Most of the time, when I ask a new client who is in control of the company, the question is not difficult to answer. Even after an election takes place, the results are usually not difficult to discern. After all, an LLC or corporation usually does not have so many members or shareholders that the votes are difficult to count. But what happens when the losing side of a vote simply does not recognize the victors, and refuses to cede control?
While this may sound bizarre, it can actually happen. If the vote result is crystal clear, a court likely will intercede and enforce the vote results immediately, But if the losing side makes up facts – such as contesting whether the members on the winning side are actually “members” of the LLC and claiming that they are mere “investors,” without the right to vote – an epic legal battle can ensue.
One such legal battle just concluded, and my clients emerged victorious. When the losing faction in an LLC election over control of the company refused to cede power, the losing (and now ousted) CEO argued that members of the winning faction were not members and had no right to vote, despite mountains of evidence to the contrary. There was an arbitration clause in the Operating Agreement so the parties were forced to go to arbitration. The arbitration lasted over four years, mostly because the ousted CEO actually changed the domicile of the LLC from New Jersey to Belize in the middle of the arbitration as a ploy to defeat jurisdiction. He argued that because of the move, all such internal battles now needed to be brought in court in Belize, rather than to arbitration in New Jersey. Apparently hoping that a court would actually go along with such a ploy, he filed a motion before a New Jersey court to stay the arbitration, so that Belize could hear the lawsuit he filed down there.
If this sounds insane to you, that is because it was. But my clients still had to fight legal battles in the New Jersey trial court (multiple times), Appellate Division, and Supreme Court, as well as the trial court and appellate courts of Belize. My clients won every legal battle fought, in more jurisdictions than they wanted to be in, but the cost was enormous. Then, to top it all off, when my clients finally took control of the company, they discovered that the ousted CEO had caused his close associate to take the servers from the company headquarters, crippling the company on his way out the door, as he sought to ship them to an overseas subsidiary that he planned to control with these servers, out of the New Jersey judge’s jurisdiction. Immediate court and police intervention were the only things that saved the company, as it would never have survived the servers being sent overseas successfully.
While I imagine that no one reading this post will ever have facts similar to these – as that case was, hopefully, one of a kind – it does highlight the importance of clear, contemporaneous record keeping for closely held businesses, as well as for individual investors. The number of clients who have little real proof that they are members of an LLC, as opposed to merely investors (who have no right to vote), is rather alarming. The fact that you receive a K-1 does not necessarily resolve the issue, as “investors” also receive K-1’s. Many have no documentation at all that they are either. What would you point to if the other members of the company suddenly argued that you weren’t really a full member, with full membership rights? Or that you weren’t an owner of any kind?
While my point is to highlight just how bad things could get if you can’t prove your ownership, it is also important to emphasize that if you are even engaged in a battle for control of a company based upon a disputed vote, make sure you retain a law firm that has fought – and won – such a battle before.
If you have any questions about this post, or other related matters, please email me at dcroberts@norris-law.com.