Breaking Bad’s Saul Goodman does not spring to mind when I think about the right type of lawyer for business partners — at least those involved in legitimate ventures — who need a divorce. But I suspect the two, separating partners in Beauchamp v. Johnstone, 2013 NY Slip Op 31656(U) (Sup Ct NY County July 15, 2013), would have been better off calling the street-wise Saul than not calling any lawyer, which apparently is what happened when they wrote up by themselves and signed a crude, one-page agreement that divided certain assets and called for certain “severance” payments, but said nothing expressly about transferring or surrendering the “severed” party’s ownership interest in the business.
A few months back I wrote about the De Well case highlighting the perils of clients negotiating and signing buy-out agreements without the assistance of counsel in the middle of pending shareholder litigation. The Beauchamp case is a variation on the same theme, except instead of prolonging an existing litigation as in De Well, in Beauchamp the parties’ do-it-yourself approach ended up instigating litigation.
According to the complaint filed by Gregory Beauchamp (read here), he and Jeremy Johnstone formed a business in November 2011 called Port and Passage, LLC (“P&P”) for the purpose of selling motion graphics and video production services. There was no written operating agreement. Beauchamp alleged, and Johnstone denied, that Beauchamp retained a majority voting interest. Beauchamp also alleged, and Johnstone also denied, that P&P made a series of loans to Johnstone, and that Johnstone failed to perform adequately or generate sufficient business.
The May 9 Agreement
Beauchamp alleged that on May 9, 2012, he met with Johnstone to discuss his concerns and that Johnstone then and there agreed to withdraw from P&P. Beauchamp on the spot drew up, and they both signed, a one-page document listing several projects to be completed by Johnstone “in return for” certain “salary” and “severance” payments (read here).
Two days later, Johnstone withdrew $27,500 from P&P’s bank account representing half the funds in the account.
About a week later, Beauchamp sent Johnstone a formal, six-page “Separation and General Release Agreement” that appears to have been prepared by his counsel (read here). The document provides for the termination of Johnstone’s “association” with P&P “as of May 18, 2012” and states that Johnstone and P&P “acknowledge and agree” that Johnstone has no equity interest in P&P. The parties never signed it.
In September 2012, Beauchamp filed suit against Johnstone seeking to recover the funds he took from the bank account, the repayment of loans, and a judgment declaring that Johnstone withdrew from P&P in accordance with the May 9 Agreement.
Johnstone filed an answer with counterclaims (read here) in which he alleged that he and Beauchamp were “equal partners” in P&P and that Beauchamp was liable to him for $400,000 damages for diversion of business opportunities and breach of fiduciary duty plus a 50% share of all profits from work in progress.
Beauchamp moved to dismiss the counterclaims primarily on the ground Johnstone ceased being a member of P&P as of the May 9 Agreement. His attorney’s affirmation in support (read here) argued, among other points, that Johnstone, having received all the monies due him under the May 9 Agreement plus more, had no basis to allege fiduciary breach.
In his opposing affirmation (read here), Johnstone’s attorney argued that the May 9 Agreement omitted material terms, did not constitute a “meeting of the minds,” and that Beauchamp misled and coerced him into signing it. He also argued that Beauchamp’s subsequent tender on May 18 of the six-page, formal agreement “shows that any discussion between the parties about the separation and relinquishment of [Johnstone’s] rights in the Company were, at best, incomplete and required significant further clarity and legal input of the parties’ respective counsel.”
The Court’s Ruling
The court’s decision, by Manhattan Supreme Court Justice Carol R. Edmead, found that the counterclaim’s allegations of breach of fiduciary duty by Beauchamp, as supplemented by the allegations in Johnstone’s affidavit, sufficiently alleged the existence of a duty, its breach and resulting damages with respect to Beauchamp’s activities before and after the May 9 Agreement. Justice Edmead further explained:
It has been held that an LLC managing member continues “to owe fiduciary duties” to the LLC members until the LLC is dissolved (McGuire v. Huntress, 83 A.D.3d 1418, 920 N. Y.S.2d 531 [4th Dept 2011] (rejecting contention that the fiduciary duty owed to LLCs members ceased when the members orally agreed for one member to buyout the equity interests of the other, since the duty continues until the LLCs were actually dissolved); see also LLC Law § 203(d), “A limited liability company formed under this chapter shall … continue until the cancellation of the limited liability company’s articles of organization”)). And, although it is has been held that a withdrawal of a member of an LLC may trigger a dissolution of an LLC (see Spires v. Casterline, 4 Misc.3d 428, 778 N.Y.S.2d 259 [Sup. Ct., Monroe County 2004] ), such a withdrawal does mandate a dissolution unless it is found that “it is not reasonably practicable to carry on the business” (Horning v. Horning Const., LLC, 12 Misc. 3d 402,816 N.Y.S.2d 877 [Sup. Ct., Monroe County 2006] citing LLC Law 702), and there is no indication that the LLC herein was dissolved. Thus, at this pleading stage, it cannot be said that defendant failed to state such a breach of fiduciary duty claim.
Justice Edmead rejected Johnstone’s argument that Beauchamp’s subsequent proffer of the unexecuted May 18 Separation Agreement rendered the May 9 Agreement non-binding, stating that the “May 9 Agreement contains no language indicating that it is merely an agreement to agree, and the Separation Agreement is unexecuted by either side.” Ultimately, however, she did not accept Beauchamp’s argument that the May 9 Agreement foreclosed Johnstone’s counterclaims or his assertion of a continuing membership interest in P&P. Here’s what she wrote:
Although the May 9 Document contains terms regarding the defendant’s separation from the Company, i.e., the remaining work to be completed by [Johnstone], a schedule of [Johnstone’s] severance payment, and a division of the Company’s equipment and domain names between the parties, [Johnstone] attests that [Beauchamp] misrepresented the value of the Company in inducing [Johnstone] to sign the Document. Thus, contrary to [Beauchamp’s] contention, it cannot be said that [Johnstone’s] withdrawal of the funds precludes him from asserting the existence of any damages, and precludes [Johnstone] from asserting a claim to damages based on his status as member of the Company. And, the May 9 Document does not conclusively establish a defense to [Johnstone’s] allegations of [plaintiff’s] breaches of his duty occurring prior to the Document’s execution.
Beauchamp and Johnstone are the only two people who know what really happened at their May 9 meeting and, as crude and incomplete as the May 9 Agreement is, whether it was intended to memorialize Johnstone’s withdrawal from P&P. Had Beauchamp checked with counsel in advance, he likely would have been advised to include express language referring to the relinquishment of Johnstone’s membership interest in consideration of the monies and other property granted to him in the agreement. Had he included such language in the agreement, their breakup still might not have been a good one, but chances are it would have not been so bad.