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

February 1, 2020

How a Law Firm Can Protect Itself From the ‘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.

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

January 30, 2019

Dissolution and the Reasonably Practicable Standard

by Jay R. McDaniel, Esq.

Most limited liability company and partnership statutes make no mention of ‘deadlock’ as grounds to order the involuntary dissolution of a business.
Deadlock arises when the members or partners are no longer able to pursue the basic agreements on which the business was organized, typically an operating agreement or partnership agreement.
The key determination in an action to force the dissolution of a limited liability company or partnership is whether it is ‘reasonably practicable’ for the business to continue.

Courts examine deadlock involving a limited liability company or partnership through the lens of the operating agreement or partnership agreement. The fundamental question in these cases is whether the LLC or partnership can pursue its essential purpose. In this article, we primarily examine the elements of deadlock applied to limited liability companies. Deadlocked partnerships are a rarity, but the analysis should be similar if not identical.

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

A limited liability company or partnership is more prone to deadlock because unanimous agreement is required in most states to act on a number of issues. The unanimity requirement is a core aspect of some of the central principles underlying unincorporated business associations (primarily partnerships and LLCs) – that the owners have unfettered discretion to pick their partners, that they cannot compelled to fundamentally change the business against their will and that they normally will participate in the day-to-day affairs of the business. Deadlock limited liability company | deadlock corporation | deadlock partnership

The Minority Veto Contributes to Deadlock

We see the “pick your partner” principle reflected in disputes over the admission of new members or partners, the unanimity requirement for amendments to an operating agreement, and in the rights of members to be free from interference in the management of the business by creditors. It is also demonstrated in many states by the requirement that mergers and other transactions outside the ordinary course of business have the approval of all of the members. Continue reading

October 15, 2018

Valuation Clause in Operating Agreement Controls Buyout Price of Medical Practice

by Jay R. McDaniel, Esq.

A limited liability company operating agreement may be amended informally by oral agreement or by a course of conduct.
The party that claims amendment of an operating agreement by a course of conduct must establish the clear and mutual intent of the parties to agree to the amendment.
A clear and unambiguous provision in an operating agreement that governs how the limited liability company will be valued in the future is an enforceable contract.

attorney for medical practice valuation A retiring member of a limited liability company was unable to convince a trial judge that the parties had amended the operating agreement through their course of conduct to adopt a new valuation approach.

Certificate of Agreed Value Required by Operating Agreement is not Updated for 17 Years

The opinion in the Chancery Division dismissed on summary judgment the plaintiff’s claim that sought to order the majority owners of a medical practice organized as an LLC to use a fair market value determination of the value of the interest of a retiring member, rather than to rely on an outdated “Certificate of Agreed Value” prepared in March 2001.

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 27, 2018

LLC Member Denied Judicial Dissolution

by Jay R. McDaniel, Esq.

New York does not recognize a cause of action for minority oppression of a member of a limited liability company.
Judicial dissolution is a remedy available to the minority LLC member when the majority is unwilling or unable to promote the purpose of the company or continuing the business has become financially not feasible.

The dismissal of a judicial dissolution claim brought by an LLC member seeking to dissolve the family business demonstrates the difficulty that an oppressed minority LLC member faces under New York law.

New York does not recognize a cause of action for minority oppression under its limited liability company statute, and so a trial judge in New York County made quick dismissal of a claim for involuntary judicial dissolution based on the allegations of a minority member that he was being treated unfairly. The plaintiff’s attorneys missed the mark and failed to assert other significant claims suggested by the facts alleged in the complaint.

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

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.

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

Most limited liability company and partnership statutes make no mention of ‘deadlock’ as grounds to order the involuntary dissolution of a business.

Deadlock arises when the members or partners are no longer able to pursue the basic agreements on which the business was organized, typically an operating agreement or partnership agreement.

The key determination in an action to force the dissolution of a limited liability company or partnership is whether it is ‘reasonably practicable’ for the business to continue.

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

The Minority Veto Contributes to Deadlock

A limited liability company operating agreement may be amended informally by oral agreement or by a course of conduct.

The party that claims amendment of an operating agreement by a course of conduct must establish the clear and mutual intent of the parties to agree to the amendment.

A clear and unambiguous provision in an operating agreement that governs how the limited liability company will be valued in the future is an enforceable contract.

Certificate of Agreed Value Required by Operating Agreement is not Updated for 17 Years

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.

New York does not recognize a cause of action for minority oppression of a member of a limited liability company.

Judicial dissolution is a remedy available to the minority LLC member when the majority is unwilling or unable to promote the purpose of the company or continuing the business has become financially not feasible.

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

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