A Primer on Florida Business Organization Disputes

[Pages:28]The Florida Bar Business Law Section Presents

A Primer on Florida Business Organization Disputes

Presented by: John P. Kelly, Esq.

The Kelly Law Firm Fort Lauderdale, FL

Organized by: Peter F. Valori, Esq.

Chair, Communications Committee Florida Bar Business Law Section

Mark D. Nichols, Esq.

Business Litigation Committee Florida Bar Business Law Section

A. Overview.

1. Business organization litigation presents complex issues and challenges for the commercial litigator. This lecture examines some of the basic litigation issues in typical disputes involving one or more business entities. An exhaustive treatment of the subject is beyond the scope of this presentation. I will try to focus on a: "hit list" of likely topics on an examination question involving business entities disputes.

2. This lecture focuses on disputes unique to and arising out of the choice of the business entity itself. Changes in the law and the exigencies of commerce have given rise to partnerships, corporations, and other business organizations, such as the relatively new concept of the limited liability company. The need for organizations of multiple interests, unified to accomplish a particular business goal, but cloaked with the protection of a limited liability for its members, has led to the creation of various types of business entities. Business planning and tax considerations often initially dictate the choice of entity. Yet litigation counsel for each entity must be prepared to deal with ensuing conflicts within the entity and protection for the members from the consequences of often unforeseen future developments. The litigation common to each entity often revolves around internal disputes among its members with multiple, and frequently differing, interests. The immediate focus of this lecture is on the unique internal disputes arising in litigation involving a business organization composed of multiple interests.

B. Identifying the Business Entity.

1. Common Entities: In the past, partnerships, joint ventures, and corporations have been the most often chosen business entities. Limited liability companies have emerged in the past decade as a "preferred" business entity, given their tax advantages in certain situations and in view of the perception that they are more flexible than corporations. However, the law on these organizations has not yet fully matured, so there is still some uncertainty about their true efficacy.

2. Other Entities: Less common and in varying degree hybrids of the basic forms, are such entities as agricultural cooperative marketing associations, banks, business trusts, common-law trusts, condominiums, cooperatives, credit unions, fraternal benefit societies, insurance companies, limited partner-ships, nonprofit cooperative associations, not-for-profit corporations, private schools, professional service corporations, public fairs and expositions, public utilities, real estate corporations, real estate investment trusts, religious societies, savings and loan associations, social clubs, and unincorporated associations. Litigation involving these various business organizations may raise substantive issues that have been treated in other publications. The primary discussion in this chapter relates to litigation issues within business organizations of the most common but protean forms -- the partnership, joint venture, and corporation, as well as the more recent forms of limited liability company and professional limited liability company.

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3. Statutory Scheme: For Profit Corporations--Chapter 607 Non-Profit Corporations--Chapter 617; Partnerships--Chapter 620; Limited Liability PartnershipsChapter 620 ; Limited Liability Companies--Chapter 608.

C. Ethical Issues.

1. Introduction: Business entity disputes obviously an area involving numerous ethical considerations involving multiple interests. Typically, in small entities, parties' contributions to the entity at formation and afterwards may vary: "money men", "sweat equity participant", and " silent partners" are common players.

2. members.

Inherent Conflict: representation of entity versus representation of

3. Representation of Organization: Chapter 4 of the Rules Regulating The Florida Bar, titled "Rules of Professional Conduct," provides rules and comment on many potential conflict situations relevant to business organization litigation. Rule 4-1.13 specifically deals with the "organization as client" and provides that a "lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents." Rule 4-1.13(a). Any communication between the organization's lawyer and a constituent in an organizational capacity is a confidential communication, even if the constituent is not a client of the lawyer. A lawyer may represent both the organization and its constituents, subject to the conflict of interest rule stated in Rule 41.7. In Gonzalez ex rel. Colonial Bank v. Chillura, 892 So.2d 1075, 1077 (Fla. 2d DCA 2004), the court, for instance, held that there was no conflict of interest in an attorney concurrently representing the plaintiff in a shareholder derivative action while at the same time representing the same plaintiff in litigation he or she is pursuing individually against the corporation, because otherwise there would be "no way for the derivative plaintiff to ever have conflict free counsel."

4. Whistle-blowing: Rule 4-1.13(b) places an affirmative duty on a lawyer to "proceed as is reasonably necessary in the best interest of the organization" if a constituent of an organization intends to act in violation of a legal obligation to the organization or in violation of the law, in a manner likely to result in substantial injury to the organization. The measures taken by the lawyer must be minimally disruptive to the organization and should take into consideration the organization's policies. However, the lawyer ultimately may be required to refer the violation to the highest authority that can act on behalf of the organization. If that authority insists on action that clearly violates the law and is likely to result in substantial injury to the organization, the lawyer may resign his or her representation in accordance with Rule 4 1.16.

5. Entity Formation. Scenario: multiple people come to a lawyer to form a business entity. Who does the lawyer represent? Case law indicates that the lawyer represents the entity (corporation) in forming the entity, but that safe harbor does not exist with respect to representation of differing interests in negotiation of shareholder agreements. Typically provisions are included in such agreements relating to waiver of

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any conflicts and that the members of the entity have had opportunity to consult independent counsel.

6. Pro Se Entity Formations: The State of Florida has chosen to open its doors for anyone to form and register a business entity online--result is a lot of "half baked" entities with no shareholder agreements or operating agreements. Pro se entity formers rarely follow "entity formalities"--complying with the minimum statutory requirements--maintaining books and records, holding themselves out to the public as a separate entity, commingling of funds, using the entity as their alter ego, or even filing the annual UBR, often leading to an administrative dissolution the following September. Ethical considerations abound as to how the lawyer can right the ship particularly when third-party rights are affected.

D. Partnership Litigation.

1. Decline: Partnerships as the favored means of conducting business has dwindled enormously due to the preference for corporations and limited liability companies as "liability shielders."

2. General Partnership: Under Florida law (Revised Uniform Partnership Act--RUPA), "the association of two or more persons to carry on as co-owners a business for profit forms a partnership." F.S. 620.8202. "Business" is defined in F.S. 620.8101(2) as "any trade, occupation, profession, or investment activity." The three essential elements of a partnership are (1) an "association" by contract or operation of law; (2) "co-ownership" in specific assets, management, and net-profit sharing; and (3) a "business for profit." The rights and remedies of partners among themselves and with others are governed by the Revised Uniform Partnership Act (RUPA), F.S. 620.81001, et seq.

3. Intent of the Parties: Under prior Florida law, the intent of the parties was the primary test for the existence of a partnership. Under current F.S. 620.8202, except for those associations noted in F.S. 620.8202(2), a partnership is formed by "the association of two or more persons to carry on as co-owners a business for profit . . . whether or not the persons intend to form a partnership." A person who receives a share of the profits of a business is, with limited exceptions, presumed to be a partner under F.S. 620.8202(3)(c). An "inadvertent" partnership may arise in a transaction involving co-profit sharing and co-management. The existence vel non of a partnership is for the trier of fact to determine, usually a judge in an equitable action. See, e.g., Perez v. Hernandez, 323 So.2d 4 (Fla. 3d DCA 1975).

4. Supremacy of Partnership Agreement. Under the RUPA, the intent is that the partnership agreement will govern all issues arising out of the partnership, and if there is no partnership agreement, the Act will control. The RUPA, like its predecessor, specifically provides that it "shall be applied and construed to effectuate its general purpose to make uniform the law." F.S. 620.81001. In a more simplified enactment than Florida's version of the UPA, the Florida RUPA also provides in F.S. 620.8104 that "[u]nless displaced by particular provisions of this act, the principles of law and equity

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supplement this act." See former F.S. 620.58. See also Krauth v. First Continental DevCon, Inc., 351 So.2d 1106 (Fla. 4th DCA 1977); Myrick v. Second National Bank of Clearwater, 335 So.2d 343 (Fla. 2d DCA 1976).

5. Mutual Liability of Partners: The hallmark of the general partnership is that "[e]ach partner is an agent of the partnership for the purpose of its business," F.S. 620.8301(1), and each partner is liable for the debts and the wrongful acts of the partnership, F.S. 620.8305, 620.8306, 620.8308. A partner, however, is not liable for the preexisting debt of a copartner, Arthus Bertrand, S.A. v. Davis, 633 So.2d 62 (Fla. 3d DCA 1994), nor is a newly admitted partner liable for any partnership obligation incurred before his or her admission, F.S. 620.8306(2). See also F.S. 620.8306(3), added by Ch. 99-285, ?9, effective June 8, 1999 ("An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership").

6. Distinction from Agency: A partnership is similar to an agency relationship, but an agent is subject to the principal's control at all times, while one partner does not necessarily control any other partner. RESTATEMENT (SECOND) OF AGENCY ??14A, B (ALI-ABA 1957). Under the RUPA, nonetheless, "[e]ach partner is an agent of the partnership for the purpose of its business," and an act of a partner generally binds the partnership. F.S. 620.8301(1).

7. Imputed knowledge: Moreover, notice to or knowledge by one partner acting in a par-ticular matter may serve as notice to the partnership. F.S. 620.8102(6); see also In re Wildflower Landholding Associates, Ltd., 49 B.R. 246 (Bankr. M.D. Fla. 1985). A partner's knowledge of the underlying facts of a trans-action, however, cannot be imputed to the partnership when the transaction involves fraud on the partnership. F.S. 620.8102(6); Grossman v. Greenberg, 619 So.2d 406 (Fla. 3d DCA 1993).

E. Joint Venture Litigation.

1. Separate Legal Relationship: Although a partnership most closely resembles a joint venture, and both are governed by the same general rules of law, they are separate legal relationships. The joint venture concept was unknown at common law, and its status as a legal entity is unique to American jurisprudence. 46 AM.JUR.2d Joint Ventures ?2. A joint venture under Florida law is a voluntary relationship arising out of the law of both express and implied contracts. Russell v. Thielen, 82 So.2d 143 (Fla. 1955); McKissick v. Bilger, 480 So.2d 211 (Fla. 1st DCA 1985); Hyman v. Regenstein, 222 F.2d 545 (5th Cir. 1955). The Florida Supreme Court has held that, in addition to the essentials of an ordinary contract, joint venture contracts must display "(1) a community of interest in the performance of the common purpose, (2) joint control or right of control, (3) a joint proprietary interest in the subject matter, (4) a right to share in the profits and (5) a duty to share in any losses which may be sustained." Kislak v. Kreedian, 95 So.2d 510, 515 (Fla. 1957); see Sutton v. Smith, 603 So.2d 693 (Fla. 1st DCA 1992). Proof that one venturer has exclusive control of the venture's business affairs and finances is inconsistent with a determination of a joint venture. Green v. Putnam, 93 So.2d 378 (Fla. 1957). The joint venture agreement must include a provision for the

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sharing of both profits and losses. Kislak; Sutton; 8B FLA.JUR.2d Business Relationships ??749, 756.

2. Mutual Agency. A joint venturer's authority may be limited, however, to the particular business-venture transaction, but a partner's authority can extend to the apparent business of the partnership. As stated by the court in Deal Farms, Inc. v. Farm & Ranch Supply, Inc., 382 So.2d 888, 891 (Fla. 1st DCA 1980), quoting 8 FLA.JUR.2d Business Relationships ?691 (now 8B FLA.JUR.2d Business Relationships ?762):

A contract of joint adventure is in effect one of mutual agency, each adventurer acting as a principal in his own behalf and as agent for his co-adventurer. Each one of several joint adventurers has the power to bind the others in matters that are strictly within the scope of the joint enterprise.

3. Less formality. Traditionally, a joint venture has a limited, specific objective and is less formal than a partnership. Russell v. Thielen, 82 So.2d 143 (Fla. 1955). A joint venture does not arise merely by indicia of joint ownership in the absence of an express or implied agreement suggesting the feature of an actual venture. 46 AM.JUR.2d Joint Ventures ??9, 11, 12, 16. See also Duvall v. Walton, 107 Fla. 60, 144 So. 318 (1932). The fact that an agreement does not expressly provide for sharing of losses is not fatal to the finding of a joint venture. Florida Trading & Investment Co. v. River Construction Services, Inc., 537 So.2d 600 (Fla. 2d DCA 1989). However, if a joint venture meets the definition of a statutory partnership, it may fall within the scope of the UPA or RUPA. A joint venture is governed by the principles which constitute and control the law of partnership. Kislak v. Kreedian, 95 So.2d 510, 515 (Fla. 1957), quoting Proctor v. Hearne, 131 So. 173, 176 (Fla. 1930); Proctor v. Hearne, 100 Fla. 1180, 131 So. 173 (1930); Rafkind v. Simon, 402 So.2d 22 (Fla. 3d DCA 1981); Century Bank of Lee County v. Gillespy, 399 So.2d 1109 (Fla. 5th DCA 1981).

4. Does Not Arise by Operation of Law: On the other hand, a joint venture cannot arise by operation of law because it is a voluntary relationship arising by contract.

5. Liabilities and Rights: The liabilities, rights, duties, and remedies of joint venturers among themselves and to others are essentially the same as those of general partners. See Hayes v. H.J.S.B.B. Joint Venture, 595 So.2d 1000 (Fla. 4th DCA 1992); Campbell v. A.B. Taff & Sons, Inc., 519 So.2d 1039, 1041 (Fla. 1st DCA 1988) ("the rights of the parties to the joint venture are governed by partnership law"). In fact, from a litigation perspective, the distinctions between a joint venture and a partnership often are blurred. A joint venture terminates when the objects of its creation have been accomplished. Kislak, 95 So.2d at 514. However, the fact that a joint venture may determine to carry out the purpose of the venture through the medium of a corporation does not alter the effect of the joint venture. Donahue v. Davis, 68 So.2d 163, 171 (Fla. 1953).

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F. Limited Liability Partnership Litigation.

1. Revised Limited Liability Partnership Act. A revised limited partnership statute, F.S. 620.1101?620.2205 (the Florida Revised Uniform Limited Partnership Act of 2005 or RULPA), became effective on January 1, 2006. A Florida "limited partnership" or "domestic limited partnership" is a partnership formed "by two or more persons" under the laws of Florida, having as members "one or more general partners and one or more limited partners[, and the] term includes a limited liability limited partnership." F.S. 620.1102(12). A limited partnership may "do all things necessary or convenient to carry on its activities." F.S. 620.1105. As with the RUPA and other model or uniform statutes, the RULPA provides for uniform interpretation with other states that have the same enactment. F.S. 620.2201(1). See also Mason v. Avdoyan, 299 So.2d 603, 606 (Fla. 4th DCA 1974) ("In construing Uniform Laws, it is pertinent to review holdings in other jurisdictions where the particular act is in force, in the interest of attempting to achieve a uniform interpretation").

2. Contribution by Limited Partner. The RULPA provides that the contribution of a general or limited partner may be "any benefit provided by a person to a limited partnership in order to become a partner or in the person's capacity as a partner." F.S. 620.1102(3). Unlike the predecessor statute, F.S. 620.1303 provides that a limited partner is not liable for any limited partnership obligations, "whether arising in contract, tort, or otherwise . . . even if the limited partner participates in the management and control of the limited partnership."

3. Fiduciary Duty. In Wulsin v. Palmetto Federal Savings & Loan Ass'n, 507 So.2d 1149, 1151 (Fla. 3d DCA 1987), approved 530 So.2d 291, the court recognized that a "limited partner is like a corporate shareholder or a trust beneficiary to whom a fiduciary duty is owed."

4. Derivative Claims: F.S. 620.2002 expressly provides a partner in a limited partnership the right to "maintain a derivative action to enforce a right of a limited partnership." A pre-suit demand is required to allow the general partners to "cause the limited partnership to bring an action to enforce the right." Id. If "the general partners do not bring the action within a reasonable time" or if such a "demand would be futile," then the partner may bring the lawsuit. Id.

G. Corporation Litigation

1. Shareholder Derivative Claims: To prevent abuses by corporate management, the courts have recognized the shareholders' derivative action. As early as 1882, the United States Supreme Court exercised its equity jurisdiction to determine the rules for a derivative action. Hawes v. City of Oakland, 104 U.S. 450, 26 L.Ed. 827 (1882). A shareholder who initiates a shareholder's derivative action is a fiduciary to the corporation. Head v. Lane, 495 So.2d 821 (Fla. 4th DCA 1986). The Florida Supreme Court recognized the fiduciary duties of directors as early as 1907 in Jacksonville Cigar

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Co. v. Dozier, 53 Fla. 1059, 43 So. 523 (1907). In Tampa Waterworks Co. v. Wood, 97 Fla. 493, 121 So. 789 (1929), the court first recognized the standing of stockholders in equity to seek relief against corporate management by the appointment of a receiver on a proper showing of fraud, spoliation, immediate danger of loss of property, or waste of assets by corporate management, coupled with self-dealing. In more recent cases, directors have been held liable "for corporate losses resulting from practices primarily designed to maintain the directors in control." Schilling v. Belcher, 582 F.2d 995, 1005 (5th Cir. 1978). Shareholder derivative actions arise in equity and are the only means for a shareholder to vindicate a corporate claim and seek redress against unfair and illegal management policies. The claim belongs to the corporation so any recovery is for the benefit of the corporation; hence, the corporation is an indispensable party that must be joined as an original defendant. Alario v. Miller, 354 So.2d 925 (Fla. 2d DCA 1978); Liddy v. Urbanek, 707 F.2d 1222 (11th Cir. 1983). The trial court may allow a realignment of the parties to satisfy this jurisdictional requirement. Francini v. International Marble Trades, Inc., 546 So.2d 777 (Fla. 3d DCA 1989).

2. Characteristics:

(a) Demand on Board of Directors: A shareholder's derivative action must be prefaced by a demand on the board of directors to institute the action that the shareholder desires to bring in a derivative capacity. The derivative lawsuit is premised on the wrongful refusal of the directors to assert a corporate claim. F.S. 607.07401(2) requires:

A complaint in a proceeding brought in the right of a corporation must be verified and allege with particularity the demand made to obtain action by the board of directors and that the demand was refused or ignored by the board of directors for a period of at least 90 days from the first demand unless, prior to the expiration of the 90 days, the person was notified in writing that the corporation rejected the demand, or unless irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.

(b) Contemporaneous Ownership: F.S. 607.07401(1) provides: "A person may not commence a proceeding in the right of a domestic or foreign corporation unless the person was a shareholder of the corporation when the transaction complained of occurred or unless the person became a shareholder through transfer by operation of law from one who was a shareholder at that time." The term "shareholder" now includes a beneficial owner whose shares are held in a voting trust or by a nominee. F.S. 607.07401(7). For a discussion of standing in a derivative action, see South End Improvement Group, Inc. by & through Bank of New York v. Mulliken, 602 So.2d 1327 (Fla. 4th DCA 1992).

(c) Jury Trial Right: In Ross v. Bernhard, 396 U.S. 531, 90 S.Ct. 733, 24 L.Ed.2d 729 (1970), the Supreme Court held that a shareholder was entitled to a jury trial in federal court on the corporation's derivative claim if the claim on the merits presents legal issues to which the Seventh Amendment guarantee of the

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