Posts Tagged ‘LLC’
Recently, a defendant testified in a deposition that I was conducting that there was no reason that he could not fire my client, who was a 28% minority shareholder in a New Jersey corporation. Since the defendant was the majority (51%) owner, he believed he could fire whomever he wanted.
Of course, he is right. He could fire whomever he wants. Most employees in New Jersey are employees at will and everyone knows that they can be fired at any point with or without reason (as long as the termination is not discriminatory, of course). So, yes, I had to admit that he had the right to fire my client. But that does not mean that there can be no consequences that flow from the termination.
Since my client had always been a valued employee and was one of the founding members of the company, he had a “reasonable expectation” that he would continue to be an employee as long as he was a shareholder (or so I argued, backed by New Jersey law). In other words, the status of shareholder and employee were inexorably intertwined with him, and rightfully so.
Because of this, my adversary’s attorney knew full well what his client did not – that the law in New Jersey protects minority shareholders in closely held corporations from termination. So, while the majority shareholder had every right to fire him as an employee, my client also had the right to be paid fair value for his shares. As a policy, New Jersey courts believe that majority shareholders should not be permitted to terminate a shareholder as an employee, but keep his capital captive. If not for this remedy, the shareholder would not only no longer be working as an employee, but he may also be precluded from getting any return on his investment.
Courts know that, while the law requires distributions to be made pro-rata to all shareholders, it is very easy for business owners to play games with salary and bonuses and overcompensate themselves, leaving little money left over for shareholder distribution.
This protection has been afforded to shareholders in New Jersey corporations for many years. As of March 2014, the LLC statute in New Jersey is being amended to apply the concept of “oppression” to New Jersey LLCs. While there is nothing specific in the amended statute detailing exactly what this means, there is every reason to believe that a New Jersey LLC member who is terminated as an employee, frustrating his or her reasonable expectations, will soon have the full weight of law in their corner. Finally, LLC owners will be afforded the same relief that is available to owners of corporations.
I have written many times over the years about the differences between a corporation and an LLC when it comes to minority owner rights in New Jersey. On many occasions, I have written about the fact that shareholder rights are much more expansive in a corporation, and much more restrictive in an LLC. That all changes of March 1, 2014.
On that date, the existing LLC statute is being repealed, and the oppressed minority shareholder statute is effectively being incorporated into the LLC statute.
Those rights, and the rest of the new LLC statute, are already in effect for LLC’s created after March of this year, as well as LLC’s that have specifically adopted the new statute. But as of March 1st of next year, every LLC member in the state of New Jersey will be protected under the new oppression section of the statute.
What protections will be afforded? Since the LLC statute will now read almost exactly the same as the corporate statute, it is likely safe to assume that many of the same protections will be found to apply, and that the body of case law relating to corporations will be applied to LLC’s. (Of course, there are no guarantees until judges start applying the new provisions.)
If that turns out to be the case, many of the things that I have written about over the years that constitute “shareholder oppression” in a corporation will likely constitute “member oppression” in an LLC. The failure to pay dividends when the company can afford it; overcompensation of majority members at the expense of member distributions; termination of employment when there was a reasonable expectation of continued employment; embezzlement; freezing a member out of management; concealment of financial information; and conducting improper, self-interested transactions, are all now likely to constitute minority oppression in the context of an LLC. As a refresher for those interested, I will be writing a series of articles discussing many of the things that could be considered minority shareholder oppression in an LLC. I will also be discussing what steps, if any, may be taken by majority owners to protect against an oppression claim in an LLC.
For now, though, minority members of New Jersey LLCs should at least take heart that, as of the spring, they will no longer take a back seat to corporation shareholders when it comes to having their interests protected by New Jersey courts.
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.