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When considering an exit strategy for leaving the ownership of a business, don’t forget to factor in the rights and input on the subject to which your fellow owners may be entitled.  In many cases, finding a buyer for your equity stake is only part of the process. 

Whether it’s a closely held corporation or LLC whose equity holders are owner-operators or an investment vehicle LLC with sophisticated equity holders, the Operating Agreement or Close Corporation Agreement is quite likely to contain some restrictions on the manner in which ownership interests can be transferred to nonowners.  Often one such restriction will be a “right of first refusal” which requires that one’s fellow owners, and/or the company itself, be given an opportunity to purchase the ownership interest before any sale or transfer to a third party is permitted. 

The typical “right of first refusal” generally follows the following sort of sequence:

1. Getting the Purchase Offer in Writing.  The equity holder wishing to sell to someone outside the existing ownernship must obtain a WRITTEN bona fide offer from the propsective purchaser setting forth the material terms and conditions of the offer and the amount of consideration offered.
   • YES, it really does need to be written.  It doesn’t necessarily have to be in the form of a formal purchase agreement, but a few notes on the back of an envelope or business card will probably not be adequate.
   • Bona fide just means it needs to be something that the prospective purchaser really will follow through on and there are not any questionable side transactions (e.g., part of the purchase price is immediately refunded to the purchaser) required to support the proposed transaction.
   • Yes, it does need to be specific.  If, for example, payment is going to be made over time, that needs to be explicitly stated.
2. Notifying the Remaining Owners.  A copy of the written bona fide offer, together with some sort of written notice setting forth the desire to sell, must be provided to all of the remaining equity holders.
   • NO, an e-mail to the remaining equity holders from the owner wishing to sell out which  summarizes the terms of a verbal offer is probably not good enough.
   • The precise form of the notice required is generally not spelled out in the Operating Agreement.  However, nothing more complicated than indicating it is a notice of the desire/intent to sell is necessary.  Some Operating Agreements do require the notice to contain a summary of the terms and conditions of the offer.
3. Waiting for a Response.  The company and the remaining equity holders are given a period of time to consider whether they wish to “meet” the offer made and buy back the equity interest.  Usually, but not always, the company is given the first “right of refusal” with the remaining equity holders being given a chance to purchase if and only if the company decides not to exercise its right of refusal.   
   • The amount of time given for consideration of the offer varies, although 15, 30, or 60  days are common choices.  Generally the length of consideration time is the same for all parties having a rights  of first refusal, i.e. both the company and the remaining owners will each be given 30 days.
   • The consideration time is usually cumulative, i.e. the company has 30 days to decide and then the remaining owners get 30 more days after that to make their decision.
   • Occasionally, Operating Agreements provide that the presentation of a bona fide offer permits the remaing equity holders to purchase the subject equity interest at predetermined price, perhaps “fair market value”, as determined by an agreed upon formula or method.
   • The purchase by the company or remaining equity holders in the aggregate must be for the entire portion of ownership interest being offered for sale - no partial purchases are permitted, although it is often possible for the equity interest to be divided among the remaining owners.
4. Exercising the Right of First Refusal.  If the parties holding “rights of refusal” wish to exercise them, they must provide the party wishing to sell with written notice of that intent within the time required.  The transaction must then be closed within the time specified by the Operating Agreement which can vary considerably from one Operating Agreement to another.  Some Operating Agreements may even prevent a closing prior to the expiration of at least some period of time, i.e. 30 or 60 days.  
5. Right of First Refusal NOT Exercised.  If the parties holding the rights of refusal choose not to exercise them, the party wishing to sell may proceed to consummate the offer under the terms and conditions disclosed.  Generally, if the transaction is not consummated within a certain period of time, perhaps as short as 30 or 60 days, the party wishing to sell will have to go through the entire right of first refusal process again.  

If you’ve been in business long at all, somewhere along the line there may well have been some sort of dispute about the amount a customer owes.  And if you’ve had any contact at all with an attorney, you have undoubtedly been told to watch out for “payment in full”  situations in which you receive checks purporting to be “in full satisfaction” or containing some similar endorsement indicating that the customer intends this payment to be it.  In fact, if you’re in Ohio, you have probably been admonished (and maybe even established as policy) that any check accompanied by a such a restrictive endorsement, or any cover correspondence using this language, MUST be returned to the customer. 

Simple enough.  But suppose you receive a cover letter enclosing a check for less than the amount owed which doesn’t use these “magic” terms of art?  What if the letter specifically states that it is not placing any restrictive endorsement on the check to you, but hastens to add something to the effect that this is all the money we believe is owed to you?

In Ohio, the answer has changed over the years.   Prior to the 1989 Ohio Supreme Court case of AFC Interiors v. DiCello, 46 Ohio St.3d 1, 544 N.E.2d 869 (1989), creditors faced the dilemma of having to choose between  accepting the lesser amount offered and writing off the balance or rejecting the partial payment being offered in favor of pursuing the debtor for the entire amount due.  If a check offered “in full payment” or “in full satisfaction” was cashed by the creditor, the remaining amount owed simply could not be recovered.

From 1989 through 1994, there followed a glorious period for creditors in which they could rely upon Ohio Rev. Code 1301.13 to take the partial payment AND still pursue the debtor for the balance if they did so while make a “reservation of rights”.  Thus if the creditor endorsed the check by writing words such as “under protest” or “without prejudice” just above their endorsement before cashing the check, the creditor had managed to have its cake and eat it too.  In this way, creditors accepted the partial payment, applied it against the balance owing and then were permittred to continue further collection efforts.  

All this changed in 1994 when Ohio adopted the revised version of Uniform Commercial Code Articles 3 and 4.  As a result of the change in the law, making a reservation of rights was no longer possible.  In addition, if the partical payment was accompanied by correspondence indicating that the payment was ended to satisfy the obligation in full. cashing the check meant that the creditor could not pursue the trmaining ballance.  New Ohio Rev. Code 1303.40 (A), which remains in effect today, provided that

the claim is discharged if the person against whom the claim is asserted proves that the instrument or an accompanying written communication contained a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim.

 This had the effect of returning Ohio to the pre-1989 common law era.

So, today, do not be fooled if receiving a partial payment check.  In addition to the obvious situation in which it is clearly marked as “payment in full”, you must also pay attention to the correspondence accompanying the payment.  If that correspondence indicates that the sender does not intend to pay the balance, then you are cashing the check at your own risk, even if there is no restrictive endorsement placed  on the check.  

Perhaps you remember the Saturday morning cartoon The Jetsons featuring poor George Jetson and his trials and tribulations in a future filled with all manner of technological conveniences.  (Click here if you’ve just been hit with a wave of nostalgia and want to relive episodes.)  George’s job at Spacely Space Sprockets mostly consisted  of pushing a button at his computer, sorta like all of us do now. 

While George may have intended to make contracts with the push of the button, we don’t always realize that’s exactly what we’ve done.  Sometimes it’s not “just” e-mail - you just made a binding contract.

Most of us think of e-mail as an informal casual form of communication.  As a result, we tend to be much less careful about what we say than when we put it in an old fashioned letter. And that could be trouble when sending e-mail about the terms of a business deal you think you’re still “just” negotiating.  I’ve posted before about how a series of letters exchanged between two parties can sometimes result in a contract being formed.  The same thing can happen with e-mails, or even voicemail.

Uniform Electronic Transaction Act. Ever heard of the Uniform Electronic Transaction Act (UETA), codified in Ohio in 2000 as Ohio Revised Code Chapter 1306?  It takes contracts into the 21st century by expanding the meaning of what it means to be the time honored “written agreement” and “signature” needed to form a binding contract enforceable against the parties to it. 

The UETA defines an “electronic record” in such a way as to include both e-mail and voicemail.  In addition, an “electronic signature”, defined as “an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted  by a person with the intent to sign a record”, can easily include something as simple as typing your name at the end of an e-mail or even just saying your name when leaving a voicemail. 

The provisions of UETA apply whenever the parties have agreed to conduct negotiations by electronic means.  Importantly, no formal agreement to use these channels is necessary - it can be implied from the surrounding situation and circumstances, including the conduct of the parties.  So… if you use e-mail to work out and close a business transaction, you are potentially at risk for creating a binding contract before you may have intended to do so. 

Real Life Example.  Is this really a potential problem or is it just another of any number of “parade of horribles” that never actually happens in “real life”?  Consider the following e-mail exchange in a recent case (Klebanoff et al. v. Haberle et al., 978 So.2d 598 (La. App, 2008)) regarding the purported settlement of a dispute involving a mineral lease:

• Phillips: “If you want, you can just propose [the plaintiffs} pay me for what I have in the deal and I will convey my interest to them."
• Scott: "We agree to this proposal of settlement."
• Phillips: Demands payment in full, saying "I will not finance.... would expect to be paid for what we have invested at which point we would convey the interest over."
• Scott: Offer accepted, but also says, "Now it seems as if the only issue that we do not have a complete meeting of the minds with respect to is how much your aunts will 'finance' this transaction/compromise and how much time you will allow them to do it."  Includes other comments, including gratuitous comment that plaintiffs had been "coerced" into signing over the interest at stake.
• Phillips: "I wll no longer try to work with you, your clients can either pay $56,136,10 in two weeks or I will have my attorney contact you.... Please let me know how you would like to proceed."
• Scott: Indicates "thrown for loop" by demand for immediate payment instead of payment plan, but says, "Nevertheless, subject to working out the financing aspect, we have a compromise.  I will do what I can do to scrounge up some financing for Carla and Melinda."
• Phillips: "If I don't receive the money before the logging of the 30-3 the deal is off and you will have to resume litigation....  Expect a letter outlining our conversation and my proposal from my attorney.  I will have [the accountant] include the information you requested below.”
• Scott: “I am pleased we have a deal…. I look forward to hearing from your attorney so we can get this matter concluded.” 
• Phillips: “What deal do we have?  The 33% back in after payout or the payment of the un-recovered funds before logging the Frierson 30-3.”
• Scott: Inquires why hasn’t gotten the documentation “to close our settlement of a return assignment of yours and Haberle’s interest in the Yarber lease for the unrecovered amount of $56,000.”
• Phillips: “The 33 percent back-in is the current structure….  However, I would rather just get the money I have in it back and move on….  We can make the deal effective Feb 1 and any additional funds received will be forwarded to your clients.”
• Scott: Advises that $$ ready to be transferred and requests assignment documentation to be executed.
• Some back and forth e-mails about the assignment and preparation of a general release.  Scott eventually files with the Court to enforce the settlement.

>>>>> Court determined that the parties had indeed reached a binding agreement, saying:

the parties’positions were clearly expressed in writings which are recognized under the [UETA].  The object of their communication was never anything other than a compromise,  We find no presumption of an intent not to be bound until the execution of a contract in a special form. 

So what should you do?  Stop using e-mail and voicemail?  Well maybe yes if you want to be super safe.  But for the rest of us who can’t imagine how we ever did business without e-mail and voicemail, the best answer is to be just a little more careful in using e-mail and voicemail.

• If you’re frequently using e-mail to reach a deal with someone, it may be a good idea to add a standard disclaimer below your signature line indicating that the message is not intended to form a binding contract until ultimately reduced to a single document signed by both parties.  If you don’t want to include this sort of disclaimer on all your e-mails, at least mention something early on, and perhaps later as well, about how of course everything needs to be reduced to a separate written agreement and reviewed by your attorney before it becomes binding. 
• When leaving a voicemail, don’t get so specific on all the terms unless you really are at the point that you’re ready to have a deal.  Sometimes it might just be better  to leave a short “call me” message.

Now that I’ve been doing this law blog thing for about eight months, I’ve had a chance to get acquainted with my neighbors in the blogosphere.  There are of course my subject matter compatriots all across the country that I’ve enjoyed coming to know through their blogs (Chris Moander of the relatively new Wisconsin Business Law and Litigation blog and Rush Nigut of Rush on Business from Iowa (the home in my youth) especially come to mind).  But today I wanted to focus on my geographically proximate neighbors practicing law in Ohio while writing their blogs.  

Like anyone else I have my favorites.  I don’t claim to be any arbiter of quality or worth so the following is really nothing more than what I’ve found I’ve liked the most so far. 

Perhaps my own personal favorite Ohio-based blog is The Briefcase which has been published by solo practitioner Russ Bensing for quite a while.   It promises to provide “commentary and analysis of Ohio law” and it certainly delivers.  Russ gives brief summaries and case updates of Ohio civil and criminal cases decided by the various Court of Appeals and the Ohio Supreme Court with a bit more criminal than civil cases.  While this is of course useful, his regular “Friday Roundup” feature focusing on the more entertaining legal cases out there is a must-read for me every week.  In addition, even the case updates and summaries are given with a definite bit of “attitude” that makes them much more interesting than the usual dry case summary.  And his “About” section is particularly well done.  Russ’s stuff is not often the sort of thing I tend to link to (which may say more about me than him), but I certainly appreciate his contributions.

My other “substantive” favorite  Ohio-based blog is the Ohio Employer’s Law Blog published by Jon Hyman of Kohrman, Jackson & Krantz  for more than a year.  Its tagline is  ”Practical employment law information for businesses in Ohio and beyond.”  What I like about this blog is Jon’s well written, informative, and useful (even “practical”) posts about important issues in the labor and employment law areas.  I also think Jon’s analysis of the legal issues he covers is clear and seems right on point.  In addition, I like his regular “What I’m Rreading” series which features several quick links to other interesting posts around the blogosphere.  I don’t practice in this area so I appreciate having such excellent resource available to keep me up to date about pertinent legal developments. 

Ohio Employer’s Law Blog is one of two Ohio-based blogs focusing on employment and labor issues.  The other is Porter, Wright, Morris & Arthur’s Employer Law Report which says it will be “Reporting on recent legal developments and trends affecting employers”.  It has been published sporadically over the last couple of years, but now seems to be adding new worthwhile posts more frequently. 

The D&O Diary published by Kevin M. LaCroix of Oakbridge Insurance Services, an insurance intermediary focused exclusively on management liability issues, focuses on perhaps the most complex issues of any Ohio-based law blog.  It is intended to be “A Periodic Journal Containing Items of Interest from the World of Directors and Officers Liability, with Occasional Commentary”.  I haven’t had much chance to become fully acquainted with this blog yet, but hope to so in the near future.

When it comes to coverage of both substantive and professional developments of interest to Ohio lawyers, I like the Cleveland Law Library Weblog the best.  It explains that ”our goal is to inform local attorneys of major legal developments important to their practice”.    I often find ideas for posts by reading this blog and appreciate the links usually provided.  The Cincinnati Law Library Blog  and the Moritz Legal Information Blog which provides “Legal Information and Research Resources Brought to You by The Michael E. Moritz Law Library at The Ohio State University” also provide these sort of services.

One of the newest Ohio-based law blogs is the Ohio Real Estate Blog published by the attorneys of the Real Estate Practice Group of Kohrman, Jackson & Krantz which started up only a couple of months ago in April.  In same real estate practice area is the Build on This! blog published by the attorneys of the Real Estate and Construction Practice Group of Buckingham, Doolittle & Burroughs, LLP which offers “Current news, information, and events affecting the real estate, construction and land use industry and its professionals”.

Another recent addition to the blogosphere is the Reasonable Doubts blog published by Jeffrey Davis.  It started in March 2008 and, as its name would suggest, focuses on crminal law.  In addition, the Ohio Family Law Blog, published by Robert Mues of Holzfaster, Cecil, McKnight & Mues, LPA, began in December 2007 and tries to provide “Family Law and Divorce Information for Ohio Families Seeking Solutions”.

Interestingly, there are TWO Ohio based law blogs called Sixth Circuit Blog.  One seems to focus on criminal law and offers “Case summaries and commentaries by federal defenders of the Sixth Circuit”.  The other, published more sporadically by Eric Zagrans, focuses primarily on civil law and is “Devoted to Appellate Law and Practice Within the Sixth Circuit and Its Constituent States”

Rounding out the roster of Ohio-based law blogs (at least those I’m aware of) are the following with which I am less familar, in part because they relate to areas of law with which I have less experience in my day to day practice:

• The Ohio Trust and Estate Blog published by Michael D. Bonasera of Buckingham, Doolittle & Burroughs, LLP
• Tsibouris & Associates Law Blog published by the attorneys at Tsibouris & Associates 
• Consumer Rights Law Blog published by Ron Burdge  and focusing on “Motor Vehicle Lemon Law, Consumer Protection Law, Car Law, News, Notes, Issues, and Updates”

While there are several newer Ohio based law blogs, there are also many that have been published for two or three years or even longer.  There are also some earlier Ohio-based blogs that are no longer publishing.  In addition, there are several “business” blogs based in Ohio that touch on legal issues from time to time, but that’s a subject for another day.

I hope I haven’t forgotten anyone, but if I have, just add a comment with your URL and then we’ll know about you too. 

Whether you’re a lender making a loan secured by a mortgage on real estate, a prospective buyer, or an unpaid tradesman making improvements to real estate, understanding Ohio mechanics’ lien law is very important.  Guernsey Bank v. Milano Sports Enterprises, LLC, 2008-Ohio 2420 (May 20, 2008), a decision recently handed down by the Franklin County Tenth Appellate District Ohio Court of Appeals, while not really that interesting as far as making new law, underscores this importance and should be seen as a warning of what could happen if proper procedures are not followed.  Francisco Luttecke of Bricker & Eckler LLP provides a useful and complete summary of the facts and holding of this case in an e-alert to whose mailing list I seem to have been added (not that I’m complaining).

Facts of Guernsey Bank Case.  At the most basic level, the Guernsey Bank case illustrates some of the problems that can arise in more complicated transactions.  The defendant Milano Sports Enterprises, LLC (”Milano Sports”) had entered into a purchase contract to buy an indoor tennis facility that it intended to convert into an ice rink.  Because Milano Sports wanted to get started on renovations immediately rather than waiting to close on the purchase, it entered into a lease agreement with the seller.  About two months later, the purchase was consumated and financed by a loan from Guernsey Bank secured by a mortgage on the subject real estate. 

Meanwhile, in the intervening two months, an electrical contractor and other tradesmen performed some of the work necessary for the conversion, but were not paid.  After the purchase transaction went through and the Guernsey Bank mortgage had been recorded, the electrical contractor and other unpaid contractors filed mechanic’s lien affidavits.  It should also not come as too much of a surprise that a few months after this, Guernsey Bank started foreclosure proceedings regarding the real estate. 

Eventually the property was sold at foreclosure sale for $525,000, leaving Guernsey Bank with a deficiency of approximately $75,000.  A priority fight broke out over who was entitled to the foreclosure sale proceeds with Guernsey Bank challenging the priority and validity of the mechanics’ liens.  Ultimately, Guernsey Bank received only about $137,000 of the foreclosure sale proceeds because the Court found the mechanics’ lien holders had priority.  Thus Guernsey Bank wound up with a deficiency of more than $475,000 instead of only $75,000. 

What to Know About Mechanics’ Liens.  Which brings us to the lessons to be learned from this rather ordinary case:

1. Mechanics’ liens CAN trump and have priority over previously recorded mortgages in certain circumstances.  If no notice of commencement is filed, the relative priority of a mortgage and a mechanics’ lien depends upon when the first of the labor or material was performed or furnished.  If the mortgage is recorded prior to any labor, work or furnishing, then the mortgage lien will have priority.  Ohio Rev. Code §§1311.13(A); 5301.23.  If, however, the labor, work or furnishing begin before the mortgage is filed for record, then the mechanics’ lien will have priority over the entire mortgage for the entire amount of the mechanics’ lienholder’s claim even if (A) some of the goods or services were provided after the mortgage was recorded or (B) the lien affidavit perfecting the mechanics’ lien is filed after the mortgage is recorded.  Ohio Rev. Code §§1311.13(A); 5301.23.
2. Determining when the first of the labor or materials were performed or furnished means establishing the date the “first visible” work or material being performed or furnished.  Ohio Rev. Code §1311.13(A)(1).  This test was set forth in the case of Huntington National Bank v. Treasurer of Franklin County, 13 Ohio App.3d 408, 469 N.E.2d 535 (10^th App. Dist. 1983) as

    whether the work performed had produced visible results which were sufficient to make it reasonably apparent to a person examining the site that the construction, excavation, or improvement had actually commenced…. In order for the work to be deemed the commencement of construction, it must form a part of the work necessary for the construction and be of a nature that can afterward be considered a component part of the structure.

   See also Schalmo Builders, Inc. v. Malz, 90 Ohio App.3d 321, 629 N.E.2d 52 (1993).

3. Make sure you get a title insurance policy and don’t just rely on a title insurance commitment.  One of the things Guernsey Bank did right was buy a title insurance policy pursuant to which the title company promised to indemnify Guernsey Bank against any loss or damage incurred because of the “[l]ack of priority of the lien of the insured mortgage over any statutory lien for services, labor or material [ ] arising from an improvement or work related to the land which is contracted for or commenced prior to the Date of Policy * * *.”  As a result, at least Guernsey Bank didn’t have to pay the mechanics’ lienholders out of its own pocket.
4. If you are the lender and/or purchaser in a real estate transaction, make sure you get an affidavit from the seller about off-record matters such as whether any labor or materials have been supplied to the property, just in case the title policy is not as generous as the one here.   
5. If you’re going to rely on the construction mortgage exception (set forth in Ohio Rev. Code 1311.14) to the special priority given mechanics’ liens, make sure you have more evidentiary support than a settlement statement (which the Court ruled was inadmissible in Guernsey Bank).
6. When preparing and filing a mechanics’ lien, take care to follow the form of affidavit set forth by statute.  Ohio Rev. Code 1311.06.  Guernsey Bank challenged the validity of one mechanics’ lien because it incorrectly stated the amount due.  While in this case, the Court upheld the validity of the mechanics’ lien,  the law in this area is often very strictly interpreted.  Crock Constr. Co. v. Stanley Miller Constr. Co., 66 Ohio St. 3d 588, 613 N.E.2d 1027 (1993).  Pursuant to Ohio Rev. Code §1311.06 - which helpfully contains an acceptable form — the lien affidavit must contain the following information: 
   • Amount due over and above all legal set offs
   • Description of the property sufficient to identify the premises with reasonable certainty, i.e as though for purposes of conveyance or by inclusion of the legal description contained in the deed conveying title to the owner (Ohio Rev. Code §§1311.06(D); 1311.04(B)
   • Name and address of the person to or for whom labor or work was performed or material furnished
   • Name of the owner, part owner, or lessee
   • Name and address of lien claimant
   • First and last days that the lien claimant performed any labor or work or furnished any material to the improvement giving rise to the lien
7. Another thing to remember is that an Affidavit of Lien must be filed with the county recorder for the county in which the property is located within seventy-five (75) days of the last day work was performed or furnished.  Ohio Rev. Code §1311.06(B)(3).  In addition, to perfect a mechanics’ lien, it is also necessary to serve the lien affidavit in accordance with the provisions of Ohio Rev. Code §§1311.07 and 1311.19 upon the owner of the subject property within thirty (30) days after it has been recorded by the appropriate county recorder; if service cannot be accomplished, then the lien affidavit must be conspicuously posted at the subject property within ten (10) days after the thirty (30) day service period.  Even if the contracting party has actual knowledge of the lien, it must still be served (or posted) to be valid.  Brown v. Pearson, 1995 Ohio App. LEXIS 2788 (2^nd App. Dist).

From the comfort and convenience of my office computer this morning, I watched the oral argument before the Ohio Supreme Court in Dombroski v. Wellpoint, Case No. 2007-2162.  In this case. the Court was asked to answer the question “when may a tort plaintiff pierce the corporate veil to pursue recovery from a “parent” corporation“.  The Court allowed both sides substantially more than the allotted 15 minutes each, asking both attorneys numerous questions. 

• As an aside I want to mention how wonderful it is to be able to see Ohio Supreme Court oral argument without the hassles of parking and transportation. The Ohio Supreme Court has been doing this since early 2004. but this was my first experience utilizing the option. Not only did I save the time coming and going (in pouring rain today I might add), I tuned in a little early and was able to work on other matters right up to the minute oral argument began. The picture is clear and shows close-ups of the attorneys and Justices as they speak. The sound quality is terrific. In many respects, this was actually better than going in person.  You can still see the oral argument by going to the video archives.
• I have a case coming up shortly before the Ohio Supreme Court which does involve the corporate veil piercing issue. So I suppose I’m just a little more interested than I otherwise would be, even though at the moment we’re only up on a preliminary procedural issue. (If I don’t win on that, we’ll be back on the corporate veil piercing issue later.)

Suzanne Richards of Vorys, Sater, Seymore & Pease argued on behalf of the defendant-appellant “parent” company shareholder against which plaintiff-appellee Dombroski seeks recovery.  Robert Palmer appeared on behalf of Ms. Dombroski.  Both attorneys were extremely well prepared.  Although the Ohio Council of Retail Merchants, Ohio Chamber of Commerce,  the Ohio Chapter of the National Federation of Independent Business, and the Ohio Farm Bureau Federation jointly submitted an amici curaie brief in support of the defendant parent company, they did not participate in the oral argument.

Factual and Procedural Background.  In a nutshell, the most salient facts are that Ms. Dombroski was denied insurance coverage for a procedure deemed “experimental”.    Ms. Dombroski had a health insurance policy issued by defendant Community Insurance Company (”CIC”) which utilized Anthem  UM Services, Inc. (”AUMS”) to administer its policies and process claims.  Still another company, Anthem Insurance Companies, Inc.  (”AICI”) defined the scope of the coverages under CIC policies.  CIC, AUMS, and AICI were all subsidiaries of  defendant Wellpoint, Inc. (”Wellpoint”).  Coverage was apparently denied as a result of a blanket policy by defendant AICI.  Dombroski sued everyone for bad faith denial of her claim.  Counsel for Ms. Dombroski conceded that undercapitalization was not an issue.

AICI and Wellpoint filed motions to dismiss each of them as a party defendant on the grounds that the contract was with CIC and not with them and there was no grounds for bypassing the corporate entities.  The trial court agreed, but the Seventh Appellate District Court of Appeals reversed, holding that the second prong of the Belvedere test could be satisfied through the showing of an “unjust” or “inequitable” act even if it did not rise to level of fraud or illegality  On appeal, the proper interpretation of Belvedere for determining when it is appropriate to pierce the corporate veil was certified because of a conflict among the Courts of Appeal.

Oral Argument Synopsis.  All of this is a very long introduction to the oral argument itself.  Counsel for Wellpoint emphasized that the second prong of  Belvedere required the parent company/shareholder to have “perpetrated a second wrong” by deliberately destroying the ability of the defendant subsidiary to satisfy any judgment against it.  Counsel for Ms. Dombroski emphasized that “piercing the corporate veil” is an “equitable argument” and that insurance bad faith claims are “fairness torts”.  He also emphasized thhat Wellpoint set corporate policy for the subsidiaries.  Several of the Justices seemed to have difficulty understanding the complete corporate structure and a couple asked if perhaps the case was not yet ripe for determination.

Justice Pfeifer suggested that perhaps the Court didn’t think all that carefully about  the test formulated in Belvedere because the veil piercing was a relatively small part of that case and that the whole test should be re-evaluated.  Later in the oral argument, he posed the question of what would happen if and when the plaintiff tried to depose the nonparty parent regarding the establishment of the policy leading to the denial of coverage.

Chief Justice Moyer suggested that, although the question certified was the proper interpretation of Belvedere, the case could actually be decided on much narrower grounds.  He posited that if a medical insurance company sets up a subsidiary with the purpose of hindering recovery by plaintiffs, that would be “illegal” and easily fall within all interpretations of Belvedere’s second prong.  Justice Lanzinger later asked a similar question.

Justice Stratton seemed to think (and I tend to agree) that Dombroski should have an adequate direct claim against CIC and consequently no veil piercing argument was necessary.  Justice O’Connor was concerned that focusing on whether an “unjust” or “inequitable” act might “open the floodgates” for litigation in this area; she indicated that she felt that there had to be “some level of dishonesty”  before recovery could be had.      

My Thoughts.  I tend to agree that more must be proven than just that there was an “unjust” or “inequitable” act perpetrated on the plaintiff to justify piercing the corporate value.  Otherwise the three prong test of Belvedere is really collapsed into a single inquiry.  I also think that sometimes the world is not fair and people who really don’t deserve it suffer misfortune; I don’t think that someone else should be held responsible for this occurrence in every case.

At the same time, I am not altogether sure that the more stringent test really helps the defendant “parent” company in this particular instance.  It does seem to me that the multiplicity of subsidiaries may well have been set up to thwart policyholders seeking to challenge denial of coverage.  To the extent that is true, I think the parent company may have abused the underlying  conceptual policies of limited liability and should be denied the benefits of that legal doctrine as a consequence.

I am also concerned, however, as to what effect a more “flexible” standard for determining when piercing the corporate veil is permissible would have on closely held companies with a limited number of individuals as equity owners.  Here, especially, something more sinister than suffering by the plaintiff ought to be required.  If that is all that is necessary, then every complaint should include a count seeking the piercing of the corporate veil.  Almost by definition, if there is any actionable claim at all, it is because something “unjust” or “inequitable” happened to the plaintiff.

Perhaps the answer is to introduce further confusion by bifurcating the standards for piercing the corporate veil, having one applicable only to closely held entities, or at least to imposing personal liability against individuals, while the other is applicable only to more sophisticated transactions.

Oh yeah - how do I want it to come out to help my case?  I like the Belvedere standard just as it is, thank you, and wouldn’t mind if you made it even more restrictive.

For more on the piercing the corporate veil concept and Belvedere, read my previous post on Piercing the Corporate Veil- What It Means and How to Avoid It. 

Everyone hates insurance companies, especially when they deny individual policyholders coverage for medical treatment.  But does that mean that corporate formalities should be ignored to permit the unfortunate policyholder to bring an action against the parent company of the subsidiary denying coverage on the grounds of a bad faith breach of the insurance policy contract?  Is it enough if the Court finds that “unjust” or “inequitable” acts have occurred even if they don’t rise to the level of fraud or illegal action?  On its face, that is what the Ohio Supreme Court is called upon to decide in Dombroski v. Wellpoint, Inc., et al., Case No. 2007-2162 when  it hears oral argument in the case on Wednesday (June 4, 9 AM, third case on the docket) this week.    

Interpreting Belvedere.  However, the Ohio Supreme Court has taken the opprtunity to resolve a conflict among Ohio Courts of Appeal concerning what is required to “pierce the corporate veil” and impose liability upon a corporation’s shareholders or upon the parent company of a corporate subsidiary.  In a January 23, 2008 Entry, the Court ordered the parties to brief the following:

Does the second prong of Belvedere Condominium Unit Owners’ Assn. v. R.E. Rourke Cos.. Inc. (1993), 67 Ohio St.3d 274, which states that the corporate veil can be pierced when control of the corporation “was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity” also allow the corporate veil to be pierced in cases where control was exercised to commit unjust or inequitable acts that do not rise to the level of fraud or an illegal act?

The Ohio Supreme Court’s Communications Office has prepared a concise summary of the factual and procedural background of the Dombroski case, as well as the specific insurance-related issue presented.  You can see and hear the oral argument from the comfort of your own computer, either live or in the archives as early as close of business on the day of oral argument, through the use of streaming video technology. 

By consulting the Supreme Court’s on-line docket, you can also review or download the briefs filed in the case, including an amicus curiae brief filed jointly in support of the appellant-defendant parent company by the Ohio Council of Retail Merchants, Ohio Chamber of Commerce,  the Ohio Chapter of the National Federation of Independent Business, and the Ohio Farm Bureau Federation.  The defendant-appellant’s brief has a rather extensive survey of caselaw in Ohio and elsewhere addressing the proper standard for “piercing the corporate veil.” 

Deciding What It Takes to “Pierce the Corporate Veil”.  The Belvedere decision established a three prong test to be met before a corporate form may be disregarded and shareholders held personally liable for the misdeeds of a corporation, namely:

• Control over the corporation by those to be held liable so complete that the corporation had no separate mind, will or existence of its own.
• Control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity.
• Injury or unjust loss resulted to the person seeking to disregard the corporate entity from such control and wrong.   

Some courts, including the Seventh Appellate District Court of Appeals below in the Dombroski case (173 Ohio App.3d 508, 2007-Ohio-5054, 879 N.E.2d 225), have broadly interpreted Belvedere to include situations in which the corporate form was abused to the detriment of the plaintiff, but no illegal act or intent to defraud could be shown.  These cases include:

• Wiencek v. Atcole Co., Inc. (3d Dist. 1996), 109 Ohio App.3d 240, 671 N.E.2d 1339
• State v. Tri-State Group, Inc. 2004-Ohio-4441 (7^th App. Dist.)
• Stypula v. Chandler,  2003-Ohio-6413 (11^th App. Dist.)
• Sanderson Farms v, Gasbarro, 2004-Ohio-1460 (10th App. Dist.)
• Dalicandro v. Morrison Rd. Dev. Co., Inc., 2001 Ohio App. LEXIS 1765 (10th  App. Dist.)
• Robert A. Saurber Gen. Contractor v. McAndrews 2004-Ohio-6927 (12th App. Dist.)

 Other cases have held such an interpretation to be too expansive:

• Collum v. Perlman, 1999 Ohio App. LEXIS 1938 (6th App. Dist.)
• Widlar v. Young, 2006-Ohio-868 (6th App. Dist.) 
• Nursing Home Group Rehab. Serv., LLC v. Suncrest Health Care, Inc., 162 Ohio App3d 577, 2005-Ohio-3945
• Siva v. 1138 LLC, 2007-Ohio-4677 (10th App. Dist.)

What Should the Standard Be?  Many of the cases involving ”piercing the corporate veil” focus on smaller privately held corporations in which the individuals constituting the shareholders have not adequately capitalized the business enterprise, commingled corporate and personal funds, or otherwise ignored corporate formalities.  In these cases, it is fairly easy to reach the conclusion that the corporate form should be disregarded.

The Domboroski case presents a more difficult situation.  As explained in plaintiff Dombroski’s brief:

The facts in Dombroski present the challenge of how the doctrine of piercing the corporate veil is to be applied in the realtiy of today’s insurance organizations, which frequently includes a parent corporation that does business through many subsidiaries…. Multi-state insurers, such as WellPoint or “nthem”, which run its insurance business through affiliates while utilizing an integrated and centralized web of policies and procedures seek to return to the “good old days” when they were free to refuse or pay claims - for good reasons, for bad reasons, for no reason at all - safe in the knowledge that regardless of the unjust resulta their decisions bring to their insured….

However, I agree with the appellant parent company and amici curiae that encouraging the expansive view of “piercing the corporate veil” advocated by plaintiff Dombroski is likely to result in shareholders, particularly in closely held companies, being added as defendants virtually anytime the company itself is sued.  As the amici curiae  brief puts it:

If the opinion below is upheld by this Court, shareholders of Ohio corporations would face being haled into court and held personally liable whenever a tort claim is asserted against the corporation, or the corporation is alleged to have violated a regulatory statute, or the corporation is portrayed as having engaged in conduct that is characterized by the plaintiff as “unjust or inequitable.”  Such a result would have devastating consequences for the concept of limited shareholder liability and for the ability of small business owners to use the corporate form as a successful engine for economic growth, jpb creation, and social progress.   

The defendant-appellant parent company’s brief makes the further point that:

Because it jettisons the most salient factor of proper veil-piercing analysis - that the shareholders must misuse the corporate form to perpetrate a fraud or an illegal act - the appellate court’s interpretation will make veil piercing more common. That result, in turn, would make it less likely that entrepreneurs will form corporations and that investors, large and small, will invest in those corporations as they conduct business activities and help the economy to grow.

My concern here is that the desire to rein in insurance companies, and what some might perceive as their arrogance, will result in “bad law” being established in this area.  While it might seem attractive under the facts of this case to be less insistent upon requiring a demonstration of fraudulent or illegal intent, the result will certainly give both large and small businesses pause.  If the focus of the “piercing of the corporate veil” analysis shifts from the actions and motivations of the company’s owners to the nature of the plaintiff’s loss, the utility of the corporate form will become much less for businesses.  Ohio’s business climate will be viewed even less favorably.

It will be interesting to see how this case unfolds.   

Suppose you’ve made an investment in an LLC running, say, a nightclub.  It’s a manager-managed LLC so someone else is handling the day to day affairs of the company.  Then, what was once a popular hot spot becomes passe and the business becomes less profitable.  So you start to worry about how things are being done and may even suspect that there has been some financial mismanagement.  You decide to take a look at the company’s books yourself, but are surprised to find that the manager of the LLC refuses to give you access.  Can he do that?  

Peter Mahler over at the New York Business Divorce blog (which has a terrific and very appropriate masthead of two hands engage in a tug-of-war) posted last week on divergent results reached in two New York cases concerning the right of non-managing LLC members to inspect the books and records of the company.  He also pointed out that the New York statutes governing access to a company’s books and records differed depending upon whether the entity was formed as a corporation or a limited liability company.  

What LLC Members Have to Do to Get Information.   Because the pertinent Ohio statute (Ohio Rev. Code 1705.22) is similar to the New York statute, I became interested.  Like New York, Ohio law provides LLC members  with a right of access to certain specified types of information, including financial information “upon reasonable demand for any purpose reasonably related to [the member's] membership interest in the company“.  In both states, one of the categories of information includes a catch-all “other information regarding the affairs of the company that is just and reasonable“.  And what does that mean?

Peter describes two recent New York cases reaching opposite results, with one holding that the member was entitled to the documents sought and the other concluding that the request was too vague.  To be fair, in the case denying the member access to LLC records, there was already litigation pending and the member was refusing to pay for the expense of copying.  In dicta, however, the court said that the desire to obtain documents to determine if the LLC manager had engaged in fraud or other wrongdoing went “well beyond the scope of the type of documents detailed in the Limited Liability Company Law.” 

In the other case described by Peter, the LLC members seeking access wanted to determine if the LLC manager had caused the LLC to improperly enter into a management contract with a certain third party in violation of Department of Health regulations.  The court determined that access to the books and records sought was required.  In contrast to the first case, the court chose to interpret the statute broadly, placing the burden on the company to justify the restrictions rather than on the member to justify inspection rights:

Respondent’s assertion that petitioners must demonstrate a need to review the records before such records are made available is without merit.  The only statutotry requirements for obtaining full access to the records is that the person demanding access is a member at the time the demand is made and that the demand is reasonably related to the member’s interest.

I didn’t find any Ohio caselaw interpreting its version of the statute.  Ohio law in the analogous situation of shareholders seeking access to corporate books and records has been to place the burden on the company to demonstrate the sound basis for any restrictions.  However, to be certain access to company records is at the level desired, it is best to spell it out in the Operating Agreement.  

Comparison with Access to Books and Records of Corporation or Partnership.  Which brings me to Peter’s other interesting point - namely, the statutes governing access to a company’s books and records are not identical to one another, regardless of whether the entity has been formed as an LLC, corporation. or partnership.  In New York, there is apparently a statute that makes obtaining access to the books and records of a corporation a bit more complicated to obtain than in the LLC context.  Ohio doesn’t have this sort of procedure, but Ohio Rev. Code 1701.37(C) does seem to establish a slightly different standard for shareholders seeking access to the corporation’s books and records.  Here, the shareholder “upon written demand stating the specific purpose thereof” may have access “at any reasonable time and for any reasonable and proper purpose.”  

Limited partners in Ohio are entitled pursuant to Ohio Rev. Code 1782.21 to access to partnership books and records “upon reasonable demand for any purpose reasonably related to the limited partner’s interest as a limited partner.”  This is quite similar to the LLC statute’s language.  However, unless prohibited by the partnership agreement, the general partner does have the right under Ohio law

… to keep confidential from limited partners, for the period of time that the general partner considers reasonable, any information… which the general partner in good faith believes is not in the best intersts of the limited partnership or could damage the limited partnership or its business…

There is no similar provision with respect to LLCs.

Do these language differences mean anything?  Francis Pileggi of the Delaware Corporate and Commercial Litigation blog also recently noted a difference in the access to records in Delaware statutes governing LLCs and corporations.  He describes a recent Delaware case involving an LLC in which the Delaware Chancery Court chose to turn to caselaw regarding the question in the context of corporations.

Whether access to the books and records of a company is given to equity holders will undoubtedly be determined on a case by case basis.  However, to me, it makes little sense to distinguish among types of entities regarding the level of access equity holders should have to the books and records of the company.  Why should an equity holder in a 3 person manager-managed LLC have different rights than the shareholder in a close corporation with three shareholders? 

  On the other hand I can see logic in distinguishing between entities depending on the sopistication of the company and number of equity holders.  In the case of “closely held” entities with only a few owners, the presumption ought to favor the equity holder.  As the entity grows larger, and is perhaps even a public company, the burden on the company and the possiblity of abuse of the right by dissident equity holders seems greater.  So here I would tend to support placing more of a burden on the equity holder to justify the need and purpose for seeking access.   

Your business supplies a service or product to a customer and then bills the customer.  One month goes by, then two, and you hear nothing from the customer - no payment, no complaint, no explanation.  By the third month, you are probably becoming rather irritated at the very least and depending on how things are going financially, may be getting a bit concerned.  Or perhaps you’ve called the customer only to receive a series of excuses and promises that payment will soon be forthcoming.  What do you do?

Chris Moander of the Wisconsin Business Law and Litigation blog has been making a series of posts about how and when to make the decision to go to court to collect these sort of delinquent accounts.  My favorite, with the attention-getting title of “Would lower legal bills motivate you to organize your files?”, explains what sort of information and records are helpful to your attorney when you turn the account over ro him or her for collection.  

What to Give Your Attorney.  I agree with everything on Chris’ list and with his general point that the more organized information you can give your attorney about a delinquent account, the more quickly — and inexpensively — things can move forward.  While all of the items mentioned by Chris are certainly helpful, here’s my list of what I find especially useful when I am asked to file a lawsuit against a customer who hasn’t paid as agreed:

• Basic contact information (i.e.name, address, phone) of customer
• Credit application, purchase order, or contract documenting the purchase
• Invoice
• Ledger or account history for at least the last 3-4 months
• Copy of any checks previously sent by the customer (or information about the bank used by the customer)
• Any correspondence (including e-mails) exchanged (i.e. sent to, or received from) the customer relevant to the outstanding debt
• Any pertinent information about general nature or length of the relationship with the customer, i.e. was it generally good before this or has this customer always been difficult, is this a huge part of your revenues

With this information, I can get a fairly good idea of what the best approach might be and have what I need to file a lawsuit.  Getting it on the front end saves both time and money.

Why Collect?  Chris also addresses the question “Why collect?”, and in another post entitled “Time to call Mr. Wolf”, provides some guidelines concerning when it might be time to turn the matter over to your lawyer.  Again I agree wholeheartedly with Chris, but let me add some additional thoughts.  As far as the “why”, that much seems rather self-evident.  Unfortunately, the world is not a perfect place and not everyone voluntarily does what they should.  If you’re not willing to force the issue of payment when appropriate from time to time, it won’t be long before you find you’re not making any money and may have to go out of business altogether.

Deciding When to Pursue Legal Action.  Knowing “when” to pursue payment through legal channels and “when” it might be helpful to turn the matter over to your attorney is more complicated.  As Chris suggests, if any of the following are true, it probably is time to “go legal”:

• The account is 90 days past due, and in some cases, even sooner.  If you wait too long to pursue legal action, events and circumstances may have occurred in the interim which make the legal option less effective
• Suddenly there’s a “problem” with the product or service sold or the customer now has some other dispute with you and the customer wants some or all of their money back.  Of course in many cases, it makes good business sense to just go along with the customer and give a discount.  However, make sure you are doing that in appropriate cases.
• You’ve endured a series of excuses and broken promises that payment is right around the corner.

There are also times when it probably doesn’t make sense to play the “legal” card:

• If there really was a problem or defect in the service or product, even if it wasn’t near as big a deal as the customer is now making it
• The amount at stake is relatively small (or relatively small in comparison to the complexity of the situation resulting in nonpayment - read, lots of legal fees to sort through the facts and counter-allegations)  
• You have very important noneconomic reasons for wanting to avoid a dispute - perhaps it’s your wife’s brother’s business
• Someone in your company engaged in some sort of objectionable behavior or made what could be characterized as misleading statements to the customer about any aspect of the business relationship between you (e.g. one of your sales people said somethingto the customer about waiting for the customer to get back on their feet before pressing for payment)
• There’s virtually no chance the customer has any money or assets available to pay any judgment obtained

Thus knowing “when” it’s time to pursue legal action is a case by case decision.  Often the choice will not be clear-cut. 

Once you’ve made the decision to pursue legal action, if the debt is small, you may still be able to handle it without the intervention of a lawyer if you really want to do so.  In Columbus where I live and practice law, and elsewhere throughout Ohio (and probably in other states as well), there are “Small Claims Courts”.  In Ohio, these courts only have jurisdiction to hear matters involving $3,000 or less.  In addition, while it is possible for an officer or employee of the company to handle the case on behalf of the company without an attorney, he or she may only present documents such as invoices and testify only about facts of his or her own personal knowledge; no questioning or cross-examination of the customer’s witnesses is permitted.  The Small Claims Division of the Franklin County, Ohio Municipal Court has prepared a very useful synopsis of how this court works.

If you decide to consult an attorney, that does not necessarily mean there has to be a lawsuit.  Often a letter from your attorney can prompt a response from the customer and it will be possible to work out a payment plan or other resolution of the matter.  An attorney can also help you make the determination whether pursuing collection makes sense in a particular case.