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.