Maryland with the intent to construct an assisted living facility.  The parcel being zoned "Rural Residential," prior owner had obtained a special exception for this same purpose but had never developed the land.

In 2012, LLC neglected its State Department of Assessments and Taxation ("SDAT") obligations and forfeited its right to use its name and do business in Maryland.  LLC's sole member was a corporation organized in the District of Columbia not registered to do business in Maryland.  LLC's rights remained forfeited in February 2014 when it applied for a special exception to operate an assisted living facility on the parcel.

The application was accepted, heard, and granted in October 2014 by the local planning commission ("Examiner").  People's Zoning Counsel, appointed by the County Council to protect the public interest and create a full and complete record, was the same attorney who had conducted the settlement and subsequent contract work around the sale of the parcel to LLC.  The record showed no objections made after his disclosure of prior involvement and no objection to his participation in the proceedings.  Examiner's decision was appealed to the County Council who remanded the matter for a determination of LLC's standing with SDAT.

In May 2015, LLC's rights were reinstated, and a month later the sole member became a qualified corporation in Maryland.  LLC provided certificates of good standing at the subsequent rehearing where the Examiner recommended approval.   Appellant, a civic association ("Citizens"), appealed to the County Council, who found LLC legally authorized to file an application for a special exception concerning real or personal property, that forfeiture had not impaired the validity of such a filing, and that the act of applying for a special exception did not constitute doing business.  The Circuit Court for Prince George's County affirmed.

Analysis:  Because Citizens accepted the factual record and objected only to the decision of the County Council on legal grounds, the only question before the court was whether the approval for special exception had been premised on legally erroneous conclusions of law.

Evaluating Citizens' claim that LLC's actions in pursuit of a special exception were a legal nullity, the court pointed to § 4A-911 of the Corporations & Associations Article (emphasis added):

The forfeiture of the right to do business in Maryland and the right to the use of the name of the limited liability company under this title does not impair the validity of a contract or act of the limited liability company entered into or done either before or after the forfeiture, or prevent the limited liability company from defending any action, suit or proceeding in a court of this State.

Irrespective of its forfeiture, LLC remained a legal entity with the power to enter binding contracts at any time.  What of the statute's proscription against bringing lawsuits?  Continuing on, the court found that because LLC had not filed its application "in a court of this State," the implicit prohibition against initiating suits was irrelevant.

"What about the sole member's initial status as an unregistered corporation?," pressed Citizens.  Applying a similar analysis, the court cited § 7-103 of the Corporations & Associations Article to find unregistered corporations to be entitled to engage in many in-state activities such as maintaining, defending, or settling actions, suits, claims, disputes, administrative or arbitration proceedings.  Citizens failed to meet their burden to prove the sufficiency of sole member's contacts or actions within the state to constitute "doing business,"  therefore, the sole member's status as co-applicant or agent in pursuing the special exception was also irrelevant. 

Finally, the court found that Citizens had not preserved for judicial review the question of People's Zoning Counsel's alleged conflict of interest because it failed to raise the issue at any stage of the administrative proceedings.

Accordingly, the court found the County Council's decision to approve the application for special exception to be correct as a matter of law.

The full opinion is available in PDF.

Charles and Margaret Levin Family Limited Partnership v. Greenberg Family Limited Partnership (Cir. Ct. Mont. Cnty)

Filed:  December 27, 2016

Opinion by:  Ronald B. Rubin

Holding:  Judicial dissolution is an inappropriate remedy for deadlock over the identity of a managing member of an LLC where an LLC’s members have (1) a reasonable exit mechanism to receive fair value for their interest and (2) the Operating Agreement provides an alternative dispute resolution mechanism such as arbitration.

Facts:  Plaintiff and Defendant, each a family limited partnership involved in a series of commercial real estate transactions since the late 1980’s, jointly operated a lucrative office and retail complex.  Originally a general partnership, the joint venture’s organizational structure in 1999 converted to an LLC whose members were Plaintiff and Defendant, each with a 50% stake.

The Operating Agreement provided that Defendant would be the managing member with an initial 5-year term, followed by one or more successive 3-year terms if members unanimously consented to each successive term.  Expiration of the initial term was met with acquiescence by both parties, and Defendant continued to serve as managing member of the LLC.

By 2013, operation of Plaintiff’s family business had passed through several hands and a separation of interests was proposed.  Negotiations were contentious and unsuccessful.  By late 2014, Plaintiff accused Defendant of material breach of the operating agreement, alleging improper authorization of an increased property management fee and exceeding its term as managing member without consent.  At a members’ meeting, Defendant agreed not to increase the management fee, but refused to step aside as managing member.

Pursuant to the Operating Agreement, Plaintiff in 2014 filed a demand for arbitration to remove Defendant as managing member.  Defendant filed a complaint in circuit court seeking a declaratory judgment that the matter was not subject to arbitration.  Each party then withdrew their demands and attempted to negotiate a resolution.  Negotiations ultimately failed, and Plaintiff filed the instant suit in mid-2015.

Plaintiff sought relief in the form of a declaration that Defendant’s term as managing member had expired, and judicial dissolution of the LLC.  Defendant generally denied the allegations, sought a declaration that Defendant could remain as managing member, and requested that judicial dissolution be found an inappropriate remedy in such a dispute.

In March 2016, the court denied cross-motions for summary judgment and set a trial date for November.  By June, Plaintiff filed an amended complaint alleging the parties were deadlocked, and moved for a preliminary injunction for Defendant’s removal as managing member.  Plaintiff again requested judicial dissolution, but alternately requested appointment of a special fiscal agent.

At a preliminary injunction hearing in July, the court granted the motion in part, ordering removal of Defendant as managing member, but denied the request for judicial dissolution.  At the hearing, the court learned that the property management firm, although an affiliate of Defendant, had run day-to-day operations for over fifteen years without serious complaint.  The court found the parties’ unaddressed disagreements to be premised on the unsuccessful attempts to wind up the business, and allowed the property management firm to carry on in conformity with the Operating Agreement despite absence of a managing member.

In October, Defendant moved again for summary judgment, arguing that its removal as managing member rendered the complaint moot, and that any remaining operational or management disputes could be resolved by pursuing arbitration according to the Operating Agreement.  The court denied the motion in favor of full examination of the parties’ relationship, motive, and intent.

Analysis:  The court began by evaluating Plaintiff’s contention that judicial dissolution was the only remedy in light of the fact that without a managing member, the LLC could neither operate generally, nor operate in conformity with its Operating Agreement.  Examining the Operating Agreement, the court found several sections reserving sole authority to bind the LLC to the Managing Member or its specially authorized agents.  Further, the Operating Agreement plainly stated that mere status as a member did not vest with capacity to bind the LLC.  Noting that the practice of stockholders running a corporation might vitiate the protections of the corporate shield, the court concluded that leaving Plaintiff and Defendant as mere members would be improper.  Nor was the property management firm an appropriate substitute for a Managing Member.

The court went on to cite Maryland statutory law, noting that while judicial dissolution is appropriate only when “it is not reasonably practicable to carry on the business in conformity with the articles of organization or the operating agreement,” the statute failed to adequately define the phrase.  Md. Code Ann. Corps & Assn’s Art. §4A-903 (2015).  Nor had Maryland courts definitely construed the statutory language.  The court therefore looked to extent to which deadlock frustrated the purpose to which the LLC was created.  Finding Defendant, as prior Managing Member, had not abused its authority, unjustly enriched itself, or harmed Plaintiff’s economic interests, the court determined the business purpose of the LLC to have been faithfully fulfilled.

The court countenanced that judicial dissolution might have been appropriate but for the fact that the Operating Agreement specifically provided for arbitration as a dispute resolution mechanism.  Although Defendant reversed its initial pre-trial position that appointment of a managing member was not a proper subject of arbitration, Plaintiff failed to argue that Defendant was judicially estopped from taking this position.  Regardless, the court stated that because both parties’  2014 filings had been withdrawn voluntarily prior to the instant suit, judicial estoppel would not have precluded Defendant from taking such a stance.

Finding no ambiguity in the Operating Agreement’s dispute resolution mechanism, the court deemed judicial dissolution to be unnecessary.  The court went on to comment that the Operating Agreement also provided a reasonable exit mechanism in a dissenting member’s ability to exit and receive the fair value of its interest.  Subject to a right of first refusal with notification requirements, Plaintiff could have solicited offers for its interest, but failed to do so.  Further, Defendant in 2015 offered 50% of the appraised value of the joint venture.  Finding the price to be a premium over fair market value (given the limited marketability and/or lack of controlling interest), the court was satisfied in denying the request for judicial dissolution, finding arbitration to be a fair and equitable result.

The full opinion is available in PDF.

Penthouse 4C, LLC v. 100 Harborview Drive Council of Unit Owners (Cir. Ct. Balto. City)

Filed: June 5, 2012.

Opinion by Judge Evelyn Omega Cannon.

Held:   The Circuit Court for Baltimore City held that it had jurisdiction to confirm an arbitration award on a petition filed within 30 days after the arbitrators’ decision on a motion to modify the award, that the arbitrators did not exceed their jurisdiction in awarding the Plaintiff LLC the amount of costs of living and relocation expenses of the LLC’s sole member who was not a party to the arbitration, and that the award would not be vacated for manifest disregard of the law because the Defendant could not show that the arbitrators disregarded the law after understanding and correctly stating it. Finally, the Circuit Court refused to modify the specific performance part of the award based on Defendant’s evidence presented to the Court but not to the arbitrators.      

Facts: On March 9, 2010, the Plaintiff LLC, whose sole member was the primary resident of a condominium managed by the Defendant condominium council and directors, sued for specific performance and damages alleging that that the Defendant’s failure to perform required maintenance caused water exposure damage (mold) in the Plaintiff LLC’s condominium unit. The Plaintiff LLC’s sole member, an individual residing in the unit, was not individually named as a party to the suit.

The Circuit Court granted the Defendant’s motion to stay pending arbitration and after five days of hearings, on November 28, 2011 a majority of the three retired judges serving as arbitrators awarded the Plaintiff $1,252,487 in damages, including $433,722 for the sole member’s consequential costs, and ordered the Defendant to perform the required maintenance.

The Plaintiff filed a petition to confirm the award in the Circuit Court.   A day later the Defendant filed with the arbitrators a motion to modify the award as to what all agreed was an inadvertent mistake. On December 28, 2011 the majority panel issued its modification of the award, in part. On January 23, 2012 the Defendant filed in the Circuit Court a Petition to Vacate the Monetary Award and to Modify the Award’s order of specific performance.

Analysis:   The Circuit Court first addressed the Plaintiff’s claim that the Petition to Vacate was not timely filed. Relying on Mandl v. Bailey, 159 Md. App. 64 (2004),  the Circuit Court found that an arbitration award, although final and complete when issued, is rendered incomplete and no longer final when a motion is timely filed with the arbitrator to modify the award, therefore tolling the 30 day period in which a petition to vacate the award can be filed with the Court. In accordance with Mandl,  the Court found the Petition to Vacate was timely because filed within 30 days of delivery of the corrected award.

The Circuit Court next addressed whether the arbitrator panel exceeded its jurisdiction when making a $433,722 award to the Plaintiff LLC for consequential costs of the LLC’s sole member. The Court found that the Defendant participated in the arbitration without objection about jurisdiction or the appropriateness of a consequential costs award to the Plaintiff LLC’s sole member. The Circuit Court further found that the arbitration panel explicitly made the award to the Plaintiff LLC and not to the LLC’s sole member, therefore no jurisdictional issues were present.  

Next, the Circuit Court addressed the Defendant’s claim that the award for the consequential costs was “completely irrational” and a “manifest disregard of the law.” Although “manifest disregard of the law” is not stated as grounds to vacate an award in the Federal Arbitration Act or the Maryland Uniform Arbitration Act, the Court followed Sharp v. Downey, 197 Md. App. 123 cert. granted, 419 Md. 646 (2011) in applying the doctrine under principles of stare decisis. Reviewing authorities, the Circuit Court found that the “manifest disregard” standard requires some showing in the record, other than the obtained result, that the arbitrators knew the law and consciously disregarded it. The Circuit Court found that the Defendant never presented an issue to the arbitrators as to an award of the amount of the LLC’s sole member’s consequential costs and the arbitrators never provided any explanation for the award. In light of the Defendant’s silence, the award could not be “completely irrational” and the Defendant’s failure to refer the arbitrators to any law on consequential damages was fatal to the requirement of the “manifest disregard of the law” doctrine that the record show that the arbitrators were aware of the law and disregarded it.

Finally, the Defendant sought three modifications to the specific performance portion of the award: 1) incorporation of two Project Manuals that were not introduced into evidence, 2) allowing the Defendant to perform a peer-review of the Project Manuals, and 3) allowing value-engineering of the Project Manuals. Because the Project Manuals were not presented into evidence before the arbitrators, the Circuit Court could not conclude whether the proposed modifications would affect the award. Defendant also was silent during the arbitration hearing about peer-reviewing and value-engineering. Consequently, the Circuit Court denied the Defendant’s Petition to Vacate or Modify the Award and granted Plaintiff’s Petition to Confirm the Award.

The full opinion is available in PDF.

Serio v. Baystate Properties, LLC (Ct. of Special Appeals)

Filed: March 8, 2012

Opinion by Retired Judge James A. Kenney, III

Held: Absent a finding of fraud, the circuit court erred by finding defendant personally liable for the debts of the limited liability company solely owned by him.

Facts: The plaintiff, a home builder, entered into a contract with defendant, as managing member of an LLC, to build houses to certain specifications on two lots lots which were owned by the defendant individually. As work progressed, the plaintiff drafted multiple addenda to the Agreement reflecting changes to the work. Each addendum, when first presented by the plaintiff, referenced the defendant individually, but the defendant revised those references and both parties signed the addenda, with the defendant signing as Managing Member of LLC. Both parties executed a waiver of any claims for personal liability under this agreement.

Shortly thereafter, payments to the plaintiff slowed. When the plaintiff contacted the defendant regarding the payments, the defendant assured that the properties would soon be sold. Although both properties had been sold, the buyers subsequently defaulted on a mortgage and the defendant received only a small portion of the sale. According to the plaintiff, none of the proceeds from the sale of the lots were deposited in the defendant's business account. 

The plaintiff sued, and the defendant LLC filed for bankruptcy protection. After a bench trial, the circuit court deemed it necessary to pierce the corporate veil to enforce a paramount equity. Accordingly, it entered a verdict against the individual defendant. The defendant appealed.

Analysis: On appeal, the Court affirmed that "except as otherwise provided [in this title], no member shall be personally liable for the obligations of a limited liability company, whether arising in contract, tort or otherwise, solely by reason of being a member of the limited liability company." The Court noted, however, that the corporate shield may be disregarded under certain circumstances. Specifically, "shareholders generally are not held individually liable for debts or obligations or a corporation except where it is necessary to prevent fraud or enforce a paramount equity." Bart Arconti & Sons, Inc. v. Ames-Ennis, Inc. 275 Md. 295 (1975).

The Court qualified this by stating the standard is so narrowly construed, that no appellate court finds an "equitable interest more important than the state's interest in limited shareholder liability." Residential Warranty v. Bancroft Homes Greenspring Valley, Inc., 126 Md. App. 294 (1999). Further, there is no precedent in the court's history of approving this extraordinary remedy of paramount equity. Even Maryland decisions that recognize alternate grounds for piercing the corporate veil do not do so absent a finding of fraud.

The Court compared this case to Hildreth v. Tidewater, where the trial court found circumstances establishing paramount equity that would warrant disregarding the entity shield based on the fact that defendant was the sole shareholder, personally involved in the transaction at issue, there was evidence of bad faith, the business conducted by the corporation was illegal because it was not registered in Maryland, Maryland law precluded an unregistered foreign corporation from engaging in business in Maryland, and there was evidence of a conscious evasion of responsibility. 378 Md. 724 (2006). The Court of Appeals, however, reversed, holding that those circumstances, individually or in combination did not warrant piercing the corporate veil. Id. at 734.

In discussing one possible ground where a corporate entity will be disregarded, the Court discussed the "alter ego" doctrine, and found it would only apply in exceptional circumstances and with great caution where a plaintiff shows "(1) complete domination, not only of the finances, but of the policy and business practice...(2) such contract was used by the defendant to commit fraud or wrong.. and (3) that such control and breach of duty proximately caused injury or unjust loss." Id. at 735. Further factors include whether the corporation was adequately capitalized, the company's solvency when entering the transaction, the observance of corporate formalities, and evidence that the corporation "has no separate mind, will or existence of its own." Id. at 736. The Court also touched upon the theory of whether the conduct was for the purpose of evading legal obligation, but found that the court's narrow interpretation of this ground did not warrant the defendant being held personally liable. The court found, moreover, the decisions of this Court and the Court of Appeals have made clear that the corporate veil will not be pierced to redress the breach of a contractual obligation in the absence of fraud when the party seeking to pierce the corporate shield has dealt with that corporation in the course of its business on a corporate basis. In sum, Maryland is averse to disregarding the entity shield in a business situation in the absence of fraud. 

Here, the circuit court did not find fraud, but found circumstances that warranted paramount equity. The circuit court viewed the defendant's failure to deposit the funds from the sale of the lots into the defendant's bank account and the fact that the defendant later filed for Chapter 7 bankruptcy as evidence of an intent to evade the company's legal obligations to the plaintiff. When reviewing these circumstances, this Court saw a greater parallel to Bart Arconti where the Court refused to pierce the corporate veil and hold a shareholder personally liable for conduct that rendered its corporation all but insolvent and was "clearly designed to cause the corporation to evade a legal obligation." 275 Md. at 305. This Court also refused to pierce the corporate veil in a situation where a shareholder placed corporate funds into his personal account and lied regarding matters affecting public safety. See Bancroft, 126 Md. App. 294.

The Court concluded that the defendant fulfilled the contract with the plaintiff until, as the defendant testified, the collapse of the housing market caused problems. The plaintiff was an established building contractor who understood and agreed that it was doing business with another limited liability company, as reflected in the Agreement, and their continuing court of business. Under those conclusions, the Court found that the circuit court abused its discretion in finding the defendant personally liable for the obligations of the defendant.

The full opinion is available in pdf.

Maryland Limited Liability Company Revision Act of 2011

The Maryland State Bar Association Business Law Section Committee on Unincorporated Business Associations has drafted a proposed set of revisions to the Maryland Limited Liability Company Act. The proposed revisions can be found here and the report of the drafting committee can be found here.

The proposed revisions have been approved by the Section Council of the MSBA Business Law Section. Needless to say, the proposed revisions are subject to amendment and modification at each step of the process, including modification before the bill is formally submitted to the General Assembly.