Tag Archives: LLC

New Act Will Apply to All Limited Liability Companies – Part Three

By Bruce Ackerman, Esq.
backerman@pashmanstein.com

New Jersey’s new law affecting every limited liability company (“LLC”) is the Revised Uniform Limited Liability Company Act (“RULLCA”), which took effect September 19, 2012.  RULLCA controls all LLC’s formed on or after March 18, 2013, and all LLC’s regardless of when formed as of March 19, 2014.  This final part of three parts explaining elements of RULLCA will address the following areas which have changed in the new Act — distributions, resignation and withdrawal, and the rights of members to information.

As to distributions, the old LLC law provides that, unless the operating agreement provides otherwise, distributions are to be made based on “the agreed value … of the contributions made by each member.”  Again highlighting the importance of the operating agreement, RULLCA provides that distributions prior to dissolution or winding up are to be “in equal shares among members and dissociated members.”  That is contrary to the ordinary agreement by members, which would provide for distributions by their percentage of ownership.  The parties must have their operating agreement set forth the terms of their agreement as to distributions.

As to resignation of a member and the right to any payment or “distribution” upon such withdrawal, the old LLC law provides for six months’ notice to withdraw and the payment of any distribution provided under the operating agreement or, if not provided, then payment of fair value for the interest held, less all applicable discounts.  In contrast, under RULLCA, a member may withdraw at any time, and there is no entitlement to any distribution upon withdrawal.  Of course, the members themselves may agree otherwise and set forth that entitlement within their operating agreement.

Finally, under the old LLC law in New Jersey, each member is entitled to receive information on the business and financial condition of the company, tax returns, member addresses, the operating agreement itself, and the value of cash and other assets held by the LLC.  The manager may maintain the information in confidence for such time as reasonably believed necessary to maintain trade secrets or other information the disclosure of which is believed not in the best interests of the LLC or required by a third party to keep confidential.

In contrast, RULLCA sets forth a procedure and time in which to secure LLC documents.  In general, RULLCA provides that the LLC shall furnish to each member any information concerning the company‘s activities, financial and other wise, that is material to the member pursuant to its operating agreement and, on demand, any other information.  Each member has that duty to provide information as well.  However, in a manager managed LLC, this information shall be provided by the manager if sought by the member for a “a purpose material to the member’s interest as a member,” and the member must make a written demand “describing with reasonable particularity the information sought and the purpose for seeking the information.”  The law provides a ten day period for the LLC to respond and inform the member when and where the LLC will provide the information and, if declined, the reasons why the information will not be provided.

As shown, a careful review of your current operating agreement should be made and appropriate changes and supplements to address those areas under RULLCA that leave to the members in their operating agreement to clarify and change what RULLCA provides.  With the March deadline looming for the RULLCA to apply to all LLC’s in New Jersey, it is important to make that review and update soon.

New Act Will Apply to All Limited Liability Companies – Part Two

By Bruce Ackerman, Esq.
backerman@pashmanstein.com

Link to Part One

New Jersey’s new law affecting every limited liability company (“LLC”) is the Revised Uniform Limited Liability Company Act (“RULLCA”), which took effect September 19, 2012.  This Part Two will address several major changes in the new Act, which controls all LLC’s formed on or after March 18, 2013, and all LLC’s regardless of when formed as of March 19, 2014.

Under the earlier law, the member’s rights to manage were “in proportion to the then current percentage or other interest of members in the profits of the LLC,” with the decision of the members owning more than 50% controlling.  In contrast, RULLCA provides that the members have “equal rights in the management and conduct of the company’s activities” and that a difference among the members in the ordinary course is decided by “a majority of the members” (not by majority percentage of ownership).  However, an act outside the ordinary course of the LLC’s activities can only be taken with the consent of all members.  Naturally, there is no definition of what is “ordinary course.”  The operating agreement can address decision making as well as the definition of “ordinary course,” to avoid or lessen later disputes, again highlighting the greater importance of addressing all issues in an integrated document defining the members’ rights.

As to the effect of the operating agreement, in the old LLC Act, the effect of the agreement upon a member was left to having a provision in the agreement that provides either that the member signs the operating agreement or another agreement showing the intent to become a member, or, failing such signature, if the member meets the conditions to become a member as provided in the operating agreement.  In contrast, under RULLCA, “[a] person that becomes a member of a limited liability company is deemed to assent to the operating agreement.”  Again, RULLCA emphasizes the importance of a properly fashioned operating agreement.

In New Jersey’s earlier LLC law, each member was, in effect, an agent of the LLC having the authority to bind the company.  In contrast, under RULLCA a member is specifically not an agent of the LLC just by being a member.  Instead, the law of agency applies, such as actual and apparent authority.  Finally, the LLC has the option to file with the State a certificate of authority designating individuals that can act and bind the LLC as well as the limitations on acting for the LLC.

The final subject for this Part II is the allocation of profits and losses.  Under the former LLC Act, either the operating agreement dictated the allocation of profits and losses, or the law took over and dictated that they would be divided by “the agreed value … of the contributions made by each member.”  However, under RULLCA, there is no provision to allocate profits and losses among the members.  Therefore, the operating agreement must address the issue.

In Part Three of this discussion, we will address the treatment of members under the old and new law in regard to the treatment of members as to each other, the payment of distributions and how members withdraw from an LLC or are removed as members.

Link to Part Three

Disassociation of LLC Member

By David White, Esq.
dwhite@pashmanstein.com

The Appellate Division recently construed the disassociation provisions of the LLC Act in a way that ostensibly eliminates the need for fault to expel a member.  In All Saints University of Medicine Aruba v. Chilana, 2012 N.J. Super. Unpub. LEXIS 2797  (2012), the Court held that judicial disassociation under N.J.S.A. 42:2B-24 b (3) may be granted, without more, where the member ‘s business conduct makes the prospect of continuing the LLC’s activities reasonably impractical.

In All Saints, plaintiffs and defendants formed a New Jersey LLC in connection with their operation of a medical school in Aruba.  Disputes arose among the members over financial issues and management of the company, including signing authority for checking accounts.  Plaintiffs’ complaints about the signatories resulted in the company’s  banks freezing its accounts.  Inability to access the accounts aggravated the already dire financial status of the medical school and threatened its operation.  The answering Defendant elicited capital contributions from the other members to continue the operation.  Plaintiffs declined to contribute and brought an order to show cause seeking relief for breaches of the Operating Agreement.  Defendant counterclaimed seeking authorization to operate the LLC unilaterally.  While the matter proceeded, defendant funded the company and sought to judicially disassociate plaintiffs from the LLC.

N.J.S.A. 42:2B-24(b) controls judicial disassociation of LLC members.  Sub section (3) (a) provides for expulsion where the member “engaged in wrongful conduct that adversely and materially affected the limited liability company’s business.”   Sub section (3)(c) permits expulsion where the member’s business related conduct “makes it not reasonably practicable to carry on the business with the member as a member of the limited liability company.”

The trial court determined that plaintiffs’ conduct met both tests, finding that it was wrongful under sub section (3)(a) and, under sub section (3)(c ), that it made impractical carrying on the business together.

On appeal, the Appellate Division observed that the statutory grounds were expressed disjunctively.  It further noted that N.J.S.A. 42:2B-24 uses the generally mandatory verb, “shall,” in providing for disassociation on the occurrence of one of the specified bases.  Accordingly, it found that either basis would suffice, calling them “equally dispositive.”

While the decision sidesteps whether the fault alleged against plaintiffs was “wrongful,” it carefully notes “the reality” of the adverse consequences.  The court limited its holding “to the facts of this rather unusual case.”  Notwithstanding the apparent equation of the wrongfulness and impracticality grounds for disassociation here, the sub-text of the Appellate decision suggests that in general, fault remains at least a background factor.

The Revised Limited Liability Company Act Creates a Statutory Remedy for Oppression of Minority Members

By David White, Esq.
dwhite@pashmanstein.com

The Revised Uniform Limited Liability Company Act (“RULLCA”), enacted on September 19, 2012, creates a statutory remedy for oppression of minority members in New Jersey limited liability companies. P.L. 2012, c. 50. The remedy parallels the relief provided to shareholders in close corporations under the Oppressed Shareholder Act (the “OSA”), N.J.S.A. 14A:12-7(1)(c),  with two slight textual differences requiring harm from oppression and an enhanced standard for an award of attorneys’ fees.

The Limited Liability Act (the “LLCA”) was silent on minority oppression.  N.J.S.A. 42:2B-1 et seq. Under the LLCA, any member of an LLC could resign and have his interest bought out.  N.J.S.A. 42:2B-24.  The LLCA provides that the resigning member’s interest is to be valued at “fair value less all applicable valuation discounts…” N.J.S.A. 42:2B-39.  The standard of valuation for an oppressed shareholder’s interest under the OSA, in contrast, is fair value without discounts.  Balsamedes v. Protameen Chems., Inc., 160 N.J. 352, 368 (1999); but see, Denike v. Cupo, 394  N.J. Super. 357 (App. Div. 2007) (disassociated member’s interests in an LLC valued without marketability or minority discounts).

As a result, courts addressing oppression of LLC members previously fashioned remedies by analogy to the OSA.  See, eg. Denike v. Cupo, 394 N.J. 357.  Without an explicit statutory remedy, however, some courts were reluctant to craft minority-oppression relief in LLCs. See, Hopkins v. Duckett, 2012 N.J. Super. Unpub. LEXIS 93, at *33.

RULLCA provides that Courts may grant various forms of relief where the managers or those in control of the company “have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant.” 2012 Bill text N.J.A.B. 1543, Art. 7, Section. 48(5) (b) (Dissolution and Winding Up).  Oppression provides grounds for ordering the sale of a member’s interests to the company or another member, as well as  dissolution of the company or appointment of a custodian or provisional managers. Id. at Article 7, Section 48 (b)

The Oppressed Shareholder Act, N.J.S.A. 14A:12-7(1) (c) provides:

The Superior Court, in an action brought under this section, may appoint a custodian, appoint a provisional director, order a sale of the corporation’s stock as provided below, or enter a judgment dissolving the corporation, upon proof that [,in] the case of a corporation having 25 or less shareholders, the directors or those in control have acted fraudulently or illegally, mismanaged the corporation, or abused their authority as officers or directors or have acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees.

The definitions of oppression in RULLCA and OSA differ slightly.  Under the OSA, oppression is a per se violation that exists, even without damages.  RULLCA, however, requires a showing of direct harm, in addition to oppressive conduct by the controlling members.

The two acts also differ with respect to awarding counsel fees.  Under the OSA, a court may award attorneys’ fees in its discretion where the award “would be fair and equitable to all parties under all the circumstances of the case.” Id.  Awarding attorney’s fees under RULLCA remains discretionary but also requires a finding that the losing party acted “vexaciously, or otherwise in not good faith.” RULLCA  Art. 7,,Section 48(c).

RULLCA takes effect six months after enactment but does not generally apply to existing LLCs until eighteen months after its effective date. RULLCA , Art.11, Sections 96 and 91.

Where You Incorporate Your LLC Matters

By Adam Schwartz, Esq.
aschwartz@pashmanstein.com

Popular convention is to incorporate in Delaware, even if a company conducts no business there.  Due to its business-friendly regulatory environment and large body of case law regarding corporate management issues, over 900,000 business entities have incorporated in Delaware.  However, if you are minority owner of a closely-held company with its principal place of business in New Jersey, you may not want to follow popular convention.

New Jersey has enacted a Minority Oppression Statute, N.J.S.A. 14A:12-7(c), which provides a range of remedies for minority owners in closely held corporations when the majority has acted to defeat the “reasonable expectations” of the minority owner or has otherwise acted fraudulently, illegally or oppressively toward the minority.  The potential remedies include the appointment of a custodian or provisional director to manage the company, ordering the corporation to purchase the minority shareholder’s interest, or dissolving the corporation.

Delaware, however, does not have a corollary to the Oppressed Shareholder Statute, and its courts have not recognized any common law remedy for minority shareholder oppression.  Under Delaware law, a minority stockholder must protect him or herself by bargaining for any such protection.  If there is no contractual provision for a buyout or the appointment of a custodian or director, a Delaware court will not imply one.  In short, New Jersey law is for more favorable for a minority shareholder.

This difference is important because, when a lawsuit involves the internal affairs of a corporation, New Jersey courts will apply the law of the state of incorporation.  Therefore, even if a company’s business is conducted solely within New Jersey, if it is incorporated in Delaware, Delaware law ordinarily governs shareholder and management disputes.  This results in a distinct disadvantage for the minority shareholder.

In 2008, the New Jersey Appellate Division found an exception to this general rule. Kraszteck v. Global Resource Industrial & Power, Inc., 2008 N.J. Super. Unpub Lexis 1360 (App. Div. 2008).  In that case, the Court recognized that “the location of incorporation is not always dispositive” and that New Jersey courts may apply the law of the state with the greatest interest in resolving the dispute.  Specifically, the Kraszteck Court noted that, for claims of minority oppression, when the company is headquartered in New Jersey and has no other connection to the state of incorporation, New Jersey the greater interest and its law applies.

However, in 2012, another Appellate Division matter, Hopkins v. Duckett, 2012 N.J. Unpub Lexis 93 (App. Div. 2012), arguably reached a different conclusion than the Kraszteck court.  In Hopkins, Appellate Division held that, even though the company had no connection with Delaware other than the fact that it was incorporated there, Delaware law applied the plaintiff’s minority oppression claims because “the [shareholders] freely entered into an operating agreement that they explicitly provided was to be governed by Delaware law” and the disputes at issue arose out of that agreement.  Consequently, the minority shareholder was not entitled to the protection of New Jersey’s Oppressed Shareholder Act.

In light of these seemingly divergent decisions, the question still remains — will New Jersey’s Oppressed Shareholder Act apply to business entities incorporated in Delaware with their principal offices in New Jersey?  Although subsequent cases may eventually follow Kraszteck, until there is a decision from New Jersey Supreme Court reconciling Kraszteck and Hopkins, the safer course of action for a minority shareholder concerned about majority management of a closely-held company would be to incorporate in New Jersey, instead of Delaware.