Disassociation of Member Pursuant to Operating Agreement Given Effect

Disassociation of Member Pursuant to Operating Agreement Given Effect

      A recent decision from Connecticut held that the provision of an operating agreement providing that upon certain defaults a member would be disassociated would be enforced. The immediate effect of this ruling is that a suit against the disassociated member for breach of fiduciary duty and conversion of company assets may proceed in federal court pursuant to diversity jurisdiction Inteliclear, LLC v. Victor, Civil No. 3:16cv1403 (JBA), 2016 WL 5746349 (D. Conn. Oct. 3, 2016).

      Inteliclear, LLC had four members: Victor (30%), Powell (30%), Barretto (30%) and DeVito (10%). Victor was the LLC’s “General Manager.” Prior to this suit they had been involved in litigation as to the company. After the dismissal of that litigation (initiated by Victor), the other members voted to remove Victor as the General Manager, and this suit was filed against him.

      The claims against Victor arose out of his operation for the LLC other than in compliance with the operating agreement. For example, while it provided that a check exceeding $5000 could be issued only with the approval of a majority of the members, Victor was apparently writing $5000 checks without that member consent. In addition, he was using company funds to pay personal expenses. Consequent to that conduct, the members other than Victor advised him that he was disassociated as provided in the operating agreement.  The operating agreement of Inteliclear, LLC provided in part:

   The default by any Member in the performance of any Member’s covenants, obligations, responsibilities, duties or undertakings set forth and provided for under the provisions of the Operating Agreement, this Members Agreement, the Members Confidentiality and Non-Compete Agreement or any amendment or successor thereto, in which event, in addition to any remedy in law or at equity available to the non-defaulting Members, the non-defaulting Members may elect to treat such default as a withdrawal of the defaulting Member in connection with such Member’s desire to no longer provide Member’s Services to the Company under paragraph 8.B of this Members Agreement and may proceed with the elections provided non-withdrawing Members in paragraphs 8.B(1) and (2) above in regard the defaulting ember’s [ (sic) ] Interest.”Barretto, Powell and DeVito advised Victor that his violations of the operating agreement would be treated as effecting Victor’s disassociation from the LLC. Victor then moved the LLC’s funds to a new bank. He as well withdrew $30,000 for himself. The suit sought a declaration that Victor, having been disassociated from the LLC, could not act on its behalf. 2016 WL 5746349, n. 7.

      The thrust of this decision was whether the suit could be filed against Victor in federal court. An LLC is treated, for purposes of diversity jurisdiction, as having the citizenship of each of its members. If Victor was still a member of the LLC, there would be no diversity and the suit would be dismissed. If, in the alternative, Victor was a disassociated (i.e., a former member) of the LLC, the suit could proceed.

      The court would hold that Victor was disassociated from the LLC (i.e., no longer a member) and in consequence his citizenship would not be attributed to the LLC. In doing so it had to resolve the question of whether it was making a determination on the merits, which it could not due absent a trial on the merits, or rather resolving a jurisdictional question. In part on the basis that there had been a hearing on the motion for a restraining order, that affording Victor due process, the court said:

   The Court is satisfied that the appropriate way to proceed is to hear and decide the factual issues bearing on its subject matter jurisdiction, recognizing that they also implicate elements of at least one of the substantive claims as well as the basis for the injunctive relief sought. 2016 WL 5746349, *5.

       Reviewing Victor’s conduct, the court found that injunctive relief keeping him from alleging he had control of the LLC was warranted on the basis that he was no longer a member of the LLC. Rather, he had been disassociated under the terms of the operating agreement consequent to his own conduct.

   The Court finds that Plaintiff has demonstrated that Barretto, Powell and DeVito had legitimate justification for believing that Defendant defaulted in the performance of his “covenants, obligations, responsibilities and undertakings” under the Agreements.  As early as the end of 2015, Barretto, Powell and DeVito suspected Defendant was broadly misappropriating InteliClear funds and hired Ram Associates, an accounting and financial consulting firm, to investigate records that they became privy to as a result of the state court action but had not been otherwise able to obtain from Defendant in the ordinary course of business.

   Most significantly, as Plaintiff claims, Plaintiff’s American Express and bank records appear to show that Defendant treated InteliClear’s accounts as his own personal piggy bank. The evidence showed that Defendant used Plaintiff’s American Express card to purchase personal items such as a guitar costing over $500 for himself; airline tickets for his wife, daughter and even his daughter’s former boyfriend, totaling well over $2,000; a gym membership costing over $1,000 for his wife and that he used InteliClear funds to pay his personal credit card bill.  The evidence showed these charges and payments were not “reasonable and necessary business, educational and profession expenses” permitted by Paragraph 4(1) of the Members Agreement, nor reimbursable expenses under Paragraph 8.1 of the Operating Agreement. Additionally, they were not authorized by the other Members. Plaintiff characterizes Defendant’s actions as, in effect, stealing from Plaintiff, demonstrating that he is a defaulting Member under Paragraph 12 of the Members Agreement. 2016 WL 5746349, *5 (citations to record deleted).