The Revised Uniform Limited Liability Company Act adopted in New Jersey permits a court to expel a member of a limited liability company when it is not reasonably practicable for the company to continue with that individual as a member.
Expulsion, known as involuntary dissociation, based on the not reasonably practicable standard requires a showing that there is a structural impediment to the members continuing in business together, such as deadlock.
When the company is able to make decisions and pursue its business purpose, the not reasonably practicable standard does not exist, whatever the level of animosity among the members.
LLC Divorce: Till Death Do Us Part, or Just Irreconcilable Differences
Should a business divorce be hard or easy? In the world of human divorces, it’s the difference between no-fault divorce and divorce only after a showing of cause. In the world of businesses, it turns on the
concept of court-ordered purchases and sales of minority interests. And in the area of law governing limited liability companies, it is the concept of “involuntary dissociation” – expulsion, if you will, of one of the members.
Involuntary Dissolution of LLC
Two recent cases in the past month demonstrate this concept. East of the Hudson River, we have the First Department of the Appellate Division in New York opinion in Barone v. Sowers, , 2015 NY slip OP 04195 (1st Dept May 14, 2015), in which the court held that allegations of oppressive conduct simply don’t make out a claim for relief under New York’s limited liability statute.
Compare this Empire State decision with one from the Garden State captioned IE Test, LLC v. Carroll, docket No. A-6159 (N.J. Super. App. Div., March 17, 2015)(Opinion Below). Here, the appellate court affirmed the expulsion of a member because it was clear that the parties personal animus prevented them from maintaining a working relationship.
Removal of LLC Member May Be ‘Prospective’ Conduct
In what is probably the most significant appellate decision involving New Jersey limited liability companies in a decade, the Appellate Division held that wrongful conduct is not required to expel a member from the LLC, nor is the member entitled to be paid for the value of the interests.
On the contrary, the opinion in All Saints University of Medicine Aruba v. Chilana, Docket No. A-2628-09T1, App. Div Dec. 24, 2012, makes clear the standard can be much lower: conduct that makes it not reasonably practicable to continue the business with the member. The former member, moreover, cannot compel purchase of their interests. They are relegated to the status of assignee, forfeiting all of their management rights but still retaining their financial interest in the business.
Removal of Members in Business Divorce Cases
Expelling a member from a New Jersey limited liability company requires a judicial order, unless the LLC’s operating agreement contains specific provisions that permit for the expulsion of members. Litigation over the expulsion of members, referred to in the New Jersey Limited Liability Company Act as involuntary dissociation, typically focuses on wrongful conduct by the member whose ouster is sought.
Revised Uniform Limited Liability Company Act Changes Legal Landscape
The effective date of New Jersey’s Revised Uniform Limited Liability Company Act is approaching. The law will be effective on March 18, 2013 for newly formed LLCs and will be applied to all LLCs effective March 1, 2014.
There is a laundry list of changes in the new statute. Our view in the firm is that it’s a significant improvement over New Jersey’s current statute, modeled under Delaware law with some fairly significant additions. But the statute is also more complicated, and for those accustomed to drafting under the old law, it’s time get started revising those model clauses.
It’s also time to start warning the owners of existing LLCs about the impending change. The differences are significant enough that some LLCs may have problems with Operating Agreements drafted under the old statute that will have significant problems under the new act.
Although the law does not apply to a new LLC until March 18, we are incorporating the new statute in the LLCs that we are forming. It will apply in just over a year anyway so it makes sense to include a clear choice of law selection, at least until next month.
A Series on New Jersey’s Adoption of the Revised Uniform Limited Liability Company Act
The fiduciary duties imposed on a member or manager of a New Jersey LLC are at present elusively and poorly defined in the statute. While the current act contains several provisions limiting the personal liability of members, nowhere does it clearly define the duties that are inherent in the relationship of the members. Attempts to impose the fiduciary obligations that have traditionally been thought to be a fundamental aspect of the relationship of partners in a partnership, or the officers and directors in a corporation, have met with uneven results.
As we noted in our recent blog post (Fiduciary Duties Murky Under Delaware Law), reviewing a decision from the Delaware Supreme Court, the issue is still undecided in the most influential jurisdiction in the country on issues of business governance, and there is little guidance in the form of controlling authority in New Jersey.
Uncertain ResponsibilitIes of LLC Members
That uncertainty should change significantly when the revisions to New Jersey’s limited liability company law take effect in March 2013 for newly formed companies, and in March 2014 for existing LLCs. In adopting the RULLC, the legislature put in place a new set of standards for the conduct of members and managers of LLCs organized under New Jersey law. While some of the changes reflect much of the judge-made law applying equitable principles to the conduct of small business owners, there are some significant differences in the way those duties will now work, and anyone involved with a New Jersey limited liability company needs to have a firm grasp of the structure.
This definition of fiduciary duties is significant because courts are often hesitant to create new rules of law by analogizing to the law of corporations or partnerships. A particularly contentious issue in New Jersey, for example, was whether a minority member of an LLC who was treated unfairly could bring an action for oppression and obtain the remedies available under corporate law. These efforts have uniformly had anything but uniform results — in New Jersey and other states with similar limited liability company statutes.
The RULLC is more comprehensive that the present New Jersey Liability Company Act. Under the current act, there is no explicit definition of the duties. The current law simply provides that to the extent that “at law or in equity” a member or manager has any duties, including fiduciary duties, those duties can be varied by the operating agreement and that the member or manager can rely on the operating agreement (N.J.S.A. 42:2B-66). The current act also provides that where the statute is silent, the “rules of law and equity” govern (N.J.S.A. 42:2B-67) Many commentators see this as the express understanding that fiduciary duties are created by the equitable principles that are widely accepted as governing the relationships between members of business enterprises. Others think not.
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.
Court Issues Writ of Execution on Minority LLC Interest of Ex-Spouse
One of the perceived benefits of the limited liability form of doing business is the limited remedy that a creditor has when attempting to use the LLC member’s interest as a source to satisfy a judgment. The majority position has been that the judgment creditor may be able to secure a charging order, but can neither foreclose on the interest (that is a force a judicial sale) or divest the debtor of their management rights.
A decision by a Chancery judge in Ocean County involving a New Jersey limited liability company affirms that the “sole remedy” is the charging order – something that is about to change under recent amendments to the LLC statute – but finds that a court may issue a writ of execution. Leonard v. Leonard, Docket No. FM:15-450-05 (App. Div. June 13, 2012)(approved for publication).
Charging Order Sole Remedy under LLC Act
Under the current law, a judgment creditor that receives a charging order is entitled to receive the distributions that the the debtor-LLC member would otherwise receive, if anything. However, beginning with limited liability companies organized after March 2013, and the following year with all New Jersey LLCs, judgment creditors will be able in some circumstances foreclose the interest of the LLC member.
The issue in this case was the ability of a judgment creditor — in this case a custodial parent seeking to enforce a child support award – to levy against the interest of a minority member of a New Jersey limited liability company. The plaintiff and defendant divorced in 2004, with the plaintiff agreeing to pay alimony and child support. The plaintiff, however, alleged that as of 2012, the defendant had unpaid support totaling $110,000. Plaintiff moved to secure a judgment and a writ of execution against the defendant’s 10% interest in a real estate limited liability company, Blydan Okay Group, LLC.
Operating Agreements for Limited Liability Companies to Change Under Revised Limited Liability Company Act
Part of an ongoing series on the adoption of New Jersey’s revised limited liability company act.
The amendments to the New Jersey’s Limited Liability Company Act, N.J.S.A. 42:2C-1-94 that begin to take effect in March 2013 will bring a new era in the way the members of a limited liability company structure their affairs. The days in which the members must put their agreements in writing will soon be over, and the owners of New Jersey LLCs should take a hard look at their own operating agreements and course of doing business.
In adopting the Revised Uniform Limited Liability Company Act, the state legislature has approved a fundamental change to the way LLCs operate in New Jersey. We are examining these changes in a series of articles and today focus on the effect of the changed definition of operating agreements.
Written Operating Agreements Not Required
The old law may have been rigid, but at least it was clear. It was not required in New Jersey (as in some other states) to have an operating agreement, but if you did, it had to be in writing. If there was no written operating agreement, then the “default” rules provided by the statute governed. That has changed significantly. The new law defines an operating agreement as
“the agreement, whether or not referred to as an operating agreement and whether oral, in a record, implied, or in any combination thereof, of all the members of a limited liability company …”
To understand just how much of a change is this definition, we can look at a 2004 decision of the Appellate Division in Kuhn v. Tuminelli, 366 N.J. Super. 431, 841 A.2d 496 (App. Div. 2004). In that case, the plaintiff and defendant owned a limosine service and the defendant embezzled funds by endorsing checks to the company and keeping the funds. Kuhn argued that the defendant did not have authority to convert the checks and named as a defendant the check cashing service that had negotiated the checks.
Corporate Dissolution Claims of Foreign Entities Not Proper
Corporations and other business entities are creatures of the law of the state where they were organized. Delaware and Nevada, for example, compete as the state of choice when organizing a new business entity. And the simple fact is that most of the businesses organized under Delaware or Nevada law have no operations in those states.
Does that mean that other courts are limited in the ability to grant relief in the event that litigation develops among the owners over corporate governance issues? That was the issue in a recent decision by Chancery Judge Carroll in Lerner v. Heidenberg, BER-C-64-12 (Chancery Div. June 8, 2012). The decision is a warning that electing to organize a company under a particular state’s law may also be a commitment to have the courts of that state resolve certain disputes if things go wrong.
LLC Member Who Refused to Retire Was Expelled by Managers
The challenges in making the transition from the the founding members of a successful enterprise to the second generation of managers are often difficult, as this litigation involving that has endured for nearly a decade demonstrates. It may be that the business has moved in a new direction, or perhaps it is simply that the founding member no longer inspires the same type of confidence as when he or she was younger. The second generation of owners often has its own ideas about the way the business should run, but the founders are loathe to cede control.
And of course there are those cases in which the founding member simply refuses to retire long after they have ceased to be a productive contributor to their business. It is not particularly unusual that the more active members of a business, whether it is a partnership, limited liability company, or a close-corporation, will ultimately seek to expel the founder from the business.