Cost Sharing in Derivative LLC Lawsuits: A Common Law Right and a One-Way Street Farrell Fritz, PC
BCL 626 governs derivative actions by shareholders or lawsuits brought by individual shareholders on behalf of and for damages caused to the company. Subsection (e) provides that if the plaintiff – the individual shareholder claiming the right of the company – recovers something of value to the company, the court may, at its discretion, award reasonable expenses, including costs. attorney’s fees, payable out of the award to the company.
While BCL 626 (e) sets out the framework for cost sharing in derivative actions brought on behalf of a company, and New York Limited Partnerships Act Section 121-1002 (e) reflects the BCL and applies to partnerships, there is no corresponding cost-sharing statute for derivative lawsuits initiated and pleaded on behalf of other entities, such as LLCs. Without statutory equivalent, is the same cost-sharing framework available?
I have yet to see a case directly addressing the issue, but the recent decision of the First Department in Bd. Des managers de 28 Cliff St. Condominium c Maguire, 2020 NY Slip Op 06844 [1st Dept Nov. 19, 2020] may open the door for a successful derivative plaintiff who is a member of the LLC to argue that the common law includes the right to recover the costs of any award made in favor of the LLC.
Even if 28 Cliff Street Is not in and of itself a business dissolution or divorce case, a dissolution petition often includes a derivative claim against the other owner alleging misappropriation of company assets or business opportunities. Derivative lawsuits have long been an essential tool in the business divorce practitioner’s toolkit, and fee collection is a topic close to the hearts of lawyers and clients alike, so we welcome the advice of the former. department on the matter.
Sharing of costs for the derivative applicant selected under the BCL
BCL 626 (e) provides, in the relevant part:
If the action on behalf of the company has been successful, in whole or in part, or if anything has been received by the plaintiff or plaintiffs or a plaintiff or plaintiffs as a result of a judgment, of a compromise or settlement of an action or claim, the court may award the plaintiff or plaintiffs, plaintiff or plaintiffs, reasonable expenses, including reasonable attorney’s fees, and will hold him to account to the company the rest of the product thus received by him or them.
Good policy underpins the cost-sharing framework set out in 626 (e). Because a successful derivative lawsuit gives the company a benefit for which the company itself would otherwise have had to pay, section 626 (e) allows the court to award plaintiffs the attorneys’ fees incurred to secure that benefit. . The prospect of cost recovery also makes derivative lawsuits more profitable, reinforcing the important role of derivative lawsuits as a layer of corporate liability.
Notably, paragraph 626 (e) does not increase, as some transfer of fees laws do, the amount owed by the offender. It also does not allow a successful defendant in a derivative suit to claim fees against the company. On the contrary, BCL 722 and 724 provide the statutory framework for the advancement and compensation of a director or company officer.
The Fire Pub at 28 Cliff St.
While Leopold Bloom reflected (in the famous not obscene Ulysses) that a “good puzzle would be to cross Dublin without passing by a pub”, crossing Manhattan on such a sober route could be an even greater challenge. An unintended consequence of the glut of breweries in New York City, the pages of this New York Business Divorce blog have featured dozens of articles covering breakups, buyouts, reviews, or misconduct in all manner of pubs, bars, lounges and more. nightclub. 28 Cliff Street is another.
The 28 Cliff St. Condominium is an unincorporated four-unit condominium in downtown Manhattan. Defendant Philomena Maguire is the former chairman of the board of directors of the condominium and owner of Ryan Maguire’s Bar & Restaurant, which occupies the commercial space on the ground floor of the building.
In 2010, a fire broke out in the pub’s basement, causing extensive damage to the entire building and displacing residents for more than a year. The condominium filed a claim under its general insurance policy, and the insurer ultimately paid over $ 1.2 million for the damage caused by the fire. As chairman of the board at the time, Maguire coordinated the restoration of the building and, consequently, the disposition of the $ 1.2 million in insurance proceeds.
Four years later, in 2014, the owners of the unit sued Maguire and the pub’s other owners, alleging they misappropriated the insurance proceeds by using the funds to improve and expand the pub while skimping on repairs to the rest of the building. The initial complaint from the owners of the unit contained a multitude of derivative and direct claims, but the trial court quickly dismissed the derivative claims, in part because the derivative and direct claims were so closely related that it was impossible to resolve. distinguish them from one another.
Maguire sought compensation from the condominium for its defense against the rejected derivative claims and the remaining direct claims. Maguire argued that the condominium claims were subject to New York real estate law, and because the RPL was silent on the issue of compensation, BCL 722 and 724, which allow compensation, applied to fill the gaps left by the RPL.
The lower court applies the BCL
The court of first instance concluded that in the absence of an applicable provision in the RPL, the BCL applied to the derivative action brought on behalf of the unincorporated co-ownership. He relied on the wording of the Prime Minister’s decision in Tsui against Chou, 135 AD3d 597 [1st Dept 2016], which cited BCL 626 (e) in support of its decision that, in the context of co-ownership, successful secondary claimants can pursue their claims for costs against the co-ownership.
So, because the court of first instance read Tsui to apply BCL 626 (e) in the context of unincorporated co-ownership, the court of first instance concluded that the BCL’s provisions on compensation – BCL 722, 724 – should also apply. “To state otherwise,” the court of first instance ruled, “would amount to accepting the absurd result that plaintiffs in derivative co-ownership actions, owners of individual units, can recover attorneys’ fees in accordance with the BCL , but the defendant officers and directors cannot do the same under the same statute.
The first department: although the BCL can be instructive, the common law applies
Acknowledging that its previous participation in Tsui was susceptible to different interpretations, the first department in 28 Cliff Street. taken care to make a clearer statement. The court ruled that the rights of unit owners in derivative lawsuits on behalf of unincorporated condominium associations are governed by common law, not the BCL. Tsui simply quotes the BCL in its interpretation of the common law:
[W]specify that Tsui does not defend the proposition that where the RPL is silent, the BCL broadly applies to all condominium associations to fill in the gaps. The reference “see” to BCL Â§ 626 (e) in Tsui is simply an acknowledgment that the BCL can be consulted to interpret the common law on derivative actions.
Turning next to the common law of derivative actions, the Court held that unlike BCL 722 and 724, there was no right to compensation or advancement at common law, so that claims for compensation and advancement of Maguire must fail.
From condos to SARLs?
28 Cliff Street is potentially important beyond the context of the condominium. On the one hand, it reaffirms that the BCL does not apply to derivative lawsuits on behalf of unincorporated entities, such as condominiums and LLCs; the common law does. (See also Case of 1545 Ocean Avenue, LLC, 72 AD3d 121 [2d Dept 2010][holding that the BCLâs dissolution sections do not apply to LLCs]). Nevertheless, the BCL can be instructive in the interpretation of this common law.
28 Cliff Street also specifies that the decision of the first department of 2016 in Tsui involves the application of common law. According to 28 Cliff Street, Tsui– which affirmed the right of a successful derivative plaintiff to claim fees – is a matter of common law. This means that under common law, a successful plaintiff in a derivative lawsuit may be awarded fees from the entity on whose behalf the lawsuit has been pursued.
In Tzolis vs. Wolff, 10 NY3d 100 , the New York Court of Appeals ruled that the common law grants members of the LLC the right to sue on behalf of the LLC to recover wrongs committed against the LLC. It won’t be long before a creative LLC member quotes 28 Cliff Street and Tsui in support of the argument that the derivative common law rights of the members of the LLC include the right to seek recovery of costs and expenses incurred in pursuing the action on behalf of the LLC.
Ultimately, 28 Cliff Street also indicates that under common law cost sharing is a one-way street. Common law does not allow the compensation and advancement of corporate officers sued by derivation. So, if there are any rights of indemnification or advancement to be found by a member or manager of an LLC being sued in a derivative manner, those rights are found in the operating agreement, not in the common law. For a more complete summary of the LLC Litigation Indemnification and Advancement Act, see my colleague Frank McRoberts’ post, Can the company pay my legal fees?
In short, in the wild west of LLC derivative lawsuits, 28, rue de la Falaise provides, albeit indirectly, an additional fulcrum for a successful plaintiff to assert their right to recover the costs of the award in favor of the LLC.
One last interesting note: 28 Cliff Street confirms that the first department Judge Gische remains an active force in the development of the law surrounding the rights of LLC members to bring derivative action. After Tzolis, Judge Gische was the first to declare, in Evans v. Perl, 19 Misc3d 1119[A] (Sup Ct NY County 2008), that the common law subjects LLC derivative plaintiffs to the same pre-action requirements that the BCL requires from shareholder derivative plaintiffs. Judge Gische then sat on the panel in Tsui and author 28 Cliff Street