Presently fourteen states and the District of Columbia have enacted the Revised Uniform Limited Liability Company Act (2006). RULLCA legislation is pending in three other states. Regrettably, New York is not one of them.
One of RULLCA’s innovative features, carried over from the original Uniform LLC Act (1996), is its provision in Section 602(6) authorizing judicial expulsion (“dissociation”) of a member who:
(A) has engaged, or is engaging, in wrongful conduct that has adversely and materially affected, or will adversely and materially affect, the company’s activities;
(B) has willfully or persistently committed, or is willfully and persistently committing, a material breach of the operating agreement or the person’s duties or obligations under Section 409; or
(C) has engaged in, or is engaging, in conduct relating to the company’s activities which makes it not reasonably practicable to carry on the activities with the person as a member.
New Jersey adopted RULLCA effective March 2013 for all new LLCs and made applicable to all existing New Jersey LLCs as of March 2014. However, even before adopting RULLCA, New Jersey’s previous LLC Act included a provision substantially mirroring RULLCA’s Section 602(6).
Perhaps for that reason, the New Jersey courts seem to be in the forefront of litigation over involuntary member dissociation. In December 2012, in a case called All Saints University of Medicine Aruba v Chilana involving a fight between 47% and 53% membership factions, which I wrote about here, the New Jersey intermediate appellate court handed down an unpublished decision affirming the trial court’s dissociation of the 53% faction whose refusal to contribute needed additional funds jeopardized the continued operations of the medical school operated by the LLC.
The court’s ruling, upholding dissociation solely on the ground that the 53% faction’s conduct prospectively made it not reasonably practicable to carry on the school’s business, stressed that that prong of the statute, unlike RULLCA Section 602(6)’s subsection (A), does not require a showing of wrongful conduct by the dissociated member, and that the statute does not compel a sale of the dissociated member’s interest, i.e., the dissociated member retains an economic interest in the LLC.
IE Test, LLC v Carroll
Earlier this year, the New Jersey intermediate appellate court again addressed involuntary member dissociation in another unpublished opinion in IE Test, LLC v Carroll (read here). As in All Saints, because the case was filed before New Jersey’s RULLCA became effective, the court applied the pre-RULLCA dissociation statute which, as the court noted in a footnote, essentially is the same as RULLCA’s dissociation provision.
The trial court in IE Test granted the company’s motion for a summary judgment expelling the defendant Carroll, a 33% member, under the same statutory provision applied in All Saints, where the conduct of the defendant, who was not actively involved in the company’s day-to-day business, made impossible the consummation of an operating agreement which in turn prevented the company from obtaining bank financing. Specifically, Carroll insisted as a condition of entering into an operating agreement, without legal justification, that the other members reimburse him for certain losses involving a predecessor business that went bankrupt.
On appeal, Carroll argued that the company’s proofs were insufficient because the dissociation statute does not permit member expulsion based upon “speculative” future disagreements or disputes between members. He also claimed that the company failed to demonstrate its inability to obtain financing or that he was interfering with the business and that, in any event, the company was profitable.
The appellate court’s opinion affirming the expulsion order treated the issue as one of first impression. Its opinion did not (and apparently could not under the court’s rules) cite the unpublished All Saints decision, and it also noted that “our research was unable to locate a reported decision interpreting this provision from any of our sister states which adopted verbatim the language of the Uniform Acts.” (Note: The official comment to RULLCA Section 602(6) cites All Saints along with Sherwood Park Bus. Ctr., LLC v Taggart, 323 P.3d 373 [Or. Ct. App. 2014], and CCD, L.C. v Millsap, 116 P.3d 373 [Utah 2005], as cases in which the courts upheld orders of dissociation. The latter two decisions, however, applied the wrongful-conduct and willful-breach standards found in RULLCA Section 602(6)(A) and (B), not the not-reasonably-practicable standard under 602(6)(C).)
The court looked outside of New Jersey, to the Colorado Supreme Court’s 2014 decision in Gagne v Gagne, an LLC dissolution case which I wrote about here, for guidance in interpreting the dissociation statute’s language referring to the not-reasonably-practicable standard which is the same standard found in the LLC judicial dissolution statute. Those factors as articulated in Gagne include:
(1) whether the management of the entity is unable or unwilling reasonably to permit or promote the purposes for which the company was formed; (2) whether a member or manager has engaged in misconduct; (3) whether the members have clearly reached an inability to work with one another to pursue the company’s goals; (4) whether there is deadlock between the members; (5) whether the operating agreement provides a means of navigating around any such deadlock; (6) whether, due to the company’s financial position, there is still a business to operate; and (7) whether continuing the company is financially feasible.
The appellate court in IE Test found the analysis in Gagne “persuasive” and, applied to the facts of the case, concluded that the trial judge correctly granted the company summary judgment expelling Carroll, explaining as follows:
The facts demonstrate that discord among the parties arose immediately after the LLC’s formation. Within two weeks of executing a rudimentary agreement regarding shares of the LLC that contained no reference to payment of [the predecessor company’s] debt, Carroll admittedly insisted on repayment of the debt, justifying this posture as acceptable business negotiations among sophisticated businessmen. Although he at one time asserted [the other members] agreed to the repayment and were legally bound to do so, Carroll subsequently admitted that he possessed “no legally enforceable right to seek repayment.”
Even if the genesis of the disagreement arose from hard-edged negotiations, it is undisputed that the relationship between [the members] never recovered from the initial exchange. Prior to the filing of plaintiff’s summary judgment motion, no proposed operating agreement was every circulated, and there is no indication in the record that Carroll ever altered his position that he was due compensation for [the predecessor company’s] debt, whether in the form of a salary draw or in some “premium” payment from the LLC’s distributions. Under these circumstances, the motion record supported Judge Klein’s decision that the continued operation of plaintiff with Carroll as a member was “not reasonably practicable” under N.J.S.A. 42:2B-24(b)(3)(c).
The court’s opinion mentions that the trial court’s order also awarded Carroll approximately $227,000 for the value of his membership interest. The opinion sheds no further light on the legal basis for the conveyance or whether it was compulsory or stipulated, mentioning only that Carroll’s appeal did not challenge the valuation. As the All Saints opinion noted, New Jersey’s pre-RULLCA dissociation statute did not authorize the court to compel the sale of a dissociated member’s interest — an omission cured by what appears to be a non-conforming provision tucked into Section 42:2C-47 of the New Jersey RULLCA.
It’s hard to tell from the IE Test opinion’s limited analysis whether the bar for dissociation under the statute’s not-reasonably-practicable standard is lower than that for judicial dissolution, though one could be excused for having that impression. Whether that’s a good thing or a bad thing certainly is open to debate, especially under the New Jersey statute which has a non-conforming omission of member standing to seek judicial dissociation of another member, i.e., unlike RULLCA as promulgated by the National Conference of Commissioners on Uniform State Laws, the New Jersey statute confers standing to seek member dissociation on the company alone. Absent provision to the contrary in the operating agreement, the majority’s control of any decision by the company to bring a dissociation action arguably can lend the statute to oppressive purposes.
For a more detailed recitation of the facts and the court’s analysis in IE Test, check out this post by New Jersey attorney Michael L. Rich.
Update August 8, 2016: Big news concerning IE Test. Carroll appealed the decision to the Supreme Court of New Jersey which last week reversed the expulsion order in an opinion setting a “high bar” for applications to expel an LLC member under the no-fault provision involved in the case. You can read here my post on last week’s decision.