Summer Shorts: Business Divorce Cases From Across the Country
August 30, 2021
Welcome to this 11th annual edition of Summer Shorts! This year’s edition features brief commentary on half a dozen business divorce cases of interest from across the country. Four of the cases involve disputes among LLC members, one among shareholders of a family-owned corporation, and one among partners in limited partnerships. Two of the cases involve buyout appraisal proceedings. Click on the case names to read the decisions.
Maine: Authority to Appoint LLC Manager (Zelman v Zelman)
Ask yourself, does the following provision in an LLC agreement — “The Manager has authority, without the vote or consent of the Members, to amend the Company Agreement to reflect the addition or substitution of Members or the Manager” — give the LLC’s manager the authority to appoint his or her replacement without member consent? Not according to the Maine Supreme Judicial Court’s ruling late last year in which it affirmed a lower court’s judgment dismissing the putative replacement manager’s claim seeking a declaration validating his status as manager of a family-owned, realty holding LLC. The previous manager appointed him manager at the same time he sold his interest in the LLC to the appointee who was one of the LLC’s existing members and a former manager. The Supreme Court looked to the dictionary, defining “amend” as to “make minor changes in (a text) in order to make it fairer, more accurate, or more up-to-date.” Ruling against the appellant, the court wrote:
Given this definition, the plain language of section 13.20(A) [the provision quoted above] permits a manager to modify the operating agreement to update it based on decisions made in accordance with other sections of the operating agreement, e.g., section 2.7, which grants the members the ability to elect a manager by a two-thirds majority, or section 10.10, which grants the members the ability to remove a manager for cause by a two-thirds majority. Section 13.20(A) is not ambiguous, and the plain language of the contract clearly reflects a purely clerical role by a manager to alter the operating agreement to reflect decisions undertaken by the authority granted in other sections of the operating agreement. The court therefore did not err in determining that section 13.20(A) did not give William the authority to appoint Andrew as a manager of the LLC.
LLC agreements for firms with numerous investors often create a corporate-style board of directors to manage the company. When disputes erupt among the stakeholders over action taken by the board, whether the claims are asserted against the members who designate their representatives on the board, as opposed to the board designees who approved the disputed action, can spell the difference between success and failure, as the unsuccessful appellant learned in this case decided last year by the Minnesota Court of Appeals. The dispute centered on whether the board’s vote to dissolve the LLC complied with the LLC agreement’s provision requiring super-majority approval including the vote of at least one of the board designees of the company’s two founding members. The plaintiff member sued the other members for breach of contract and breach of fiduciary duty.
The appellate court last year affirmed the lower court’s decision dismissing both claims on the ground that, under the default provisions of Minnesota’s LLC Act precluding member liability merely on account of member status, read together with the LLC agreement’s provisions delegating management authority to the board, the members could not be held liable under either legal theory. The court rejected the appellant’s argument that members are subject to breach-of-contract claims because they appointed the board members who took the challenged action. By similar logic it also rejected the fiduciary breach claim, writing,
Because the only alleged conduct potentially amounting to a breach of fiduciary duties is the breach of the member-control agreement, and the breach of that agreement is based on the obligations of the board, not the members, 40 Ventures has failed to allege a legally sufficient claim of breach of fiduciary duties.
Ryan is a high stakes statutory fair-value appraisal case following the company’s election to purchase the petitioner’s shares after it sued for judicial dissolution. The trial court placed a value of $467 million (plus $256 million in prejudgment interest) on the petitioner’s shares in the family-owned business, described as a worldwide leader in developing and manufacturing cell stabilization technology for use in hematology, immunology, and molecular diagnostics. The valuation hearing featured the testimony of two of the country’s leading business appraisers. The petitioner’s appraiser valued its 52.275% interest at $467 million — the value adopted by the court — versus the company’s appraiser’s $304 million valuation. Both appraisers utilized a DCF income approach.
In its opinion last April affirming the trial court’s valuation, the Nebraska Supreme Court rejected the company’s primary argument that, by adopting the petitioner’s valuation and proposed findings of facts nearly verbatim, the trial judge failed to exercise independent judgment as the finder of fact. The court stated that, even if the company identified mistakes in the trial court’s findings, the record regarding valuation “considered as a whole” failed to demonstrate that the company suffered any prejudice as a result of any erroneous findings. The court also found no error in the trial court’s findings that the company’s appraiser’s analysis overall “reflected a downward bias which rendered his conclusions unreliable.” Among the many interesting aspects of the opinion’s detailed description of the competing valuations, the court noted that, while both experts applied a 14% premium to reflect the value of the economic benefits associated with the company’s status as an S corporation, the company’s expert halved the premium due to the risk that the company could elect to become a C corporation in the future. The Supreme Court found no error in the trial court’s finding that the “arbitrary halving of the S Corp premium” reflected the appraiser’s “downward bias.”
New Jersey: Dissociation of LLC Member with Profit-Sharing Interest (Decandia v Anthony T. Rinaldi, LLC)
Decandia involves an LLC in the construction management and general contracting business. Some years after its formation, the plaintiff began working for the LLC and entered into an LLC agreement as a 10% non-managing “member.” The capital contributions schedule to the agreement, however, described the interest as a “performance based” profits interest. Plaintiff received a certificate denoting his 10% membership interest, later increased to 20%. Years later, occasioned by discussions with the company’s founder about a possible buy-sell agreement, the founder disclosed that the LLC was under criminal investigation by the Manhattan DA’s office. When plaintiff expressed concern that his certificate might expose him to criminal liability, the founder suggested he resign and return his certificate, which plaintiff did. Afterward, plaintiff received bonuses instead of profit-sharing compensation.
After he left the LLC and took employment with a competitor, plaintiff brought suit claiming minority member oppression and breach of fiduciary duty, seeking a compelled buyout of his alleged 20% equity interest in the company. The court issued a post-trial decision concluding that plaintiff did not have an ownership interest in the LLC; that he was merely an employee who received additional compensation through a profit-sharing arrangement; and that he “dissociated” from the LLC when he turned in his certificate. On appeal, decided last year, the intermediate appellate court agreed that “plaintiff’s surrender of his shares dissociated him from the LLC and validly transferred his profit-sharing interest back to the LLC.” The appellate court also agreed that plaintiff never held an equity interest based on his tax returns not reflecting an ownership interest and based on testimony credited by the trial court that plaintiff balked at the idea of personally guaranteeing the LLC’s credit and bonds.
The only good news for plaintiff in the court’s opinion was a reversal of the trial court’s finding that he was liable for breach of the statutory fiduciary duty of loyalty for providing certain company information to his new employer. The court agreed with plaintiff that as a non-managing member of the manager-managed LLC, he owed no such duty.
Ohio: Dissolution of Limited Partnerships Upon General Partner’s Death (810 Properties VII, LLP v Sukenik)
In this case, an Ohio intermediate appellate court affirmed the trial court’s order dissolving two realty holding limited partnerships. Under the limited partnership agreements, the partnerships were set to terminate in 2005 and 2006, but that did not occur and no issues were raised about their continuation. One of the limited partnership’s two general partners died in 2016. Neither partnership elected to continue the partnerships within 30 days of death as required by the agreements. Two affiliated limited partners later petitioned for dissolution based on the termination dates in the partnership agreements and/or the general partner’s death. The trial court granted the petition, dissolved the partnerships, and appointed a liquidating trustee.
Among the more interesting arguments raised on appeal by the remaining general partner, the appellate court considered whether the plaintiff limited partners lost standing to assert any claims under the partnership agreements because, in 2018, they both converted from a general partnership to a statutory limited liability partnership and, therefore, were not the real parties in interest to the action. By the same logic the appellant contended that the petitioners breached the partnership agreements by failing to seek written permission to “assign” their interests into the newly formed LLPs.
In its opinion handed down last year, after labelling the argument “a bit convoluted,” the appellate court rejected it outright, finding that under the express language of the statutory conversion scheme, the LLP that emerges “continues to be the same entity that existed” before the filing of the conversion statement of qualification. After disposing of the standing argument, the court upheld the lower court’s dissolution order based on the surviving general partner’s failure to elect to continue the partnership within 30 days of the death of the other general partner.
The case went to trial on multiple claims and counterclaims between the plaintiff 25% member and the majority owners of two LLCs that own and operate hotel franchises, including the valuation of the plaintiff’s 25% member’s interests in both. After finding that the plaintiff was not oppressed and was validly expelled, the trial court awarded the member approximately $400,000 for the buyout of his interest in one of the LLCs based on the book value of its assets, and $990,000 for the other LLC calculated as 25% of the LLC’s fair market value after applying marketability and minority discounts. The plaintiff appealed from both valuation awards, contending that the court erred by using book value instead of fair market value for the one LLC, and that the court should not have applied discounts to the fair market value of the other LLC.
In June of this year, the Oregon Court of Appeals rendered a split decision. As to the lesser valued LLC interest, the court affirmed the lower court’s award based on the LLC agreement’s provision for compensating an expelled member, providing that “the assets of the company shall be valued at book value for purposes of this section, and no value shall be attributed to goodwill.” As to the other LLC, however, the court disagreed that marketability and minority discounts should have been allowed, again basing its ruling on the LLC agreement’s provision stating that, upon the LLC’s election to purchase a member’s interest, “the value of the affected member’s interest shall be determined by multiplying the member’s percentage ownership interest by the fair market value of all LLC assets.” As the court explained:
[T]he operating agreement does not provide that plaintiff be compensated for the fair market value of his 25 percent interest. The operating agreement unambiguously required that plaintiff be compensated for his share in the fair market value of all the assets of the LLC, not for the fair market value of his share of the company. The distinction is subtle but significant. Plaintiff’s compensation under the agreement was to be 25 percent of the fair market value of Riddhi’s assets, not the fair market value of his own 25 percent interest. Thus, if, as [the appraiser] Mettler determined, the fair market value of all the assets of Riddhi was $5.5 million, then plaintiff was to be compensated for 25 percent of that amount. There is no basis in the operating agreement for applying discounts to plaintiff’s compensation to reflect that his ownership was a minority interest in a closely held company.
The opinion does not state the combined percentage of the two, disallowed discounts, but I imagine it’s likely between 30% and 50%.