Two recent decisions from the New Jersey Appellate Division explore some key issues for members of limited liability companies. In Denike v. Cupo (394 N.J. Super. 357), the court ruled that, under the New Jersey Limited Liability Company Act (LLCA), the value of a member’s interest must be determined as of the date of his dissociation from the LLC. In Flores v. Murray (App. Div. October 19, 2007), the court addressed the grounds for the expulsion of a member and the forfeiture of his interest. In both decisions, the Appellate Division stressed that members of LLCs could not take advantage of analogous provisions of New Jersey’s Minority Shareholder Act.
The Denike case involved a dispute between the two 50% members of a mortgage broker, Classic Mortgage LLC. Plaintiff Lawrence Denike and defendant Michael Cupo agreed that they would keep 70% of their commissions but would contribute the remaining 30% toward the company’s overhead expenses. They also agreed to divide up the responsibilities so that Denike managed the business and Cupo managed the sales force and handled payroll. Over time the company grew and Denike began spending much more time running the business. By 2002, his commissions exceeded Cupo’s by nearly $450,000. As a result of their agreement, this meant that Denike was funding a disproportionate amount of the company’s overhead expenses. To correct this situation, the two men agreed in July 2002 that Denike would receive $15,000 per month as a management fee. However, the relationship between the two deteriorated and, in September, they decided to separate.
After they were unable to agree on a buy-out fi gure for Cupo’s interest, they agreed to mediate their dispute in December 2002. For purposes of the mediation, Cupo agreed to a December 31, 2002, valuation date. During the mediation, Cupo remained at Classic Mortgage and was paid his 70% commission on sales. In July 2003, after the mediation ended unsuccessfully, Denike commenced an action to terminate Cupo’s membership and acquire his interest. On July 18, 2003, the court issued an order deeming Cupo dissociated from the company, subject to a later determination as to the appropriate compensation for his interest. Denike then moved to establish the valuation date as December 31, 2002, while Cupo claimed the appropriate date was July 18, 2003, when the court deemed him dissociated from the company.
The trial court determined that December 31, 2002, was the appropriate date under all of the circumstances, reasoning that it had the same discretion as it would have under the Minority Shareholders Act (N.J.S.A. 14A:12-7(8)(a)) to select a valuation date “deemed equitable by the court.” The appellate court disagreed, noting that Classic Mortgage was governed by the LLCA, which did not incorporate a similarly fl exible provision. Even though it found the LLCA silent as to the valuation date for the purposes of purchasing a member’s interest, it construed the LLCA, like the Uniform Limited Liability Company Act, to require that the valuation be based on the date of dissociation. The court went on to discuss the expert valuation testimony that had been offered by each side. The trial judge discounted both parties’ experts as fl awed and unreliable and retained an independent expert to sort out the issues. The court’s independent expert concluded that the valuation of Cupo’s interest should not include marketability or minority discounts, reasoning that the sale was to the remaining member who wished to continue the business, rather than to a third-party purchaser. The appeals court found no abuse of discretion in the trial court’s decision to adopt that standard. The New Jersey Supreme Court has granted certifi cation in the Denike case and a decision is expected in 2008.
The Flores case involved claims by members of an LLC against another member (who also served as the CEO) for breach of his fi duciary duties. The court chronicled a litany of misconduct by defendant John Murray that led the court to sustain the claim.
Murray had agreed with several others to form Crystex Composites, LLC. The operating agreement required each member to contribute $200,000 to capitalize the company. Murray hired his son and supplemented his salary with undisclosed payments disguised as company expenses. Murray also promised one of the investors that, in return for pledging certain stock to secure a company obligation, the company would guarantee a minimum distribution to the investor of $94,500 each year. When the other members found out that Murray had not contributed his $200,000, Murray promised to do so within six months or else forfeit his interest. As the deadline approached, Murray fraudulently executed an employment agreement between himself and Crystex providing that he could not be terminated without a substantial payout. In addition, the other members discovered the secret payments to his son and the minimum guarantee arrangement, which had never been authorized by the other members. Accordingly, they terminated Murray as CEO, expelled him from Crystex, and then sued to recover damages.
Murray challenged his expulsion and forfeiture claiming that he did not breach any fi duciary duty to the LLC and that, even if he did, his breaches were not suffi ciently material. The trial court rejected both claims and the appeals court agreed. First, the court noted that the LLCA authorized an LLC to provide for forfeiture of a member’s interest in the event a required cash contribution was not made. Indeed, the lower court went further and held that, inasmuch as the contribution was a precondition of membership, Murray had never acquired an interest.
Second, the court sustained the members’ decision to expel Murray, fi nding ample support to do so under the LLCA (N.J.S.A. 42:2B-24b(3)), which allows dissociation where (a) a member has engaged in wrongful conduct that adversely and materially affects the LLC’s business; (b) a member willfully or persistently commits a material breach of the operating agreement; or (c) a member engages in conduct relating to the LLC’s business which makes it not reasonably practicable to carry on with the member as part of the LLC. The court noted that the secret payments to Murray’s son violated state and federal tax laws and subjected the company and the other members to serious potential liability. In addition, the misappropriation of company funds to pay a noncompany debt subjected Murray to potential criminal liability.