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“Is You Is or Is You Ain’t:” Membership in an LLC

Membership in a LLC - Limited Liability Company

The New Jersey Superior Court, Appellate Division case Giordano DeCandia v. Anthony T. Rinaldi, LLC d/a The Rinaldi Group and Anthony Rinaldi, (N.J. App. Div., Oct. 5, 2020) per curiam, is about whether the plaintiff was or is a member of the LLC, and the economic consequences of that determination. The Appellate Division affirmed the rulings of the trial court (in a bench trial), except for reversing one of the defendants’ counterclaims. The case is most important for two reasons: first, it underscores the potential for chaos resulting from the uncertainties of oral versus written claims; and second, it reveals that the New Jersey judiciary, even at the intermediate appellate level, still finds a limited liability company (even 27 years after the first NJ LLC statute was adopted) a strange and challenging creature. The critical issue of membership is nicely captured by the rather famous old jazz song written by Louis Jordan and Billy Austin and first recorded on October 4, 1943, just over three weeks after your author was born. As its title invokes, when uncertainty abounds, it is difficult to have more than an ephemeral relationship.

Membership in an LLC

Rinaldi had a construction management and general contracting business in New York and New Jersey. In 2003, he formed the LLC as a manager-managed LLC, with himself as both the sole member and the manager. Plaintiff DeCandia began working for the LLC in 2011, with a compensation package of a salary plus a 10% ownership interest, with the ability (based on the amount of work the plaintiff brought in) to go to 20% of “net profits on that work.” The plaintiff signed an operating agreement on February 14, 2011. The Capital Contribution schedule attached to that 2011 agreement stated that the “plaintiff’s ownership interest is performance-based rather than through capital contributions.” The plaintiff received an LLC membership certificate reciting the arrangement. Rinaldi later testified that “profit-sharing is a prevalent and customary compensation mechanism within the commercial construction industry.” It is worth noting that the LLC’s comptroller also testified that the parties advised of the arrangement and that she had a similar profit-sharing deal. On September 25, 2013, the parties signed an amended operating agreement (the “2013 agreement”), adding two more members as the company grew, and giving them similar percentage interests. The plaintiff received an increase to a 20% interest, and a replacement LLC membership certificate reciting the new terms. The old certificate was voided.

In 2015, Rinaldi and the plaintiff began negotiating a buy-sell agreement, to buy out a deceased member’s interest from the surviving spouse, in case either Rinaldi or the plaintiff died. The Court notes that the initial draft of the agreement said that plaintiff would own “twenty percent of the common stock of the LLC.” On October 19, 2015, the parties, two other LLC “employees” (the Court’s term), and the LLC’s accountant met to discuss the buy-sell agreement, tax implications, and financial liabilities related to being (what the Court calls) “an equity partner.” Plaintiff, per the accountant, purportedly said that he was interested in “profits, not taxes.” The Court also reports, without any clarifying explanation, that plaintiff “wanted to avoid any personal liability on the LLC’s bonds.” The plaintiff may have been referring to payment and performance bonds, which are usual in the construction business, as opposed to debt instruments. In that meeting, Rinaldi disclosed that the LLC was under criminal investigation by the New York City Borough of Manhattan District Attorney after the NY Department of Buildings found that numerous safety violations by the LLC caused death at a construction site. Testimony asserted that the plaintiff became frightened that his LLC membership certificate might expose the plaintiff to criminal liability. Rinaldi told the plaintiff that if he was scared, he should resign and turn his LLC membership certificate over to the LLC’s attorney. Shortly after, the plaintiff did so, without signing the certificate or providing any other “explanatory writing.” No buy-sell agreement was ever entered into with the plaintiff. The Court states that after that October meeting, the plaintiff received his salary plus bonuses, but no “profit-sharing.” The plaintiff never sought to recover his membership certificate.

By March 2017, things had deteriorated to the point that Rinaldi terminated the plaintiff. The plaintiff, apparently anticipating that deterioration had contacted a competitor of the LLC in 2016. On the plaintiff’s last day with the LLC, he sent his wife the LLC’s proposed budget for a job it was bidding on; she forwarded the budget to the competitor, which submitted a rival bid. The plaintiff then met with the executives of the potential customer and urged them to hire the LLC’s competitor. The employment agreement plaintiff signed on April 28, 2017, recited that he did not have an ownership interest in any competitor of his new employer. On September 15, 2017, the plaintiff sued the LLC, and Rinaldi, seeking a declaratory judgment that he was a 20% owner of the LLC and other relief. Defendants counterclaimed that the plaintiff had breached his common law duty of loyalty as an employee AND his duty of loyalty as a member of the LLC. The trial court held against the plaintiff on all claims and granted the defendants’ counterclaims. The Appellate Division upheld the trial court’s rulings on all but the counterclaim for breach of the duty of loyalty as a member of the LLC. That statutory obligation applies to members of a member-managed limited liability company, but the LLC was manager-managed so that the duty applied only to managers; Rinaldi was the sole manager. The plaintiff’s efforts to assert equitable claims relating to minority oppression and the like failed because, as both the trial court and the Appellate Division found, the plaintiff’s double-dealing gave him “unclean hands.”

“Is You Is or Is You Ain’t”

Carefully written documents could have resolved most of the factual ambiguities. But both trial and appeal courts found sufficient basis for concluding that the plaintiff had voluntarily withdrawn from the LLC, one of the acts of dissociation that ends membership. Given the trial, the Court’s determination that the plaintiff was not a member or had withdrawn as a member, it is not clear how the trial court could have found that the plaintiff had violated a duty of loyalty owed by a member of a limited liability company. Even more troubling in both opinions (beyond the occasional inaccurate language, e.g., limited liability companies do not have “common stock;” a member of a limited liability company is not an “equity partner”) is the finding that the concept of a contingent percentage interest in an unincorporated business was mere compensation and did not result in plaintiff owning a membership interest in the LLC. That is simply a misstatement of the law. A person may become a member of a limited liability company with a present, vested interest or with a contingent, earning-based interest. Or as it appears from the recitals noted in the Appellate Division opinion, both. The plaintiff’s original deal was:

  • salary;
  • 10% membership interest; and
  • contingent 10% “profit-sharing” interest based on the work plaintiff brought in

Ultimately, as both courts held that plaintiff had given up “whatever ownership interest he may have held in the LLC,” the issue was moot. But the language in the Appellate Division opinion might well allow a future court to find that someone who is in fact a member of a limited liability company in New Jersey is not a member at law – a troubling risk and a reason to consider forming an unincorporated entity under the law of a jurisdiction other than New Jersey.

If you have any questions about this post or any other related securities or general business law matters, please feel free to contact me at pdhutcheon@norris-law.com.