District Court Underscores the Importance of Suing the Correct Party in Action for Recovery of Distributional Interest
In FW Associates LLC v. WM Associates LLC, 2019 WL 354953 (No. 18 C 5081) (N.D. Ill. Jan. 28, 2019), the United States District Court for the Northern District of Illinois held that a dissociated LLC member may not sue another member to recover his distributional share in a company, but that the appropriate party for such a suit is the LLC itself. The court also dismissed the member’s conversion claim for his distributional interest because that interest was “intangible” and thus could not be converted.
This case arose out of a dispute between the owners of Smart Bar, a company that produces an automated cocktail dispenser known as the Smartender. In 2012, William Metropulos and FW Associates, LLC (“FWA”) formed Smart Bar, USA, LLC and Smart Bar International, LLC (together, Smart Bar). Before long, the parties began to experience friction in their relationship and, by 2013, found themselves in arbitration amid reciprocal claims of breach of the Smart Bar operating agreement and various acts of misconduct. In April 2015, the arbitrator ordered Metropulos dissociated from Smart Bar and required him to pay several hundred thousand dollars in attorneys’ fees and expenses to FWA and Smart Bar. The Circuit Court of Cook County confirmed the arbitrator’s award, and the Illinois Appellate Court affirmed.
Metropulos alleged that Smart Bar dissociated him on November 21, 2016. This normally would mean that he was still entitled to receive distributions from the entities, but could no longer participate in management of them. However, according to Metropulos, Smart Bar effectively extinguished his rights entirely by also purporting to take away his distributional interest in the company. In addition, Metropulos had already transferred his interest in Smart Bar to WM Associates, a new entity Metropulos established after he was dissociated.
In 2018, FWA brought suit against Metropulos and WM (collectively “Defendants”), claiming that Metropulos had wrongfully transferred his interest in the Smart Bar entities to WM in an effort to avoid paying the arbitration judgment. Defendants brought two counterclaims. The first asserted that FWA had violated section 35-60 the Illinois Limited Liability Company Act (the “LLC Act”), by failing to buy out Metropulos’ distributional interest in Smart Bar upon his dissociation. In addition, Defendants claimed that FWA had engaged in other conduct warranting their dissociation from the company.
FWA argued that Defendants’ counterclaims should be dismissed because FWA was not the proper party for Metropulos to sue to obtain recovery of his distributional interest. Instead, Defendants should have sued Smart Bar itself. The court agreed, rejecting Defendants’ three arguments to the contrary.
First, Defendants claimed that section 15-20(a) of the LLC Act permitted a “member [of an LLC] to maintain an action against….another member” (emphasis added) to enforce its rights under the Act. But the court pointed out that this provision no longer applied to Metropulos because he had ceased to be a member of Smart Bar upon his dissociation in 2016. (See section 35-55(a)(1) of the LLC Act: “Upon a member’s dissociation from the LLC, he ceases to be a member and is treated as a transferee.”)
Second, Defendants contended that, because they were seeking to dissolve Smart Bar due to FWA’s harmful or oppressive conduct, section 35-1(b) of the LLC Act gave the court power to provide relief other than dissolution, “including….a buyout of the applicant’s membership interest.” Again, however, Defendants had to bring their claims against Smart Bar, not FWA, the member. In fact, the court suggested that Smart Bar was a necessary party to Defendants’ action, because it had a present, substantial interest in the matter being litigated, which was its own potential dissolution.
Third, Defendants asserted that suing FWA was essentially the same as suing Smart Bar because FWA, as the purported 100% owner of the company, was Smart Bar’s “alter ego.” The court rejected this assertion because an “alter ego” exists between an owner and a company only if (1) there is a unity of interest and ownership that is so strong that the separate personalities of the corporation and the owner “no longer exist,” or (2) treating the company and owner as separate entities would promote injustice or inequity. However, defendants failed to allege such circumstances.
In their second counterclaim, Defendants sought to have FWA dissociated from Smart Bar based upon various acts of oppressive or illegal conduct FWA allegedly perpetrated upon Metropulos, including attempting to take away his distributional interest in Smart Bar and moving the company’s headquarters to Nevada without legal authority to do so. Defendants asked the court to find that WM Associates was the owner of Metropulos’s distributional interest in Smart Bar or, alternatively, to award defendants damages for FWA’s conversion of that interest.
The court denied Defendants’ request to have WM declared the owner of Metropulos’s distributional interest, reiterating that FWA was not the proper entity to sue for such relief. With regard to conversion, the court held that Illinois law does not recognize conversion claims based upon “intangible rights.” Here, the distributional share allegedly converted by FWA was merely an intangible right of future payment, rather than a tangible or intangible thing that could be converted. Accordingly, Defendants’ claim for conversion had to be dismissed as well.
FW Associates LLC v. WM Associates LLC makes it clear that any former LLC member seeking to recover his or her distributional interest must name the LLC itself as a party, not a fellow member and that a conversion claim may not be used a vehicle for recovery.
Mansour Nasrabadi (“Nasrabadi”) hired attorney Taher Kameli (“Kameli”) to represent him throughout the EB 5 visa process; a program by which a foreign national may obtain permanent U.S. residency upon investing at least $500,000 in a qualifying enterprise. Kameli advised Nasrabadi that investing in the Aurora Fund (the “Fund”), which Kameli owned, would satisfy EB 5 requirements. He explained that the Fund would lend the money to another entity for the construction of an assisted living facility and that Nasrabadi would have a first priority security interest in the facility’s assets and real estate. Nasrabadi agreed, signed a conflict waiver, and gave $500,000 to the Fund by a transaction in which Kameli also represented him.
Nasrabadi later sued for malpractice and breach of fiduciary duty, alleging that Kameli never acquired the promised security interest for his money and that Kameli failed to inform Nasrabadi that his conflicts were unwaivable. Rather, Nasrabadi claimed that Kameli kept his money for personal use and secured a separate first priority mortgage loan to finance the facility. Thus, when the bank holding Kameli’s and the Fund’s first priority loan foreclosed, it had priority over Nasrabadi’s interest.
Kameli moved to dismiss Nasrabadi’s claim for malpractice for being duplicative and untimely. On the matter of duplicity, Kameli cited the rule that “when a breach of fiduciary duty claim is based on the same operative facts as a legal malpractice claim, and results in the same injury, the later claim should be dismissed.” Id. at 3. The Court did not hold that such a rule applied here as it was “not clear at this point in the proceedings whether Kameli’s alleged failure to secure priority for the Fund’s loan to the Facility… can be said to be within the scope of his representation of Nasrabadi.” Id. at 3.
Regarding timeliness, Kameli’s arguments failed as well. There, he asserted that Nasrabadi’s claims were based on the engagement letter signed eight years ago, well outside Illinois’ two-year statute of limitations and six-year statute of repose for legal malpractice. 735 ILCS 5/13-214.3(b); 735 ILCS 5/13-214.3(c). The Court disagreed, stating that “the injury in a legal malpractice action is not the attorney’s negligent act itself” but “the loss for which a client may seek monetary damages.” Id. at 4. However, the alleged injury in this case was the loss of Nasrabadi’s investment, not the signing of the engagement letter. Nasrabadi did not plead facts establishing precisely when that loss took place, but a complaint “does not have to anticipate” the affirmative defense of timeliness. Id. “As long as the Court can imagine a scenario in which the claim is timely,” the Court explained, “it is improper to dismiss it on the pleadings.” Id.
(This is for informational purposes and is not legal advice.)
Nature of Act or Omission Determines what Statutes of Limitations and Repose to Apply Against an Attorney
Partners for Payment Relief DE IV, LLC (“PPR”), as an assignee of a mortgagee, filed a complaint to foreclose against the mortgagor, John Daily (“Daily”), for lack of payment on a second mortgage. Three months later, Daily sued his former attorneys, Barash & Everett, LLC (“Barash”) and Clinton A. Block (“Block”), who had represented him during Chapter 13 bankruptcy proceedings years before, for implied indemnity. He alleged that they had advised Daily that this second mortgage would be “stripped off or avoided” in his bankruptcy. Id. at ¶4. This, Daily asserted, constituted professional negligence in that the Barash and Block failed to provide Daily with competent legal advice, and failed to timely seek a discharge of the second mortgage. Barash and Block moved to dismiss Daily’s complaint as untimely under Illinois’ statutes of limitations and repose. The trial court granted the motion with prejudice, finding that the claim was barred by both the statute of limitations and repose.
On appeal, the Third District addressed Daily’s argument that a legal malpractice action brought in an indemnity action should be governed by the limitations period in 735 ILCS 5/13-204 (Contribution and indemnity) rather than 735 ILCS 5/13-214.3(c) (Attorneys). Citing the Illinois Supreme Court, it stated that “13-214.3 of the Code unambiguously applies to all claims brought against an attorney arising out of actions or omissions in the performance of professional services.” Id. ¶11. This was because “pursuant to the express language of section 214.3 of the Code, it is the nature of the act or omission, rather than the identity of the plaintiff, that determines whether the statute applies to a claim brought against an attorney.” Id. Here, the claims against Barash and Block, though stated as an implied indemnity action, were all claims against attorneys arising out of actions or omissions in the performance of professional services. Thus, the Court held that “section 13-214.3 of the Code governs the action, rather than the general contribution an indemnity statue.” Id. at ¶12.
(This is for informational purposes and is not legal advice.)
In this unpublished opinion, the Second District affirmed the dismissal of a legal malpractice claim for lack of causation. The court held that the plaintiff lacked standing to assert the underlying claim that his lawyer allegedly committed malpractice by failing to bring on his behalf. Because the plaintiff had filed for bankruptcy and been discharged, the bankruptcy trustee owned the underlying claim. As a result, the plaintiff’s lawyer could not have asserted it on the plaintiff’s behalf and, therefore, did not damage the plaintiff by failing to do so.
(This is for informational purposes and is not legal advice.)
In this unpublished opinion, the First District affirmed the dismissal of a legal malpractice claim due to the complaints failure to allege causation. The court held that plaintiffs’ loss had either; (a) already occurred when he retained lawyers, and thus they did not cause it; or (b) was caused by another party’s breach of contract as to which he still retained a viable cause of action.
The court held that the plaintiff failed to state a claim against a lawyer, in part, because she failed to allege the existence of an attorney client relationship. The fact that the plaintiff was represented by other counsel made it implausible that the defendant lawyer represented her. The court further held that the claim was barred by the statute of limitations. The claim accrued when the underlying bankruptcy court made its initial decision; accrual did not depend upon the result of the subsequent appeal.
Stevens v. Sharif, No. 15 C 1405, 2017 WL 449175 (N.D. Ill. Feb. 2, 2017)
(This is for informational purposes and is not legal advice.)
By Shelby L. Drury
On October 15, 2015, the Illinois Supreme Court announced the adoption of various changes to the Illinois Rules of Professional Conduct that will take effect on January 1, 2016. The text of the changes can be found here. Link. The changes are summarized below.
According to a press release issued by the Court, several of the rule changes were “designed to bring attorney ethics rules up to date with advances in technology and developments in global legal practices.” (10/15/15 Press Release.) The Court also “approved changes to [Supreme Court] Rules 705 and 716 to address client needs and market demands in an increasingly borderless world.” (Id.)
The changes to the Rules of Professional Conduct that appear to be directed at advances in technology are summarized below:
• Rule 1.0: Terminology Sub-section (n) was changed to include “electronic communications” within the definition of the terms “writing” or “written”. The definition previously referenced email but that was expanded to electronic communications.
• The comments to Rule 1.0 regarding the term “Screened” were revised to make clear that if lawyers who are screened from a matter due to a conflict of interest are required to sign an undertaking to avoid contact with firm files related to the matter, the screen should include “information in electronic form” related to the matter.
• The Court revised the comments to Rule 1.1: Competence to provide that in order to maintain competence a lawyer must, among other things, keep abreast of “the benefits and risks associated with relevant technology.”
• The comments to Rule 1.4: Communication were changed to provide that “A lawyer should promptly respond to or acknowledge client communications.” This comment previously referred only to acknowledging “client telephone calls.”
• Rule 1.6: Confidentiality of Information added section (e) which provides that “A lawyer shall make reasonable efforts to prevent the inadvertent or unauthorized disclosure of, or unauthorized access to, information relating to the representation of a client.” This change “makes explicit the duty to safeguard confidential client information in an electronic age.” (See 10/15/15 Press Release.) The comments list a number of factors to be considered in determining whether the lawyer has made the required “reasonable efforts,” including “the cost of employing additional safeguards . . . and the extent to which the safeguards adversely affect the lawyer’s ability to represent clients (e.g., by making a device or important piece of software excessively difficult to use.).”
• Rule 4.4: Respect for Rights of Third Persons now makes clear that a lawyer’s duty to promptly notify the sender when he or she receives a document relating to the representation of the lawyer’s client that he or she knows was inadvertently sent also applies to “electronically stored information” (which, in some circumstances, includes metadata). The comments describe when electronically stored information is considered to have been “inadvertently sent.” The rule does not address whether the lawyer is required to return or delete inadvertently received information. The comments provide that “[w]here a lawyer is not required by applicable law to do so” that is a matter of “professional judgment ordinarily reserved to the lawyer.” The rule also does not address whether the inadvertent disclosure waives the privileged status of the information.
• The title and comments to Rule 5.3: Responsibilities Regarding Nonlawyer Assistance were amended and comments were added regarding the lawyer’s duties when using nonlawyers outside of the lawyer’s firm to assist in rendering legal services to a client, including document management services and Internet-based services to store client information.
• The comments to Rule 7.2: Advertising have been revised to address Internet advertising, among other things.
• Rule 7.3’s title has been changed from “Direct Contact With Prospective Clients” to “Solicitation of Clients” and the language of the rule and comments have been changed consistent with the new title. The comments also address permissible and impermissible solicitation by electronic means.
Other changes effective January 1, 2016:
• The Court added comments to Rule 1.1: Competence regarding a lawyer’s responsibility when retaining or contracting with lawyers outside of the lawyer’s firm on a matter.
• The Court amended Rule 1.2 Scope of Representation and Allocation of Authority Between Client and Lawyer, to provide an express exception to the Rule’s prohibition on a lawyer counseling or assisting a client to engage in criminal conduct. The addition of Section (d)(3) clarifies any uncertainty with respect to whether an Illinois lawyer may provide legal advice on the matters covered by the passage of the Illinois Compassionate Use of Medical Cannabis Pilot Program Act effective January 1, 2014, which legalized the use of marijuana in certain circumstances. The amended rule provides that “a lawyer may . . . counsel or assist a client in conduct expressly permitted by Illinois law that may violate or conflict with federal or other law, as long as the lawyer advises the client about that federal or other law and its potential consequences.” With respect to this change, the comments provide, among other things, that the amendment “is not restricted in its application to the marijuana law conflict. A lawyer should be especially careful about counseling or assisting a client in other contexts that may violate or conflict with federal, state, or local law.” (Link to Shelby Drury’s blog entry on this ‘proposed’ rule change.)
• Rule 1.6: Confidentiality of Information, was amended to add a seventh circumstance under which a lawyer may reveal information related to the representation of a client to the extent the lawyer “reasonably believes necessary.” Per the amendment, a lawyer may reveal such information “to detect and resolve conflicts of interest if the revealed information would not prejudice the client.” Comments were added explaining this change.
• The comments to Rule 1.17: Sale of Law Practice were amended to clarify that a lawyer must obtain client consent before providing a purchaser access to client information beyond that allowed by new rule 1.6(b)(7).
• The amendment clarifies some of the language in Rule 1.18: Duties to Prospective Clients. The amended language and additional comments clarify how a person becomes a prospective client and emphasizes that “[n]ot all persons who communicate information to a lawyer are prospective clients.”
• Rule 3.8: Special Responsibilities Of A Prosecutor was amended “to clearly state that prosecutors have an obligation to disclose evidence that creates a reasonable likelihood a convicted defendant did not commit the offense and to seek to remedy the conviction.” (See amended rule & 10/15/15 Press Release.)
• Rule 5.5: Unauthorized Practice of Law; Multijurisdictional Practice of Law, as amended, allows a lawyer admitted to practice and in good standing in a foreign jurisdiction to provide legal services through an office in Illinois if the legal services are provided to the lawyer’s employer or its organizational affiliates and do not require pro hac vice admission and the lawyer is otherwise authorized by federal or other law or rule to provide services in this jurisdiction. This part of the rule previously only applied to lawyers in other U.S. jurisdictions. The comments provide that a foreign lawyer must also satisfy the requirements of Illinois Supreme Court Rule 716 to be admitted as house counsel.
• There are minor changes to the comments of Rule 7.1: Communications Concerning A Lawyer’s Services and Rule 8.5: Disciplinary Authority; Choice of Law.
Other changes this year that have already taken effect:
• Rule 1.15: Safekeeping Property was amended effective July 2015 to instruct a lawyer how to handle unidentified funds in an IOLTA account. The rule defines “unidentified funds” as amounts “that cannot be documented as belonging to a client, a third person, or the lawyer or law firm.”