LLC Member Disputes.
New York Supreme Court.

What an LLC Member Dispute Usually Looks Like

Most of the LLC disputes I see start the same way. Two or three people formed a company together, signed an operating agreement they never looked at again, and ran the business on trust. Then trust broke. The problems that bring a member to a lawyer fall into a few patterns:

• You have been shut out of decisions. The managing member stops consulting you, signs contracts alone, or tells the bank you are no longer an authorized signer.
• Your distributions stopped. The company is still earning, but the profit now goes out as salary, management fees, or "expenses" to the members in control.
• You cannot see the books. Requests for bank statements, tax returns, or the general ledger go unanswered.
• A member is dealing with himself. The LLC hires a construction company, a landlord, or a vendor owned by one of the managers, at prices nobody else approved.
• Someone wants out and there is no exit. The operating agreement has no buyout formula, so the departing member and the remaining members cannot agree on a number.
• Two equal members are deadlocked. A 50/50 company with no tiebreaker cannot act at all.

The Operating Agreement Comes First

An LLC member dispute in New York is, at its core, a contract dispute. The operating agreement sets out how the company is managed, who votes on what, how profits are distributed, whether a member can be removed, and what happens when a member leaves. Where the agreement is silent, the default rules of the Limited Liability Company Law fill the gap. The Appellate Division has described judicial dissolution of an LLC as "initially a contract-based analysis" that begins with the operating agreement (Matter of 1545 Ocean Ave., LLC, 72 A.D.3d 121, 128 [2d Dept 2010]), and the same is true of almost every other claim between members.

So the first thing I do is read your operating agreement, every amendment, and any side agreements or buyout contracts the members signed later. Members are often surprised by what they find: an arbitration clause, a buyout formula nobody remembered, a provision letting the manager act alone, or a cap table that does not match what everyone believes they own.

Your Right to See the Company's Records

A member who has been cut off from information has a statutory right to get it. Under LLC Law 1102(b), any member may inspect and copy, for any purpose reasonably related to the member's interest, the records the company is required to keep: the list of members with their contributions and shares of profits and losses, the articles of organization, the operating agreement and its amendments, and the company's tax returns for the three most recent fiscal years. The member may also inspect the financial statements for the three most recent fiscal years and "other information regarding the affairs of the limited liability company as is just and reasonable." The operating agreement can set reasonable standards for how inspection happens, but it is the starting point for nearly every case.

A written records demand is often the most useful first step. It costs little, it shows the other members you are serious, and the response, or the refusal, tells you a great deal about what happened to the money.

Claims Against a Managing Member

Breach of the operating agreement

If the members in control stopped distributions the agreement requires, acted without a vote the agreement requires, or removed you in a way the agreement does not allow, the claim is breach of contract.

Breach of the manager's duties

LLC Law 409(a) requires a manager to perform his or her duties "in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances." Members who manage the company can also owe fiduciary duties to the other members. See Breach of Fiduciary Duty for how those claims work.

Deals between the LLC and a manager's own business

LLC Law 411 addresses contracts between the LLC and a manager, or a business in which the manager has a substantial financial interest. If the manager's interest was not disclosed and the deal was not approved by the disinterested managers or the members as the statute requires, the LLC may avoid the contract unless the parties to it "establish affirmatively that the contract or transaction was fair and reasonable" to the LLC when it was approved. That shifts the burden onto the member who was dealing with himself.

Claims on behalf of the company

When the harm is to the LLC itself, such as diverted revenue or overpayments to an insider's company, the claim may belong to the company and be brought as a derivative claim. The Second Department noted in 1545 Ocean that a derivative claim is available to an LLC member aggrieved by a manager's conduct (72 A.D.3d at 132).

What New York Law Does Not Give LLC Members

Two points surprise members who have read about shareholder disputes. First, the "oppressive conduct" ground that lets a minority shareholder of a corporation petition for dissolution under BCL 1104-a does not apply to LLCs. The Second Department declined to import corporate or partnership dissolution grounds into the LLC Law (1545 Ocean, 72 A.D.3d at 126-127). Second, the LLC Law has no counterpart to BCL 1118, the statute that lets a corporation or the other shareholders elect to buy out a petitioning shareholder at fair value. In an LLC, a buyout comes from the operating agreement or from a negotiated resolution.

That makes the operating agreement, the records, and a well-chosen claim more important in an LLC case than in a corporate one. It also makes the threat of judicial dissolution under LLC Law 702 a serious piece of leverage when the facts support it. See Judicial Dissolution of an LLC and Business Deadlock.

How I Handle an LLC Member Dispute

1. Read the documents

The operating agreement, amendments, buyout contracts, tax returns, and the K-1s you received. These set the rules and often reveal the real ownership.

2. Demand the records

A written demand under LLC Law 1102 and the operating agreement, so the case is built on the company's own numbers.

3. State the claim and the exit

A demand letter that names the breach, the remedy, and, where you want out, the terms on which you will leave. Many member disputes resolve here, with a negotiated buyout or a restructured agreement.

4. Commence the case in Supreme Court

If the other side will not deal, the case goes to Supreme Court as a plenary action, a dissolution petition, or both, with a request for provisional relief where money is leaving the company.

Talk to an LLC Member Dispute Lawyer in New York

Send me your operating agreement and a short description of what has happened. I will tell you where you stand under the agreement and the LLC Law, and what I would do first.

Related: LLC Dissolution and Deadlock  ·  Frozen Out by Your Business Partners  ·  Partnership and LLC Disputes  ·  Breach of Fiduciary Duty  ·  Operating Agreement Review

Attorney Advertising. Prior results do not guarantee a similar outcome. The information on this page is general and is not legal advice. Consult an attorney about the specific facts of your matter. Law Office of Frederic R. Abramson, 160 Broadway, Suite 500, New York, NY 10038. 212-233-0666.

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