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

October 4, 2022

When Can a LLC Member Be Expelled?

The removal of a member from a limited liability company, known as involuntary dissociation, is permitted by statute in most states and may also be permitted in an operating agreement.
Removal is permitted when a member has engaged in wrongful conduct that has or will materially affect the company or when the member has repeatedly breached the operating agreement.
Removal may also be permitted when a member files for bankruptcy or if it is not reasonably practicable for the LLC to continue with them as a member.

There are plenty of choices that we make in our lives that we would like to undo. Some we can and some we can’t. Breaking up with a business partner is the topic of this discussion. More particularly, how a member of a limited liability company can be expelled from the business. We’ll cover the circumstances in which members can be expelled, when it’s easy and when it’s not.

September 4, 2022

Minority Veto Rights Lead to Deadlocked LLCs

by Jay R. McDaniel, Esq.

Limited liability company statutes often require the unanimous approval of the members before actions may be taken outside the ordinary course of business or for any amendment of the Operating Agreement.
The requirement for unanimous action creates a minority veto – any member can veto the actions of the majority – often leading to deadlock.
States that have adopted the Uniform Limited Liability Company Act, including New Jersey, Pennsylvania and Connecticiut, require unanimous actions. Other states, including Delaware and New York, permit major actions to be taken by simple majority vote.

These days we’re seeing a political world in which we have a national politics that is very, very closely divided, and one or two people have tremendous control over the rest of the country. It’s not just the Congress, but over everyone. And they’re basically, even though they only have one vote, they’re able to stop things, able to derail a process. They have a minority veto. 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 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 2, 2020

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.

The expulsion of a member is likely the most litigated issue in disputes involving members of a member of a limited liability company. The expulsion, or involuntary dissociation, is a remedy for 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 for misconduct and some recent decisions indicate that in the states that do, it will likely 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

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

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.

The removal of a member from a limited liability company, known as involuntary dissociation, is permitted by statute in most states and may also be permitted in an operating agreement.

Removal is permitted when a member has engaged in wrongful conduct that has or will materially affect the company or when the member has repeatedly breached the operating agreement.

Removal may also be permitted when a member files for bankruptcy or if it is not reasonably practicable for the LLC to continue with them as a member.

Limited liability company statutes often require the unanimous approval of the members before actions may be taken outside the ordinary course of business or for any amendment of the Operating Agreement.

The requirement for unanimous action creates a minority veto – any member can veto the actions of the majority – often leading to deadlock.

States that have adopted the Uniform Limited Liability Company Act, including New Jersey, Pennsylvania and Connecticiut, require unanimous actions. Other states, including Delaware and New York, permit major actions to be taken by simple majority vote.

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

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

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

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.