Purpose Driven General Counsel

It is a beautiful Friday afternoon in downtown Grand Rapids – which is why I took a picture of Rosa Parks Circle. You can see the zamboni is out on the rink. I can’t imagine the ice will last, since the weather is supposed to get in the upper 50s this weekend…

I often tell my clients that lawyers see the worst case scenarios.  Yes, in business, you can usually rely on your relationships to go as they should – (you send an invoice for services and typically you will get paid).

Lawyers see the relationships that go wrong.

We often have clients come to us to protect against disasters, yes, but also to guide our clients after  a disaster has happened.

For instance – when a dispute has erupted between business partners. Someone wants out of the business.

It is much easier to protect a client on the front end. That is particularly why when setting up business partnerships – whether through an LLC, corporation, or some other joint venture, it is crucial to have “the end in mind.”

How do the partners exit their relationship?

A recent court case provides lessons to business owners exiting such relationships.

Since the most common business entity formed in my practice is a limited liability company, I am always looking to read the latest court decisions that come out on LLCs.

There are relatively few court opinions covering the Michigan Limited Liability Company Act, which is why I was excited to read the August 18, 2016 unpublished decision of Joby Clark v Butoku Karate School, LLC – and it just so happened that the facts of this case are somewhat interesting.

The facts of this case seem to be somewhat publicized – at least in Macomb County.

The relevant facts:

1. Butoku Karate School, LLC, a limited liability company in which Clark and John Wasilina were the only members.
2. Plaintiff and Wasilina formed the company in 2002 for the purpose of operating a karate school, and together operated the school until plaintiff left the company in January 2011
3. Rumors that Plaintiff was involved in an inappropriate and illegal relationship with a minor surfaced,
4. On January 5, 2011, plaintiff and Wasilina together went to the bank and withdrew $100,000 from the company’s account,
5. Plaintiff and Wasilina each received $50,000 of the proceeds of the account.
6. On January 12, 2011, Wasilina met with plaintiff and requested that plaintiff sign two documents. The first document was entitled “Notice of Dissolution
7. The second document was entitled “The Consent of the Members” – which, among other things, extinguished Clark’s membership interest in the Company.
8. Both plaintiff and Wasilina signed the documents on January 12, 2011.
9. Thereafter, Plaintiff argued “we agreed my withdrawal was temporary.”
10. Plaintiff sued alleging three counts arising from the dissolution of the business relationship, fraud, failure to distribute, and conversion.

LAW:

IF YOU DO NOT WANT THE DEFAULT RULES UNDER THE MICHIGAN LIMITED LIABILITY COMPANY ACT TO CONTROL YOUR RELATIONSHIP IN THE LLC THEN YOU MUST “CONTRACT OUT” OF THOSE RULES.

I’ve previously written about why an operating agreement matters. A business relationship agreement should be drafted with the end in mind: how do the parties get out of the business relationship?

It is a relatively simple concept:

If you, as an owner in an LLC, do not want to leave your relationship with the other members of the LLC completely subject to the default rules under Michigan law – get your agreement in writing.

In the Butoku Karate case, the Court of Appeals cited the Michigan Limited Liability Company Act regarding the rights of a Member to withdraw from an LLC:

“MCL 450.4509 provides: (1) A member may withdraw from a limited liability company only as provided in an operating agreement….”

MCL 450.4305 provides: Until the effective date of withdrawal, a withdrawing member shall share in any distribution made in accordance with section 304. An operating agreement may provide for an additional distribution to a withdrawing member. If a provision in an operating agreement permits withdrawal but is silent on an additional withdrawal distribution, a member withdrawing in accordance with the operating agreement is entitled to receive as a distribution, within a reasonable time after withdrawal, the fair value of the member’s interest in the limited liability company as of the date of withdrawal based upon the member’s share of distributions as determined under section 303.”

As the Court noted:

“Pursuant to MCL 450.4509, a member’s withdrawal from a limited liability company is governed by that company’s operating agreement. Only if an operating agreement is silent on the subject of additional distribution to a withdrawing member is distribution to a withdrawing member governed by §305”

In this case, the Parties Operating Agreement was clear.

Further, the Parties signed a Consent Resolution concerning the Plaintiff’s withdrawal – that agreement was also clear.

The Court found that “the clear language of the Consent of the Members states that plaintiff relinquished any potential right to additional payment that he may have had previously.”

A few take aways:

If you are going into business with a business partner there are a few things you want to remember:

1. Execute an Operating Agreement (all parties need to sign it); and
2. Make sure that you have thought through how a member may withdraw – in what instances and under what conditions?
3. Any revision to that relationship must be signed in writing.
4. A Court will uphold an agreement signed by all LLC members (absent a clear showing of fraud or other exigent circumstances)

Questions? Comments?

e-mail: Jeshua@dwlawpc.com

http://www.dwlawpc.com

Twitter: @JeshuaTLauka