New Jersey Business Dissolution Journal - Jay McDaniel

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.

1.         Understand the Statutory Framework.

Different types of businesses may be treated the same for taxes – partnerships, S Corporations and limited liability companies – but they are very different creatures when it comes to disputes between the principal owners.  The “default rules” for issues that have not been addressed in the business organization documents are very different, and the liability of individuals can be widely different.

A couple of examples should give you an idea.  The limited liability company and partnership statutes in many states contain provisions that permit the expulsion of a troublesome member or partner.  There are standards that have to be met, and they are significant, but the member or partner who makes it nearly impossible to continue the business with their participation can be tossed out.

Not so with the close corporation.  Most statutes permit the minority to demand the purchase of his or her shares if the majority has acted oppressively, but not the other way around.  If the majority doesn’t have the votes to fire or remove a shareholder, they may be stuck with that person.

Most partnerships and limited liability statutes have a minority veto built into their structure.  Unless it was previously agreed, you cannot change the basic operating documents – the partnership agreement or the operating agreement – without the consent of all of the members or partners.  Corporations on the other hand can usually operate with a majority vote and can change their by-laws or certificate of incorporation.

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Promoters of LLC Subject to Breach of Fiduciary Duty Claims

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.

 Real Estate Investments by LLC

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.

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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.

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A contract means what it says, even if the two parties who came to the agreement may have understood something different.  This can be a trap for the business that is not careful to ensure that the contract that it signs at the end of negotiations accurately reflects exactly what it thinks it has agreed to.

It is not particularly unusual that, at the end of a period of negotiations, the contract that is finally written up does not exactly fit the terms the parties thought they had negotiated or that it does not contain all of the terms that the parties thought were relevant.  A court, however, is unlikely to read those terms into the agreement, or even permit one of the parties to argue that they should have been there – at least not when the meaning of the agreement is plain from its terms.  

Court Review

The New Jersey Appellate Division opinion in MicroBilt Corp. v. L2C, LLC demonstrates just how difficult it can be to get a court to consider that there were important terms missing from the final document that should have been included. 

MicroBilt signed a contract with L2C under which L2C would perform credit evaluations of MicroBilt’s potential customers and provide customer credit scores to MicroBilt.  MicroBilt later claimed that L2C was also required to supply the underlying data used to calculate the credit score, which L2C obtained from a third party vendor.  L2C claimed it could not provide the underlying data because its contract with its vendor prohibited the release. 

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Oppressed Shareholder Settlement Void

Shareholders in New Jersey's Wild West City cannot distribute assets to resolve an oppressed shareholder action due to an unresolved claim involving an employee's accidental shooting. The case is a warning, perhaps, that prudence requires some due diligence before a release is signed to ensure  that there is not a lurking claim that could upset the settlement.

Purchase of Minority Interest

Oppressed shareholder actions almost invariably end with the compelled purchase and sale of the minority shareholder's interest. An unresolved claim, however, that could give a third party an interest in the company's assets may prevent any resolution of the dispute.

Stabile v. Stabile (Stabile v. Stablie.pdf) involved a dispute between the members of several family owned businesses owning a large tract of land in rural Sussex County, New Jersey and operating Wild West City, a western theme park. The businesses also held a liquor license and owned a contiguous restaurant. The litigation among the family members began in September 2005, when James Stabile filed suit alleging various breaches of duties by the directors of the business and minority shareholder oppression. In June 2006, the Court entered an order that the plaintiff was be bought out at fair value. The real estate holdings were appraised at about $11.45 million.

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