Delaware Court Applies Statute of Frauds to LLC Operating Agreement
Limited liability company statutes in Delaware and a number of other states -- but not New York -- expressly authorize oral operating agreements, as does Section 102(13) of the Revised Uniform Limited Liability Company Act (2006). Most if not all states also have a general statute of frauds that bars enforcement of an agreement that cannot be performed within one year unless it is contained in a writing signed by the party against whom the agreement is to be enforced.
What happens when the two statutes collide? Deciding an issue of first impression, the Delaware Court of Chancery has ruled that the statute of frauds applies to an LLC operating agreement under Delaware law. The court therefore dismissed a lawsuit seeking enforcement of an alleged oral operating agreement the performance of which necessarily extended beyond one year. Olson v. Halvorsen, C.A. No. 1884-VCL (Del. Ch. Oct. 22, 2008). Click here to read the decision.
The decisive facts in Olson were largely undisputed. In 1999 the parties founded a hedge fund known as Viking Global. The ownership and administrative structure comprised a Delaware limited partnership and three Delaware LLCs. The plaintiff, Olson, held a 22.5% interest. Short-form operating agreements were signed for the LP and LLCs #1 and #2. Long-form operating agreements for those three entities also were drafted (only one of them was signed), each of which provided that a partner or member who leaves Viking is only entitled to his capital account balance and compensation owed.
LLC #3 had a draft, unsigned long-form operating agreement with an earnout provision not included in any of the other operating agreements. The earnout gave a member varying percentages of the LLC's income over the six years following retirement. The unsigned agreement also contained provisions requiring the remaining members to adjust the profit percentage of the retiring member so as to maintain his economic interest; preventing the remaining members from taking any action to reduce the retiring member's interest; and restricting the remaining members' right to reduce their investments below a specified level.
Continue Reading...Terminated Member of Professional Corporation is Not Entitled to Statutory Stock Redemption
Professional service corporations are "interesting" and "strange creatures". So says Nassau County Commercial Division Justice Ira B. Warshawsky in an interesting (but not strange) post-trial decision issued last month, rejecting a claim for statutory buyout in a suit brought by a terminated partner in a law firm organized as a professional corporation.
The case is Lubov v. Welikson, 2008 NY Slip Op 28392 (Sup Ct Nassau County Sept. 29, 2008). You can read the decision here. Additional background is found in the court's January 2008 decision denying summary judgment motions (read here).
The law firm in Lubov initially was organized in 1989 as a general partnership. In 1993 it converted to a professional service corporation ("P.C.") under Article 15 of the Business Corporation Law. P.C.s are a popular form of limited liability entity eligible for partnership tax treatment, available to lawyers, doctors, accountants and other regulated professions.
The plaintiff alleged that prior to the firm's conversion to a P.C. the partners made an agreement to redeem the interest of a withdrawing partner for the sum of the partner's capital contribution and percentage of accounts receivable. Plaintiff also alleged that the shareholders nee partners of the P.C. adopted the same agreement.
Plaintiff's percentage interest in the P.C. started at 30%. In 1994 he voluntarily surrendered half his interest at the same time he began working fewer days and pursued other personal business affairs. At the time, he allegedly asked about redemption of the surrendered shares, but supposedly was put off by the majority shareholder. Plaintiff's percentage interest rose to 16% in 1997 when another 10% shareholder left the firm.
Continue Reading...Delaware Court of Chancery Narrowly Construes LLC Dissolution Statute
When it comes to rulings by its Court of Chancery, what happens in Delaware definitely does not stay in Delaware.
Each year Delaware breeds for export thousands of corporations, LLCs and limited partnerships. Many of those Delaware entities have their principal place of business in New York; their internal affairs, when adjudicated by New York courts, are governed by Delaware statute and case law. In addition, the unsurpassed quality, scholarship and keen attention to precedent that characterize Chancery Court decisions make them a powerful guiding force in the judicial formulation nationwide of domestic business laws and policy.
All that being said, as I've commented before, one area of growing divergence between Delaware and New York law has been in the areas of LLC governance and judicial dissolution. The Delaware Chancery Court's pronouncements strongly emphasize the members' virtually unfettered contractual freedom to order their own relationships in the operating agreement, including enforcement of fiduciary outs and judicial dissolution waivers, and the Court's concomitant aversion to judicial intervention. In contrast, New York courts by and large have not hesitated to impose fiduciary obligations on LLC managers and to import dissolution principles developed in the context of shareholder corporation breakups.
Case in point: In re Seneca Investments, LLC, 2008 WL 4329230 (Del. Ch. Sept. 23, 2008) (read decision here), in which the Delaware Chancery Court recently dismissed a petition to dissolve a Delaware LLC brought by a minority member who'd been removed from his management positions by the majority. This is one of the few cases construing Delaware's LLC dissolution statute, and the result stands as a warning to any minority member who does not bargain for status protection and/or fair exit mechanisms in the operating agreement.
Continue Reading...Certified Partisan Accountant? Court Allows LLC Member's Suit Against Company's CPA, Alleging Improper Assistance to Other Member in Judicial Dissolution Proceeding
Judicial dissolution proceedings have spawned legal malpractice cases; I once testified as an expert witness in such a case. Likely there have been accountant malpractice cases as well, brought by company owners disappointed with their own accountant's advice in connection with buyout negotiations or judicial valuation proceedings.
But until Anda Management, LLC v. Needlemen & Schacter, LLP, 2008 NY Slip Op 31534(U) (Sup Ct Nassau County May 20, 2008) (read decision here), I'd never heard of spin-off litigation involving charges against a professional for improperly taking sides in the underlying dissolution case.
Here's what happened: Anda Management and Wilmington Paper Corp. formed a Delaware LLC called Worldwide Fibers to market paper products overseas. Worldwide retained the defendant accounting firm as its accountant without a written agreement. Three years later, Worldwide's principals had a falling out, prompting Wilmington to file a proceeding for judicial dissolution of Worldwide in Delaware Chancery Court. Wilmington accused Anda's principals of impermissibly withdrawing funds from Worldwide for personal reasons and then falsely booking them as legitimate business expenses.
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