Partnership, LLC and Shareholder Disputes in the Bay Area and California

When co-owners of a closely held business fall out, the fight is about control and money. One owner runs the company; another wants a fair share of the profits or a fair price to leave. Reiser Law, P.C. represents partners, LLC members, minority shareholders, co-founders and their companies, as plaintiffs and defendants, in California state and federal courts and in arbitration. From our Walnut Creek office in Contra Costa County, we serve clients throughout the San Francisco Bay Area and across California. Our practice areas page describes the rest of our work.

What these disputes involve

An owner is removed as manager and locked out of the bank accounts. Members are allocated taxable income but receive no cash. The controlling owner's pay rises while profit shrinks. A partner steers an opportunity to a side company. Buy-sell terms and arbitration clauses in the governing agreement often decide how an exit is priced and where the case is heard.

The claims that come up most

• Breach of fiduciary duty, for self-dealing, diverted opportunities, excessive compensation or competing with the business
• Accounting, to establish what the business earned and where the money went
• Breach of the partnership, operating or shareholder agreement, including buy-sell, distribution and management provisions
• Breach of the implied covenant of good faith and fair dealing, when one owner uses discretion under the agreement to deprive another of its benefits; see our article on the implied covenant in California
• Fraud and concealment, when an owner was induced to invest or sell by misstatements
• Inspection, dissolution and buyout proceedings under the Corporations Code
• Declaratory relief over who owns what, who controls the company, and whether a removal or capital call was valid

Our article on whether you can sue your business partner walks through these claims in plain terms.

Fiduciary duties among owners

Partners owe the partnership and each other duties of loyalty and care. Loyalty requires a partner to account for any benefit derived from the business or its property, including a diverted opportunity, and not to compete with it or deal with it on behalf of an adverse party. The duty of care is narrower: it reaches grossly negligent or reckless conduct, intentional misconduct and knowing violations of law. The same duties apply to members of a member-managed LLC and to the managers of a manager-managed LLC, whose members owe none solely by reason of membership. Cal. Corp. Code §§ 16404(a)-(c), 17704.09(a)-(c), (f).

In a corporation, majority shareholders owe the minority a fiduciary duty to use their control "in a fair, just, and equitable manner." Jones v. H.F. Ahmanson & Co., 1 Cal. 3d 93, 108 (1969).

Books and records

A shareholder may inspect the accounting books, records and minutes on written demand, for a purpose reasonably related to the holder's interests as a shareholder. The right covers domestic corporations and foreign corporations that keep records in California or have their principal office here, and it cannot be limited by the articles or bylaws. Cal. Corp. Code § 1601(a)-(b). Partners, and former partners for the period they were partners, may inspect and copy partnership books and records. LLC members have similar rights to inspect required company records and obtain copies of its tax returns, and any waiver of those rights is unenforceable. If a corporation or LLC fails to comply without justification, the court may award reasonable expenses, including attorney's fees. Cal. Corp. Code §§ 1604, 16403(b), 17704.10(b), (g)-(h).

Direct or derivative

Some harms belong to the company, such as a partner diverting company funds, and must usually be pursued derivatively, on the company's behalf. Others, such as being frozen out of distributions owed to you, may be personal. The distinction decides who must be sued, what must be done before suit, and who receives any recovery.

A shareholder bringing a derivative claim must generally have owned shares at the time of the transaction complained of, and must allege with particularity the efforts made to get the board to act, or the reasons for not making the effort. The shareholder must also have informed the corporation or board in writing of the ultimate facts of each claim, or delivered a copy of the proposed complaint. Cal. Corp. Code § 800(b)(1)-(2). Within 30 days after service of summons, a defendant may move to require the plaintiff to post security for the defendants' expenses, and if the court grants the motion the security may not exceed $50,000. § 800(c)-(d). LLC members bringing derivative claims face parallel requirements. Cal. Corp. Code § 17709.02. Our article on California minority shareholder rights discusses these claims.

Deadlock, dissolution and buyouts

Dissolution rules differ by entity. Holders of at least 33 1/3 percent of a corporation's shares or equity, not counting shares of anyone who took part in the alleged misconduct, may file, as may any shareholder of a close corporation. Grounds include deadlock, persistent and pervasive fraud, mismanagement or abuse of authority, and, in a corporation with 35 or fewer shareholders, a showing that liquidation is reasonably necessary to protect the rights or interests of the complaining shareholder. Any LLC manager or member may file on grounds that include deadlock or internal dissension. A partner may seek dissolution when another partner's conduct makes it not reasonably practicable to carry on the business with that partner. Cal. Corp. Code §§ 1800(a)(2), (b), 16801(5), 17707.03(a)-(b).

The court can stabilize a company while the case is pending. When the ground for dissolution is board deadlock, the court may appoint a provisional director. Cal. Corp. Code § 1802. On a showing that the corporation and its shareholders will otherwise suffer, the court may appoint a receiver to manage the business and preserve its property pending the hearing. Cal. Corp. Code § 1803.

Unless the articles provide otherwise, the corporation, or if it declines, holders of 50 percent or more of the voting power, can avoid dissolution by buying the moving shareholders' shares for cash at fair value. In an LLC, the other members can buy the moving members' interests for cash at fair market value. If the sides cannot agree on price and the buyers post bond, the court stays the dissolution and fixes the value. Cal. Corp. Code §§ 2000(a)-(b), 17707.03(c)(1)-(2).

From there, valuation drives the case. For a corporation, fair value is determined on the basis of liquidation value, taking into account the possibility of selling the entire business as a going concern. Cal. Corp. Code § 2000(a). In an involuntary dissolution case, the valuation date is the date the action was commenced, unless the court sets another date for good cause. § 2000(f). The filing date can therefore fix the price, which makes timing a strategic decision.

Arbitration clauses

Many operating and partnership agreements require arbitration. On a petition to compel, a California court must order arbitration if an agreement to arbitrate the controversy exists, unless the right has been waived, grounds exist for rescission of the agreement, or a party is also in pending litigation with a third party arising from the same transactions and there is a possibility of conflicting rulings. Cal. Civ. Proc. Code § 1281.2(a)-(c). Where the case is heard affects its cost, its speed and the scope of review, so we address the forum at the outset.

Deadlines and fees

Deadlines depend on the claim. An action for fraud must generally be brought within three years, and the claim does not accrue until the aggrieved party discovers the facts constituting the fraud. Cal. Civ. Proc. Code § 338(d). Claims not covered by a more specific statute have a four-year period. Cal. Civ. Proc. Code § 343. Which period applies to a fiduciary duty claim depends on what the claim is really about, so the safest course is to act promptly.

California generally follows the rule that each side pays its own attorney's fees, but many owner agreements contain a fee clause. When a contract provides for fees to one party or to the prevailing party, the party who prevails on the contract is entitled to reasonable fees, whether or not that party is the one named in the clause. Cal. Civ. Code § 1717(a). Fee exposure belongs in every decision to sue or settle.

How a business divorce usually proceeds

1. Assessment. We review the governing documents, the company's financial statements and tax returns, and the communications between the owners.
2. Records demand. If the client lacks information, a written inspection demand comes first. The response, or the refusal, often shapes the case.
3. Negotiation. Many disputes end in a negotiated buyout once both sides see the numbers. A credible litigation plan improves the terms.
4. Litigation or arbitration. If negotiation fails, we file in the proper forum, seek interim relief where control or assets are at risk, and develop the valuation evidence.
5. Resolution. Most cases end in a buyout, a sale or a structured separation. Some go to trial or an award.

What to gather before you call

• The partnership agreement, operating agreement, bylaws and any shareholder or buy-sell agreement
• Financial statements, tax returns and K-1s for the last several years
• Bank statements and general ledger entries you have access to
• E-mails and messages among the owners about the dispute
• Any notices of removal, capital calls, meetings or written consents

Our team

Michael J. Reiser, the firm's founder, has been a member of the State Bar of California since 1988 and is admitted in the Ninth Circuit and the Northern, Central, Eastern and Southern Districts of California. Sean Svendsen, a member of the State Bar of California, handles California litigation with the firm from the Bay Area. Matthew W. Reiser and Isabella Martinez, based in Miami, are members of the State Bar of California and The Florida Bar, so a dispute spanning both states stays with one team.

Questions clients ask

I own a minority stake. Can I see the company's books?

Usually. Shareholders, partners and LLC members all have statutory inspection rights. A shareholder must demand inspection in writing, for a purpose reasonably related to the shareholder's interests.

My co-owner and I are deadlocked. What are our options?

Check the agreement for buy-sell terms or a deadlock procedure. Deadlock can also support dissolution of a corporation or LLC, the court can appoint a provisional director in a deadlocked corporation, and the other side can then buy out the owner who filed.

I was pushed out of a company I co-founded. Do I still have rights?

It depends on what you still own and what your agreements say. If you still hold shares or a membership interest, the rights above generally apply. See our page on co-founder and startup disputes.

Should I sue individually or on behalf of the company?

It depends on whose injury it is. Claims for harm to the company are usually derivative and come with procedural requirements, including a demand on the board and a possible security motion. Claims for injury to you personally can be brought directly.

How is my interest valued in a buyout?

For a corporation facing a dissolution petition, the statute uses fair value based on liquidation value, considering a going-concern sale, as of the filing date unless the court sets another date. The agreement may set its own formula, and expert valuation evidence usually decides the number.

Talk to us

To discuss a dispute, call (925) 256-0400, email Michael J. Reiser at michael@reiserlaw.com or Sean Svendsen at sean@reiserlaw.com, or use our contact page. Our office is at 1990 North California Blvd, 8th Floor, Walnut Creek, CA 94596.

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