In several shareholder disputes we have handled, the other side has attempted to argue that a shareholder agreement executed years prior by the shareholders, had fallen into disfavor and was not typically followed, such that it had become “unenforceable” because it was “abandoned.” The driver in both cases was the existence of strong non-compete language in the underlying shareholder agreement. Is this a good tactic to take? It depends.
First and foremost, if you are going to argue that an agreement has been abandoned, and you are in a partnership, corporation, or limited liability company, keep in mind that the law will impute terms that must be followed by virtue of applicable default statutes that will apply in the absence of a written agreement. In other words, be sure you are not jumping from the frying pan into the fire, when attempting to avoid a written agreement because you don’t like some of its terms. For example, just because you may defeat a non-compete clause in a written shareholder’s agreement does not mean that you can justify having taken action to divert a corporate opportunity to yourself while still a shareholder.
Proving that your contract was “abandoned” is a large undertaking. An abandonment of contract defense is the equivalent of a “waiver” defense. See County of Morris v. Fauver, 153 N.J. 80, 96 (1998)(expressly recognizing that such a defense is a species of waiver and requires evidence of the “consent of both parties [as well as] clear evidence of the waiver as of the existence of the contract”).
Fauver is the seminal New Jersey case on the issue of abandonment of contract. The case involved a dispute between the County of Morris and the State Department of Corrections (“DOC”). The issue revolved around how much Morris County was entitled, per diem, for housing DOC’s inmates in the Morris County facility. The DOC argued that the parties had “partially abandoned” that provision of the contract over the years by settling on a lower rate, despite the existence of a contract setting forth the rate at which it would pay Morris County to house the inmates.
The New Jersey Supreme Court disagreed, and made it quite clear that the proofs required to establish an abandonment of a contract are quite rigorous, and that there is no such thing as a “partial abandonment” of contract:
“It is well established in this State that, ‘[i]n the absence of some vested derivative interest in another, a contract may be modified, abrogated or rescinded by … the contracting parties.’
However, an abandonment of a contract ‘can only take place by the consent of both parties, ‘and requires as clear evidence of the waiver as of the existence of the contract.’ To effectuate an abandonment, mutual assent is always required. As with the formation of a contract, a proposal to terminate the contract by one party must actually be accepted by the other in order to constitute an abandonment.
The determination of whether contracting parties intend to abandon their agreement need not be express; it may be inferred from all their acts and circumstances. As a general rule, a contract “will be treated as abandoned where one party acts in a manner inconsistent with the existence of the contract and the other party acquiesces in that behavior.’ The intention to abandon a contract by actions or acquiescence, however, must be ‘clearly expressed.’” [(Id. at 95-98)(citations omitted)].
In short, it has long been held that a party in litigation will not be permitted to “repudiate the unfavorable parts of [an agreement] and claim the benefit of the residue.” Magliaro v. Modern Homes, 115 N.J.L. 151, 155 (E. & A. 1935). In considering whether to argue that your shareholder, inter-member, or partnership agreement has been abandoned, you must always consider the consequences of winning, and the high burden needed to get there.
If you have any questions about this blog post, please contact me.