516-227-0700

Judicially Expelled Member Pays Heavy Price For Abandoning LLC

December 04, 2023

Last month, in Flor v Greenberg Farrow Architectural Inc., a three-judge panel of the New Jersey Appellate Division handed down an opinion with important lessons for business owners and practitioners in states that have adopted the Revised Uniform LLC Act, such as New Jersey, as well as in states that haven’t, such as New York.

The main lesson for those both in RULLCA and non-RULLCA states — one familiar to readers of this blog — is the danger of letting LLC formation and operation get ahead of the LLC’s constitutive documentation to the point where the putative LLC co-members disagree whether they entered into a binding transaction or, at most, a non-binding agreement to agree.

For those in RULLCA states, whose LLC statutes authorize judicial dissociation a/k/a expulsion of an LLC member, the additional lesson is not to underestimate the importance of the equities, both as to the circumstances justifying expulsion and the potential consequences that flow from expulsion.

A Promising Partnership Quickly Splinters

The first half of the court’s lengthy opinion in Flor details the facts of the case as drawn from the record of six-day jury trial in a suit brought by Jaclyn Flor against Greenberg Farrow Architectural Inc. (GF), a large private-sector engineering firm based in Atlanta, Georgia. What follows attempts to relate the most salient facts while necessarily omitting many of the details that provide additional context and color.

Initial Discussions. The plaintiff Flor worked for many years as a civil engineer with a New Jersey public sector engineering firm. By 2011, Flor was vice-president and an equity shareholder of the firm based on her client relationships, leadership skills, and generation of lucrative contracts with municipalities.

In 2015, GF contacted Flor to ask if she was interested in a job with GF which was looking for engineers to employ in its recently opened New Jersey office. A week later, Flor met with GF’s COO, Keith Johnston, who explained that GF wanted to move into public sector development projects. Flor initially resisted, explaining that she was not interested in a career move for various reasons, particularly if the move offered no equity interest.

Over the following year Flor continued discussions with Johnston and other principals of GF including its President and Chairman of the Board, Esmail Ghadran. At a meeting in May 2016, Ghadran and Johnston offered Flor a 51% ownership and management interest in a to-be-formed company which GF would bankroll for two years in exchange for a 49% equity interest in the new company.

The First “Preliminary Agreement” Letter Flor expressed her interest, following which Johnston sent Flor an email entitled “preliminary offer” attaching a Johnston-signed letter laying out the terms of an offer. The letter stated that its purpose was “to formally offer this opportunity to you and outline the following basic parameters of this preliminary agreement.”

The letter, set up for counter-signature by Flor, offered her 51% ownership along with GF’s 49% in a to-be-named professional LLC with a “guaranteed” annual base salary of $175,000 for two years. The letter also spelled out certain “initial business set-up services and continuing business support services” to be provided by GF to the proposed LLC, including office space and facilities, insurance, human resource management, accounting, IT, marketing, and legal counsel to assist in “forming the partnership and associated agreements to be filed as a legal business entity.”

The letter closed with an acknowledgement by both parties that “this is a preliminary agreement and a final, formal partnership and/or operating agreement as outlined above will also commence upon acceptance.”

The Second “Business Opportunity Offer” Letter. Flor did not counter-sign the letter. Among other qualms, Flor testified that she was not comfortable signing the agreement without being able to review the proposed LLC’s operating agreement. Instead, she and her attorney marked up the letter and sent it back to Johnston. Johnston replied with another letter entitled “Business Opportunity Offer Letter.” The letter generally tracked the first letter but with certain important revisions:

  • The to-be-formed LLC would be designated as a Woman-Owned Business Enterprise (WBE).
  • The letter outlined “basic principles of employment with the understanding that certain, additional transactional documents will be executed by and between the parties under separate cover.”
  • The guarantee of $175,000 annual salary was termed as a “guaranteed and unconditional and irrevocable obligation of GF to pay you.”
  • GF’s business support services to the new LLC was expanded to provide “all related business administration matters that GF otherwise provides for its other employees.”
  • GF’s provision of insurance to the LLC was expanded to cover RFQs and RFPs.
  • Flor’s employment would commence on July 16, 2016.

Rather than including an acknowledgment, as in the first letter, that the agreement was “preliminary” with a “final and formal partnership and/or operating agreement” to follow, the second letter closed with a joint acknowledgement “that this offer of employment will be supplemented by the operative documents contemplated to achieve the obligations of GF and WBE, LLC for the successful partnership.”

The New LLC Gets Off the Ground, Barely. After Flor resigned from her then-employer and signed the Business Opportunity Offer Letter, GF registered a New Jersey LLC that Flor named ENGenuity Infrastructure LLC. Flor started working at ENGenuity on July 11, 2016.

Over the next two weeks, Flor and GF took a number of steps to advance the new firm, including opening up a business checking account (to which Flor was not given access); looking at possible office space; getting GF’s approval to hire various professional and administrative positions at a budgeted cost of $535,000 annually; and hiring a marketing firm to develop a website and marketing material for which GF paid the required 50% deposit.

In the same period, Flor secured a two-year consulting subcontract with her prior firm for a municipal construction project and was actively pursuing a multi-year contract as engineer for another municipality. On July 20, 2016, Johnston sent an email to all GF managing partners clarifying that ENGenuity was not a GF subsidiary but was a stand-alone company with Flor as managing partner and GF as minority partner. The ultimate goal, he wrote, was for ENGenuity to obtain WBE certification making it “very important” to show that Flor was “managing the LLC from day one.”

Johnston Surprises Flor with a Letter of Intent. On July 27, 2016 — by which date GF had not paid Flor the promised signing bonus or any salary and had not secured insurance for ENGenuity — Johnston sent Flor an email entitled Letter of Intent to which he attached a five-page letter signed by him. The letter’s purpose, stated in its first paragraph, was “to confirm each of our intent so that formal agreements can be prepared” and that “this letter is not intended to be binding on either of us.”

The LOI went on to state that Flor and GF would execute an operating agreement requiring unanimous member consent for a list of 22 enumerated actions including approval of any employment agreement, issuance of distributions or any check over $10,000, borrowing funds in excess of $2,500, and purchasing or leasing property valued more than $5,000.

The LOI stated that the operating agreement would include membership interest transfer restrictions and buy-sell provisions including forcing Flor to buy GF’s interest at the end of the two-year start-up period, or to sell her interest to GF if GF terminated her employment. It also stated that there would need to be a management agreement whereby GF would charge ENGenuity a monthly fee for services, and that GF would lend ENGenuity $100,000 for “initial working capital” to be repaid over five years.

Flor testified she was “shocked” when she read the LOI and felt that it was a power grab” by GF. When she confronted Johnston, he replied that GF’s managing principals and Board had drafted the LOI, assured her it was nonbinding, and encouraged her to “just mark it up” and send it back to him. In late August, by which time Flor still hadn’t been paid any salary, feeling she had no “other choice,” Flor sent Johnston a markup of the LOI.

GF Bails. On September 9, 2016 — one day after GF sent Flor paychecks totaling $49,000 — Johnston sent Flor an email stating that GF had decided “to not pursue” its 49% interest “with the potential WBE entity at this time.” Johnston continued:

The recent negotiations have taken the parties far apart from the original spirit and intent of the partnership. While we feel that we have made every effort to put forth a very generous offer and diligently pursue the intent of the partnership, the potential increased risk associated with your counter-offer concepts are not prudent pursuits for [GF]. Your guaranteed salary offer as an employee of [GF] is still valid.

Flor testified that she was both shocked and blindsided by Johnston’s announcement, and was forced to figure out how she was going to support her family, preserve her client relationships, and salvage her reputation. Soon afterward Flor had a conference call with Johnston and Ghadran in which the latter said — contrary to Johnston’s July 20 email to management — that he considered ENGenuity a “subsidiary” of GF and wanted Flor and Johnston to work out their differences regarding the LOI and for Flor to become an employee of GF. Flor responded that early on in their negotiations she had rejected the employee offer and was not interested in revisiting it.

Over the next several weeks Flor continued to pursue contracts for ENGenuity while carrying on further discussions with GF concerning the LOI. Meanwhile, GF refused to pay for insurance for ENGenuity, which prevented it from executing contracts. Flor was forced to use her personal funds for insurance and other operating expenses.

GF delivered the coup de grâce on October 3, 2016, notifying Flor orally and in writing that it was terminating its membership interest and any relationship with ENGenuity.

Flor Sues, Wins Jury Verdict for Damages for Breach of Contract

Flor continued solo to build and self-finance ENGenuity’s business. In March 2017, she filed suit against GF, Johnston and Ghadran primarily seeking to recover damages for breaching their agreement to fund her salary and ENGenuity’s operating expenses for its first two years. Her complaint also sought a declaration that GF is expelled from ENGenuity and that Flor is its sole member.

Following discovery and the court’s denial of GF’s and Flor’s summary judgment motions, the case went to trial before a jury. GF contended at trial that it never entered into a binding and enforceable agreement with Flor to fund her salary or ENGenuity’s operating expenses.

Following a six-day trial, the jury returned a verdict in Flor’s favor, finding that GF had breached the agreement to pay Flor’s salary and fund ENGenuity in its first two years and awarding Flor damages of $904,000 consisting of $599,000 in operating expenses and $305,000 salary. The jury’s verdict awarded Flor an additional $375,000 compensatory damages for breach of the implied covenant of good faith and fair dealing, however on GF’s motion the court set aside that award as duplicative of the damages for contract breach.

In its ruling on Flor’s post-trial motion, the court declared that GF was dissociated or expelled from ENGenuity under three independent provisions of New Jersey’s Revised Uniform LLC Act based on:

  • GF’s abandonment/voluntary withdrawal from ENGenuity under the New Jersey Act’s analog to RULLCA 601(a);
  • GF’s wrongful conduct adversely and materially affecting ENGenuity’s activities under the New Jersey Act’s analog to RULLCA 602(6)(A); and
  • GF’s conduct which made it not reasonably practicable to carry on ENGenuity’s activities with GF as a member under the New Jersey Act’s analog to RULLCA 602(6)(C).

The trial court did not order payment of any compensation to GF on account of its lost membership interest or credit any such payment against its liability for compensatory damages.

The Appellate Court Affirms

GF’s subsequent appeal challenged the trial court’s pre-trial denial of GF’s summary judgment motion (which I won’t further address) and its post-verdict order denying GF’s motion for judgment notwithstanding the verdict (JNOV). It also appealed from the trial court’s declaratory judgment directing GF’s expulsion and dissociation from ENGenuity without compensation for its abandoned interest.

Denial of GF’s JNOV Motion. GF argued that the evidence at trial showed that the parties never reached a final agreement on a partnership and that the agreement they had was limited to a promise to pay Flor’s compensation, not the operating expenses of an LLC. It also contended that the jury’s $599,000 award for operating expenses put Flor in a far better position than she would have been in had there been no breach because it required GF to fund ENGenuity’s operating expenses but didn’t allow GF to retain its 49% interest in the company. Stated differently, GF claimed that the damages award actually was a specific performance award requiring “mutual performance by ENGenuity through the delivery of 49% of the membership interests of the company.”

The appellate court’s opinion, upholding the trial judge’s refusal to set aside the verdict, agrees that the jury reasonably could conclude that the Business Opportunity Offer Letter contained all the required elements of a contract — “meeting of the minds, offer and acceptance, consideration and certainty” — and thus became a valid and enforceable “employment contract” upon execution by Flor.

The opinion also agreed with the trial judge’s findings that:

  • The letter’s reference to anticipated “supplemental” transactional documents merely suggested that the documents were intended to “tweak” the employment relationship and benefits offered to Flor.
  • GF’s subsequent conduct, including the salary it paid to Flor and the initial support it provided ENGenuity, were circumstantial evidence of the existence of a contract.
  • The case “rested primarily on credibility” and the jury was entitled to find Flor to be the more credible witness at trial, quoting the trial judge’s description of the GF witnesses as “mechanical, scripted, and orchestrated” and “reluctant to answer questions during cross-examination.”
  • RULLCA does not require parties to execute a formal operating agreement as a “necessary condition precedent” to participation in the LLC and the creation of an enforceable contract.
  • The judge — not the jury — expelled GF, thus the jury’s verdict requiring GF to fund ENGenuity’s operating expenses was not a specific performance award requiring mutuality of performance.
  • The jury’s damages award “was the direct result of GF’s breach, was supported by the evidence, and was appropriate under the law of compensatory damages.”

GF’s Dissociation. To this writer, the more intriguing feature of the case outcome is the trial judge’s grant of Flor’s post-trial application to expel GF from ENGenuity without payment for its underlying 49% membership interest.

The appellate court’s opinion summarizes and agrees with the trial judge’s findings that:

  • GF voluntarily withdrew from ENGenuity by abandoning its interest in the company as confirmed in its October 3, 2016 notice to Flor and by its subsequent refusal to contribute to the business.
  • GF engaged in both pre-termination and post-termination wrongful conduct that frustrated the purposes of the LLC and adversely and materially affected ENGenuity’s business operations, including GF’s attempted “coup to seize control from the majority member,” thereby warranting expulsion.

The appellate court’s opinion also finds that “no law required a compensation award under the facts of this case, and it would have been inequitable to award compensation for an interest GF had abandoned shortly after forming the LLC.” The opinion emphasizes that the New Jersey statute gives the court the discretion to order a sale of the expelled member’s interest, but does not require it to do so.

The opinion finds further support for the no-compensation expulsion based on the absence of any evidence in the record that ENGenuity had any value when GF walked away, “and any value it accumulated by the time of judgment was the result of Flor’s hard work and personal investments.” Thus, the court added, “it would have been inequitable to award GF any compensation for value that Flor alone created.”

As alluded to at the top of this post, the novelty of the outcome in this case, whereby GF was ordered to pay ENGenuity’s operating expenses as damages while at the same time losing its membership interest, appears to be driven by the balance of the equities as much if not more than the letter of the governing statutory provisions. Frankly, it’s hard to imagine a judge forcing Flor to resume partnership with GF, entitling it as minority member to a 49% share in profits generated by Flor, years after GF ditched ENGenuity and left Flor high and dry.

For those who want to dig deeper into the Flor case, you can check out the parties’ appellate briefs here: GF’s Opening Brief, Flor’s Brief, GF’s Reply Brief.

My thanks to attorney Daniel S. Furst, who represented the winning plaintiff in Flor, for passing on the court’s opinion and the parties’ appellate briefs.