Fiduciary Duties

September 15, 2023

Equitable Accounting Opens the Black Box of Business Finances

An equitable accounting is a cause of action that requires those in control of the finances of a closely held business to account for their use of the money.
An accounting a two-stage process. First the controlling party must render an account of how it used the assets of the business. Then there is a proceeding for the minority to object to the accounting.
When a court finds that the party in control has misappropriate or misued the assets of the company, it can order repayment.
A minority member should demand an accounting before seeking the accounting in court and be prepared to support the request with plausible claims of misconduct.

For many minority owners of closely held businesses, the finances are sometimes a black box. There is a result, but where that result came from is unknown. The cause of action for an equitable accounting is a tool that gives the owners who don’t have day-to-day management roles a look inside the black box of the closely held company’s finances.

More Questions? Learn More. You can call me at 973-602-3915 or use our Contact form to reach me by email.

The term black box comes from engineering and describes devices or systems that give a result from a set of inputs, but the process inside is a mystery. This lack of transparency makes it challenging to troubleshoot issues or make modifications to the black box without specialized knowledge or access to its internal components.

The same may be true of the finances of the closely held corporation, limited liability company, or partnership, particularly when there are questions about the majority’s behavior. Where, for example, there is a question about the misuse of an LLC’s assets, the minority may be able to sue and hire its own forensic accountants to reconstruct the workings of the black box. But if they can prevail in a cause of action for an equitable accounting, they shift the responsibility for the process to those in charge of the books. Equitable Accounting Provides Transparency in Finances for LLC, closely held corporations

There is a significant difference between putting the responsibility to explain the use of the assets of the LLC and pay back what was improperly taken and simply getting access to records. That has been the central point of a number of cases involving claims for equitable accounting. We examine some of those cases here under New York and New Jersey law, including a very recent decision from a federal court in the Southern District of New York applying state law.

August 15, 2023

When Are Limited Liability Companies Required to Distribute Profits?

by Jay R. McDaniel, Esq.

There is no statutory right to receive a distribution of profits from a limited liability company before it dissolves and winds up its affairs. Distributions before then are discretionary.
Profit distributions are in the discretion of the majority members or commonly in the discretion of the managers of the limited liability company.
A minority member who is not receiving distributions may have a claim under the operating agreement or as an oppressed minority member if the majority refuses to make profit distributions.

Profit distributions are a frequent source of dispute among the members of a limited liability company. The fundamental question of who decides when distributions are made, how much is made, and how to deal with the tax issues related to distributions, profits and losses can all be the source of conflict.

More Questions? Learn More. You can call me at 973-602-3915 or use our Contact form to reach me by email.

The short answer to the question of when a limited liability company must distribute profits is that ‘it depends.’ And many minority owners of LLC interests are frustrated to learn that they have less control over the process than they anticipated. New Jersey minority oppressed LLC member attorney

Limited Liability Companies Often Do Not Have Operating Agreements

Entrepreneurs choose limited liability companies as the form of a new business far more often than corporations or partnerships. They are cheap and easy to form and do not require the type of documentation and formalities that you generally see associated with other entities, corporations in particular. Continue reading

June 15, 2023

No Foul in Dissociated LLC Member’s Refusal to Cooperate in PPP Loan

by Jay R. McDaniel, Esq.

A ‘passive’ member with no rights or responsibilities in the management of a limited liability company cannot be held liable for refusing to participate in a PPP loan application.
Dissociated LLC members with no management rights can withhold their voluntary consent to proposed actions.
The waiver of fiduciary duties in an operating agreement is enforceable under New Jersey law if it is not manifestly unreasonable.

Jeanne Qin Lamme was a “passive” owner in the businesses owned by her late husband, Joseph Lamme. Her status was as a dissociated member under New Jersey’s Revised Limited Liability Company Act meant that she had no management rights in the business. New Jersey dissociated LLC member may refuse to cooperate | New Jersey LLC disputes attorney

So when Jean Lamme refused to assist the business in securing a federal Paycheck Protection Program (PPP) loan during the Covid pandemic, did she set herself up for a lawsuit and damages? Not if she had no duty to cooperate.

Widow of Owner Refuse Request for PPP Loan Application

That’s the holding in an Appellate Division opinion in Lamme v. Client Instant Access, a lawsuit between Lamme and her late husband’s business associate, Joseph Vacarella. It’s worth considering the decision because members of small businesses say “no” – frequently to the detriment of the business – simply because they can. Continue reading

May 23, 2023

The Equitable Value of an Oppressed Minority Shareholder’s Interest

by Jay R. McDaniel, Esq.

A New Jersey Court conducing the valuation of a business may use any technique or method generally acceptable in the financial community.
The application of a minority discount is a question of law, but likely will be based on the factual determinations of the court about the culpability of the litigants.
Business divorces cases are commonly heard in the Chancery Division, a court of equity in which principles of fairness and justice may be applied in addition to any statutory cause of action.
New Jersey’s statutory cause of action for oppression of a minority shareholder does not prevent the court from providing equitable remedies available outside the statute as a matter of common law.

New Jersey Business Valuation ATORNEY In Sipko v. Kroger, the New Jersey Supreme Court declined to apply a minority discount in valuing the interest of a minority shareholder.

There was no real surprise there. New Jersey courts are reluctant to apply a minority discount in the valuation of closely held businesses, which reduces the value of the minority interest. Those discounts, which can signicantly lower the value of an interest — often by a third, or more — tend to reward wrongdoers. Continue reading

June 21, 2022

Retroactive Expulsion of LLC Member

by Jay R. McDaniel, Esq.

The effective date of an LLC member’s expulsion may be a critical issue in business divorce litigation and may be tied to critical events or the litigation.
Courts will look at the facts and circumstances of the case before determining the effective date, but are often guided by the parties’ own intent.
A court may give the expulsion a retroactive date, often the date that litigation was commenced.

February 25, 2021

Share Purchase for $500,000 Required in Accounting Firm Breakup

by Jay R. McDaniel, Esq.

Accounting firm is compelled to repurchase the equity of departing shareholder who moved practice to competitor firm.
A shareholder agreement that is integrated and intended to be the parties’ complete agreement may preclude a claim for breach of corporate by-laws.
A shareholder in an accounting firm organized as a professional corporation did not breach any fiduciary duties by negotiating with a competitor and disclosing general information about his and the firm’s practice, even if he was to be compensated based on the clients who followed him to his new employer.

For 22 years Robert Dick worked in a growing accounting firm before he left for a competitor, taking with him a number of clients. Before giving his resignation, however, Dick put together an estimate of his billings and a description of his client base, although apparently not providing any details on client identify. This discussion – common in a professional move – was one of the principal defenses to a lawsuit that Dick brought to compel his former employer to repurchase his Acountant share repurchase shares.

Resignation of Account from Professional Corporation

Dick was a 30 percent shareholder in Koski Professional Group, P.C. who had built a following among health care clients, having purchased shares in the professional corporation on multiple occasions since 2005. In 2015 he moved his practice to a competitor, Bland and Associates under an arrangement in which he received base compensation plus a percentage commission on his client’s billings. At the time of his departure, Dick was one of four owners. He was followed by a number of clients, leading to the litigation and ultimately an appeal to the Nebraska Supreme Court. (Opinion here) Continue reading

February 5, 2021

Estate Plan Sows Father and Son Business Divorce

by Jay R. McDaniel, Esq.

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.
A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.
In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

Some cases make you wince when you think about the underlying relationship. This case in which a son sued his father over the repayment of a mortgage is one of them. It comes from the Iowa Court of Appeals and is interesting from my perspective because the underlying statute is the same as applies here in New Jersey and because it demonstrates the scope of equity to reframe disputed issues into a more manageable solution. field-213364_1920-e1612533257149-1024x379

The dispute in Erwin v. Erwin (opinion here) addressed the dispute between Michael Irwin and his son, Richard, that grew out of the father’s attempt to pass the family farm without incurring tax liability. The father and Richard’s mother, who owned the farm individually, formed a limited liability company, Erwin Farms II, LLC, in 2012 and passed the land to the company. At the time of the transfer, the land was subject to a mortgage. Richard received a block of non-voting membership units. The remaining membership units, including all of the voting units, were owned by the parents.

The operating agreement of the company named Michael Erwin as manager. In addition to the existing mortgage, after the land was transferred to the LLC, the Erwin parents took two loans for improvements. By the time of the trial, those loans had all been paid. Continue reading

January 18, 2021

Surrender of Membership Certificates Was Dissociation from LLC

by Jay R. McDaniel, Esq.

A limited liability company member withdraws by voluntary dissociation, which occurs when the company has notice of his ‘express will” to withdraw. Voluntary dissociation terminates management rights, but not economic rights.
A court may refuse relief on a claim when the plaintiff has acted with unclean hands with regard to the subject matter of the action. The doctrine applies to an evil practice or wrong conduct in the particular matter for which the court has been asked to provide a remedy.
A member in a manager-managed limited liability company owes no statutory duty of loyalty to the company, but will owe a statutory duty of loyalty under the common law if he or she is also an employee.

A sales representative who held a non-equity percentage interest in a New Jersey limited liability company effectively withdrew as a member of the company by leaving his “share certificates’ with the company’s lawyer, a trial and appellate court have agreed. building-lot-3391379_1920-e1610995346583-1024x402

This withdrawal, known under New Jersey’s version of the Revised Uniform Limited Liability Company Act (RULLCA) as a voluntary dissociation occurred even though the circumstances surrounding that act – leaving a certificate with a lawyer – was disputed. Dissociation in limited liability and partnership law is an act by which an individual owner’s association with the business is severed, voluntarily or involuntarily. It may apply in either a resignation or an expulsion.

The Appellate Division case at issue, Decandia v. Anthony T. Rinaldi, LLC (see opinion here) involved a dispute between a sales representative who received a commission styled as a membership interest in a construction company, but which was actually a non-equity profit interest in his own originations. The sole equity owner of the firm, Rinaldi, retained all of the management rights in the business. Continue reading

November 4, 2020

Controlling Shareholders owe Fiduciary Duties to Minority Members

by Jay R. McDaniel, Esq.

The controlling shareholders of a corporation owe fiduciary duties to the minority shareholders by virtue of their ability to control the affairs of the company.
Even when a merger complies with statutory requirements, where it benefits the controlling shareholders and does not have an apparent business purpose, it must also satisfy equitable principles of fairness.
The fiduciary duties owed by controlling shareholders is a basis to grant injunctive relief, even it is appears that money damages might make the minority shareholders whole for any misconduct.

Corporations Attorney

Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36 (Chancery Division 1975)

Statute: NJSA 14:14-1(1)(a)

Synopsis: In class action seeking injunctive relief blocking merger of defendant Power/Mate with corporation controlled by the majority shareholders, on application for a preliminary injunction, the court enjoined a going-private merger by the defendant controlling shareholders to compel the sale by the minority shareholders to a corporation they controlled. Held that despite compliance with statutory requirements, the merger would be preliminarily enjoined. See opinion Berkowitz v. Power/Mate Corporation. Continue reading

September 21, 2018

Business Judgment Rule Trumps Oppression; Minority Shareholder Entitled to Attorney’s Fees in Defense of Counterclaim

by Jay R. McDaniel, Esq.

The business judgment rule insulates decisions made in good faith and in the best interests of the enterprise from being subject to judicial second guessing ordinary business decisions
Majority shareholders that failed to pay dividends to a non-employee minority shareholders in valid exercise of business judgment rule did not engage in wrongful conduct.
Common law dissolution under New York law is available only for a palpable breach of duty so egregious as to disqualify the majority from exercising rights over dissolution.
A minority shareholder subject to a counterclaim has a right to be indemnified against legal fees and an advance of funds for expenses.
A trial court may preclude individual defendants from using corporate funds to defend an oppressed minority shareholder lawsuit.

Feldmeier The decision of controlling shareholders that a corporation will not pay dividends to a former employee and director is subject to the business judgment rule, in this case defeating the shareholder’s claim of oppressive conduct by the majority.

The Fourth Department of the Appellate Division of New York Supreme Court rejected the claim brought by a minority shareholder of a family-owned equipment business in Syracuse, applying the presumption that an action taken in good faith by a business in the best interests of the business should be free from second-guessing by the minority and the Court. (Opinion in Feldmeier v. Feldmeier Equipment, Inc. here.) Continue reading

An equitable accounting is a cause of action that requires those in control of the finances of a closely held business to account for their use of the money.

An accounting a two-stage process. First the controlling party must render an account of how it used the assets of the business. Then there is a proceeding for the minority to object to the accounting.

When a court finds that the party in control has misappropriate or misued the assets of the company, it can order repayment.

A minority member should demand an accounting before seeking the accounting in court and be prepared to support the request with plausible claims of misconduct.

There is no statutory right to receive a distribution of profits from a limited liability company before it dissolves and winds up its affairs. Distributions before then are discretionary.

Profit distributions are in the discretion of the majority members or commonly in the discretion of the managers of the limited liability company.

A minority member who is not receiving distributions may have a claim under the operating agreement or as an oppressed minority member if the majority refuses to make profit distributions.

Limited Liability Companies Often Do Not Have Operating Agreements

A ‘passive’ member with no rights or responsibilities in the management of a limited liability company cannot be held liable for refusing to participate in a PPP loan application.

Dissociated LLC members with no management rights can withhold their voluntary consent to proposed actions.

The waiver of fiduciary duties in an operating agreement is enforceable under New Jersey law if it is not manifestly unreasonable.

Widow of Owner Refuse Request for PPP Loan Application

A New Jersey Court conducing the valuation of a business may use any technique or method generally acceptable in the financial community.

The application of a minority discount is a question of law, but likely will be based on the factual determinations of the court about the culpability of the litigants.

Business divorces cases are commonly heard in the Chancery Division, a court of equity in which principles of fairness and justice may be applied in addition to any statutory cause of action.

New Jersey’s statutory cause of action for oppression of a minority shareholder does not prevent the court from providing equitable remedies available outside the statute as a matter of common law.

The effective date of an LLC member’s expulsion may be a critical issue in business divorce litigation and may be tied to critical events or the litigation.

Courts will look at the facts and circumstances of the case before determining the effective date, but are often guided by the parties’ own intent.

A court may give the expulsion a retroactive date, often the date that litigation was commenced.

Accounting firm is compelled to repurchase the equity of departing shareholder who moved practice to competitor firm.

A shareholder agreement that is integrated and intended to be the parties’ complete agreement may preclude a claim for breach of corporate by-laws.

Resignation of Account from Professional Corporation

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.

A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.

In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

A limited liability company member withdraws by voluntary dissociation, which occurs when the company has notice of his ‘express will” to withdraw. Voluntary dissociation terminates management rights, but not economic rights.

A court may refuse relief on a claim when the plaintiff has acted with unclean hands with regard to the subject matter of the action. The doctrine applies to an evil practice or wrong conduct in the particular matter for which the court has been asked to provide a remedy.

A member in a manager-managed limited liability company owes no statutory duty of loyalty to the company, but will owe a statutory duty of loyalty under the common law if he or she is also an employee.

The controlling shareholders of a corporation owe fiduciary duties to the minority shareholders by virtue of their ability to control the affairs of the company.

Even when a merger complies with statutory requirements, where it benefits the controlling shareholders and does not have an apparent business purpose, it must also satisfy equitable principles of fairness.

Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36 (Chancery Division 1975)

The business judgment rule insulates decisions made in good faith and in the best interests of the enterprise from being subject to judicial second guessing ordinary business decisions

Majority shareholders that failed to pay dividends to a non-employee minority shareholders in valid exercise of business judgment rule did not engage in wrongful conduct.

Common law dissolution under New York law is available only for a palpable breach of duty so egregious as to disqualify the majority from exercising rights over dissolution.

A minority shareholder subject to a counterclaim has a right to be indemnified against legal fees and an advance of funds for expenses.

A trial court may preclude individual defendants from using corporate funds to defend an oppressed minority shareholder lawsuit.