When establishing a business with partners, sometimes family or friends, the termination or deconstruction of the business is often not a primary area of focus. However, business relationships or associations sometimes encounter disputes or do not work out for any number of reasons. When that occurs, the members of the business are often so at odds that agreeing on a path forward is not possible. In New Jersey, if the business entity is a limited liability company (“LLC”), the New Jersey Revised Uniform Limited Liability Company Act (“RULLCA”), N.J.S.A. 42:2C-1 et seq., or its predecessor statute, governs the members and the LLC’s options in terms of resolving the dispute.
In 2014, RULLCA went into effect. RULLCA implemented numerous changes from the statute governing LLCs that preceded it, the New Jersey Limited Liability Company Act. This post will look at two aspects of RULLCA relating to disputes between LLC members: shareholder oppression and disassociation.
Before RULLCA, members of LLCs that were being oppressed by fellow members did not have the same recourse available to minority shareholders of closely held corporations. Such shareholders could force the dissolution of the corporation or pursue other remedies if those in control of the corporation acted fraudulently or illegally, or otherwise mismanaged the corporation or acted unfairly toward a minority shareholder. N.J.S.A. 14A: 12-7(1)(c); Brenner v. Berkowitz, 134 N.J. 488, 506 (1993). Some examples of oppression include majority shareholders awarding themselves excessive compensation, furnishing inadequate dividends, or misapplying and wasting corporate funds. Muellenberg v. Bikon Corp., 143 N.J. 168, 179 (1996).
Since the enactment of RULLCA, oppressed members of LLCs have rights similar to those of shareholders in close corporations. Oppressed members can now seek the dissolution of the LLC, the appointment of a custodian for the LLC and other remedies. N.J.S.A. 42:2C-48.
Another option offered by RULLCA to members of an LLC in the event of a dispute is referred to as dissociation or disassociation. Disassociation means that a member can be forced out or removed from the LLC without dissolving or terminating the LLC. In other words, a business can survive and continue even after the removal of the disassociated member.
Disassociation can occur in a variety of ways, even where no conflict or dispute exists. N.J.S.A. 42:2C-46. RULLCA provides for a number of factual circumstances that cause disassociation. A member can also agree to disassociate and can become disassociated pursuant to the terms of the LLC’s operating agreement.
Where there is a conflict or dispute, a member can also be forced to disassociate if a Court grants the business’s request for an order expelling a member. Such forced disassociation requires the business to show that the person being expelled:
(1) has engaged, or is engaging, in wrongful conduct that has adversely and materially affected, or will adversely and materially affect, the company's activities;
(2) has willfully or persistently committed, or is willfully and persistently committing, a material breach of the operating agreement or the person's duties or obligations under section 39 of this act; or
(3) has engaged, or is engaging, in conduct relating to the company's activities which makes it not reasonably practicable to carry on the activities with the person as a member;
N.J.S.A. 42:2C-46(e). It is important to keep in mind that if a disassociation suit is filed, the member whose expulsion is being sought not only has the right to oppose the suit, but can also seek the dissolution of the LLC in place of disassociation.
To determine that the remedy of disassociation or expulsion is appropriate a court must evaluate the LLC member’s conduct relating to the LLC. A court must also assess whether the LLC can be managed notwithstanding that conduct given the terms of the LLC’s operating agreement or the default provisions of RULLCA. According to the New Jersey Supreme Court, proving that expulsion is appropriate requires clearance of “a high bar.” IE Test, LLC v. Carroll, Docket No. A-63-075842 (2016). The New Jersey Supreme Court has directed lower courts to engage in a case specific analysis and consider a variety of factors when considering disassociation, including:
(1) the nature of the LLC member's conduct relating to the LLC's business;
(2) whether, with the LLC member remaining a member, the entity may be managed so as to promote the purposes for which it was formed;
(3) whether the dispute among the LLC members precludes them from working with one another to pursue the LLC's goals;
(4) whether there is a deadlock among the members;
(5) whether, despite that deadlock, members can make decisions on the management of the company, pursuant to the operating agreement or in accordance with applicable statutory provisions;
(6) whether, due to the LLC's financial position, there is still a business to operate; and
(7) whether continuing the LLC, with the LLC member remaining a member, is financially feasible.
Even when a court has determined that disassociation is appropriate and orders expulsion, that does not mean the expelled person automatically ceases to have any connection to the business. N.J.S.A. 42:2C-47. Although the disassociated person’s right to participate as a member in the management and conduct of the company terminates, the person continues to have fiduciary duties to the company and remains responsible for any debts already owed to the business. In addition, the expelled member continues to own their interest in the LLC until and unless that interest is sold. When a court expels a member from a company under RUCCLA, the court can choose to force the sale of the expelled member’s ownership interest in the business.
The best way to avoid becoming embroiled in a lawsuit involving dissolution, disassociation or oppression is by starting out with a detailed operating agreement that addresses all of the obligations and rights of members of an LLC at the time the LLC is established. Nonetheless, sometimes even the best planning cannot anticipate a conflict years down the road and litigation can become unavoidable.
The New Jersey business lawyers at the Law Office of Bart J. Klein advise clients on issues relating to New Jersey business formation and in a broad range of commercial disputes. We welcome you to call us at (973) 763-6060, email email@example.com, or complete our online contact form for more information.
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