In my prior blogs, I have addressed the importance of having an operating agreement for any business owner. Most importantly, for those operating as a limited liability company. I have also covered legislative changes in New Jersey with the adoption of the Revised Uniform Limited Liability Company Act.
All Saints Case
An Appellate Division decision in New Jersey, All Saints University of Medicine Aruba v. Chilana, highlights the intricacies in the law for inter-member disputes and the importance of having a clear operating agreement. Certainly, this is particularly so with the adoption of the Revised LLC Act. The decision provides guidance on the type of conduct that will cause a court to allow a forced dissociation with the business. In this case there was a failure to advance working capital and interruption with business operations. The case also clarifies that a forced sale of the dissociated member’s shares is not permitted under the existing LLC Act.
All Saints involves the “judicial dissociation” of two shareholders in a New Jersey limited liability company, ASUMA, LLC, through a final order expelling them from further involvement in the LLC’s business. The founding members sought and obtained a financial infusion by a New Jersey resident who acquired a minority interest in the company. Meanwhile, the school developed financial and other problems. After that, litigation over the entity’s operations ensued in the Bergen County Chancery Division involving the LLC’s four shareholders. The plaintiffs were Joshua Yusuf and Richmond Paulpillai. On the other side, the defendants were Gurmit Singh Chilana and Peter Silberie. In the course of the litigation, the court appointed a fiscal agent for the school.
Following a bench trial, the Chancery judge ordered the expulsion of Yusuf and Paulpillai from the LLC. The court found that they had engaged in conduct authorizing such judicial dissociation. Subsequently, Yusuf appealed various rulings below, including the trial court’s determination that the value of his interest need be arrived at as part of a forced sale, and the determination that he had engaged in conduct authorizing dissociation.
On appeal, the appellate panel affirmed the trial court’s final judgment ordering plaintiffs’ dissociation from the LLC based solely upon subsection 3(c) of the statute, which pertains where a member engaged in “conduct relating to the [LLC’s] business which makes it not reasonably practicable to carry on the business . . . as a member of the [LLC].” The trial court had looked to the LLC Act for grounds of dissociation since the parties’ operating agreement failed to speak to that issue. As grounds for dissociation, the Appellate Division found persuasive the failure of the two shareholders to advance working capital, causing the medical school to have significant financial problems, and the actions of the shareholders in causing a deadlock over the company’s financial accounts which led banks to freeze company accounts.
However, the court did take issue with the trial judge’s determination that N.J.S.A. § 42:2B-24(b) compels the sale of the shares of a dissociated member. Therefore, the court remanded the matter for further proceedings below on that issue. The court observed that the parties’ operating agreement spoke to the issue, stating that no shareholder could be “compelled to give up or sell [his] shares for any reason.” Lastly, the All Saints case does provide some guidance on the expert proofs needed in determining value of shares in an inter-member dispute.
Revised LLC Act
In September 2012, New Jersey enacted the Revised LLC Act, which replaced the statute governing New Jersey limited liability companies. The bill filled in gaps to preexisting New Jersey law. Additionally, the bill updated existing law that had become outdated and contains a number of very important changes from the existing law. Above all, members of New Jersey LLC’s, and those wishing to form LLC’s in New Jersey, need to fully understand the LLC law.
The Revised LLC Act went into effect in February 2013 for all new companies formed after that date. Likewise, it applied to all LLCs, whenever formed starting in February 2014.
Know the Law
Members of companies that are currently operating in the form of an LLC should know the law. Consequently, the law dictates the way an LLC operates and how to resolve inter-member disputes. We generally view the Revised LLC Act favorably as a business-friendly. That said, the law contained significant changes that could be a trap for the unwary. For example, it includes a provision dealing with the precise issue of a forced sale/buyouts:
“A court that expels a member from a company pursuant to subsection e. of section 46 of this act may order the sale of the interests held by such person immediately before dissociation to either the company or to any other persons who are parties to the action if the court determines, in its discretion, that such an order is required by any other law, rule or regulation, or that such an order would be fair and equitable to all parties under all of the circumstances of the case.”
All Saints and the LLC law both highlight the importance of drafting a written operating agreement for any business. An effective operating agreement can to avoid prolonged and expensive litigation in the event of member discord and management issues.
Our team is available to counsel your business in these areas. As a result, we can help you adopt a written operating agreement. Additionally, we provide counsel with respect to any inter-member disputes or litigation. For more information, please contact me.