Fiduciary Duties

May 23, 2023

The Equitable Value of an Oppressed Minority Shareholder’s Interest

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

August 10, 2018

Fair Value of a Corporation: Art not Science

by Jay R. McDaniel, Esq.

In valuing the shares of a minority shareholder, a trial court must consider any valuation technique that is generally acceptable in the financial communities. Determining fair value is an art, not a science.
Directors that hold a majority interest in a closely held business have a duty to deal fairly with the minority and in a merger to make full and fair disclosures and offer a fair price in exchange for shares.
A minority shareholder that sits by or acquiesces to wrongful conduct by the majority waives the right to later pursue a claim based on that behavior.
Fee awards are available only to shareholders with a statutory right to dissent and in the discretion of the judge.

Casey v. Brennan, 344 N.J. Super. 83 (App. Div. 2001)

Statutes: NJSA 14A:11-1, NJSA 14A11-3; NJSA 14A:6-14: NJSA 14A:11-6; NJSA 14A:11-10

Action challenging the valuation provided by controlling directors (also majority shareholders) in corporate reorganization as plan to reduce number of shareholders to 75 or less to qualify for subchapter S status. Directors approved plan of merger at $73 a share in reorganization plan requiring small shareholders to sell. Trial Judge set value at $90 a share. (Opinion here.) The Supreme Court affirmed the Appellate Division. (Opinion here.)

Facts: Community Bank adopted a plan of merger as part of a plan of reorganization that would reduce the number of shareholders by acquring holdings of persons with less than 15,000 sharesat a price of $73 per share. Statutory dissenters and non-statutory dissenters brought various actions consolidated for trial. Trial court holding that proxy statement was misleading and provided non-statutory dissenters with right to sue, and determined fair value $90 per share. Affirmed in part and remanded for reconsideration of valuation issues that were rejected by trial court. Continue reading

September 13, 2017

Business Divorce: Sources of the Law

by Jay R. McDaniel, Esq.

The law that controls any business organizations is a creature of state law, and disputes among owners in a business divorce involve the application of the law where the business was formed. More often than not that means the law of the state in which the dispute is being heard, but not always. And significantly, at least for our present purposes, it does not mean that we will find the answer to a business divorce issue in the state in which the litigation is pending, even among the binding decisions of the state law where the enterprise was formed.

Here’s an example: a New York court is calle Business Divorce Attorneys d upon to determine whether a managing member of a limited liability company breached his or her duty in negotiating a sale of a substantial asset to a third party that the manager negligently believed was an objectively fair price. The plaintiff seeks to expel the manager or to force a dissolution and sale of the business as a going concern. Does the Court apply New Jersey law? If there is no New Jersey case on point – and there is no binding decision on all of the points in this scenario – does the Court apply New York law, and to which issues?

Even if this case is litigated in New Jersey, and there is no law on point, where does the trial court look to guidance. The nearly automatic response is Delaware, because the courts of Delaware have by far the most developed body of law applicable to corporate governance disputes. However, Delaware may be the wrong choice if the limited liability company statute needs interpretation. A well-reasoned decision from an Appellate Court in Illinois, for example, should be much more persuasive to a court construing New Jersey’s limited liability company statute because of the similarity between the two states’ laws.

August 22, 2017

Minority Shareholder’s Silence Waives Oppression Claim

by Jay R. McDaniel, Esq.

It was the stuff of which a good minority oppression claim is easily cooked up. The party in control of the corporation had used the corporate bank accounts as his personal piggy bank while operating a competing business, paid himself inflated office rents and bankrolled an extra-marital affair with money taken from the business.

None of that, however, could carry the day in a lawsuit brought by the minority shareholders of a New Jersey corporation because they waited years to complain.

Minority Shareholder Oppression Alleged by Ousted Officer of Closely Held Corporation

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.

In valuing the shares of a minority shareholder, a trial court must consider any valuation technique that is generally acceptable in the financial communities. Determining fair value is an art, not a science.

Directors that hold a majority interest in a closely held business have a duty to deal fairly with the minority and in a merger to make full and fair disclosures and offer a fair price in exchange for shares.

A minority shareholder that sits by or acquiesces to wrongful conduct by the majority waives the right to later pursue a claim based on that behavior.

Fee awards are available only to shareholders with a statutory right to dissent and in the discretion of the judge.

Casey v. Brennan, 344 N.J. Super. 83 (App. Div. 2001)

Minority Shareholder Oppression Alleged by Ousted Officer of Closely Held Corporation