Opinion
18929/08.
Decided August 24, 2009.
Steven D. Hurd, Esq., Proskauer Rose LLP, New York, NY, Attorney for Defendants.
Alan C. Trachtman, Esq., Nourse Bowles, LLP, New York, NY, Attorney for Plaintiffs.
The instant action, framed as a derivative suit, accuses the individual defendants, who together own 100% of defendant Massey Knakel Realty Holdings LLC (Holdings), the managing member of the subject Company, Massey Knakal Realty of Brooklyn, LLC (MKRB or the Company), of "acts of self-dealing, waste, breach of fiduciary duty of loyalty and misappropriation" in transferring funds of the Company to affiliates and to themselves as loans (Complaint, Paragraph 20). Numerous alleged violations of law are also claimed to have placed the Company at risk. Plaintiff is a 10% owner of the Company, a real estate brokerage based in Brooklyn. Defendants Massey and Knakal, through their ownership of Holdings, own 70% of the Company. In addition to plaintiff, five other individuals own minority interests in the Company. Both the Company and Holdings were formed on August 29, 2002 as Delaware Limited Liability Companies. On August 29, 2002, an operating agreement was entered in to by plaintiff, Holdings as the managing member, Thomas Donovan and John Ciraulo. The operating agreement was amended in March 2004 to add members James Ventura and Christy Moyle, and, in January, 2005, to add member Brian Leary.
Upon joining MKRB in September, 2002, plaintiff executed a service agreement with the Company, pursuant to which, he became the manager of the day-to-day operation of MKRB, which is an affiliate of a larger umbrella entity controlled by defendants, "Massey Knakal Realty Services", based in Manhattan. Late in 2004, plaintiff was promoted to be Chief Operating Officer (COO) for the entire Massey Knakal Realty enterprise and was directly involved in management meetings relating to all of the city-wide affiliates. However, in 2006, defendants, who, as sole members of Holdings which, as managing member, under the terms of the operating agreement, has exclusive and nearly unfettered control of the Company, determined that plaintiff was not performing as required and directed him to take a paid leave of absence. Following plaintiff's return as co-manager of MKRB, defendants continued to be dissatisfied with plaintiff, finding that his professional interests did not conform to their business model, and, on February 26, 2008, defendants terminated plaintiff without cause.
The controlling Second Amended and Restated Limited Liability Company Agreement dated January 1, 2005 ("Operating Agreement") provides that, upon the termination of employment of any member who is a natural person, that member must sell to the managing member his or her entire membership interest within 90 days for Fair Market Value, to be determined by the accounting firm of Bonfiglio Associates "in its sole good faith judgment" (Operating Agreement, Section 8.3B, G). Applying the formula set forth in the Operating Agreement, by letter dated July 29, 2008, Bonfiglio Associates provided to Holdings, the valuation of plaintiff's interest at $7,771,646. This figure has not been accepted by plaintiff and negotiation has ensued. Defendants contend that the sole purpose of the instant derivative suit is to put pressure on them to improve their buy-out offer. Such contention has not been denied by plaintiff, but, nonetheless, plaintiff contends that defendants, as the sole constituent members of the Company's managing member, have breached their fiduciary duty to the Company and all of the minority members thereof. It is well-established, under both New York and Delaware law (the Operating Agreement, Section 10.6, provides that it "shall be governed by and construed in accordance with the laws of the State of Delaware"), that a managing member owes a fiduciary duty to the non-managing members of an LLC, the breach of which may be addressed through a derivative action. Tzolis v. Wolff , 10 NY3d 100 , 104-105 (2008); cf. Douzinas v. American Bureau of Shipping, Inc., 888 A.2d 1146 (Del. Chancery, 2006); 6 Del. C. § 18-1001.
During the pendency of this matter, this Court has sought to facilitate a resolution between the parties, deferring action upon open Orders to Show Cause seeking a preliminary injunction and, subsequently, seeking punishment for contempt, with the consent of the parties. The dispute was mediated through JAMS by a most distinguished former member of this bench, but to no avail. Defendant has cross-moved to dismiss upon several grounds and to compel arbitration. It is noted that, although defendants' contention that some of the relief requested by plaintiff, specifically the demand for an audited accounting of financial statements which is to be provided pursuant to the Operating Agreement, would not be appropriate in a derivative action, is correct (see Tooley v. Donaldson, Lufkin Jenrette, Inc., 845 A. 2d 1031 (2003)), this Court directed the production of such records as interim relief in the hope that such information would facilitate a settlement. As much of the requested information has been provided, defendants' motion insofar as predicated on that ground, has been rendered moot.
At oral argument on July 13, from the bench, and for reasons stated on the record, the Court denied plaintiff's motion for a preliminary injunction and vacated a temporary restraining order, finding that plaintiff had failed to demonstrate a sufficient likelihood of success on the merits, a reasonable risk of irreparable harm and that the equities were balanced in his favor to justify such relief. Plaintiff's motion for contempt was denied as meritless in light of defendants' substantial compliance with the prior directives of the Court. The Court further ruled that plaintiff had met his burden to demonstrate that a demand upon the managing member to prosecute his complaints would be futile in light of the allegations ( London v. Tyrrell, 2008 Del. Ch. LEXIS 75 [demand excused where director stands on both sides of the challenged transaction]; Aronson v. Lewis, 473 A.2d 805 (Del Sup Ct 1984) [where managing authority is not disinterested, demand deemed futile]), and that the contention that plaintiff is not an appropriate representative for the interests of the Company was not supported by competent proof. The Court reserved decision on the defendants' motion to compel arbitration. That motion is now granted.
Section 10.6 of the Operating Agreement provides: "Any and all disputes arising out of or relating to this Agreement shall be resolved by arbitration." In moving for an order compelling arbitration of this derivative action, defendants rely upon Elf Atochem North America, Inc., 727 A.2d 286 (Del Sup Ct 1999). In contending that the derivative claims set forth in the complaint "fall outside the operating agreement" and are therefore not subject to the contractual arbitration provision contained therein, plaintiff relies on Parfi Holding AB v. Mirror Image Internet, Inc., 817 A.2d 149 (Del Sup Ct, 2002), in which the claims of minority shareholders of a breach of fiduciary duty were held not to be within the scope of the contract which contained the arbitration clause and therefore not subject to arbitration. In contrast, in Elf Atochem, the court found the contractual arbitration provision to be binding upon the corporation and directed arbitration of a derivative claim based upon the language contained in the operating agreement prohibiting the commencement of any action "based upon any claim arising out of or related to this Agreement". Fortunately for this court, any apparent inconsistency in these two cases has been explained and reconciled in Douzinas, 888A.2d 1146.
In Douzinas, Vice Chancellor Strine explained that the corporate, as opposed to "alternative entity"(LLC) structure was critical to the decision to direct arbitration of the derivative claims. Parfi involved a corporation. The contract which contained the arbitration provision was an underwriting agreement document entered between the corporation and third parties which would not be binding on all individual shareholders seeking to protect their interests as shareholders against the breach of fiduciary duty by corporate management in the derivative suit. In contrast, Elf Atochem involved an LLC in which, as here, the contractual arbitration provision was set forth in the operating agreement which was binding on all members. The operating agreement also defined the rights and obligations of the members and the managing member such that any claim of a breach of duty would also implicate the terms of the operating agreement itself. Thus, a claim of a breach of fiduciary duty to an LLC is inherently a breach of contract cause of action as among the members of the LLC and is properly resolved in arbitration where the operating agreement contains an arbitration provision.
Accordingly, whereas the policy of the State of Delaware, like that of the State of New York, strongly favors arbitration and advocates the enforcement of contractual agreements to arbitrate ( Wilcox Fetzer, Ltd., v Corbett Wilcox, 2006 WL 2473665 [Del. Ch. Aug. 22, 2006]["[D]oubts concerning arbitrability should be resolved in favor of arbitrability when a reasonable interpretation in that direction exists'." quoting Ishimaru v Fung, 2005 WL 2899680, at *13 [Del. Ch. Oct. 26, 2005]), and the language of the provision at bar essentially tracks the language of the provision in Elf Atochem and Douzinas, the motion to compel arbitration is granted and the parties shall proceed to arbitrate in New York in accordance with the Commercial Arbitration Rules of the American Arbitration Association in conformity with section 10.6 of the Operating Agreement.
This constitutes the decision and order of the court.