Waiver of Derivative Actions for Unincorporated Entities

In the New York Business Divorce blog, Peter Mahler analyzes recent New York case law concerning a waiver of the right of a member of an LLC to maintain a derivative action on behalf of the company.

As Mahler notes, such a provision would be unenforceable in Delaware under Del. C. § 18-109(d), for well-settled reasons: 

The question lurking in the background but not decided in Univest, whether an LLC member’s common-law right under Tzolis to bring a derivative action can be waived ex ante, to my knowledge has not been decided by any New York court. In Delaware, where the right to sue derivatively exists by statute, any such waiver is prohibited by Section 18-109(d) of the LLC Act. Last year, writing on his Kentucky Business Entity Law blog, Tom Rutledge expressed concern over dicta in a decision by the Kentucky Court of Appeals in which the court noted in passing the trial court’s determination that a non-managing LLC member lacked authority to maintain a derivative action based on the operating agreement’s provision barring any action on the LLC’s behalf without the manager’s consent.

But in states without such a statutory restriction, like New York, the question is unresolved. Mahler concludes:

It bears emphasizing that in both Univest and the Gorbrook case mentioned above, the derivative eviction proceedings were aimed at tenants who had close affiliations with the LLC’s controller. It could be argued that under those circumstances, as Justice Walker noted, the demand requirement (and its exceptions) adequately protect the legal and equitable interests of all parties and the LLC, without unduly interfering with the fiduciary-infused exercise of management rights. Query, however, whether the demand requirement adequately protects the LLC and management rights from derivative litigation against unaffiliated tenants (or other third parties), where the damage is done the moment the suit is brought whether or not it survives the pleading stage, and where a waiver provision might provide the quickest path to dismissal. For instance, would a court enforce a waiver provision in the operating agreement of a realty company prohibiting a non-managing member from bringing a derivative action against unaffiliated (however defined) tenants? Perhaps, as lawyers who draft operating agreements continue to push the LLC freedom-of-contract envelope, such questions will be the subject of future litigation and a future post on this blog.

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