New Jersey LLC Derivative Lawsuits: Do I Have Standing To Sue?

Imagine this scenario. You are a member of a New Jersey Limited Liability Company and discover that your partner has been embezzling from the company and binding it to unfavorable contracts without your knowledge or consent. Do you have standing to file a lawsuit to recover damages against your partner on behalf of the LLC or to challenge the contracts that he bound the company to?  Without derivative standing, you cannot individually file these claims against your partner because they are direct causes of action belonging to the LLC.

As a general matter, standing “refers to the plaintiff’s ability or entitlement to maintain an action before the court.” New Jersey Citizen Action v. Riveria Motel Corp., 296 N.J. Super. 402, 409 (App. Div.), certif. granted, 152 N.J. 13 (1997), and appeal dismissed as moot, 152 N.J. 361 (1998). “Entitlement to sue requires a sufficient stake and real adverseness with respect to the subject matter of the litigation.” In re Adoption of Baby T, 160 N.J. 332 (1999) (citing Crescent Park Tenants Ass’n v. Realty Equities Corp., 58 N.J. 98, 107 (1971)).  For the purposes of standing, a substantial likelihood of some harm visited upon the plaintiff in the event of an unfavorable decision is needed. See Home Builders League of South Jersey, Inc. v. Berlin Tp., 81 N.J. 127, 134-135 (1979). If a plaintiff lacks standing, the court is precluded from considering any of the substantive issues presented for determination. See Watkins v. Resorts Int’l Hotel and Casino, 124 N.J. 398, 424 (1991).

While courts recognize that limited liability companies and corporations share the attribute of limited liability, they are seen in the eyes of the law as distinct legal entities with different characteristics to satisfy different policy goals. See e.g. Mariner’s Bank v. 4921 Bergenline Corp., 2014 N.J. Super. Unpub. LEXIS 120, at *11-15 (App. Div. Jan. 23, 2014). Consequently, courts should not “mechanistically import principles of law governing corporations to the law governing limited liability companies.” Id. (citing Steven C. Bahls, Application of Corporate Common Law Doctrines to Limited Liability Companies, 55 Mont. L. Rev. 43, 90-91 (1994)).   That being said, courts recognize that the law of corporations is instructive in numerous contexts relevant to limited liability companies. Id. (citing Elf Atochem N. Am., Inc. v. Jaffari, 727 A.2d 286, 293-94 (Del. 1999) (applying corporate law to determination of whether a lawsuit against an LLC was derivative or direct because the “derivative suit is a corporate concept grafted onto the limited liability company form”).

New Jersey’s Revised Uniform Limited Liability Company Act (the “LLC Act”) restricts the ability of an LLC member from asserting claims that belong to the LLC.  Specifically, the LLC Act provides that a member may “maintain a derivative action to enforce a right a limited liability company” – that is, in the company’s favor – only if “the member first makes a demand on the other members in a member-managed limited liability company . . . requesting that they cause the company to bring an action to enforce the right, and the managers or other members do not bring the action within a reasonable time” or if they establish that a demand “would be futile.” See N.J.S.A. § 42:2C-68. The LLC Act’s provisions for standing are similar to corporation law, which restricts a corporation’s shareholder from asserting claims of the corporation. See Pepe v. Gen. Motors Acceptance Corp., 254 N.J. Super. 662, 666 (App. Div.), certif. denied, 130 N.J. 11, (1992) (“shareholders cannot sue for injuries arising from the diminution in value of their shareholdings resulting from wrongs allegedly done to their corporations.  Nor can stockholders assert individual claims for . . . other income lost because of injuries assertedly done to their corporations.”). In a derivative action, the complaint shall state with particularity: (1) the date and content of plaintiff’s demand and the response to the demand by the managers or other members; or (2) if a demand has not been made, the reasons a demand would be futile. See N.J.S.A. § 42:2C-70.   “Implicit in these provisions of the LLC Act is that a member of a limited liability company may not bring an action in his or her own name, to redress wrongs to the company, even if the member indirectly suffers harm as a result.” Mariner’s, supra, 2014 N.J. Super. Unpub. LEXIS 120 at *11-15. To assert a claim in his or her own name against another member, a manager, or the limited liability company to enforce the member’s rights and otherwise protect the member’s interests, the member must plead and prove “an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the limited liability company.” See N.J.S.A. § 42:2C-67.

A court, in its discretion, may “dispense with adherence to the requirements of a derivative action in cases involving closely-held corporations.” Brown v. Brown, 323 N.J. Super. 30, 36-37 (App. Div.), certif. denied, 162 N.J. 199 (1999)). The court may do so “’if it finds that [it] will not (i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons.” Id. at 36 (quoting American Law Institute, Principles of Corporate Governance: Analysis and Recommendations § 7.01(d) (1992)).

Based on the foregoing, an LLC member risks dismissal of their complaint if they file a lawsuit to redress wrongs to their company in their capacity as a member, even if they are indirectly suffering harm as a result. As such, it is critical that a member establish derivative standing before filing such an action.

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