Operating Agreement | Shareholder Agreement Category Archives — The Business Divorce Law Report Published by Business Lawyer

July 30, 2018

Minority Shareholder Lacks Standing to Sue for Dissolution

by Jay R. McDaniel, Esq.

New York’s BCL requires at least 50 percent of shares to petition for dissolution based on deadlock, unless there has been a failure to elect directors.
The fact that a shareholders agreement required the election of two deadlocked directors was not a basis to waive the statutory requirement.
Parties avoid claims of wrongdoing and oppressed shareholder action that could trigger mandatory sale of minority interest.

Oppressed Shareholder lawsuit attorney

Judicial Dissolution Petition Requires 50 Percent Shareholder

A minority shareholder in New York will have a difficult time pursuing a claim for dissolution because of a deadlocked board of directors or a deadlock among the shareholders. New York law permits a cause of action for judicial dissolution based on deadlock, but only by shareholders with holdings of 50 percent or greater, unless the shareholders are unable to elect directors.

The statute can be harsh in its application, as demonstrated by a trial judge’s decision to dismiss a petition for dissolution under BCL § 1104, the provision of the New York Business Corporations Law that creates a statutory cause of action for judicial dissolution. (We discuss the issue of deadlock in more detail in our series on the topic, here and here.) Continue reading

September 13, 2017

Unanimous Consent Signed by LLC Members Operates as Amendment to Operating Agreement

by Jay R. McDaniel, Esq.

Cases-of-Note-Corporations-1-300x169

Clark v. Butoku Karate Sch., LLC, No. 326638 (Mich. App., 2016)

Statutes: MCL 450.4101, MCL 450.4305, MCL 450.4509

Plaintiff Joby Clark and Defendant were the sole members of a Michigan Limited Liability Company operating a karate school. Clark was the subject of a rumor that he had a sexual relationship with an underage student. The parties agreed that Clark would leave the business to prevent damage to the school.

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.

July 27, 2017

Oral Agreement to Transfer Shares Is Enforceable

by Jay R. McDaniel, Esq.

The prior owner of a woman-owned business will be required to pay upwards of $500,000 to an oppressed shareholder after a trial court found — and the Appellate Division confirmed — that she had entered into a valid agreement to transfer her shares in return for an agreement that allowed her to continue collecting her husband’s salary while he was in prison.

Opressed Shareholder Sues to Enforce Transfer Agreement

The unreported decision in Dilworth v. DiSalvatore, Docket No. A-4492-14T2 (N.J. App. Div. March 16, 2017) is interesting in a number of respects. First, it presents a case in which we see the results of failing to commit agreements among the owners of a closely held business to writing. It’s great for the litigators but no so fortunate for the owners that failed to get it in writing.

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 28, 2017

How to Expel an LLC Member

by Jay R. McDaniel, Esq.

There are circumstances in which a member of a limited liability company in most states may be expelled as a member from the company. This is known as involuntary dissociation.
An action may be brought by the LLC seeking a court order of involuntary dissociation on the basis that the member has engaged in wrongful conduct that has or will harm the company, has repeatedly breached the operating agreement, or because it is not ‘reasonably practicable’ for the company to continue with him or her as a member.
Dissociated members lose their rights to participate in management, but retain their financial interest and a right to receive distributions.
In litigation over an involuntary dissociation, a court may order a sale of the interests of a member to the LLC or to any other party to the litigation.

Probably the most litigated issue in my practice involves the expulsion of a member of a limited liability company in response to some wrongful conduct or breach of the operating agreement. We represent majority owners when they are trying to remove a member and we represent the minority member who is fighting removal. Not all states permit removal or expulsion – known as involuntary dissociation – for misconduct and some recent decisions indicate that in the states that do, it may be harder than once thought.

Involuntary Dissocation of a Limited Liability Company Member

There was a belief, perhaps unreasonably so, that Courts were unwilling to keep people in business together when plainly the owners were no longer capable of maintaining a working relationship. The New Jersey Supreme Court, in the first decision by any state supreme court on the topic, held that the concept of “not reasonably practicable” to stay in business together means more than a personality conflict. It requires a structural inability to act, such as ongoing deadlock or significant wrongful conduct. Continue reading

December 16, 2016

Anti-Reliance Clause in Purchase Agreement Defeats Fraud Claim

by Jay R. McDaniel, Esq.

The parties to a transaction, including a transaction that concludes a business divorce, will often include a provision that states that neither side is relying on verbal representations of the other. Most often, this provision refers to the due diligence that precedes a transaction, but it can also refer to other circumstances including the discovery in an ongoing litigation.

We were recently involved in a case in which one of the parties claimed that it had been fraudulently induced into a transaction, notwithstanding the substantial discovery that had occurred. It wasn’t a successful argument, but it added to the complexity of the case.

More often, however, there is a claim either that there were facts or circumstances that were hidden or that that there were oral representations made that were material to the decision to enter into the transactions. A recent decision of the Delaware Chancery Court in IAC Search, LLC v. Conversant LLC , C.A. No. 11774-CB (Del. Ch. Nov. 30, 2016) demonstrates that an anti-reliance provision in a contract can avoid such a fraud in the inducement claim.

December 15, 2016

What’s in that Buy-Sell Agreement Again? Better Take a Look

by Jay R. McDaniel, Esq.

A business divorce case came into the office a couple of years ago, one of the second-generation owners was looking to force one of the first generation owners — who never came to work anymore — into retiring and selling his interests.

We reviewed the shareholder ledger and the by-laws and the second generation had a clear majority of shares. So at least the majority could terminate the employment of the minority if that was the way they wanted to go, and he would then have the ability to bring a suit to be bought out. Or more likely, once he was fired, he would want to be bought out. So far, so good.

But then the buy-sell agreement. It provided a formula for valuation that was pegged to the equity accounts of the shareholders some 25 years earlier. The books and records for that time period had long since disappeared. In the end, we were able to piece together a guess about the equity accounts and to negotiate a package.

May 15, 2015

Does the LLC Statute Trump Agency Law?

by Jay R. McDaniel, Esq.

Agent Fails to Dislcose Principal Exists, Avoids Liability

Was the limited liability company statute supposed to eliminate basic principles of agency law? That seemsto be the import of a decision by the Appellate Division of Superior Court in Castro v. Giacchi, Docket No. A-6220-12T2 (N.J. Super. App. Div. December 5, 2014)(Opinion Below) that reversed a judgment against an individual who failed to disclose that he was acting on behalf of a limited liability company.

Perhaps just as important as our first question: does it really matter? Here the answer is pretty easy. Absolutely. Understanding agency law – that is the law that governs when one person acts on behalf of another – is critical to understanding how business entities function. The reason is that even though a business entity is a legal person, but it can an only act through its agents. The business entity is distinct from its principals.

Contractor’s Handshake Deal with Sub

The decision arose out of a contruction contract. Castro was subcontracted to do carpentry work on a new home under construction in Southhamptom by Defendants. It was a handshake deal. Plaintiff contended that he never knew Giacchi was acting on behalf of anyone other than himself, but he received two progress payments John & Sons ANG, LLC. The final bill was sent to ANG.

Ordinarily, an agent who fails to disclose he is entering into a contract on behalf of a principal is individually liable on the contract, unless the other party knows or had reason to know the agent was acting on behalf of a principal.

* * *

But N.J.S.A. 42:2B-23 shielded a member or agent of a limited liability company from all of its debts. The statute did not limit the circumstances under which a member or agent was immune from liability, including those where a member or agent of a limited liability company entered into a contract without disclosing the identity of its principal. Being clear and unambiguous, our sole function is to enforce the statute according to its terms.

May 15, 2013

The Little Big Breach – Restrictive Covenants

by Jay R. McDaniel, Esq.

Most of the cases that we handle – like any other litigation – get settled before trial. One of the incentives to settle is that invariably the departing owner will agree to some sort of restrictive covenant against competing against his former company.

The case that goes to trial, or which is resolved on a substantive motion, leaves this issue wide open. In fact, there is no statutory basis to deter the ousted business owner from setting up a competitor and trying to lure away the business of his former company, and one would suppose with a bankroll secured by the purchase of his or her interest.

Since most business divorce litigation ends with a deal, and restrictive covenants are critical aspects of those transaction, I thought it worthwhile to write about a recent decision of the Appellate Division that gives a stern warning that the restrictive covenant had better been honored.

New York’s BCL requires at least 50 percent of shares to petition for dissolution based on deadlock, unless there has been a failure to elect directors.

The fact that a shareholders agreement required the election of two deadlocked directors was not a basis to waive the statutory requirement.

Parties avoid claims of wrongdoing and oppressed shareholder action that could trigger mandatory sale of minority interest.

Judicial Dissolution Petition Requires 50 Percent Shareholder

Clark v. Butoku Karate Sch., LLC, No. 326638 (Mich. App., 2016)

Opressed Shareholder Sues to Enforce Transfer Agreement

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

There are circumstances in which a member of a limited liability company in most states may be expelled as a member from the company. This is known as involuntary dissociation.

Dissociated members lose their rights to participate in management, but retain their financial interest and a right to receive distributions.

In litigation over an involuntary dissociation, a court may order a sale of the interests of a member to the LLC or to any other party to the litigation.

Involuntary Dissocation of a Limited Liability Company Member

Agent Fails to Dislcose Principal Exists, Avoids Liability

Contractor’s Handshake Deal with Sub