Opinion
No. CV 08-5017829 S
July 23, 2009
MEMORANDUM OF DECISION ON MOTION TO DISMISS (#112)
In Connecticut, in order for shareholders of a corporation to bring a direct or personal action against the corporation or its directors, the shareholder must allege an injury that is separate and distinct from that suffered by other shareholders or the corporation itself. If the injury is not separate and distinct, the shareholder is required to bring a shareholder derivative suit alleging injuries to the corporation or to the shareholders collectively. Although this rule is well-established with respect to corporations, there is a dearth of Connecticut authority as to whether it applies to limited liability companies ("LLCs"). Therefore, this case raises important questions regarding the applicability of this rule to members of a LLC, specifically where one member of the LLC seeks to sue, among others, the other two members of the LLC for mismanagement and misappropriation of the LLC's assets. For the reasons set forth below, the court concludes that the plaintiff in this case may not maintain a direct action against the majority members, but instead is obligated to assert his claims in a derivative suit. Accordingly, the defendants' motion to dismiss is granted.
FACTS AND PROCEDURAL HISTORY
The plaintiff, Kenneth C. Ward, Jr. is a minority member of Yoshu, LLC ("Yoshu"), a Connecticut LLC. Yoshu operates a restaurant in West Hartford, Connecticut, known as Plan B American Tavern. The plaintiff has a 13 percent pro rata interest in Yoshu. The individual defendants in this action are the two majority members of Yoshu, Allie J. Gamble and Shawn M. Skehan. Gamble and Skehan have a 60 percent and 27 percent interest in Yoshu respectively. In his amended complaint, the plaintiff alleges that Gamble and Skehan used Yoshu's assets, trade secrets and menu ideas to open similar, competing restaurants in Glastonbury and Simsbury. These restaurants, however, are not owned by Yoshu. Instead, the Simsbury restaurant is owned by B Fare, LLC ("B Fare") and the Glastonbury restaurant is owned by B East, LLC ("B East"). The plaintiff alleges that Gamble and Skehan are members of B Fare and B East but that he has not been given an ownership interest in either LLC. Both of these LLCs are also named as defendants in this action.
The defendants now move to dismiss the action. The defendants assert that this court lacks subject matter jurisdiction over the action because the plaintiff lacks standing to file this direct action against the defendants. The court agrees.
STANDARD OF REVIEW
In deciding this motion to dismiss, the court is obligated to, "take the facts to be those alleged in the complaint, including those facts necessarily implied from the allegations, construing them in a manner most favorable to the pleader . . . [A] motion to dismiss admits all facts well pleaded and invokes any record that accompanies the motion, including supporting affidavits that contain undisputed facts . . . If a resolution of a disputed fact is necessary to determine the existence of standing when raised by a motion to dismiss, a hearing may be held in which evidence is taken." (Citation omitted; Internal quotation marks omitted.) May v. Coffey, 291 Conn. 106, 108-09, 967 A.2d 495 (2009).
The defendant's motion to dismiss challenges the plaintiff's standing to bring this action. "Standing is the legal right to set judicial machinery in motion. One cannot rightfully invoke the jurisdiction of the court unless he [or she] has, in an individual or representative capacity, some real interest in the cause of action, or a legal or equitable right, title or interest in the subject matter of the controversy . . . When standing is put in issue, the question is whether the person whose standing is challenged is a proper party to request an adjudication of the issue Standing requires no more than a colorable claim of injury; a [party] ordinarily establishes standing by allegations of injury. Similarly, standing exists to attempt to vindicate arguably protected interests . . .
"Standing is established by showing that the party claiming it is authorized by statute to bring suit or is classically aggrieved . . . The fundamental test for determining aggrievement encompasses a well-settled twofold determination: first, the party claiming aggrievement must successfully demonstrate a specific, personal and legal interest in [the subject matter of the challenged action], as distinguished from a general interest, such as is the concern of all members of the community as a whole. Second, the party claiming aggrievement must successfully establish that this specific personal and legal interest has been specially and injuriously affected by the [challenged action] . . . Aggrievement is established if there is a possibility, as distinguished from a certainty, that some legally protected interest . . . has been adversely affected." (Citations omitted; internal quotation marks omitted) AvalonBay Communities Inc. v. Orange, 256 Conn. 557, 567-68, 775 A.2d 284 (2001).
"The issue of standing implicates subject matter jurisdiction and is therefore a basis for granting a motion to dismiss. Practice Book § 10-31(a). It is the burden of the party who seeks the exercise of jurisdiction in his favor . . . clearly to allege facts demonstrating that he is a proper party to invoke judicial resolution of the dispute." May v. Coffey, supra, 291 Conn. 113.
ANALYSIS
A. The rules pertaining to shareholder derivative actions apply to LLCs.
In Connecticut, shareholders of a corporation are not permitted to bring a direct cause of action against the corporation or its directors for harm that is not separate and distinct from the harm suffered by the corporation itself or by shareholders collectively. See Yanow v. Teal Industries, Inc., 178 Conn. 262, 281-82, 422 A.2d 311 (1979). If the shareholder's injury is not separate and distinct from the harm suffered by other shareholders, then the shareholder is obligated to seek redress to the corporation by way of a shareholder derivative action. See Yanow v. Teal Industries, Inc., supra, 178 Conn. 281-82.
To bring a derivative action in Connecticut, the shareholder must fairly and adequately represent the interests of the shareholders similarly situated in enforcing the right(s) of the corporation. General Statutes § 52-572j. Although derivative suits are required if there is an injury to the corporation or shareholders collectively, if the injury is to the shareholder individually, the cause of action is personal and a derivative suit is not required. Id. In order to bring a personal or direct cause of action then, the plaintiff must sustain a loss separate and distinct from that of the corporation or from other shareholders, seeking redress for a wrong done to him individually. Fink v. Golenbock, 238 Conn. 183, 201, 680 A.2d 1243 (1996).
It is unclear whether the rule set forth in Yanow and Fink applies to LLCs. Because the parties' briefs did not directly address this question, the court ordered the parties to file supplemental briefs. Having now reviewed all of the pleadings and briefs, the court concludes that this rule does apply to limited liability companies.
At the outset, it is important to note that Connecticut's statute on derivative actions, § 52-572j, is silent with respect to the applicability of derivative actions to LLCs. The statute provides in relevant part: "Whenever any corporation or any unincorporated association fails to enforce a right which may properly be asserted by it, a derivative action may be brought by one or more shareholders or members to enforce the right, provided the shareholder or member was a shareholder or member at the time of the transaction of which he complained . . . The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association." General Statutes § 52-572j. This statute has not been amended since 1982.
In 1993, Connecticut passed the Connecticut Limited Liability Company Act ("CLLCA"). The CLLCA is also silent on the applicability of derivative actions to LLCs. On the other hand, the court and the parties have not been able to identify any Connecticut statue that prohibits the filing of a derivative action against a LLC.
The same policy justifications that underlie the rule requiring derivative actions against corporations if a shareholder's injury is not separate and distinct from other shareholders support the application of the rule to LLCs. The predominant policy justification behind the rule is that if the injury is to the corporation itself, any recovery should be shared by those affected, namely the corporation and shareholders. Thus, the rule ensures that any action brought for redress of such injuries is for the collective benefit of those injured by the wrongs committed. As one commentator has noted: "Primarily, the injury resulting from mismanagement or wrongful use of corporate property by corporate officers is to the corporation, and a suit for the damages suffered should be by the corporation rather than by the shareholders. However, if the officers refuse to sue, or a demand to sue is unnecessary, shareholders may sue in equity in their own names, for the benefit of the corporation, bringing suit on behalf of themselves and such other shareholders as may come in, and making the corporation and the guilty officers defendants. Such an action is in reality one brought on behalf of the corporation . . . The relief granted belongs to the corporation and not to the shareholder individually, and recovered money goes to the corporation." 3A W. Fletcher, Cyclopedia of the Law of Corporations (2008) § 1283.
Accordingly, one of the main functions of derivative actions is to allow for an individual shareholder to bring suit when corporate directors refuse to do so. But at the same time, derivative actions also make it harder for a shareholder to reap individual benefits for wrongs committed to the corporation because the recovery is for the corporation and shareholders collectively, not for the individual shareholder only. Therefore, if the shareholder chooses to bring suit for wrongs committed to the corporation, and their injuries are not separate and distinct, they have not only the right, but also an obligation to bring a derivative action. There is no functional or material difference between a corporation and a LLC that would justify treating the two entities differently with respect to the rule.
The New York Court of Appeals has also concluded that these policy justifications support extending the corporate rule to LLCs: "Substituting direct remedies of LLC members for the old fashion derivative suit . . . raises unanswered questions. Suppose, for example, a corporate fiduciary steals a hundred dollars . . . a liability [that] could be enforced in a suit by the LLC itself. Is the same fiduciary also liable to each injured LLC member in a direct suit for the member's share of the same money? What, if anything, is to be done to prevent double liability?" Tzolis v. Wolff, 10 N.Y.3d 100, 106, 884 N.E.2d 1005, 855 N.Y.S.2d 6 (2008).
Although there is no appellate authority in Connecticut directly addressing the applicability of derivative actions to LLCs, the Appellate Court in Wasko v. Fancy, 108 Conn.App. 156, 170, 947 A.2d 978 (2008), did hold that a member of a LLC may not bring an individual action for a wrong committed to the LLC or its members. In Wasko, the court noted that, "[a] limited liability company is a distinct legal entity whose existence is separate from its members . . . A limited liability company has the power to sue or be sued in its own name . . . A member may not sue in an individual capacity to recover for an injury the basis of which is a wrong to the limited liability company." (Citations omitted.) Id. If, under Wasko, a member may not sue individually for an injury to the LLC or its members, the need for a derivative action is virtually self-evident. Accordingly, the Wasko decision supports a conclusion that derivative actions are in fact available for members of an LLC, and in fact, may be absolutely necessary to provide a means to bring suit against the LLC or its other members for wrongs committed to the LLC itself or its members collectively.
Although a few Superior Court decisions have concluded that derivative actions may be brought against an LLC, these cases contain virtually no analysis. See Nawrot v. Daly, Superior Court, judicial district of Hartford, Docket No. CV 06 40265586 (February 25, 2009, Langenbach, J.); Connors v. Howe Elegant, LLC, Superior Court, judicial district of Ansonia-Milford, Docket No. CV 08 4003783 (January 8, 2009, Levin, J.)) [ 47 Conn. L. Rptr. 107]; Taurus Advisory Group, Inc. v. Sector Management, Inc., Superior Court, judicial district of Stamford-Norwalk at Stamford, Docket No. CV 96 0150830 (August 29, 1996, Lewis, J.) [ 17 Conn. L. Rptr. 496].
As noted above, New York agrees with this proposition. Like Connecticut, New York's statutes do not explicitly authorize derivative actions to be brought against members of an LLC. Despite the lack of statutory authority, the New York Court of Appeals held as a matter of common law that members of LLCs may sue derivatively. Tzolis v. Wolff, supra, 10 N.Y.3d 106. In Tzolis, the court held that, "it could hardly be argued that the mere absence of authorizing language in the Limited Liability Company law bars the courts from entertaining derivative suits by LLC members." Id., 106. The court found derivative actions to be a fundamental component of corporate law and that to refuse to extend them to LLCs would be unwise. See Id., 103. Derivative actions, "when meritorious, serve as an important deterrent against breaches of fiduciary duties by the directors of such corporations." (Internal quotation marks omitted.) Id., 107. This court agrees with the New York Court of Appeals that the absence of a statute authorizing derivative actions with respect to LLCs does not mean that such actions cannot be recognized as a matter of common law.
The plaintiff's additional arguments in support of its claim that derivative actions are inapplicable with respect to LLCs are not persuasive. First, the plaintiff argues that the Office of Legislative Research ("OLR") bill analysis for General Statutes §§ 34-100 to 34-242, which codifies the act authorizing the formation of LLCs in Connecticut, states: "[M]embers [of a LLC] may not file derivative suits unless permitted to do so by their operating agreement or by the appropriate vote of the members of managers." Office of Legislative Research, Bill Analysis for Substitute House Bill No. 6974. OLR analysis, however, is not competent evidence of any legislative intent to preclude or limit derivative actions with respect to LLCs. Harpaz v. Laidlaw Transit, Inc., 286 Conn. 102, 124 n. 15, 942 A.2d 396 (2008).
The plaintiff's final argument is that even if derivative suits are held to apply to a LLC, Yoshu had not yet been form as an LLC at the time of the events alleged in the complaint, and thus a derivative action would not be available. This argument also fails. Even if any of the alleged injuries arose before the date of incorporation of Yoshu, Yoshu would have existed as an unincorporated association. Section 52-572j explicitly authorizes derivative actions with respect to unincorporated associations. For the foregoing reasons, this court finds that derivative actions are, in fact, available for members of a LLC.
B. The plaintiff lacks standing to bring a direct action against the defendants.
In light of the court's conclusion that derivative actions are available to members of an LLC, the court now turns to the question of whether, in the context of this case, the plaintiff was obligated to bring the action as a derivative action rather than as a direct action. The court concludes that the plaintiff is obligated to bring these claims in a derivative action because the plaintiff has alleged injuries that are not separate and distinct from those suffered by the LLC or other members.
In order for the plaintiff to bring an individual action, the alleged injuries must be separate and distinct from those suffered by Yoshu. See Yanow v. Teal Industries, Inc., supra, 178 Conn. 282. The plaintiff alleged that the defendants usurped Yoshu's value and profits, and improperly used trade secrets, assets, and other proprietary information. All of these injuries, however, are to Yoshu itself and not to the plaintiff individually. Therefore, the injuries are not separate and distinct as required for an individual action.
This case is unlike Yanow v. Teal Industries, Inc., supra, 178 Conn. 282, in which the plaintiff's injuries were determined to be separate and distinct. In Yanow, the court permitted the plaintiff's direct action because he alleged that corporate officers' fraudulent conduct caused their stock to be worth more than his stock. Yanow v. Teal Industries, Inc., supra, 178 Conn. 281-82. Unlike Yanow, the plaintiff does not allege Gamble and Skehan engaged in fraud, or caused their percentage interest to be worth more than his percentage interest.
The present case is more factually similar to Smith v. Snyder, 267 Conn. 456, 839 A.2d 589 (2004), in which the Supreme Court held that plaintiff's alleged injuries were not separate and distinct, thus making a direct action improper. In Smith, the plaintiffs sued the director of the corporation, alleging he breached his fiduciary duty. Id., 459. The court held that the plaintiffs lacked standing to bring a personal cause of action because if the allegations in their complaint were true, it would demonstrate that the defendant's actions harmed the corporation itself, but not the plaintiffs individually. Id., 462.
Here, as in Smith, the plaintiff fails to allege an injury suffered by him that is separate and distinct from that suffered by Yoshu or any other member. The complaint alleges injuries to Yoshu involving the financial health of the LLC, the misuse of its assets, and the distribution of its trade secrets to the detriment to the LLC. As in Smith, the plaintiff's allegations, if proven, would demonstrate harm to Yoshu itself, and therefore derivatively, to all of the members' interests in Yoshu. Therefore, the plaintiff has not alleged injuries that are separate and distinct from those to Yoshu.
The plaintiff argues that he falls within an exception to this rule. In Fink v. Golenbock, supra, 238 Conn. 202, the Supreme Court carved out an exception to the general rule stating that "there may be some instances in which the facts of a case give rise either to a direct action or to a derivative action-such as when an act affects both the relationship of the particular shareholder to the corporation and the structure of the corporation itself, causing or threatening injury to the corporation." In a subsequent case, however, the court reiterated the narrowness of the Fink exception by holding that it did not apply if the predominant injury occurs to the corporation, and such injury simply affects the relationship of the shareholders to the corporation. May v. Coffey, supra, 291 Conn. 122.
The present case does not fit within the Fink exception because the alleged wrongful acts did not affect both the plaintiff's relationship to the LLC and the structure of the LLC. Rather the facts of this case fit more squarely with Coffey, that due to an injury to Yoshu itself — misuse of assets, violation of trade secrets, etc. — the plaintiff's interest in Yoshu was affected. Therefore, unlike Fink, the plaintiff did not have the option to bring either a derivative or an individual action. Instead, his sole option in this case is to bring a derivative suit.
Finally, plaintiff maintains that a derivative action is not required because, under § 52-572j, a derivative action may not be maintained if the "plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated." The plaintiff maintains that because he is a minority member of the LLC, his interests are in complete opposition to the other two members and therefore he cannot fairly and adequately represent their interests. The court is not persuaded. It is true that the two other members of the LLC, whose interests the plaintiff would be representing in the derivative action, are the two members whom he accuses of wrongdoing. This fact, however, does not mean that the plaintiff cannot adequately represent their interests because all members of the LLC will share in any monetary recovery that Yoshu may receive if the plaintiff prevailed in a derivative action. If B East and B Fare are held liable for usurping the value of Yoshu's brand, trade secrets, and menu concepts, then that recovery should belong to Yoshu, and its members will equally enjoy (according to their percentage interests) in those damages. Accordingly, the court concludes that the plaintiff would adequately represent the interests of the other members of Yoshu in a derivative action.
Because there is no separate and distinct injury alleged by the plaintiff that would warrant an individual rather than derivative suit, and he can fairly and adequately represent the interests of the other members of Yoshu, the plaintiff lacks standing to bring this individual cause of action.
CONCLUSION
For the foregoing reasons, the motion to dismiss is granted.