Landmark Decision Will Make Removal of Members Eaiser
Many limited liability company litigators have presumed that to expel a member from a New Jersey limited liability company you must establish wrongful conduct such as dishonesty or involement in a a competing business. And moreover, if the case is successful, the next assumption was that the company must buy back the interest of the ousted member
Both the trial court and the attorneys involved in All Saints University of Medicine Aruba v. Chilana, Docket No. A-2628-09T1, App. Div Dec. 24, 2012 (read decision below), seem to have made the same assumptions. The appellate court, however, in this recent decision made clear that neither is accurate.
Limited Liability Company Act Permits Expulsion Through Involuntary Dissociation
Similar situations actually arise with some frequency. One of the members of an LLC, for whatever reason, becomes a hindrance to the continued operations of the business. Perhaps the LLC needs capital and the member will not, or cannot, contribute their fair share. Perhaps the LLC relies on the members working in the business on a daily basis and one of them stops coming to work. (Editor’s note: The Supreme Court has drawn portions of the reasoning of the Apellate Division into question in its 2016 decisions in IE Test v. Kenneth Carroll. Read our coverage of the decision here.)
The conduct is detrimental, but it is not dishonest or a breach of the terms of the LLC’s operating agreement. We recently had a similar case in the office in which the business needed a capital infusion, but one of the owners was unwilling to put up their share and under the terms of the operating agreement, if the other member put the money into the business it would be treated as a loan – a loan that would not be repaid in the forseeable future.
Business Divorce Attorneys in New Jersey
The Appellate Division, however, construed the New Jersey Limited Liability Company Act to permit removal when an action of a member simply related to the business and is such that it is not reasonably possible to continue the business with that person as a member. In our case, we framed the issue in the pleadings, but were certainly apprehensive about the fact that there was no clear authority from an appellate court.
The appellate court also held that once a member is expelled under the involuntary dissociation provisions of the statute, they simply become an assignee, meaning that they have the right to the financial benefits of their interests, but forfeit any management rights.
That does not mean that the ousted LLC member is left as a silent partner in perpetuity, however. Rather, because New Jersey’s LLC Act permits a member to resign at any time regardless of the terms of the Operating Agreement, the former-member-now-assignee can always quit. Once the member resigns, the LLC will be obligated to buy back the interest at fair value.
Resignation of Member from New Jersey LLC
The difference between the two approaches can be significant, however. Resignations only take effect after six months and the net result could well be that two lawsuits are required: the first over dissociation and the second if the member does actually resign.
The case involved LLC formed in New Jersey to operate a medical school in Aruba. In a dispute between the members, the trial court held that involuntary dissociatin was required both because of wrongful conduct that harmed the business and because it was not reasonable to continue with them as members. The court also assumed that the dissociated members were entitled to be paid the fair value of their interests.
Under the current Limited Liability Company Act, members of an LLC can be involuntarily dissocated under N.J.S.A. 42:2B-24, for any of the following reasons:
(a) the member engaged in wrongful conduct that adversely and materially affected the limited liability company’s business;
(b) the member willfully or persistently committed a material breach of the operating agreement; or
(c) the member engaged in conduct relating to the limited liability company business which makes it not reasonably practicable to carry on the business with the member as a member of the limited liability company[.]
The Appellate Division held that any one one of the three criteria in the statute will suffice to expel a member. Thus the court did not evaluate the trial of wrongful conduct, but focused on the fact that under the circumstances, the conduct of the expelled members related to the business and was such that it was unreasonable for them to remain as members.
That that statutory provision, has a “prospective orientation” the Appellate Division explained, as opposed to finding that actual harm from past conduct.