Good faithIf, as appears likely, the drafters of the LLC membership interest repurchase provisions at issue in Saleeby v Remco Maintenance, LLC, 2016 NY Slip Op 31447(U) [Sup Ct NY County July 25, 2016], thought they were helping the company avoid the possibility of litigation over the value assigned to the outgoing member’s interest, as it turns out they were sorely mistaken.

Poorly drafted or not, the LLC’s managers also likely did themselves and the company no favor by assigning a zero-dollar value to the membership interest of the terminated member in the Saleeby case, and by muddling the timing of the company’s exercise of its repurchase option.

Here, in a nutshell, is what happened in Saleeby as described in Manhattan Commercial Division Justice Anil C. Singh’s decision: In 2005, the defendant company Remco Maintenance, a New York based Delaware LLC, hired plaintiff Saleeby as its President and CEO. Saleeby’s employment agreement granted him a 7.5% Class B membership interest which fully vested by the time he was terminated without cause in February 2012. Over the next two years, Saleeby and the company attempted without success to negotiate their dispute over his termination, severance, vacation pay, and rights to unemployment insurance. In 2014, the company informed Saleeby that in 2013 it had exercised its option under the LLC Agreement to repurchase his membership units at a “fair market value” of zero dollars. Saleeby subsequently filed suit against the LLC for breach of contract and conversion.

The Repurchase Option.  The lawsuit and the company’s pre-answer dismissal motion centered on the language of the repurchase option in Section 6.05 (a) of the LLC Agreement and the definition of “Fair Market Value” in Section 1.01 (read agreement here). Section 6.05 (a) granted the company the option to repurchase the Class B membership units of a terminated employee at their Fair Market Value as of the termination date, and required the company to exercise its option within 60 days after the later to occur of the termination date or “the final resolution of any disputes relating to such termination.”

Section 1.01 defined Fair Market Value as:

the value determined by the Board in good faith, based on all factors which the Board, in its sole discretion, determines to be relevant and appropriate, including, without limitation, type of asset, marketability  (or absence thereof), restrictions on disposition, purchases of the same or similar securities by other investors, pending mergers or acquisitions and current and prospective financial position and operating results.

The Company’s Contentions.  In support of its dismissal motion, the company argued that it timely and properly redeemed Saleeby’s membership interest in 2013 for $0 in accordance with Sections 6.05 (a) and 1.01 of the LLC Agreement. The company’s supporting brief (read here) stressed its reliance on Section 1.01’s definition of Fair Market Value giving the Board “sole discretion” to value the shares “without any input from the Plaintiff.”

Saleeby’s Contentions.  Saleeby’s complaint (read here) alleged that Remco’s business was acquired for $6 million around the time he became CEO; that by the time he left in 2012 the company was attracting third-party offers in the $30 million range giving his 7.5% interest a value of at least $2.25 million; that the company provided no analysis in support of its $0 valuation of his membership units; and that he never consented to the company’s repurchase of his units. In opposition to the company’s dismissal motion, Saleeby’s brief (read here) argued that the repurchase option was invalidly exercised beyond the 60-day post-termination period allowed and that, rather than valuing his interest in “good faith” as required by Section 1.01, the company simply “misappropriated” his membership interest.

The Decision.  Justice Singh granted dismissal of Saleeby’s conversion claim as duplicative of his claim for breach of contract as to which he denied dismissal. Under the judge’s interpretation of Section 1.01,

The Fair Market Value pursuant to the agreement gives the Board sole discretion in determining the factors to be used but also limits their determination to one that is done in good faith. Plaintiff contends that valuing his interest at zero dollars, the Board’s determination was not in good faith. Remco counters that the Board had sole discretion to determine the value of Class B shares. While the Board has “sole discretion” in determining the factors and value of the shares, the contract does provide that it be done in “good faith.” New York courts have held that “good faith” is the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. . . . Whether the determination in this case was made in good faith is an issue that cannot be determined on a motion to dismiss.

Justice Singh also denied dismissal of the claim for contract breach on the ground “there is a question as to whether Remco’s purchase of the shares was timely under Section 6.05 [of the] LLC agreement.” The judge based this not on Saleeby’s contention, that there was no dispute over his termination and therefore the company’s option expired 60 days after his termination in 2012, but on the ground that the “final resolution” of the dispute over Saleeby’s termination did not occur until 2014, a year after the company’s alleged repurchase of Saleeby’s interest.

Takeaway #1.  There’s no way for me to divine the actual intent of the parties to the LLC Agreement when they adopted a definition of Fair Market Value seemingly in tension with itself, on the one hand requiring that the Board determine value “in good faith” and, on the other hand, giving the Board “sole discretion” how to go about doing so. If they intended to make the Board’s determination of value under Sections 6.05 (a) and 1.01 conclusive and binding upon the terminated member, clearly the language they chose failed in its purpose. There are much better drafting techniques to achieve that purpose while also achieving a reasonable degree of fairness in the resulting valuation, thereby providing the employee/equity holder with efficient performance incentives.

Takeaway #2.  Section 6.05 (a)’s language governing the timing of the company’s option exercise leaves much to be desired and, based on the court’s decision, ultimately could prove decisive against the company in the Saleeby litigation even assuming its $0 valuation prevails. The problem lies in its use of an indefinite, 60-day time period measured from “the final resolution of any disputes relating to such termination.” What constitutes a “final resolution”? Shouldn’t there at least be a requirement that one side or the other give notice of a final resolution to start the running of the 60-day period? And what disputes do or do not relate to the termination? There’s no certainty. It’s always better to tie the timing of an option exercise to objective mileposts.

Update March 24, 2017:  Saleeby appealed the court’s dismissal of his claims for conversion and for breach of contract against the defendants other than Remco, to no avail. Read here the appellate court’s decision handed down yesterday affirming the lower court’s ruling. Saleeby’s claim against Remco for breach of contract remains the subject of ongoing litigation.