Last week I wrote about a pair of decisions by a Manhattan trial judge and the Delaware Chancery Court concerning LLC member access to books and records (read here). This post presents another twofer of recent decisions by the same courts on a different subject: disputes between accounting firms and retiring partners over the interpretation of agreements governing the firms’ buyout obligations.
In the New York case, the court in a multi-faceted ruling held that the accounting firm’s contractual obligation to make retirement payments to the former partner was independent of the former partner’s contractual obligation to compensate the firm for client business that followed him to a new firm. In the Delaware case, the court held that the retired member of an accounting firm organized as an LLC was entitled to his pro rata share of the firm’s liquidation value and not "fair value" under the Delaware LLC Act’s default rule.
Phillips involves a three-partner accounting firm organized as a New York limited liability partnership. In 2006, the three began planning for the retirement of defendant Herbert Speiser to take effect at the end of 2007 upon his reaching age 65. The partnership agreement contains a comprehensive formula for calculation of retirement benefits and payment terms. The agreement also states that if post-retirement the partner provides accounting services to a partnership client, either on his own or with another firm, he must pay the partnership a "Withdrawal Obligation" computed as a fixed percentage of the client billings over the preceding three years.
The agreement contains two other provisions critical to the lawsuit. One states that if the partnership fails to make installment payments to the retired partner for six months, the entire amount due the retired partner accelerates and becomes due and payable as a lump sum. Another authorizes the partnership to offset estimated Withdrawal Obligation payments by the retired partner against amounts due the retired partner.
Difficulties began even before Speiser’s retirement at year-end 2007, including an aborted effort by the two remaining partners to dissolve the partnership. In 2008, after Speiser retired, the partnership filed an action against Speiser accusing him of soliciting firm clients and employees even before he left the firm, and of breaching an oral agreement to help transition the firm clients that he handled. The partnership also claimed that Speiser’s failure to pay his Withdrawal Obligation, which it calculated to be $688,000 on account of the clients Speiser took with him, relieved it of its obligation to pay retirement benefits which Speiser calculated to be in excess of $1.4 million.
Speiser countered that, based on correspondence from the partnership in February 2008, the partnership "elected" to offset Speiser’s entire Withdrawal Obligation against the entire amount of retirement payments due Speiser, thus rendering the partnership presently liable for the entire differential based on the partnership’s failure to make payments to him over six months.
Speiser moved for summary judgment dismissing the partnership’s claims against him and in his favor on his counterclaims. The partnership cross moved for summary judgment in its favor. The court’s decision (read here), by Manhattan Supreme Court Justice Judith J. Gische, denied all of the parties’ motions with the exception of granting summary judgment of liability for Speiser on a collateral claim for compensation due him for the period prior to his retirement.
Justice Gische rejects Speiser’s reliance on the partnership’s supposed "election" to offset the entire Withdrawal Obligation against the entire retirement payment obligation. Here’s what she says:
Nothing in the partnership [agreement] limits the plaintiffs to having to make a one time, binding and unchangeable election to offset the Withdrawal Obligation against any amount due the Withdrawing Partner. Even if, as Speiser claims, the plaintiffs offset the Withdrawal Obligation against the monies to be paid to Speiser, the correspondence contains statements of account only through March 1, 2008. The letter does not elect to make these offsets indefinitely, on an ongoing basis. Furthermore, had it been the parties’ intention that once the plaintiffs elect to offset these monies one against another any such election is irrevocable, then such language would have been included in the Partnership Agreement [citation omitted]. There being no such condition in the Partnership Agreement, plaintiffs have raised a triable issue of fact regarding whether they elected to offset monies and whether it was a one time or ongoing basis.
Justice Gische likewise rejects the partnership’s argument that Speiser’s failure to pay his entire $688,000 Withdrawal Obligation is a material breach relieving it of its obligation to pay Speiser post-retirement benefits, reasoning as follows:
This claim is supported by arguments that if a retiring partner services firm clients after he leaves (i.e. takes business) but does not pay his withdrawing obligation, Firm billables decrease and the Firm cannot afford to pay him Post-Retirement benefits. While this may be the practical effect of a retiring partner not paying his Withdrawal Obligation, it is clear from the Partnership Agreement that the obligation to pay Post-Retirement benefits is separate from the retiring partner’s obligation to pay the Withdrawal Obligation. Therefore, Speiser’s breach, if any, in paying the Withdrawal Obligation does not relieve the Firm’s own, separate, obligation to pay the Post-Retirement benefits.
The decision also notes the parties’ disagreements over the calculations of the Withdrawal Obligation and the post-retirement benefits.
According to the court’s website, the case is set for mediation next month.
Showell also involves a three-partner accounting firm, organized as a Delaware LLC, in which the petitioner, Glenn Showell, held a 29% interest. In early 2007, Showell and partner William Pusey, who held a 61% interest in the firm, agreed that Showell should retire to help with his family’s trailer park business. By the time Showell left the firm, however, there was no agreement on the amount to which he was entitled upon his retirement.
The firm’s LLC agreement does not allow for the withdrawal or resignation of its members. A supplemental written agreement addresses repurchase of a member’s interest upon a "Retiring Event" defined as certain events not including a voluntary retirement. A qualified Retiring Event (such as death and bankruptcy) triggers a repurchase at a price equal to the member’s "Net Equity" defined as his proportionate share of "the amount that would be distributed to such a Member in liquidation of the Company."
Showell petitioned the Delaware Chancery Court for a determination of the amount due him for his interest, which he argued should be the going concern "fair value" under the default rule for distributions upon resignation contained in §18-604 of the Delaware LLC Act. The statute, which is similar to New York LLC Law §509, provides as follows:
Except as provided in this subchapter, upon resignation any resigning member is entitled to receive any distribution to which such member is entitled under a limited liability company agreement and, if not otherwise provided in a limited liability company agreement, such member is entitled to receive, within a reasonable time after resignation, the fair value of such member’s limited liability company interest as of the date of resignation based upon such member’s right to share in distributions from the limited liability company.
The firm and the remaining members argued that, because the LLC agreement forbids member withdrawal, and because the supplemental agreement makes no provision for payment to a member who voluntarily retires as opposed to other defined Retiring Events, Showell was not entitled to any payment. Alternatively they argued that Showell is entitled to no more than his share of the firm’s liquidation value.
In his decision (read here), Vice Chancellor Sam Glasscock, III finds that Showell’s argument for application of §18-604 is negated by the prohibition against member withdrawal expressly stated in the LLC agreement. He also notes the omission of voluntary retirement as a defined Retiring Event in the supplemental agreement. On the other hand, he continues, it was undisputed that Showell and Pusey, representing 90% of the firm’s membership interest (i.e., more than the percentage required to amend the LLC agreement) had in fact agreed that Showell could retire and that the firm would purchase his interest. Therefore, VC Glasscock concludes, in order to "harmonize" Showell’s agreed retirement with the intent of the parties as expressed in their written agreements, the purchase price for Showell’s interest should be liquidation value as defined in the supplemental agreement. VC Glasscock explains:
Because the Agreements read as a whole evidenced careful planning for the obligations of [the firm] upon a member’s retirement, I reject Showell’s argument that the "default" provision of 6 Del. C. §18-604 should apply. The members (including Showell), in creating the Operating Agreement and Supplemental Agreement, did contemplate the effects of a retirement and provided specifically for the obligations of [the firm] upon such an event happening. The statute itself provides that "fair value" is the measure of the LLC’s obligation to a withdrawing member only if the Agreement fails to provide otherwise. Because [the firm] permitted Showell to retire despite the fact that his reason for retiring did not constitute a "Retiring Event," and because I find that an agreement existed to purchase his interest, the measure of [the firm’s] obligation is as set out in the Supplemental Agreement, Article 1.1 as though a Retiring Event had occurred. That obligation is based on the liquidation value of the Company as set out in the Supplemental Agreement at Article 1.6, and payment is due on the schedule provided and at the interest rates provided in the Supplemental Agreement, Article 1.1(d).
Showell’s appraisal expert testified that Showell’s 29% share of the firm’s fair value as a going concern including good will was $281,000, as opposed to its liquidation value of $65,000. The firm’s expert testified, and VC Glasscock agrees, that the good will component of the fair value appraisal, including the firm’s client list, is of "minimal value" because the LLC agreement lacks a provision prohibiting a retiring member from competing with the firm. "Therefore," VC Glasscock writes, "even if ‘fair value,’ rather than liquidation value, were to be used to calculate the amount to which Showell is entitled here, the net difference would be minimal."
In other words, according to the court’s assessment of the valuation evidence, the dispute over application of the default statute’s fair value standard versus the agreement’s provision for liquidation value is a tempest in a teapot.