Arizona Court of Appeals Considers Direct Versus Derivative Distinction in LLCs and the Demand Requirement

Arizona Court of Appeals Considers Direct Versus Derivative Distinction

in LLCs and the Demand Requirement

      In a recent decision, the Arizona Court of Appeals parsed a complaint filed by a member of an LLC as to whether particular allegations were direct or derivative in nature and, as to the derivative claims, whether there had been demand made before the derivative action was brought.  The court has well addressed the capacity of a dissolved LLC to prosecute suit for collecting assets as part of its winding up.  Rose Goodyear Properties, LLC, v. NBA Enterprises Limited Partnership, No. 1 CA-CV 12-0484, 2014 WL 443 (Ariz. App. Aug. 5, 2014).

      Able Commercial Ventures was formed as an LLC by Rose Goodyear Properties, NBA Enterprises and Hohokam Acres for the purpose of developing certain real estate.  The manager was Civica Development, LLC (the opinion is unclear as to the relationship of Civica to any of the members).  Able borrowed $2 million dollars secured by its property, and loaned those funds to Hohokam and NBA.  Able then defaulted on that loan.  The property was sold for just over $1 million dollars, and Able was sued for the deficiency exceeding a million dollars.

      Consequent to certain disputes whose nature is not identified in the opinion, NBA and Hohokam caused Civica to be removed as the manager.  In turn, they formed a new LLC, Hamba, and appointed it as the LLC’s manager.  Thereafter, Rose filed its complaint alleging a variety of claims against NBA, Hohokam and Hamba.  

      At some unidentified point in the dispute, Rose underwent an administrative dissolution. Although it was apparently reinstated, the opinion focused upon its capacity to act notwithstanding reinstatement. Responding to the allegation that Rose did not have the capacity to bring either direct or derivative claims because of its dissolution, the Arizona Court of Appeals interpreted the LLC Act and specifically the provision allowing a dissolved LLC to do “all other acts required to liquidate its business and affairs” as being sufficiently broad to allow a dissolved entity to bring suit by which it may collect its assets.

• This guidance is useful in Kentucky which, at KRS § 275.300(2)(e), authorizes a dissolved LLC to do “every other act necessary to wind up and liquidate its business and affairs.”  That said, likely this guidance is not necessary in Kentucky as KRS § 275.300(4)(a) provides that dissolution of an LLC shall not “Prevent commencement of a proceeding by or against a limited liability company in its name.”

      Turning to the derivative claims, the primary issue was whether there is been sufficient demand made upon the manager of Able prior to the bringing of the derivative action.  Note that the Arizona LLC Act contains an express provision on derivative actions, including a requirement that before bringing a derivative action a demand be made. Ariz. Stat. § 29-831(2).  In this instance, the letter upon which Rose relied nowhere demanded that Hamba cause the LLC to bring suit. Rather, the relied upon letter was merely a recitation of Rose's position as to certain matters.  Another letter meeting the demand requirements that was submitted after the complaint was filed was found to be insufficient, the statute requiring that the demand letter be tendered prior to the time the derivative action is brought. On that basis, the dismissal of the derivative aspects of the complaint was affirmed.

      The Court of Appeals did reverse the trial court as to certain counts brought in the complaint on the basis that these were direct, and not derivative, claims. Specifically, allegations based upon breach of fiduciary duty by NBA and Hohokam, the refusal to arbitrate a claim for breach of contract and for violation of the implied covenant of good faith and fair dealing (the implied covenant claim being cast as well as a tort) were found to constitute direct, not derivative, claims that should not have been dismissed for failure to satisfy the demand requirement for bringing a derivative action.