The Business Divorce Law Report

February 25, 2013

Expelled LLC Members: No Right to Force Purchase

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.

December 4, 2012

Fiduciary Duties Change In New Jersey LLC Law

by Jay R. McDaniel, Esq.

Law Specifies Fiduciary Duties for Members and Managers of New Jersey LLCs

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.

November 26, 2012

Fiduciary Duties of Limited Liability Principals Undecided

by Jay R. McDaniel, Esq.

Court Rejects as Unnecessary Statutory Interpretation Finding Fiduciary Duties in LLC Act

One of the burning issues in limited liability company law is the existence and scope of
the fiduciary duties that are the core of the business relationship between the owners and managers of the business. Our discussion of a recent decision from Delaware is intended to emphasize the unsettled nature of the question in much of the country and to provide a good starting point for an ongoing discussion of just how deep are the changes in the recently enacted changes to New Jersey’s limited liability company statute.

The decision, Gatz Properties, LLC v. Auriga Capital Corp., C.A. No. 4390 (Nov. 7, 2012), is significant to the members and managers of New Jersey LLCs not just because of the influence of the Delaware courts, but because the New Jersey statute – for a short while longer – contains an identical provision. We don’t discuss the case at length here because our point is somewhat different – the the different way fiduciary duties are addressed by the Revised Uniform Limited Liability Company Act adopted in September. There are some excellent discussions of the case and its impact can be found on the blogs of Francis Pileggi’s blog (post here), Stoel Rives LLP (post here) and Peter Mahler (post here.)

There are those that argue that an LLC is at its core is a creature of contract, and that the relationship between the members or managers carries with it no inherent fiduciary obligations. Thus, the argument goes, the members and managers owe each other no greater obligations that they do in any other contractual relationship and the only fiduciary duties that exist are those that are created by the LLC’s operating agreement.

Others, meanwhile, argue that a limited liability is a business enterprise and that the fiduciary relationships that one finds in other forms of business organization, such as corporations or partnerships, should apply. In many states, including New Jersey, it is an open issue. So when a Delaware Chancery Court judge went out of its way to find that the Delaware limited liability company statute itself creates fiduciary duties akin to those widely accepted in the context of corporate governance, people paid attention. Delaware is still considered the fatherland of corporate governance and its decisions, even those of trial judges, carry a great deal of influence.

Any certainty, however, disappeared with the holding of the Delaware Supreme Court that the finding of the trial court concerning any fiduciary duties under the statute was dicta not necessary to the final outcome of the case, and expressly stating that the question of the fiduciary duties of limited liability company managers is still an open issue under Delaware law.

November 9, 2012

LLC Mortgage May Be Challenged

by Jay R. McDaniel, Esq.

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.

November 9, 2012

Stock Certificate Transfer Claim Rejected

by Jay R. McDaniel, Esq.

Ownership Transfer Rejected When Stock Certificate Note Endorsed

One of the principles of corporate law that comes up with some frequency in shareholder disputes is that a share certificate is not an interest in a company, but only evidence of ownership. That does not mean, however, that the formalities for issuing and transferring shares can be ignored.

As a recent case from the Appellate Division of the New Jersey Superior Court demonstrates, a court may refuse to recognize what the plaintiff claimed had been a transfer of shares in a closely held corporation when the alleged transferee could not produce the endorsed stock certificate.

November 6, 2012

Shareholder Oppression Claim Requires Trial

by Jay R. McDaniel, Esq.

Claims of Shareholder Oppression Are Disputed by Majority Owner

A motion for judicial dissolution of a retail business based on the claims that the majority owner had oppressed the minority shareholders should be denied when the facts are in dispute. An evidentiary hearing is necessary to resolve the disputed issues. Ho v. Nest & Ginseng, Inc., 950 N.Y.S.2d 494 (Queens Feb. 28, 2012).

Two minority shareholders each holding 25 percent of the corporation brought suit as oppressed shareholders against the 50 percent owner of the business, which operated a J Mart in a shopping mall in Flushing, Queens, seeking dissolution of the business under Business Corporation Law 1104-a.

BCL 1104-a permits the dissolution of a corporation on application of the holders of 20 percent or more of the business based on the oppressive conduct of the majority or the directors of the corporation. The petitioners in this action alleged that the majority shareholder, Yuk Yung Yu, was operating the business in a suspicious manner and that he had been promoting the sale of her stock in the corporation in violation of the shareholders agreement.