By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Limited Liability Company (LLC) Attorney
The LLC laws provide 3 scenarios in which a court can order a member of an LLC to dissociate under N.J.S.A. 42:2B–24(b)(3). They are the following:
- The member engaged in wrongful conduct that adversely and materially affected the limited liability company’s business;
- the member willfully or persistently committed a material breach of the operating agreement; or
- the member engaged in conduct relating to the limited liability company business which makes it not reasonably practicable to carry on the business with the member as a member of the limited liability company
The first and three scenarios were recently highlighted in a case that came before the New Jersey Supreme Court, IE Test, LLC v. Carroll, 226 N.J. 166 (2016).
The defendants, Carroll, and Cupo formed an LLC called Instrument Engineering under Delaware laws in 2004. The LLC filed for bankruptcy in 2009, with it owing Carroll about $ 2,543,318, which it was never able to repay, and the debt was subsequently forgiven in bankruptcy proceedings. Carroll, Cupo, and a former employee of Instrument Engineering, James, created a new LLC in New Jersey called IE Test, LLC that did a lot of what Instrument Engineering did. Cupo had a 34% share in the LLC, while Carroll and James each had 33% shares. Cupo managed the engineering, manufacturing, and financial components of the business, James handled business development, and Carroll had a limited role. Despite not having a role, Carroll wanted to be paid back for the money Instrument Engineering owed him, even though the debt was discharged in bankruptcy. He demanded to be paid either in an equal share of profits with a premium or a salary with an equal share of the profits. Cupo and James rejected both ideas. With Carroll’s plans for the LLC different than those of Cupo and James, they asked Carroll to disassociate from the LLC, which Carroll refused. The LLC then filed to have Carroll expelled as a member of the LLC.
IE Test argued that Carroll engaged in wrongful conduct by demanding a salary on the sole basis that he wants to have paid an unpaid debt, and that his demands made it not reasonably practicable to continue to work with him as a member. On a summary judgment motion, the trial court and Appellate Division found for IE Test only on the argument that it would not be reasonably practicable to carry on the business with Carroll. The Supreme Court reversed, holding the findings of the trial court to be insufficient to warrant summary judgment for IE Test, and remanded to the trial court for further consideration. It stated that the conduct of the member of the LLC is to be evaluated, with the court then determining whether the LLC can survive in spite of the conduct.
Factors a trial court should include are:
- The nature of the LLC member’s conduct relating to the LLC’s business
- With the LLC member remaining a member, the entity may be managed so as to promote the purposes for which it was formed;
- The dispute among the LLC members precludes them from working with one another to pursue the LLC’s goals
- There is a deadlock among the members
- Despite that deadlock, members can make decisions on the management of the company, pursuant to the operating agreement or in accordance with applicable statutory provisions
- Due to the LLC’s financial position, there is still a business to operate
- Continuing the LLC, with the LLC member remaining a member, is financially feasible.
Often times, with a fluid standard as “reasonably practicable”, you will get a factor test from the Supreme Court so the trial courts can be given guidance about how to evaluate a claim. The Court here suggests that this test with these factors makes it difficult for IE Test to maintain its claim against Carroll, as the evidence shows that despite Carroll’s demands and the inability for the members to work together, the financial position of the LLC is still strong. As courts begin to wrestle with these claims, it will be interesting to see the correlation between the current financial position of the LLC and the deadlock that is occurring that could have damaging economic consequences, and whether that is sufficient to expel a member of the LLC.
To discuss your NJ LLC matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at firstname.lastname@example.org. Please ask us about our video conferencing consultations if you are unable to come to our office.