With so much corporate law being determined in the Delaware Chancery Court, it’s interesting to consider decisions coming out of other jurisdictions. Here’s one from our home state of New Jersey from about a year and a half ago, with both legal and computational twists (including a math error by the bench!).¹

  • The trial judge incorrectly applied NJ’s Business Corporation Act (also “the Act”) to a case involving a limited liability company:
    • The plaintiffs filed a suit against their former business partners in August 2005, accusing them of minority shareholder oppression. The plaintiffs alleged that the defendants had performed multiple actions in violation of the Act, including:
      • Awarding bonuses to company employees and raising salaries (including their own) above an agreed-to salary cap, without the consent of all of the shareholders;
      • Engaging in negotiations with a potential investor, Sage Capital Growth Inc. (also “Sage”), without informing all of the shareholders;
      • Controlling the business check book and flow of information in such a manner to eliminate the minority shareholders’ claims on earnings and deprive them of the ability to participate in the affairs of the company; and
      • Reallocating treasury shares upon the merger of Markov Processes Inc. and Miksoft Inc. (entities in which the defendants each held minority interests) into Markov Processes International LLC (“MPI”), without the consent of the other shareholders.
    • The trial judge ruled in favor of the plaintiffs, finding that the above actions evidenced minority shareholder oppression as defined under the provisions of the Act. However, the Act only applies to corporations and, by the time the suit was filed, Markov Processes Inc. and Miksoft Inc. had already been merged into a single limited liability company (MPI).
    • The provisions of the Business Corporation Act cannot be applied to a limited liability company, which is instead governed under the Limited Liability Company Act (“LLC Act”). Under the LLC Act, a dissatisfied minority member can simply resign, an option not available to dissatisfied minority shareholders in a corporation.
  • The trial judge incorrectly valued the interest in MPI purchased by Sage:
    • Based on a recent investment in MPI made by Sage ($500,000 in exchange for a common stock interest of about 10%), the trial judge determined the fair value of MPI’s equity to be $5.0 million. The trial judge noted that a discount for lack of marketability was embedded in this value, and estimated the appropriate size of that discount to be 35%.
    • In computing the pre-discount value of MPI’s equity, the trial judge added 35% to the fair market value of $5.0 million, arriving at a grossed-up value of $6.75 million ($5,000,000 times 35% = $1,750,000, plus $5,000,000 = $6,750,000). However, the correct formula for grossing-up a net amount is as follows:


  • Thus, the pre-discount value should have been calculated by dividing the fair market value by 0.65 (1.0 minus 0.35), which would have yielded a value of just under $7.7 million.

An appellate panel found that the plaintiffs could not be considered oppressed shareholders. The treasury shares were not considered misappropriated once the new entity (an LLC) was formed. In addition, the panel found that no attorney fees ($1.7 million) should be awarded to the plaintiffs because it is not permitted under the LLC Act. However, since the pre-discount value was incorrectly calculated by the trial judge, both Tutunikov (10.45% interest) and Zurakhinsky (7.8375% interest) should have received higher payouts based on the increased valuation ($7.7 million versus $6.75 million).

¹Roman Tutunikov and Viktor Zurakhinsky, et al. (plaintiffs), v. Michael Markov and Mikhail Kvitchko, et al. (case number A-1827-10T3, in Superior Court of the State of New Jersey, Appellate Division).