Folks who’ve been following this blog for years know that periodically I like to venture beyond New York’s borders to find and report on interesting decisions from other states in business divorce cases.

Historically there have been significant differences in the statutory and case law of the 50 states that limit the utility of cross-border research and citation in disputes between co-owners of partnerships, close corporations, and LLCs. Delaware law, for example, does not authorize a claim for judicial dissolution of a close corporation based on shareholder oppression.

On the other hand, the growing proportion nationwide of business divorce cases involving LLCs, which by their nature lend themselves to a contract-centric mode of jurisprudence, have had something of an interstate leveling effect which encourages business divorce practitioners to keep abreast of out-of-state case law developments.

In that vein, following are summaries of five noteworthy, recent court decisions from five different states — two involving LLCs, one involving a limited partnership, and two involving close corporations.

Delaware: Chancery Court Invalidates LLC Manager’s Removal Based on Unauthorized Amendment of Operating Agreement

In DiDonato v Campus Eye Management, LLC, decided earlier this year by Vice Chancellor Will, the plaintiff sued under Section 18-110 of the Delaware LLC Act for a declaration that the majority member of the parent company of the defendant management services organization (MSO) improperly removed him as the MSO’s sole manager pursuant to an invalid amendment of its operating agreement adopted without the plaintiff’s consent.

The original LLC Agreement provided in Section 25 that “The Agreement may be amended, modified, waived or supplemented by the Manager with the written consent of all Members.” The amendment, which the plaintiff learned about long after the majority essentially expelled him from the MSO and its affiliated medical practices, provided that the MSO is managed by its parent company — the majority members of which controlled its board of managers — as its sole member.

The decision was a clear-cut victory for the plaintiff. As VC Will wrote,

The plain terms of the MSO LLC Agreement support judgment in DiDonato’s favor. The MSO LLC Agreement provides that the Manager must be involved in any amendment. But DiDonato–the MSO’s sole Manager–played no role in the Purported Amendment, which is invalid for want of authority. None of the defenses raised by the NSO lead to a different result.

Those interested should read VC Will’s entire opinion which addresses in turn each of the MSO’s rejected defenses. The only one I’ll mention here is MSO’s argument that Section 25’s purpose was not to require the Manager’s approval of any and all amendments of the LLC Agreement, but merely to serve “as a limitation on the ability of the Manager to amend without ‘the written consent of all Members.'” Not so, according to VC Will who responded that Section 25, the sole provision in LLC Agreement dealing with the power to amend, “does not contemplate unilateral amendment by members. . . . As in [DLLCA Section 18-302(e)], the use of ‘may’ in Section 25 indicates that an amendment is permitted (not mandated), so long as it is done in accordance with the MSO LLC Agreement’s terms.”

Pennsylvania: Statutory Default Provisions Codifying “Pick Your Partner” Principle Defeat Claims by Assignee of 50% LLC Membership Interest

If the court’s decision in DiDonato can be likened to an easy basketball layup, the Pennsylvania Superior Court’s recent decision in Larikov, LLC v Cao (read here) equates to a slam dunk.

Larikov involves a realty-holding LLC initially owned by two 50% members, one of whom assigned his interest to the plaintiff without the other 50% member’s consent. The LLC’s minimal operating agreement had no provisions governing the transfer of membership interests. The plaintiff-assignee brought suit against the other 50% member for various alleged breaches of contract and fiduciary duty that pre-dated the assignment.

The trial trial and the Superior Court on appeal both held that the plaintiff lacked standing to sue, not only because the alleged breaches pre-dated the assignment, but primarily because under the governing statutory default rule, the assignment made without the defendant’s consent merely gave plaintiff a “transferable interest” defined as the right to receive distributions without any right to participate in the LLC’s management or to sue derivatively or to have access to records.

The Superior Court’s decision liberally quoted from the trial court’s ruling and the latter’s quotation in turn from the Committee Comments to the Pennsylvania statute amplifying on the “pick your partner” principle that animates the distinction between transferable and membership interests:

[Section 8852] is the core of this chapter’s provisions reflecting and protecting [the ‘pick your partner’] principle. A member’s rights in a limited liability company are bifurcated into economic rights (the transferable interest) and governance rights (including management rights, consent rights, rights to information, and rights to seek judicial intervention). Unless the operating agreement otherwise provides, a member acting without the consent of all other members lacks both the power and the right to: (i) bestow membership on a non-member; or (ii) transfer to a non-member anything other than some or all of the member’s transferable interest. The rights of a mere transferee are quite limited-i.e., to receive distributions as provided in subsection (b), and, if the company dissolves and winds up, to receive specified information pertaining to the company from the date of dissolution as provided in subsection (c). . . . Mere transferees have no right to participate in management or otherwise intrude as the members carry on the affairs of the limited liability company and their activities as members.

Therefore, the court concluded, “because [plaintiff] retains, at most, an economic interest in the LLC, it does not have standing to sue [defendant].”

Illinois: Court Rejects Admission of New General Partner in Violation of Limited Partnership Agreement

The Illinois Appellate Court’s recent decision in Schwartz v Schwartz (read here) is yet another example of cases turning on the interpretation of a governing ownership agreement — in this case, a limited partnership agreement — and, more specifically, of what can happen when the drafters leave what seem like foreseeable gaps in the agreement.

The case involves a limited partnership called Lionfish L.P. of which Lionfish LLC was sole general partner. The L.P. owned a Caribbean hotel. The LLC, owned by Amy Schwartz and Randy Schwartz, had no operating agreement. Three or so years into the venture, Amy individually and derivatively on behalf of the LLC sued Randy for breach of fiduciary duty and requested the appointment of a receiver.

Under the Illinois Uniform Limited Partnership Act, Amy’s request for a receiver automatically triggered the LLC’s dissociation as general partner of Lionfish L.P. A week later, limited partners holding 74% of the partnership interests in the L.P. by written consent appointed an LLC under their control named Cheloniidae LLC as new general partner.

Over the next two years, Randy filed counterclaims in the suit brought by Amy, also requesting a receiver for the LLC; Cheloniidae and the L.P. sued Lionfish LLC and Amy seeking, among other relief, a declaration that Cheloniidae is the L.P.’s lawful general partner; and another limited partner sued for a declaration that Lionfish LLC remained the L.P.’s general partner.

The trial court granted Cheloniidae summary judgment declaring it to be the lawful general partner following the undisputed dissociation of Lionfish LLC as general partner due to Amy’s and Randy’s requests for receivership.

On appeal from the trial court’s order, the issue boiled down to whether:

  • Cheloniidae’s succession as general partner was permitted by the Illinois Uniform L.P. Act’s provision allowing a majority in interest, within 90 days after the dissociation of a general partner, to “admit at least one general partner” in order to avoid dissolution of the partnership, or
  • Cheloniidae’s succession was barred by provision in the L.P. Agreement barring the appointment of a new or additional general partner except when the general partner “ceases to be a General Partner as a result of death, bankruptcy, incapacity, or removal . . . upon the affirmative vote of all the Limited Partners.”

The Appellate Court took the latter view and reversed the lower court’s decision, essentially holding that the L.P. Agreement’s provision trumped the Act’s default rule. According to the Court, in the absence of any provision in the L.P. Agreement addressing the dissociation of a general partner, the provision for replacing a general partner upon “death, bankruptcy, incapacity, or removal” established “the parties’ intent to admit a new general partner only under those circumstances with the unanimous approval of the remaining limited partners.”

The decision remanded the case for further proceedings without commenting on what those proceedings will look like. Chances are, absent a settlement among all parties concerned, with no general partner the L.P is headed to the chopping block, all because the drafters of the L.P. Agreement failed to take into account the statute’s provision dissociating a general partner that seeks appointment of a receiver.

Wisconsin: Appellate Court Affirms Dismissal of Non-Dissolution Action Demanding Buyout Based on Minority Shareholder Oppression

The law in New York is anything but settled whether minority shareholders of a closely held corporation have a cause of action for shareholder oppression untethered from a claim for judicial dissolution (read here). The Wisconsin Court of Appeals recently addressed the question but stopped short of answering it in a decision that summarily dismissed a minority shareholder oppression claim on other grounds.

Eichhoff v New Glarus Brewing Co. (read here) involves an S corporation formed in 1993 to own and operate what evolved to become a highly successful and profitable microbrewery. The plaintiffs are among the original investors who acquired relatively small stakes at $10 per share. The corporation’s majority owner is its President, CEO, and sole director.

The plaintiffs, who never held any position with, or were employed by, the corporation, brought suit alleging minority shareholder oppression and seeking an order primarily compelling a buyout of their shares at fair value. Their primary complaint was that the company and its controlling owner refused to pay shareholder dividends beyond those sufficient to cover taxes on their pass-through net income, even though the corporation holds $40 million in cash and cash equivalents, generates annual net income between $14 million and over $20 million, and has retained earnings of about $100 million with virtually no debt.

Other complaints included: the majority shareholders’ “autocratic control” of the corporation, depriving plaintiffs of any say in the brewery’s operation; alleged self-dealing by the majority shareholder; alleged excessive compensation paid to the majority shareholder and her family members who work for the brewery; and the majority shareholder’s alleged refusal to sell the brewery and intent to keep it “locally owned.”

The lower court issued an order granting the defendants’ motion to dismiss the complaint for failure to state a valid claim, which the Court of Appeals affirmed. In general, the appellate court agreed that the complaint’s allegations of oppression either did not satisfy the reasonable-expectations standard — e.g., under the governing shareholders agreement they had no expectation of having any voice in the brewery’s management and no guarantee of distributions which were left to the sole discretion of the single-member board — and/or failed to allege facts to support the majority shareholder’s alleged over-reaching and self-dealing.

At the very tail end of the court’s 39-page opinion, “for the sake of completeness,” the court addressed the “primary issue” raised by the majority shareholder “focusing on the relief sought in the complaint” limited to a buyout and ancillary relief other than dissolution. The majority shareholder argued that under the governing statute for judicial dissolution, dissolution is the only permissible remedy for oppression, and that since the complaint affirmatively disavowed any desire to dissolve the corporation, the complaint failed to state a valid claim for relief.

The plaintiffs countered that Wisconsin courts have “implicitly acknowledged the availability under the statute of alternative, less drastic forms of relief to meet the needs of a particular case” and “the court’s broad discretionary authority in what is an equitable proceeding.”

Alas, the court punted, stating that “[w]e need not, and do not, resolve these disputes given our conclusion that the complaint’s factual allegations, separate from the request for relief, do not state a claim.”

Georgia: Court Rejects Experts’ Opinions in Fair Value Appraisal Case, Instead Uses Average of Historical Share Buy-In Prices

There are numerous court decisions in fair value appraisal cases that acknowledge the court’s authority to dispense with the proffered opinions of the dueling expert appraisers, but very few that take that step. Abeome Corp. v Stevens (read here), decided by a U.S. District Court judge in Georgia, is one of those rare cases.

Abeome involves a closely held biotechnology company formed in 2006 with over 100 shareholders, focused on development of antibodies. As the court’s opinion noted, the company “never produced revenues or an earnings stream and that from the very beginning investors in Abeome were betting more on the science than on the current financial condition of the company.” By 2021, when according to the court “the company was in serious distress,” it entered into third-party merger and asset sale transactions “as a last-ditch effort to keep the company’s dream alive.”

The transactions triggered dissents and appraisal demands from several shareholders holding a combined 6% of Abeome’s capital shares. At the valuation hearing, the company’s expert, using a modified version of the Black Scholes “Back Solve” methodology, opined that the per share value was $0.217. The dissenters’ expert opined that the per share value was $1.19 based primarily on two stock buy-ins in 2018 and 2020 for $1.25 per share, and representations from management and the Board as to that value.

The court was unpersuaded by both expert’s opinions — the company’s expert mostly because he relied on a single transaction that did not involve the sale of stock or the exercise of a option to purchase stock; the dissenter’s expert because he ignored the company’s dire straits as of the valuation date and the peculiar circumstances surrounding the 2018 and 2020 stock sales at $1.25 per share.

After a thoughtful discussion of Abeome’s hand-to-mouth financial history, and comparing its valuation task to determining “how much a reasonable person would likely pay to join a consortium of gamblers who want to pool their funds to buy lottery tickets for the possibility of wining the next big ‘Power Ball’ drawing,” the court concluded that “the only objective information that the Court can evaluate is what shareholders have paid in the past for the chance of being an owner in one of the few biotech startups that makes it to the finish line.”

Under that approach, using an unweighted mathematical average of annual stock buy-ins between 2006 and 2020 ranging from $0.25 to $1.25, the Court concluded a fair value of $0.56 per share which resulted in awards to the three plaintiffs around $56,000, $308,000, and $938,000.