The Business Divorce Law Report

January 18, 2021

Surrender of Membership Certificates Was Dissociation from LLC

A limited liability company member withdraws by voluntary dissociation, which occurs when the company has notice of his ‘express will” to withdraw. Voluntary dissociation terminates management rights, but not economic rights.
A court may refuse relief on a claim when the plaintiff has acted with unclean hands with regard to the subject matter of the action. The doctrine applies to an evil practice or wrong conduct in the particular matter for which the court has been asked to provide a remedy.
A member in a manager-managed limited liability company owes no statutory duty of loyalty to the company, but will owe a statutory duty of loyalty under the common law if he or she is also an employee.

A sales representative who held a non-equity percentage interest in a New Jersey limited liability company effectively withdrew as a member of the company by leaving his “share certificates’ with the company’s lawyer, a trial and appellate court have agreed. building-lot-3391379_1920-e1610995346583-1024x402

This withdrawal, known under New Jersey’s version of the Revised Uniform Limited Liability Company Act (RULLCA) as a voluntary dissociation occurred even though the circumstances surrounding that act – leaving a certificate with a lawyer – was disputed. Dissociation in limited liability and partnership law is an act by which an individual owner’s association with the business is severed, voluntarily or involuntarily. It may apply in either a resignation or an expulsion.

The Appellate Division case at issue, Decandia v. Anthony T. Rinaldi, LLC (see opinion here) involved a dispute between a sales representative who received a commission styled as a membership interest in a construction company, but which was actually a non-equity profit interest in his own originations. The sole equity owner of the firm, Rinaldi, retained all of the management rights in the business. Continue reading

December 29, 2020

Psychologists, Like Lawyers, Not Subject to Restrictive Covenants

by Jay R. McDaniel, Esq.

Restrictive covenants preventing competition by former employers are enforceable only to the extent that they are reasonable under New Jersey law.
Lawyers and psychologists are exceptions to the general rule, however, because both are subject to disciplinary rules that prohibit restrictions against competition.
Courts have recognized that the personal relationship and confidentiality that exist between a lawyer or psychologist and their clients are such that a restriction on competition is appropriate.
Physicians continue to be subject to restrictions on competition that protect a legitimate interest and that do not impose unreasonable restrictions on the party subject to the agreement.

In the world of business divorce, one of the key issues is the existence or absence of restrictive covenants that prohibit competition from former shareholders, partners, members or employees. It affects the value of a business – particularly professional and sales-driven businesses – because restrictive covenants generally protect the good will of the enterprise.

There are only two classes of professionals for whom restrictions on competition are always unenforceable. These are lawyers and psychologists, not because of psychologist-5154576_1920-1024x683 any specific distinction between them and other deeply personal relationships, but because the professions are subject to unique restrictions. Attorneys are prohibited from restricting competition by the Rules of Professional Conduct that govern lawyers. Psychologists are subject to an administrative regulation that have the same effect.

Restrictions on Competition Barred by Regulation

In a 2005 decision, the New Jersey Appellate Division distinguished between physicians, who are subject to “reasonable” restrictions on competition, from those imposed on psychologists.

There are also two classes of restrictive covenants to consider. The are those restrictive covenants in which there has been some purchase of good will, which courts will distinguish from a traditional employment business. Enforcing a restrictive covenant against a party that has sold a business, for example, is going to be quite different from enforcing a restrictive covenant against

When there is no contractual limation to restrict the key players from competing, or when restrictive covenants are unenforceable, the value of the good will in the business is typically diminished. Consider the rainmaker who leaves a law firm with his or her large book of business. All of the good will tied up in those relationships is portable, and any valuation of the firm has to consider the loss of those clients and so much of the reputation of the firm that was tied to the departing attorney. Continue reading

November 4, 2020

Controlling Shareholders owe Fiduciary Duties to Minority Members

by Jay R. McDaniel, Esq.

The controlling shareholders of a corporation owe fiduciary duties to the minority shareholders by virtue of their ability to control the affairs of the company.
Even when a merger complies with statutory requirements, where it benefits the controlling shareholders and does not have an apparent business purpose, it must also satisfy equitable principles of fairness.
The fiduciary duties owed by controlling shareholders is a basis to grant injunctive relief, even it is appears that money damages might make the minority shareholders whole for any misconduct.

Corporations Attorney

Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36 (Chancery Division 1975)

Statute: NJSA 14:14-1(1)(a)

Synopsis: In class action seeking injunctive relief blocking merger of defendant Power/Mate with corporation controlled by the majority shareholders, on application for a preliminary injunction, the court enjoined a going-private merger by the defendant controlling shareholders to compel the sale by the minority shareholders to a corporation they controlled. Held that despite compliance with statutory requirements, the merger would be preliminarily enjoined. See opinion Berkowitz v. Power/Mate Corporation. Continue reading

March 26, 2020

Does Your Law Firm Have an Attorney Separation Agreement? It Should.

by Jay R. McDaniel, Esq.

Attorney separation agreements may require that a lawyer give reasonable notice to his firm before resignation, reducing conflict with departing lawyers.
Lawyers may agree in advance how they will handle such issues as billing, transfer of file responsibilities and return of equipment.
Joint notice to clients by the law firm and the departing lawyer is the preferred method of advising clients of an attorney’s departure from the firm.

Attorney separation agreements that contain provisions for a minimum notice period before an attorney’s resignation and other terms for notice, transfer of files and billing should be common. They are not, and it is likely bad for the clients and the firm. Canva-Two-Person-Shake-Hands-683x1024

The free-for-all that may follow a resignation is something that can be avoided, and a recent opinion of the ABA’s standing committee holds that the minimum notice requirement is ethical as long as it does not restrict competition by the departing lawyer or limit the client’s ability to choose counsel.

Separation Agreements to Manage Lawyer Resignations

What would such an agreement look like? We suggest that the following issues should be addressed whether dealing with withdrawing principals or resigning attorneys.

Minimum Notice to Law Firm of Intended Departure

In many circumstances the withdrawal of a senior lawyer from a law firm for another practice is a process that is implemented over weeks or months. The orderly transition of files by a process that is mutually acceptable to everyone involved serves a number of interests held by all involved, particularly the clients. Continue reading

February 26, 2020

ABA Says Minimum Notice Requirements Are Ethical

by Jay R. McDaniel, Esq.

Law firms may not limit the ability of lawyers to resign, solicit clients and compete with the firm, but they may contract for a reasonable notice period necessary for the orderly transfer of client matters.
Both the departing lawyer and the law firm share an ethical obligation to assure the client of continued competent representation during the transition period before the lawyer’s departure.
The notice requirement cannot act as a financial disincentive to competition and the departing lawyer’s willingness to cooperate in the transfer of matters and post-departure billing is a factor in determining whether the notice period is reasonably imposed.

There are some very good reasons for lawyer firm management to fear the “grab and go.” A key lawyer resigns with little or no notice and immediately begins to solicit clients. In some instances, the result can devastate the fortunes of a law firm, drawing out cash flow and personnel, but leaving the firm to continue to carry the same level of expenses.

Canva-Stack-of-Old-Suitcases-1024x683

The Law Firm Grab and Go

It’s sometimes known as the “grab and go.” It occurs when one or more lawyers resign without notice while simultaneously soliciting the firm’s clients to follow them. In some cases, the grad and go will strip a small firm of a substantial portion of its revenue while leaving it with large liabilities such as leases, advanced expenses and personal financial exposure for the remaining principals. Can a law firm contract with its principals and attorneys to prevent the grab and go? 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

November 12, 2019

Tax Treatment Alone Does Not Establish General Partnership

by Jay R. McDaniel, Esq.

Courts determine whether an individual has an equity interest in a law firm partnership by examining the financial investment and risk taken by the claimed owner, such as payment of capital and guarantees of obligations.
The rise of the non-equity partner in law firms management has changed the status associated with the title partner. Nearly half of all law firm partners are now classified as non-equity or limited equity.
The way in which the firm reports the income of a partner to the IRS in its tax filings are evidence of an equity interest in many cases, but describing an individual as an equity owner may not be conclusive.

The last refuge of the general partnership may be the law firm. However, the term “partner” in a law firm can have a number of different meanings and it often does not identify only the traditional equity owner of the enterprise. In many circumstances, “partner” is a title that indicates a senior attorney, usually at the top of the firm’s professional structure. It does not, however, provide a particularly reliable indication of either management responsibilities or a financial interest in the firm. partnership-526413_1280-1024x562

Not all partners are created equally. In fact, the rise of non-equity partner, those that do not share in the profits or capital of the law firm, is rising rapidly. Only 56 percent of the partners in law firms in 2018 were equity partners. (Above the Law, 3 Reasons to Embrace the Rise of Non-Equity Partners). That trend is a 250 percent increase over the past two decades. In 1999 the figure was 17.1 %.(Altman Weil, Inc. What Should Law Firms Do about Non-Equity Partnership).

Not surprisingly, the existence of an equity interest, or not, is not an uncommon area for dispute. In this post we consider here involving the effect of tax documents on the claim of an attorney that he held an equity interest in a well-known personal injury firm. Treatment for income tax purposes is invariably a key component of holding equity. Is it dispositive? In this case, no. Continue reading

August 12, 2019

Attorney Charing Liens in New Jersey

by Jay R. McDaniel, Esq.

Attorneys have common law and statutory security interests in the proceeds of recoveries of their clients, generally referred to as charging liens.
A statutory lien is created when a lawyer files a pleading with an affirmative claim for recovery and may be enforced by filing a petition in the underlying action.
Clients have an interest in the assertion of an attorney charging lien and must be notified of their right to have the amount of the fee determined by arbitration.

Attorneys that provide services to clients with that yields a financial recovery to the client will typically have a security interest in that recovery to secure their fee. The lien may be statutory or, in some cases, the attorney may have a lien that is enforceable in equity. These two types of liens, statutory and equitable, have significant differences, but both types of liens provide the lawyer with a security interest in the proceeds of the case. Law Firm Business Divorce Attorneys

In this article, we will take a look at some of the mechanics of asserting and enforcing a lien. In a subsequent post, we will examine the manner in which courts have allocated competing claims for fees.

The Attorney Charging Lien

A lien is more than just a claim for fees. It is a secured interest in the recovery that a client achieves – through the lawyer’s efforts, of course — for the satisfaction of the debt. It may be asserted over all of the recovery and, therefore, even against the client. As a practical matter, liens are asserted when a lawyer is replaced or in rare instances when a client fires the lawyer in an attempt to avoid paying a fee. Continue reading

July 2, 2019

Shotgun Agreements and Other Methods to Break Deadlock

by Jay R. McDaniel, Esq.

Buy-sell agreements, like a shotgun sale triggered by a deadlock, are the principal means by which the owners of closely held businesses protect against the worst consequences of deadlock.
Commonly used shotgun provisions allow one party to set the price and allow the other party to decided whether to buy or sell at the offered price. Closely related to the shotgun is an auction that allows offerors a chance to sweeten their offers to buy.
The compelled sale of an equity interest triggered by a buy-sell agreement will be subject to the fiduciary duty of loyalty and the implied covenant of good faith and fair dealing.
Courts may apply shotgun or auction techniques when compelling the sale of a business as a going concern.

A well-drafted agreement between the owners of a business will address the issue of what to do in the event they become deadlocked. This is true of effective shareholder agreements or corporate by-laws, limited liability company operating agreements or partnership agreements.

Agreements that are intended to prevent or resolve a deadlock in most circumstances will contain language that in some circumstances will require the exit of one person from the business. This exit, in turn, requires payment of the value of the equity interest of the departing owner.

Canva-Photo-of-Silver-and-Brown-Flintlock-Pistol-With-Brass-Ammo-1024x683

In this post, the last in a series on deadlock in the closely held business, we look at buy-sell agreements as a means of breaking deadlocks without litigation and, in particular, a form of buy-sell often referred to as a shotgun. A buy-sell often avoids or greatly simplifies litigation between the deadlock owners of a business, sure. It also has the effect of avoiding deadlock in the first instance.

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

Shotgun provisions are a form of weapons control, like the mutually assured destruction that has – thankfully so far, at least – kept the world powers from global conflagration. Owners of a closely held business have an emotional as well as a financial investment in a business and triggering a process in which they may be forced to sell will be seen as a very unwelcome choice. In many cases, shotgun language in governing documents triggers compromise among the owners of a closely held business.

Buy-Sell Agreements Triggered by Deadlock

A limited liability company member withdraws by voluntary dissociation, which occurs when the company has notice of his ‘express will” to withdraw. Voluntary dissociation terminates management rights, but not economic rights.

A court may refuse relief on a claim when the plaintiff has acted with unclean hands with regard to the subject matter of the action. The doctrine applies to an evil practice or wrong conduct in the particular matter for which the court has been asked to provide a remedy.

A member in a manager-managed limited liability company owes no statutory duty of loyalty to the company, but will owe a statutory duty of loyalty under the common law if he or she is also an employee.

Restrictive covenants preventing competition by former employers are enforceable only to the extent that they are reasonable under New Jersey law.

Lawyers and psychologists are exceptions to the general rule, however, because both are subject to disciplinary rules that prohibit restrictions against competition.

Courts have recognized that the personal relationship and confidentiality that exist between a lawyer or psychologist and their clients are such that a restriction on competition is appropriate.

Physicians continue to be subject to restrictions on competition that protect a legitimate interest and that do not impose unreasonable restrictions on the party subject to the agreement.

Restrictions on Competition Barred by Regulation

The controlling shareholders of a corporation owe fiduciary duties to the minority shareholders by virtue of their ability to control the affairs of the company.

Even when a merger complies with statutory requirements, where it benefits the controlling shareholders and does not have an apparent business purpose, it must also satisfy equitable principles of fairness.

Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36 (Chancery Division 1975)

Attorney separation agreements may require that a lawyer give reasonable notice to his firm before resignation, reducing conflict with departing lawyers.

Lawyers may agree in advance how they will handle such issues as billing, transfer of file responsibilities and return of equipment.

Joint notice to clients by the law firm and the departing lawyer is the preferred method of advising clients of an attorney’s departure from the firm.

Separation Agreements to Manage Lawyer Resignations

Minimum Notice to Law Firm of Intended Departure

Law firms may not limit the ability of lawyers to resign, solicit clients and compete with the firm, but they may contract for a reasonable notice period necessary for the orderly transfer of client matters.

Both the departing lawyer and the law firm share an ethical obligation to assure the client of continued competent representation during the transition period before the lawyer’s departure.

The notice requirement cannot act as a financial disincentive to competition and the departing lawyer’s willingness to cooperate in the transfer of matters and post-departure billing is a factor in determining whether the notice period is reasonably imposed.

The Law Firm Grab and Go

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

Courts determine whether an individual has an equity interest in a law firm partnership by examining the financial investment and risk taken by the claimed owner, such as payment of capital and guarantees of obligations.

The rise of the non-equity partner in law firms management has changed the status associated with the title partner. Nearly half of all law firm partners are now classified as non-equity or limited equity.

The way in which the firm reports the income of a partner to the IRS in its tax filings are evidence of an equity interest in many cases, but describing an individual as an equity owner may not be conclusive.

Attorneys have common law and statutory security interests in the proceeds of recoveries of their clients, generally referred to as charging liens.

A statutory lien is created when a lawyer files a pleading with an affirmative claim for recovery and may be enforced by filing a petition in the underlying action.

Clients have an interest in the assertion of an attorney charging lien and must be notified of their right to have the amount of the fee determined by arbitration.

The Attorney Charging Lien

Buy-sell agreements, like a shotgun sale triggered by a deadlock, are the principal means by which the owners of closely held businesses protect against the worst consequences of deadlock.

Commonly used shotgun provisions allow one party to set the price and allow the other party to decided whether to buy or sell at the offered price. Closely related to the shotgun is an auction that allows offerors a chance to sweeten their offers to buy.

The compelled sale of an equity interest triggered by a buy-sell agreement will be subject to the fiduciary duty of loyalty and the implied covenant of good faith and fair dealing.

Courts may apply shotgun or auction techniques when compelling the sale of a business as a going concern.

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

Buy-Sell Agreements Triggered by Deadlock