Operating Agreement | Shareholder Agreement Category Archives — The Business Divorce Law Report Published by Business Lawyer

March 4, 2024

Court Relies on Implied Contract Theory To Hold Partner to Agreement

It’s a decision involving a law firm partnership that, if widely followed, will likely have a sweeping effect on the interpretation of the statutory requirement for unanimity in adopting critical agreements that govern partnerships and liited liability companies. Lerner-David

Attorney Andrew Zidel, an attorney who left prominent intellectual property boutique firm Lerner David in Westfield, failed in his attempt to use a minority veto to block the adoption of a law firm partnership agreement that treated retiring partners differently than withdrawing partners.

The trial court finessed the unanimity requirement found in the partnership statute, and was affirmed in an unreported decision of the appellate division.

Court Discounts Literal Language of Partnership Statute; Implies Consent to Adopt Partnership Agreement

The reason for Zidel’s failure to rely on the language of the statute was that the law firm had, for many years, operated without a formal partnership agreement. Therefore, the trial court found that the written formal agreement would be considered an amendment to the existing partnership agreement, and, under the partnership’s prior practices, it did not require a unanimous agreement.

October 24, 2023

Arbitration Fails to Resolve Business Divorce Dispute

by Jay R. McDaniel, Esq.

The failure of the parties to submit evidence on an issue during arbitration caused a failure to decide all of the issues of the dispute.
A Court may modify an arbitration award rather than vacate and permit partial enforcement while permitting litigation of claims were not included in an arbitration hearing.
Failure to clearly define the mechanics of an arbitration and to agree on the issues that the arbitrator is to decide can make an award unenforceable.

This court decision addresses a recurring issue when parties agree to resolve their dispute by arbitration: exactly what was it that we agreed to arbitrate? Unless the answer to that question is clear and unambiguous, trouble is likely to follow. Continue reading

August 15, 2023

When Are Limited Liability Companies Required to Distribute Profits?

by Jay R. McDaniel, Esq.

There is no statutory right to receive a distribution of profits from a limited liability company before it dissolves and winds up its affairs. Distributions before then are discretionary.
Profit distributions are in the discretion of the majority members or commonly in the discretion of the managers of the limited liability company.
A minority member who is not receiving distributions may have a claim under the operating agreement or as an oppressed minority member if the majority refuses to make profit distributions.

Profit distributions are a frequent source of dispute among the members of a limited liability company. The fundamental question of who decides when distributions are made, how much is made, and how to deal with the tax issues related to distributions, profits and losses can all be the source of conflict.

More Questions? Learn More. You can call me at 973-602-3915 or use our Contact form to reach me by email.

The short answer to the question of when a limited liability company must distribute profits is that ‘it depends.’ And many minority owners of LLC interests are frustrated to learn that they have less control over the process than they anticipated. New Jersey minority oppressed LLC member attorney

Limited Liability Companies Often Do Not Have Operating Agreements

Entrepreneurs choose limited liability companies as the form of a new business far more often than corporations or partnerships. They are cheap and easy to form and do not require the type of documentation and formalities that you generally see associated with other entities, corporations in particular. Continue reading

June 15, 2023

No Foul in Dissociated LLC Member’s Refusal to Cooperate in PPP Loan

by Jay R. McDaniel, Esq.

A ‘passive’ member with no rights or responsibilities in the management of a limited liability company cannot be held liable for refusing to participate in a PPP loan application.
Dissociated LLC members with no management rights can withhold their voluntary consent to proposed actions.
The waiver of fiduciary duties in an operating agreement is enforceable under New Jersey law if it is not manifestly unreasonable.

Jeanne Qin Lamme was a “passive” owner in the businesses owned by her late husband, Joseph Lamme. Her status was as a dissociated member under New Jersey’s Revised Limited Liability Company Act meant that she had no management rights in the business. New Jersey dissociated LLC member may refuse to cooperate | New Jersey LLC disputes attorney

So when Jean Lamme refused to assist the business in securing a federal Paycheck Protection Program (PPP) loan during the Covid pandemic, did she set herself up for a lawsuit and damages? Not if she had no duty to cooperate.

Widow of Owner Refuse Request for PPP Loan Application

That’s the holding in an Appellate Division opinion in Lamme v. Client Instant Access, a lawsuit between Lamme and her late husband’s business associate, Joseph Vacarella. It’s worth considering the decision because members of small businesses say “no” – frequently to the detriment of the business – simply because they can. Continue reading

October 26, 2022

Shotgun Buy-Sell Agreements – Solution to Deadlock

by Jay R. McDaniel, Esq.

Well-drafted business governance documents include buy-sell agreements to address deadlock among the owners.
A shotgun buy-sell is an offer that sets only the price. It can be accepted as either an offer to buy out the other side or to sell to the other side at the price in the offer.
Shotgun buy-sells are an efficient means to set the price of a transaction, but may be flawed when the owners have unequal knowledge of the business or inadequate financial resources.

What happens when the owners of a business can’t come to an agreement on an issue that is critical to the business? This happens when neither side has a majority. For example, when there are two 50-50 owners or when unanimous agreement is required and there are holdouts. Our discussion today concerns how the owners of a small business may use contractual arrangements to address this problem.

These contracts are known generally as buy-sell agreements, and that is that they require one party to sell and the other to buy. Now, buy-sell agreements can also include shotgun sales, which is a buy-sell agreement that’s triggered by a deadlock. And we’re going to focus today on the shotgun sale. That refers to the type of agreement that allows one party to set the price and then allows the other the party to decide whether, based on that price, they’re going to buy or sell.

Continue reading

October 4, 2022

When Can a LLC Member Be Expelled?

by Jay R. McDaniel, Esq.

How to Expel a Member from a Limited Liability Company

The removal of a member from a limited liability company, known as involuntary dissociation, is permitted by statute in most states and may also be permitted in an operating agreement.
Removal is permitted when a member has engaged in wrongful conduct that has or will materially affect the company or when the member has repeatedly breached the operating agreement.
Removal may also be permitted when a member files for bankruptcy or if it is not reasonably practicable for the LLC to continue with them as a member.

There are plenty of choices that we make in our lives that we would like to undo. Some we can and some we can’t. Breaking up with a business partner is the topic of this discussion. More particularly, how a member of a limited liability company can be expelled from the business. We’ll cover the circumstances in which members can be expelled, when it’s easy and when it’s not.

September 4, 2022

Minority Veto Rights Lead to Deadlocked LLCs

by Jay R. McDaniel, Esq.

Limited liability company statutes often require the unanimous approval of the members before actions may be taken outside the ordinary course of business or for any amendment of the Operating Agreement.
The requirement for unanimous action creates a minority veto – any member can veto the actions of the majority – often leading to deadlock.
States that have adopted the Uniform Limited Liability Company Act, including New Jersey, Pennsylvania and Connecticiut, require unanimous actions. Other states, including Delaware and New York, permit major actions to be taken by simple majority vote.

These days we’re seeing a political world in which we have a national politics that is very, very closely divided, and one or two people have tremendous control over the rest of the country. It’s not just the Congress, but over everyone. And they’re basically, even though they only have one vote, they’re able to stop things, able to derail a process. They have a minority veto. Continue reading

March 1, 2021

An Email Does Not Make an Operating Agreement

by Jay R. McDaniel, Esq.

An email from the sole owner of a limited liability company announcing that employees had become partners with a profit interest was not sufficient to constitute admission as a member of the LLC.
The fact that the party claiming an equity interest in an LLC had refused to execute an operating agreement was a strong indication that the issuance of equity was still the subject of negotiations.
A court is likely to consider the completeness of the terms of an alleged oral agreement to admit a new member; without sufficient details the agreement will be deemed incomplete and unenforceable.
The issue of whether an individual is a member of a limited liability company is properly tried by a judge rather than a jury.

What does it take to make someone a member of a limited liability company? The Revised Uniform Limited Liability Company Act (RULLCA) as adopted in New Jersey and most operating agreements contain some requirement for unanimous consent. The requirement on unanimous consent reflects the policy underlying the “pick your partner rule” in smalll business organizations: no one should be forced to share ownership of a closely held business against their will. mail-1454731_1920-1024x1024

Unanimous Consent Required for Admission of New LLC Members

The contours of what is unanimous consent is often not clear, however. Does a promise of admission as a member or partner constitute consent? What about the formality of signing an operating agreement? These are facts that vary by the case and the circumstances.

The line between equity owner and a highly compensated senior employee – sometimes with the title of partner – is often blurred, particularly in certain professions such as lawyers in which the non-equity or contract partner is a common occurrence. In a case recently before the Appellate Division in New Jersey, the business at hand was a private equity fund and a senior employee. Continue reading

February 5, 2021

Estate Plan Sows Father and Son Business Divorce

by Jay R. McDaniel, Esq.

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.
A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.
In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

Some cases make you wince when you think about the underlying relationship. This case in which a son sued his father over the repayment of a mortgage is one of them. It comes from the Iowa Court of Appeals and is interesting from my perspective because the underlying statute is the same as applies here in New Jersey and because it demonstrates the scope of equity to reframe disputed issues into a more manageable solution. field-213364_1920-e1612533257149-1024x379

The dispute in Erwin v. Erwin (opinion here) addressed the dispute between Michael Irwin and his son, Richard, that grew out of the father’s attempt to pass the family farm without incurring tax liability. The father and Richard’s mother, who owned the farm individually, formed a limited liability company, Erwin Farms II, LLC, in 2012 and passed the land to the company. At the time of the transfer, the land was subject to a mortgage. Richard received a block of non-voting membership units. The remaining membership units, including all of the voting units, were owned by the parents.

The operating agreement of the company named Michael Erwin as manager. In addition to the existing mortgage, after the land was transferred to the LLC, the Erwin parents took two loans for improvements. By the time of the trial, those loans had all been paid. Continue reading

February 2, 2021

One Business Divorce, Multiple Actions

by Jay R. McDaniel, Esq.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.
A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.
Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Multiple lawsuits from a business divorce may not be entirely commonplace, but it does happen when the controlling governance documents contain an arbitration clause, but there are outsiders not bound by the agreement to arbitrate that are involved in the dispute. These may be former employees, agents, competitors or vendors. gavel-2492011_1920-1024x569

Simultaneous Arbitration and Litigation in Court

The result is that some of the parties may be obligated to arbitrate, or that some of the dispute may not be subject to the agreement to arbitrate. Consider the case in which there are disputed events that occurred while the parties still had fiduciary obligations to each other – such as between partners or employer and employee – and those that occur outside the fiduciary obligation. These might include unfair competition or claims arising from a competitor hiring someone under a restrictive covenant. Continue reading

Court Discounts Literal Language of Partnership Statute; Implies Consent to Adopt Partnership Agreement

The failure of the parties to submit evidence on an issue during arbitration caused a failure to decide all of the issues of the dispute.

A Court may modify an arbitration award rather than vacate and permit partial enforcement while permitting litigation of claims were not included in an arbitration hearing.

Failure to clearly define the mechanics of an arbitration and to agree on the issues that the arbitrator is to decide can make an award unenforceable.

There is no statutory right to receive a distribution of profits from a limited liability company before it dissolves and winds up its affairs. Distributions before then are discretionary.

Profit distributions are in the discretion of the majority members or commonly in the discretion of the managers of the limited liability company.

A minority member who is not receiving distributions may have a claim under the operating agreement or as an oppressed minority member if the majority refuses to make profit distributions.

Limited Liability Companies Often Do Not Have Operating Agreements

A ‘passive’ member with no rights or responsibilities in the management of a limited liability company cannot be held liable for refusing to participate in a PPP loan application.

Dissociated LLC members with no management rights can withhold their voluntary consent to proposed actions.

The waiver of fiduciary duties in an operating agreement is enforceable under New Jersey law if it is not manifestly unreasonable.

Widow of Owner Refuse Request for PPP Loan Application

Well-drafted business governance documents include buy-sell agreements to address deadlock among the owners.

A shotgun buy-sell is an offer that sets only the price. It can be accepted as either an offer to buy out the other side or to sell to the other side at the price in the offer.

Shotgun buy-sells are an efficient means to set the price of a transaction, but may be flawed when the owners have unequal knowledge of the business or inadequate financial resources.

The removal of a member from a limited liability company, known as involuntary dissociation, is permitted by statute in most states and may also be permitted in an operating agreement.

Removal is permitted when a member has engaged in wrongful conduct that has or will materially affect the company or when the member has repeatedly breached the operating agreement.

Removal may also be permitted when a member files for bankruptcy or if it is not reasonably practicable for the LLC to continue with them as a member.

Limited liability company statutes often require the unanimous approval of the members before actions may be taken outside the ordinary course of business or for any amendment of the Operating Agreement.

The requirement for unanimous action creates a minority veto – any member can veto the actions of the majority – often leading to deadlock.

States that have adopted the Uniform Limited Liability Company Act, including New Jersey, Pennsylvania and Connecticiut, require unanimous actions. Other states, including Delaware and New York, permit major actions to be taken by simple majority vote.

An email from the sole owner of a limited liability company announcing that employees had become partners with a profit interest was not sufficient to constitute admission as a member of the LLC.

The fact that the party claiming an equity interest in an LLC had refused to execute an operating agreement was a strong indication that the issuance of equity was still the subject of negotiations.

A court is likely to consider the completeness of the terms of an alleged oral agreement to admit a new member; without sufficient details the agreement will be deemed incomplete and unenforceable.

The issue of whether an individual is a member of a limited liability company is properly tried by a judge rather than a jury.

Unanimous Consent Required for Admission of New LLC Members

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.

A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.

In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.

A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.

Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Simultaneous Arbitration and Litigation in Court