Faculty Publications

Every state authorizes shareholder derivative litigation, and the vast majority extend this remedy to LLCs and limited partnerships. As the availability and incidence of derivative litigation has expanded over time, a number of procedural hurdles have evolved in an effort to limit nuisance or strike suits. The theory is that these strike suits are brought by small shareholders, and the need to post a bond may deter these shareholders from bringing these suits. As part of this effort, some states have enacted “security for expense” provisions, requiring owners to post a bond to cover the defendants’ expenses before they can proceed with their suit. A few state have also enacted such provisions for derivative suit by LLC members and/or limited partners.

The quintessential derivative suit is a suit by a shareholder to force the corporation to sue a manager for fraud, which is admittedly an awkward and likely unpleasant endeavor and, according to the Supreme Court, a "remedy born of stockholder helplessness."* Where ownership and control of an enterprise are vested in the same population, the need for a corrective mechanism like a derivative suit is greatly lessened because the owner/managers' self-interests will arguably guide managerial conduct. But where ownership and control are in separate hands, the incentives change, and managerial conduct may not conform to the owners' views of the best course of action.

Twenty years ago, the New York Limited Liability Company Law was enacted, including § 609(a), which explicitly disclaims liability of members, managers, and agents for the debts and obligations of the LLC. However, New York courts have held that this limitation on liability is not absolute, and certain conduct on the part of the owners can erode the liability shield. The statute provides that the members will not have personal liability for LLC debts solely because of their role as owners in the LLC. The statute does not say that members will never have liability, just that any liability will not be as a result of their owner status, leaving open the question of when members will be liable for debts of the LLC.