The Business Divorce Law Report

August 1, 2016

Single Member LLC May Be a Poor Choice for Asset Protection

Asset Protection, Charging Order — LLCs Can Protect Individual Assets From Judgement Creditors

One of the principal reasons for forming a business entity is to protect the owners from personal liability for the debts of the corporation. At the same time, business owners may use the business, most often a limited liability company, as a way to protect their business interests from being at risk for personal liabilities.

Understanding how a charging order could ultimately be applied is particularly important for individuals in high-risk professions. This includes not just the professionals like doctors or engineers, but also anyone who routinely deals with intellectual property, including patents, copyrights, trademarks and trade secrets. In all of these areas, the insurance coverage is poor and the risk is high. For that reason, many individuals will seek to hold assets inside of other vehicles, including a limited liability company.

August 1, 2016

Fraud Claim Against Yankee Star Derek Jeter Survives

by Jay R. McDaniel, Esq.

Derek Jeter promised his new business partners that his ownership and support of the Frigo brand of men’s underwear would not conflict with the superstar Yankee’s obligations to sportswear giant Nike. In return, RevolutionWear, Inc. gave him 15 percent of the company and a seat on the board.

Apparently, Nike did not take too kindly to Jeter becoming well-known as one of the principal owners of a competitor, and when the athlete failed to embrace the brand — $50 undershirts and $100 briefs — the relationship spun out of control. Jeter filed suit first, seeking a declaration supporting his conduct. RevolutionWear counterclaimed, alleging fraud and breach of fiduciary duty.

The decision of the Delaware Chancery Court in Jeter v. Revolutionwear, Inc., C.A. No.11706-VCG (Del. Chancery July 19, 2016) points out some of the pitfalls in trading equity for services. Once Jeter was on board, according to the plaintiff’s counterclaim, he was loathe to be publicly associated with the enterprise, or in other words, to live up to his obligations.

July 25, 2016

Buy-Sell Agreements: Planning for the Business Divorce

by Jay R. McDaniel, Esq.

Few of us have the liquidity that we need to contemplate the divorce while we are making plans to get marriedIt just doesn’t enter our minds at the time and, of course, when if it does later become an issue, it is way too late to come to an easy decision about how to handle the breakup.

The same is true for businesses. It is difficult to get the new business owners to focus on what they will do if one leaves — and the probability is that one will — when they are in the formation mindset. It’s a type of honeymoon, I suppose, full of optimism and promise. And yet, experience says that if the business survives long enough, the absence of a buy-sell provision is going to create an issue, and maybe event a lawsuit.

Business owners need to reflect on the fact that with enough success, they will want to retire, or may become disabled or die. That they might want to bring children into the business. Or that one of them will undergo some type of personal change or circumstances that just makes it impossible to carry on. A company’s organizing documents without a buy-sell in some form or fashion is incomplete. It keeps the litigators happy, but it’s not wise. Chris Mercer’s blog post here talks about some of the elements that you find in a reasonable buy-sell agreement.

July 18, 2016

Parties to Arbitrate MD Expulsion

by Jay R. McDaniel, Esq.

070116_1250_PartiestoAr1 The subject of the Appellate Division’s recent decision in Ames v. Premier Surgical, LLC, Docket No. A-1278-15T1 (June 29, 2026) is who decides whether a dispute is subject to mandatory arbitration. But the nature of dispute here suggests a cautionary tale about withdrawal and valuation, and what happens when the exit rules from a business don’t have clear valuation provision accepted by all as fair.

Limited Liability Company Valuation Dispute Triggered by Member Departure

The direction that you’re headed at the time certainly determines the parties’ perspective in business divorce and succession cases. Here the office to buy a retired surgeon’s shares was just 2.5 percent of his demand, and only about 13 percent of what the membership units cost 15 years earlier.

June 27, 2016

Partner Who Wrongfully Dissolved Partnership Hit With Whopping 66% Minority Discount

by Jay R. McDaniel, Esq.

Talk about playing your cards wrong.

A partner with a 3.08% interest worth $4.85 million in a partnership that owns a major shopping mall likely will walk away with only a few hundred thousand dollars after a court decision finding that he wrongfully dissolved the partnership and deducting from the value of his interest the other partners’ damages including legal fees, a 15% discount for goodwill, a 35% marketability discount, and a whopping 66% minority discount.

Last week’s decision by the Brooklyn-based Appellate Division, Second Department, in Congel v Malfitano, 2016 NY Slip Op 03845 [2d Dept May 18, 2016], rejected the partner’s appeal from the trial court’s determination of wrongful dissolution and also upheld its valuation determination with one major exception: the appellate court held that the trial court erred by failing to apply a minority discount and that it should have applied a 66% minority discount based on the “credible” expert testimony “supported by the record.”

June 27, 2016

Goodwill Valuation is Key in Professional Partnership Valuations

by Jay R. McDaniel, Esq.

The limited liability partnership or LLP is a highly popular form of business association for professional practices including law firms and medical groups. As its name suggests, the LLP combines the attributes of a partnership with the limited liability traditionally associated with corporations, except that professionals in LLPs generally remain personally liable for their own misconduct or negligence.

See How to Avoid Bad Blood Over Goodwill in Professional Partnership Valuations

This is a story about a recent case involving a fight over the inclusion or exclusion of goodwill in valuing the interest of a retired partner in a medical practice organized as a limited liability partnership, and how it easily could have been avoided.

February 11, 2016

Majority Rule Creates Fiduciary Duties

by Jay R. McDaniel, Esq.

The three majority members of a five-member limited liability company decide that they want to take a major action, such as selling the assets of the business or buying another business. They present the decision to the minority and proceed over their objections (We’ll assume for the moment that the action is permitted by the Operating Agreement.) The minority are bitterly opposed. Is this a problem? Often, it is.

Majority Rule and Minority Rights

The line between what is a right as an equity owner and what is a breach of fiduciary duty to the minority members is often blurry. We presume that as the owner of equity in a business, be it a limited liability, partnership, or a corporation, that we have the right to vote our economic self interest.

January 26, 2016

Supreme Court Will Decide LLC Expulsion Dispute

by Jay R. McDaniel, Esq.

The New Jersey Supreme Court will consider the standards for expulsion of a member from a limited liability company. The Court granted certification in IE Test, LLC v. Carroll, Docket NO. A-6159-12T4 (N.J. Super. App. Div., March 17, 2015)(see our discussion here.) The opinion construes N.J.S.A. 42:2B-24(b)(3)(a) of the now repealed Limited Liability Company Act.

The language, however, is nearly identical to that found in New Jersey’s current LLC law, the Revised Uniform Limited Liability Company Act (RULLCA) N.J.S.A. 42:2C-46(e)(3), which governs the involuntary dissociation of members. Here the court affirmed the expulsion of the defendant based on the impracticability of the business continuing with him as member. the now-repealed Limited Liability Company Act.

Seven-Factor Test Applied to Expulsion

May 26, 2015

Limited Liability Company Breakup: Crossing the Hudson Makes a Difference

by Jay R. McDaniel, Esq.

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.

May 15, 2015

Does the LLC Statute Trump Agency Law?

by Jay R. McDaniel, Esq.

Agent Fails to Dislcose Principal Exists, Avoids Liability

Was the limited liability company statute supposed to eliminate basic principles of agency law? That seemsto be the import of a decision by the Appellate Division of Superior Court in Castro v. Giacchi, Docket No. A-6220-12T2 (N.J. Super. App. Div. December 5, 2014)(Opinion Below) that reversed a judgment against an individual who failed to disclose that he was acting on behalf of a limited liability company.

Perhaps just as important as our first question: does it really matter? Here the answer is pretty easy. Absolutely. Understanding agency law – that is the law that governs when one person acts on behalf of another – is critical to understanding how business entities function. The reason is that even though a business entity is a legal person, but it can an only act through its agents. The business entity is distinct from its principals.

Contractor’s Handshake Deal with Sub

The decision arose out of a contruction contract. Castro was subcontracted to do carpentry work on a new home under construction in Southhamptom by Defendants. It was a handshake deal. Plaintiff contended that he never knew Giacchi was acting on behalf of anyone other than himself, but he received two progress payments John & Sons ANG, LLC. The final bill was sent to ANG.

Ordinarily, an agent who fails to disclose he is entering into a contract on behalf of a principal is individually liable on the contract, unless the other party knows or had reason to know the agent was acting on behalf of a principal.

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But N.J.S.A. 42:2B-23 shielded a member or agent of a limited liability company from all of its debts. The statute did not limit the circumstances under which a member or agent was immune from liability, including those where a member or agent of a limited liability company entered into a contract without disclosing the identity of its principal. Being clear and unambiguous, our sole function is to enforce the statute according to its terms.