Source: https://www.pbwt.com/ny-commercial-division-blog/when-can-an-outside-attorney-serve-as-a-special-litigation-committee-in-an-llc-derivative-suit-when-the-parties-contract-says-so-says-first-department
Timestamp: 2019-04-26 06:10:36+00:00

Document:
In a decision handed down on August 15, 2017, by the New York Appellate Division First Department, the court endorsed the practice of the appointment of a Special Litigation Committee (SLC) by a limited liability company (LLC) “at least where explicitly contemplated” by the LLC’s operating agreement. However, where the operating agreement does not explicitly provide for such an appointment or otherwise evince intent to delegate core governance functions to a nonmember, the LLC cannot appoint an SLC that has authority over a major decision of the LLC.
The underlying dispute involves several LLCs. Plaintiff LNYC Loft, LLC (LNYC) brought derivative claims on behalf of two other New York LLCs—HRC-NYC Development LLC (HRC) and One York Street Associates, LLC (One York)—related to the parties’ investment in a condominium building in lower Manhattan. The building is owned by One York, which, in turn, is owned by defendant Jani Development II, LLC (Jani) and HRC. Jani and HRC have a 25% and 75% interest in One York, respectively. HRC is owned by LNYC, which has a 44% interest in the entity, and Hudson Opportunity Fund I, LLC (Hudson), which has a 56% interest in the entity. Jani is One York’s managing member, and Hudson is HRC’s managing member.
The One York operating agreement provides that Jani cannot make a “Major Decision” without the prior written consent of One York’s co-owner, HRC. “Major Decisions” in the One York operating agreement include a decision to amend the operating agreement and to prosecute or settle any material legal actions. HRC’s operating agreement similarly provides that neither of its owners, Hudson and LNYC, can make a “Major Decision” without the prior written consent of the other owner. This operating agreement also defined a “Major Decision” to include an amendment to the agreement and the prosecution or settlement of any material legal action.
According to LNYC, Hudson allegedly violated the HRC operating agreement in May 2010 by entering into an amendment to the One York operating agreement—i.e., making a “Major Decision”—without LNYC’s prior written consent. The amendment modified One York’s distributions in a manner that was allegedly detrimental to HRC’s and LNYC’s interests and beneficial to Jani’s interests.
The court found that the appointment of an SLC constituted a “Major Decision” under the One York and HRC operating agreements because the SLC was granted the authority to determine the position and actions of the companies with respect to the litigation. Because the One York and HRC operating agreements did not provide for delegation of decision-making authority to someone other than a member—e.g., an SLC—the court found the appointment of the SLC to be improper under both agreements.
The First Department’s decision represents a departure in the trend of courts using statutory and common law on partnerships and corporations to address questions in the LLC context that are not directly addressed by the LLC operating agreement. As the decision notes, LLCs are “creatures of contract” and thus emphasis should be placed on an LLC’s operating agreement to address issues related to an LLC’s internal affairs.
The decision sends a clear message to LLCs: If they wish to have the option to appoint an independent SLC, they should expressly say so in their operating agreements. When this option is expressly agreed to by the parties in writing, LLCs can rest assured that the SLC appointment will be enforced pursuant to general principles of contract law.
On the other hand, where the operating agreement is similar to the One York and HRC operating agreements—in that it neither expressly allows for an SLC, nor otherwise indicates that the parties intended such an appointment—courts are likely to prohibit the appointment of an independent SLC.
In short, an LLC should expressly state its intentions with respect to appointment of an SLC in the operating agreement. If courts are confronted with anything short of such an express statement, they will employ general principles of contract law to determine if the appointment is permitted under the contract.
 LNYC Loft, LLC v. Hudson Opportunity Fund I, LLC, No. 650969/11, 4096, 2017 N.Y. App. Div. Lexis 6108, at *2 (1st Dep’t Aug. 15, 2017).
 Id. at *1 (quoting Tzolis v. Wolff, 10 N.Y.3d 100, 109 (2008)).
 Id. (citing Najjar Grp., LLC v. W. 56th Hotel LLC, 974 N.Y.S.2d 58 (1st Dep’t 2013); Segal v. Cooper, 856 N.Y.S.2d 12 (1st Dep’t 2008)).
 Id. at *8 (citing Gottlieb v. Northriver Trading Co. LLC, 872 N.Y.S.2d 46 (1st Dep’t 2009)).
 Id. (citing JMM Props. LLC v. Erie Ins. Co., 5:08-CV-1382 (GTS/ATB), 2013 U.S. Dist. LEXIS 5080, at *17 (N.D.N.Y. 2013), aff’d 548 Fed. App’x 665 (2d Cir. 2013)).

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