When it comes to LLC jurisprudence, equity’s on a roll.
A few major examples come to mind: the recent Carlisle case in which the Delaware Court of Chancery enforced “equitable dissolution” of an LLC upon the petition of the assignee of a membership interest who lacked standing under the dissolution statute; the Mizrahi case in which a New York appellate panel ordered an “equitable buy-out” of a 50% LLC member upon petition by the other 50% member in the absence of a statutory buy-out remedy; the Gottlieb decision in which another New York appellate panel gave birth to common-law “equitable accounting” claims.
Add to the growing list of equity-driven rulings for these contract-centric creatures of statute an unpublished decision last week by a New Jersey intermediate appellate court in All Saints University of Medicine Aruba v Chilana, No. A-2425-13T1 [N.J. Super. Ct. App. Div. Oct. 27, 2015], directing the lower court on remand to consider ordering a forced sale of a dissociated LLC member’s interest as a “common law equitable remedy” for “common law breaches of duty” notwithstanding the appellate court’s recognition that neither the applicable dissociation statute nor the LLC’s operating agreement authorized a compulsory sale.
This is All Saints‘ second round-trip to the Appellate Division. I wrote about the first appeal in a post entitled “But I Did Nothing Wrong!” No Defense to Involuntary Dissociation of LLC Member in which I told the woeful tale of a start-up Caribbean medical school organized as a New Jersey LLC on the fringes of financial failure due to dissension between two 53% and 47% membership factions laboring under an operating agreement that required unanimous approval of all management decisions. The appellate court on that occasion upheld the trial court’s decision dissociating the 53% faction under the statute’s provision authorizing dissociation when a member engages in conduct “which makes it not reasonably practicable to carry on the business with the member as a member of the limited liability company.”
The underlying reason for dissociation was the member’s refusal to contribute cash to keep the financially troubled school afloat, requiring the 47% member to bail it out with a $350,000 loan. The trial court also found that the dissociated member “acted recklessly and purposefully to undermine the interests of the LLC, and the medical school” by various acts including “causing and perpetuating its financial deadlock.”
Due to uncertainty whether the parties had previously stipulated to a buy-out in the event of dissociation from the LLC (which the trial court also determined had a zero fair value), the appellate court remanded the case for further proceedings to determine whether the dissociated member wished to have the court consider whether he could withdraw from the stipulation and retain his non-managing, non-voting, economic interest.
In my prior post, I noted that the outcome was not
an entirely happy outcome for the prevailing 47% faction which, if the dissociated member chooses [to remain a passive investor], may be hobbled in any future efforts to raise capital or obtain debt financing for the school’s operations and growth, and whose strategic business plan may be influenced by the built-in disincentive provided by the ongoing economic interest of the dissociated member.
Apparently the 47% faction saw it the same way, because on remand they fought to enforce the stipulation and the zero-dollar buy-out. The trial judge, however, found the stipulation inoperative and also concluded that the 47% faction’s alternative argument — that the court should order a forced buy-out as an equitable remedy for the dissociated member’s breach of his common law duties as previously found by the court — was outside the appellate court’s remand mandate. This time, the 47% members appealed.
Successfully, as it turned out. In its ruling last week, the appellate court explained that “[n]ow that it is established that the parties did not stipulate to a buyout on dissociation, the case must be remanded to allow the judge to consider the question of remedy anew,” adding,
To do otherwise would prevent the trial court from considering a remedy for the breaches of [the dissociated member’s] fiduciary duties and duty of loyalty, thus running afoul of “the maxim lying at the foundation of equitable jurisprudence, that equity ‘will not suffer a wrong without a remedy.'” [Citation omitted.]
In reaching its conclusion, the court rejected the dissociated member’s arguments that the LLC’s operating agreement prohibited a forced sale. It also reasoned that, while the dissociation statute “does not compel the sale of the shares of a dissociated member,” at the same time “we see no reason to conclude that it precluded such a remedy for a member’s breach of his fiduciary duties and duty of loyalty as occurred here.” Absent a compulsory buy-out remedy, the court further observed, the prevailing 47% members likely “would have preferred [a judicial dissolution] remedy to the one entered on remand, which removed the [dissociated member] from management in [the LLC] but left him the ongoing economic benefit of his interest.” Summing up, the court wrote:
Given the circumstances of this case, namely that [the prevailing members] infused in excess of $350,000 during the pendency of the litigation without which [the medical school] would not have survived, that the trial court found, and we affirmed, that there was no proven value of [the LLC] as of the valuation date and that it would require an infusion of an additional $550,000 to sustain [the medical school] before it would realize a profit, equity demands that the trial court not be precluded from considering a non-statutory remedy that terminates [the dissociated member’s] interest on dissociation in addition to removing him from management. . . .
Accordingly, we remand for the limited purpose of allowing the trial court to consider anew the remedy for [the dissociated member’s] breaches of his fiduciary duties and duty of loyalty, including leave to consider whether [his] wrongful conduct warrants a forced buyout, an issue on which we express no opinion.
Anyone want to lay odds that, after the next decision by the trial court on the second remand, we’ll see a third trip to the Appellate Division?
The dissociation statute at issue in All Saints predates New Jersey’s recent adoption of the Revised Uniform LLC Act. The new Act also contains provision for judicial dissociation, now augmented by express authorization to “order the sale of the interests held by such person immediately before dissociation to either the company or to any other persons who are parties to the action if the court determines, in its discretion, that such an order . . . would be fair and equitable to all parties under all of the circumstances of the case.”
Interestingly, the forced-sale remedy now embedded in the New Jersey statute is not found in the Revised Uniform LLC Act (2006) as promulgated by the National Conference of Commissioners on Uniform State Laws. In many if not most states, New York included, the LLC laws omit any judicial dissociation remedy, much less the double-barreled remedy of dissociation and forced sale, thereby making such outcomes dependent on their presence or omission in the operating agreement or perhaps, for argument’s sake, unless a judge decides that equity requires otherwise.
Update August 12, 2016: My prediction of a third trip to the Appellate Division came true, after the trial court upon remand from the second appeal decided to compel as an equitable remedy a $0 buy-out of the dissociated member’s interest. In its decision last week (read here), the Appellate Division upheld the forced buy-out. The opinion quotes from the trial court’s decision as follows:
It would be grossly inequitable to permit Dr. Yusuf [the dissociated member] to reap the benefits of a continuing economic interest in an entity he was content to see destroyed. . . . A contrary holding would grant an undeserved windfall to Dr. Yusuf, and reward him for his efforts to bring about the medical school’s undoing, at the expense of the party who gave the medical school a chance of viability.