Category Archives: operating agreement

Will the Disability Provision of an Operating Agreement be Upheld Under New Jersey Law?

In Zavodnick, Perlmutter & Boccia L.L.C., v. Zavodnick, No. A-1242-11T1 (App. Div. August 2, 2012), the Superior Court of New Jersey, Appellate Division, upheld an arbitrator’s decision to allow a law firm to buyout a disabled member. Id. at 8.  In so doing, the Court refused to limit the scope of the arbitrator’s authority to determine issues relating to the disability.

In that case, the members of the law firm, Zavodnick, Perlmutter & Boccia L.L.C (“law firm”), had signed an operating agreement that provided of resolution of any disputes concerning the withdrawal of a disabled member.  That resolution was to be handled by the parties themselves, if possible.  If not, the exclusive remedy would be arbitration under the rules of the American Arbitration Association (“AAA”).  An AAA arbitration was instituted in regard to the members’ decision to require one of the attorneys, Allen Zavodnick, Esq. withdraw due to his disability.

Zavodnick challenged the arbitrator’s ruling upholding the decision to have him removed.  In that
regard, Zavodnick filed a lawsuit in the Superior Court of New Jersey, Chancery Division, Hudson County.  The Court upheld the arbitrator’s decision. Zavodnick appealed to the Appellate Division. 

The Appellate Division also upheld the decision.  In its opinion, it stated in part “[b]ecause the request for arbitration  . . . clearly encompassed the issue of whether defendant’s disability or his
cessation of professional service constituted a withdrawal event, and because the operating agreements plain terms required arbitration of that issue, we find defendant’s arguments to be of insufficient merit to warrant discussion in a written opinion.” Id. at 8.

This case highlights the importance of paying particular attention to the disability provision of an operating agreement before entering into one.  Very few of us ever expect to become disabled; however, it is best to account for the unlikely event that such a provision might need to be invoked.

Comments/Questions: gdn@gdnlaw.com

© 2012 Nissenbaum Law Group, LLC

May a Party be Bound to an Executed Operating Agreement That Was Not Intended to be Final?

In Fabrau, L.L.C. v. Prashant Shah, et. al., No. A-4464-10T3 (N.J. Super. Ct. App. Div. July 11, 2012), the Appellate Division of the Superior Court of New Jersey was presented with the following question: Should parties be bound by an executed operating agreement that was not intended by all the parties to be final when there is evidence that a subsequent operating agreement was created but was not signed?

In that case, Fabrau, L.L.C. (“Fabrau”) filed a complaint against two of its alleged members, Prashant Shah (“Shah”) and Srinivisa Nallamotu (“Nallamotu”) (collectively “Parties”) for breach of the confidentiality and non-competition provisions of an operating agreement. Id. at 2.

Fabrau sought to develop low-cost, transparent software to assist in setting prices for pharmaceuticals sold by smaller pharmaceutical companies to government entities.  Chester Schwartz (“Schwartz”) was approached to help with sales and marketing, Nallamotu was approached because he was also interested in a more affordable alternative to a government pricing system and Shah was approached to help develop the product.  A draft amended operating agreement was created naming the members as Fabriczi (one of the creators of Fabrau), Rau (the other creator of Fabrau) (collectively “The Creators”), Nallamotu, Schwartz and Shah.  However, Shah sent an email explaining that there was changes he wished to discuss as per his lawyer’s suggestion.  At some point either before or after this e-mail, an undated draft operating agreement was executed by everyone except Nallamotu in a parking lot.

Fabrau argued that the signed agreement was final and binding on both Shah and Nallamotu because, although Nallamotu did not sign it Nallamotu had written an e-mail to a customer announcing that he had formed a company with a few people from the industry.  See Id. at 5.  Fabrau contended that this evidenced Nallamotu’s intention to be bound by the operating agreement. See Id. 

In contrast, Shah asserted that he was induced to sign the agreement by The Creators’ representation that Schwartz would not do his part of the work unless an agreement were signed; Shah also claimed that all who signed in the parking lot acknowledged that the agreement was not binding. See Id.  Nallamotu asserted that the fact that he never executed the agreement at issue should have been enough to show that he was not bound by its terms. 

The Appellate Division pointed to evidence that showed that sometime after the execution of the initial agreement, another member was recruited to the company.  The operating agreement was amended to reflect Christopher Biddle’s (“Biddle”) name, however, it was never executed.  A subsequent email was sent to all of the members asking that the document be executed and a few days after that another email listed the execution of the agreement as one of the “Company Action Items.” Id. at 7.  The Parties contended that the unexecuted document further evidenced that no agreement was ever reached.

After months of struggling to make sales of the pricing system, and after months of no communication between the members, The Creators decided to contact an outside vendor to see about converting the Shah-designed government pricing system to a web-based application.  Then they contacted a venture capital company (“Company”) to promote the product. Unbeknownst to The Creators, Shah and Nallamotu had also contacted the Company for help with the same product.  As a result of intellectual property concerns, the Company made inquiries that led to The Creators and Shah and Nallamotu finding out that each group was trying to promote the product. The Creators consequently filed a lawsuit against Shah and Nallamotu.

At trial, the Superior Court of New Jersey, Law Division, found that because Shah was admittedly the sole creator of the product, he had an ownership interest in the software.  Further, they found that no certificate of formation of Fabrau named Shah and Nallamotu as members of the company.  The Law Division concluded that a viable partnership agreement had never been reached by the parties.

On appeal, the Appellate Division agreed with the Law Division and also found that there was no meeting of the minds with respect to the operating agreement. It remained unexecuted in the Parties’ eyes at the time it was presented to Biddle and thereafter (as evidenced by the e-mail asserting that execution of the agreement was on the “Company Action Items” list). See Id. at 15. Ultimately, the Appellate Division found that the agreement that was executed in the parking lot was a sham designed to mislead Schwartz into believing that his expectations would be protected if he proceeded.  The parties’ conduct failed to manifest intent to be bound by their initial agreement.  See Id. at 17.  The Appellate Division affirmed the Law Division’s holding that no contract existed, and Shah and Nallamotu could not be bound.  See Id.

Proof of execution of an agreement is not the only thing that courts use to determine the rights and obligations of parties.  As shown in Fabrau, a court might consider the intent of the parties in conjunction with electronic communication that evince a contrary intention than what is displayed in the agreement.  The parties should have a common understanding of their expectations and responsibilities under the agreement.  Most importantly, it is vital that any correspondence or documentation between the parties reflect what they intend. This will serve to increase the agreements enforceability in court.

Comments/Questions: gdn@gdnlaw.com

© 2012 Nissenbaum Law Group, LLC

Will a Court Enforce a “Put” Offering Buy Out Clause in a LLC Operating Agreement

In Martin Heller v. Lauren Gardner Trust, No. A-0914-11T2 (N.J. Super. Ct. App. Div. June 27, 2012), the court considered the enforceability of a “put offering notice, by which one or more members could require the other members to buyout their shares.”  The mechanism was straightforward.  It involved the following:

Under the terms of the Agreement, ‘upon receipt of the Put Offering Notice, the responding member shall be obligated to purchase the Membership Interest of the Initiating Member at the purchase price set forth in subsection (b) of this Section 6.03.’

Id. at 3.

In that case, the issue was whether an April 27, 2010 letter from one of the members to the other was enough to invoke the put option.  The letter stated, in part, “as per page 19 paragraph 6.03-Put Option, this letter should be construed as a put offering notice.”  The court determined that the letter was clearly sufficient to invoke the Put.

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© 2012 Nissenbaum Law Group, LLC