Holland & Knight Team Secures Significant Victory for California Ambulatory Surgery Center

After more than 10 years of litigation, attorneys from Holland & Knight secured a win in the California Court of Appeal that affirmed both a grant of summary judgment and a bench trial victory in the Superior Court for Los Angeles County. Tuli v. Specialty Surgical Center of Thousand Oaks LLC involved an ambulatory surgery center’s (ASC) involuntary buyout of an LLC member’s ownership interest after that member’s bad acts. The Court agreed with Holland & Knight’s arguments that the client’s decision was protected under California’s business judgment rule. This landmark published decision confirms the rights of an limited liability company (LLC) to govern itself according to the terms of its operating agreement.

Background

Specialty Surgical Center of Thousand Oaks implemented an operating agreement that included a “terminating event” provision to deter an insider from harming the surgery center’s business. The plaintiff was personally involved in crafting the operating agreement and the terminating event provision. Eventually, one of the surgery center’s members – the plaintiff and appellant in this case – tried to do just that. The surgery center board voted unanimously to terminate the plaintiff’s ownership interest.

The plaintiff, who is not a doctor, effectively abandoned his responsibilities to the surgery center’s operations but continued to collect a share of its profits. Though the other physician-investors offered to buy his interest, the plaintiff refused. A few years later, the surgery center sought new surgeon-investors through a private offering. The plaintiff claimed the price of the offering was too low and attempted to sabotage it.

Although the plaintiff had not read the offering memorandum, he sent a letter baselessly alleging the surgery center’s involvement in illegal conduct, Anti-Kickback Statute violations, bad faith dilution efforts and more. He sent his letter broadly, to potential physician-investors and both members and employees of the surgery center. The letter specifically demanded that the recipients deliver the letter to any prospective investors and emphasized that individual liability may result for each recipient.

The surgery center responded in accordance with its operating agreement. First, the surgery center notified the plaintiff that his letter constituted a terminating event and that he had 30 days to cure by retracting his letter. After the plaintiff refused to cure, the surgery center’s governing board used the terminating event formula in its operating agreement to purchase the plaintiff’s ownership interest. The formula, which the plaintiff helped design, resulted in a zero-dollar valuation of the plaintiff’s interest.

The plaintiff filed suit against the surgery center and its governing board claiming a breach of fiduciary duty, breach of the operating agreement and violations of California’s Unfair Competition Law statute, among other claims. The trial court ruled in the surgery center’s favor based on the business judgment rule and dismissed the entire complaint.

The plaintiff then amended to add a new claim for unlawful forfeiture under a century-old California statute that had never been applied in the context of LLC membership interests. After a months-long bench trial on the forfeiture claim, the court again granted judgment for the surgery center and awarded attorneys’ fees as well. The Court of Appeal affirmed both the summary judgment ruling and the trial court ruling in full.

Analysis of the Court’s Decisions

The surgery center and its board successfully argued that the business judgment rule protected its decision to terminate the plaintiff’s interest. California’s business judgment rule protects business decisions made on an informed basis, in good faith, and in the honest belief the action is in the best interest of the company. Applying the business judgment rule, the Court of Appeal held the surgery center’s decision to be rational and in the center’s best interest.

Although the plaintiff tried to argue a conflict of interest existed because each board member had an ownership stake, the Court rejected this. Instead, the Court determined that the board acted in the best interest of the company as a whole rather than on behalf of themselves as individuals.

Even more, the Court explained that the board’s decision to terminate the plaintiff’s interest was not made in bad faith as claimed by the plaintiff. Contrary to the plaintiff’s bad faith assertions, offering to buy out an unproductive member of a company or expressing distaste for unproven accusations were both irrelevant and justified.

Lastly, the plaintiff argued the surgery center’s involuntary buyout of his ownership interest represented an unlawful forfeiture entitling him to restitution. The plaintiff argued that even though he had defaulted on his duties and collected his share of years of profits, he was due yet more following his breach. The Court wholly rejected this, holding that the plaintiff had received enough, that nothing about the buyout was unfair, unreasonable or illegal, and that his loss was not a forfeiture. The Court’s conclusion hinged on the reasonable relationship between the plaintiff’s loss – the value of his ownership interest – and the potential harm the parties anticipated when entering the operating agreement – the entire value of the surgery center. The plaintiff intended to harm the surgery center through his letter and was defanged by the very provisions he helped put into the operating agreement to deter bad actors.

The ruling in Tuli v. Specialty Surgical Center of Thousand Oaks LLC offers strong protection to healthcare joint ventures and other LLCs under California’s business judgment rule, vindicating the LLCs’ rights to govern themselves according to the provisions the members chose to include in the LLC’s operating agreement. The ruling is also significant in that it affirms the rights of LLC members to include provisions to strip internal bad actors of their ownership, if doing so has a reasonable relationship to anticipated harm.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.