Articles Posted in Operating Agreement | Shareholder Agreement

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.

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 calleBusiness Divorce Attorneysd 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.

Share-Certificate
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.

business divorce attorneys medical practiceWhat 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

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.

Attorney for Buy-Sell Agreement
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.

agency-1

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. agent3December 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.

Continue reading

restrictive-covenant

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.

mistake

New Jersey Limited Liability Company Attorneys

Imagine that the limited liability company you and your partners started five years ago is involved in a nasty corporate governance lawsuit.  Perhaps one of the partners needs to be expelled, or maybe one of the owners is involved in a competing business.  Imagine that you are spending tens of thousands of dollars every month on legal fees, that the business is in a state of constant disruption and that you haven’t had a good night’s sleep in weeks.

And now, accept the fact that this could have been avoided.

The chances are that if a closely held business is involved in this type of litigation it is because the owners did not plan well when they started the business.  How do I know?  Having litigated many of these matters over the years, I see the same mistakes made early in the life of the business surfacing again and again as the source of litigation.

New Jersey Limited Liability Company Operating Agreement

This is my non-exclusive list of what I think  are the most expensive mistakes that I see people make in their business.  There are others, to be sure, but these are the ones that I see as the source of litigation among the members.

No Operating Agreement:  Actually, I am not going to count not having an operating agreement as one of the five “mistakes.”  It is not really a mistake, it is a colossal blunder, kind of like drunk driving – you may get away with it for a while, but you know how it’s going to end.

Continue reading

refuse

Purchaser Alleges Mortgage Was Not Approved by All LLC Members

A mortgage given by a New Jersey limited liability company to one of its members can be challenged by the purchaser in a court-approved sale of the business, the Appellate Division holds, reversing the trial court.

This case arises out of the estate planning undertaken by John Best and his wife, defendant Patricia Ann Best, after Mr. Best learned that he was terminally ill.  The couple owned Sea Village Marina in Northfield (across the bay from Margate).  They had transferred 25 percent of the business to their son, John, in 1994.

Contact Information