The New Jersey Supreme Court has decided a new case addressing what it takes to expel a member from an LLC in New Jersey.
The applicable statute in New Jersey (42:2C-46(e)) has three subsections dealing with expelling a member, two of which are fairly clear. One section permits the expulsion of a member by the Court when he or she engages in activity that may hurt the company in a material way, or is about to engage in such activity; and another permits expulsion when a member willfully and persistently breaches the Operating Agreement or the member’s fiduciary duties. Both of these sections are simple and straightforward. If a member is acting against the company’s interests, he or she can lose his membership in the LLC. Of course, the LLC has to pay for the shares, but expulsion may be a valid remedy.
A third section provides that a member may be expelled by Court order when he or she engages in conduct relating to the company that makes it “not reasonably practicable to carry on” the business with that person as a member.
If you can understand exactly what that means, you are light years ahead of most every lawyer who practices in this area of law. The statute does not define what this means, and the meaning is not obvious from a plain reading of the words. One client wanted it applied to a minority owner who was hosting a porn website in his spare time. The fact that this conduct was not related to his ownership of the company in any way caused my client to decide against spending the money to see if his interpretation of the statute would hold up.
The Supreme Court has finally issued an opinion that sets forth a seven-part test that is too cumbersome and, quite frankly, boring to repeat in detail here. However, it essentially boils down to whether the company is in such a deadlock that it is difficult for business to be conducted.
Some lawyers are writing scholarly articles explaining the subtle nuances of this new seven-part test. But business owners need not memorize what the Supreme Court has done. What is important to know is that, if your NJ LLC is in a crisis in which nothing can effectively be done because of the conduct of one member, or where that member is actively harming the company, you may be able to force him to sell his interest and expel him from the LLC.
Under the statute, such an application is supposed to be made by the company. What has not yet been decided is whether a minority member may bring such an action against a majority owner, derivatively, in the name of the company. If New Jersey courts decide this is appropriate, then minority members will have yet another very powerful tool in their arsenal. Rather than simply suing for member oppression seeking to be bought out, the claim can forcefully be made that the minority member should be able to buy out the majority. Perhaps the Supreme Court will clarify this issue soon.