Tzolis v. Wolff Case Brief Analysis

January 22, 2012

Tzolis v. Wolff

COURT OF APPEALS OF NEW YORK (2008)

FACTS: The Plaintiffs in the case are the members of the Pennington Property Co. LLC who own 25% of the membership interest in the company. They claim that the managing directors of the company have arranged first the lease, and then the sale of the LLC’s principal asset for sums below market value; that the lease was unlawfully assigned; and that the company fiduciaries gained personal benefit from the sale while at the same time damaging the company’s interests. The Plaintiffs bring the action “individually and in the right and on behalf of” the company to remedy the wrongs of the directors by voiding the sale and terminating the lease.

The trial court dismissed the Plaintiffs’ case, mainly basing their decision on the fact that “New York law does not permit members to bring derivative actions on behalf of a limited liability company”. The Appellate Division reversed the trial court’s decision, by concluding that derivative suites on behalf of LLCs are permitted.

ISSUE: Should members of Limited Liability Companies be allowed to bring derivative suites on LLC’s behalf, even though there is no provision for such suits in the Limited Liability Company Law?

OUTCOME: The Appellate Division found that the legislative history of the New York law on the Limited Liability Company does not permit the courts to infer that the Legislature intended to eliminate the centuries-old protection of shareholders from the wrong doings of the agents. The court concluded therefore that derivative suits should be recognized even though no statute provides for them, and that LLC members may sue derivatively.

REASONING: The Appellate Division’s decision draws its conclusion based on four cases going back as far as 1742, 1832, 1965, and 1966. All these cases have one thing in common – they rely on the basic principle in the law of trusts that the shareholders have the right to sue for the benefit of trust if the trustees refuse to perform their duties to act in the best interest of the company. The shareholders also have the right to seek the remedy through derivative suit in the court even if no statutory provision exists for this, as long as the law does not explicitly prevents them from this. All four cases referred in the decision have another commonality which makes them relevant to the current case: they were applied to the fairly new business entities at the time. Nevertheless, the absence of statutory provisions did not prevent the courts from recognizing the remedy for the shareholders against the entity’s agents.

DISSENT: The Court has read into a statute provisions and made their decision against the choices that the Legislature unquestionably considered and rejected. The history of New York legislation on LLC shows that the provisions for derivative suits have been deliberately omitted, and therefore the Court’s decision effectively rewrites the law and usurps the legislative prerogative.

COMMENTS: The core issue at the Court’s decision, and especially the presence of the dissent in this case points out to the intrinsic value of the Courts and their role in the scheme of “checks and balances” between the Legislature, Judicial system, and Executive branch. This case, admittedly, touches upon the relation between the Legislature and the Courts powers only.

Do the courts have the responsibility to uphold the spirit of the law, and more broadly the values of our society, or are they just established to blindly endorse the letter of the law? Even though in no way I support the idea of the Courts usurping the legislative prerogative, because at the same token the Legislature may try to abolish the Judicial powers, I firmly believe that the Courts are called to uphold the basic principles on which our society lays its foundation.

The Court’s decision is appropriately pointing out the precedents in which the courts upheld the inalienable rights of shareholders to protect their company from fraudulent actions of its agents, even though the statutory provisions did not exist at the time due to relatively new forms of entities involved.

Especially, since the law did not have explicit provision to deny the LLC the right for derivative suits. The LLC, yet another relatively new legal entity, was created to combine the tax advantages of partnerships with the limited liability of corporations, both of which are long-established and well-recognized entities. It was not created to provide a loophole for fraudulent actions, whether due to legislative oversight or political bargaining at the time of passing the law.