Friday, May 3, 2013

Challenge to Expulsion From LLC Based on Good Faith and fair Dealing Rejected

      A recent decision in the Wisconsin Court of Appeals focuses primarily upon the assertion by certain expelled members of an LLC that their expulsion and the redemption of their interests violated the contractual obligation of good faith and fair dealing.  Summary judgment was granted the defendants by the trial court, and that summary judgment was affirmed by the Wisconsin Court of Appeals.  Berndt and Gretzinger v. Berndt, Matttison and Hybrid Fitness, LLC, Appeal No. 2011 AP 2425 (March 21, 2013). 
      Hybrid Fitness, LLC, organized in Wisconsin, had four members, namely Robin Berndt, Chris Gretzinger, Ryan Berndt (the opinion does not detail the relationship between Robin Berndt and Ryan Berndt), and Sarah Mattison.  The LLC was owned 24% by Robin, 24% by Chris, 25% by Sarah and 27% by Ryan.  All were engaged in the operation of the fitness facility. 
      For reasons that are not detailed in the decision, there was a breakdown in the relationship between the four members.  Ryan and Sarah, constituting 52% of the total ownership of the LLC, terminated Robin and Chris as employees thereof and sent them notice of numerous breaches of the company’s operating agreement.  That operating agreement provided that, upon a default thereof, the other members would have an option to acquire the defaulting member’s ownership interests for the “Determined Value.”  Due to this being an early-stage business, the Determined Value at the time Robin and Chris were expelled from the LLC was zero.
      Robin and Chris brought an action challenging their termination and buy-out.  With respect to their challenge to the summary judgment given as to the claimed breach of the obligation good faith and fair dealing, the Court wrote:
On appeal, Robin and Chris argue that summary judgment was erroneously granted on the breach of good faith and fair dealing claim because genuine issues of fact exist as to the motivation for purchasing their shares.  Robin and Chris concede the operating agreement “did indeed authorize Members to purchase the ownership units of other Members in the event of ‘any breach of the agreements or provisions contained in this Agreement.’”  Nevertheless, they insist their breaches were “wholly immaterial and resulted in no actual harm to Hybrid Fitness.”  Furthermore, they contend the manner in which Ryan and Sarah acted on their breaches “raised further suspicions about their true reasons for first terminating Robin and Chris and then re-purchasing their ownership shares.”

      The Court easily set this argument aside.  While agreeing that every contract contains an obligation of good faith and fair dealing, it was undisputed that their removal as members was done in accordance with the operating agreement, as was the re-purchase of their interests.  On that basis, the Court found that there was no breach of the obligation of good faith and fair dealing.  The Court distinguished a number of cases in which employees or commission independent contractors had been terminated with the expectation of depriving them of accrued but as of the time of termination unpaid compensation.  Under the law of Wisconsin, those payments were still due and owing.  No such effort to deprive Robin and Chris of accrued benefits was here at issue.  Rather:
The present case is not one of an agent suing a principal, or an employee suing an employer for terminating the relationship to avoid paying benefits or compensation previously earned.  It is a case of co-owners of a business suing other co-owners for expelling them and depriving them not of an accrued benefit, but of their ownership interests and potential future profits.  When the terms of the operating agreement are complied with and sufficient grounds for termination of the ownership under the operating agreement existed, as in this case, the defendants’ motives in exercising their prerogatives under the agreement are not material.
      This panel of the Wisconsin Court of Appeals was not going to allow the parties to an agreement to avoid its application.  Also, this is useful guidance with respect to the obligation of good faith and fair dealing.  As has been reviewed in innumerable decisions, the implied covenant informs the performance of contractually agreed to terms, filling as necessary interstices therein.  It will not, however, affect the addition of terms to the agreement or limited a party’s rights that are provided for therein.

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