Financing Fiduciary Litigation

     posted by Gary Rosin

In Authority and Deadlock, I discussed Maitland v. Int'l Registries, LLC, C.A. No. 3669-CC (Del. Ch. June 6, 2008).  Maitland involved a dispute between partners in a two-partner firm, in which the Court held that one partner had no authority to use firm resources to finance his end of the ensuing lawsuit.  The Maitland court used deadlock as the basis of denying the partner authority to act on behalf of the firm.

Peter Mahler (NY Business Divorce blog) pointed me to some similar recent decisions in New York, including Caplash v Rochester Oral & Maxillofacial Surgery Assoc., LLC.  2008 NY Slip Op. 51056(U) (N.Y. Sup. Ct. May 12, 2008)(as corrected, May 29, 2008).  Caplash is a long-running dispute between the only two members of an LLC (see Mahler's most-recent post, Caplash Redux: 50% Member Cannot Hire Lawyer to Represent LLC in Dispute with Other 50% Member).  In Caplash, the LLC was found to be manager-managed, with "plenary" authority given to its "'President".  Id. at *3-4.  Despite this, the court held that one member, even the LLC's president,

...had no authority to hire counsel for ROMSA for the purpose of prosecuting in the LLC's name an action against a co-equal 50% member; the sole remedy was the derivative suit he instituted by way of his own counterclaim. See Stone v. Frederick, 245 AD2d 742, 744-45 (3d Dept. 1997)(collecting authorities), discussed in Hellman, supra, slip opn. at 12.  * * * Drawing an analogy from the partnership context, "[s]ince this is a dispute between partners over the interpretation of the rights and obligations under the partnership agreement, it is not a proceeding by or against the partnership [citation omitted], even though the partnership is made a nominal party plaintiff." Tesco Properties, Inc. v. Troy Rehabilitation and Insp. Project, Inc., 166 AD2d 839, 841 (3d Dept. 1990).

Id. at *8-*9.  Thus, both members could use only personal resources in connection with the dispute.

Taken together, Maitland and Caplash suggest that inter-owner disputes in UBEs should remain just that--disputes between the owners--with no owner having the advantage of tapping firm resources to finance the dispute.  That seems a most reasonable proposition, particularly in two-owner firms.  For that matter, that same principle ought to apply to disputes among the owners of small firms that with more owners.  Arguably, Larry Ribstein's recent SSRN working paper, Reforming Limited Liability Company Fiduciary Litigation (abstract also posted on his blog as Down with LLC derivative suits), is on the same wavelength.  Given the strong entity rhetoric of the day, I doubt that will be the case.  It will be interesting to watch this develop.