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.

COBRA Coverage and Termination Due to Gross Misconduct

Under The Consolidated Omnibus Budget Reconciliation Act (“COBRA”), employees and their families are not entitled to COBRA coverage under the employer’s group health plan when an employee is terminated for “gross misconduct.”  There will be no qualifying event under COBRA unless the voluntary or involuntary termination of employment is for reasons other than gross misconduct.

However, the term “gross misconduct” is not specifically defined in COBRA or in regulations under COBRA. Therefore, employers should be very cautious about withholding COBRA benefits when an employee is terminated for misconduct.  Whether a terminated employee has engaged in “gross misconduct” is a determination for the Courts and will depend on the specific facts and circumstances of the situation.  Employers should be aware that there can be serious consequences for failing to comply with COBRA if an employee’s misconduct is not deemed “gross misconduct”.

There are certain offenses that clearly constitute gross misconduct, and have been deemed so by Courts.  Generally, it can be assumed that being fired for most ordinary reasons, such as excessive absences or generally poor performance, does not amount to “gross misconduct.”

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

Michigan Supreme Court Allows Detroit Public Schools to Keep Funds Collected through Unauthorized Tax Levy

The Michigan Supreme Court’s March 30, 2010 ruling in favor of the Detroit Public Schools (DPS) allows DPS to keep millions of dollars that DPS collected improperly, by continuing to charge taxpayers for a millage for three years after it expired.  Briggs Tax Service, LLC v Detroit Public Schools.

In September 1993, voters in Detroit approved a 32.25 mill school operating property tax.  As a result, DPS was authorized to levy and collect property taxes from Detroit property owners until the millage expired on June 30, 2002.  After the expiration of the millage in 2002, DPS continued to levy the tax through 2004.  Taxpayers continued to pay the tax without objection.

In 2005, Briggs Tax Service filed a claim against DPS in the Michigan Tax Tribunal seeking a refund of the unauthorized taxes levied and collected by DPS.

The underlying issue in this case was whether the claim must be dismissed due to lack of jurisdiction (failure to timely file).  Ordinarily, the time limit to file a claim for a refund in Michigan is 35 days after a final decision. MCL 205.735(3).  Briggs did not meet this deadline and the Tax Tribunal initially dismissed Plaintiff’s claim.  The Tax Tribunal then allowed Briggs to amend its petition in order to assert a claim under MCL 211.53a, which has a three year statute of limitations.  Under MCL 211.53a, in order to assert a successful claim, the taxpayer must have been assessed and paid taxes in excess of the correct amount due to either (1) a clerical error or (2) a mutual mistake of fact by the assessing officer and the taxpayer.

There was no clerical error.  The DPS intended to levy the taxes.  Thus, in order for Briggs to successfully assert a claim under MCL 211.53a, Briggs had to prove that there was a mutual mistake of fact by both the assessing officer and the taxpayer.

The Michigan Supreme Court held that although a DPS employee certified the tax levy, a DPS employee is not the same as a tax assessor. Thus, there was no mistake by the assessing officer, because the “assessor” never certified the tax.

The Michigan Supreme Court also held that any mistake was a mistake of law, rather than a mistake of fact. The validity of a tax is a legal issue, rather than a factual issue.

While we find the result of the case somewhat surprising, the Michigan Supreme Court’s decision points out the importance of reviewing tax bills carefully, and promptly objecting to any item on the tax bill that you question.

Click here to download a PDF of the Michigan Supreme Court Opinion in Briggs Tax Service, LLC v Detroit Public Schools.

This article was written by Mark S. Demorest, Managing Member of Demorest Law Firm.

Michigan Consumer Protection Act Does Not Provide Protection for Businesses that are Consumers

The Michigan Consumer Protection Act provides consumers with protection against many unfair business practices.  However, the Act only applies to “the conduct of a business providing goods, property or service primarily for personal, family or household purposes …”  The Michigan Court of Appeals has previously ruled that the protections of the Act do not apply to transactions intended primarily for business or commercial purposes.

In the recent case of Edwards v Cape to Cairo, LLC, the Court of Appeals decided that the key is not who entered into the transaction, but rather the true nature of the transaction.  In the Edwards case, the plaintiff was planning a trip for himself and several members of his church to Africa.  The trip was going to involve both leisure activities and charitable mission work. The plaintiff paid the deposits for the trip through his corporation, and used also the staff of his corporation to make arrangements for the trip.  The defendant argued that the case should be dismissed because it had dealt with a corporation.  The Court of Appeals disagreed, ruling that the true purpose of the planned trip to Africa was personal in nature.  The trip had nothing to do with the business of the plaintiff’s corporation.  Furthermore, the plaintiff’s corporation was reimbursed for the deposits.  The Court of Appeals ruled that the corporation’s role in planning the trip “was done merely for convenience, not for any purpose related to [the corporation], which is an automotive supplier with no ties to Africa. … [T]he trip was planned for members of plaintiff’s family and church, not employees of [the corporation].”

Click here to download a PDF copy of the Court of Appeals Opinion in Edwards v Cape to Cairo, LLC.

This article was written by Mark S. Demorest, Managing Member of Demorest Law Firm.

Check your Arbitration Agreement

Many companies, concerned about the cost and timeliness of court litigation, have adopted policies requiring that disputes with discharged employees must be submitted to arbitration.    The employee agrees to the arbitration provision as a condition of employment.

A recent decision of the Michigan Court of Appeals suggests that employers need to check their arbitration agreements to make sure that they will not have to simultaneously deal with both court litigation and arbitration.  In Riley v Ennis, a former employee sued her supervisor for personal liability for discrimination.  Her former employer was not a party to the lawsuit.  The Court of Appeals ruled that the arbitration agreement only applied to claims against the employer, because only the employer and the employee were parties to the arbitration agreement.

The Court of Appeals stated, “a party cannot be required to arbitrate an issue that the party did not agree to submit to arbitration. …  Although plaintiff’s claims against [her supervisor] might be interwoven with her claims against [her employer], because plaintiff and [her employer] did not agree to give [the employer’s] agents the protection of the arbitration provision in the employment contract with respect to their own potential individual liability, we conclude that defendant [the individual supervisor] cannot compel arbitration.”

The agreement could have required the arbitration of claims against individuals, as well as the company.  This arbitration agreement did not state that it covered claims against individual supervisors or corporate officers.   The arbitration agreement also did not state it applied to any dispute arising out of the employment relationship.

In light of the Court of Appeals’ decision in Riley v Ennis, you should check your arbitration agreement to make sure whether it would require the arbitration of claims against individual corporate officers, agents or supervisors.  Otherwise, the company might have to deal with both a lawsuit in court and an arbitration proceeding.

To download a PDF of the Court of Appeals’ decision click here.

This article was written by Mark S. Demorest, Managing Member of 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.

Damages Under The Anti-Lockout Statute

In Christie v Fick, a recent unpublished Michigan Court of Appeals case (March 2, 2010, No.285924), the Court was asked to review whether a tenant alleging violation of Michigan’s Anti-Lockout Statute (MCL 600.2918) was entitled to exemplary damages.

The Anti-Lockout Statute specifically states that “any tenant in possession of premises whose possessory interest has been unlawfully interfered with by the owner, lessor, licensor, or their agents shall be entitled to recover the amount of his actual damages or $200.00, whichever is greater, for each occurrence and, where possession has been lost, to recover possession.” (emphasis added).  This statute prohibits a landlord from attempting self-help eviction of a tenant, or eviction without legal process.

In Christie, plaintiff tenant filed a complaint alleging that defendant landlord unlawfully locked them out of the rental premises and also moved a large quantity of valuable equipment from the rental premises to storage, where it was subsequently damaged.  Defendants argued that the plaintiffs were behind in rent, the plaintiffs had abandoned the premises, and that plaintiffs had numerous opportunities to retrieve their personal property after it was moved.

At trial, the court gave the jury an instruction regarding the award of exemplary damages.  Specifically, the jury was instructed that “an award of exemplary damages is proper if it compensates a plaintiff for humiliation, sense of outrage, and indignity resulting from injustices maliciously, willfully, and wantonly inflicted by the defendant.”  After a jury found for plaintiffs and against defendants on plaintiffs’ claim for violation of the anti-lockout statute, MCL 600.2918, they awarded plaintiffs treble damages for the anti-lockout claim, or three times the actual damages amount.

Defendants appealed on this issue, arguing that a statutorily based cause of action will not allow for damages other than those specified in the statute.  Exemplary damages are not specifically provided for in the Anti-Lockout Statute.

Although Michigan Court of Appeals in Christie agreed with Defendants argument, it did not reverse the ruling.  The Court reasoned that, under Michigan law, recovery under the Anti-Lockout Statute may include damages for emotional distress, embarrassment, and humiliation, as part of actual damages.  Therefore, although a separate award for exemplary damages is not appropriate in a statutorily based action unless the statute in question specifically provides for such damage, damages for mental distress are allowable as part of a plaintiff’s actual damages. As a result, the Court allowed plaintiffs to recover the damages awarded as emotional distress damages under the Anti-Lockout Statute.

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

Attorney’s Signature Creates Binding Settlement

You might think that the settlement of a lawsuit requires the signature of the client.  That is not the case under this Michigan Court Rules.   A settlement may be enforced if (a) it is agreed to before the Judge in open court on the record by the client or attorney or (b) if there is “written evidence” of the settlement signed by the client or attorney.  MCR 2.507(G0.

In Kennedy v Hayduk, the plaintiff’s attorney claimed that a settlement had not been reached.  The Michigan Court of Appeals disagreed.  The defense attorney sent a letter summarizing the terms of a proposed settlement.  There were more detailed settlement documents still to be prepared.  The plaintiff’s attorney then signed and returned to the defense attorney a stipulation and order to dismiss the case.  The plaintiff later argued that there were terms of the settlement that had not been agreed upon, so there was no binding settlement.    The Court of Appeals ruled that: “The signed stipulation was unconditional acceptance of defendants’ offer. … The objective evidence shows that an agreement was reached.”

A lesson from this case:  Don’t sign a settlement until all terms have been agreed upon.

Download a PDF of the decision by clicking here.

This article was written by Mark S. Demorest, Managing Member of Demorest Law Firm.

CARD Act – How the New Credit Card Law Works

The Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (or “CARD Act”) went into effect on Monday, February 22.  The purpose of this Act was to prevent credit card companies from using predatory lending practices and excessive penalties for credit card customers.  Note, however, that the CARD Act only applies to personal credit cards, not business credit cards.

Key provisions of the CARD Act include:

• Interest rates on existing balances cannot be changed unless (1) your payment is 60 or more days late; or (2) you have an introductory rate that expires.
• If a payment is more then 60 days late, but your payments for the next 6 months are all on-time, the credit card company must reduce your interest rate back to the original rate.
• Interest rates on new purchases can be changed, but the credit card company must give you 45 days notice before raising your rate.  You can opt out of the rate change, but that means your account will be closed and you will have five years to pay off the existing balance at the existing interest rate.  There are some exceptions to this rule, however.  For example, if you have a variable rate card tied to the prime rate, this provision does not apply.
• Credit card companies can no longer use the “universal default” provision that some were using.  If you pay late or default on any account (credit card, utility, etc.), other card issuers can no longer raise your interest rate on your existing balance on those cards.
• Credit card companies can no longer approve a charge that exceeds your limit and then charge you an over-limit fee and penalty interest rate.  Beware of “opt-in” offers to avoid over-limit fees, as this is a scam.
• You cannot be charged for paying online, by mail, or over the phone, unless you speak to a live operator and then they must disclose the fee before you pay.
• Payment due dates must be the same every month, and if the due date falls on a holiday or weekend, the payment is due the next business day.
• Your bill must now disclose how long it will take to pay off the current balance if you only pay the minimum amount each month, as well as the total amount of principal and interest you would pay over that time period.
• Anyone under 21 cannot get a credit card without either (1) proof of income to pay the bills or (2) an adult co-signer.

One problem with the CARD Act, however, is that it was signed into law in May 2009, but did not become effective until this week.  This gave credit card companies significant time to find ways around the new laws, including cutting credit limits and raising interest rates before the restrictions on such practices went into effect.  Some other new negative practices include:

• Closing accounts or charging fees for inactivity or even for “low activity”
• The return of annual fees to many cards – even if you have never had an annual fee on a particular card, there is nothing to stop the card issuer from charging one now
• Converting fixed rate cards to variable rate cards, and setting these rates with a floor that they will never fall below
• Redefining terms of certain fees, such as what is considered an “international transaction”
• Increasing balance transfer fees and cash advance fees
• Adding fees for paper statements
• Changing the terms of rewards programs or eliminating such programs altogether
• Stricter review of who is issued credit
• Reducing credit limits without warning

Pay attention to all correspondence from your credit card company, and if they are acting in a way that should be covered by the CARD Act, call and complain.  If that doesn’t work, contact your US Senator or Representative.

This article was written by Melissa L. Demorest, Associate at Demorest Law Firm.

To Quality as a Future Advance Mortgage, Correct Language Must By Included in the Recorded Mortgage

A mortgage has priority over other liens on the property from the date it is recorded with the Register of Deeds. The mortgage can also have priority for amounts advanced by the lender after the date of recording if the mortgage contains certain specific language making it a “future advance mortgage”. In Citizens State Bank v. Nakash (2010), the Michigan Court of Appeals considered what happens when a recorded mortgage references a promissory note or agreement that contains the future advance language, but the recorded mortgage itself contains no future advance language. The Court of Appeals ruled that the mortgage creates no priority for future advances by the lender when the promissory note or agreement containing the future advance language is unrecorded. MCL 565.901(b) holds that the instrument creating a future advance mortgage must be recorded. This ruling makes sense, because the recorded mortgage should put other parties on notice that it is a future advance mortgage, and not merely refer to another document that is not part of the chain of title.

To download a PDF of the case click here.

This article was written by Mark S. Demorest, Managing Member of Demorest Law Firm.