A new set of laws governing New Jersey limited liability companies will become effective in March. The changes are profound. The Limited Liability Company Act fundamentally changes a number of bedrock principles about the manner in which limited liability companies are organized and managed.
Corporations and other business entities are creatures of the law of the state where they were organized. Delaware and Nevada, for example, compete as the state of choice when organizing a new business entity. And the simple fact is that most of the businesses organized under Delaware or Nevada law have no operations in those states.
Does that mean that other courts are limited in the ability to grant relief in the event that litigation develops among the owners over corporate governance issues? That was the issue in a recent decision by Chancery Judge Carroll in Lerner v. Heidenberg, BER-C-64-12 (Chancery Div. June 8, 2012). The decision is a warning that electing to organize a company under a particular state’s law may also be a commitment to have the courts of that state resolve certain disputes if things go wrong.
The challenges in making the transition from the the founding members of a successful enterprise to the second generation of managers are often difficult, as this litigation involving that has endured for nearly a decade demonstrates. It may be that the business has moved in a new direction, or perhaps it is simply that the founding member no longer inspires the same type of confidence as when he or she was younger. The second generation of owners often has its own ideas about the way the business should run, but the founders are loathe to cede control.
And of course there are those cases in which the founding member simply refuses to retire
long after they have ceased to be a productive contributor to their business. It is not particularly unusual that the more active members of a business, whether it is a partnership, limited liability company, or a close-corporation, will ultimately seek to expel the founder from the business.
The New Jersey Appellate Division affirmed a trial court decision holding that lease renewals would revive stale claims in a partnership dispute. In Munoz v. Perla, et al., A-5922-08T3, the Munoz brought claims, among others, for breach of fiduciary duty for his partners’ failure to charge fair market rates in connection with the lease of the partnership’s property. Despite that the rents were calculated and leases drawn up in 1994, the partnerships acts of renewing the leases in 2003 were found to be separate acts that revived the otherwise time-barred claims.
Munoz was one of three partners in a real estate venture called The Heritage Partnership. The three partners for started their business relationship in 1983 as principals of a professional engineering firm. Munoz was an inactive partner of Heritage and was not involved in the partnership’s day-to-day operations. The purpose in forming Heritage was to “maintain, operate, manage, sell and/or lease” a commercial building. Each partner contributed capital to the venture and held a one-third ownership interest. The parties’ partnership agreement provided that their rights and obligations were governed by the Uniform Partnership Act, N.J.S.A. 42:1A-1 to -56.
An oppressed shareholder claim is not outside the reach of the New Jersey Arbitration Act, the Appellate Division of Superior Court held in litigation that appears to arise in significant part from a broken promise over the lease of a BMW.
The oppressed shareholder action was filed by dentist David Edenbaum, one of the two owners of State of the Art Smiles, P.A., alleging wrongful conduct under the New Jersey Business Corporation Act’s oppressed shareholder provision, N.J.S.A. 14A:12-7.
The allegation of shareholder oppression was made in an action filed in Chancery Division as well is an a counterclaim to a lawsuit filed by the other owner, Teresa Addeiego-Moore, claiming that Edenbuam had breached a separate agreement requiring him to transfer to her a portion of his interest in the practice equal to the leased vehicle in the event that he default on the payments.
It’s the Wednesday afternoon before Thanksgiving and the phone rings with a new client. The situation in the office has become an emergency. Either someone has been locked out or someone needs to be locked out, or someone is walking out the door with a key client. Many of our cases begin as emergencies.
The dispute between LLC members, shareholders or partners erupts into a lawsuit without warning, or so it seems, and without planning. Here are five considerations that are important to success in a litigated business divorce.
The fiduciary duties owed among partners can change with time and circumstances, and the disclosures that were appropriate when all of the partners worked together in the business may become inadequate when one of the partners has ceased to take an active role.
This is the lesson of Munoz v. Perla, Docket No. A-5922-08T3 (App. Div. Dec. 20, 2011) in which the Appellate Division affirmed a trial court decision holding that the members of a partnership had failed to make adequate disclosure of the terms of the leases held by the engineering firm, of which the parties had all once been partners.
Although the case involved the now-repealed Uniform Partnership Act, and thus not all of the holdings may be applicable to partnerships formed under later law, the decision is instructive as to how the fiduciary relationships between partners my evolve as time passes and circumstances change. (For another reason decision involving fiduciary duties among partners, see our blog post here.)
Limited liability companies are clearly the vehicle of choice for new, closely held businesses. That means that more often than not the principals have some existing relationship before they take up their new business together. Can that prior relationship create fiduciary duties even before the company has begun operations?
A decision out of the New York Court of Appeals indicates that there may be fiduciary duties in such a relationship, in particular duties of full disclosure and fair dealing. Moreover it appears that these duties may exist before the limited liability company is formed or membership interests are acquired. In Roni LLC v. Arfa, 2011 N.Y. Slip Op. 09163 (Dec. 20, 2011), The court held that the existence, or not, of a fiduciary relationship depends up the relationship of the parties and whether it meets the traditional criteria necessary to create fiduciary obligations.
This case involved the conduct of promoters, the individuals who organize a new business and seek out other participants or investors. The defendant promoters organized seven limited liability companies under New York law for the purpose of buying and renovating buildings in the Bronx and Harlem for resale. The plaintiffs were a number of Israeli investors who acquired interests in the LLCs.
Small business owners sometimes run into difficulties with their business partners after much time has passed since they first set up the business. They come to discover that the operating agreement either does not address their problem or the result is not what they intended. Small business owners should take care to draft their controlling documents by considering as many scenarios as possible.
Members of limited liability companies are given considerable leeway to craft a management and business structure as they see fit. This control is one of the reasons why the LLC form is attractive to those engaged in new business ventures. The LLC’s operating agreement is the contractual means by which the members will determine the business structure – and courts continuously warn parties that failure to craft the operating agreement carefully will sometimes force unintended results.
Sometimes an expert valuation opinion, however well documented, leads to a conclusion that just doesn’t square with reality. That was the case with an expert opinion in Rughani-Shah v. Noaz, Docket No. A-4943-08T2 (Sept. 16, 2011) that valued a one-third interest in a medical practice at just $25,000. The trial court’s decision was affirmed by the Appellate Division of New Jersey Superior Court.
The trial judge didn’t buy it – not when the practice was grossing $1.7 million a year and not when the buy-in for the shareholder seeking the buyout had been eight times that amount. Common sense said the number was just too low, and the expert’s opinion was rejected.
