Opinion ID: 2031322
Heading Depth: 1
Heading Rank: 3

Heading: Background and Legislative History

Text: The limited liability company (LLC) first appeared in Wyoming in 1977, followed by Florida, which adopted an LLC act similar to Wyoming's in 1982. As in Wyoming, the Florida statute was enacted to lure capital into the state, but [a]s a result of the lingering uncertainty as to both tax treatment and the protection of the entity's members from personal liability, other states did not immediately follow suit (Keatinge et al., The Limited Liability Company: A Study of the Emerging Entity, 47 Bus Law 375, 383-384 [1992]). After the Internal Revenue Service's public ruling in 1988 that it would treat a Wyoming LLC as a partnership for tax purposes, however, many states and drafting commissions began to consider, or experiment with, LLC laws ( id. at 384). While all of this was happening, New York's Business Corporation Law was increasingly viewed as unfriendly to fledgling businesses. Indeed, in late 1993 a corporate lawyer in a major New York City law firm suggested that [t]here are many cases where a lawyer who uses New York as the state of incorporation without discussing it in advance with his client is probably guilty of malpractice because of the many disadvantageous aspects of the New York law (Peter Blackman, Corporate Update, Move over Delaware! Making New York Incorporation-Friendly, NYLJ, Dec. 16, 1993, at 5, col 2 [statement of Richard R. Howe]). By the early 1990s, New York legislators and Governor Cuomo had advanced improving New York's overall business climate to the forefront of the political agenda in Albany ( see id. [In an effort to make New York a more attractive state in which to incorporate, several legislators have moved to even the imbalance between (New York and Delaware)]). Although this pro-business agenda manifested itself in various ways  for example, it was in 1994 that Governor Cuomo and Chief Judge Kaye first sought to establish the Commercial Division of the Supreme Court ( see Gary Spencer, Cuomo Seeks State Commercial Court, Other Bills Aimed at Improvement of Business Climate, NYLJ, Jan. 6, 1994, at 1, col 3)  two of the highest-profile pro-business initiatives were bills pending in Albany to modify the treatment of derivative lawsuits and to authorize limited liability companies (Blackman, NYLJ, Dec. 16, 1993, at 5, col 2). They were often cited together in reports of the legislative and gubernatorial agenda in 1993 and 1994 ( see id. ; see also Spencer, NYLJ, Jan. 6, 1994, at 1, col 3 [pro-business proposals include bills that would: (d)iscourage shareholder derivative lawsuits ... and (a)llow the formation of limited liability companies]; Dao, New York Times, June 30, 1994, at B7 [(Governor Cuomo) has lobbied for legislation to limit a type of lawsuit, known as derivatives, brought by shareholders against corporate boards for wrongdoing.... He has advocated creating a hybrid business entity  a limited liability company  that would possess the liability protections of corporations but have the lower tax rates of partnerships]). By mid-1992, 18 states ... permit[ted] the formation of LLCs[,] ... two states [recognized] LLCs formed in other states[,] LLC statutes [we]re pending or [we]re being considered in approximately 28 other states, and the National Conference of Commissioners on Uniform State Laws [wa]s drafting a uniform LLC statute (Brian L. Schorr, Limited Liability Companies: Features and Uses, 62 CPA J [Issue 12] 26 [Dec. 1992], reprinted in 805 PLI/Corp 191, 193). On March 19, 1992, a Joint Drafting Committee of the Association of the Bar of the City of New York and the New York State Bar Association submitted a proposed limited liability company act for the New York Legislature's consideration; by early May 1992, LLC bills had been introduced in both houses of the New York State Legislature (New York Limited Liability Company Law Update, 805 PLI/Corp at 211-212). A limited liability company bill was introduced in the New York State Assembly as A11016 on March 31, 1992, less than two weeks after receipt of the Joint Drafting Committee's draft. A11016 was, for purposes of this case, substantially identical to the finally enacted Limited Liability Company Law with two related exceptions: article IX of the bill authorized members to bring derivative actions; [1] and section 610, which set out the general rule that a member may not initiate an action by or against the company, included a derivative suit under article IX as an exception to this rule. [2] A11016 was referred to committee after its introduction; the Assembly took no further action on this bill in 1992. On May 12, 1992, a limited liability company bill was introduced in the New York State Senate as S8180. This bill was substantially identical to the Assembly bill except for the notable absence of any language authorizing derivative actions. S8180 was amended and reprinted three times between May 12 and June 25 of 1992, at which point S8180-C  which still did not contain any provisions relating to derivative actions  was referred to committee and left for a subsequent session. On June 11, 1992, public hearings were held on the Assembly bill. Testifying at these hearings on behalf of the Bar Association of the City of New York and the Joint Drafting Committee were Brian Schorr [3] and Howard Lefkowitz. At the Assembly hearings, Mr. Schorr observed that [t]he Assembly bill does contain provisions concerning the right of a member to bring a derivative action. These provisions are adapted from the [Partnership Law] ... [T]he Senate bill contains no comparable provisions (testimony of Brian L. Schorr, Transcript of Assembly Public Hearing on Limited Liability Company Legislation, June 11, 1992, at 27). At those same hearings, Mr. Lefkowitz, who was the chair of City Bar's Committee on Corporation Law, spoke extensively in favor of derivative actions on behalf of LLCs. Before the Senate, however, the only reference to derivative rights in any testimony was the following statement by Mr. Schorr: The Senate bills are based in large part on the proposed limited liability company law prepared by the Joint Drafting Committee, with changes that have been agreed to with other proponents of a limited liability company law. Subject to two exceptions, [City Bar] enthusiastically supports the Senate bills ... The two exceptions are the inclusion of a publication requirement and the lack of derivative action provisions (testimony of Brian L. Schorr, Senate Public Hearing on Limited Liability Company Legislation, Dec. 4, 1992, at 2). As the subsequent legislative history of the Limited Liability Company Law confirms, the omission of provisions authorizing derivative actions was a material  if not the material  term in the legislative bargain struck by the Senate and the Assembly. As noted earlier, LLC bills were introduced, in substantially complete form, in both chambers of the Legislature in the spring of 1992. The Assembly bill (A11016) authorized derivative actions; the Senate bill (S8180) did not. After both chambers failed to pass an LLC bill in 1992, efforts to negotiate a mutually agreeable statute resumed in 1993. On January 6, 1993, an LLC bill, S27, was introduced in the Senate; neither S27 nor any of its three reprints in 1993 contained any provision authorizing derivative actions. On March 30, 1993, an LLC bill containing article IX and the accompanying language in section 610 was again introduced in the Assembly as A7127. This bill was referred to committee, and no further action was ever taken on it. On June 25, 1993, the Assembly Rules Committee introduced A8676, another LLC bill containing these same provisions authorizing derivative actions. On July 7, 1993, the Assembly passed the B print of this bill  which still allowed for derivative actions  and delivered it to the Senate. The Senate, which had never introduced any LLC bill sanctioning derivative actions, did not act on A8676-B, thus delaying the passage of any LLC law until at least 1994. On March 8, 1994, S27 was reintroduced. On April 5, 1994, the Assembly Rules Committee introduced A11317, a companion to S7511, which was introduced in the Senate the same day. Unlike all prior Assembly bills, A11317 did not authorize derivative actions; as was the case with every prior Senate bill, S7511 likewise did not authorize derivative actions. On June 30, 1994, S7511 passed the Senate and was delivered to the Assembly. That same day, the Assembly substituted S7511 for A11317, and on July 1, 1994, the Assembly passed S7511 and returned it to the Senate. The adopted bill was delivered to the Governor on July 15, 1994, and was signed into law on July 26, 1994, as chapter 576 of the Laws of 1994. The deletion from the adopted LLC legislation of provisions authorizing derivative actions manifests a legislative bargain: the Senate refused to pass an LLC statute if it allowed for derivative suits. Nearly finalized LLC bills appeared in the Legislature as early as spring of 1992, and the Assembly actually passed a bill in mid-1993. Yet the Senate was unbending: at a time when serious consideration was being given to legislation cutting back on the derivative actions authorized by existing laws, the Senate refused to endorse any legislation allowing members of this new form of business entity, the LLC, to sue derivatively. It is this compromise  excision of provisions authorizing derivative actions from the Assembly bill in exchange for the Senate's agreement to the balance of the law  to which Mr. Rich, a participant in the drafting of the proposed Limited Liability Company Law, no doubt refers when he states that [t]he absence of an Article IX from the LLCL was a conscious omission, not a typographical error, as the decision to omit derivative rights occurred late in the legislative session (Practice Commentaries, McKinney's Cons Laws of NY, Book 32/32A, Limited Liability Company Law, at 181 [2007 ed]). The rejection of language authorizing derivative actions strongly militates against a judgment that [the Legislature] intended a result that it expressly declined to enact ( Gulf Oil Corp. v Copp Paving Co., 419 US 186, 200 [1974] [conference committee deleting House language]; see also Pacific Gas & Elec. Co. v State Energy Resources Conservation & Development Comm'n, 461 US 190, 220 [1983] [House bill deleting Senate language]; Posner, Statutory Interpretation  in the Classroom and in the Courtroom, 50 U Chi L Rev 800, 820 [1983] [(W)here the lines of (legislative) compromise are discernible, the judge's duty is to follow them, to implement not the purposes of one group of legislators, but the compromise itself]). [4] The majority contends, however, that the Legislature's deletion of language authorizing derivative actions does not necessarily bespeak compromise, and is, in any event, essentially unimportant because the language was superfluous. This is so because derivative rights are so well-entrenched in existing law that the Legislature might have reasonably expected the courts to do what the majority has now done: extend the right to commence a derivative action to an LLC member based on analogy to either a cestui que trust or a shareholder, both of whom historically enjoyed standing to sue derivatively, as a matter of equity in the former case and common law in the latter. To support this proposition, the majority relies on the Second Circuit's decision in Klebanow v New York Produce Exch. (344 F2d 294 [2d Cir 1965, Friendly, J.]) ( see majority op at 104-105, 106), and an oblique reference to Klebanow and Riviera Congress Assoc. v Yassky (18 NY2d 540 [1966]) (without referring to either case by name) made by Mr. Lefkowitz in his testimony at Assembly (not Senate) hearings in 1992 ( see majority op at 108). In Klebanow, the United States Court of Appeals for the Second Circuit held that, even in the absence of statutory authorization, a limited partner in a dissolved firm had capacity to sue on behalf of the partnership (i.e., derivatively) for injury arising out of conduct proscribed by the antitrust laws where the partnership and the liquidating partner had disabled themselves or had a conflict of interest, rendering futile any demand for the partnership to sue. The court reasoned that this was so because a limited partner was more like a shareholder (especially a preferred holder), or perhaps a cestui que trust, than a creditor. [5] But this case is not Klebanow. First, as Judge Friendly acknowledged, there was no suggestion that the framers of the Uniform Limited Partnership Act or the legislature of 1922 had focused on the problem ... at issue (344 F2d at 298); i.e., whether to authorize limited partners to bring derivative suits. In this case, we know that the Legislature did indeed focus[] on the problem ... at issue  whether to authorize members of LLCs to bring derivative suits  and decided not to do it. Second, section 118 of the Partnership Law, captioned Rules for cases not covered, specifies that [i]n any case not provided for in this article the rules of law and equity, including the law merchant, shall govern (emphasis added). This provision lends support for the view implicitly taken by the courts in Klebanow and Riviera that the Legislature intended judges to interpret the Partnership Law with the freedom with which they would construe and apply principles of the common law or equity to fill in perceived legislative blanks, and  without doubt  at common law a shareholder could maintain a derivative suit, which is a remedial invention of equity. [6] There is no provision comparable to section 118 in the Limited Liability Company Law. Although one federal judge has expressed the view that [h]ad the legislature intended to preclude derivative claims by LLC members, it easily could have written an explicit prohibition into the law ( Bischoff v Boar's Head Provisions Co., Inc., 436 F Supp 2d 626, 632 [SD NY 2006]), the Legislature does not customarily write zipper clauses into its statutes, or explicitly prohibit the courts from implying rights or liabilities that it did not choose to include. Rather, the modern Legislature reasonably expects the judiciary to respect its policy choices ( see e.g. Sherman v Robinson, 80 NY2d 483, 489 [1992] [where the legal duty owed to a third party by a store selling alcoholic beverages is limited by General Obligations Law § 11-101 and does not include a duty to investigate possible indirect sales, (g)iven the Legislature's choice not to provide liability for (indirect sales), we decline to expand the common law to impose such liability]). Next, Mr. Lefkowitz, who testified in favor of the right of LLC members to bring derivative suits, observed that [s]tate and federal courts in New York have permitted derivative actions by a limited partner on behalf of limited partnerships without express statutory authority and opined that  if and to the extent that members of a limited liability company are analogous to a minority shareholder or a limited partner ... such member would, as a matter of common law precedent, have the right to bring a derivative action on behalf of a limited liability company whether or not the statute contains such an express right (testimony of Howard Lefkowitz, Assembly Transcript, June 11, 1992, at 132, 133 [emphasis added]). This testimony has been cited to support the proposition that the absence of an explicit provision in the Limited Liability Company Law authorizing derivative actions does not matter because the Legislature was aware that, under settled law, these provisions were unnecessary ( see Bischoff, 436 F Supp 2d at 632-633; majority op at 108). Courts have on occasion taken the position that disappearance of a provision from a statute during the legislative travel may not be significant when settled law indicates that the omitted provision would have been surplusage ( Diamond Crystal Salt Co. v P.J. Ritter Co., 419 F2d 147, 148 [1st Cir 1969] [in light of the overwhelming weight of judicial authority favor(ing) retrospective construction, the Massachusetts long-arm statute applied retroactively notwithstanding that, in the year the law was enacted, four bills were filed, two of which expressly provided for retroactivity, and the Legislature enacted a bill omitting this language]). But here, there is no settled law in New York, or elsewhere for that matter, respecting LLCs and derivative suits ( see Walker, New York Limited Liability Companies and Partnerships: A Guide to Law and Practice § 3:22, at 67 [1 West's NY Prac Series 2002] [while (t)here is well-established case law for the treatment of C corporations, S corporations, limited partnerships and general partnerships on many questions, (n)o such extensive body of law yet exists for LLCs, although all of the states and the District of Columbia have enacted LLC statutes]). This vacuum no doubt exists because LLCs are a fairly recent statutory innovation, unknown to the common law; a new business form combining corporate-type limited liability with partnership tax advantages and organizational characteristics. On the matter of derivative suits in particular, there are divergent views throughout the country. The Uniform Limited Liability Company Act developed by the National Conference of Commissioners on Uniform State Laws provides for derivative suits modeled on the provisions of the Revised Uniform Limited Partnership Act. Many states have adopted laws along similar lines. By contrast, other states, preferring the American Bar Association's (ABA) Prototype Limited Liability Company Act, require disinterested members or managers to authorize litigation. The co-author of the major treatise on limited liability companies  who (unlike the majority) questions the utility of derivative suits in the LLC context  advocates the ABA's approach as a reasonable compromise ( see Ribstein, The Emergence of the Limited Liability Company, 51 Bus Law 1, 23 [1995-1996] [If the (derivative suit) remedy is justified ..., it is only because requiring plaintiffs to seek authorization from the thousands of shareholders of publicly held firms could prevent some legitimate suits, but (t)he same point does not apply ... to closely held firms. Moreover, LLC members generally have other means of self-protection at their disposal that corporate shareholders may lack, including a default right to sell their interests back to the firm and substantial veto and removal powers]). In short, there is no settled law in New York or elsewhere on the subject of derivative rights for LLC members. Certainly, a third-party advocate's prediction that the courts might ignore the Legislature's policy choice (which, after years of contrary Supreme Court and Appellate Division holdings, is today made prescient) does not express or create settled law. Essentially, the majority simply disagrees with the Legislature, calling a decision not to authorize derivative suits in the context of LLCs a radical step ... that might be expected to harm the `business climate' more than help it (majority op at 107). But whether or not to vest LLC members with the right to sue derivatively is the Legislature's choice to make, not ours. Moreover, although the majority argues that failing to recognize a derivative right under the statute is an extreme result ( id. at 108), creating an uncharted path upon which we will not readily conclude that the Legislature intended to set us ( id. at 106), the uncharted path is the one taken by the majority: judicially legislating a cause of action that was rejected by the Legislature, and, for more than a decade after the Limited Liability Company Law's enactment, was not recognized by any New York court.