Shareholder agreements for close corporations often include provisions designed to protect the company and its shareholders against involuntary stock transfers or other potentially disruptive court decrees arising from the dissolution of a shareholder’s marriage.  The same holds true for limited liability company (LLC) operating agreements and their members.  Sometimes, as this week’s featured case illustrates, such provisions can backfire when a member’s marital woes coincide with internal disputes among the LLC’s members.

Matter of Madelone (Viscomm Group, LLC), 18 Misc 3d 1131(A) (Sup Ct Albany County 2008), involved an LLC formed in 2003 by three members to engage in advertising and public relations.  Initially, the three members — Whitten, Harrington and Madelone — each held a one-third interest.  Whitten served as manager.  Subsequently, a fourth person was brought in as a 10% member, reducing the others to 30% each.

In 2005, when Whitten was experiencing marital difficulties, he proposed certain amendments to the operating agreement which the membership adopted.  The amendments required a member who files, or whose spouse files, for legal separation or divorce to sell, and the other members to buy, the membership interest of the member involved in the marital proceedings.  The amendments also established a method for computing the purchase price and the payment terms.  The following year, Whitten filed for separation from his wife whereupon he relinquished his position as manager and was appointed to a salaried position with the company, only to be reinstated as a member and manager upon reconciling with his wife.

The reconciliation was short lived.  In May 2007, Whitten re-filed an action for divorce.  In late 2007, Madelone and Harrington executed a document formally removing Whitten as manager and notified him of the purchase price and payment terms for the sale of his membership interest.  However, Whitten refused to acknowledge either the applicability of the mandatory transfer provisions or that he no longer had a vote on company business, and he continued to hold himself out as the company’s manager.  Meanwhile, Harrington switched sides, and he, Whitten and the 10% member prepared to remove Madelone as a member and employee of the LLC, which prompted Madelone to commence an action to enforce the transfer provision triggered by Whitten’s divorce filing.  Madelone’s petition alternatively sought to dissolve the LLC on the ground he was frozen out of the company’s business.  He also alleged that Whitten had taken steps to drive down the LLC’s value in connection with his pending matrimonial litigation.

The issue came before Justice Richard M. Platkin of the Albany County Supreme Court, Commercial Division, on Madelone’s motion for a preliminary injunction to prevent his removal as a member of the LLC, and to enjoin any company transactions except in the normal course of business.  Whitten and the other respondents argued that the parties’ conduct demonstrated that the involuntary transfer provisions were not intended to be self-executing, as evidenced by the other members’ inaction after Whitten’s 2006 divorce filing and for months after his 2007 divorce re-filing.  As to the first filing, Justice Platkin agreed with Madelone that any steps taken by the LLC to effectuate the involuntary transfer provisions were rescinded following Whitten’s withdrawal of that proceeding.  As to the second filing in 2007, Justice Platkin rejected the respondents’ waiver argument, pointing to the express non-waiver provision in the operating agreement which required that any waiver be in a signed writing .  The judge also rejected respondents’ contention that the operating agreement required a member vote to activate the involuntary transfer provision.  Lastly, the judge refused to recognize the validity of a resolution "passed" by Harrington and the 10% member at a member meeting in November 2007, purporting to confirm Whitten’s member status, stating:

The Court cannot accept respondents’ position that the members’ action [at the November 2007 meeting] constituted (or could constitute) a waiver, estoppel or de facto amendment of the operating agreement.  In addition to the "no-waiver" clause (Section 12.5), the Agreement includes "no-estoppel" and "no-amendment" clauses.  . . .  In absence of compliance with such provisions, the Court sees no basis for giving force and effect to the November 20, 2007 resolutions (even assuming they were properly adopted).  Further, respondents’ effort to intentionally estop the company from enforcing the terms of its operating agreement cannot and will not be countenanced by this Court.

Justice Platkin accordingly concluded that Madelone established a likelihood of success with respect to his claim for enforcement of the operating agreement’s involuntary transfer provisions.  He also found that Madelone would be irreparably harmed by the respondents’ plan to terminate his employment and membership interest, and therefore granted the requested preliminary injunction against the LLC acting by and through the respondents.

Query:  Assuming Madelone ultimately obtains a judgment granting specific enforcement of the involuntary transfer by Whitten, what is the remedy if the two respondents other than Whitten either can’t or won’t purchase their pro rata share of Whitten’s membership interest?  Perhaps the operating agreement provides that Madelone has the right to acquire those shares as well.  If not, the more pressing issue may become, can the LLC remain a viable business pending such uncertainties concerning its ownership?