Friday, May 10, 2013

Relationship of Membership Interest Redemption, Employment Agreement, Insolvency Defense

New York Court Addresses Relationship of Membership Interest Redemption,
Employment Agreement, Insolvency Defense
      In a recent decision, a New York Federal District Court considered a pair of issues, namely (a) how an agreement for the redemption of a membership interest should be interpreted in relationship to an employment agreement between the redeemed member and the LLC and (b) the application of the insolvency defense to an otherwise agreed-upon redemption.  In this instance, the Court found the termination of the employment agreement did not limit the redeemed member’s rights to the full agreed-upon redemption consideration and that the LLC had failed to put forth probative evidence of its solvency if required to perform.  Dauphin v. Crownbrook ACC LLC, No. 12-CV-2100 (ARR) (SMG) (E.D.N.Y. April 10, 2013).
      Dauphin had been a member of Crownbrook ACC LLC, as well as an employee thereof.  He withdrew as a member from the LLC, taking a promissory note in the amount of $1.25 million.  In addition, he entered into a new employment agreement with the LLC providing for annual compensation of $60,000.  The LLC made the first few payments under the promissory note, but thereafter defaulted.  After the default, Dauphin withdrew from the employment agreement, and he thereafter filed suit for damages flowing from the LLC’s breach of the promissory note.  The LLC, in defense, raised a pair of arguments.  First, it argued that under the terms of the employment agreement, Dauphin, in effect, waived his claims for further payments under the note.  In addition, the LLC argued that payment on the note would render it insolvent and that it is precluded from paying on a redemption obligation when insolvent.
      As for the argument that Dauphin’s termination of the employment agreement effected as well a termination of obligations under the note, the company relied on the following provision:
In the event that [Dauphin’s] employment is terminated … by [Dauphin] for any reason … prior to the Termination Date [i.e., the due date of the last payment under the promissory note], [Dauphin] shall only be entitled to receive the compensation payment [i.e., any compensation accrued but not yet paid under the employment agreement].  The compensation payment shall be paid to [Dauphin] in a single lump sum on the 30th day following such termination of [Dauphin’s] employment.  [Dauphine] shall not be entitled to any other payments or benefits from the Company.  After the termination of [Dauphin’s] employment under this Section 6.4, the obligations of the Company under this Agreement to make any further payments or provide any benefits herein to ]Dauphin] shall thereupon cease and terminate.

      Following Dauphin’s termination of the employment agreement, the company argued that the sentence “[Dauphin] shall not be entitled to any other payments or benefits from the Company” effectively terminated its obligation to make further payments under the note.  The Court, applying various principles of contract construction, found that the limitations of Section 6.4 of the employment agreement referred solely to payments due under the employment agreement and did not impact upon the company’s obligations to perform under the note.  The Court noted as well that it is “inconceivable” that Dauphin would have made payments under the note contingent upon his continued employment by the LLC pursuant to an agreement terminable at will by either party.  Further, the Court noted that the promissory note itself did not reference the employment agreement.  With that in mind, the Court found that the note unambiguously created an obligation of the LLC not dependent on the terms of the employment agreement.
      With respect to the insolvency defense, for reasons that are never made clear in the opinion, the defendant LLC cited the provision of the New York Business Corporation Law which provided that a corporation may not redeem its shares when it is either insolvent or when the redemption would render the corporation insolvent.  See N.Y. Bus. Corp. L. § 513(a).  The defendant properly pointed out that it is the New York LLC law, not the law governing business corporations that controls and that § 508 thereof imposing limitations upon distributions to a member; it does not, unlike the corporate law, specifically reference redemptions.  In further support of its argument as to insolvency, the LLC issued very supplemental information, including an affidavit that the Court found could not have been based upon personal knowledge and which as well noted the inaccuracy of certain of the financial statements submitted therewith.  Having raised the prospect of insolvency as an affirmative defense, the Court found that the LLC had “produced no affirmative evidence of insolvency in its opposition to plaintiff’s partial summary judgment motion,” and summary judgment was granted.

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