Posts Tagged ‘LLC’
New Case Reaffirms the Difference Between Corporations and LLC’s When It Comes to Rights of Minority Owners
I have written extensively about the difference between the law in New Jersey protecting a minority shareholder in a corporation, and the law protecting a minority member in a limited liability company (LLC). Most lawyers practicing extensively in this area of law have long argued, and believed, that the statute protecting minority shareholders in a corporation from what is considered “shareholder oppression” does not apply to LLC’s (much as we may want it to). The New Jersey Appellate Division reaffirmed this principle in a recent, unreported decision, Hopkins v. Duckett.
The importance of this legal distinction cannot be stressed enough. Actions such as the failure to give dividends to shareholders (in certain circumstances), termination of a shareholder as an employee, and excess payments to themselves by the majority shareholders have all been held to constitute shareholder oppression, often giving rise to the right to be bought out of a NJ corporation. However, these same acts may not give rise to the right to be bought out of an LLC. Instead, the rights of a minority member of an LLC may be much more complicated, and the remedy may not include a buyout of the minority member’s interest.
Of course, the rights and obligations under an LLC in New Jersey may also be much simpler, assuming the LLC’s Operating Agreement does not prohibit withdrawal. If it does not, in NJ, a member may simply withdraw from the LLC and have the statutory right to be paid for his membership interest a much less expensive, procedure than a shareholder oppression lawsuit. However, the Operating Agreement often bars such withdrawal, and then a very careful analysis of the facts is necessary to determine a minority member’s rights.
A minority member of an LLC may still protect himself, even if the majority members insist on prohibiting withdrawal at the time the Operating Agreement is drafted. Absolutely nothing prevents the members of an LLC from adopting the rights and remedies set forth in the shareholder oppression statute, thus making them applicable to an LLC by contract. This could be a fair compromise between simply permitting withdrawal, and providing no relief at all. What is absolutely critical, though, is to utilize the services of an attorney who is well-versed in this area of law. Lawsuits brought by minority members against my corporate clients have been thrown out because the attorney on the other side based his entire case on the shareholder oppression statute, when the company at issue was an LLC. Those clients learned the hard way that this area of law can be complicated and wished they had done more due diligence in hiring their attorney.
When you started your company all those years ago, you were certain you didn’t need a Shareholders’ Agreement (or, in the case of an LLC, an Operating Agreement). An attorney would have charged you more than you wanted to pay at the time to draft one (as they usually do), and after all, you trusted your business partner (back then). If an issue between you ever arose, you were confident in your ability to work it out quickly and easily.
But now, you and your business partner have encountered a dispute that cannot be resolved – a fundamental difference of opinion over the direction of the company. He blames you, and he wants out. A carefully-drafted Shareholders’/Operating Agreement might have contained a buy-sell agreement that spelled out each shareholder’s right to be bought out by the other under certain circumstances. Without such an agreement, though, your partner feels trapped, as if he has no choice but to sue.
So he sues, alleging shareholder oppression and mismanagement, accusing you of failing to undertake numerous actions that were never your responsibility. Had an agreement been in place, you might have been able to point to language showing that the responsibilities you are alleged to have breached never were charged to you. Once again, a written agreement, spelling out the rights and responsibilities of all the owners, would have proven quite useful.
I have seen this situation, where the absence of an agreement between the parties has led directly to shareholder dispute litigation.
Then, to add insult to injury, after your attorney has charged tens of thousands of dollars to defend you against the shareholder oppression claim, your business partner finds a buyer and announces that he intends to sell his 50% interest to him, completing his exit strategy. Without an agreement to protect you, you are now in business with someone you’ve never met, and this stranger owns the other half of your own company. But you saved money by not having to pay for an agreement at the outset. Congratulations.
All of this can be avoided by making sure that you consult with an attorney who is conversant in shareholder dispute issues – not only when you get sued, or when you are ready to sue your business partner – but also when things are going well. As with so many things, a little legal “preventive medicine” can save a fortune down the road.