Academic journal article The Review of Litigation

May a Member of an LLC or a Limited Partner Bring a Breach of Fiduciary Duty Claim against Those Controlling the LLC or Partnership as a Diversity Action?

Academic journal article The Review of Litigation

May a Member of an LLC or a Limited Partner Bring a Breach of Fiduciary Duty Claim against Those Controlling the LLC or Partnership as a Diversity Action?

Article excerpt

I. THE ISSUE

What are your client's alternatives if he invests in an LLC that operates a restaurant, and shortly thereafter, the managing member of the LLC takes all the equipment purchased with these funds, transfers it to a different business, and effectively locks your client out of the business in which he had invested?1 What would you do if you and several partners of your New York law firm invested in a real-estate development in North Carolina and later found that the general partner had absconded with all the funds?2 Assuming that there is diversity between you (or your client) and those who had misappropriated the funds, could a claim be brought in federal court based on diversity jurisdiction?

A general partner or an LLC manager may breach a duty of loyalty, for example, by (1) paying himself payments to which he was not entitled, (2) selling business assets to himself or an affiliate for less than fair market value, (3) making sweetheart deals with his affiliates, (4) using firm assets as security for personal loans, (5) paying himself an improperly high price when selling assets to the entity, or (6) failing to properly disclose information about the business. The manager or partner likewise may breach a duty of care by (1) failing to monitor the operations of the business, (2) mismanaging funds, (3) failing to perform obligations imposed in the partnership or operating agreement, or (4) failing to properly investigate a business opportunity. Assuming diversity exists between the investor and the wrongdoer, may the investor bring an action in federal court based on diversity jurisdiction?

If an LLC member or limited partner brings her breach of fiduciary duty suit in federal court based on diversity jurisdiction, the plaintiff will face a serious obstacle. Often the court will conclude that either because the claim is derivative in nature, or because the provisions of Rule 19 of the Federal Rules of Civil Procedure so require, the LLC or partnership should be joined as a "necessary" party. Unless the court is then willing to decide that, although "necessary," the entity is "dispensable," the action must be dismissed.3 Joinder of the partnership or LLC automatically will destroy diversity. This article explores whether the LLC or partnership should be deemed either "necessary" or "indispensable" when a member or partner brings a claim for breach of fiduciary duty. It explores those cases that have applied the provisions of Rule 19 of the Federal Rules of Civil Procedure in determining whether the "entity" is itself a necessary or indispensable party. Most of the authorities considered in this article involve a closely held business;4 however, the principles discussed herein may apply more broadly to almost any LLC or limited partnership.

Although a primary focus of this article is whether members of an LLC have the ability to bring actions in federal court, many of the authorities considered in this article involve limited partnerships. Although the limited partnership and the LLC have obvious differences, for purposes of determining whether the entity is either necessary or indispensable, the two often, if not always, have the identical features that will determine whether the entity is a required party in disputes alleging breach of fiduciary duty by those in control of the business.5 The Delaware Supreme Court has noted that, in many respects, the LLC is very similar to the limited partnership.6 However, most states permit LLC members to configure the structure of their LLC to more directly resemble a corporation.7

II. MECHANICS AND THE EFFECT OF JOINDER OF THE LLC OR PARTNERSHIP

If the LLC or partnership, as an entity, is required to be joined, it will initially be joined as a defendant,8 but it may be realigned for diversity purposes as a plaintiff. In bringing a claim against the general partner, the plaintiff also may join the other limited partners or LLC members as nominal defendants,9 and, as is discussed in this article, it often is critical that he do so. …

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