“Equitable Buyout” as a Remedy for LLC Wrongdoing?
In the world of LLCs, buyouts — where one member sells his/her membership interest to another member or the LLC itself — are commonplace. Buyouts generally fall into one of two categories:
- contractual — where the operating agreement provides a buyout mechanism
- statutory — where one member sues for dissolution, the other members can trigger a statutory right to purchase the plaintiff member’s interest under Corporations Code section 17707.03(c)
But in a case recently published by California’s Second Appellate District — Reliant Life Shares, LLC v. Cooper — the court ordered an “equitable buyout” of a member who proved breaches of fiduciary duty and other wrongdoing by his co-members. This is the LLC Jungle‘s first encounter with the concept of an equitable LLC buyout, so let’s dive in.
Facts: Two LLC members attempt to force the third member out
Reliant Life Shares, LLC was a profitable company brokering fractional shares in life insurance policies, buying the policies from owners who can no longer afford to pay the premiums and selling the policies in fractional shares to investors. The LLC was owned in equal parts by three members: Daniel Cooper, Seam Michaels, and Scott Grady.
In 2013, Cooper stopped working out of Reliant’s office due to a medical condition. There was no expectation by the other members for Cooper to return to the office, and the operating agreement did not require Cooper to perform any work services in order to maintain his membership interest. Michaels quickly confirmed to Cooper by email that he was still “1000% loyal to you as a business partner.” Shortly afterward, Cooper and Michaels signed an agreement confirming that Michaels would run the day-to-day business of Reliant while Cooper would maintain a one-third ownership interest.
However, beginning in 2014, Michaels and Grady undertook various shenanigans aimed at forcing Cooper out. While regular distributions were previously made to all three members, Michaels and Grady agreed (without notice to Cooper, in violation of the operating agreement) to stop distributions to Cooper, and pay themselves essentially all company profits. When Cooper’s accountant attempted to conduct a forensic examination, Michaels and Grady withheld key records.
Later, Michaels and Grady purported to amend the operating agreement (again, without notice to Cooper, in violation of the operating agreement) to expand the LLC’s contractual buyout provisions, enabling the provisions to be triggered if a “majority of the members” determined that another member should surrender his membership interest “for the best interest of the company.” Michaels and Grady then attempted to trigger this new provision, but failed to comply with its timing requirements.
Reliant (at the direction of Michaels and Grady) sued Cooper seeking a declaratory judgment that Cooper was validly removed as a member of the LLC. Cooper cross-complained against the LLC, Michaels, and Grady for breach of fiduciary duty, fraud, breach of contract, accounting, and other claims.
Trial court: award of “buyout damages”
In the first phase of the bifurcated trial the trial court determined the equitable claims, ruling that the efforts to remove Cooper were improper because Michaels and Grady “did not follow any proper procedures” and commenting: “It’s not a close call.” The court found Cooper remained a one-third member, and was entitled to receive one-third of all monies paid to the other two members since November 2013. To that end, the court imposed a constructive trust over certain LLC interests.
For reasons that are unclear from the opinion, the trial court also set a valuation date of January 1, 2019 “for any analysis of Cooper’s interest in Reliant[.]”
In the second phase of trial, the jury found against Michaels and Grady on the claims for breach of the operating agreement, fraud, and breach of fiduciary duty, and other claims. The phase two judgment held that Michaels and Grady were jointly and severally liable for over $6 million in damages for the claims of wrongdoing, prejudgment interest of almost $1.5 million, punitive damages of $1,001,000 against Michaels and $500,000 against Grady, and attorney fees.
The court also determined that the value of Cooper’s interest in the LLC as of the valuation date was $4.2 million, and awarded that amount (plus prejudgment interest) as “buyout damages” against Michaels and Grady in exchange for the transfer of Cooper’s membership interest.
Reliant, Michaels, and Grady (referred to in the opinion as “the Reliant Parties”) appealed, contending the “buyout damages” were “legally unauthorized.”
Court of Appeal: nothing wrong with an “equitable buyout”
The Court of Appeal affirmed the trial court’s judgment.
The Reliant parties argued that the trial court had no jurisdiction to order a buyout in the absence of a claim for dissolution, with the defendant triggering the statutory buyout procedure in section 17707.03.
The Court of Appeal disagreed, finding that nothing in section 17707.03 or case law suggests that a court has no equitable power “to order buyout damages under other circumstances not involving a member’s decision to seek dissolution.” Section 17707.03, the court held, did “not apply here because Cooper did not seek a decree of dissolution, and Cooper did not have to seek a decree of dissolution to obtain buyout damages in this case.”
The court also noted that a buyout of Cooper’s interest was consistent with the relief that Reliant had sought in the first place. “Reliant’s complaint was filed to do exactly what the court has now done, and had the equitable power to do. A court of equity has broad powers and comparatively unlimited discretion to do equity without being bound by any strict rules of procedure.”
The Reliant parties also argued that the buyout damages were duplicative of the damages awarded for fraud. The court rejected this argument too, ruling “There were no duplicative damages awarded.” The jury’s award of damages for fraud “compensated Cooper for the monies he should have received as distributions as a one-third owner. The court’s award of $4.2 million compensates Cooper for his equity interest in Reliant, in return for which he gives up his ownership interest. There is no duplication anywhere.”
Lesson
Under the holding of the Reliant Life Shares opinion, a trial court has authority to order an “equitable buyout” of an LLC member as a remedy for the other members’ wrongdoing.
As an equitable remedy, the application of equitable buyouts will be hyper-sensitive to the specific facts and claims of each case. (Would Cooper have been awarded an equitable buyout if Reliant’s claims hadn’t also sought a buyout?) LLC disputes frequently lack convenient “off-ramps” for the members. The equitable buyout remedy might provide one.