An LLC Member In Manhattan May Not Intermingle Derivative Claims, Brought On The LLC’s Behalf, With Individual Claims

On September 7, 2011, in Waxman Real Estate LLC v. Sacks, Index No. 652057-2010, 2011 N.Y. Slip Op. 51667 (N.Y. Sup. Ct. N.Y. County Sept. 7, 2011) (Fried, J.), the Supreme Court, New York County held that a member of a limited liability company (an “LLC”) in New York State may not, within the same causes of action, combine derivative claims, brought on behalf of the LLC, with the member’s individual claims.

A derivative claim is one that a plaintiff brings as a stockholder on behalf of the corporation or limited liability company. In contrast, an individual claim is one that the plaintiff brings to vindicate his personal rights as an individual.

In Tzolis v. Wolff, 10 N.Y.3d 100, 102, 884 N.E.2d 1005, 1005, 855 N.Y.S.2d 6 (N.Y. 2008), the New York Court of Appeals held that “members of a limited liability company (LLC) may bring derivative suits on the LLC’s behalf . . . .” Tzolis, 10 N.Y.3d at 102, 884 N.E.2d at 1005.

In the Waxman Real Estate LLC case, two members of an LLC engaged in the business of real estate investment sued two principals and managers of the LLC, both individually and derivatively on behalf of the LLC, for breach of contract, unjust enrichment, fraud in the inducement, breach of fiduciary duties, and injunctive relief based on, among other things, the alleged distribution, by the defendant principals and managers of the LLC, of false and misleading progress reports to investors. The plaintiff members mixed together, within the same counts of their Complaint, derivative claims, brought on the LLC’s behalf, with the member’s individual claims. See, e.g., Complaint ¶ 35 (alleging that “Plaintiffs and the [limited liability] Company have been irreparably injured and damaged by the foregoing wrongful acts and conduct of [the defendant principals and managers of the LLC]”).

The Waxman Real Estate LLC Court dismissed without prejudice, for failure to state a cause of action, the plaintiff members’ derivative claims. The Supreme Court, New York County (Fried, J.) found that dismissal, without prejudice to serving and filing an amended complaint, was warranted because “plaintiffs have improperly mingled their individual claims with their derivative claims” within the same causes of action.

The Waxman Court acknowledged that “there is indeed ‘limited case law’ on whether derivative claims brought on behalf of LLCs may be intermingled with individual claims . . . .” However, the New York County Supreme Court reasoned that, because a shareholder or a partner may not blend together, within the same causes of action, his or her individual claims with derivative claims brought on behalf of a corporation or a partnership, so too an LLC member may not conflate, within the same counts of a Complaint, his or her individual claims with derivative claims brought on behalf of the LLC.

Aggrieved members of limited liability companies in Manhattan, NYC, and LLC members’ lawyers, should learn, from the Waxman Real Estate LLC case, the following lessons:

1. It’s OK for a member of an LLC in Manhattan, NYC to maintain, in the same lawsuit, both (a) derivative claims brought on behalf of the LLC and (b) the member’s individual claims. However, the counts of the member’s Complaint that allege derivative claims brought on the LLC’s behalf must be separate from the counts of Complaint that plead the member’s individual claims. In other words, no count of the LLC member’s Complaint may contain both a derivative claim, brought on the LLC’s behalf, and an individual claim of the plaintiff member.
2. In drafting a complaint by a member of a limited liability company of Manhattan, NYC, the LLC member’s lawyer must avoid utilizing phrases that conflate derivative and individual claims. For example, in stating a breach of fiduciary duty claim, the LLC member’s Complaint should not allege that “[the defendant] has an obligation to [the plaintiff member] and to [the LLC’s] other members to adhere to fiduciary standards of conduct and to exercise his responsibilities in good faith” or that “[the defendant] has breached his fiduciary duties to [the LLC] and [the plaintiff member].”

If your company wants to bring, or needs a lawyer to defend it in, business litigation and you are located in the Manhattan, New York City area, call Attorney David S. Rich at (347) 941-0760.