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 ), 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.