Members | Partners | Shareholders Category Archives — Page 2 of 5 — The Business Divorce Law Report Published by Business Lawyer

February 2, 2021

One Business Divorce, Multiple Actions

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

June 28, 2019

Dividing Fees in a Law Firm Business Divorce

by Jay R. McDaniel, Esq.

Business divorce disputes among lawyers will often require the division of contingent fees realized after the parties have separated their business interests.
An agreement between lawyers in a firm to divide fees in the event of their separation cannot function as a restriction on a lawyers right to practice and to compete with a former firm, but otherwise is generally enforceable.
Courts also use principles of quantum merit — ‘as much as he deserves – to allocate contingent fees between lawyers who once practiced togther.

The division of fees, in particular contingent fees earned after a firm is dissolved or the resignation of a rainmaker, are the catalyst for business divorce disputes in law firm breakups. These disputes involve some key issues: business-861325_1280-1024x768

Is there an agreement in place covering the division of fees?
If there is an agreement, is it enforceable?
If there is no agreement, how will a court divide the fees?

Agreements to Divide Fees

Lawyers practicing together in a firm frequently make agreements on how fees will be divided after the withdrawal of a lawyer. These agreements may be part of the firm’s partnership, operating agreement or corporation bylaws, or embodied in an employment contract or separation agreement. These types of agreements are generally, but not always, enforceable.

Getting the client’s consent to such a division is also a good practice and, in at least one jurisdiction, may be required.

June 26, 2019

Anti-Deadlock Agreements in Business Divorce Litigation

by Jay R. McDaniel, Esq.

Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.
Anti-deadlock provisions may provide for the appointment of an independent director, for alternative dispute resolution, or for the compelled sale of an equity interest.
The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

After a closely held business becomes deadlocked, it is extremely difficult to push the parties toward some mechanism that might either break the deadlock or preserve the current management system, or event let the parties separate themselves on mutually agreeable terms.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Human nature stands in the way. The parties likely have financial and emotional positions that they are unwilling to compromise. These may range from the ability to control some aspect of the operations of the business to the payment of dividends or bonuses.

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Lawyers and their clients try to address the potential for future deadlock with these contractual provisions that are known by a number of descriptions, such as buy-sell agreements, shotgun

provisions, put-call terms. In the world of closely held limited liability companies, corporations and partnerships, a buy-sell agreement that is triggered by a deadlock is the pre-nuptial agreement of business divorce.

In this and the following post, we examine these contractual provisions that are used to break deadlocks. We consider first the scope of anti-deadlock provisions, when they may be invoked and whether they are subject to judicial controls. In a following post, we will look at buy-sell agreements in more detail and, in particular, shotgun language that is intended to keep a forced sale on terms acceptable to both parties. Continue reading

September 18, 2018

Action by Written Consent of LLC Managers is Valid to Fire Executive

by Jay R. McDaniel, Esq.

Any action that the managers of a Limited Liability Company might take at a meeting can also be taken by executing a written consent.
An action by written consent may, in some circumstances, avoid the need to assemble a quorum of the managers.
The managers of an LLC many be contractually obligated to effect management changes by an operating agreement, but those obligations are not self-executing.

Limited Liability Company Lawyers A venture capital company and the independent manager of a limited liability company were permitted to correct a questionable vote and use a written consent to terminate one of the founders as manager of a group of holding companies.

The fired manager had challenged the vote as lacking a quorum, with only two of the four members present. The managers simply acted by written consent, permitted under Delaware Law, and the court held that the action had the necessary “disinterested” votes under the LLC’s operating agreement to remove the manager.

August 20, 2018

Member-Managed Limited Liability Company Similar to Partnership

by Jay R. McDaniel, Esq.

A trial court reasons that because a member-managed limited liability company is similar in management to a partnership, the court may reason from partnership law in fashioning a remedy for an expelled member.
The majority members of the LLC, who voted under the Operating Agreement, to compel the withdrawal of the member are jointly and severally liable to pay the ousted member the fair value of his equity interest.
When no other provision of the limited liability company statute applies, in many states a court may turn to recognized “rules of law and equity” to fashion a remedy.

Limited Liability Company Disputes Attorney A Delaware chancery judge drew a liberal comparison between a venture capital fund organized as a limited liability company and a limited partnership in holding that a member that had been forced out was entitled to fair value rather than the value of his capital account. The result was that his buyout increased by some fivefold, but not for the reasons advanced by the departing member.

Compelled Withdrawal of Member Requires Payment of Fair Value

The case, Domain Associates, LLC v. Shah, is significant for two principal holdings. First, it represents a relatively rare occurrence when a trial court falls back on the equitable catch-all provision that one finds in a number of limited liability company and partnership statutes. Second, the trial judge considered the management structure – the LLC at issue was member-managed similar to a partnership – as good reason to follow a decision construing the equitable catch-all provision found in Delaware’s partnership statute. Continue reading

June 13, 2017

Evidence of LLC Membership by Plaintiff MD is Lacking

by Jay R. McDaniel, Esq.

What is sufficient evidence of membership interest in a limited liability company? It is not uncommon that the intentions of the parties in forming a limited liability company are poorly documented and or non-existent.

The plaintiff in this case argued that documents that indicated his initial interest in the LLC were sufficient to establish his membership. These include emails in which he expressed his interest in participating in the LLC, the fact that he was included as a signatory in an early letter of intent with HUMC, the fact that he was initially included in an email group of members and the receipt of meeting notices.

Appellate Court Considers Evidence of LLC Membership in Ownership Dispute Among Critical Care Doctors

February 14, 2017

Limited Liability Company Owners Personally Liable to Creditor

by Jay R. McDaniel, Esq.

We counsel many owners of limited liability companies that the filing of a Certificate of Formation does note automatically protect the owners from person liabilities. There are a number of business practices, often referred to as the “corporate formalities” that should be followed.

A case from Iowa’s Court of Appeals illustrates this principle, in which the court affirmed the finding of a trial court that the owners of a limited liability company were personally liabile for $235,000 owed to a supplier. Keith Smith Co. v. Bushman, 873 N.W.2d 776(Table), 2015 WL 8364910(Table) (Iowa App., 2015).

The supplier claimed that the defendant was essentially a shell company with inadequate capitalization. The trial court agreed and the appeals court affirmed.

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.

Business divorce disputes among lawyers will often require the division of contingent fees realized after the parties have separated their business interests.

An agreement between lawyers in a firm to divide fees in the event of their separation cannot function as a restriction on a lawyers right to practice and to compete with a former firm, but otherwise is generally enforceable.

Courts also use principles of quantum merit — ‘as much as he deserves – to allocate contingent fees between lawyers who once practiced togther.

Agreements to Divide Fees

Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.

Anti-deadlock provisions may provide for the appointment of an independent director, for alternative dispute resolution, or for the compelled sale of an equity interest.

The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Any action that the managers of a Limited Liability Company might take at a meeting can also be taken by executing a written consent.

An action by written consent may, in some circumstances, avoid the need to assemble a quorum of the managers.

The managers of an LLC many be contractually obligated to effect management changes by an operating agreement, but those obligations are not self-executing.

A trial court reasons that because a member-managed limited liability company is similar in management to a partnership, the court may reason from partnership law in fashioning a remedy for an expelled member.

The majority members of the LLC, who voted under the Operating Agreement, to compel the withdrawal of the member are jointly and severally liable to pay the ousted member the fair value of his equity interest.

When no other provision of the limited liability company statute applies, in many states a court may turn to recognized “rules of law and equity” to fashion a remedy.

Compelled Withdrawal of Member Requires Payment of Fair Value

Appellate Court Considers Evidence of LLC Membership in Ownership Dispute Among Critical Care Doctors