De Facto Corporation Doctrine Also Applies to an LLC

One of the main reasons to establish a corporation is to avoid personal liability for the corporation’s debts.  However, the protection may not be available if there was some defect in the way the corporation was formed, or the corporation had not yet been formed when a contract is signed.

In Duray Development, LLC v Perrin, the issue was that the defendant had signed a contract and Articles of Organization to create a new limited liability company on the same date.  However, the Articles were not officially accepted by the State of Michigan until a month later.  The plaintiff tried to hold the defendant individually liable for the contract because the limited liability company did not legally exist on the date the contract was signed.

Michigan Courts have recognized the concepts of “de facto corporation” and “corporation by estoppel” for years as they apply to corporations.   The de facto corporation provides that a defectively formed corporation—one that fails to meet the technical requirements for forming a corporation—may still receive the protection of a corporation if the incorporators attempted in good faith to form the corporation, signing the necessary documents.

Corporation by estoppel is not a legal status, but an equitable remedy.  The court will hold that when a body assumes to be a corporation and acts under a particular corporate name, and a third party dealing with it under such assumed name believes it Is actually dealing with a corporation, the third party is estopped (prevented) to later deny its corporate existence.

These two concepts typically arise in situations where the court has to assess corporate versus individual liability. The issue of first impression before the Michigan Court of Appeal in Duray Development, LLC v Perrin (decided April 13, 2010) was whether these same legal doctrines apply to limited liability companies, which is a newer type of entity.  The Court of Appeals held that because the Business Corporation Act and the Limited Liability Act relate to the common purpose of forming a business and because both statutes contemplate the moment of existence for each, they should be interpreted in a consistent manner.  Therefore, the Court of Appeals ruled that the de facto corporation doctrine is also applicable to limited liability companies.

The Court of Appeals did not decide whether the doctrine of “corporation by estoppel” also applies to limited liability companies, because the defendant did not raise the issue at the Circuit Court level, so the issue was not properly before the Circuit Court.  However, the Court of Appeals’ reasoning in Duray Development strongly suggests that this legal doctrine will also apply to limited liability companies.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

Where is your Businesses “Nerve Center”?

The United States Supreme Court recently decided a case that will assist corporations in removing litigation from the often unfriendly confines of state courts to the more neutral federal court system.    Under federal law, a case filed in state court can be removed (transferred) by the party being sued if there is diversity of citizenship, meaning the parties are citizens of two different states.   However, different federal circuits have applied different standards and tests as to how to determine a corporation’s “citizenship.”  The recent decision in Hertz Corp v Friend, now provides clarity and uniformity as to how a corporation’s citizenship should be determined when a federal court is deciding whether it has jurisdiction over the case because of diversity of citizenship.

To determine whether Hertz was a citizen of California for purposes of jurisdiction, the lower courts held that the level of Hertz’s business activities within the state were significant enough to satisfy the “principal place of business” standard under the diversity jurisdiction statute.   Because the lower court determined that Hertz was a citizen of California, and the plaintiff was as well, there was not diversity of citizenship and the case could not be removed to federal court.

The recent decision by the U.S. Supreme Court adopted a “nerve center” standard for addressing where their principal place of business was and the question whether the corporation was a citizen of the respective state for purposes of diversity jurisdiction.  The “nerve center” standard focuses on the location of the corporation’s core executives and where administrative functions are primarily carried out.    The application of the new standard will make it easier for corporations to remove cases to federal courts when they are being sued in a forum outside of the state where their “nerve center” is headquartered.

Click here to download a copy of the decision in PDF format.

Don’t Sign the Satisfaction Unless You’re Satisfied

The Michigan Court of Appeals recently reaffirmed the Michigan Common Law that when a plaintiff enters into a release and provides an accord and satisfaction to settle a lawsuit, that if the plaintiff seeks to later repudiate the accord and satisfaction, he or she must return all the money that was paid by the defendant originally to settle the suit before a new suit may be commenced.    An accord and satisfaction is more than a release of a claim. An accord and satisfaction requires that the claim be disputed and the substituted performance be agreed upon and accomplished.

In the case decided by the Michigan Court of Appeals, the plaintiff purchased a manufactured home from the defendant.   Soon after the plaintiff took possession, she discovered several serious defects and sued the defendant.    The parties reached an out-of-court settlement, wherein the defendant agreed to repair all the various defects and pay plaintiff and her attorney $8,500.  After the repairs were made, plaintiff inspected the repairs with her attorney and signed off on them, signing both a release and satisfaction.

A year later, plaintiff discovered high levels of toxic mold, later filing suit against the same defendant arguing that the defendant breached the settlement agreement by not completing the original repairs in a workmanlike manner.

The Court of Appeals affirmed the trial court’s holding that nothing prevented the plaintiff from having a professional inspect the defendant’s work before she signed the original satisfaction.   Just because the mold was not visible to the naked eye does not mean the satisfaction does not cover it.    Thus, plaintiff’s second lawsuit was an attempt to repudiate the release that she gave defendants originally.    The Court held that because plaintiff signed the release and satisfaction, and because defendants made the repairs and paid her, the contract was complete.    The Court held because plaintiff was attempting to repudiate the release she must give back the consideration before filing suit.    If she had not signed the satisfaction, she could have filed suit without having to return the money first.

Click here to download a PDF copy of the Michigan Court of Appeals Decision in Bain v Community Sales.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

Is the Other Side Liable for Attorney’s Fees if I Win My Case?

In most countries when a party loses an adversarial proceeding such as a lawsuit, he or she is made to pay for the other party’s costs and attorney’s fees.   However, the United States subscribes to what is in essence a no-fault legal system where both parties pay for their own legal fees and costs despite which party prevails.   There are statutory exceptions, but again these are exceptions, not the rule. Michigan has select statutes where attorney’s fees are awarded to a prevailing party such as consumer protection laws or civil rights violations.  Parties are also free to include language in a contract wherein should litigation be necessary; the non-prevailing party would be liable for the other party’s attorney’s fees and costs.  Michigan statutes and Court Rules also provide for an award to any party in a lawsuit, if another party has forced him to expend money on attorney’s fees to defend against a claim utterly or substantially lacking any possible merit.   This is typically called a frivolous lawsuit.   Again, the awarding of attorney’s fees and costs is the exception and not the rule.

Recently, our firm won two separate awards of attorney’s fees for two companies in lawsuits they were forced to file or defend.    In the first case, the statute allowed for attorney’s fees and costs to our client when the opposing bank refused to honor an irrevocable letter of credit.    Our second case involved the judge ruling that based on the statute and the Michigan Court Rules the other party’s complaint was so frivolous that sanctions, including attorney’s fees and costs were warranted.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

What You Need to Know About Severance Agreements

Contrary to popular belief, employers are not obligated to provide severance pay upon an employee’s termination of employment due to a layoff. If an employer does choose to provide severance pay, it should be accompanied by a severance agreement.

The most important provisions in a severance agreement are those regarding payment, non-competition, and the release of claims. In a severance agreement, the employee typically agrees to accept payment in exchange for agreeing to release employer from claims he or she may have against employer. It is also very typical for a severance agreement, like many employment agreements, to include a non-compete provision. An agreement not to compete should be reviewed for reasonableness, which will vary depending on the specifics of the situation.

It is recommended that employers offer the terminated employee a reasonable period of time to consider signing a severance agreement with a release. A release is unenforceable unless the employee voluntarily executes it, i.e., the execution is not the result of duress or coercion.

Employers should make sure to have legal counsel draft or review their severance agreement to ensure that the employer is adequately protected. Employees should consult legal counsel before signing a severance agreement to ensure that the agreement terms are fair and reasonable.

This article was written by Natalie C. Najarian, Associate at Demorest Law Firm.

A Contract Could Effect Damages in a Lawsuit

In a previous article we had examined the fact that the Michigan Court of Appeals affirmed the common law principle that contract provisions that shorten the statutory period for bringing a cause of action are allowable.   Recently, the Court applied similar reasoning in affirming the principle that a contract can even limit the amount of damages if the agreement is violated. The parties can agree in their contract to limit the damages to only those that occurred within a certain period of time before the date that the lawsuit was filed.

In the Michigan Court of Appeals case Bronco Oil v Citizens Bank (click here to download), the contract language, in essence, immunized the breaching party from having to pay the damages it allegedly caused because they occurred outside of a 12-month period before the lawsuit was filed. Even though the lawsuit was timely, the potential damages were lost because of when the lawsuit was filed.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

Don’t Sign Away Unrelated Rights on Release Agreements

In all aspects of business and contracting, but especially after a lawsuit has been filed or threatened, one party may approach the other party with a comprehensive release agreement as part of a settlement of the dispute.     A release agreement is a form of contract wherein the party who has allegedly committed the wrong requests a written release of the claim from the aggrieved party in exchange for a settlement payment.    The release may be specific to the claims involved in the dispute, or it may be a “general release” of all claims of all types between the parties.  Once the claim is released, the agreement is binding on both parties, and the claim is rendered inactionable.   The terms of the release are negotiable.  Just because you didn’t author the document does it mean you do not have a say in what claims you are releasing.

Here is a scenario where a general release was used, which demonstrates the importance of reviewing the specific language used.   The example comes from the recent case of Levy v Ford Motor Company (Click here for a PDF of this decision).   Party A had a history of contracting with Party B for delivery of construction materials and services. In October 1998, an incident occurred involving a truck owned by Party A and a train owned by Party B. Each party maintained that the other was responsible. Party B issued a debit memorandum in 2001, and thereafter stopped paying invoices to offset its alleged losses from damage to its train.   In connection with other contracts, Party A sued Party B for payment for ready-mix concrete shipped after May 2004. The parties settled that case, and their agreement included a release that comprehensively waived any further claims Party A might have against Party B “from the beginning of time,” but “with the sole exception of any claim arising out of damage to the train equipment.

In 2007, Party A filed an action as a claim for payments due under invoices dating from “2001 and before” in connection with deliveries of materials to Party B.  Party A sought monetary contract damages plus an accounting.   However, the Court held that Party A had already released any and all claims it might have otherwise had against Party B arising from events prior to 2004, despite the fact that the claims were not related to the train accident. Because of the comprehensive language and nature of the release it had signed in the first settlement, Party A wound up releasing any and all claims it could have had against Party B, despite the fact the causes of action were completely different.

Always have an attorney review your settlement and release documents to ensure you are preserving valuable rights and not being taken advantage of in the settlement.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

Settlement Discussions: What You Say Will Not Be Held Against You

An estimated 95% of lawsuits brought in Michigan are settled out-of-court, without ever going to trial.  Trial preparation is expensive and fears of excessive verdicts are a major motivating factor for small businesses to settle matters.  A settlement amount might not always be palatable because it is lower or higher than expectations, but it removes the unknown variable of an unpredictable jury or judge from the equation.

Both the Michigan Rules of Evidence and the Federal Rules of Evidence recognize the vital importance of settlement discussions between two or more parties involved in active litigation.  The specific settlement rules recognize the need to afford protections to parties before they enter into settlement discussions.   The litigants will only arrive at a meaningful settlement if they are assured that they can speak freely without any offers, admissions, or other details being used against them at trial, should a settlement not be reached.

The relevant Michigan Rule precludes the admission at trial of any of the content of the settlement discussions, any amounts offered to settle the case, or any discussion of liability.  This protection allows the parties to speak freely without the fear of a jury learning of a settlement offer and possibly using it as a floor for its verdict.

Before commencing settlement discussions, it is important that your attorney inform the other party that you are undertaking settlement discussions pursuant to the Rules of Evidence and require all participants sign a document signifying their understanding of the purpose and inadmissibility of the discussions.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm.

Forum Selection Clauses

When entering into agreements with larger business entities, whether it be to lease a photocopier or host your website, for example, it is critical that you read the entire agreement, including one possibly costly paragraph – the choice of forum clause. A choice of forum clause binds the parties to litigate the matter in the state or county selected by the offering party. This clause is usually boilerplate language and typically glanced over by the accepting party. However, the inclusion of such a clause could cost you or your company thousands of extra dollars in legal fees should you be sued for failure to make payments or another issue related to a breach of the agreement.

An example would be a pre-printed, non-negotiated commercial lease for an office photocopier. There is typically no room for negotiation other than the price. These agreements also typically contain a choice of forum clause wherein as a party to the lease you have agreed that any disagreements related to the lease will be litigated in the state where the leasing company is located. Should you or your company begin missing payments or have some other dispute with the leasing company, the leasing company would be allowed by the terms of the agreement to sue you in their home state, as far away as New York, Florida or California. You would be required to locate an attorney in that jurisdiction to defend your interests. You might also be required to travel there for a deposition of trial. If you ignore the lawsuit filed in the selected forum, a default judgment could be entered against you, and the Judgment then recognized and enforced by Michigan Courts because of the language in the agreement.

Before entering into an agreement, it is imperative that you review all the language and the fine print, including the choice of forum clause and know that should you have a dispute with the other party, you could be hauled into court in a different state. You may be able to negotiate to remove the forum selection clause from the contract, or simply choose another vendor.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm. Click here to view his professional resume.

WHAT IS A PRELIMINARY INJUNCTION

A typical lawsuit seeks the court’s aid in collecting monetary damages where there has been injury to property or person or one individual has failed to live up to their end of a bargain.     However, there is a mechanism is available to prevent a party from taking an action that can’t be adequately compensated through payment of money.    It is in this scenario where a party would seek an injunction from the court.   A preliminary injunction is a judicial remedy issued in order to prohibit a party from doing or continuing to do a certain activity while the lawsuit is pending.    Examples of injunctions are the prohibition of employee layoffs, enforcement of a non-compete agreement,  preventing a tree from being cut down, or a building from being bulldozed.

Injunctive relief is an extraordinary remedy.    That is because most wrongs can be remedied by financial reparation.   However, as an example again, a 90 foot oak tree cannot be replaced once it is cut down.    The first step for a party seeking to stop an action would be to seek a preliminary injunction.   A preliminary injunction serves to preserve the status quo pending a final hearing, enabling the rights of the parties to be determined without injury to either party.

To determine whether this equitable relief should be granted, the issuing court must consider (1) the likelihood that the party seeking the injunction will prevail on the merits; (2) the danger that the party seeking the injunction will suffer irreparable harm if the injunction is not issued; (3) the risk that the party seeking the injunction would be harmed more by the absence of an injunction than the opposing party would be protected by issuance of the injunction; and (4) the harm to the public interest if the injunction is issued or not issued. All of these prerequisites must be met before a preliminary injunction may be granted.

The preliminary injunction is a mere stop gap, but not the final decision on the matter.  The preliminary injunction maintains the status quo until both sides can present evidence to the deciding court whether or not the subject action should be allowed to be undertaken.

The party seeking the injunction has the lofty burden of demonstrating why the opposing party should be prevented from undertaking its desired action.   This is an extraordinary remedy and issuance of an injunction is not a matter taken lightly by the courts.

It is advisable to contact us or another law firm to review the merits of your case and to advise you on your chances of success in seeking the remedy of injunction.

This article was written by Michael R. Dorfman, Senior Associate at Demorest Law Firm. Click here to view his professional resume.