Section 420 of New York’s LLC Law authorizes an LLC, “subject to the standards and restrictions, if any, set forth in its operating agreement,” to indemnify and hold harmless, and advance expenses to, any member, manager or other person “against any and all claims and demands whatsoever.” The statute goes on to prohibit indemnification if a “judgment or other final adjudication adverse to such member, manager or other person” establishes that his or her acts were committed in bad faith or resulted from deliberate dishonesty, or that he or she gained a wrongful financial advantage.

In plain English, (1) if an LLC member, manager or other agent is successfully sued for actions relating to the LLC’s business and is hit with a damages award, so long as that person didn’t act in bad faith, dishonestly or profit illegally, when it’s all over the LLC can pay the award and reimburse the person’s legal expenses, and (2) the LLC also can fund (“advance”) the person’s legal expenses during the lawsuit, but the funds will have to be repaid if ultimately there’s a final judgment against the person and his or her conduct fails the bad-faith test.

There are few reported decisions by New York courts addressing claims for advancement in internecine lawsuits among LLC members. Best known is the 2009 Ficus decision in which the Appellate Division, First Department followed Delaware law to enforce advancement rights in litigation among members of a Florida LLC, emphasizing that rights of advancement and indemnification are “independent of one another” and that a court’s finding of misconduct for purposes of interim relief does not defeat advancement rights granted under the company’s operating agreement (read here). And then there’s the Borriello case, about which I wrote here, in which Justice Demarest enjoined an LLC from advancing the controlling members’ legal expenses in the face of the operating agreement’s provision which authorized indemnification only.

As those two cases illustrate, sometimes it’s the non-controlling member trying to use advancement to shift his or her defense costs indirectly to the controlling members, and sometimes it’s the other way around. Such cost-shifting can give one side or the other a huge and sometimes decisive litigation advantage. In a recent, novel ruling by Nassau Commercial Division Justice Stephen A. Bucaria, the court decided to “level the playing field” by ordering the LLC to advance legal expenses of both sides. PFT Technology LLC v Wieser, Short Form Order, Index No. 8679/12 [Sup Ct Nassau County Feb. 20, 2014].

Background

PFT Technology is a member-managed, New York LLC engaged in the business of detecting gas and fluid leaks in power networks for public utilities. A dispute arose among member Robert Wieser and the other three members, and efforts to buy out his interest failed. The majority members then brought suit in the company’s name against Wieser accusing him of misuse of his company credit card, abandoning his job responsibilities, and sabotaging company equipment.

The company’s complaint against Wieser asserted claims for breach of fiduciary duty as well as a claim for judicial dissolution of the company. The court’s decision doesn’t disclose the percentage interests held by the members, so I can only speculate that perhaps the operating agreement included a super-majority requirement that precluded the three-member majority from filing an administrative, voluntary dissolution. Also, it’s unclear how the company — as opposed to individual members — asserted a claim for judicial dissolution since the statute, LLC Law § 702, only gives standing to members.

Wieser’s answer to the complaint opposed dissolution but nevertheless requested a buy-out and “fair valuation” of his membership interest. He also asserted counterclaims against the other three members individually for an accounting and for breaching the operating agreement by paying themselves unauthorized salaries and failing to pay him his share of distributions. In addition, Wieser counterclaimed for indemnification and advancement under a provision in the operating agreement that essentially tracked the language of LLC Law § 420.

Wieser’s Successive Applications for Advancement

In June 2013, Wieser initially moved for partial summary judgment on his claim for advancement, which Justice Bucaria denied by decision dated July 1, 2013 (read here) on the grounds that it was not possible to determine the reasonableness of Wieser’s legal expenses sought as a dissenting member in a dissolution case, and because Wieser failed to establish that “his actions towards PFT were in good faith.”

In January 2014, Wieser renewed his request for advancement based on “new facts” learned after his prior motion was denied. Specifically, Wieser asserted that PFT was reimbursing the other members for their attorney’s fees incurred in defending Wieser’s breach of fiduciary duty counterclaims. Wieser argued that there was no basis for this “disparate treatment.” He also pointed out that the operating agreement’s provisions effectively required unanimous member consent for all member distributions and for any expenditures over $100,000. PFT and the other members opposed Wieser’s request and cross moved for partial summary judgment dismissing Wieser’s counterclaim for advancement.

Justice Bucaria’s Decision

In his recent decision, Justice Bucaria initially summarizes basic principles of indemnification and advancement as articulated by the First Department in its Ficus opinion:

By easing the burden of litigation-related expenses, indemnification provisions help companies to attract officers with various skills and other forms of expertise. In particular, advancement provides corporate officials with immediate interim relief from the personal out-of-pocket financial burden of paying the significant on-going expenses inevitably involved with investigations and legal proceedings. . . . Advancement of legal expenses is available in an action by a corporation against an officer for breach of fiduciary duty. Mere allegations of theft will not relieve the company of an obligation to advance expenses. [Citations omitted.]

How does Justice Bucaria apply these principles in the PFT case where, he notes, “the primary issue appears to be valuation of the interest of the minority member”? Wieser gets off to a rocky start, with Justice Bucaria adhering to his prior determination that, in seeking advancement, Wieser “has not carried [his] prima facie burden” to establish his “entitle[ment] to judgment with respect to PFT’s breach of fiduciary duty claims.”

But Wieser still manages to get his wish granted, due to the court’s concerns, first, that “[i]n order for the members to resolve their valuation dispute fairly, advancement of legal expenses should be generally available,” and second, to avoid the inequity arising from the majority members’ self-bestowed advancement of their own legal expenses while excluding Wieser from the same benefit. As Justice Bucaria writes:

Wieser has not carried [his] prima facie burden. Nevertheless, to ensure a “level playing field” with respect to the general issue of valuation of PFT Technology as an ongoing business, an advancement of  legal fees should be awarded. Clearly, there has been no unanimous agreement as to reimbursement of legal fees as required by the operating agreement. However, by reimbursing their own legal expenses, the individual counterclaim defendants have impliedly consented to an expenditure of up to $100,000 each, for both the majority and minority members.

You have to admit, it’s a creative and balanced solution to unusual circumstances in which the parties’ dueling financial claims and counterclaims — the authorized triggers for advancement — likely are to be folded into the ultimate determination of the value of Wieser’s membership interest, which standing alone would not normally give rise to advancement or indemnification rights. It also avoids, for the apparent benefit of all, the strict application of the operating agreement’s provision requiring unanimous consent for any cash distributions to members, which the majority members failed to get and which never could be gotten absent parity among all the members.

Update June 3, 2015:  Justice Bucaria’s advancement ruling described above has been affirmed by the Appellate Division, Second Department (read here).