The challenges in making the transition from the the founding members of a successful enterprise to the second generation of managers are often difficult, as this litigation involving that has endured for nearly a decade demonstrates. It may be that the business has moved in a new direction, or perhaps it is simply that the founding member no longer inspires the same type of confidence as when he or she was younger. The second generation of owners often has its own ideas about the way the business should run, but the founders are loathe to cede control.
And of course there are those cases in which the founding member simply refuses to retire long after they have ceased to be a productive contributor to their business. It is not particularly unusual that the more active members of a business, whether it is a partnership, limited liability company, or a close-corporation, will ultimately seek to expel the founder from the business.
In Hopkins v. Duckett, Docket No. A-7783-08T1 (January 17, 2012), litigation between the founder of a turnaround firm and the second generation of managers endured for nearly nine years. That lawsuit including the recent decision of the Appellate Division, is instructive for a couple of key points.
Former LLC Member Claims Age Discrimination
First, the court affirms a trial court determination that the senior manager in this case is not an employee for purposes of the Law Against Discrimination. In our experience the LAD is a frequent counterclaim when a founder is expelled from the business. The defendants in this case opened the door to the claim when they told the founder theirs was a “young man’s game.”
Second, and perhaps most importantly, this litigation emphasizes the risk of not establishing exit rules before there is a dispute. The defendants dodged a bullet on the age discrimination claim, not because they planned for the eventuality of the founder’s retirement, but through fortuitous circumstance.
The age discrimination claim under New Jersey’s Law Against Discrimination (LAD) that was asserted by the Nightingale plaintiff is not, in my experience, unusual in such cases. Age frequently is a factor in such disputes and the LAD claim should not be unexpected. In rejecting the claim, the Appellate Division affirmed the trial court’s holding that the plaintiff expelled LLC member was not an employee for purpose of age discrimination, applying the six factor analysis articulated by the U.S. Supreme Court and adopted in the context of a Conscientious Employee Protection Act (CEPA) claim in Feldman v. Hunterdon Radiological Associates, 187 J.J. 228
Owner Was Not Employee
The six factors used to determine whether the partner, officer, member of the board or major shareholder qualifies as an “employee” under federal anti-discrimination law are:
- Whether the organization can hire or fire the individual or set the rules and regulations of the individual's work
- Whether, and if so, to what extent the organization supervises the individual's work;
- Whether the individual reports to someone higher in the organization;
- Whether, and if so, to what extent the individual is able to influence the organization;
- Whether the parties intended the individual to be an employee, as expressed in written agreements or contracts;
- Whether the individual shares in the profits, losses, and liabilities of the organization.
The decision turned on an interesting, though not for our purposes particularly useful, conflict of laws analysis. Applying the Feldman factors to the facts of the case, the trial Court found that the plaintiff expelled LLC member did not meet the standard for employee and thus that the age discrimination claim was properly dismissed.
It could have gone the other way, however. There are organizations that are more structured and formalized, in which the founders do actually report to others within the organization. And some organizations, in particular corporations, execute employment contracts with the principals. There was no real good evidence of culpable conduct in this case and the defendants were the beneficiary of the fact that until shortly before his ouster, the plaintiff pretty much operated as he chose.
Planning for Senior Member's Withdrawal
Here are some steps that could have been taken that might have helped to avoid a decade’s worth of litigation:
- Develop a management succession plan before it is time for one of the principals to retire. If you wait until the event is about to happen, the difficulty in coming to an agreement increases exponentially. Ongoing employment by the enterprise must be a condition for equity ownership.
- Do not create economic incentives to fight. One of the factors that appear to have been motivation for further litigation was an apparent difference between the established value in the event of a voluntary sale and the potential for a larger payout in the event of an involuntary sale.
- Document performance issues, if any. If someone is going to be terminated, make sure that there is cause for the termination. Otherwise, you may find yourself fighting off an age discrimination suit. Even if the suit doesn’t have much objective merit, it isn’t worth the toll.