Purchaser of a Membership Interest in an LLC Who Had Not Been Admitted as a Member Pursuant to Operating Agreement Lacked Standing to Pursue Derivative Claims

• Posted on: Feb 20 2019

A shareholder’s derivative action is a lawsuit “brought in the right of a … corporation to procure a judgment in its favor, by a holder of shares or of voting trust certificates of the corporation or of a beneficial interest in such shares or certificates.” Marx v. Akers, 88 N.Y.2d 189, 193 (1996) (quoting Business Corporation Law § 626 (a)). Derivative claims against corporate officers and directors belong to the corporation itself. Auerbach v. Bennett, 47 N.Y.2d 619, 631 (1979). See also Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (“The nature of the action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.”).

In New York, as in most jurisdictions, a derivative plaintiff must be a shareholder of the company “at the time of bringing the action,” and at the time of the alleged wrongdoing. See, e.g., BCL § 626(b); Pessin v. Chris-Craft Indus., 181 A.D.2d 66, 70 (1st Dept. 1992).  See also Lewis v. Anderson, 477 A.2d 1040, 1049 (Del. 1984). “[A] plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing” to sue derivatively. Lewis, 477 A.2d at 1049. Accordingly, courts have focused on the plaintiff’s stock ownership during both points in time, and in particular at the time of the alleged misconduct.

In New York, the contemporaneous ownership rule is “strictly enforced.” Honzawa Holding Co. v. Hiro Enter. USA, 291 A.D.2d 318, 318 (1st Dept. 2002). To satisfy the requirement, the plaintiff must have owned stock in the corporation

throughout the course of the activities that constitute the primary basis of the complaint. This is not to say that a plaintiff must have owned stock in the company during the entire course of all relevant events. It does mean, however, that a proper plaintiff must have acquired his or her stock in the corporation before the core of the allegedly wrongful conduct transpired.

In re Bank of New York Deriv. Litig., 320 F.3d 291, 298 (2d Cir. 2003).

“[F]ailure to satisfy the . . . contemporaneous ownership requirement of § 626(b) is such a fundamental lack of capacity that it results in failure to state a cause of action.” Roy v. Vayntrub, 15 Misc. 3d 1127(A), 2007 N.Y. Slip Op. 50868(U) (Sup. Ct. Nassau County 2007), at *6 (citing Barr v. Wackman, 36 N.Y.2d 371 (1975)). For this reason, courts require the plaintiff to plead contemporaneous ownership with particularity rather than through boilerplate assertions. See, e.g., In re Computer Sciences Corp. Deriv. Litig., 2007 WL 1321715, at *15 (C.D. Cal. Mar. 26, 2007) (“[G]eneral allegation[s] [are] insufficient to allege contemporaneous ownership during the period in which the questioned transactions occurred.”).

The foregoing standing rules apply to limited liability companies (“LLCs”). Tzolis v. Wolff, 10 N.Y.3d 100, 102 (2008); Jacobs v. Cartalemi, 156 A.D.3d 605 (2d Dept. Dec. 6, 2017). Thus, a person may bring a derivative action so long as he/she is a “member” of the company.

To be a member of an LLC, a person must have been admitted to the company’s membership “in accordance with the terms and provisions of the Limited Liability Company Law and the limited liability company’s operating agreement,” and possess “a membership interest” in the LLC “with the rights, obligations, preferences, and limitations specified under the Limited Liability Company Law and the operating agreement.” Limited Liability Company Law § 102(q). Under the Limited Liability Company Law, a “[m]embership interest” means “a member’s aggregate rights in a limited liability company, including, without limitation: (i) the member’s right to a share of the profits and losses of the limited liability company; (ii) the member’s right to receive distributions from the limited liability company; and (iii) the member’s right to vote and participate in the management of the limited liability company.” Limited Liability Company Law § 102(r).

In Kaminski v. Sirera, 2019 N.Y. Slip Op. 01067 (2d Dept. Feb. 13, 2019) (here), the Appellate Division, Second Department addressed the standing of a derivative plaintiff seeking relief on behalf of an LLC and found that the plaintiff failed to satisfy the standing requirements for bringing a derivative action.

Kaminski v. Sirera

Kaminski arose in connection with the acquisition of membership units in Melange Med Spa, LLC (the “LLC”) by the plaintiff, Jill Kaminski (“Kaminski” or “Plaintiff”). Kaminski acquired the units from a prior member in or about 2009 or 2010.

In 2016, Kaminski commenced the action individually and derivatively on behalf of the LLC against, among others, Christina Sirera, a managing member of the LLC, seeking, inter alia, declaratory and injunctive relief, an accounting, and damages for waste and breach of fiduciary duty. Kaminski also asserted causes of action against Allyson Avila (“Avila”) and Wilson, Elser, Moskowitz, Edelman & Dicker, LLP (“Wilson Elser”), attorneys for the LLC, alleging legal malpractice, breach of contract, breach of fiduciary duty, and aiding and abetting a breach of fiduciary duty.

Avila and Wilson Elser moved to dismiss the complaint on the ground that, inter alia, Kiminski lacked standing to assert claims on behalf of the LLC. The motion court denied the motion to dismiss the derivative causes of action alleging breach of fiduciary duty (fifth and sixth causes of action), aiding and abetting breach of fiduciary duty (seventh and eighth causes of action), and entitlement to the attorneys’ fees and costs incurred in prosecuting the action (seventeenth cause of action). Avila and Wilson Elser appealed the denial of their motion to dismiss.

The Second Department reversed.

The Court held that Kaminski lacked standing to bring the action derivatively. The Court found that Kaminski failed to comply with the terms of the LLC’s operating agreement. In that regard, Kaminski “failed to obtain the consent of the nonselling members to be admitted as a member of the LLC when she acquired her membership interest,” a requirement in the LLC operating agreement:

Here, the plaintiff does not dispute that she failed to obtain the consent of the nonselling members to be admitted as a member of the LLC when she acquired her membership interest. Paragraph 8 of the LLC’s operating agreement provides that “[n]ew members may be admitted only upon the unanimous consent of the Members and upon compliance with the provisions of this agreement,” and paragraph 32(e) of the operating agreement provides that “[a] non-member purchaser of a member’s interest cannot exercise any rights of a Member unless, by unanimous vote, the non-selling Members consent to him becoming a Member” (see Limited Liability Company Law § 602).

Slip Op. at *2.

Therefore, concluded the Court, “the plaintiff, as a nonmember purchaser who had not been admitted as a member of the LLC, lack[ed] standing to pursue derivative causes of action on behalf of the LLC.” Id.  As such, the motion court “should have granted those branches of the motion of Avila and Wilson Elser which were to dismiss the fifth, sixth, seventh, and eighth causes of action and, in addition, the seventeenth cause of action insofar as asserted against them.” Id.

Takeaway

The derivative standing rules are designed to prevent plaintiffs from buying into a lawsuit or commencing a derivative action by simply purchasing shares after the alleged wrong has occurred. See, e.g., Independent Investor Protective League v. Time, Inc., 50 N.Y.2d 259, 263 (1980). Although there are exceptions to the rule, the law has long required plaintiffs bringing a derivative action to have a stake in the company on whose behalf the action is commenced.  After all, if the plaintiff is not a shareholder of the company, then he/she has no right to vindicate the company’s rights and obtain a judgment on its behalf. In Kaminski, the Second Department reinforced this rule.

Kaminski also reinforces the importance of an LLC’s operating agreement. As this Blog has noted in the context of judicial dissolution, courts look to an LLC’s operating agreement to determine whether it contains provisions that govern the outcome of the dispute between the parties. In Kaminski, the operating agreement contained such provisions and, therefore, controlled the outcome of the appeal.