Recent Appellate Rulings Clarify Standards for Challenging Releases Given to Fiduciaries of Closely Held Business Entities: Part 1
Two years ago, in Littman v. Magee, 54 AD3d 14 (1st Dept 2008), the Manhattan-based Appellate Division, First Department, made waves with a decision in which it reinstated a complaint for breach of fiduciary duty and fraudulent inducement by an LLC member who sold his minority interest to the majority, gave them a comprehensive release and, over a year later, after the majority sold the company at a substantial premium, claimed he had been misled as to the true value of his interest. My write-up of the decision (read here) referred to Littman as "lowering the bar" for claims of this sort by making broad pronouncements that seemingly elevated beyond the power of release the purchaser-fiduciary's duty to disclose to the seller all material facts bearing on the transaction. At the time, with some degree of concern, I posed the question, "After Littman, can business owners pursue and exploit the profitable sale of their business or its assets without risk of liability to a former partner whose interest was acquired at a cheaper price?"
In a recent pair of decisions, the First Department effectively has enervated Littman's broad pronouncements regarding the inefficacy of releases vis-à-vis the fiduciary duty of disclosure. In Centro Empresarial Cempresa S.A. v. America Movil S.A.B. de C.V., 2010 NY Slip Op 04719 (1st Dept June 3, 2010) (hereafter "Centro"), and Arfa v. Zamir, 2010 NY Slip Op 06070 (1st Dept July 13, 2010) (hereafter "Arfa"), lower courts had denied motions to dismiss fraudulent inducement claims by LLC members who entered into transactions which included an exchange of general releases. In both cases, the plaintiffs argued, and the lower courts agreed, that under Littman a general release does not insulate a fiduciary from liability for failing to disclose the fiduciary's own wrongdoing. On appeal in both cases, the First Department reversed the lower courts' orders and directed dismissal of the claims, finding that the plaintiffs had failed to allege facts sufficient to set aside their releases. In both cases, the First Department expressly distinguished Littman by limiting it to its particular facts.
Interestingly, both appellate decisions were authored by Associate Justice David Friedman who was not on the panel that decided Littman as were none of the other Arfa panel members and only one of the Centro panel members. As related below, the one Centro panel member who also decided Littman -- Associate Justice Catterson -- was half of a two-judge dissent in Centro.
In this Part One of a two-part series, I report on the Centro decision. In next week's Part Two, I'll report on the Arfa decision.
The Centro Decision
Centro involved a dispute between minority and majority members of a Delaware LLC that owned an Ecuadorian mobile telephone company known as Conecel. In March 2000, the majority member Telmex (controlled by Mexican billionaire Carlos Slim) acquired a 60% interest in Conecel. Telmex simultaneously entered into two agreements with the plaintiff minority members. The first stipulated that, in the event Telmex rolled up its Latin American telecommunications interests into one entity for the purpose of an equity offering, the plaintiffs would have the right to exchange their interest in Conecel for an interest in the new entity (the "Roll-Up Agreement"). The second agreement gave plaintiffs the right to put their Conecel interests to Telmex at specified intervals spread over 6 1/2 years at a fixed price based on Conecel's 1999 valuation (the "Put Agreement").
The plaintiffs alleged that Telmex's formation in late 2000 of a new company known as America Movil triggered their right of exchange under the Roll-Up Agreement. They further alleged that over the next year Telmex dodged most of their requests for financial information necessary to determine the exchange rate, and that the information they did extract painted a false, bleak picture of the company's finances.
Having been led to believe that Conecel was in financial difficulty, in March 2002 the plaintiffs exercised their first put right under the Put Agreement by selling 50% of their membership interests to Telmex for $64 million. After another year of alleged obfuscation and misrepresentation by Telmex of Conecel's financial condition, in March 2003 Telmex offered to purchase the plaintiffs' remaining 50% interest ahead of the Put Agreement's schedule at the same floor price of $64 million. In July 2003, Telmex and the plaintiffs entered into a Purchase Agreement for the remaining 50% which also included a broad general release in Telmex's favor of all claims relating to the plaintiffs' membership interests in Conecel.
Plaintiffs' complaint alleged that, years after the buy-out of their interest, Telmex's alleged dishonesty was exposed as a result of an audit of Conecel by the Ecuadorian tax authority which allegedly revealed that Conecel's true financial results in 2001-03 were considerably better than represented by Telmex when it offered to purchase plaintiffs' interests. Plaintiffs claimed that, had Telmex honored their right to negotiate an exchange of their Conecel units for America Movil shares, plaintiffs would have owned America Movil shares worth more than $1 billion as of May 30, 2008 (the date of the complaint).
The lower court, in an unreported December 2008 decision dictated on the record by Justice Richard B. Lowe III, denied Telmex's dismissal motion in which Telmex contended that the general release given by plaintiffs barred their claim. Telmex appealed.
Over a vigorous two-judge dissent, a three-judge majority reversed the lower court's order and dismissed the complaint. The self-responsibility theme of Justice Friedman's majority opinion is struck early, in his description of the facts, when he notes that
It is undisputed that the Purchase Agreement [including the general release] was the product of rigorous, arm's length negotiations between sophisticated parties, all of whom were advised by their own expert legal counsel.
The legal analysis portion of Justice Friedman's opinion initially establishes that the plaintiffs' fraudulent inducement claim falls squarely within the scope of the broad release given in the Purchase Agreement, and that "[w]hether or not plaintiffs had reason to suspect that defendants were misrepresenting the value of Conecel in the negotiation of the 2003 transaction, they cannot reasonably contend that they did not intend to release possible fraud claims as to that matter of which they were unaware."
Justice Friedman then strongly rejects the central premise of plaintiffs' Littman argument, keyed to Telmex's fiduciary status as the controlling member of Conecel, writing as follows:
While Telmex LLC, as the holder of the majority interest in TWE (and, through TWE, Conecel) owed plaintiffs certain fiduciary duties, the foregoing principles apply (at least among sophisticated parties advised by counsel) even where the releasee is a fiduciary. If Telmex LLC's fiduciary status alone sufficed to prevent it from obtaining the dismissal of this action based on the 2003 release, the implication would be that a fiduciary can never obtain a valid release without first making a full confession of its sins to the releasor, regardless of the releasor's sophistication and the arm's length nature of the negotiations from which the release emerged. This is not the law. Such a rule would render useless and meaningless any release of a party that owed the releasor a fiduciary duty, thereby unjustifiably impinging on the freedom of commercial actors to order their own affairs by contract and, moreover, contravening the public policy favoring the settlement of business disputes. We are not aware of any precedent compelling us to accept such an absurd result. [Citations omitted.]
The plaintiffs, Justice Friedman continues, "entered into the 2003 transaction well aware that defendants had not given them access to the internal financial records of Conecel" and "should have insisted on access to Conecel's internal books and records" and, moreover, should have sued if necessary to obtain the information. He also notes that during the period in question, "relations between the parties were adversarial, if not outright hostile, thereby negating as a matter of law any inference that business entities as sophisticated as plaintiffs were relying on defendants for an objective assessment of the value of their investment."
Justice Friedman distinguishes Littman in a footnote. He does not confront Littman's broad pronouncements, but instead focuses on the specific factual allegations in that case, writing as follows:
[In Littman], a general release in the agreement for the sale of the plaintiff's interest in a closely-held business was held not to bar a fraud action against a former fiduciary at the pleading stage because the complaint was deemed to allege that the defendant fiduciary had told the plaintiff that no further documentation bearing on the valuation of the enterprise existed, thereby exonerating the plaintiff from the need to investigate further (54 AD3d at 19). Here, plaintiffs do not allege that defendants told them that no information about Conecel's financial condition beyond the minimal amount that had been shared with plaintiffs was in existence. In addition, the Littman plaintiff alleged that he was induced to sell out in part by a "threat[] that if [he] did not agree to the proposed sale, approximately $1 million in income would be allocated to him for the year 2004, while no distribution would be made to him to cover the taxes resulting from that allocation" (id. at 16). No such threat or duress is alleged here.
Justice Friedman's opinion also distinguishes Littman's doctrinal forebear, Blue Chip Emerald v. Allied Partners, 299 AD2d 278 (1st Dept 2002), where the First Department upheld a fraudulent inducement claim involving a buy-out of a minority partner who alleged that the majority kept secret a third-party offer for the company's sole asset at a substantially higher price. Here's what he says about Blue Chip:
It was critical to the result in Blue Chip that the plaintiff in that case did not have "at its disposal ready and efficient means" for ascertaining whether such an oral agreement (or an offer in the relevant price range) even existed (299 AD2d at 280). Here, by contrast, plaintiffs were well aware that Conecel did have a value, and nonetheless chose to cash out their interests without either insisting on verifying defendants' representations as to that value or, on the other hand, conditioning the deal on the accuracy of the information they did receive. Indeed, as previously discussed, plaintiffs here were well aware that they were not in possession of all the information they believed they were entitled to when they sold their interests.
In a lengthy dissent, Associate Justice James M. Catterson sharply takes the majority to task for "overlook[ing] the well-established precept that releases 'must be knowingly and voluntarily entered into', and propound[ing], instead, the view that an effective release is one in which the releasor is hoodwinked by the releasee" (citations omitted). Citing Littman, Justice Catterson writes that a general release "will not insulate a tortfeasor from allegations of breach of fiduciary duty, where it has not fully disclosed alleged wrongdoing," and therefore the plaintiffs in Centro
were reasonably justified in their expectations that the defendants would disclose any information in their possession that might affect plaintiffs' decision on their best course of action especially as to signing the release that the defendants now argue bars this action.
Justice Catterson also disagrees with what he calls "the majority's attempt to distinguish Littman," writing that
The majority does so on the basis that the plaintiff in Littman was told that no further documentation bearing on the valuation of the enterprise existed, thus exonerating him from the need to investigate further whereas here the plaintiffs were not so told. I fail to see how being told that no documentation exists provides a better basis for exoneration than receipt of publicly filed documents. In the instant case, whatever message was being conveyed by the defendants' stonewalling, it was not incumbent on the plaintiffs to suspect that the defendants were defrauding a governmental agency by publicly filing false information.
On June 21, 2010, the plaintiffs in Centro filed a notice of appeal to the New York Court of Appeals which they are allowed to do as of right because of the two-judge dissent. It will be most interesting and important to see how the state's highest tribunal resolves the clash of judicial philosophies evident in the dueling opinions of the Centro majority and dissenters.
Update May 2, 2011: The oral argument of the appeal in Centro to the Court of Appeals was heard on April 27, 2011. Click here to watch the video.
New Jersey Courts Apply State's Dissolution Statute to Foreign Corporations: Can it Happen in New York?
Many New York businesses are incorporated in other states, Delaware being the traditional favorite. In most instances these corporations are foreign in name only, i.e., their offices, assets, employees, shareholders and directors all are located in New York. Can a shareholder sue for dissolution of a New York-based foreign corporation in a New York court under New York's dissolution statutes?
The lead article in this month's online newsletter published by Drinker Biddle highlights two recent, unpublished New Jersey court decisions in which that state's dissolution statute was applied to foreign corporations based in New Jersey. In Krzastek v. Global Resource Industrial and Power, Inc., No. A-1815-06T2 (App. Div. Sept. 11, 2008), the New Jersey appellate court upheld application of the state's oppressed minority shareholder dissolution statute in a suit brought by a minority shareholder of a Massachusetts corporation. In Conway v. DialAmerica Marketing, Inc., No. BER-C-116-08 (Super.Ct. Sept. 30, 2008), the trial court did the same in a case brought by a minority shareholder of a Delaware corporation. In both cases, the courts applied New Jersey law based on an interests-based conflict of laws analysis. In both cases, the New Jersey dissolution statute afforded the plaintiffs rights and/or remedies (especially in regard to buyout) broader than those available under the laws of the states of incorporation. In both cases, the defendants unsuccessfully argued for dismissal based on the the "internal affairs doctrine" under which courts traditionally refused to exercise jurisdiction where the determination of the rights of the litigants involves regulation and management of the internal affairs of a foreign corporation.
Could it happen in New York? Case precedent suggests not, although the issue is not fully settled.
The leading New York precedent on the internal affairs doctrine is Langfelder v. Universal Laboratories, Inc., 293 NY 200 (1944), decided by the New York Court of Appeals (the state's highest court). The case was brought in New York by dissenting shareholders objecting to the terms of a merger involving two Delaware corporations. Here's the court's description of the internal affairs doctrine under which the case was dismissed:
There are cases in which our courts will entertain jurisdiction in suits against foreign corporations where suitors, even stockholders, are entitled to some relief which the State court is competent to grant. But it is well settled that jurisdiction in any case will be declined either in the absence of jurisdiction in the strict sense or where a determination of the rights of litigants involves regulation and management of the internal affairs of the corporation dependent upon the laws of the foreign State or where the court in which jurisdiction is sought is unable to enforce a decree if made or where the relief sought may be more appropriately adjudicated in the courts of the State or country to which the corporation owes its existence.
Although the doctrine generally has fallen out of favor in the ensuing decades (see former Justice Herman Cahn's highly informative discussion of the issue in Matter of Topps Co., Inc. Shareholder Litigation, 19 Misc 3d 1103(A), 2007 NY Slip Op 52543(U)), it has retained vitality in the realm of judicial dissolution proceedings brought under Article 11 of the New York Business Corporation Law.
This is due in large part to a pair of rulings by the Appellate Division, Second Department, in Warde-McCann v. Commex, Ltd., 135 AD2d 541 (2d Dept 1987), and Matter of Porciello, 253 AD2d 467 (2d Dept 1998), where, with virtually no discussion, the court invoked the internal affairs doctrine in dismissing proceedings to dissolve Delaware and Florida corporations. These cases have been followed in numerous lower court decisions within and outside the Second Department. (A recent example is Justice Bucaria's Schneck decision about which I wrote last year.)
The First Department's decision in Matter of Hospital Diagnostic Equipment Corp., 205 AD2d 459 (1st Dept 1994), arguably points in a different direction. There, the court upheld the dismissal of a deadlock dissolution proceeding involving a Delaware corporation on the discretionary ground of forum non conveniens due to the corporation's lack of substantial contacts with New York. The New York Attorney General also had moved for dismissal on the ground the court lacked jurisdiction to dissolve a foreign corporation. In its decision the First Department expressly rejected the Attorney General's argument that, whatever the court's authority to grant other forms of relief, under principles of comity it lacks jurisdiction to order dissolution of a foreign corporation.
There's been little, subsequent case activity putting Hospital Diagnostic's jurisdictional view to the test. In Sokol v. Ventures Education Systems Corp., 10 Misc 3d 1055(A) (Sup. Ct. NY County 2005), the court held that it could not entertain a request to dissolve a New York-based Delaware corporation but that it had jurisdiction to grant remedies short of dissolution. Here's how New York County Commercial Division Justice Richard B. Lowe III navigated the cross currents created by the First and Second Department precedents:
"It is well settled that 'a foreign corporation is controlled, as to its dissolution, by the laws of its domicile, and is not affected by laws which are intended to govern the dissolution of corporations created under local laws' " (Matter of Warde-McCann v Commex, Ltd., 135 AD2d 541, 542 [2d Dept 1987], quoting 17A Fletcher's Cyclopedia of the Law of Private Corporations § 8579, at 516 [Perm ed] [now, at 454-55 (1998 rev ed)]; Matter of Porciello v Sound Moves, Inc., 253 AD2d 467 [2d Dept 1998]; Mook v Berger, 26 AD2d 925 [1st Dept 1966], appeal granted 19 NY2d 581 [1967]; see BCL § 1104-a). A corporation is domiciled only in the state where it is incorporated (Sease v Central Greyhound Lines, Inc., of New York, 306 NY 284 [1954]). VESC is incorporated under the laws of Delaware and, therefore, may be dissolved only by order of a Delaware court.
For these reasons, the branches of Sokol's cross motion for dissolution of VESC and appointment of a liquidating receiver are denied.
However, this court may exercise subject matter jurisdiction over the other issues raised by the parties. Subject matter jurisdiction over the internal affairs, short of dissolution, of a foreign corporation may be found, in the court's discretion, to exist in equity where the corporation's sole connection to a foreign state or country is its place of incorporation and the corporation has significant and substantial ties with New York (Matter of Dissolution of Hospital Diagnostic Equip. Corp. [Klamm], 205 AD2d 459 [1st Dept 1994]; Broida v Bancroft, 103 AD2d 88 [2d Dept 1984]; Tosi v Pastene & Co., 34 AD2d 520 [1st Dept 1970]). Where jurisdiction exists, "the fact that the relief nominally sought (i.e., dissolution and forfeiture of the corporate charter) is not technically within the power of the Court does not bar the award of lesser or alternative relief in this action . . . which will attain substantial justice between the parties" (Matter of Dohring for the Dissolution of CVC Prods., Inc., 142 Misc 2d 429, 433 [Sup Ct, Monroe County 1989]).
Significantly, in Sokol Justice Lowe rejected the plaintiff's request to apply New York's substantive law to the plaintiff's claim of minority shareholder oppression. Rather, Justice Lowe held that the claim had to be decided under the more demanding standards of Delaware statutory and common law because the corporation's charter and bylaws demonstrated that the founders (including the plaintiff) "agreed to govern VESC's internal affairs in accordance with the laws of Delaware." In this regard, Sokol seems incompatible with the New Jersey courts' analysis in Krzastek and Conway.
I did not find in the two New Jersey opinions any acknowledgment of the "technical" barrier to dissolution of a foreign corporation noted in the New York cases, namely, the inability of a court in one state to order the secretary of state in another state to dissolve a corporation. The practical answer may lie in New Jersey's strong policy in favor of buyouts, as reflected in the New Jersey dissolution statute's express provisions authorizing the court to compel the respondent shareholders to purchase the petitioner's shares or vice versa. New York courts have rarely compelled buyouts and, to my knowledge, never in the form of a compelled buyout of a respondent by a petitioner.
Perhaps some day one of the other Appellate Division Departments will unequivocally split with the Second Department, requiring the New York Court of Appeals to decide once and for all the scope of judicial authority to entertain a petition for judicial dissolution of a foreign corporation. Until then, New York shareholders of closely held foreign corporations who seek the remedy of judicial dissolution must do so in the state of incorporation. In the case of a minority shareholder of a Delaware corporation, this can be a daunting challenge given Delaware's lack of a minority shareholder oppression statute (except for statutory close corporations) and given Delaware case law that is generally more hostile to oppression claims than New York's.
Shareholders unwilling to sue for dissolution in the state of incorporation alternatively may consider bringing a derivative action, e.g., for breach of fiduciary duty, in New York state court as specifically authorized by Section 1319 of the New York Business Corporation Law. As explained by Justice Kenneth Fisher in Potter v. Arrington, 11 Misc 3d 962, 2006 NY Slip Op 26062 (Sup. Ct. Monroe County 2006), in such an action the court is still required to apply New York's conflict of laws rules, which likely will result in application of the foreign state's substantive law.
My thanks to Brian Waters at Drinker Biddle for providing copies of the Krzastek and Conway decisions.
Court Bars Minority Member From Intervening in Creditor's Suit Against LLC
The whimsically named Rocketboom LLC runs a videoblog offering what it calls "daily internet culture." A dust-up between the company's owners has now made a small but noteworthy contribution to the legal culture of New York LLCs, in the form of a recent appellate court decision holding that an LLC member may not intervene as a party defendant in a creditor's suit against the LLC, even if the suit and its settlement allegedly result from impropriety by the controlling member. Baron v. Rocketboom, LLC, 2008 NY Slip Op 09656 (1st Dept Dec. 9, 2008).
Rocketboom was formed in 2005, owned 51% by Andrew Baron and 49% by Amanda Congdon. Congdon stopped working at the company in June 2006 under disputed circumstances. Congdon claimed that Baron terminated her. Baron claimed that Congdon left voluntarily and thereby forfeited her membership interest.
From inception Rocketboom was financed by Baron's father, Fred. In October 2006, by which time Fred had loaned approximately $300,000, he and his son on Rocketboom's behalf executed a Loan and Security Agreement establishing a $500,000 loan facility collateralized by all property of Rocketboom. In March 2007, Fred sued Rocketboom for nonpayment and to foreclose Rocketboom's interest in the collateral (read complaint here).
Congdon learned of the suit and, in April 2007, moved to intervene in the case as a party defendant (read her notice of motion here). She alleged that Baron entered into the Loan and Security Agreement without her knowledge or consent; that as Rocketboom's 49% owner she has an interest in the action; and that Rocketboom (by Baron) was not adequately protecting her interest. She also argued that Baron was a necessary party to the action and that his non-joinder was ground for dismissal. Congdon's proposed answer also included cross claims for declaratory relief, an accounting, damages for breach of fiduciary duty and breach of contract.
While the motion was pending, in June 2007, Rocketboom (by Baron) entered into a stipulation of settlement with Fred acknowledging its liability and agreeing to entry of judgment for over $800,000.
The case came before New York County Commercial Division Justice Richard B. Lowe III who, in a decision dated July 16, 2007 (2008 NY Slip Op 32202(U)), analyzed Congdon's motion under Civil Practice Law and Rule 1012(a) permitting intervention as of right "upon timely motion . . . when the representation of the person's interest by the parties is or may be inadequate and the person is or may be bound by the judgment." There was no issue of timeliness. The main problem for Congdon, Justice Lowe concluded in denying intervention, was that as an LLC member she is not personally bound by a judgment against Rocketboom under Section 609(a) of the LLC Law. The statute in general provides that LLC members are not liable for the debts of the LLC. Justice Lowe also found that Congdon could not establish inadequate representation because her allegations of wrongful termination and improper execution of the Loan and Security Agreement
sound in an action against A. Baron for an alleged wrong done to her with respect to her role in Rocketboom. These do not sound in a defense to the loan's repayment, which is the instant action's subject matter.
Justice Lowe also rejected Congdon's contention that Baron was a necessary party to the action, stating that "Congdon's redress for her allegations against A. Baron are best addressed elsewhere."
Congdon appealed to the Appellate Division, First Department, which last week upheld Justice Lowe's order using a somewhat different approach. Instead of Section 609, the appellate court relied on Section 610 of the LLC Law which provides:
A member of a limited liability company is not a proper party to proceedings by or against a limited liability company, except where the object is to enforce a member's right against or liability to the limited liability company.
Here's the pertinent excerpt from the First Department's decision:
Appellant was properly barred from intervening in this matter (see CPLR 1012[a]). To allow otherwise would override the restriction in Limited Liability Company Law § 610 that prohibits a member of a limited liability company from entering an action against the company except where the object is to enforce the member's right against the company. Here, appellant essentially argues that she fits within the § 610 exception insofar as she seeks to preserve the value of her equity interest in the company, which includes the company's assets. However, apart from a claimed individual right to an "equity interest" in the company, appellant has not demonstrated her individual right to any of the company's assets. Her alleged equity interest cannot be equated to a "right" to the company's assets, except upon dissolution of the company. Absent a derivative action on the company's behalf (see e.g. Tzolis v Wolff, 10 NY3d 100 [2008]), appellant is barred by § 610 from intervening in an effort to block enforcement of the company's obligation to repay the loan to the lender.
The court's citation to the Court of Appeals' February 2008 Tzolis decision, which confirmed the right to bring derivative actions on behalf of LLCs, is the most important takeaway from the Rocketboom case. UnderLLC Law Section 601 an LLC member has no interest in specific property of the LLC. Outside of dissolution an LLC minority member therefore must utilize the derivative action to assert claims of collusion or other impropriety between a controlling member and an outside creditor in order to bar enforcement of the alleged LLC obligation. Assuming Congdon had a basis to challenge the LLC's debt owed to Fred, instead of seeking intervention as a party defendant, she could have filed a separate action (and sought consolidation with Fred's action) asserting derivative claims for declaratory and equitable relief with respect to Fred's claims along with her individual claims against Baron relating to her termination and membership status.
Professor Larry Ribstein, no fan of Tzolis, gives his take on the Rocketboom case here.
LLC Members May Bring Derivative Suits
The New York Court of Appeals (the state's highest court), in a split decision with a vigorous dissent by three of the court's seven judges, today resolved the hotly debated question whether members of New York limited liability companies may bring derivative suits on the LLC's behalf. Answer: they may. Here's the decision in Tzolis v. Wolff, 10 NY3d 100 (2008).
A number of lower courts, in refusing to grant member standing to sue derivatively, interpreted the LLC Law's legislative history as indicative of the legislature's deliberate omission of statutory authority for derivative suits. The Court of Appeals majority held otherwise, finding the legislative history "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" (p. 11).
Waving the separation of powers banner, the dissenters accuse the majority of "judicial fiat" by "effectively rewrit[ing] the law to add a right the Legislature deliberately chose to omit", adding: "The proponents of derivative rights for LLC members -- who were unable to muster a majority in the Senate -- have now obtained from the courts what they were unable to achieve democratically" (p. 20).
The availability to LLC members of derivative rights will have a substantial impact on LLC member relations and the kind of litigation that may ensue when members seek judicial recourse. Without such rights, members holding minority interests in LLCs had little recourse against majority abuses that caused direct injury only to the LLC (e.g., taking excessive compensation or other forms of self dealing). The LLC Law's provision for judicial dissolution has not proved to be a potent remedy in the face of typical operating agreement provisions giving broad management control to the majority owners. Today's decision in Tzolis evens the playing field by providing an alternative avenue for judicial relief.
Update (September 26, 2008): For LLC derivative plaintiffs whose actions were dismissed for lack of standing pre-Tzolis, and whose appeals from the dismissals are still pending, the good news is that the Second Department earlier this week reinstated such an action. Stack v Midwood Chayim Aruchim Dialysis Assoc., Inc., 2008 NY Slip Op 07114 (2d Dept Sept. 23, 2008).
Update (October 16, 2008): New York County Commercial Division Justice Richard B. Lowe III's decision in Jacobson v. Croman, 2008 NY Slip Op 32805(U) (NY Sup Ct NY County Oct. 6, 2008), has an extended discussion of retroactive application of Tzolis, and collects several other cases on the subject.
