A couple of interesting things caught my eye about an otherwise garden-variety lawsuit brought by a dissident LLC member in which Nassau County Commercial Division Justice Stephen A. Bucaria issued a decision earlier this month granting a motion to reargue and reinstating the previously dismissed complaint asserting that the controlling members withheld the plaintiff’s pro rata share of distributions.
First, the prior order of dismissal last July in Webster v Forest Hills Care Center LLC (read here) was another in a series of rulings by Justice Bucaria, which I highlighted on this blog a year ago, in which he dismissed lawsuits asserting various and sundry claims among co-owners of close corporations and LLCs while granting leave to file either a new action or an amended pleading seeking judicial dissolution. Justice Bucaria based these rulings on the ancient principle of partnership law barring “piecemeal” adjudications among “squabbling” partners and requiring them, as stated by the Court of Appeals in Gramercy Equities Corp. v Dumont, 72 NY2d 560 , either to “settle their own differences amicably or dissolve and finally conclude their affairs by a full accounting.”
The plaintiff in Webster, a 15% member of two affiliated LLCs that own and operate a nursing home, declined the invitation to sue for dissolution. Instead, she filed a motion asking Justice Bucaria to reconsider and to vacate his dismissal order on the ground that he had “misunderstood” her claims seeking an accounting and damages for withheld distributions (read complaint here) and that, contrary to the court’s characterization of her position, she had not argued that the LLCs were unable to carry on their business in accordance with the operating agreements. The plaintiff disavowed any intention, desire, or grounds to dissolve the LLCs and argued that the partnership rule reflected in Gramercy Equities does not apply to LLCs.
In his ruling dated November 10, 2015 (read here), Justice Bucaria agreed with the plaintiff “that the court may entertain her request for distributions without requiring dissolution of the limited liability companies” and that a “non-managing member of a limited liability company may pursue such a breach of fiduciary duty claim without seeking dissolution of the company.” In so ruling Justice Bucaria did not comment on the plaintiff’s argument disputing the applicability to LLCs of the partnership rule against piecemeal adjudications.
LLC Law Section 508
The second thing that piqued my interest in the latest Webster ruling was the court’s additional determination to apply a three-year statute of limitations to the plaintiff’s claims, which Justice Bucaria described as seeking a “purely monetary” remedy for breach of fiduciary duty, thereby cutting off the plaintiff’s right to seek allegedly withheld distributions pre-dating September 2011.
There’s nothing especially controversial about that, although the plaintiff’s counsel subsequently wrote the court asking it to clarify its ruling by limiting application of the three-year limitations period to the complaint’s claims for breach of fiduciary duty as opposed to the accounting claims for which, plaintiff contends, a six-year period applies (as of this writing, no response to the letter is posted online).
What I found more interesting, when I looked at the defendants’ underlying statute of limitations argument, was their reliance on section 508(c) of the LLC Law which provides that a member who receives a “wrongful distribution” from an LLC “shall have no liability under this article or other applicable law for the amount of the distribution after the expiration of three years from the date of the distribution.” Permit me to offer the following thoughts on that:
- Section 508(c), which derives almost verbatim from section 121-607(c) of New York’s Revised Limited Partnership Act, is more aptly described as a statute of repose than a statute of limitations. The former is a stricter, substantive rather than procedural limitation that abolishes the claim after the passage of the specified time period. The difference may be critical when the plaintiff presents an estoppel or other equitable defense that can defeat a statute of limitations but not a statute of repose.
- Notwithstanding that section 508(a) prohibits an LLC from making distributions that render the LLC insolvent, and section 508(b) imposes liability on a member for the amount of any such distribution knowingly received, section 508(c) has been construed broadly to cover not just insolvency claims but also “wrongful distributions” made in violation of the LLC’s operating agreement or that constitute fraudulent conveyances. (Justice Carolyn Demarest’s opinion in Board of Managers v Chocolate Partners, LLC, 2014 NY Slip Op 50754(U) [Sup Ct Kings County 2014] and the Bankruptcy Court’s opinion in In re Die Fliedermaus LLC, 323 BR 101 [SDNY 2005], are good places to start for anyone interested in learning more on the subject.)
- The New York statute differs from the model provisions found in sections 405 and 406 of the Revised Uniform LLC Act (2006) which provide for a stingier two-year statute of repose and explicitly apply to distributions made in violation of the LLC’s articles of organization or operating agreement.
- The complaint in Webster sought as the sole remedy an accounting and damages representing plaintiff’s pro rata share of distributions allegedly made to the other members. The complaint does not seek to compel the other members to return to the LLC wrongful distributions received by them, which may explain why Justice Bucaria made no mention of section 508(c) in his decision.
- By the same token, lawyers representing controlling members or managers of LLCs against claims of financial abuse should not overlook section 508(c)’s usefulness as a potential defense. I’ve seen many complaints asserting derivative claims by non-controlling LLC members alleging that those in control wrongfully paid themselves “de facto distributions” in the form of excessive compensation. Arguably, section 508(c) might cut off claims to claw back such monies received more than three years prior to suit.
Addendum: Professor Dan Kleinberger a/k/a He Who Knows Everything About LLCs, emailed me the following comment:
I think your 508(c) idea is pretty neat (if you’ll excuse the technical language …), especially if the LLC lacks funds to pay the “make up” amount of distributions to the plaintiff. A couple of additional thoughts: (1) assuming that it was the LLC that breached the distribution obligation, the controlling members might well be liable to the plaintiff for tortiously interfering with the operating agreement; and (2) those members might also be subject to claim in restitution.