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and/or worthy of controlling the entity, not to mention which party should
prevail in terms of relief.
Judges who hear these
cases can also be inconsistent in their rulings. Some
will follow the letter of the
law and well-crafted governance agreements. Others,
sensing inequity in the
documents or procedures,
will cast them aside and effectively override asserted
Business owners may hope
for a judge who will faithfully follow their rules —
but they must prepare for
the possibility that a judge
who hears “their case” will not be as benevolent.
Surprise No. 1: Company Procedures Ignored —
The first rude awakening for the scrupulous business
owner is that governance formalities are often ignored.
Details concerning LLC member or manager structures,
shareholders, members, director or officer meeting
notices, waivers, quorums and resolutions or the “terms”
of an operating agreement or bylaws may fall victim to
“the bigger picture”. Procedural errors (e.g., the propriety
of notices, the use of proxies to obtain votes, the ratifica-tion of actions in routine corporate documents, etc.) are
rarely fatal to a business dispute argument. Judges often
ignore these aspects of governance and consider more
seriously the actions taken by the parties.
Surprise No. 2: Majority May Not Be Controlling
— A second surprise is that majority owners (or a group
owning a majority) may not actually control the company.
Judges can rule that the majority abused its control,
abused its voting owner, squeezed out minority holders
and/or oppressed other owners. Judges can overrule corporate actions, grant minority owners rights to damages,
appoint a receiver to operate the company or, in extreme
cases, dissolve the company. Effectively, the company
becomes a ward of the state.
Surprise No. 3: Buy-Sell Prices Ignored — Often, the
governance documents of closely-held businesses contain buy/sell provisions establishing buyout prices to aid
disputes involving an owner leaving the business. However,
when bickering owners come before a judge, they may be
shocked to learn that the judge deems the formula or price
mechanisms of the underlying buy/sell provisions unfair.
The judge may even set a hearing to determine the company’s value. So much for pre-existing buy/sell agreements.
Surprise No. 4: In Some States, The Law Allows
Judges To Do Almost Anything — In some states, the
law provides judges with a non-exclusive statutory list of
options for resolving ownership disputes and managing
a company from the bench. These include cancelling or
altering bylaws or articles of incorporation/formation;
removing managers, directors, partners or officers; appointing third-party managers, directors, officers and/or
receivers; mandating dividends/distributions; dissolving
the company; or overruling any act of the company. Such
“equitable remedies” often times contradict the expectations of business owners.
Surprise No. 5: LLCs — The All or Nothing Entities —
Unlike corporations, courts tend to approach LLCs from
one of two extremes. On the one hand, they can honor
and uphold a detailed and professionally drafted operating agreement as if it were sacred text. On the other
hand, courts can create “equitable solutions” — especially
for entities using thin or poorly drafted agreements. If
the LLC operating agreement is detailed and tailored for
the situation before the court, judges often respect it. But
if the operating agreement is ill-suited; a short, vague
skeleton; or, worse, oral — the judge will rule the day.
When forming an LLC, it is important for business
owners to keep these points in mind so that they understand the risks involved, but ensure that the governance
of his or her business is correctly documented.
Fred Mendelsohn is partner at Burke, Warren, MacKay
& Serritella, P.C. in Chicago, IL. He can be contacted at
email@example.com or 312-840-7004.