Court Opinion

ID: 9523635
Source: CourtListenerOpinion
Date Created: 2023-08-07 02:44:56.042253+00
Date Added: 2024-06-11T13:07:03.169723
License: Public Domain

OPINION OF THE COURT
Smith, J.
We hold that members of a limited liability company (LLC) may bring derivative suits on the LLC’s behalf, even though there are no provisions governing such suits in the Limited Liability Company Law.
Facts and Procedural History
Pennington Property Co. LLC was the owner of a Manhattan apartment building. Plaintiffs, who own 25% of the membership interests in the LLC, bring this action “individually and in the *103right and on behalf of’ the company. Plaintiffs claim that those in control of the LLC, and others acting in concert with them, arranged first to lease and then to sell the LLC’s principal asset for sums below market value; that the lease was unlawfully assigned; and that company fiduciaries benefitted personally from the sale. Plaintiffs assert several causes of action, of which only the first two are in issue here: The first cause of action seeks to declare the sale void, and the second seeks termination of the lease.
Supreme Court dismissed these causes of action. It held that they could not be brought by plaintiffs individually, because they were “to redress wrongs suffered by the corporation” (12 Misc 3d 1151[A], 2006 NY Slip Op 50851[U], *4). It also held, following Hoffman v Unterberg (9 AD3d 386 [2d Dept 2004]), that “New York law does not permit members to bring derivative actions on behalf of a limited liability company” (id. at *5). The Appellate Division, concluding that derivative suits on behalf of LLCs are permitted, reversed (39 AD3d 138 [1st Dept 2007]), and granted two defendants permission to appeal on a certified question. We now affirm the Appellate Division’s order.
Discussion
The issue is whether derivative suits on behalf of LLCs are allowed. The basis for appellants’ argument that they are not is the Legislature’s decision, when the Limited Liability Company Law was enacted in 1994, to omit all reference to such suits. We hold that this omission does not imply such suits are prohibited. We base our holding on the long-recognized importance of the derivative suit in corporate law, and on the absence of evidence that the Legislature decided to abolish this remedy when it passed the Limited Liability Company Law in 1994.
I
The derivative suit has been part of the general corporate law of this state at least since 1832. It was not created by statute, but by case law. Chancellor Walworth recognized the remedy in Robinson v Smith (3 Paige Ch 222 [1832]), because he thought it essential for shareholders to have recourse when those in control of a corporation betrayed their duty. Chancellor Walworth applied to a joint stock corporation—then a fairly new kind of entity—a familiar principle of the law of trusts: that a beneficiary (or “cestui que trust”) could bring suit on behalf of a trust when a faithless trustee refused to do so. Ruling that *104shareholders could sue on behalf of a corporation under similar circumstances, the Chancellor explained:
“The directors are the trustees or managing partners, and the stockholders are the cestui que trusts, and have a joint interest in all the property and effects of the corporation. . . . And no injury the stockholders may sustain by a fraudulent breach of trust, can, upon the general principles of equity, be suffered to pass without a remedy. In the language of Lord Hardwicke, in a similar case [Charitable Corp. v Sutton, 2 Atk 400, 406 (Ch 1742)], T will never determine that a court of equity cannot lay hold of every such breach of trust. I will never determine that frauds of this kind are out of the reach of courts of law or equity; for an intolerable grievance would follow from such a determination.’ ” (3 Paige Ch at 232.)
Eventually, the rule that derivative suits could be brought on behalf of ordinary business corporations was codified by statute (see Business Corporation Law § 626 [a]). But until relatively recently, no similar statutory provision was made for another kind of entity, the limited partnership; again, the absence of a statute did not prevent courts from recognizing the remedy. In Klebanow v New York Produce Exch. (344 F2d 294 [2d Cir 1965, Friendly, J.]), the Second Circuit Court of Appeals held that limited partners could sue on a partnership’s behalf. For the Second Circuit, the absence of a statutory provision was not decisive because the court found no “clear mandate against limited partners’ capacity to bring an action like this” (id. at 298 [emphasis added]). We agreed with the holding of Klebanow in Riviera Congress Assoc. v Yassky (18 NY2d 540, 547 [1966, Fuld, J.]), relying, as had Chancellor Walworth long before, on an analogy with the law of trusts:
“There can be no question that a managing or general partner of a limited partnership is bound in a fiduciary relationship with the limited partners . . . and the latter are, therefore, cestuis que trustent. . . . It is fundamental to the law of trusts that cestuis have the right, ‘upon the general principles of equity’ (Robinson v. Smith, 3 Paige Ch. 222, 232) and ‘independently of [statutory] provisions’ (Brinckerhoff v. Bostwick, 88 N. Y. 52, 59), to sue for the benefit of the trust on a cause of action which *105belongs to the trust if ‘the trustees refuse to perform their duty in that respect’. (Western R. R. Co. v. Nolan, 48 N. Y. 513, 518 .. . .)”
After Klebanow and Riviera were decided, the Partnership Law was amended to provide for derivative actions by limited partners (see Partnership Law § 115-a [1]).
We now consider whether to recognize derivative actions on behalf of a third kind of entity, the LLC, as to which no statutory provision for such an action exists. In addressing the question, we continue to heed the realization that influenced Chancellor Walworth in 1832, and Lord Hardwicke 90 years earlier: When fiduciaries are faithless to their trust, the victims must not be left wholly without a remedy. As Lord Hardwicke put it, to “determine that frauds of this kind are out of the reach of courts of law or equity” would lead to “an intolerable grievance” (Charitable Corp. v Sutton, 2 Atk at 406).
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. Derivative suits are not the only possible remedy, but they are the one that has been recognized for most of two centuries, and to abolish them in the LLC context would be a radical step.
Some of the problems such an abolition would create may be seen in the development of New York law since the Limited Liability Company Law, omitting all reference to derivative suits, was passed in 1994. Several courts have held that there is no derivative remedy for LLC members (see Hoffman v Unterberg, 9 AD3d 386 [2d Dept 2004]; Lio v Mingyi Zhong, 10 Misc 3d 1068[A], 2006 NY Slip Op 50016[U] [Sup Ct, NY County 2006]; Schindler v Niche Media Holdings, 1 Misc 3d 713, 716 [Sup Ct, NY County 2003]). But since the Legislature obviously did not intend to give corporate fiduciaries a license to steal, a substitute remedy must be devised. Perhaps responding to this need, some courts have held that members of an LLC have their own, direct claims against fiduciaries for conduct that injured the LLC—blurring, if not erasing, the traditional line between direct and derivative claims (see Matter of Marciano [Champion Motor Group, Inc.], 2007 NY Slip Op 34071[U], *4 [Sup Ct, Nassau County 2007]; Out of the Box Promotions LLC v Koschitzki, 15 Misc 3d 1134[A], 2007 NY Slip Op 50973[U], *7 [Sup Ct, Kings County 2007]; Lio, 2006 NY Slip Op 50016[U], at *4). Similarly, Supreme Court’s decision in this case upheld several of plaintiffs’ claims that are not in issue here, characterizing *106the claims as direct, though they might well be derivative under traditional analysis (see generally, Kleinberger, Direct Versus Derivative and The Law of Limited Liability Companies, 58 Baylor L Rev 63 [2006]).
Substituting direct remedies of LLC members for the old-fashioned derivative suit—a substitution not suggested by anything in the language of the Limited Liability Company Law—raises unanswered questions. Suppose, for example, a corporate fiduciary steals a hundred dollars from the treasury of an LLC. Unquestionably he or she is liable to the LLC for a hundred dollars, a liability which could be enforced in a suit by the LLC itself. Is the same fiduciary also liable to each injured LLC member in a direct suit for the member’s share of the same money? What, if anything, is to be done to prevent double liability? No doubt, if the Legislature had indeed abolished the derivative suit as far as LLCs are concerned, we could and would answer these questions and others like them. But we will not readily conclude that the Legislature intended to set us on this uncharted path.
II
As shown above, courts have repeatedly recognized derivative suits in the absence of express statutory authorization (Robinson v Smith, 3 Paige Ch 222 [1832]; Klebanow v New York Produce Exch., 344 F2d 294 [2d Cir 1965]; Riviera Congress Assoc. v Yassky, 18 NY2d 540 [1966]). In light of this, it could hardly be argued that the mere absence of authorizing language in the Limited Liability Company Law bars the courts from entertaining derivative suits by LLC members. It is argued, however, by appellants and by our dissenting colleagues, that here we face not just legislative silence, but a considered legislative decision not to permit the remedy. The dissent finds, in the legislative history of the Limited Liability Company Law, a “legislative bargain” to the effect that derivative suits on behalf of LLCs should not exist (dissenting op at 113). We find no such thing. For us, the most salient feature of the legislative history is that no one, in or out of the Legislature, ever expressed a wish to eliminate, rather than limit or reform, derivative suits.
The Legislature clearly did decide not to enact a statute governing derivative suits on behalf of LLCs. An Assembly-passed version of the bill that became the Limited Liability Company Law included an article IX, entitled “Derivative Actions.” In the Senate-passed version, and the version finally *107adopted, the article was deleted, leaving a conspicuous gap; in the law as enacted, the article following article VIII is article X. Nothing in the legislative history discusses the omission. Our only source of information on the reason for it is a sentence written by the author of the Practice Commentaries on the Limited Liability Company Law: “Because some legislators had raised questions about the derivative rights provisions, to avoid jeopardizing passage of the balance of the entire law, Article IX was dropped” (Rich, Practice Commentaries, McKinney’s Cons Laws of NY, Book 32/32A, Limited Liability Company Law, at 181 [2007]). Nothing tells us what the “questions” were, or why they would have jeopardized the bill’s passage.
The dissent attempts to fill this gap by reviewing some other events preceding the passage of the legislation. The dissent points out that New York politicians in 1993 and 1994 wanted to improve “New York’s overall business climate” (dissenting op at 110), and that among the proposed means of doing so were “bills ... to modify the treatment of derivative lawsuits and authorize limited liability companies” (id., quoting Blackman, Corporate Update, Move Over Delaware! Making New York Incorporation-Friendly, NYLJ, Dec. 16, 1993, at 5, col 2 [emphasis added]). But the dissent cites no evidence, and we know of none, that anyone ever suggested doing away with derivative suits entirely—a radical step, as we have already pointed out, and one that might be expected to harm the “business climate” more than help it.
In fact, the reforms of derivative suits that were under discussion in 1993-1994 came nowhere near to abolition. They were, in substance, proposals to codify and expand on our decision in Auerbach v Bennett (47 NY2d 619 [1979]), holding that a decision by disinterested directors to terminate a derivative suit would be honored by the courts (see Blackman, NYLJ, Dec. 16, 1993, at 5, col 2). All three of the bills introduced to reform derivative suits began with an endorsement of such suits in principle:
“The legislature finds and declares it to be the public policy of the state of New York to maintain the shareholder derivative suit proceeding as a remedy for shareholders on behalf of New York corporations because such suits, when meritorious, serve as an important deterrent against breaches of fiduciary duties by directors of such corporations.” (See NY *108Senate Bill S6222 [introduced Dec. 15, 1993]; NY Senate Bill S6222-A [amended Dec. 17, 1993]; NY Assembly Bill A8938 [Dec. 17, 1993]).
The connection, if any, between the proposed reforms of derivative suits and the fate of proposed article IX of the Limited Liability Company Law is obscure. It seems to be true that the Senate favored a bill from which article IX was absent, and that the Assembly acquiesced in the Senate’s preference. But this does not prove that any legislator, much less the Legislature as a whole, thought that the absence of article IX would render derivative suits nonexistent—an extreme result that no legislator is known to have favored. We simply do not know what consequences the legislators expected to follow from the omission. It is possible that some legislators did expect—though no one expressed the expectation—that there would be no derivative suits. It is possible that some legislators expected the courts to follow the established case law, and to recognize derivative suits in the absence of a “clear mandate against” doing so (Klebanow, 344 F2d at 298); one witness at a legislative public hearing did express that expectation (statement of Howard N. Lefkowitz, chair of Committee on Corporation Law, Association of Bar of City of NY, Transcript of Assembly Public Hearing on Limited Liability Company Legislation, June 11, 1992, at 133). It is possible that the Senate expected one thing, and the Assembly the other. It is even possible that neither expected anything, except that the problem would cease to be the Legislature’s and become the courts’. The legislative history is, in short, far too ambiguous to permit us to infer that the Legislature intended wholly to eliminate, in the LLC context, a basic, centuries-old protection for shareholders, leaving the courts to devise some new substitute remedy.
The dissent says that, in upholding the right of LLC members to sue derivatively, we leave that right “unfettered by the prudential safeguards against abuse that the Legislature has adopted ... in other contexts” (dissenting op at 121). But the right to sue derivatively has never been “unfettered,” and the limitations on it are not all of legislative origin. The case in which derivative suits originated, Robinson v Smith, held that such a suit could be brought only on “a sufficient excuse”—i.e., a showing that those in control of the corporation “refused to prosecute” because they were themselves the wrongdoers, or were in “collusion with” them (3 Paige Ch at 232, 233). Later cases reaffirmed the rule that a derivative action could not be *109brought “unless it is necessary because of the neglect and refusal of the corporate body to act” (see e.g. Continental Sec. Co. v Belmont, 206 NY 7, 15 [1912]). The statutes governing ordinary business corporations and limited partnerships now reflect the existence of that rule, requiring the complaint in a derivative suit to allege “the efforts of the plaintiff to secure the initiation of such action ... or the reasons for not making such effort” (Business Corporation Law § 626 [c]; Partnership Law § 115-a [3]). Other statutory provisions impose other limitations (see Business Corporation Law § 626 [b]; Partnership Law § 115-a [2] [contemporaneous ownership of plaintiffs interest]; Business Corporation Law § 627; Partnership Law § 115-b [posting security for expenses]). What limitations on the right of LLC members to sue derivatively may exist is a question not before us today. We do not, however, hold or suggest that there are none.
Finding no clear legislative mandate to the contrary, we follow Robinson, Klebanow and Riviera in concluding that derivative suits should be recognized even though no statute provides for them. We therefore hold that members of LLCs may sue derivatively (accord Bischoffv Boar’s Head Provisions Co. Inc., 436 F Supp 2d 626 [SD NY 2006]; Weber v King, 110 F Supp 2d 124 [ED NY 2000]; contra Pennacchio ex rel. Old World Brewing Co., Inc. v Powers, 2007 WL 446355, 2007 US Dist LEXIS 8051 [ED NY 2007]).
Accordingly, the order of the Appellate Division, insofar as appealed from, should be affirmed with costs and the certified question answered in the affirmative.