A year ago, in Tzolis v. Wolff, 10 NY3d 100 (2008), New York’s highest court recognized the common law right of LLC members to bring a derivative action on the LLC’s behalf.   Late last month, in Gottlieb v. Northriver Trading Co., LLC, 58 AD3d 550 (1st Dept 2009), an intermediate appellate court cited Tzolis in support of its decision recognizing the right of LLC members to seek an equitable accounting under common law. 

The "equitable action on account" has a rich legal history in early English and American law, reflecting a time when forms of pleading and the scope of judicial powers made sharp distinctions between actions "at law" and those "in equity."  In modern usage, the accounting action allows a trust beneficiary, partner, etc. to compel a fiduciary entrusted with property to render an account of his or her actions and for the recovery of any balance found to be due.  The accounting involves more than simply turning over existing financial records.  In New York practice, if the court grants an accounting, it may order the fiduciary to prepare a "long accounting" with detailed schedules of income and expenses over a defined period, followed by the filing of objections to the accounting, followed by proceedings before a court-appointed referee to hear and determine the accounting.  (To view a form of order of reference to determine an account, click here.)

In the partnership setting, the partner’s common law right to an equitable accounting also is codified in New York’s Partnership Law Section 44 (derived from Section 22 of the Uniform Partnership Act) stating that "any partner shall have the right to a formal account as to partnership affairs" under broadly defined circumstances.  In the business corporation setting, Section 720 of the Business Corporation Law authorizes a shareholder’s derivative action against directors or officers to compel an accounting.

New York’s LLC Law contains no provision authorizing a judicial accounting remedy.  The Gottlieb case appears to be the first one to address the availability of an equitable accounting remedy in the LLC setting.

According to plaintiff Helene Gottlieb’s complaint, Northriver Trading Co., LLC was in the securities trading business from 1994 through 2000.  She initially held a 50% interest reduced to 20.6% in 1999.  Defendant Steven Schlam is the managing member.  The complaint alleges that at the time it ceased doing business, Northriver "had substantial assets, the precise value of which is unknown to plaintiff, but upon information and belief, exceeded $2,000,000."

Gottlieb alleges that, beginning in 2001, she unsuccessfully sought an accounting of Northriver’s financial affairs and the "net amount due plaintiff"; that the defendants "wrongfully failed and refused" to provide her with the requested accounting; and that they imposed "onerous and unreasonable preconditions on an accounting, beyond the means of [Gottlieb] to satisfy, such as the requirement that any accounting must be conducted by an accountant approved in advance by defendants."

The single-count complaint alleges that Gottlieb "has no adequate remedy at law" and demands a judgment

compelling defendants [Northriver and Schlam] to provide plaintiff with a full and complete accounting of the financial affairs of defendant [Northriver] including but not limited to income and expenses, profits and losses, overpayment of trading commissions, the amount of accounts receivable and efforts being made to collect the same, and the net amount due to plaintiff.

The defendants asked the trial court to dismiss the complaint.  They argued that Northriver provided Gottlieb with all documents pertaining to its finances — including balance sheets, income statements, tax returns, bank statements, canceled checks, vendor invoices, correspondence, detailed brokerage statements and work papers — and thereby satisfied its obligations under Section 1102 of the LLC Law to provide member access to company records.  (The decision does not indicate whether the information was given to Gottlieb pre-litigation or post-litigation in discovery.)

In a decision dated May 9, 2007, written by New York County Supreme Court Justice Jane S. Solomon, the trial court agreed with the defendants and dismissed the complaint.  The court found that Northriver "has provided all of the documents that it is required to provide" under LLC Law Section 1102.  It further held that the "plaintiff is not entitled to an accounting merely by virtue of her status as a member of the limited liability company" and that "there is nothing in the LLC Law to suggest otherwise."  The court distinguished Gottlieb’s case authorities "because they do not involve limited liability companies."

On appeal, Gottlieb won a reversal.  Devoting all of three sentences to the issue, the Appellate Division, First Department wrote as follows:

Contrary to the court’s ruling, members of a limited liability company may seek an equitable accounting under common law.  The assertion that such members are limited to statutory remedies with regard to potential fraud is inconsistent with the reasoning in Tzolis v Wolff (10 NY3d 100 [2008]).  Furthermore, while plaintiff’s sole claim was for an accounting, the ad damnum of her complaint did seek monetary damages based on misallocation of the company’s assets, and the case should thus be permitted to go forward.

In Tzolis, by a vote of 4-3, the Court of Appeals ruled that the legislature’s deliberate omission from the LLC Law of proposed language authorizing derivative actions by LLC members did not preclude the courts from finding a right to bring derivative claims under common law.  Whether one agrees or disagrees with Tzolis, it’s hard to quarrel with the First Department’s implied prediction that the Court of Appeals likely would apply similar reasoning to uphold an LLC member’s common law right to an accounting.

Gottlieb can be viewed as another step toward New York’s judicial homogenization of the closely held business entity, in which court-imposed fiduciary obligations and common law remedies are imported and spread evenly across partnerships, business corporations and now limited liability companies.  For better or worse, this is in sharp contrast to the emerging Delaware model in which LLCs are "creatures of contract" and the courts are loathe to impose duties or create remedies outside the four corners of the members’ operating agreement.

For Professor Larry Ribstein’s decidedly negative take on Gottlieb, see here.  For a spirited defense of Gottlieb, read the below comment by the attorney who argued the appeal.

  • Bruce D. Katz

    My firm handled the Gottlieb appeal on behalf of the Appellant. I have some comments in response to this criticism of the decision. In briefing the Gottlieb appeal, we provided the First Department with a history of the accounting remedy and demonstrated that an accounting is generally available from anyone acting in a fiduciary capacity – regardless of the nature of the business organization in which the parties are engaged.
    Professor Ribstein’s comments are not well taken. An interpretation of the LLC law as eviscerating the common law right to seek an accounting would be tantamount to encouraging theft by a fiduciary. Nothing in the legislative history of the LLC law indicates that a member is precluded from seeking an accounting. Although the statutory right to an accounting might not exist under the LLC law, the statute cannot be construed to abrogate this long recognized right in the absence of explicit language precluding its availability. Such a construction would be tantamount to a legislative endorsement of an LLC member’s right to steal from the LLC and/or its other members — without any recourse. This is not a reasonable construction of the LLC law (or any statute).
    In Gottlieb, the First Department did not address the conditions under which an accounting might be available. It merely stated that it is available. As in all other cases, an LLC member must first establish his or her right to an accounting. This requires a showing of some sort of wrongdoing. In other words, there is no automatic right to an accounting. It is generally available when a member has breached a fiduciary duty. Most commonly, this would include a member’s misallocation/misappropriation of funds or a breach of the duty of loyalty. That an accounting is available under such circumstances does not significantly impact the law. Whenever such a breach is shown, monies are redistributed accordingly. An accounting is simply another word for the determination of each party’s rights to assets and the redistribution of those assets.
    As for the issue of wrongdoing, it hasn’t received consistent treatment. We synthesized the caselaw to show that while wrongdoing need not be alleged, the defendant can escape the requirement of providing an accounting by showing that he/she committed no wrong. In other words, if the defendant can show that there was no wrongdoing, and hence no possibility of a monetary recovery to the plaintiff, an accounting can be avoided.
    However, there is simply no basis in the LLC law or in judicial precedent to preclude a party from exercising its ancient right to seek an accounting. In the absence of a statutory prohibition, it is clear that an LLC member has such a right. Indeed, if the LLC law precluded a member from seeking an accounting even when fraud exists, it’s likely that the LLC would become a rarely used form of business entity.
    The commentator suggests looking at Delaware LLC law until NY courts “get the law straight.” In this regard, Delaware law is consistent with the Gottlieb decision. Like New York, Delaware recognizes the right to an accounting from any fiduciary. As discussed in a recent decision, Technicorp Int’l II, Inc. v. Johnston, 2000 WL 713750 (Del.Ch.), 26 Del. J. Corp. L. 689:
    An agent or fiduciary is under a duty to keep and render accounts and, when called upon for an accounting, has the burden of proving that he properly disposed of funds which he is shown to have received for his principal or trust. See Restatement 2d: Agency, §§ 382, 399, comment e; see also Restatement: Trusts, §§ 172, 244-245.2; Scott, Trusts (2d ed.) §§172, 244-245.2. Substantially the same principles are applicable to corporate directors and officers.
    Although the Technicorp Court was referring to a corporation’s directors and officers, LLC members owe each other the same fiduciary duties. Under common law, a fiduciary relationship comes into existence, inter alia, when one person is placed in a position of trust over the property of another in furtherance of a joint venture. In drafting the LLC laws, no legislature intended to erase the fiduciary duty of one member to another. Again, that would be tantamount to endorsing the theft of LLC property without recourse. It is an untenable position. Even without the benefit of the Court of Appeals’ Tzolis decision, the First Department could not have decided Gottlieb differently. We could find no contrary decision from any court.
    Many states (e.g., Michigan and Florida) have provided a statutory basis for an accounting in an LLC. Other states (e.g., New York, Massachusetts, Rhode Island) have recognized a member’s right to an accounting from other members of an LLC. Other than the lower Court decision in Gottlieb, no court has issued a published ruling denying an LLC member the right to an accounting.
    In summary, LLC members have nothing to worry about…long as they don’t misappropriate funds from other members.

  • james walsh

    All this flows logically from the LLC law and the current state of the case law. However, in the context of seeking an accounting based on breach of fiduciary duty, for purposes of the Statute of Limitations (whether the 3 year or 6 year) how far back may an LLC member seek that accounting. In other words, at what point does the SOL run? The initial harm? The last harm? Discovery of the harm?
    PAM: I don’t think the discovery rule would apply unless the complaint alleges fraud-based breach of fiduciary duty (see Kaufman v Cohen, 307 AD2d 113 [1st Dept 2003], a case I litigated). My guess is that the claim accrues from the date of wrongdoing.

  • David Smoren

    Great information on accounting remedy. I have been orderd to provide an accounting in one of my partnership cases as the defendant, however, I am arguing that the partnership should bear the cost not my client. Can anyone assist me as to what is the authority if any on the subject of accounting costs? The order was silent as to costs and I recommended a neutral accountant but plaintiff rejected same.
    Thank you in advance
    David Smoren, Esq
    PAM: I haven’t come across any NY cases on this issue, which may or may not turn on the court’s finding that the accounting partner is “at fault”. I’ve seen some non-NY cases stating that the allocation or shifting of accounting costs is left to the trial court’s discretion, and others stating that such costs are part of the costs and disbursements recoverable by the prevailing party, but the law may vary from state to state. The question also may implicate indemnification and advancement provisions in the partnership agreement, if any.