There’s been a recent flurry of courtroom battles over the authority of one 50% owner to engage counsel to represent the company adverse to the other 50% owner in dissolution proceedings or other types of internecine corporate warfare. I’ve previously written about some of these cases, including Sports Legends, Inc. v. Carberry, in which the court dismissed as unauthorized a suit by the corporation initiated by one 50% shareholder against the other for conversion of company assets (read here), and the infinitely fascinating Caplash v. Rochester Oral & Maxillofacial Surgery Associates, LLC, where one 50% LLC member hired company counsel in a multi-faceted litigation with the other 50% member that included dueling dissolution applications (read here and here).
Two new decisions reinforce the general proscription against the hiring and militant alignment of company counsel by one 50% owner against the other. One comes out of the Delaware Court of Chancery, which many — present company excluded, I’m a dyed-in-the-wool New York partisan — consider the premier business law court. The other decision appears to be the final word in the Caplash saga.
The Delaware case, Maitland v. Int’l Registries, LLC, 2008 WL 2440521 (Del. Ch. June 6, 2008), is an action to inspect books and records brought by a 50% member of a member-managed Delaware LLC. The other 50% member hired counsel who filed an answer on the LLC’s behalf opposing the relief. The plaintiff moved to strike the answer and disqualify company counsel.
In his letter ruling granting the plaintiff’s motion, Chancellor William B. Chandler III focuses on the operating agreement’s provision vesting management of the LLC’s affairs in the members by majority rule. So long as the LLC has only two co-equal members, the Chancellor concludes, neither one “can unilaterally control the LLC”. “Where they disagree,” he continues, “the LLC is deadlocked” and a “deadlocked LLC cannot validly retain counsel and file an answer.” Were the rule otherwise, the Chancellor further notes, the court might face the impossible situation of two competing company counsel hired separately by each member.
Does that leave the company defenseless against the plaintiff’s action? Chancellor Chandler deals with this by granting the non-party LLC member leave to intervene as a party defendant with authority to defend on behalf of the LLC. Assuming the non-party member could have intervened in the first place, you might further ask, what’s this skirmish over representation really about? The answer: legal fees. As hinted in the letter ruling, both sides appear to be jousting in an effort to have the LLC foot the bill for their side’s fees (but not the other’s), either in the first instance or by way of indemnification. Footnote 1 of the letter ruling puts this to rest by clearly indicating that, per the so-called American Rule, each side must pay its own legal fees.
When we last visited this case, Monroe County Commercial Division Justice Kenneth R. Fisher issued a mid-trial decision (1) denying Dr. Salahuddin’s summary judgment application to dismiss Dr. Caplash’s request to dissolve the LLC for lack of standing, and (2) dismissing counterclaims against Dr. Caplash filed on behalf of the LLC by a lawyer hired by Dr. Salahuddin. On the first issue, the central inquiry requiring completion of the trial was whether the putative company lawyer was authorized to accept Dr. Caplash’s December 2007 letter resigning from the LLC which, in turn, depended on which of the two doctors held the office of President in the aftermath of a June 2007 member meeting. This issue took on importance because of Justice Fisher’s finding that, under the terms of the operating agreement, the LLC was managed by the President absent a superseding directive by a majority of the members. A secondary issue requiring trial was whether the resignation letter was unequivocal or conditioned on the release of Dr. Caplash from restrictive covenants and, therefore, ineffective because the conditions were not accepted regardless of the lawyer’s authority.
Justice Fisher’s 21-page post-trial decision (20 Misc 3d 1104(A), 2008 NY Slip Op 51216) is characteristically rich with evidentiary detail and analysis. Court opinion junkies will particularly enjoy reading the judge’s descriptions and resolution of the conflicting witness accounts of the June 2007 member meeting, and of the fast-paced procedural ping-pong preceding and post the December 2007 Caplash resignation letter. The court ultimately finds that Dr. Caplash was validly elected President at the June 2007 meeting, hence the putative company lawyer was not authorized to accept the resignation letter, hence Dr. Caplash had standing to file his request for dissolution following the letter, hence the LLC’s dissolution is ordered based on unquestionable, dysfunctional deadlock. Justice Fisher also finds that Dr. Caplash’s resignation letter was conditional on the LLC releasing him from his employment agreement containing restrictive covenants, which release was never accepted. “Any other result,” Justice Fisher writes, “would lead to manifest unfairness.”
Justice Fisher’s opinion cites Chancellor Chandler’s Maitland letter ruling in rejecting Dr. Salahuddin’s contention that, as a 50% member of the LLC, he was authorized to hire company counsel. I don’t think either case would come out differently in a court of either state, but I find interesting the somewhat different approaches taken in the Delaware and New York cases addressing LLC governance. Delaware case law views LLCs as creatures of contract (see, e.g., Fisk Ventures, LLC v. Segal, 2008 WL 1961156 [Del. Ch. May 7, 2008]) and decides governance disputes strictly based on the terms of the operating agreement, as reflected in Maitland. The New York cases, particularly those involving member-managed LLCs, implicitly if not explicitly cut against Delaware’s contractarian approach in the ease and frequency with which they will resolve LLC governance disputes based on equitable, common law principles including the imposition of implied fiduciary duties. Professor Larry Ribstein’s Ideoblog and the Unincorporated Business Law Prof Blog are good places to explore more learned viewpoints on the subject, including Professor Gary Rosin’s recent posting on the Maitland and Caplash cases.