Court Cancels Capital Call For Want of a Postage Stamp

Farrell Fritz, P.C.
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Who says email is more efficient and cheaper than regular mail?

Not the manager of the McGuire family real estate business after winning a lower court ruling only to see it reversed on appeal last month in a decision agreeing with his siblings that his issuance of dilutive capital calls, notice of which he emailed to them, was ineffective because the governing LLC agreement required all notices to be sent by first class mail.

The case and the decision by the Appellate Division, Fourth Department in McGuire v McGuire is not as simple as it sounds. Permit me to explain.

According to the complaint filed by three of the six McGuire siblings (referred to collectively by their first name initials, JKM) against their brother James, in the 1990s all six obtained equal membership interests in a number of holding companies originally formed by their father that owned dozens of commercial real properties as well as health care businesses and skilled nursing facilities. In 2006, James formed a real estate development and property management company, McGuire Development Co., LLC (MDC), also owned in equal percentages by all six siblings, to manage the McGuire family business empire.

By agreement in 2011, James’s membership interest in MDC increased 5% more than the other members reflecting his role as general manager of MDC and the other entities that make up the McGuire family business. By 2017, after one of the siblings exited MDC, James held a 24.8% membership interest and the other four siblings each held an 18.8% interest. Over the next two years, during which JKM were negotiating with James a buyout of their own interests in MDC, James made a series of capital calls under Section 4.2 of MDC’s operating agreement permitting him “from time to time” as manager to request pro rata additional capital contributions and diluting the membership interests of members who elect not to contribute additional capital.

Here’s where things get interesting: James sent notices of the MDC capital calls to his siblings by email rather than by personal delivery or “by first class mail, postage prepaid” as specified in Section 12.1 (“Notices”) of the operating agreement.

JKM did not contribute the requested additional capital, consequently their membership interest percentages were diluted to 9.98% each, leaving James with almost 50% and the fifth sibling, who worked in the business with James, with almost 21%. JKM did not respond or take any other action with respect to the capital calls except to object in mid-2019 that a capital call made earlier that year was procedurally defective, apparently without specifying the nature of the defect.

James Prevails in the Lower Court

The JKM buyout negotiations collapsed. In mid 2020, JKM filed suit against James alleging claims for breach of contract, breach of fiduciary duty, improper dilution of their MDC membership interests based on failure to give proper notice, and demanding an accounting for MDC and the various other McGuire entities.

In September 2020, a justice of the Erie County Supreme Court granted summary judgment for James dismissing JKM’s claims alleging that James breached the MDC operating agreement’s notice requirement with respect to the capital calls that resulted in the dilution of JKM’s membership interests. The court’s email decision — How appropriate given the subject matter! — which was later incorporated in a formal order, found that JKM:

waived the right to object to the disputed notices relating to the 2018 and 2019 capital calls at issue, and are estopped from claiming ownership interests that are inconsistent with those set forth in, inter alia, verified tax documents, such that the respective ownership interests are hereby determined to be: F. James McGuire: 49.3869%; Michael McGuire: 9.9803%; Kathleen M. McGuire: 9.9803%; Jeannie Marie McGuire: 9.9803%; and Jacquelyn McGuire Gurney: 20.6727%.

The Appellate Court Reverses, Finding the Email Notice and Capital Call Potentially Defective in More Ways Than One

The appellate court wasted few words finding that under the operating agreement’s notice provision, “[t]here is no dispute that the challenged capital calls from 2018 and 2019 were sent only by email and thus did not strictly comply with that provision.” The parties’ real dispute, the court said, is James’s contention that JKM “waived strict compliance with the notice provision through their course of conduct, and consequently whether email notice of the capital calls was sufficient.”

The court’s opinion reviewed the legal standards for finding waiver, emphasizing that waiver requires an “intentional abandonment of a known right” that may not be inferred “from mere silence” but also that “a waiver may be established by the parties’ course of conduct and actual performance” even where, as in the case of MDC’s operating agreement, the agreement contains a nonwaiver clause.

The court concluded that on the record before it, James did not establish that JKM’s conduct as a matter of law constituted a waiver of the notice provision, for two reasons. First, the capital calls were issued in the “unique business context” of ongoing negotiations between JKM and James “about a buyout where [JKM] would exit MDC.” As the court further noted,

There is no dispute that the purported February 2018 capital call was MDC’s first ever request for capital contributions, and therefore, there is no historical pattern of conduct that would support the conclusion that plaintiffs waived the notice requirement prior to any of the capital calls at issue here. Moreover, plaintiffs’ emails from the time of the capital calls express surprise that MDC required additional capital from them, despite defendant’s participation in the ongoing buyout negotiations, and do not reflect any intent to waive the notice requirement.

Second, the court rejected James’s reliance on JKM’s failure to object to email notices of capital calls for other McGuire entities, finding it to be “irrelevant to waiver of the notice requirement for MDC because any waiver by plaintiffs with respect to a separate contract or agreement cannot be imputed as a waiver of the notice requirement in MDC’s operating agreement.”

Notice by email versus regular mail was not the only issue addressed by the court concerning dilution of JKM’s membership interests. It also rejected James’s argument that the doctrine of tax estoppel precluded JKM from disputing their diluted membership interests as shown in their Schedule K-1s, finding that “[i]t would distort the doctrine of tax estoppel beyond recognition to conclude that plaintiffs are precluded from taking a position contrary to a tax document they did not swear to or sign, and which was, in effect, prepared by their opponents.”

Non-compliance with the operating agreement’s notice provision? Check. Non-waiver due to the “unique” context of the capital calls and other factors? Check. Tax estoppel out? Check. Having lost his bid at summary judgment, with those findings it’s hard to see how James ultimately is going to come out the victor on the issue of dilution, especially when the court also found that his own submissions “raise issues of fact whether plaintiffs received any notice of the capital calls that resulted in dilution of their membership interests, and whether the calls that were noticed by email were actually responsible for the dilution of plaintiffs’ membership interests in MDC.” As the court explained:

Specifically, . . . the precise amounts, timing, and method of the capital calls do not support the court’s calculations of plaintiffs’ membership interests in MDC or the court’s conclusion about which capital calls actually diluted plaintiffs’ membership interests in MDC. For example, although the emails to plaintiffs regarding requests for capital were made in February and July 2018, defendant’s submissions establish that the dilution of plaintiffs’ interest in MDC did not occur until November of that year. Further, based on defendant’s own submissions, the value of the dilution in plaintiffs’ interest in November 2018 is not comparable to the value of the capital calls purportedly noticed in the emails dated February and July 2018. Consequently, there are issues of fact with respect to whether plaintiffs had any notice at all of the capital call that actually resulted in the dilution of their membership interests in MDC.

Always, Always Check and Follow the Notice Provision

My initial reaction to reading this case was how quaint it is to see an operating agreement prepared in the last two decades (at least) with a notice provision requiring delivery of all notices either personally or via uncertified snail mail. I saw nothing in the court’s decision indicating that any of the plaintiffs didn’t have and regularly use an email account, which otherwise might have explained the MDC agreement’s antiquated notice provision. If I had to guess, it would be that whoever prepared the MDC operating agreement copied a form from the earliest days of New York LLCs in the mid 1990s, before email became the dominant mode of written communication.

Family-owned businesses are famous for ignoring organizational formalities. While the MaGuire plaintiffs never denied receiving the emailed capital call notices, and in at least some instances gave responses acknowledging receipt, given the importance of the capital calls and their unprecedented impact on the equity ownership of MDC, one would think that James either did or should have consulted with counsel who would have reviewed the agreement and advised James to follow to the letter the operating agreement’s notice provision before pulling the trigger on capital calls. James still could have sent courtesy copies of the capital calls by email as well as licking some envelopes and spending a few bucks on postage stamps instead of many thousands on legal fees.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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