Business Owner Rights
Lessons in Handling a Partnership Dispute or Other Business Divorce
Published Date: June 20, 2022
Since handling a partnership dispute is complicated, I’ve written before on a number of important topics. For example, having a strong operating agreement for a limited liability company. Similarly, having a strong partnership agreement. In these agreements, you must consider alternative dispute resolution (“ADR”) provisions. These factors help formulate a well-thought out strategy before embarking on litigation.
On April 7, 2020, a legal odyssey in a case styled Gastelu v. Martin came to an end with a final decision. The New Jersey Appellate Division ended the case. However, in its wake, lessons abound for anyone who may find themselves locked out of an LLC or in a dispute with a partner.
The Gastelu case stems from an LLC formed between a New York attorney (Martin), his cousin and a third member. The purpose of the LLC was to operate a bar (“Aqua Lounge”) in Asbury Park, New Jersey.
Partnership Dispute Lesson #1
The first lesson from Gastelu is the need for a strong ADR provision, or none at all. The members of Aqua Lounge formed the entity. They entered into an LLC Operating Agreement that was allegedly drafted by Martin, the New York attorney. The LLC agreement had a rather loose ADR clause which arguably gave an option between mediation and arbitration:
Disagreement among the Members shall be resolved by mediation or arbitration. The Members shall first attempt to resolve their differences with the assistance of counsel and the Managing Member. If they are unable to do so then the LLC shall retain the services of a mediator or the American Arbitration Association, Monmouth County, New Jersey.
The impact of this poor arbitration clause was that a dispute erupted immediately over whether the claims were even arbitrable. This cost the parties dearly, resulting in multiple motions and an appeal. All of which was likely expensive and time-consuming. In the end, the Appellate Division ruled that the dispute between the members of the LLC was subject to arbitration. However, not subject to arbitration were the legal malpractice claims against Martin and his law firm. Plaintiff’s counsel included these claims in his lawsuit.
You can see how, in some cases, a poorly drafted ADR clause causes mischief and delay. Unfortunately, some defendants play this game. They wear down their partner or co-member through litigation.
For those with a poorly drafted ADR clause and a dispute with a partner or co-member, it may be beneficial to simply stay in Court and not try to go the arbitration route. This can help avoid unnecessary litigation costs when your adversary refuses to honor the ADR clause.
Partnership Dispute Lessons #2 & #3
The inter-member dispute in question resulted in two separate appeals. Largely, over whether distinct claims against Martin and his law firm for malpractice should be included within the arbitration. Also, the viability of those claims. This points to the second and third lessons from Gastelu to be applied in handling a partnership dispute.
Partnership Dispute Lesson #2
Professional, such as lawyers, accountants, and engineer, must use caution when entering into an LLC or partnership with others. Failure to do so can lead to exposure to claims of professional malpractice. Therefore, agreements must clearly define the scope of services that the professional provides to the new entity. Likewise, be sure to comply with all ethical requirements (such as signed waivers from the co-members if you are an attorney entering into business with a client).
Partnership Dispute Lesson #3
This lesson is for the plaintiff contemplating suit against co-members and/or fellow partners for breach of fiduciary duty. You must carefully plan your strategy and the type of claims you are making. Likewise, have an understanding as to the potential success of those claims before you make them. Additional claims may be a lighting rod for motion practice. This has the potential to bog down the litigation with nominal chance of success. Overall, this may not be the right strategy for you.
If you are contemplating a lawsuit against your co-members or co-shareholders, you should carefully look at the governing documents including shareholder agreements, operating agreements and others. Then, consider the pros and cons of arbitrating your dispute, and plans for making all appropriate claims. If not done at the inception of the dispute, you risk a finding of waiver of those provisions. Thus, ending up in endless motion practice and appeals.
Please contact me for help handling a partnership dispute, or with other business owner issues.