Members | Partners | Shareholders Category Archives — The Business Divorce Law Report Published by Business Lawyer

May 16, 2023

Reasonable Expectations Define Oppression of Minority LLC Member

Limited Liability Company laws in New Jersey and many states provide a cause of action for the oppression of minority members of company against those in control of the business.
Oppression of a minority LLC member is measured by the reasonable expectations of the minority member in those states that have adopted the Uniform Limited Liability Company Act
Courts assess reasonable expectations by looking at the operating agreement, the behavior of the members and purpose of the members in joining the business.

Majority rule in any limited liability company is not without its risks, in particular the potential for the majority owners to oppress the minority members, together with the difficulty the minority member is likely to have in recouping the investment in the business.

Minority members of a limited liability company may always voluntarily dissociate, or resign, as a member, at which point they give up the right to participate in management. As a “dissociated member,” the minority member who has resigned is entitled to his or her share of profits, but not to participate in decisions or get full information about the operations of the business. Continue reading

January 24, 2023

FTC Ban on Non-Competes Would Have Major Impact on Closely Held Businesses

by Jay R. McDaniel, Esq.

The Federal Trade Commission is considering an administrative rule that would enact a broad ban on non-compete agreements that would prohibit contracts that restrict the employee from working for a competitor or starting a competing business.
The rule would also apply to ‘de facto’ non-competes, such as non-solicitation agreements, that have the effect of limiting a worker’s activities after employment.
The proposed rule will likely have a negative impact on the competitiveness and value of closely held businesses. Non-competes in equity transactions would be prohibited unless the equity stake involved is at least 25 percent.

A proposed rule pending before the Federal Trade Commission would bar noncompete agreements across-the-board, and in a way that could bring some very profound changes to the business climate in this country. If it is adopted in its present form, it likely will have a direct effect on the value of the investments of business owners in their own businesses and make the smaller, privately held business less competitive.

This proposed rule is a big shift in resources from business owners to the employees. It is something to watch and understand because of the effect it is likely to have if the proposed rule is adopted in its present form. It’s controversial and has already run into opposition from the U.S. Chamber of Commerce.

October 1, 2022

Anatomy of a Business Divorce Lawsuit

by Jay R. McDaniel, Esq.

- A business divorce is the process by which the owners of a business separate their business interests. The process involves negotiation and may also require litigation.
- These cases can be divided into four phases: the emergent phase, the examination phase, the valuation phase and the resolution phase.
- Most owner lawsuits end in a negotiated transaction because it gives the parties more flexibility over the manner in which the case is resolved.

We’re going to look at business divorce in terms of the four phases that the typical case goes through from its start to the time that is resolved, either through settlement or trial.We should start with the most basic definition of what is a business divorce. I use the term to describe the process by which people who were in a business together disentangle themselves. Continue reading

March 1, 2021

An Email Does Not Make an Operating Agreement

by Jay R. McDaniel, Esq.

An email from the sole owner of a limited liability company announcing that employees had become partners with a profit interest was not sufficient to constitute admission as a member of the LLC.
The fact that the party claiming an equity interest in an LLC had refused to execute an operating agreement was a strong indication that the issuance of equity was still the subject of negotiations.
A court is likely to consider the completeness of the terms of an alleged oral agreement to admit a new member; without sufficient details the agreement will be deemed incomplete and unenforceable.
The issue of whether an individual is a member of a limited liability company is properly tried by a judge rather than a jury.

What does it take to make someone a member of a limited liability company? The Revised Uniform Limited Liability Company Act (RULLCA) as adopted in New Jersey and most operating agreements contain some requirement for unanimous consent. The requirement on unanimous consent reflects the policy underlying the “pick your partner rule” in smalll business organizations: no one should be forced to share ownership of a closely held business against their will. mail-1454731_1920-1024x1024

Unanimous Consent Required for Admission of New LLC Members

The contours of what is unanimous consent is often not clear, however. Does a promise of admission as a member or partner constitute consent? What about the formality of signing an operating agreement? These are facts that vary by the case and the circumstances.

The line between equity owner and a highly compensated senior employee – sometimes with the title of partner – is often blurred, particularly in certain professions such as lawyers in which the non-equity or contract partner is a common occurrence. In a case recently before the Appellate Division in New Jersey, the business at hand was a private equity fund and a senior employee. Continue reading

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

February 2, 2021

One Business Divorce, Multiple Actions

by Jay R. McDaniel, Esq.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.
A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.
Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Multiple lawsuits from a business divorce may not be entirely commonplace, but it does happen when the controlling governance documents contain an arbitration clause, but there are outsiders not bound by the agreement to arbitrate that are involved in the dispute. These may be former employees, agents, competitors or vendors. gavel-2492011_1920-1024x569

Simultaneous Arbitration and Litigation in Court

The result is that some of the parties may be obligated to arbitrate, or that some of the dispute may not be subject to the agreement to arbitrate. Consider the case in which there are disputed events that occurred while the parties still had fiduciary obligations to each other – such as between partners or employer and employee – and those that occur outside the fiduciary obligation. These might include unfair competition or claims arising from a competitor hiring someone under a restrictive covenant. Continue reading

February 26, 2020

ABA Says Minimum Notice Requirements Are Ethical

by Jay R. McDaniel, Esq.

Law firms may not limit the ability of lawyers to resign, solicit clients and compete with the firm, but they may contract for a reasonable notice period necessary for the orderly transfer of client matters.
Both the departing lawyer and the law firm share an ethical obligation to assure the client of continued competent representation during the transition period before the lawyer’s departure.
The notice requirement cannot act as a financial disincentive to competition and the departing lawyer’s willingness to cooperate in the transfer of matters and post-departure billing is a factor in determining whether the notice period is reasonably imposed.

There are some very good reasons for lawyer firm management to fear the “grab and go.” A key lawyer resigns with little or no notice and immediately begins to solicit clients. In some instances, the result can devastate the fortunes of a law firm, drawing out cash flow and personnel, but leaving the firm to continue to carry the same level of expenses.

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The Law Firm Grab and Go

It’s sometimes known as the “grab and go.” It occurs when one or more lawyers resign without notice while simultaneously soliciting the firm’s clients to follow them. In some cases, the grad and go will strip a small firm of a substantial portion of its revenue while leaving it with large liabilities such as leases, advanced expenses and personal financial exposure for the remaining principals. Can a law firm contract with its principals and attorneys to prevent the grab and go? Continue reading

February 1, 2020

How a Law Firm Can Protect Itself From the ‘Grab and Go’?

by Jay R. McDaniel, Esq.

Law firms should recognize that lawyer resignations and the loss of clients are inevitable in the modern law practice due to prohibitions on agreements that restrict competition.
Law firms can protect the interests of clients and the firm by adopting best practices that govern lawyer resignations.
Law firms should recognize the investments made in the firm’s intellectual property and adopt policies that limit misappropriation.

Law firms must survive in a world in which key employees are free to leave at any time and to take as much of the firm’s business with them as they can. Many lawyers, motivated by the financial incentives that are part of their separation, believe that there are no rules limiting their solicitation of clients, copying of key documents and compensation for their old firm. This view may be mistaken, but sorting it out after the resignation or withdrawal is expensive, time-consuming football-1717630_1280-1024x682 and threatens to draw off the time and attention of key managers.

The grab and go is the unexpected resignation without notice combined with the immediate unilateral solicitation of clients. Its corollary is the law firm lockout, in which a lawyer that has indicated his or her intention to leave is locked out of the firm and cut off from clients while the clients are intensely solicited by the firm.

Best Practices to Manage Lawer Resignations

Here is a list of some of 10 policies that a law firm should have in place before a key lawyer decides to move his or her practice. But first, the reality check. Lawyers will leave and lawyers will take clients. Not only that, but lawyers have a right to leave and take clients. The only issue on the table is managing the process.

Law firms, the individual lawyers that work there and the clients that we serve are better served by articulating a clear set of rules beforehand, by adopting key internal policies and by recognizing that resignation need not equate with conflict. Lawyers and their former law firms should remember that life goes on after the departure. But when one side tries to gain an unfair advantage over the other, however, life gets complicated and messy. Continue reading

November 12, 2019

Tax Treatment Alone Does Not Establish General Partnership

by Jay R. McDaniel, Esq.

Courts determine whether an individual has an equity interest in a law firm partnership by examining the financial investment and risk taken by the claimed owner, such as payment of capital and guarantees of obligations.
The rise of the non-equity partner in law firms management has changed the status associated with the title partner. Nearly half of all law firm partners are now classified as non-equity or limited equity.
The way in which the firm reports the income of a partner to the IRS in its tax filings are evidence of an equity interest in many cases, but describing an individual as an equity owner may not be conclusive.

The last refuge of the general partnership may be the law firm. However, the term “partner” in a law firm can have a number of different meanings and it often does not identify only the traditional equity owner of the enterprise. In many circumstances, “partner” is a title that indicates a senior attorney, usually at the top of the firm’s professional structure. It does not, however, provide a particularly reliable indication of either management responsibilities or a financial interest in the firm. partnership-526413_1280-1024x562

Not all partners are created equally. In fact, the rise of non-equity partner, those that do not share in the profits or capital of the law firm, is rising rapidly. Only 56 percent of the partners in law firms in 2018 were equity partners. (Above the Law, 3 Reasons to Embrace the Rise of Non-Equity Partners). That trend is a 250 percent increase over the past two decades. In 1999 the figure was 17.1 %.(Altman Weil, Inc. What Should Law Firms Do about Non-Equity Partnership).

Not surprisingly, the existence of an equity interest, or not, is not an uncommon area for dispute. In this post we consider here involving the effect of tax documents on the claim of an attorney that he held an equity interest in a well-known personal injury firm. Treatment for income tax purposes is invariably a key component of holding equity. Is it dispositive? In this case, no. Continue reading

Limited Liability Company laws in New Jersey and many states provide a cause of action for the oppression of minority members of company against those in control of the business.

Oppression of a minority LLC member is measured by the reasonable expectations of the minority member in those states that have adopted the Uniform Limited Liability Company Act

Courts assess reasonable expectations by looking at the operating agreement, the behavior of the members and purpose of the members in joining the business.

The Federal Trade Commission is considering an administrative rule that would enact a broad ban on non-compete agreements that would prohibit contracts that restrict the employee from working for a competitor or starting a competing business.

The rule would also apply to ‘de facto’ non-competes, such as non-solicitation agreements, that have the effect of limiting a worker’s activities after employment.

The proposed rule will likely have a negative impact on the competitiveness and value of closely held businesses. Non-competes in equity transactions would be prohibited unless the equity stake involved is at least 25 percent.

A business divorce is the process by which the owners of a business separate their business interests. The process involves negotiation and may also require litigation.

These cases can be divided into four phases: the emergent phase, the examination phase, the valuation phase and the resolution phase.

Most owner lawsuits end in a negotiated transaction because it gives the parties more flexibility over the manner in which the case is resolved.

An email from the sole owner of a limited liability company announcing that employees had become partners with a profit interest was not sufficient to constitute admission as a member of the LLC.

The fact that the party claiming an equity interest in an LLC had refused to execute an operating agreement was a strong indication that the issuance of equity was still the subject of negotiations.

A court is likely to consider the completeness of the terms of an alleged oral agreement to admit a new member; without sufficient details the agreement will be deemed incomplete and unenforceable.

The issue of whether an individual is a member of a limited liability company is properly tried by a judge rather than a jury.

Unanimous Consent Required for Admission of New LLC Members

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.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.

A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.

Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Simultaneous Arbitration and Litigation in Court

Law firms may not limit the ability of lawyers to resign, solicit clients and compete with the firm, but they may contract for a reasonable notice period necessary for the orderly transfer of client matters.

Both the departing lawyer and the law firm share an ethical obligation to assure the client of continued competent representation during the transition period before the lawyer’s departure.

The notice requirement cannot act as a financial disincentive to competition and the departing lawyer’s willingness to cooperate in the transfer of matters and post-departure billing is a factor in determining whether the notice period is reasonably imposed.

The Law Firm Grab and Go

Law firms should recognize that lawyer resignations and the loss of clients are inevitable in the modern law practice due to prohibitions on agreements that restrict competition.

Law firms can protect the interests of clients and the firm by adopting best practices that govern lawyer resignations.

Law firms should recognize the investments made in the firm’s intellectual property and adopt policies that limit misappropriation.

Best Practices to Manage Lawer Resignations

Courts determine whether an individual has an equity interest in a law firm partnership by examining the financial investment and risk taken by the claimed owner, such as payment of capital and guarantees of obligations.

The rise of the non-equity partner in law firms management has changed the status associated with the title partner. Nearly half of all law firm partners are now classified as non-equity or limited equity.

The way in which the firm reports the income of a partner to the IRS in its tax filings are evidence of an equity interest in many cases, but describing an individual as an equity owner may not be conclusive.