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.
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.
6 Common LLC Creation Mistakes
Starting a new business is exciting but also a little intimidating. There’s a lot you probably don’t know, and mistakes can end up costing you.
If you’ve decided to start a limited liability company (LLC), then you’ve already avoided the biggest mistake, which is not having a business entity at all. But you’ll also want to avoid these 6 other common mistakes people make when starting an LLC.
Mistake 1: Choosing to Become an LLC When It’s Not the Right Entity for Your Business
The first mistake people make when creating an LLC is choosing an LLC to begin with. The limited liability company is a great business structure for many business ventures, but it’s not suitable for all.
The main consideration is money. Do you plan on growing with capital from outside investors? If so, a corporation is likely a better choice for you. Investors are typically more comfortable investing in corporations than in LLCs. Corporations are also the only entities that can issue stock, so if you dream of a big IPO in the future, then the corporation is the entity for you.
Mistake 2: Incorporating Your Business in the Wrong State
Once you’ve determined that the LLC is the right entity for your business, your next step is to decide on where to incorporate it, i.e., where to register it.
Most of the time, incorporating in the state where you live and do business is the best solution. Some entrepreneurs want to incorporate in other states like Delaware, Wyoming, or Nevada for the supposed tax and legal benefits. This can make sense for larger companies, but it rarely makes sense for smaller LLCs.
Incorporating your business in a state your business isn’t based in means taking on hassles like maintaining a registered agent in both the state you live in and incorporate in, filing paperwork in both states, and paying fees to both states. After considering the time and money involved, it’s typically not a savvy move for most LLCs. It’s usually smarter to incorporate in your home state.
Mistake 3: Choosing the Wrong Type of LLC
There are actually four types of LLCs you can create in South Carolina, as we’ve covered before in a previous blog. Check out that blog for more information, but in short, know that an LLC can be either “term” or “at will” and “member managed” or “manager managed.” If you select the wrong type when setting up your LLC, it can be bad for the LLC and the members down the line.
Mistake 4: Choosing a Bad Name
What makes a “bad” name? One that’s already being used.
Before choosing a business name, do some research. You can search for existing business names in South Carolina here under “Existing Business,” which is a good start. (South Carolina does not allow a new business to register a name that’s not “grammatically distinguishable” from existing names.) You might also want to search the trademark database at the US Patent and Trademark Office here to see if the name you have in mind is being used somewhere else. Finally, a thorough Google search for your proposed name can turn up other uses of the name.
Your name matters because if you inadvertently violate someone else’s trademark, you can get in trouble. Disputes over names can end up being costly and time-consuming if someone sues you over the name and you want to defend your right to use it. But even if you decide to let go of the name, it will cost you time and money to rebrand your digital and physical presence. Worse, you will have lost the brand recognition and goodwill you’ve built up over the years in your community. So choose wisely.
Mistake 5: Not Having Corporate Governance Documents
This is probably the single biggest mistake you can make when you plan to start an LLC with business partners. Many people go into business with friends or family members, and at the start everything is copacetic. Everyone gets along and there are no major disagreements. But many an experienced business attorney will tell you that times change, and that’s when things can get ugly.
Imagine that you’re in a business with two friends and everything is going well at first. Then one friend unexpectedly dies, and you find you’re now in business with their spouse. Or the other friend starts slacking off, working fewer hours but taking the same profits as the hard-working partners. Or you become incapacitated and can no longer work. Or the three of you disagree on how to raise money for the company. What happens to you, your investment, and the business in these situations?
Corporate governance documents are intended to lay out the rules so that when a disagreement or unpleasant situation arises, what happens next is clear. These simple documents can preserve good relations between partners, protect the partners’ investments, and protect the business itself.
Two important documents that any business owner with partners should consider getting during the creation of their business:
An operating agreement. This spells out how the company should be managed, how profits and losses are handled, how much of the company each member owns, what each member’s responsibilities are, and more.
A buy-sell agreement. This document covers what happens to the business when a member dies, becomes incapacitated, stops working, etc. Read more about buy-sell agreements here.
By addressing future scenarios now, you can avoid major problems down the line. Just know that it’s vital to discuss these things before you and your partners start operating your business.
Mistake 6: Not Getting Legal Assistance When You Need It
It’s very easy to go online and get the forms to start an LLC yourself, without the help of an attorney. Is that smart?
In some cases, doing so is fine and poses no future problems, particularly with single-member LLCs that operate within one state and are wholly self-funded. These business owners would likely benefit from speaking with a business attorney, but they may feel pretty confident that they can create their LLC on their own.
But other entrepreneurs should consider speaking with an attorney before and during the creation process of their LLC. This is especially true in any of the following situations:
- You have business partners
- You plan to take on money from outside investors
- You plan to do business in multiple states
The cost is usually the main reason that people don’t want to spend the money on an attorney at this stage, and that’s understandable. Business owners want to make money before they spend it. But the money you spend up front on corporate governance documents or advice from an experienced attorney can save you money and mistakes down the road. (Plus, don’t forget this expense is a business write-off when it comes to tax time.)
Questions About Your LLC? Speak with Business Attorney Gem McDowell
Gem McDowell is a business attorney with over 25 years of experience helping people start and run their businesses. He’s a problem solver who can help you start out right and avoid the many mistakes he’s seen in the past. Contact Gem at his Mt. Pleasant office today to schedule a free consultation by calling (843) 284-1021 or filling out this contact form.
