The Business Divorce Law Report

December 4, 2012

Fiduciary Duties Change In New Jersey LLC Law

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.

November 2, 2012

Buy-Sell Agreement to Arbitrate is Enforceable

by Jay R. McDaniel, Esq.

Dispute Related to Repurchase of Shares Under Buy-Sell Agreement Subject to Agreement to Arbitrate

Agreements to arbitrate are frequently added to buy-sell agreements and other corporate governance contracts. These agreements will be enforceable in nearly all circumstances and the parties should be certain that arbitration – rather than litigation in court – is what they really want.

In a recent appeal from a court order refusing to enforce an agreement to arbitrate after the parties had already been in litigation for two years, the Appellate Division of Superior Court rejected arguments that the arbitration clause was narrowly drawn. Gatta v. Gatta, Docket No. A-3161-11T (App. Div. October 26, 2012). Because the subject matter of the dispute was also the subject matter of the contract, the agreement to arbitrate was enforceable notwithstanding the delay in asserting the right.

Shareholder Seeks to Enforce Arbitration Right

The appeal was brought by Defendant Joseph Gatta from the trial court’s denial of an application to compel arbitration under a shareholders agreement. Gatta and the company, Joseph Gatta & Sons, Inc., were sued by Gatta’s brother, Anthony Gatta, one of four shareholders in the business. Anthony sued after he was fired and the company did not respond to his demands to purchase his interest.

November 1, 2012

LLC Minority Interest Subject to Levy

by Jay R. McDaniel, Esq.

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.

October 25, 2012

New Jersey Limited Liability Company Operating Agreements

by Jay R. McDaniel, Esq.

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 liabilit industry-agreement y 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 agree

ment and whether oral, in a record, implied, or in any combination thereof, of all the members of a limited l

iability 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.

October 10, 2012

Buyout Agreement Enforced

by Jay R. McDaniel, Esq.

Fraudulent Inducement Claims Rejected by Court

In Shareholder Buyout Dispute

The broad release language contained in a buyout agreement is enforced, despite claims of fraudulent inducement, affirms the Appellate Division of Superior Court in Marino v. Twin Rivers Podiatry, P.A., Docket No. A-5630-10T1 (May 19, 2012).

October 8, 2012

Protecting Profit Margins from Employee Saboteurs

by Jay R. McDaniel, Esq.

Employee Held Liable for Actively Competing With Current Employer

The success of businesses in specialized fields often depends on the employees’ ability to deliver consistent-quality service and implement specialized techniques and processes. Business owners in these fields know that the costs of investment in employee training and development can be very high. What is a business owner to do when employees take this costly knowledge and expertise to a new company and begin competing against the former employer? Fortunately, New Jersey offers relief from such acts, as discussed in the recent Appellate Division case of Baseline Services, Inc. v. Kutz, et al., A-5214-09T3.

Baseline provides metrology services involving repair, maintenance, and calibration of laboratory equipment to its clients. The corporation had a substantial annual contract – in the amount of $269,000 – with Global Pharmaceutical Sourcing Group (GPSG), which is a division of Johnson & Johnson, Inc. The contract was primarily serviced from 2002 to 2006 by two Baseline employees – Kutz and Nicoludis.

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

Uncertain ResponsibilitIes of LLC Members

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

Purchaser Alleges Mortgage Was Not Approved by All LLC Members

Ownership Transfer Rejected When Stock Certificate Note Endorsed

Claims of Shareholder Oppression Are Disputed by Majority Owner

Dispute Related to Repurchase of Shares Under Buy-Sell Agreement Subject to Agreement to Arbitrate

Shareholder Seeks to Enforce Arbitration Right

Court Issues Writ of Execution on Minority LLC Interest of Ex-Spouse

Charging Order Sole Remedy under LLC Act

Part of an ongoing series on the adoption of New Jersey’s revised limited liability company act.

Written Operating Agreements Not Required

Fraudulent Inducement Claims Rejected by Court In Shareholder Buyout Dispute

Employee Held Liable for Actively Competing With Current Employer

Fraudulent Inducement Claims Rejected by Court

In Shareholder Buyout Dispute