The Business Divorce Law Report

June 26, 2019

Anti-Deadlock Agreements in Business Divorce Litigation

Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.
Anti-deadlock provisions may provide for the appointment of an independent director, for alternative dispute resolution, or for the compelled sale of an equity interest.
The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

After a closely held business becomes deadlocked, it is extremely difficult to push the parties toward some mechanism that might either break the deadlock or preserve the current management system, or event let the parties separate themselves on mutually agreeable terms.

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

Human nature stands in the way. The parties likely have financial and emotional positions that they are unwilling to compromise. These may range from the ability to control some aspect of the operations of the business to the payment of dividends or bonuses.

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Lawyers and their clients try to address the potential for future deadlock with these contractual provisions that are known by a number of descriptions, such as buy-sell agreements, shotgun

provisions, put-call terms. In the world of closely held limited liability companies, corporations and partnerships, a buy-sell agreement that is triggered by a deadlock is the pre-nuptial agreement of business divorce.

In this and the following post, we examine these contractual provisions that are used to break deadlocks. We consider first the scope of anti-deadlock provisions, when they may be invoked and whether they are subject to judicial controls. In a following post, we will look at buy-sell agreements in more detail and, in particular, shotgun language that is intended to keep a forced sale on terms acceptable to both parties. Continue reading

April 9, 2019

Direct or Derivative Lawsuits: Who Owns the Recovery

by Jay R. McDaniel, Esq.

When a shareholder, LLC member or partner sues to recover for damages based on wrongs committed against the business entity, the claim is derivative and the recovery belongs to the business. Derivative claims have special procedural rules.
Courts have discretion to allow the owners of closely held businesses to sue individually on a derivative claim when the plaintiff can show “special injury” or when the direct action is not unfair to the business, its creditors or other equity holders. The right to bring derivative actions is available to corporate shareholders, LLC members and partners in general and limited partnerships.
A shareholder may bring a direct claim to enforce rights that are contractual in nature or which enforce some right as shareholder, such as the right to vote or elect the directors.

It is not always easy to determine whether the remedy for the injury suffered as a result of some wrong among the owners of a closely held business belongs to the entity – whether a corporation, limited liability company or partnership – or instead belongs to one or more of the owners.

The distinction is both procedural and substantive, and may be fatal to the plaintiff’s claim. Some claims can belong only to the company. In addition, there are specific procedures in place for bringing a derivative claim in which an owner seeks to assert a right owned by the company. These procedural and substantive requirements can be fatal to a plaintiff’s claim.

But the line is often blurred in the context of the closely held business, and courts can ignore the distinction in some circumstances. In this post, we look at some recent cases in New Jersey considering the distinction, one involving a limited liability company and the other involving a closely held corporation. Although most of the case law has developed in corporate derivative actions involving shareholders, derivative causes of action may also exist in claims brought by members of a limited liability company or partners in a partnership.

Derivative Lawsuits Assert Claims that Belong to the Business

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

January 25, 2019

Understanding Deadlock in Limited Liability Companies and Partnerships

by Jay R. McDaniel, Esq.

Deadlock in a limited liability company or partnership occurs when the members can no longer pursue the purpose of the business as agreed in an operating agreement or partnership agreement.
A ‘minority veto’ occurs when a minority member or partner uses the unanimity requirement to block the will of majority.
Actions outside the ordinary course of business are likely to require unanimous consent, including the admission of a new member or partner, amendment to the operating or partnership agreement, a merger or sale of substantially all of the business’ assets.

Deadlock among the members of a limited liability company, or among the partners in a general partnership, involves the inability of the company to make decisions that are material to the continued operation of the business. It is not an infrequent occurrence. The direct participation of the owners in the day-to-day affairs of the LLC or partnership and the requirement that — in most circumstances — the most important decisions require a unanimous vote make it important that an LLC or partnership is able to reach consensus on the most important decisions.

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

Because LLCs and partnerships are unincorporated business associations, they are typically quite different in structure than a traditional corporation. And while deadlock among the members of a limited liability company or partnership involves many of the same principles that one finds in the closely held corporation, there are significant differences as well.

Deadlock limited liability company | deadlock corporation | deadlock partnership

In this article, we look at some of the differences between deadlock in corporations, which are generally governed by statute, and deadlock in unincorporated business associations (primarily partnerships and limited liability companies), which are governed primarily by principles of contract. In many cases, the results are not very different, but there are some key distinctions.

In later posts, I will examine some of the circumstances in which the courts have been asked to resolve deadlock disputes through lawsuits seeking involuntary dissolution actions or the expulsion of a member or partner.

Deadlock Occurs When Contracts Fail

Unlike a corporation, which conceptually is a creature of statute, deadlock in a partnership or limited liability company usually does not involve any specific statutory provision that is intended to address the problem of deadlock. In fact, neither the Revised Uniform Limited Liability Company Act (RULLCA) nor the Revised Uniform Partnership Act (RUPA) specifically mention deadlock. Rather, because the limited liability company and partnership are fundamentally creatures of contract, the focus is not on the statutory criteria but the nature and scope of the express and implied agreements that exist between the owners.

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 21, 2018

Business Judgment Rule Trumps Oppression; Minority Shareholder Entitled to Attorney’s Fees in Defense of Counterclaim

by Jay R. McDaniel, Esq.

The business judgment rule insulates decisions made in good faith and in the best interests of the enterprise from being subject to judicial second guessing ordinary business decisions
Majority shareholders that failed to pay dividends to a non-employee minority shareholders in valid exercise of business judgment rule did not engage in wrongful conduct.
Common law dissolution under New York law is available only for a palpable breach of duty so egregious as to disqualify the majority from exercising rights over dissolution.
A minority shareholder subject to a counterclaim has a right to be indemnified against legal fees and an advance of funds for expenses.
A trial court may preclude individual defendants from using corporate funds to defend an oppressed minority shareholder lawsuit.

Feldmeier The decision of controlling shareholders that a corporation will not pay dividends to a former employee and director is subject to the business judgment rule, in this case defeating the shareholder’s claim of oppressive conduct by the majority.

The Fourth Department of the Appellate Division of New York Supreme Court rejected the claim brought by a minority shareholder of a family-owned equipment business in Syracuse, applying the presumption that an action taken in good faith by a business in the best interests of the business should be free from second-guessing by the minority and the Court. (Opinion in Feldmeier v. Feldmeier Equipment, Inc. here.) Continue reading

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.

September 2, 2018

Business Divorce of Closely Held Corporations – An Overview

by Jay R. McDaniel, Esq.

‘Business Divorce’ refers to disputes in which the owners of a closely held business, whether a corporation, limited liability company, partnership or limited partnership, must separate their business interests.
In many cases, such as oppressed minority shareholder cases or oppressed LLC member cases, there are allegations that those in control of the company have engaged in wrongful behavior. In other cases, the deadlock of the owners on an important issue is the source of the dispute.
Courts that hear business divorce cases have the ability to intervene and impose short-term relief, such as an injunction or appointment of a custodian, and a permanent remedy, including the sale of the business, the compelled purchase of an owner’s interest or even the dissolution and liquidation of the enterprise.

achievement-agreement-body-language-1179804-1024x600 No one gets married expecting to get divorced. And no one forms a business expecting that it will fall apart. Just as people get divorced, many businesses come to the point at which a business divorce is the best alternative because the partners cannot, or will not, continue to work together. When that happens, the parties need to restructure, and often separate, their business interests.

Business Divorce Defined

We use the term business divorce to describe a series of different types of lawsuits that involve the owners of a closely held business. The defining character of the business divorce is that co-owners of a business must separate their business interests. There are typically two alternatives. Either one or more of the owners exits the business as part of a sale, or the business itself will be sold. While much of the business divorce litigation in the courts today is in the form of an action for involuntary dissolution of the business, it is the rare case in which the business actually dissolves by settling its debts and selling its assets. There are far better alternatives. In this article, we focus on the closely held corporation. Some of the principles are similar with other types of businesses, which we address in other articles, but the application of the principles are often quite different.

The law varies from state to state and much of this discussion is general. To the extent that we discuss specific state laws that apply to business divorce, we focus on New York, New Jersey and Delaware law. Continue reading

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

Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.

Anti-deadlock provisions may provide for the appointment of an independent director, for alternative dispute resolution, or for the compelled sale of an equity interest.

The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

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

When a shareholder, LLC member or partner sues to recover for damages based on wrongs committed against the business entity, the claim is derivative and the recovery belongs to the business. Derivative claims have special procedural rules.

A shareholder may bring a direct claim to enforce rights that are contractual in nature or which enforce some right as shareholder, such as the right to vote or elect the directors.

Derivative Lawsuits Assert Claims that Belong to the Business

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

Deadlock in a limited liability company or partnership occurs when the members can no longer pursue the purpose of the business as agreed in an operating agreement or partnership agreement.

A ‘minority veto’ occurs when a minority member or partner uses the unanimity requirement to block the will of majority.

Actions outside the ordinary course of business are likely to require unanimous consent, including the admission of a new member or partner, amendment to the operating or partnership agreement, a merger or sale of substantially all of the business’ assets.

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

Deadlock Occurs When Contracts Fail

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

The business judgment rule insulates decisions made in good faith and in the best interests of the enterprise from being subject to judicial second guessing ordinary business decisions

Majority shareholders that failed to pay dividends to a non-employee minority shareholders in valid exercise of business judgment rule did not engage in wrongful conduct.

Common law dissolution under New York law is available only for a palpable breach of duty so egregious as to disqualify the majority from exercising rights over dissolution.

A minority shareholder subject to a counterclaim has a right to be indemnified against legal fees and an advance of funds for expenses.

A trial court may preclude individual defendants from using corporate funds to defend an oppressed minority shareholder lawsuit.

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.

‘Business Divorce’ refers to disputes in which the owners of a closely held business, whether a corporation, limited liability company, partnership or limited partnership, must separate their business interests.

In many cases, such as oppressed minority shareholder cases or oppressed LLC member cases, there are allegations that those in control of the company have engaged in wrongful behavior. In other cases, the deadlock of the owners on an important issue is the source of the dispute.

Business Divorce Defined

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