The Business Divorce Law Report

March 27, 2014

Attachment of LLC Interest in Management Dispute

A recent dispute involving the owners of a medical office building demonstrates, once again, how unexpected business governance issues can threaten an ongoing business.

This opinion from the Appellate Division, in New Jersey Realty Concepts, LLC v. Mavroudis, Docket No. A-2013-12T1 (App. Div. March 18, 2014)(opinion here), demonstrates how the failure to put a business enterprise into a business form with limited liability, be it a corporation, limited liability company or limited liability partnership, can make it impossible for the business to continue.

The case itself turned on the scope of authority of a special fiscal agent, which is a court appointee typically found in shareholder or limited liability company litigation. We’ll discuss this in more detail below.

Judgment Creditor Attaches LLC Interest in Rents

The real issue, however, is buried at the end of the opinion in which the Appellate Court held that a debtor could directly attach rents paid by the building tenants because the owners’ interest was itself assignable. And that is the big difference as far as asset protection goes – a joint tenancy offers no real protection to creditors.

Had the owners of the building placed it in some type of holding company, then the remedy against a debt owed by of one of the principals would have been much more limited — and would not have threatened the viability of the enterprise. Here, as a result of the form of the enterprise, a judgment creditor of one of the participants was able to levy against 60 percent of the rent roll, leaving the building itself apparently insolvent.

Had the building been held as a limited liability company, the best the judgment creditor could have done was a charging order against the individual interest of the member that was a judgment creditor. Similarly, in a corporation, the remedy would have been limited to the individual shareholder’s interest – assuming no buy-sell agreement restricted transfer.

March 4, 2014

New Jersey LLC Statute Limits Creditors Rights

by Jay R. McDaniel, Esq.

A recent amendment to New Jersey’s limited liability company law changes the rights of creditors seeking to collect a judgment from a member of a limited liability company, eliminating the creditor’s right to foreclose the member’s interest.

Foreclosure of LLC Member Interests Eliminated

This particular aspect of the Revised Uniform Limited Liability Company Act (RULLC) is one of the more controversial provisions of the newly enacted statute because it eliminated a key asset protection aspect of LLCs. Under the prior statute, a creditor’s right was limited to a “charging order.” The amendment to the statute simply restores the prior law.

Under most state limited liability company statutes, a creditor has the right obtain a charging order that provides that when an LLC distributes money to its members, the debtors share goes to the party holding the charging order. It only works if any money is actually distributed to the members.

The RULLC was based on a model act devised by the Uniform Law Commission and contained a provision that allowed judgment debtors to foreclose an interest under certain circumstances. What that meant was that if the judgment creditor was being paid, it had a right to seek a foreclosure of the interest, meaning that it would be sold at a judicial auction.

October 28, 2013

Ownership Stake Conceded in Business Divorce Case

by Jay R. McDaniel, Esq.

Appellate courts usually defer to a trial court’s factual findings in a business divorce case that
makes it to trial. Here is a rare decision, however, in which the Appellate Division reversed the factual determinations of the trial judge, finding that the disputed ownership interest had been conceded by one of the parties.

Limited Liability Company Decision is Reversed

The case, Surgem LLC v. Adhievmed, Inc., Docket No-A4198-11T! (October 16, 2013) involved a dispute between a successful surgeon, John Hajjar, who established a chain of same day surgical centers and his former business partner, John Seitz. The businesses, and the relationships, were poorly documented, however, and the outcome turned on the issue of whether the parties had made an oral agreement.

We represent clients in the formation stages of limited liability companies as well as during disputes. Consult with us about limited liability operating agreements and disputes between members.

LLC Operating Agreement

Notably absent from the Appellate Division opinion is any mention of the terms of the LLC’s operating agreement. It appears that this is another case in which the owners of a business failed to document the basic details of their relationship and the trial court had to fashion a decision from evidence that was equivocal – or so the trial court thought.

September 19, 2013

No Shareholder Oppression in Refusal to Buy Minority Interests

by Jay R. McDaniel, Esq.

Holding a family business together gets more difficult as time passes, as this recent opinion
from the Appellate Division demonstrates. A rift between the family members still working for, and in control of H. Schultz & Sons, resulted in the minority members who stopped receiving dividends while the company was trying to remake itself from a retailer to a distributor.

No Shareholder Oppression in Exercise of Majority’s Business Judgment

The failure to pay dividends and a refusal to use the assets of the business to buy out the non-employee shareholders, however, in itself is the type of conduct that rises to shareholder oppression.

The group of minority shareholders who claimed that the corporation’s refusal to purchase their interests was shareholder oppression failed to establish a viable claim under New Jersey’s Oppressed Shareholders Act, says the Appellate Division

Affirming the trial court’s opinion in Goret v. H. Schultz & Sons, Inc., Docket No. A-4281-10T1 (App. Div. Sept. 10, 2013), the Appellate Division affirmed the holding that the refusal to repurchase minority interests no longer receiving dividends was an appropriate exercise of the business judgment rule.

May 15, 2013

The Little Big Breach – Restrictive Covenants

by Jay R. McDaniel, Esq.

Most of the cases that we handle – like any other litigation – get settled before trial. One of the incentives to settle is that invariably the departing owner will agree to some sort of restrictive covenant against competing against his former company.

The case that goes to trial, or which is resolved on a substantive motion, leaves this issue wide open. In fact, there is no statutory basis to deter the ousted business owner from setting up a competitor and trying to lure away the business of his former company, and one would suppose with a bankroll secured by the purchase of his or her interest.

Since most business divorce litigation ends with a deal, and restrictive covenants are critical aspects of those transaction, I thought it worthwhile to write about a recent decision of the Appellate Division that gives a stern warning that the restrictive covenant had better been honored.

February 25, 2013

Expelled LLC Members: No Right to Force Purchase

by Jay R. McDaniel, Esq.

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.

February 25, 2013

Court Permits LLC Removal Without Wrongful Conduct

by Jay R. McDaniel, Esq.

Landmark Decision Will Make Removal of Members Eaiser

Many limited liability company litigators have presumed that to expel a member from a New Jersey limited liability company you must establish wrongful conduct such as dishonesty or involement in a a competing business. And moreover, if the case is successful, the next assumption was that the company must buy back the interest of the ousted member

Both the trial court and the attorneys involved in All Saints University of Medicine Aruba v. Chilana, Docket No. A-2628-09T1, App. Div Dec. 24, 2012 (read decision below), seem to have made the same assumptions. The appellate court, however, in this recent decision made clear that neither is accurate.

Limited Liability Company Act Permits Expulsion Through Involuntary Dissociation

Similar situations actually arise with some frequency. One of the members of an LLC, for whatever reason, becomes a hindrance to the continued operations of the business. Perhaps the LLC needs capital and the member will not, or cannot, contribute their fair share. Perhaps the LLC relies on the members working in the business on a daily basis and one of them stops coming to work. (Editor’s note: The Supreme Court has drawn portions of the reasoning of the Apellate Division into question in its 2016 decisions in IE Test v. Kenneth Carroll. Read our coverage of the decision here.)

February 5, 2013

NJ Limited Liability Company Law Effective March 18

by Jay R. McDaniel, Esq.

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.

December 31, 2012

Five Expensive Mistakes When Forming a New Jersey LLC

by Jay R. McDaniel, Esq.

New Jersey Limited Liability Company Attorneys

Imagine that the limited liability company you and your partners started five years ago is involved in a nasty corporate governance lawsuit. Perhaps one of the partners needs to be expelled, or maybe one of the owners is involved in a competing business. Imagine that you are spending tens of thousands of dollars every month on legal fees, that the business is in a state of constant disruption and that you haven’t had a good night’s sleep in weeks.

And now, accept the fact that this could have been avoided.

The chances are that if a closely held business is involved in this type of litigation it is because the owners did not plan well when they started the business. How do I know? Having litigated many of these matters over the years, I see the same mistakes made early in the life of the business surfacing again and again as the source of litigation.

New Jersey Limited Liability Company Operating Agreement

This is my non-exclusive list of what I think are the most expensive mistakes that I see people make in their business. There are others, to be sure, but these are the ones that I see as the source of litigation among the members.

No Operating Agreement: Actually, I am not going to count not having an operating agreement as one of the five “mistakes.” It is not really a mistake, it is a colossal blunder, kind of like drunk driving – you may get away with it for a while, but you know how it’s going to end.

December 17, 2012

Operating Agreements That Modify Fiduciary Duties

by Jay R. McDaniel, Esq.

Statutory Fiduciary Duties May Be Limited or Eliminated – Sometimes

A Series on New Jersey’s Adoption of the Revised Uniform Limited Liability Company Act

The revised limited liability company law that takes effect in March 2013 creates a new statutory structure of fiduciary duties for LLC members and managers. The statutory standards are floor, not a ceiling, and courts are still able to find a duty based on the circumstances at issue. Limited liability companies may alter or amend those duties by statute – or ratify a breach after it has occurred – but not without limits.

The new law is a significant improvement over the existing law, which is largely silent on the precise duties owed by members and managers to an LLC. The current law seems to presume that the members will define these duties for themselves; an assumption that in practice is often not true. It also opens the door to business practices that may be oppressive and assumes that all have an equal say in the terms under which an agreement is organized. The new law adopts a “manifestly unreasonable” standard that limits the ability of LLC members to create businesses under contracts that include oppressive provisions.

The drafters of the Revised Uniform Limited Liability Company Act (RULLC) noted that the model statute

rejects the ultra-contractarian notion that fiduciary within a business organization is merely a set of default rules and seeks instead to balance the virtues of “freedom of contract” against the dangers that inescapably exist when some have power over the interest of others.