New Connecticut Law Adds Additional Grounds to Kick Out Member of an LLC

Here’s a common scenario I see as an attorney handling business disputes:  Four members start an LLC to engage in business together.  They all get along as friends, colleagues, or business associates.  Lets call the hypothetical business Harmony LLC. When they start Harmony, each person has an assigned role with ownership of 25% of the company.  Harmony has two members with management experience, another member has the sales experience, and the fourth member has the technical expertise.  They all verbally agree that each member will work full-time to make the business work. They put a budget together to get started.  Someone in the group brings up legal expenses for a partnership or membership agreement.  In Connecticut, this governance document is referred to as an operating agreement.  The four partners are tight on funds and springing for the legal expenses for a comprehensive operating agreement is not high on the list of priorities.  One of the members brings up that in Connecticut, LLCs are not required to have an operating agreement and there are online sources for cheap, inexpensive form agreements.   Plus, they figure they all get along so why do they need a comprehensive agreement?  As a result, Harmony starts operating in business with either no operating agreement or a bad form agreement.

What happens if Harmony struggles at first, or more than anticipated, or circumstances change for some members?  For example, what if the business potential in the long run is very strong, but Harmony is not generating enough income in the early stages for all four members to survive financially.  As a result, some of the members feel financial pressure.   Lets say the sales or technical member pursues another job offer somewhere and one of them leaves Harmony.  All of the sudden Harmony has 25% of its work force leave the company.  Then, maybe the second member leaves for another job.  Now only two members are left working with Harmony.  However, both of the departing members say they will not give up their collective 50% ownership interest.  Even more problematic, the departing members start competing for clients or customers.  What do you do? Do the two remaining members keep working full time only to have to turn over 50% of the profits to the non-working members?

The two remaining members decide to go to an attorney.  They find out that without an operating agreement, Connecticut LLC’s are governed by Connecticut General Statutes.  Similarly, if you have a poorly drafted operating agreement and the agreement does not address specific issues, then Connecticut’s LLC statute will govern.  Many times this has unintended consequences that might favor some members over others.  A comprehensive operating agreement might cover the Harmony scenario.  It might have provisions that address what happens when a member stops working for the LLC or factually withdraws.  In the absence of such an agreement, however, the members of Harmony may have limited options.  You can be faced with a situation where members of an LLC are forced to go to court to judicially dissolve the entire LLC because they are otherwise locked in with non-performing members.

One the many new changes to the LLC law in Connecticut (effective July 1, 2017) relates to what is known as disassociation of a member.  This is legal jargon for when a member leaves or is kicked out of an LLC.   The new changes to the LLC law provide some potential relief to the remaining members of LLC’s in the same situation as the members of Harmony.  Section 34-263a of Connecticut’s General Statutes addresses “Events causing disassociation.”  One of the provisions states, in pertinent part:

On application by the company or a member in a direct action under section 34-271, the person is expelled as a member by judicial order because the person: (A) Has engaged or is engaging in wrongful conduct that has affected adversely and materially, or will affect adversely and materially, the company’s activities and affairs; (B) has committed wilfully or persistently, or is committing wilfully or persistently, a material breach of the operating agreement or a duty or obligation under section 34-255h; or (C) has engaged or is engaging in conduct relating to the company’s activities and affairs which makes it not reasonably practicable to carry on the activities and affairs with the person as a member

There could be many reasons why the remaining members of Harmony do want to ask the court to dissolve the entire LLC.  Instead, the remaining members may prefer to try to “disassociate” or kick out the members who left.  Section 34-263(a)(5) provides some new grounds to potentially get a court order to judicially remove the members.  The statute permits either the LLC itself or a member to proceed with an application to the court to seek disassociation for the grounds listed, including when it is “not reasonably practicable to carry on the activities and affairs with the person as a member.”    This option was not available prior to July 1, 2017 and provides some useful potential relief for feuding members of an LLC.

Although there are now additional options for disassociation of LLC members, business owners are well advised to address the situation in an operating agreement.  This might avoid the time and expense of going to court with or the last option of judicial disassociation of a member or dissolution of the LLC itself.  Moreover, as I will address in future posts, there are other new changes to the LLC laws in Connecticut that will govern in the absence of an operating agreement.

Dispute Between Business Partners Ends In Dissolution and Double Damages Under Connecticut Wage Act

In Saunders v. Firtel, a decision to be officially released on September 22, 2009, the Connecticut Supreme Court upheld an award of double damages under Connecticut’s wage and hour laws in what amounted to a dispute between two business partners, Barry Saunders and Burton Firtel.  The supreme court also upheld judicial dissolution of a company owned by the partners.  The case highlights the complications that can arise between partners when one partner is also an employee in the business.  

In this case, Saunders became part owner of a company that Firtel previously formed by himself.  Saunders also became an employee of the company as part of a larger business relationship.  This is not an uncommon arrangement in business, especially when a small business is purchased by a larger company.    Saunders and Firtel also formed another limited liability company together as equal owners. The business relationship was documented with an operational agreement. 

Although the partners successfully operated the business for years, a dispute arose out of unpaid wages after Saunders unsuccessfully tried to change the compensation structure of the business relationship.  In response, Firtel fired Saunders.  Saunders brought a lawsuit in Connecticut state court for unpaid wages claiming he was an employee.  He also sought to dissolve the limited liability company formed with Firtel. 

A few months ago, Connecticut’s wage and hour laws were in the national spotlight because of the scandal with AIG’s bonus plan for its employees in Wilton, Connecticut.    AIG claimed that it had to pay the bonuses because it feared double damages under Connecticut’s wage and hour laws.  In this instance, Saunders brought his case in court relying on the same provisions that AIG feared. 

Connecticut’s unpaid wage law, General Statutes section 31-72 ,provides that:

When any employer fails to pay an employee wages . . . the employee may recover, in a civil action, twice the full amount of such wages, with costs and such reasonable attorney’s fees as may be allowed by the court . . 

To recover double damages, although not mentioned in the statute, courts require a finding of bad faith, arbitrariness, and unreasonableness by the employer.  In Saunders’ case, he won because the trial court found that the failure to pay was willful.  What might seem strange about the case is that Saunders was not only an employee, but he was also a 49% stockholder and an officer in the company he sued to obtain double damages.  Firtel was a 51% owner, and the President. 

Dan Schwartz’s Employment Law Blog has a nice summary of the supreme court’s treatment of how Saunders qualified as an employee as well as the implication of the decision on employers.  I tend to agree with Dan that there is no significant impact on employers because if wages are earned, the wages should be paid regardless of the business relationship.

I think the case does highlight important considerations for business partners.  The case demonstrates how a breakdown in the relationship between two business partners can turn into a dispute where one partner effectively ends up in the shoes of the employer subject to wage and hour laws.  This was probably not intended and it is unlikely that Saunders and Firtel viewed themselves as employee and employer.  In fact, they appeared to be nearly equal partners.

The case is also another example of a once successful business partnership ending in arguments over compensation and written agreements.  It further shows that dissolution of a company is another judicial remedy, along with disassociation and expulsion in partnerships, for a company that can no longer operate in a practical manner. 

 

Connecticut Supreme Court Confirms Expulsion Is Available Remedy In Partnership Dispute

In an issue of first impression, the Connecticut Supreme Court confirmed that partnerships can expel a partner rather than dissolve when there is a breakdown of the business of the partnership.  The case is Brennan v. Brennan Associates, et al.  The official opinion will be released on August 18, 2009, but the advanced opinion already was released online. 

The case involves a complicated set of facts and circumstances surrounding the deterioration of a once successful partnership that operated a shopping center in Trumbull.  The breakdown of the partnership began after the death of a partner.

The decedent partner essentially ran the partnership and kept all the books until his death.  The decedent’s will directed that his interest go to his two cousins.  Following the will reading, the partnership broke down over disputes on check writing authority, access to records, the transfer of interest, and an old tax conviction of a surviving partner who was the plaintiff in the case. 

The plaintiff  offered to buy out the decedent’s interest, which as rejected by the estate.  The plaintiff subsequently filed a lawsuit seeking, among other things, to accomplish a buy out of the decedent’s partnership interest and to gain access to the books and records.  The surviving partners wanted to continue the partnership’s business rather than dissolving it.  As such, in addition to other claims by the defendant administrators, they filed a counterclaim application seeking to expel the plaintiff from the partnership under section 34-355 of Connecticut’s Uniform Partnership Act.

The statutory scheme at issue permits a trial court to grant an application for expulsion if a partner engages in conduct that "makes it not reasonably practicable to carry on the business in the partnership with the partner." In this case, after a bench trial, the court issued a ruling granting the application filed by the surviving partners to expel or dissociate the plaintiff partner.  The plaintiff appealed claiming that acrimony and distrust between partners may be proper for a dissolution, but it was not a proper basis for dissociation.

On appeal, the Connecticut Supreme Court  disagreed with the plaintiff and ruled that dissociation was an available remedy given the facts present as an alternative to dissolution.  The supreme court noted that under Connecticut’s Partnership Act,

a partnership now has a choice, either to dissolve the partnership or to seek the dissociation of a partner who has made it not reasonably practicable to carry on the partnership with him.  The new remedy of dissociation permits a financially viable partnership to remain intact without dissolving the partnership and reconstituting it.

In this case, the conduct at issue for the dissociated partner was a past felony tax conviction, a pattern of adversarial conduct toward other partners, and a false accusation of fraud against the others partners.  With these facts present, the supreme court found that a trial court had enough to grant an application for expulsion and dissociation of the partner.  The court stated:  

irreparable deterioration of a relationship between partners is a valid basis to order dissolution, and, therefore, is a valid basis for the alternative remedy of dissociation.

It is worth noting that the court indicated that an old felony conviction standing alone likely would not meet the required standard.   In any event, the case essentially provides that there is no basis for a higher burden for dissociation as opposed to dissolution.

My takeaway from the decision is that it promotes the policy of cooperation amongst partners by confirming expulsion as an option for getting rid of a "problem" partner.  As noted in the decision, prior to the statutory scheme permitting dissociation, partnerships faced with similar problems had to dissolve.  This process could perhaps create too much leverage for a "problem" partner forcing dissolution.  Instead, this decision confirms the statutory availability of dissociation under no higher of a standard than dissolution.  This may be a more preferable remedy for many Connecticut partnership disputes.

The decision also serves as a reminder of how a partnership or  closely held company can breakdown following the death or disability of a partner or key member of the business.  These circumstances highlight the need for specificity in partnership and operating agreements including buy out provisions for death and disability, transfer or assignment of interests, and continuation of operations.   

It is also important to note that the supreme court left open the dissociated partner’s rights to bring a proceeding to compel valuation and purchase of his interest after dissociation.  The court also indicated that the partnership agreement could have included a provision allowing the remaining partners to initiate a valuation proceeding, but it did not in this case.