A few weeks ago, a Florida appellate court clarified what it described as a complicated and confusing legal issue that has become increasingly prevalent with the growing popularity of LLC’s: the question of when a member of an LLC can sue a fellow member directly instead of having to sue derivatively on behalf of the LLC. The distinction is an important one, as any recovery in a derivative suit is realized by the LLC rather than the individual member.
The case, Dinuro Investments, LLC v. Felisberto Figueira Camacho, involved a real estate development LLC, San Remo, comprised of three members. After San Remo fell behind on certain real estate loans, the bank required its members to make additional capital contributions to San Remo as a condition of modifying the loans. Two of the members did so. The other, Dinuro Investments, did not. After San Remo defaulted, the two paying members formed a new entity that purchased the promissory notes from the bank and subsequently foreclosed on San Remo’s properties. As a result, the two paying members of San Remo took title to San Remo’s properties through their new entity, leaving Dinuro with no ownership interest in the properties and San Remo without assets. Dinuro sued the other two members, alleging that they intentionally allowed San Remo to default so they could purchase the loans at a discount and foreclose on San Remo’s properties, leaving San Remo (and Dinuro’s investment therein) worthless. The court framed the question as follows: “When can an action alleging damages resulting from membership in an LLC be brought directly in an individual suit?”
The court surveyed the case law from around the country and identified three approaches that courts commonly employed: the “direct harm” test, the “special injury” test, and the “duty owed” test. Under the first approach, the court considers whether the alleged wrongful conduct devalued the company as a whole or was directed specifically towards the individual member. Under the second approach, the court determines whether the individual member’s alleged injury is substantially different than those suffered by the other members. The third approach involves an examination of the applicable statute and contractual terms to determine whether the duty at issue was owed to the individual member or to the LLC generally.
After explaining that Florida courts had not followed any particular approach, and instead had seemingly confused the various approaches and decided cases inconsistently, the court settled on the following standard: A member may bring an action directly against a fellow member only if (1) there is a direct harm to the member such that the injury does not flow from an initial harm to the company, and (2) the member suffers an injury separate and distinct from the injuries sustained by the other members. In effectively adopting two of the aforementioned three approaches and requiring a member to satisfy both in order to sue directly, the court has signaled that individual members frequently will be unable to pursue claims against their fellow members directly.
There is an important exception, however: Even if a member cannot satisfy the foregoing test, it can still bring its claim directly against any other members that owed a separate duty to that member, either because of the applicable statute or because of the operating agreement. In Dinuro’s case, it could not allege a direct harm because its injuries were merely the result of the total devaluation of San Remo. Nor could Dinuro rely on the exception that would allow it nonetheless to sue its fellow members directly, because nothing in the operating agreement provided that the other members owed a duty directly to Dinuro or that the members could be liable to one another for breaches of the agreement. As a result, Dinuro could not sue its fellow members directly.
This new rule underscores the importance of the LLC’s operating agreement, which affords the LLC’s members the flexibility to set their respective obligations. As the court noted, many operating agreements do not specify who owes a particular duty, and to whom that duty is owed. Members are generally free to decide that each individual member owes duties only to the LLC, and not to the other members.
Importantly, the court did not have an opportunity in this case to decide whether a member can bring a direct claim against a managing member (or manager) for breaching its statutory duties of loyalty and care. Under Section 608.4225(1), Florida Statutes, the managing member or manager owes these duties not only to the LLC but to all of its members. Moreover, Section 608.423(2) provides that the operating agreement may not unreasonably reduce or restrict these duties. The same is true under Sections 605.04091(1) and 605.0105 of the Revised LLC Act, which already applies to any LLC formed on or after January 1, 2014 and which will govern all LLC’s as of January 1, 2015. Thus, notwithstanding the operating agreement, it is likely that a member will be allowed to sue a manager directly for breaching the manager’s statutory duties.