Member Disputes

How Do I Prove I am a Member of a California LLC?

Question:  Last year my friend and I formed a California limited liability company by filing Articles of Organization with the California Secretary of State.  He opened a bank account on which he is the sole signer.  Although both of us have been providing services on behalf of the LLC my “friend” now says that he owns 100% of the LLC.  How do I prove I own 50% of the LLC?

Answer:  Unfortunately your problem is one we hear about a lot.  It is a problem that can easily be avoided if all the members of a newly formed LLC would sign an Operating Agreement immediately after forming the LLC.  One of primary reasons to sign an Operating Agreement is because it identifies all the members and states the percentage of the LLC owned by each member.  The lack of a good Operating Agreement leads to member disputes and conflict.

The Articles of Organization of a California limited liability company does not contain the names of the members (owners) of the LLC so it is not helpful.  However, California law requires that the members of a newly formed California LLC file a Statement of Information with the California Secretary of State within 90 days of the date the LLC was formed.  If you or your friend filed this document it would be evidence that you are a member of the LLC.  Read “California LLC Statement of Information.”

If your LLC filed a partnership tax return or an S corporation tax return the names and percentage ownership of the LLC should be set forth in the tax return.  If you friend filed the tax return and didn’t give you a copy of the return your friend may not give you a copy of it now.

If you can’t resolve the situation your only recourse may be to file a lawsuit and ask the court to find that you are a member of the LLC.

By |2016-07-03T16:52:53-07:00April 3rd, 2016|Categories: CA LLC Formation, FAQs, How Do I, Member Disputes, Members|0 Comments

California Court of Appeal Rules RULLCA Does Not Apply to LLC Lawsuit Filed before 1/1/14

The California Court of Appeal held in Kennedy v Kennedy, 235 CA4th 1474 (2015), that the California Revised Uniform Limited Liability Company Act (RULLCA) did not apply to a dispute among members of a California limited liability company because their lawsuit was filed before January 1, 2014, the RULLCA effective date.  The court based its ruling on California Corporations Code Section 17713.03 which states,

This title does not affect an action commenced, proceeding brought, or right accrued or accruing before this title takes effect.

The defendants argued that RULLCA applied because they wanted to be able to use the mandatory disgruntled member buy-out scheme set forth in Corporations Code Section 17707.03(c)(1) which states:

In any suit for judicial dissolution, the other members may avoid the dissolution of the limited liability company by purchasing for cash the membership interests owned by the members so initiating the proceeding, the “moving parties,” at their fair market value.

Subsections (c)(2) – (6) set forth a procedure for consummating the buy out.  Subsection (c)(6) states,

A dismissal of any suit for judicial dissolution by a manager, member, or members shall not affect the other members’ rights to avoid dissolution pursuant to this section.

The defendants wanted RULLCA to apply so they could carry out a buy out under Section 17707.03(c) despite the fact the plaintiff had dismissed the claim for judicial dissolution.  There is no mandatory buy out under California’s LLC law before January 1, 2014.

By |2016-12-13T21:20:06-07:00July 3rd, 2015|Categories: CA Law, CA LLC Statutes, Lawsuits, Member Disputes|0 Comments

California LLC Allocation of Profits

Question:  My friend and I started a California LLC.  We never signed an Operating Agreement.  I assumed that we would share the profits equally, but my friend says that he gets 60% of the profits and I get 40%.  This dispute has ruined our business relationship.  What should I do?

Answer:  Your dispute is too common.  Unfortunately the toothpaste is out of the tube, and it may be too late to solve the huge problem created by the members failure to sign an Operating Agreement that states how profits and losses will be allocated among the members.  The California Revised Uniform Limited Liability Act does not specify how profits and losses will be allocated among members of a multi-member California LLC.

Members of a California limited liability company must agree in an oral agreement or in a written and signed Operating Agreement as to how profits and losses will be allocated among the members.  The problem with an oral agreement is that it is a recipe for disaster because when people disagree they have no way to prove what they previously agreed to.

One of the main reasons all of the members of a multi-member California LLC need to sign an Operating Agreement is so they have proof in the document as to how the profits and losses are allocated among the members.

By |2015-05-09T10:34:06-07:00May 9th, 2015|Categories: FAQs, Member Disputes, Operating Agreements, Operating LLCs|0 Comments

LLC Lawsuits- Direct or Derivative

Prior to the creation of the first limited liability company (LLC), shareholders were able to sue the corporation through a direct or derivative lawsuit.  Classifying the claim as direct or derivative would determine the procedure of the complaint, in addition to determining the remedy and likely outcome.  Now, with the popularity of the LLC, the derivative and direct classifications are applying to members’ complaints about the operation of the LLC.  Since LLC law does not have too many of these cases, it is beneficial to look at the corporate law (especially because LLC law often borrows from corporate law).  In fact, as seen in several states, it is often corporate case law which determines the outcome of LLC disputes between a member and the LLC itself.  For these reasons, a brief description of the differences between a direct and derivative lawsuit would be beneficial not only to a shareholder, but also to a member or manager of an LLC.

Direct

A direct claim allows the member or members to pursue the lawsuit in their own name(s).  This is allowed only if the member or group of members were injured by the actions of the LLC, and it is those members (not the LLC) who would receive the benefit of recovery.  However, if the entire LLC was injured by the action of a manager, the claim does not classify as direct.  An example of a direct claim would be if the voting rights or interests of a certain member were lost.  Here, it is not the entire LLC that is harmed, but only that member.

Furthermore, for a direct claim, the remedy sought is usually equitable, or non-monetary.  In the example above, the proper remedy would not be money damages, but an injunction to prevent the LLC from harming the voting interest of the particular member.  Overall, if a member is injured (not the LLC), and the remedy is equitable, then the claim is direct.

Derivative

A derivative claim is much more complicated than a direct claim.  A derivative lawsuit is one in which the entire LLC is harmed (by the LLC), rather than a specific member bring injured.  In other words, the lawsuit is brought by a member on behalf of the entire LLC, against the LLC itself.  An example of a derivative law suit would be if the LLC engaged in an agreement to pay an extraordinary amount of money to an individual who is not performing.  Here, a law suit would benefit the entire LLC, and the remedy would be the money lost on the violated agreement.

A key difference between a derivative and direct lawsuit is that the concept of “demand.”  Under a derivative lawsuit, the plaintiff is required to either make demand of the company, or prove that demand of the company is futile.  Demand refers to demanding the LLC take on the case.  Since the lawsuit is meant to benefit the entire LLC, courts have mentioned that the LLC should have the ability to investigate and determine the validity of the case itself.  However, it is apparent that if an LLC hears about the complaint and chooses to investigate, a conflict of interest could result in the LLC dismissing a valid claim, rather than bringing the suit.  Furthermore, since courts often defer to the business judgment of business entities like the LLC, there is a low likelihood that a plaintiff will be able to show that the LLC wrongfully dismissed the suit.

For all of the problems associated with making demand of the company, the plaintiff in this type of suit usually chooses to show demand futility.  To show demand futility, the plaintiff usually has to show that there is reasonable doubt that the managers and directors are independent, or that there is doubt that the agreement/transaction was a valid business decision.  In California, however, there is not a specific test to show demand futility.  If demand futility is shown, then the suit proceeds.  If not, then the suit is dismissed because demand should have been made.

The next step in a derivative lawsuit is based on whether the LLC has hired a special litigation committee (SLC).  An SLC is a committee often employed by the LLC to settle these types of disputes.  A court will defer to the decision of the SLC, as long as the SLC is independent.  To test this, courts analyze how the SLC came to it’s conclusion, evaluating whether the SLC used good faith in it’s reasonable investigation.  If the SLC was not independent, the court could apply it’s own business judgment to determine the value of the suit.  After this, the derivative suit has taken all possible steps, and the suit either proceeds, settles, or has been dismissed along the way.

As one can easily imagine, the direct law suit is much easier for a plaintiff to bring than the derivative suit.  On the other hand, the LLC would prefer a suit to be classified as derivative, because of the multiple opportunities to dismiss the suit, through the demand doctrine or an SLC.  Therefore, if an issue arises in your LLC, be sure to investigate the complaint to determine what steps can and should be taken to protect yourself and the LLC.

 

 

By |2016-12-13T21:20:14-07:00February 25th, 2015|Categories: Lawsuits, Member Disputes, Miscellaneous|0 Comments

Single Member’s Death Could Cause Dissolution of LLC

Some states require that a limited liability company (LLC) have at least two members.  Many states, including California, allow for single member LLCs.  Another jurisdiction that permits a single member LLC is Alabama.  The LLC law of California and Alabama provide that when the single member dies, the LLC must be dissolved, subject to two exceptions.  First, the single member LLC can continue if the operating agreement provides for the continuation and a method for determining the successor(s) to the deceased member.  Second, the LLC can continue if the assignee(s) of the interest of the deceased members elect to continue the business within 90 days of the death.  Recently, in L.B. Whitfield III, Family LLC v. Whitfield, the Supreme Court of Alabama dealt with the dissolution of the single member LLC.

In this case, the single member of an Alabama LLC died, and left his interest in the LLC to his four children.  There was no vote to continue the LLC, and no special provisions in the operating agreement.  Still, the children operated the business for 10 years after their father’s death.  The four children began to have business disputes and one child (the manager) filed a lawsuit against the other three children.  The three defendants discovered the Alabama law that dissolves a single member LLC unless the majority of the heirs agree to continue the business within 90 days.  The three children then sued for a court order that the LLC distribute its assets to the members because the LLC was statutorily dissolved 90 days after the father’s death.

Despite the defenses offered by the plaintiff, the court held that the three children were correct, and that the LLC was dissolved when the children failed to continue the business within 90 days after the father’s death.  The Supreme Court of Alabama said it did not matter that the LLC continued to operate for 10 years.  The court highlighted that the fundamental principles of an LLC include membership admission through a written agreement that is signed.  Since this new agreement was never established, the LLC was dissolved.

Caution:  If a California resident dies his or her membership interest may be subject to an expensive and time-consuming California probate.  To learn about nasty California probates and how to avoid a California probate and save your loved ones mega-bucks read “Trusts Should Own Valuable LLCs to Avoid Probate.”

For more on this topic see “What Happens If the Sole Member of a CA LLC Dies?“

By |2016-12-13T21:20:15-07:00June 22nd, 2014|Categories: CA Law, Lawsuits, Member Disputes|0 Comments

Arkansas Rules that Member v Member Claims Are Direct

When one member of a limited liability company has a claim against another member or a manager of the limited liability company (LLC), it can be classified as direct or derivative.  A direct claim is one where the individual member is negatively affected by an action of the LLC, but the whole LLC is not injured.  A derivative suit is one in which the entire LLC is affected by a decision of one of it’s managers or members.  In these derivative cases, a member usually brings suit on behalf of the LLC.  Determining the classification is important, because it reveals how the procedure of the claim will be handled

For the LLC, a derivative suit is preferable because there are many opportunities in the procedure which allow for the claim to be dismissed.  However, the plaintiff (LLC member) would rather the claim be direct, so they can avoid procedural obstacles and take have their claim proceed much easier.  For more detail, including implications of both cases, see direct and derivative suits.

Though the differences between direct and derivative claims may be clear, which category the claim falls under might be difficult to discern.  This is especially true for LLCs, because they do not have a long history of these types of cases.  The Arkansas Supreme Court dealt with this issue in Muccio v. Hunt.  Here, minority members of an LLC sued the other members and managers.  They alleged that these majority members committed fraud, breached their duty to disclose information, and converted their membership interests.

The trial court found that the claim was derivative.  This meant that the minority members of the LLC had no standing because the LLC itself was the proper party to bring this complaint.  However, the Supreme Court of Arkansas reversed, holding that the claim may proceed in the members’ names, stating that the members themselves were injured; and therefore, the claim was direct.  The court addressed the fraud, breach of duty to disclose, and conversion separately.

Regarding fraud, the court first noted these types of suits are normally derivative.  The  court noted that direct suits are appropriate, however, when the member shows an injury that is unique to the member, and not applicable only to the LLC.  In applying this rule to the present situation, the court found that the minority members suffered loss of their ownership.  The court further noted that the fraud being alleged by plaintiffs was not fraud that harmed only the LLC.  This resulted in the claim of fraud to be classified as direct, not derivative.

When analyzing the duty to disclose, the Arkansas Supreme Court noted their LLC statute.  This requires the LLC managing members to make available full and true information that reasonably affects any member.  The court later stated that these statutory rights of members supported individual claims, not claims made by the LLC.  This led the court to rule that this claim was also direct.

Finally, the court addressed the claim of conversion (wrongful possession of another person’s property).  In this case, the plaintiffs contended that the LLC converted the minority member’s interests.  In their complaint, the plaintiffs stated the the managing members did this through fraudulent misrepresentation.  The court agreed that the conversion was tied to the fraud; since the fraud claim was direct, then the conversion claim was also direct.

Throughout the opinion, the Arkansas Supreme Court constantly compared LLC and corporate law.  The court even mentioned corporate case law and applied it to the LLC case at hand. This was a surprise to many, and appeared to blur the line between the two business entities.  By ruling that these types of claims were direct, the Arkansas Supreme Court made it easier for a disgruntled LLC member to bring a suit against the other members.  If this type of ruling becomes a trend for other states, it means that the LLC may have to take more steps to protect themselves from liability.

 

 

By |2019-03-17T14:05:51-07:00April 18th, 2014|Categories: Lawsuits, LLCs & Corporations, Member Disputes|0 Comments
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