New York practitioners should review a recent decision by a sharply divided Court of Appeals establishing that members of limited liability companies may bring derivative suits on behalf of their LLCs. The majority of the court reached this conclusion even though New York law provides no explicit authorization of such suits. Describing the majority’s decision as “unique in the annals of the Court of Appeals,” the dissenters accused the majority of deliberately defying the Legislature, stating that “never before has a majority of the Court read into a statute provisions or policy choices that the enacting Legislature unquestionably considered and rejected.”
In Tzolis v. Wolff, 2008 WL 382345 (N.Y. 2008), the plaintiffs owned 25% of Pennington Property Co. LLC, which owns a Manhattan apartment building. According to the plaintiffs, those in control of the LLC arranged to lease and sell the apartment building for sums that were below market value, improperly assigned a lease, and benefited personally from the sale. The plaintiffs brought their lawsuit “individually and in the right and on behalf of” the LLC and sought to declare the sale void and terminate the lease. The trial court dismissed the action, holding that New York law did not permit derivative suits on behalf of LLCs. The Appellate Division reversed, concluding that derivative actions were available, and certified the issue to the Court of Appeals.
The Court of Appeals affirmed, holding that derivative suits may be brought by members of a New York LLC. The New York Limited Liability Company law, which was enacted in 1994, does not include any reference to derivative actions. Nevertheless, the court held “this omission does not imply such suits are prohibited.” The court noted that derivative suits have been part of the state’s corporate law since 1832 and that this cause of action was created by case law and not by statute. The rule that derivative suits could be brought on behalf of corporations was eventually. Other derivative causes of action have also been recognized in the absence of statutory authority. For instance, the Second Circuit recognized that members of a limited liability partnership were able to pursue such a claim before the partnership law was amended to recognize such suits.
In addressing whether derivative suits should be available to members of an LLC, the court relied on the long-recognized principle that “when fiduciaries are faithless to their trust, the victims must not be left wholly without a remedy.” Citing decisions from the 18th and 19th century involving corporations, the court stated that “to hold that there is no remedy when corporate fiduciaries use corporate assets to enrich themselves was unacceptable in 1742 and in 1832, and it is still unacceptable today.” According to the court, “the Legislature obviously did not intend to give corporate fiduciaries a license to steal.” Noting that derivative suits had been a recognized remedy for corporate malfeasance for more than two centuries, the court concluded that “to abolish them in the LLC context would be a radical step.”
Three of the justices dissented, however, stating that the majority’s decision was, itself, “radical.” The dissenters claimed that the Legislature, having full knowledge of general corporate law, obviously choose to omit any reference to derivative suits from the act establishing limited liability companies. Indeed, the dissenters cited to the legislative history, which indicates the Legislature intentionally deleted provisions regarding derivative suits from the law. In the dissent, Judge Susan Phillips Read stated that “the majority has effectively rewritten the law to add a right that the Legislature deliberately chose to omit. . .for a Court that prides itself on resisting any temptation to usurp legislative prerogative, the outcome of this appeal is curious.” Unless the Legislature changes the law, in the wake of Tzolis, LLC members will be able to pursue derivative lawsuits.
Full Decision Text: http://www.nycourts.gov/ctapps/decisions/feb08/5opn08.pdf