What Are Enterprise Goodwill and Personal Goodwill and Are They Marital Assets in SC?
The value of a business is determined by a number of factors, including its income, physical assets like buildings and equipment, and intangible assets like goodwill.
But what exactly is “goodwill” in business, and what’s the difference between personal goodwill and enterprise goodwill? And is goodwill subject to division as marital property in divorce proceedings (as discussed by the SC Court of Appeals in Bostick v Bostick, 2022)?
Personal Goodwill vs. Enterprise Goodwill
“Goodwill” is an intangible business asset. Goodwill can encompass many things, depending on the nature of the business, including branding and brand recognition, customer relations, employee relations, and intellectual property (trademarks, copyrights, patents, and trade secrets).
Goodwill can be divided into two types, personal and enterprise.
Personal goodwill is inextricably tied to an individual or individuals, often the business owner(s). The individual’s exceptional knowledge or skills, experience, reputation, and relationships with customers, employees, and suppliers may all be factors in a company’s personal goodwill valuation.
Enterprise goodwill is tied to the business itself rather than to an individual, such as its brand, location, convenience for customers, unique offerings, intellectual property, and the like.
Say a highly regarded chef sells one restaurant and leaves to start another. If the regular customers follow the chef to the new restaurant, that’s an example of personal goodwill. Once the chef has gone, the restaurant has lost that intangible asset (the personal goodwill tied to the chef) that brought in business and made money. But it still boasts a great location, convenient opening hours, and a unique menu, all of which will outlast the presence of the founding chef and continue to bring in revenue; that’s enterprise goodwill.
Determining the dollar value of a company’s personal goodwill and/or enterprise goodwill can be a challenge for business owners.
Is Goodwill a Marital Asset Divisible in Divorce? Bostick v Bostick Background
Another issue some business owners face is whether their company’s personal goodwill and enterprise goodwill are marital assets that can be divided in a divorce. This varies by state. The South Carolina Court of Appeals weighed in on the issue in the case Bostick v Bostick in March 2022 (read the opinion here).
Josie M. Bostick and Earl A. Bostick, Sr., were married in 1971 and began divorce proceedings in 2017. During their marriage, Earl was a dentist with a successful practice in two locations, Ridgeland and Bluffton. Earl retired before the divorce was finalized and sold the Ridgeland practice to the Bosticks’ son for $569,000 plus $51,113.15 in accounts receivable. The contract divided the $569,000 in two parts: $144,860 for purchased assets and $424,140 for goodwill. The contract also required Earl to be available for up to 60 days after the sale to help transition, and it contained a covenant not to compete.
How this money should be divided in the divorce was a point of disagreement. The family court determined that the hard assets and accounts receivable were marital assets to be divided 50/50, as the Bosticks had previously agreed. But it held that the goodwill was a nonmarital asset because it was personal goodwill and was therefore Earl’s alone. The court based this decision on Moore v Moore (2015), which ruled that enterprise goodwill is a marital asset subject to division, while personal goodwill belongs solely to the professional and is not subject to division.
Josie contended the family court erred in this decision. The appeals court agreed.
Was it Personal or Enterprise Goodwill?
The SC Court of Appeals notes that if the dental practice were an “ongoing concern,” then “the majority, if not all” of the goodwill would be personal, but it was known that Earl was leaving the practice and the profession altogether. The court does note that the agreement for Earl to be available for 60 days after the sale and the covenant not to compete do weigh in favor of personal goodwill but concludes that there was no evidence that the entire amount should be considered personal goodwill.
Plus, Earl had previously sold his Bluffton location, and the revenue from that sale – which also included a goodwill portion – was put on his side of the ledger for purposes of equitable distribution. The court says it sees no reason to treat the sale of this second location any differently.
“Therefore, we conclude the family court erred in not treating the entirety of the sales price as marital property,” says the court.
(Note that there is a possibility this decision could be appealed and go to the SC Supreme Court.)
Buying, Selling, and Growing Your Business in South Carolina
No matter what stage of business ownership you’re in, you can use the guidance and advice of an experienced business attorney like Gem McDowell. With over 30 years of experience helping clients in South Carolina, Gem is a problem solver who is ready to help you whether you need advice and assistance buying or selling an existing business, starting up a new one, or helping your business thrive while protecting your interests.
Call Gem and his team at his Mt. Pleasant, SC office at 843-284-1021 to schedule a free consultation.
Employee or Independent Contractor? A Closer Look at the Four-Factor Model
How do you know whether a worker in South Carolina should be classified as an employee or an independent contractor? The decision has big consequences for both employer and worker, as that classification impacts taxes, workers’ compensation, and more.
While the IRS has its own standard for determining whether a worker should receive a 1099 or a W-2 (which you can read about in this blog), right now we’ll focus on how the State of South Carolina approaches this question.
The Four-Factor Model to Determine Employment Status
For many decades, South Carolina courts have used what is called the four-factor model or four-factor test to determine whether a worker should be considered an employee or an independent contractor.
The four factors are:
- The right or exercise of control;
- Furnishing of equipment;
- Method of payment; and
- The right to fire.
Let’s look a closer look at all four.
The right or exercise of control. When an employer controls or directs the worker – or has the right to, even if that right is not exercised – that denotes an employer-employee relationship. An employee is told when to do their job, how to do it, and is typically supervised to some degree. In contrast, an independent contractor decides their own hours, determines how to do their work, and works without supervision.
Furnishing of equipment. When equipment is furnished by the employer to the worker to complete their job, that’s evidence in favor of an employee classification. An employee uses, for example, the computer and desk, or truck and tools, of the employer at the employer’s expense. An independent contractor uses their own materials and tools at their own expense.
Method of payment. Time-based payment tends to show an employee relationship while project-based payment tends to show an independent contractor relationship.
Right to fire. South Carolina is an at-will employment state meaning that an employer can fire an employee and end the relationship immediately with no further obligations or liabilities (assuming the termination was not unlawful). In contrast, many independent contracts include clauses in their contracts that require full or partial payment if a job is terminated unexpectedly before its conclusion.
When determining the status of a worker, no single factor is determinative, and South Carolina courts weigh all the evidence to come to a conclusion. The examples above are as black-and-white as possible, but when these types of cases reach the Court of Appeals or the Supreme Court of South Carolina, they are never as clear cut.
The Four-Factor Model Put to the Test in Ramirez v May River Roofing, Inc.
A case heard in the South Carolina Court of Appeals in November 2020, Ramirez v May River Roofing, Inc. (read the opinion here), shows the four-factor model in action and how SC courts approach the issue of determining a worker’s classification.
The Background
Francisco Cedano Ramirez started a business as a sole proprietor called Cedano Roofing. About a year later, he began working for a company called May River Roofing, Inc., and he worked “continuously and exclusively” with them for approximately three years.
In January 2016, Ramirez was on a roofing job when he fell to the ground, a fall of about 16 feet, and sustained “significant injuries to his back, neck, shoulders, chest, ribs, lungs, and upper extremities” as a result.
The Claims
Ramirez filed a claim for workers’ compensation on the basis that he was May River’s direct or statutory employee.
The Single Commissioner at the SC Workers’ Compensation Commission determined that Ramirez was neither a direct employee nor a statutory employee of May River, but an independent contractor, and therefore was not eligible for workers’ compensation benefits. Ramirez appealed and an appellate panel affirmed the decision.
This appeal followed in which the SC Court of Appeals looked at the evidence de novo to come to its own conclusion about whether Ramirez was an employee of May River and thus eligible for workers’ comp benefits.
Weighing the Evidence to Determine Employee or Independent Contractor Classification
Statutory employee: A statutory employee is worker whose income is treated as if they’re an independent contractor but whose taxes are treated as if they’re an employee. In South Carolina, “settled law commands” a sole proprietor may not be considered a statutory employee, so Ramirez’s claim that he was a statutory employee of May River was denied.
Direct employee: Here the court spends time looking at the evidence using the four-factor model.
- Right or Exercise of Control
Factors in favor of independent contractor classification:
- Ramirez had “a great deal of autonomy”
- Ramirez set his own schedule
- Ramirez did not punch a time clock
- Ramirez was free to negotiate for additional payment or decline the job
- Ramirez was free to hire additional help on a job without approval from May River
Factors in favor of employee classification:
- Ramirez was required to wear a May River branded t-shirt at the jobsite
- Ramirez was required to display a magnetic May River decal on his truck
- Ramirez worked exclusively with May River for three years, which suggested to the court that May River had the right to control Ramirez by withholding work
There was also conflicting testimony about the level of supervision, so that was not considered as a factor in favor of either party.
The court acknowledges that May River’s control over Ramirez’s appearance and their exclusive working relationship might seem “trivial” but thinks they are not. It concluded that May River’s control over Ramirez was more than that of a typical employer-independent contractor relationship and concluded that this factor weighed in favor of an employee relationship.
- Furnishing Equipment
Factors in favor of independent contractor classification:
- Ramirez provided his own tools
- Ramirez provided his own vehicle
Factors in favor of employee classification:
- May River provided Ramirez with all the materials used in the roofing jobs
- May River gave Ramirez a branded t-shirt and magnetic truck decal he was required to display
The court concluded that May River furnishing all the materials at its own expense showed “direct evidence of control” over Ramirez and found that this factor also weighed in favor of employee classification.
- Method of Payment
Factors in favor of independent contractor classification:
- Ramirez was paid “per roofing square” for roofing work (the majority of the work he did)
Factors in favor of employee classification:
- Ramirez was paid by the hour for repair work (a minority of the work he did)
Because the majority of Ramirez’s work was paid on a project or piecemeal basis and his payment did not depend on the amount of time he spent working, the court concluded that this favored an independent contractor relationship.
- Right to Fire
The court did not find any evidence that weighed in favor of either party.
Conclusion: Employee Relationship
The evidence in this case was a mix of factors in favor of both employee relationship and independent contractor relationship. However, after considering all the evidence the court concluded that May River and Ramirez did have an employer-employee relationship, meaning that Ramirez was eligible for workers’ compensation benefits.
Employers Take Note – South Carolina Courts Favor the Employee Classification
Even though Ramirez set his own schedule, had freedom to negotiate payment, could hire help without approval, was paid per roofing square the majority of the time, and used his own vehicle and tools, the SC Court of Appeals still found that the relationship he had with May River constituted an employer-employee relationship.
This reflects the tendency of South Carolina courts to strongly favor the employee classification over the independent contractor classification when it comes to cases involving benefits for injured workers. “The general rule is that workers’ compensation law is to be liberally construed in favor of coverage in order to serve the beneficent purpose of the [Workers’ Compensation] Act; only exceptions and restrictions on coverage are to be strictly construed,” the SC Court of Appeals states in this opinion. While this has long been a general rule, this bias towards employee classification has been even stronger since the Lewis v L. B. Dynasty (2015) case (covered briefly in the 1099/W-2 blog).
If you’re an employer, keep this in mind when hiring and classifying workers. You must treat independent contractors like independent contractors. Seemingly small things, like asking your worker to wear a branded t-shirt, can become evidence of an employer-employee relationship, as seen in this case. Otherwise, hire the worker as an employee so they have the protections they’re entitled to under South Carolina law.
Business Law and Strategic Advice
For help with starting, running, or ending a business, call attorney Gem McDowell of the Gem McDowell Law Group. He and his team help business owners in the Charleston area and across South Carolina with forming LCCs and corporations, drafting corporate governance documents like buy-sell agreements, handling commercial real estate transactions, and more. Gem is also a problem solver who can give you strategic advice so you can avoid problems and protect yourself and your assets. Call him at his Mt. Pleasant office today at 843-284-1021 to schedule a free consultation.
Can You Be Bound by an Arbitration Clause You Didn’t Agree to?
In June 2016, 90-year-old Bonnie Walker moved into the Brookdale Senior Living Center, a residential care facility in Charleston, SC. Six weeks later, she wandered out of the center one evening, and the following day her body was found by family members at a retention pond on the property, where she had been maimed and dismembered by an alligator.
This tragic event forms the basis of Weaver v. Brookdale Senior Living, Inc. (find the opinion here), a case heard by the South Carolina Court of Appeals in 2020. Walker’s granddaughter Stephanie Walker Weaver brought a lawsuit in her personal capacity (rather than on behalf of her deceased grandmother or anyone else) against the facility, its owner, and its director (collectively, the Appellants) for negligence, negligent infliction of emotional distress, and intentional infliction of emotional distress.
However, those aren’t the main issues for the court here. Instead, the court focuses on arbitration – specifically, whether the Appellants could compel Weaver to arbitration.
Arbitration and Potent Public Policy
Arbitration is an effective form of alternative dispute resolution (ADR) that settles matters out of the courtroom. In binding arbitration, the outcome is legally binding, just as it would be in litigation. Unlike litigation, however, arbitration is typically less expensive and faster in reaching a resolution. Another benefit of arbitration is that it keeps private business private, as opposed to resolving an issue in court where it becomes a matter of public record.
In this case, the Appellants say the trial court erred by denying their motion to compel Weaver to arbitration because there is strong state and federal policy favoring arbitration. The court of appeals agrees there is “potent” public policy favoring arbitration, but only in terms of interpreting and enforcing arbitration agreements that are entered into validly. The Federal Arbitration Act, which was signed in 1925 and applies to both state and federal courts, commands that arbitration agreements be treated like other contracts – no better or worse – but it doesn’t compel arbitration where mutual agreement among parties to arbitrate is absent. Nor does it give Appellants a “leg up,” in the words of the appeals court, in determining whether a valid arbitration agreement exists in the first place.
With this in mind, the issue in the present case is to determine whether a valid arbitration agreement exists: Are Weaver and the Appellants bound by a valid arbitration agreement?
When Nonsignatories Can Be Bound to Arbitration Agreements
If you’ve signed many contracts in your life or clicked “I Agree” on terms of service online, there’s a high chance you’ve agreed to binding arbitration with certain parties. That’s because standalone arbitration agreements and arbitration clauses within contracts are now commonplace. In those situations, you’ve agreed that you and the other party will settle disputes through arbitration rather than through litigation.
The residency agreement that Weaver’s grandmother signed when she entered the Brookdale facility contained an arbitration provision. It not only bound Walker to arbitration, but “third parties not signatories to this Arbitration provision,” including her family members, too.
However, Weaver herself never signed such an agreement with Brookdale, and there’s no evidence that she was aware of the content of the agreement her grandmother signed, yet the Appellants moved to compel her to arbitration. How is this possible?
In South Carolina, state law says that that nonsignatories can be bound to arbitration in an agreement they were not a party to under a number of theories, such as incorporation by reference, assumption, veil piercing/alter ego, and estoppel. For appellants, there’s only one theory: equitable estoppel, also called direct benefits estoppel in arbitration.
Equitable Estoppel, or Direct Benefits Estoppel
Equitable estoppel prevents someone taking legal action that goes against their previously stated words or prior behavior. The idea of equitable estoppel is that the party wishing to use it was in some way misled by the other party.
Under equitable estoppel/direct benefits estoppel, a nonsigner can be compelled to comply with a contract’s arbitration provision if all three of these conditions are met:
- The nonsigner’s claim arises from the contractual relationship;
- The nonsigner has “exploited” other parts of the contract by reaping its benefits; and
- The claim relies solely on the contract terms to impose liability
As to the first point, the court of appeals concludes that Weaver’s claims do not arise from the contractual relationship. Her claims are not about how the Appellants breached any provision(s) in the residency agreement entered into with her grandmother; rather, they’re about general duties Appellants owe to everyone.
For instance, the court notes that one of Weaver’s claims was for emotional distress over the Appellants’ mishandling and failure to safeguard her grandmother’s remains. There is no provision in the residency agreement Walker signed relating to handling of remains. So Weaver’s claims do not arise directly from the contractual relationship between Walker and the Appellants, meaning the first of the three conditions is not met.
As to the second point, the court concludes that Weaver “exploited” and otherwise benefited from the residency agreement as much as “a pedestrian run over by a truck has benefited from the contract for the purchase of the truck” – that is to say, not at all. Therefore the second condition is not met, either.
Since all three conditions must be met and the first two weren’t, equitable estoppel cannot be used here. The court of appeals concludes that there is no valid arbitration agreement between Weaver and Brookdale and therefore affirms the trial court’s denial of the Appellants’ motion to compel arbitration.
Legal Help for Strong Contracts
Whatever side of the agreement you’re on, it’s important to understand the rights and limitations relating to arbitration whenever you sign a contract or agree to terms of service that include an arbitration provision. South Carolina courts have enforced arbitration agreements when valid but do not go so far as to bind nonsignatories to arbitration except under certain conditions.
For help with arbitration clauses, contracts, and other business matters, contact Gem McDowell at the Gem McDowell Law Group in Mt. Pleasant, SC. He and his associates serve clients in the Charleston area and across South Carolina, protecting their business interests and helping them plan for the future. If you have an issue to discuss or are looking for an experienced business attorney to advise you, call Gem today at 843-284-1021 to schedule a free consultation.
Is Promissory Estoppel Subject to Statute of Limitations in South Carolina?
Thomerson v. DeVito came to the Supreme Court of South Carolina on certification from the U.S. District Court for the District of South Carolina, as the U.S. District Court needed a matter of South Carolina law settled before it was able to issue a full judgment in the case. (Read the SC Supreme Court’s opinion here.)
The certified question is: “Does the three-year statute of limitations of S.C. Code Ann 15-3-530 apply to claims for promissory estoppel?”
First let’s briefly look at the background of the case, then at what promissory estoppel is, and finally at how the court answered the question and the reasoning behind it.
Thomerson v. DeVito
Johnny Thomerson was hired at Lenco Marine, a boat products manufacturer, and stated that in employment negotiations he (along with another employee) discussed getting ownership interest in the company as part of his compensation package. Richard DeVito, president of Lenco at the time, said they’d “work on that as we go down the road,” and the subject was dropped.
A few years later, in early 2009, DeVito told Thomerson and the other employee that Lenco was buying back 15% interest from a minority shareholder, and the plan was to distribute those shares in equal 3% amounts to five separate employees. Thomerson stated that he believed the shares would be issued when the buyback occurred.
But by 2011, Thomerson still hadn’t received any shares. He asked DeVito about it, who said he didn’t want to distribute shares while the company was involved in a lawsuit. By 2013, the lawsuit had been settled, but DeVito continued to put Thomerson off about the ownership shares. (By this time, the other employee had left the company, without ever receiving the promised 3% interest.) In 2016, DeVito finally admitted he was not going to fulfill the promise he made to Thomerson to give him 3% ownership interest in the company.
In 2018, Thomerson brought a lawsuit against DeVito and Samuel Mullinax, CEO of Lenco at the time in question (collectively, the Defendants), in federal district court. The court granted summary judgment in favor of the Defendants on all but one of Thomerson’s many claims on the basis that they were barred by the three-year statute of limitations. The court determined that the three years started counting down in 2013 after the lawsuit against Lenco was settled and DeVito still refused to give Thomerson the promised ownership interest. To be in time, Thomerson should have filed by 2016, but he didn’t bring suit until 2018.
The one claim the district court didn’t grant summary judgment on was Thomerson’s claim of promissory estoppel, as it was unclear whether the statute of limitations applies to promissory estoppel in South Carolina.
What is Promissory Estoppel?
First, what is promissory estoppel? Promissory estoppel is a legal doctrine that says a promise is enforceable by law when the person making the promise goes back on their word to the detriment of the person they made the promise to. This is true even when there’s no valid written agreement memorializing the promise. When it’s enforced, the promiser must follow through on their promise, or somehow make it up to the wronged party if the promise can no longer be kept.
In the Thomerson case, DeVito promised Thomerson a 3% share of ownership in the company but went back on his word. So when Lenco Marine was sold to another company in 2016, Thomerson didn’t see any money from the sale because he never received the ownership interest he was promised.
Since Thomerson’s five other claims were barred by the district court, promissory estoppel was the only claim left that could bring him relief – if the Supreme Court of South Carolina determined that the statute of limitations is not applicable to promissory estoppel.
Is Promissory Estoppel Subject to Statute of Limitations in South Carolina?
No. The Supreme Court of South Carolina determined that promissory estoppel is not subject to the three-year statute of limitations in the state.
Most of the opinion is the legal reasoning and discussion behind this conclusion, which is too detailed to cover fully on this blog, but here are some of the main points.
The South Carolina Supreme Court has recognized that the statute of limitations applies to actions at law (that is, where legal relief is sought, often monetary damages), while laches applies to suits in equity (that is, where equitable relief is sought, such as an injunction or specific performance, rather than monetary damages). Whether promissory estoppel is subject to the statute of limitations depends on whether it’s characterized as a legal or equitable claim.
The court ultimately reasons that it’s an equitable claim, which is subject to laches rather than the statute of limitations. This is true even if in certain cases the relief being sought is monetary. For instance, in Thomerson, the equitable remedy of enforcing the promise by making the Defendants give Thomerson 3% ownership interest in the company is impossible because the company has already been sold. The fair remedy now would be monetary damages to make up for what Thomerson would have received in the sale had he originally been given the 3% he was promised.
Legal Help with Contract Law and Business Law in South Carolina
Though promissory estoppel can be enforced in some circumstances even when a written contract isn’t present, it’s always best to get things in writing to protect your interests. For help with contracts and other business matters, including governance documents, business planning, business acquisition, and commercial real estate transactions, contact Gem McDowell of the Gem McDowell Law Group. Gem has over 30 years of experience solving problems and advising his clients to protect their business interests.
Gem and his associates serve clients in the Charleston area and across South Carolina. Call the Mt. Pleasant office today to schedule your free, no-obligation consultation at 843-284-1021.
What is Title Insurance and Why is It Important?
We’ve previously discussed the importance of a title search on this blog. A title search occurs before a real estate closing to ensure that the property in question is free of any liens, pending lawsuits, unpaid taxes, and other similar issues that could “cloud” the title.
Once the title search is completed, the purchaser may then wish to buy title insurance. While South Carolina doesn’t require buyers to get title insurance, lenders typically do, meaning if you have a mortgage on property in SC then you most likely have title insurance to cover it.
Title insurance was the subject of a case that went before the South Carolina Court of Appeals in 2020, Jericho State v. Chicago Title Insurance (read the opinion here). This case demonstrates what’s at stake for property owners who discover a defect or encumbrance on their title and shows how the court views the role of title insurance in protecting property owners’ interests.
Jericho State v. Chicago Title Insurance Background
The case centers around a large piece of commercial real estate in Horry County, South Carolina.
In 2006, Peachtree Properties of North Myrtle Beach, LLC (Peachtree) bought 131.40 acres in Horry County (the Property) from the McClam family for $22.5 million. The plan was to develop the land into a residential subdivision on the waterway. It was financed with two mortgages: one from Jericho State Capital Corporation of Florida (Jericho) and one from R.E. Loans, LLC (REL).
In 2007, Peachtree defaulted on the loans. Jericho foreclosed and successfully bid on the Property at sale, getting a master’s deed to the land that was still subject to the REL mortgage, which was later assigned to Lynx Jericho Partners, LLC (Lynx Jericho).
Two years later, in 2009, the South Carolina Department of Transportation (SCDOT) filed an eminent domain action against Jericho for 10.18 acres of the Property to use for a roadway, the Carolina Bays Parkway.
Previously, in 1999, Horry County created a map which included proposed locations for parts of the Carolina Bays Parkway, and a 2002 amendment to the map added a right of way that had the parkway bisecting the property in question and crossing the intracoastal waterway. The 1999 Official Map Ordinance (Ordinance) had established Horry County’s right to reserve future locations of streets, utilities, and other building projects in the public interest, as allowed by South Carolina law. The land SCDOT claimed for eminent domain was land that had been reserved for future use in Horry County’s map.
Jericho and Lynx Jericho were awarded $2.1 million dollars in 2014 by a jury as just compensation for the government taking the land. During the litigation, Jericho and Lynx Jericho submitted title insurance claims to Chicago Title Insurance Company (Chicago Title), which had written both title insurance policies for the two original mortgages.
Chicago Title denied their claims, which led to Jericho and Lynx Jericho (collectively, the Appellants) suing Chicago Title for breach of contract, breach of the covenant of good faith and fair dealing, and bad faith refusal to pay insurance benefits. A special referee granted summary judgment to Chicago Title. The case was then appealed.
What is Title Insurance and What Does Title Insurance Cover?
While title searches should, ideally, discover all actual or potential defects and encumbrances to a piece of property so they can be dealt with before closing, it’s not guaranteed that a title is entirely free and clear. That’s where title insurance comes in. Title insurance protects the real estate buyer or the mortgage holder/lender from problems that arise due to a defect in or encumbrance on the title to the land. The court of appeals defines encumbrance as “a burden on the land that is adverse to the landowner’s interest and impairs the value of the land but does not defeat the owner’s title.”
Many title insurance claims are related to:
- Back taxes
- Pre-existing liens
- Easements
- Judgments
- Unmarketable title
- Fraud and forgery
- Inheritance issues (e.g., conflicting wills or undisclosed heirs)
Title insurance is different from other common kinds of insurance. Car insurance and homeowners insurance, for example, protect you against things that happen after you purchase your car or home. But title insurance protects you against losses that arise from issues that were already present before you purchased the property. Quoting another case, the court of appeals says the purpose is to “place the insured in the position he thought he occupied when the policy was issued.”
The SC Court of Appeals’ Findings in Jericho
The questions for the court of appeals in Jericho are whether the Appellants’ claims were covered or excluded by their title insurance policies and whether the special referee erred in granting summary judgment to Chicago Title.
The relevant part of the title insurance policies (which used the same language, as they were created using the same standard form) is as follows:
“SUBJECT TO THE EXCLUSIONS FROM COVERAGE, THE EXCEPTIONS FROM COVERAGE… AND THE CONDITIONS AND STIPULATIONS, CHICAGO TITLE INSURANCE COMPANY… insures, as of Date of Policy… against loss or damage… sustained or incurred by the insured by reason of:…
“2. Any defect in or lien or encumbrance on the title;
“3. Unmarketability of the title…”
When it comes to what’s covered, the insured has the burden of proving its claims fall under the policy’s coverage. When it comes to what’s excluded, the burden of proof flips, and it’s up to the insurer to show that the claims are excluded from the policy’s coverage. With that in mind, here are some issues the court discusses:
Did the Ordinance constitute a defect or encumbrance that was subject to the insurance policy?
The Appellants argued that the Horry County Ordinance caused a defect or encumbrance on the title which burdened the land and depreciated its value. The court of appeals agrees. It concludes that the Ordinance went beyond regulating use of the land and created a third-party interest in the Property in favor of the County. Such a defect or encumbrance is covered under point 2 in the policy.
Chicago Title argued that the Ordinance allowed landowners to appeal and oppose their property’s inclusion on the map which reserved lands for future use, but that just proved the Appellants’ point: the Ordinance created an encumbrance on the Property.
Did the Ordinance affect the marketability of the title?
Quoting another case, the appeals court says, “A marketable title is one free from encumbrances… It is a title which a reasonable purchaser, well-informed as to the facts and their legal significance, is ready and willing to accept.” It must be not only free of defects and encumbrances but “the reasonable probability of litigation,” too. Here, the Ordinance did create a reasonable probability of litigation over the title.
Chicago Title argues that the Ordinance only regulated the use of the Property and therefore didn’t affect the marketability of the title. But the court again stresses that the Ordinance created a “third party interest in the Property,” saying that it was “so foreign” from normal land use measures that there’s no real argument here that it made the title unmarketable. The court agrees with Chicago Title that any landowner may face eminent domain claims, but the Ordinance and maps made Horry County’s intentions clear several years earlier and there was a high probability of such a claim here.
The court sides with the Appellants on the issue of the title’s marketability and reverses the special referee’s grant of summary Judgment to Chicago Title.
Were the Appellants’ claims excluded from coverage?
Exclusion 1 bars coverage for “Any law, ordinance or governmental regulation… restricting, regulating, prohibiting, or relating to (i) the occupancy, use or enjoyment of the land…” However, as discussed above, the Horry County Ordinance didn’t just affect the use of the land, but its title, and therefore Exclusion 1 doesn’t apply.
Exclusion 2 bars coverage related to eminent domain, but the Appellants’ complaint is for the loss of value in the title when they acquired it in 2007, not for the eminent domain action that occurred in 2009 (after the effective date of the policies). Therefore, Exclusion 2 does not apply.
Exclusion 3(d) excludes coverage for defects, liens, encumbrances, and so on that occur after the effective date of the policy. Since the Ordinance and the 2002 amendment to the map creating the encumbrance were already in existence years before the policies went into effect, Exclusion 3(d) does not apply.
The court of appeals determined that none of the Appellants’ claims were barred by the policies’ exclusions, and that the special referee erred in finding they applied.
Summing up the purpose of title insurance and how exclusions should be interpreted, the court of appeals says, “Real estate investors buy title insurance to protect against such unforeseen ‘off the record’ risks… The fundamental idea behind title insurance is to cover rather than exclude unforeseen and unknown risks; otherwise, title insurance would not provide the peace of mind it touts.”
Help with Commercial Real Estate Deals in South Carolina
When it comes to buying real estate, having a free and clear title as well as title insurance is important to protect your interests, whether it’s a commercial deal or a private one.
If you’re involved in commercial real estate transactions in South Carolina, work with an experienced commercial real estate attorney like Gem McDowell. Gem has nearly 30 years of experience practicing law in South Carolina and has closed over $1 billion in real estate deals, including one deal worth $270 million. He helps his clients close the deal while advising them, protecting their business interests, and preventing problems before they arise. He’s ready to do the same thing for you.
Call Gem and his team at the Gem McDowell Law Group in Mt. Pleasant, SC today at 843-284-1021 to schedule your free consultation.
A Classic Squeeze-Out: Minority Member Oppression in Wilson v Gandis
In the previous blog, we looked at one of the risks of being in an LLC, minority member oppression. This happens when a member or members of the LLC act to reduce a minority member’s involvement in the company against their will. The majority member(s) may try to “squeeze out” or “freeze out” the minority member from the company altogether. Or they may engage in conduct like withholding distributions and reducing the minority member’s involvement in the company while essentially trapping their investment in the LLC with no way for the minority member to get it back out.
This was the central issue in a case heard by the South Carolina Supreme Court in June 2019, Wilson v Gandis, in which the oppression was described as a “classic squeeze-out.” It’s rather convoluted, with multiple lawsuits and issues, but we’ll focus on the issue of minority oppression and exactly what constitutes it in the eyes of South Carolina courts.
The Background
In 2007, David Wilson and John Gandis formed Carolina Custom Converting (CCC), a company selling film, resin, and other materials. It was a manager-managed LLC, with each owning 50% membership interest. Importantly, Wilson and Gandis never executed a formal operating agreement and had no employee, noncompete, nondisclosure, or nonsolicitation agreements. Many of their oral conversations and agreements were memorialized through email, however.
CCC’s business was intricately linked to other businesses owned by Wilson and Gandis. When CCC was formed, Wilson owned Eastern Film Solutions (EFS) and Gandis owned DecoTex and M-Tech. Wilson agreed to wind down EFS and bring that business over to CCC, for which he was compensated $8,000 per month, later raised to $12,000 per month. Gandis agreed to extend a line of credit to CCC from DecoTex and M-Tech. Plus, CCC operated out of a building owned by M-Tech, so Gandis received the benefit of the rent money paid by CCC.
Gandis brought on Andrea Comeau-Shirley, a CPA, to help with accounting and advice. In 2009, Gandis and Wilson each transferred 5% of their interest to Shirley. She didn’t have a formal voting interest but was actively involved in managing CCC.
Not long after, things started to go south for Wilson. Shirley and Gandis grew closer and began excluding Wilson from discussions about the company’s operations. Over the course of years, they exchanged many emails, which later the trial court said “provide[d] evidence of their oppressive conduct against Wilson.”
The Lawsuits: Wilson v Gandis
After a long period of behavior unfavorable to Wilson, lawsuits followed. The main issue we’ll be looking at is Wilson’s claim against Gandis and Shirley for minority member oppression. (Other issues not relevant here include Gandis’s and Shirley’s counterclaim against Wilson for breach of fiduciary duty, which they lost, and CCC’s claim against Wilson and companies he worked with after CCC for misappropriation of trade secrets, which they also lost.)
In a 5-day bench trial in 2014, a trial court found Gandis and Shirley had engaged in oppressive conduct against Wilson, saying “This is a classic squeeze-out,” and that the body of emails between Gandis and Shirley “abounds with evidence of calculated oppression” and “could serve as a script” for minority member oppression. The court found in favor of Wilson and ordered Gandis and Shirley to buy out Wilson’s interest in CCC as individuals, rather than having CCC buy him out.
Gandis and Shirley appealed, and in an unpublished decision, the appeals court agreed with the trial court and adopted the order in its entirety. They appealed again, and the South Carolina Supreme Court heard the case in June 2019.
Examples of Oppressive Conduct
In its opinion, the supreme court states that it’s not necessary for the plaintiff to prove illegal or fraudulent conduct in order to prove minority oppression. The minority investor instead needs to show that their investment is “trapped” and that they’re facing exclusion from participation in business returns for an indefinite period of time. What constitutes oppressive behavior must be determined on a case-by-case basis.
In this case, the supreme court agrees with the trial court’s conclusions about oppressive conduct on the part of Gandis and Shirley. Here are many of the acts Gandis and Shirley engaged in that the courts found oppressive:
Conspiring together to “get Wilson out.” Many emails exchanged between Gandis and Shirley blatantly and boldly discussed their plans to get Wilson out by different means, including making him an employee with a 5-year noncompete agreement and firing him on the smallest of pretexts.
Withholding distributions. From 2007 to 2010, CCC set aside funds to cover members’ individual tax liabilities, which were proportional to their membership interests. In 2011, this changed. Shirley emailed Gandis and encouraged him to use the funds that would have gone to members to help pay their tax liabilities to instead pay back what was owed on CCC’s line of credit from Gandis’s other business, which would directly benefit Gandis and leave Wilson without money to pay his tax liability. Shirley let Wilson know that there would be no distributions that year to members to cover tax liabilities.
Secretly monitoring Wilson’s emails. Gandis and Shirley began reading Wilson’s emails and referenced them in their own email exchanges. In 2011, they read an email to Wilson from his wife in which she expressed frustration over how Shirley and Gandis were managing CCC. From then on, Gandis’s and Shirley’s efforts to exclude Wilson from the LLC increased.
Gandis and Shirley later said in court that they were simply archiving all of CCC’s incoming emails in order to keep customer quotes and so forth available, but the trial court said this testimony was not credible, and the supreme court agreed. They also said that the employee handbook makes it clear that company email should not have an expectation of privacy – but the handbook was never issued.
Withholding income from Wilson. Not long after reading the email to Wilson from his wife, Gandis and Shirley stopped paying Wilson the monthly $12,000 they had agreed upon to compensate him for bringing his previous company’s business over to CCC.
Plus, they began classifying Wilson’s distributions as loans. When the situation came to a head in October 2011, Gandis (on Shirley’s advice) gave Wilson two options. 1. Surrender his membership interest in order to satisfy his loan balance of $123,000, which began accruing once they recategorized his distributions as loans. Or 2. Become an at-will employee of CCC (with the aim of firing him for the smallest of reasons, according to an email from Shirley).
From there, Wilson and Gandis entered into back-and-forth negotiations. Wilson was trying to find a way to either stay involved fairly or leave with his rightful share of what he was owed, while Gandis was trying to find a way to get Wilson out paying as little as possible.
Revoking financial authority. Around this time, Shirley removed Wilson as signatory on CCC’s bank account, leaving Gandis as the only signatory on the account, and revoked Wilson’s authority to make wire transfers. Wilson’s ability to access CCC’s financial information was also limited.
Misrepresenting the company’s finances. Gandis and Shirley made it look as if CCC had less cash than it had and later manipulated the December 2011 pro forma balance sheet to make it look like Wilson’s interest in the company was less than it really was.
Locking Wilson out of the building. In January 2012, after Wilson and Gandis were unable to come to an agreement about what should happen, Wilson arrived at the office to find Gandis there with a police officer and a locksmith. Since Wilson was a co-owner, the officer didn’t make him leave, and Wilson was able to enter the building and take two laptops, a Blackberry, and a number of files with him before he left and the locks were changed.
Emails between Gandis and Shirley showed that this was their plan. They discussed the legality of it and what to use as a cover story – first that Wilson had resigned (which he protested he didn’t), then that they did it because Wilson was competing with CCC.
Terminating Wilson’s health insurance coverage and cell phone services. These benefits were cut off for Wilson – but not for other members of the LLC – after he was locked out. Plus, from here Gandis and Shirley increased CCC’s monthly rent, which, remember, directly benefited Gandis since CCC rented a building from Gandis’s company M-Tech. They also raised the rate on the line of credit, which again directly benefited Gandis.
Starting up a competing company. In July 2012, Gandis and Shirley started up another LLC, ZOi Films, without telling Wilson. They said they founded it in an attempt to rebrand CCC and it was to be a wholly-owned subsidiary of CCC, but the trial court characterized it as an attempt to “siphon off” business from CCC.
Minority oppression must be determined on a case-by-case basis, says the supreme court, and in this instance it was not ambiguous – the trial court, court of appeals, and supreme court all agreed that Gandis and Shirley engaged in oppressive acts that were “brazen” and “unconscionable” (in the words of the trial court).
A Point of Disagreement
There was one point on which the supreme court disagreed with the trial court, and that’s the issue of who should be responsible for buying Wilson out. Gandis and Shirley argued against the trial court’s order that they must buy out Wilson’s share with their own money, as they argue that the LLC should protect them. They cited subsection 33-44-303(c) of South Carolina Code which protects LLC members from personal liability when acting in the course of ordinary business. But engaging in acts of calculated oppression is not in the course of ordinary business, the court determined.
Still, the supreme court did reverse the trial court’s order for Gandis and Shirley to personally buy Wilson out and remanded the case back to the trial court. CCC is ordered to buy out Wilson’s share, and if it doesn’t do that in a timely manner, then Gandis and Shirley will have to do so personally in a way that’s proportional to their interest in the business.
Protect Your Interests with LLC Governing Documents
The supreme court’s opinion called out that Wilson and Gandis did not have an operating agreement, employee handbook, or other optional but important documents to help them run their business. While having governance documents can’t entirely prevent minority oppression, they can help protect minority members’ interests and give recourse should the issue go to court. Not all instances of minority oppression are as blatant (and numerous) as in the case above.
If you are planning to start up an LLC with other people, or even if you already run one but don’t have anything beyond Articles of Incorporation, get your governance documents drafted and done. Call business attorney Gem at the Gem McDowell Law Group in Mount Pleasant, SC. He and his associates can draft documents that are tailored to your business that are fair to members and will help as you run the business and run into questions. Call today to schedule a free consultation at 843-284-1021.
Your Risks as a Minority Member in an LLC: Oppression and Squeeze-Out
A limited liability company (LLC) is a great thing for many entrepreneurs. Among other things, it provides liability protection while requiring fewer formalities than a corporation. But it’s not risk-free. One of the potential risks is minority oppression of members who own less than 50% of the LLC.
Today we’re going to look at what minority member oppression is, what your rights are as a minority member of an LLC, and what you can do to protect yourself.
Risk of Oppression for Minority Members in an LLC
Minority member oppression occurs when a member or members of an LLC act to reduce a minority member’s involvement in the LLC against their will.
When minority shareholder oppression occurs in a corporation, the shareholder can simply sell their shares (albeit at an unfairly low price in many cases) and walk away. However, in an LLC and close corporations, it’s often not so easy. The minority member may find that their investment is essentially being held hostage, and they don’t have a legal avenue to get it out of the company. Walking away means losing their investment.
The oppression often entails reducing the minority member’s income from the business, keeping them out of the loop regarding company business, and excluding them from important management decisions. Another tactic is for the majority member(s) to create a new, separate business entity and merge that with the existing business without giving the minority member any ownership in the new merged business, instead exchanging their interests for cash or eliminating it altogether.
When the end goal of this oppression is to force the minority member to give up their ownership in the LLC altogether, that’s commonly referred to as a squeeze-out or freeze-out.
LLC Minority Members’ Rights Under South Carolina Law
If your LLC does business without important governance documents (covered in the section below) and a dispute arises and goes to court, then South Carolina laws regarding LLCs apply. These vary somewhat depending on what kind of LLC it is (member-managed or manager-managed), but under SC law, minority members can expect certain rights, including:
- The right to a share of distributed profits
- The right to a share of proceeds of a sale if the LLC is sold or dissolved in proportion to their ownership
- The right to see the company’s books and financial records
- The right to sue another member or members for breach of fiduciary duty if they engage in misconduct
These protections sound great but they may not play out the way you want in real life. For example, majority members may take an income as an employee (rather than a distribution as an owner) or spend the company’s money in another way to avoid making distributions to minority members. Or they could structure a sale of the LLC in such a way as to legally cut out a minority member from the proceeds.
In short, don’t rely on default South Carolina laws to protect your interests as a minority member in an LLC. It’s best to have governance documents including an operating agreement with terms that are favorable to minority members and for you as a minority member to know, understand, and agree to those terms.
How Minority Members Can Protect Themselves: The Operating Agreement
In South Carolina, the Articles of Incorporation is the only document your LLC is legally required to have to be in business. Other governing documents are optional but extremely important for multi-member LLCs, the most important of which is the operating agreement.
An operating agreement details the ways in which the LLC will operate, covering such topics as ownership, members’ and managers’ duties, voting rights, how decisions are made, how profits and losses are handled, and more. Terms regarding buying and selling ownership or the LLC may be included or can be handled in a separate buy-sell agreement. Same with raising capital, which may be included in the operating agreement or detailed in a separate capital call agreement.
It’s important to understand that an operating agreement is not bulletproof. Majority members may still try to squeeze out or freeze out a minority member. However, when drafted in a way that protects a minority member’s interests, an operating agreement can help. If an issue arises and goes to court, then the court will look at the terms of the operating agreement rather than defaulting to SC law, which will be better for you (assuming the agreement is drafted well).
Work with a Business Attorney to Draft Your LLC’s Governing Documents
Each LLC is different and the members within each LLC are different, so no two operating agreements are alike. If you’re planning on joining or starting up an LLC with other people, or if you’re already in one but don’t have governing documents, talk to a business attorney. They can not only draft an operating agreement (and other documents) tailored to you and your business, they can also advise you on potential pitfalls and situations you may not have considered. Because what you don’t know can hurt you.
Gem McDowell is a business attorney in Mount Pleasant, SC, serving clients in the Charleston area and across the state. He and his associates at the Gem McDowell Law Group help people start, grow, and protect their businesses and business interests. Gem is a problem solver who has seen a lot in over 30 years of experience, and he can advise you on your situation and help you protect your interests. To schedule a free consultation, call 843-284-1021 today.
Get It in Writing – It’s the Law
Please be advised that the Court assumed for purposes of the Motion for Summary Judgment that all the facts the Plaintiff (Kagan) alleged were true in the light most favorable to him and without consideration of the Defendants Simchons’ version of the events to form the basis for their legal analysis.
Have you heard that oral contracts are legally binding? While many verbal agreements are valid and can be upheld in court, that’s not always the case. South Carolina law requires written contracts for certain types of agreements, and without evidence in writing, the contract cannot legally be enforced.
Still, some people, either not knowing the law or not seeing the need for a written contract, go ahead with a deal in good faith based on a verbal agreement and a handshake.
Jeffrey S. Kagan did so, lending large amounts of money on handshake deals, in a case (Kagan v Simchon) that was heard by the South Carolina Court of Appeals in May 2019.
Can you guess how it turned out for him?
Lending Money Without a Written Contract
Kagan had a close relationship with Renee Simchon, the respondent in the case, and her husband, Sam. Kagan worked as an independent contractor for many years for Sam’s company, Bay Island Sportswear, Inc., which was next door to Simchon’s realty company, Greenwood Realty, in Greenwood, SC.
Over the years, Kagan occasionally loaned them money, including $129,000 in June 2009 (First Loan), $210,000 in October 2010 (Second Loan), and $52,000 in November 2013 (Third Loan). Kagan later stated that the agreements for the First Loan and Third Loan were not reduced to writing, but stated there was written evidence of the Second Loan.
Simchon used the money from the Second Loan to pay off a mortgage she held for one of her clients, and the plan was to repay the principal when the property was sold. Instead, after the sale of the property, Simchon wrote Kagan a check for $31,616.46 and gave the remaining $180,000 to her husband Sam to invest on Kagan’s behalf. Kagan later stated in a deposition that he did not authorize that transfer of money to Sam.
Kagan also believed that from this point, the First Loan and Second Loan were consolidated. When he made the Third Loan, he stated he believed that it was also consolidated with the first two. Again, this consolidation was not put down in writing, and was done on the basis of “a handshake, a look in the eye and a personal relationship.”
Sam made periodic payments until November 2013. In April 2014, Kagan’s employment with Sam’s shop was terminated.
Taking It to the Courts
In August 2015, Kagan filed summons and complaint seeking repayment on all three loans, alleging breach of contract and other actions. In response, the defendants filed a motion to dismiss.
The case was heard in circuit court in February 2016, in which Kagan’s claims regarding the First Loan and the Third Loan were dismissed after he admitted that the terms of these loans had not been reduced to writing. The case was heard again in circuit court in January 2017 after some claims were dismissed and Simchon remained as the only defendant. This time, the Second Loan was dismissed for the same reason; despite Kagan claiming that there was written evidence of the Second Loan, he was not able to produce it.
Without written evidence of the terms of the loans, the court was not able to enforce Kagan’s claims for repayment, citing Section 37-10-107 of South Carolina Code:
No person may maintain an action for legal or equitable relief […] to lend or borrow money; […] or […] to renew, modify, amend, or cancel a loan of money […] involving in any such case a principal amount in excess of fifty thousand dollars, unless the party seeking to maintain the action or defense has received a writing from the party to be charged containing the material terms and conditions of the […] agreement and the party to be charged, or its duly authorized agent, has signed the writing.
In short, if you make a business deal that involves lending, borrowing, renewing, modifying, amending, or canceling a loan over $50,000, you must have the agreement written down and signed to be legally enforceable. (Note that this does not apply to “a loan of money used primarily for personal, family, or household purposes,” per 37-10-107(3)(a).)
The circuit court thus granted Simchon’s motion for summary judgment. The case was appealed and heard by the SC Court of Appeals in May 2019.
The Statute of Frauds in South Carolina
The circuit court cited the statute of frauds (SOF) as the reason for barring or dismissing Kagan’s claims. SOF requires that certain types of agreements be written down and signed to be enforceable. The concept comes from common law and is present in every state in one form or another.
In South Carolina, the statute of frauds is found in SC Code Title 32 Chapter 3. Agreements that must be reduced to writing and signed by an authorized party are those:
- Requiring an executor or administrator to pay damages from their own estate
- Requiring a person to pay the debt of another
- Made in the consideration of marriage (i.e., prenuptial agreements)
- Involving the contract or sale of land
- That take longer than a year to perform
In addition, Section 36-2-201(1) requires a contract recording the sale of goods valued over $500 in order for any related action to be enforceable, and, as seen above, Section 37-10-107 requires written evidence to enforce actions on lending or borrowing $50,000 or more in business deals, or making changes to the agreement related to it.
Kagan argued that the circuit court erred because Simchon used the money from the Second Loan to pay off a mortgage that was in her name – not that of her realty company – therefore making it a personal loan that wasn’t subject to 37-10-107.
The SC Court of Appeals disagreed, stating that even if the mortgage was in her own name, the money was “used” (the word in the statute, the court notes) on behalf of a client in the course of business, making it subject to 37-10-107. The Court of Appeals agreed with the circuit court’s finding that Kagan’s claim with respect to the Second Loan was therefore barred.
The Statute of Limitations in South Carolina
The circuit court found that Kagan’s breach of contract claim was barred because of the statute of limitations (SOL), or the time allowed by law in which to bring a legal claim. Kagan argued that the circuit court erred, saying that Sam’s payments on the loans tolled the statute of limitations until the payments stopped.
“Tolling” means pausing or delaying the time left on the SOL. Tolling may allow someone to bring a lawsuit even after the SOL has seemingly run out.
However, in this case, the appeals court did not agree that the SOL was tolled, as that would have depended on the loans being consolidated. If you remember, Kagan stated that he believed all three loans were consolidated. He also stated that the terms of the consolidation were never written down – and that’s the problem.
The appeals court affirmed the circuit court’s finding, again citing 37-10-107, which states (as discussed above) that any amendment or modification to a loan over $50,000 must be in writing to be enforceable. Without the terms in writing, there is no tolling of the SOL.
The SOL therefore began when Simchon breached their agreement by failing to transfer the remainder of the money from the sale of the property to Kagan. This happened on March 21, 2011, and since the SOL for a breach of contract claim in South Carolina is three years, Kagan had until March 21, 2014 to file. He didn’t until August 2015, nearly a year and a half after the SOL had run out.
Get Help with Your Contracts
The South Carolina Court of Appeals affirmed the circuit court’s order to grant summary judgment to Simchon. Unfortunately for Kagan, he wasn’t able to use the force of the law to help him recover the outstanding money he was owed. This could have been avoided had he gotten everything in writing.
Contracts exist for a reason, and a correctly written one can save you time, money, and heartache. Don’t rely on a handshake or the goodwill you have with another party when making a deal, especially when there’s a substantial amount of money on the line. Work with an attorney to ensure that your interests are looked after and protected.
Business attorney Gem McDowell of the McDowell Law Group in Mt. Pleasant, SC, serves clients in the greater Charleston area and the state of South Carolina. He and his associates can help you with contracts, business creation and planning, commercial real estate, and more. To make an appointment or to schedule a free 20-minute consultation with an attorney, call Gem and his team today at 843-284-1021.
Marketability and Minority Discounts in South Carolina Courts
If you’re a part owner of a closely held corporation, it can be challenging to determine the dollar value of your interest in it. Not only do closely held corporations not make their finances public, making it difficult to know the company’s value as a whole, but your interest in it could be subject to discounts – like a marketability discount or a minority discount – that reduce the value to less than you might expect.
A case heard by the South Carolina Supreme Court, Clark v Clark, discussed both marketability discounts and minority discounts (also called lack of control discounts) in the context of a divorce, illuminating how SC courts consider and evaluate such discounts.
First let’s look at the methods used to determine the value of closely held corporations, then what the discounts are, then the case itself.
Methods to determine value a closely held company
The value of a closely held corporation and an interest in it can be determined by a few different methods.
Income approach. This method examines the company’s past earnings in order to project future earnings. This approach is popular because it looks at something that’s of interest to the potential buyer: how much money they can expect to see from their investment. However, it ultimately relies on making predictions about the future which no one can really know, which is the primary disadvantage.
Value, asset, or book approach. This method adds together the value of assets (minus depreciation) and then subtracts liabilities. It’s simple and straightforward and doesn’t require any guessing, but it fails to take many factors into consideration, such as a company’s brand recognition, customer goodwill, and other intangible but important factors.
Market approach. This method compares the private company in question to public companies that are similar in size, industry, and so on to come to a value. This approach works well when there are public companies that are similar enough to the closely held corporation to make a fair comparison, but it’s a poor choice when there aren’t.
Discounts on Interest in Closely Held Corporation
Two common discounts that can be applied to an owner’s partial interest in a closely held business are the lack of marketability discount (also called, simply, the marketability discount) and the lack of lack of control discount (also called the minority discount).
Marketability discount. This discount may be applied since there’s typically a significantly smaller market of potential buyers for privately held stock compared to publicly held stock. The transaction usually takes longer and involves higher transaction costs, too.
Lack of control/minority discount. Similarly, this discount recognizes that being a partial owner without controlling interest in a company is much less appealing than owning a controlling share. (In fact, control is so important in closely held businesses that controlling interests can sell for more than face value due to what’s called “premium for control.”)
Background of Clark v Clark
In the case at hand, Clark v Clark, the central issue is the value of the minority interest held by Patricia Clark in her husband George Clark’s family business.
The two married in 1987 and filed for divorce in 2012. At the time of the divorce, George owned 75% of the family business his father founded in the late 1980s, Pure Country, Inc., which manufactures and sells custom tapestry, blankets, afghans, and so forth. George had been 100% owner after his father died but then transferred 25% interest to Patricia in 2009 when she approached him about getting equity in the company. The stock agreement for the transfer restricted her ability to sell her interest “to the business, other shareholders, or immediate family members.”
Putting a value on Patricia’s equity
In an 8-day bench trial, George and Patricia called separate experts to testify as to the value of Patricia’s 25% interest in Pure Country, Inc. George’s expert, Catherine Stoddard, used three different approaches to determine the value and explained her reasoning to the court.
- The income approach led to an initial value of Patricia’s 25% at $116,365. Stoddard then applied a 35% marketability discount to account for the issues discussed above as well as the specific stock agreement in this situation that limited Patricia’s ability to sell her interest to select buyers.
- The asset approach valued the entire company at $736,000 and Patricia’s share, with a marketability discount and a lack of control discount applied, at $83,725.
- The market approach led to a value of $65,430 for Patricia’s 25% interest.
Stoddard determined that $75,000 was the appropriate value. This included both discounts.
Patricia’s expert, Marcus Hodge, came to a different conclusion. He compared the company to other companies he believed were comparable – also in the mill industry in North Carolina, as Pure Country, Inc. was – but didn’t show how they were indeed comparable in terms of size, scope, and lines of manufacturing. He valued the entire company at $1.8 million and applied a 26% marketability discount, but later said it should not be discounted. Hodge did not apply a minority discount.
The family court debated whether or not discounts should be applied since the business was not actually going to be sold. Ultimately, it found Stoddard to be more credible and agreed that Patricia’s 25% interest was worth $75,000.
The SC Court of Appeals heard the case and affirmed the family court’s decision to apply a lack of control discount. However, it rejected the marketability discount, in part because there was no evidence that George planned to sell the company, and it wasn’t appropriate to engage in the “fiction” that the business was going to be sold.
The Supreme Court hears the case
Both parties appealed, and the Supreme Court of South Carolina heard the case in December 2019.
The supreme court agreed with the family court that a marketability discount did apply. Whether or not the company is actually going to be sold, “a party’s interest in a closely held corporation is valued according to its fair market value.” That amount is what a willing buyer would pay a willing seller in a sale. It’s not required that be business will actually be put up for sale, but that fiction is a helpful way to determine the value of a company or interest in it. In a footnote in the opinion, the court states, “South Carolina embraces fair market value, which is not controlled by an owner’s intent—rather it reflects the time it would take to sell the asset in question.”
However, it doesn’t mean that a marketability discount need apply in every situation. South Carolina has recognized that its applicability can and should be determined on a case-by-case basis. The supreme court believes the best approach is to allow the family court or trial court judges the discretion to apply them depending on the facts of the case before them. In this case, the supreme court agreed with the family court that George’s expert, Catherine Stoddard, was more credible.
The supreme court also agreed with the family court that a lack of control discount applies here. Patricia argued that because her 25% interest would be going to George, making him 100% owner of the company, the lack of control discount should not apply. But the supreme court stated that “the minority status certainly affects an asset’s fair market value” so it’s appropriate for courts to consider applying them.
The supreme court ultimately found that the appropriate value of Patricia’s 25% interest was $86,226.
Dissenting opinion
Three justices agreed with the majority opinion, while two disagreed in an interesting dissent. They believed that neither discount should have been applied in this case. The similarities to a previous case, Moore v Moore – in which the share in question would go to the individual who owns the rest of the company, and there’s no intent to sell – are strong enough that it makes sense to follow the conclusions of that case, in which neither discount was applied. Since Patricia’s 25% would go to George, who owns the other 75%, there is no real, actual possible devaluation of her interest. Therefore, it’s not appropriate to apply either discount in this case.
Business Advice from an Experienced Business Attorney
For business legal advice on protecting your majority or minority shareholder status in a closely held corporation, work with an experienced business attorney like Gem McDowell. Gem has over 30 years of experience helping people start, grow, and protect their businesses. He and his associates at the Gem McDowell Law Group can help you, too. Call the Mount Pleasant office today at 843-284-1021 to schedule a free consultation.
Sharing the Cost of Liability: What is Contribution?
Let’s say there’s an accident that leaves a person injured. The injured party sues the party at fault – the tortfeasor – who ends up paying damages. The injured party has received compensation for their injury, and the tortfeasor has paid what they owe. End of story.
But what if more than one party is liable for the accident? What is a party to do when they have paid the full amount of damages for an accident they’re only partly responsible for?
The answer: seek contribution.
What is Contribution in Civil Law?
Contribution is the “tortfeasor’s right to collect from others responsible for the same tort after the tortfeasor has paid more than his or her proportionate share, the shares being determined as a percentage of fault,” as defined in United States v. Atl. Research Corp.
In other words, a defendant (tortfeasor) who has paid out more than their fair share of money to a plaintiff has the right to seek contribution (money) from other parties who also bear liability for the injury or wrongful death in question. That money must be in a proportional amount, so the tortfeasor is limited to recovering an amount equal to the excess paid to the plaintiff.
This right of contribution does not exist for any party that intentionally caused or contributed to the injury or wrongful death in question. (For more on the ins and outs of contribution, read the South Carolina Contribution Among Tortfeasors Act in the SC Code here.)
A Case Concerning Contribution: The Background
The South Carolina Court of Appeals heard a case in December 2018 that concerned contribution, Charleston Electrical Services, Inc. v. Rahall. (Find the decision here.) The situation is nuanced and involves a party seeking contribution from a daughter for an injury to her mother, which makes it especially interesting.
In August 2010, Wanda Rahall and her mother, Elsie Rabon, visited Rahall’s fiancé at his apartment in Charleston. The apartment of her fiancé, George Kornahrens, was located in a building on property he owned but was leasing to Charleston Electrical Services (CES). He was the business manager of CES but had no ownership in the company.
During the August visit to the property to see Kornahrens, Rabon was knocked down and injured by Gunner, an “overly friendly” German shepherd owned by CES. Rabon was hospitalized and it was determined she had a broken hip.
In December 2010, Rabon filed a lawsuit against CES for negligence and strict liability. The parties later settled for $200,000, and Rabon released CES, Rahall, and Kornahrens from liability.
In July 2013, CES and Selective, its insurance carrier, filed a lawsuit against Rahall seeking contribution in the amount of half the settlement paid to Rahall’s mother Rabon. The issue went before a master-in-equity in August 2016, who found against CES and Selective. They appealed to the SC Court of Appeals.
Here’s Where Contribution Comes In
A party can only successfully seek contribution if there is another party partially responsible for the injury. CES and Selective needed to show that Rahall was also responsible for her mother’s injury in order to recover money from her.
CES and Selective argued that Rahall was negligent, and therefore was partially liable for the accident. To show negligence, the following points must be established: 1) the defendant (Rahall) owed a duty of care to the plaintiff (Rabon); 2) the defendant breached the duty of care by negligent act or omission; 3) the defendant’s breach was the cause of the plaintiff’s injury; and 4) the plaintiff suffered damages as a result.
Premises liability
Rahall owed her mother a duty of care, CES and Selective argued, under a premises liability theory. In SC, a landowner owes a duty of care to guests on their property. This includes a duty to warn a guest of potential dangers they should know about.
Remember that Rahall was not the owner of the property where the accident occurred; her fiancé was, and he was leasing it to CES who had full control of the property at the time when the injury occurred. However, Rahall had been engaged to her fiancé for four years and lived in the apartment on the property with him when she was in Charleston. She kept things there and had a key. Based on this, CES and Selective argued that she was a “possessor of the Property” and therefore owed a duty of care to Rabon.
The Court of Appeals disagreed. Rahall didn’t pay utilities, rent, or taxes on the apartment, she kept a separate home in a different city, and she had no ownership interest or control of any part of the property. (The master had even called the idea that she was liable under a theory of premises liability “patently meritless.”) Therefore, she had no duty of care and negligence could not be established as a basis of liability under a premises liability theory.
Special relationship exception
In SC, no one owes a duty to warn another person about potential danger or to control their conduct with these five exceptions: 1) where the defendant has a special relationship to the victim; 2) where the defendant has a special relationship to the injurer; 3) where the defendant voluntarily undertakes a duty; 4) where the defendant negligently or intentionally creates the risk; and 5) where a statute imposes a duty on the defendant.
CES and Selective argued that Rahall owed a duty to Rabon under this “special relationship exception” rule. She knew that Gunner had previously jumped on visitors, they asserted, and should have known that the dog would pose a threat to her elderly mother – and warned her.
But the master and later the Court of Appeals disagreed with this argument. “Our jurisprudence has not extended a legal duty to children to protect, warn, or supervise a parent,” stated the Court of Appeals in its decision.
Ultimately, the Court of Appeals affirmed the master-in-equity’s decision, and CES and Selective were unsuccessful in their attempt to seek contribution.
The Challenges of Seeking Contribution
CES believed it was not wholly responsible for the accident that injured Rabon and so sought contribution from another party they believed was also partially liable. But you can see that seeking contribution can be challenging – they had to prove liability, and they failed. It’s also a large commitment of time and finances on the part of the defendant. It’s something no business wants to go through.
In situations like these, sound legal advice is a necessity. If you’re a business owner looking for help with a legal issue, contact Gem McDowell and his team at the Gem McDowell Law Group in Mt. Pleasant, SC. With over 25 years in business law in SC, Gem has the experience to not only handle legal matters but also offer sound strategic advice that can protect your business and help it grow. Schedule a free consultation to discuss your business with him by calling 843-284-1021 today.
Is Your Company’s Website ADA Compliant? And Does It Need to Be?
If you own a brick-and-mortar business that serves the public and has an associated website or app, read this blog, as it pertains to you directly.
Most people are familiar with the American with Disabilities Act (ADA), a landmark piece of legislation signed into law in 1990 that requires businesses serving the public to make their locations accessible to people with disabilities. This means things like installing ramps, providing accessible parking spaces, and making walkways wide enough to accommodate wheelchairs.
In this digital age, companies are learning that the ADA may apply to many websites and mobile applications, too, and what that means for them.
Domino’s Website and App Not Accessible
Normally on this blog we look at court cases from the South Carolina Court of Appeals and Supreme Court, but today’s case is actually from the US Court of Appeals for the 9th Circuit (which encompasses several western states, Alaska, and Hawaii), Robles v. Domino’s Pizza, LLC, which you can find here.
Guillermo Robles is a blind man who relies on screen-reading software to vocalize visual information of websites so he can use them. On at least two occasions, he was unable to order a pizza online from Domino’s Pizza because, he said, the company’s website and app were designed in a way that weren’t accessible to him.
In 2016, Robles filed a suit against Domino’s seeking damages and injunctive relief, arguing that Domino’s website and mobile app violated the ADA as well as the California’s Unruh Civil Rights Act (UCRA), which outlaws discrimination based on disability and other factors. Domino’s argued that the ADA didn’t apply to their website and also argued that enforcing ADA compliance standards would violate their 14th Amendment right to due process. The case went to a district court and was later appealed.
Two questions (among others) the US Court of Appeals had to answer were:
- Are Domino’s Pizza’s website and mobile app subject to the ADA?
- Does the Department of Justice have to articulate specific standards for businesses to follow before these businesses make their websites and mobile apps ADA-compliant?
Here’s what the court found.
Yes, Domino’s Websites and Mobile App Are Subject to the ADA
The district court held that the ADA (specifically, Title III) did apply to Domino’s Pizza’s website and mobile app, and the court of appeals agreed.
The intention of the ADA is to eliminate discrimination against individuals with disabilities in a variety of ways. The Act expressly states that places of public accommodation where goods and services are available to the public – like Domino’s Pizza – must take steps to ensure that people with disabilities are not excluded or denied services. These businesses must provide “auxiliary aids and services” to ensure access.
But does a website need to meet the same standards of accessibility as a place of public accommodation? The court of appeals states in its decision that a website associated with a physical location does need to be accessible. The inaccessibility of Domino’s Pizza’s website and app in this case prevented a disabled user, Robles, from accessing the goods and services of the physical location, thus violating the ADA. In making this determination, the court joins several other courts that have come to the same conclusion in similar cases.
No, the DOJ Does Not First Have to Articulate Specific Standards
The Department of Justice (DOJ) is tasked with regulating implementation of the ADA, and it promised to provide guidelines for website accessibility back in 2010. But that hasn’t happened.
One of Domino’s arguments was that it wasn’t responsible for making its website or mobile app accessible because the guidelines promised by the DOJ hadn’t materialized, so it didn’t know exactly which standards to adopt.
However, there does exist a widely known set of standards that Domino’s could have reasonably adopted and could still adopt as a possible equitable remedy. Those are the Web Content Accessibility Guidelines (WCAG) 2.0, a set of private industry standards for website accessibility. In a footnote, the court mentions that even though these guidelines are private industry standards, they have been widely adopted by many entities, including by federal agencies on their public-facing electronic content. The Department of Transportation requires airlines to adopt WCAG 2.0, and the DOJ has required several ADA-covered entities to adopt them in consent decrees and settlement agreements in the past.
The district court said that imposing WCAG 2.0 standards on Domino’s “fl[ew] in the face of due process” and stated that the DOJ needed to provide guidelines.
The court of appeals disagreed. The Constitution doesn’t require the DOJ or Congress to articulate exactly how a business should comply with the law. “The Lack of Specific Regulations Does Not Eliminate Domino’s Statutory Duty,” says the court (emphasis added). Further, though it hasn’t come out with specific guidelines, the DOJ has “repeatedly” affirmed that websites of public accommodation are subject to Title III of the ADA. Because of this, it’s reasonable to say that Domino’s Pizza has been “on notice” since at least 1996 and has been aware that it has a duty to make its website accessible.
What This Means for You, a Business Owner
Domino’s Pizza petitioned the US Supreme Court to take up the case in June 2019. Showing support for Domino’s were a number of outside parties filing amicus curiae briefs: the Washington Legal Foundation, Retail Litigation Center, Inc., et al., the Cato Institute, the Restaurant Law Center, and the Chamber of Commerce of the United States, et. al.
But the US Supreme Court denied certiorari, meaning the decision discussed above by the US Court of Appeals for the 9th Circuit stands for its district. This will likely have big ramifications for businesses not only in that district, but the rest of the country.
If you own a business with a physical location that is open to the public and you have a website that helps people acquire goods and services from your business, the smart move is to make sure that your website is accessible to people with disabilities. As the DOJ has made clear for many years, it is your legal responsibility to make sure your website is accessible. (It’s also good business.)
If you work with a web developer, ask them about your site’s accessibility. Or if you’re developing your own site and haven’t ever thought about accessibility, learning about WCAG 2.0 is a good place to start.
What if you own a business but it’s not open to the public, or you run a website that has no connection to a brick-and-mortar location? There’s no obligation for such websites to be ADA compliant, so it’s up to you whether you want your site to be accessible or not.
Strategic Business Advice and Guidance
The case above is just one example where the law and business intersect, but it happens all the time. By knowing more about your company’s legal duties, options, and potential pitfalls, you can help strengthen your business. For smart strategic advice to help protect and grow your business, contact business attorney Gem McDowell and his associates at the Gem McDowell Law Group in Mt. Pleasant, SC by calling 843-284-1021 today.
Can You Be Held Personally Liable for Your LLC’s Debts?
Entrepreneurs who create a limited liability company (LLC) are protected from putting their personal assets at risk for business debts. Right? After all, that’s the main purpose of the LLC. “Limited liability” is even in the name.
Well, not always. There are situations in which a member of an LLC is not protected and can be held personally responsible for business debts.
Today we’re going to look at a 2019 case from the South Carolina Court of Appeals, Johnson v Little (read it here), that touches on a number of issues that are important for business owners to know, including limited liability and breach of contract.
Johnson v Little: The Facts of the Case
Robin Johnson of CQI Pharmacy Services, LLC and Robert Little of CQI Oncology/Infusion Services, LLC, had a rather unusual situation. Both were the sole owners of their companies and at the same time were employees at the other’s company, with the power to write checks from the other’s business.
In spring 2013, Johnson paid invoices in the amount of $25,568.59 to settle vendor accounts for Little’s company, CQI Oncology. At some point, Little removed Johnson as an authorized signatory for his business and the checks Johnson had signed and sent to the vendors ended up not going through.
Shortly thereafter, the two entered into a contract for Johnson to purchase assets of Little’s company for the price of $30,000. The contract stated that “the Property is free and clear of any liens or encumbrances” but due to the bounced checks, that turned out not to be the case. Johnson discovered that the invoices were still outstanding and that as the new owner, she owed the outstanding amount to the vendors.
Johnson sued Little for breach of contract, among other things. The matter was tried by a master, who found in favor of Johnson. An appeal followed.
The Three Elements of Breach of Contract
The master found that the following three elements of breach of contract were satisfied in this situation:
- There was a valid contract. Neither party disputed this.
- There was a breach of the contract. The contract contained language stating the Property was free and clear of “encumbrances” when that was not true. The outstanding invoices were a clear encumbrance. Little tried to argue this point unsuccessfully.
- There were damages resulting from the breach. Johnson had to pay the vendors’ invoices herself, costing her over $25,000.
All three criteria must be satisfied in order to find a breach of contract occurred, as they were in this case.
The standard remedy for a breach of contract is for the breaching party to reimburse the nonbreaching party so that it’s as if the breach had never happened. The Court of Appeals reaffirmed this standard in this case, by rejecting the master’s decision to award Johnson an additional $30,000 above the amount of the invoices. This would have put her in a better position than she would have been had the breach never occurred, which violates the general rule for breach of contract remedy.
A Lesson on the Limits of Limited Liability
Now we come to the part about personal liability for company debts. In the appeal, Little argued that the master erred in finding him personally liable in addition to his company. The contract he entered into with Johnson was done so and signed by Little as the sole member and manager of the LLC, and as an individual.
This is so important, it bears repeating: Little entered into the contract and signed it as a representative of his LLC and on his own behalf.
The Court of Appeals states that because Little “was a party to the contract as an individual and his actions caused the contract to be breached, the master did not err in holding him individually liable.”
A simple lesson here is to always sign anything relating to your business as the LLC’s owner. When signing a contract or endorsing a check, include the full name of the LLC and sign as “John Q. Smith, Manager.” Sign a company check (which already has the LLC’s name on it) with your name and role.
Other Limits of Limited Liability
If Little had signed only as a member/owner and not as himself, could he still have been found personally liable? Possibly. In its decision, the Court of Appeals cites a 2012 South Carolina Supreme Court case, Dutch Fork Dev. Grp. II, LLC v. SEL Props: “as a matter of law, a manager of a limited liability company can wrongfully interfere with his company’s contracts and be held individually liable for his acts.” In the case at hand, the Court did determine that Little’s actions constituted “wrongful interference” with the company contracts, whether he signed the contract as an individual or not.
Another way a business owner may be held personally liable is if they commit a tort, or wrongful act, such as fraud. Liability can also be suspended due to piercing the corporate veil. Learn more about this important concept on our blog, here.
Get Help with Contracts Strategic Business Advice
This is just a brief overview of the ways in which an LLC owner may be held personally liable for business debts, and the true lesson is that business law is often not as straightforward as it appears. For that reason, it’s smart to have an experienced business attorney in your corner who can provide you with strategic business advice like Gem McDowell.
Gem is a problem solver and a business attorney with over 25 years of experience who can advise you whether you’re looking to buy a company, start a new company, or grown an existing company. Call Gem and his associates at their Mt. Pleasant office at 843-284-1021 to schedule a free consultation today and get the help you need.
