Suit Dismissed Where Member Lacked Authority to Initiate Same

Suit Dismissed Where Member Lacked Authority to Initiate Same

      In a recent decision from the U.S. District Court for Nevada, suit purported to have been brought on behalf of an LLC was dismissed on the basis that the member initiating the action lacked authority to being either a direct action in the LLC’s name or a derivative action.  Gashtili v. J.B. Carter Properties II, LLC, Case No. 2:12-CV-00815-MMD-PAL, consolidated with Case No. 2:12-CV-1156-MMD-PAL (D. Nev. April 23, 2013).

      Carter, a member of J.B. Carter Properties II, LLC, initiated a suit in the LLC’s name against Nashrollah Gashtili and Integrated Dynamics Solutions, Inc.  In response to a motion that all of the claims of Carter and the LLC should be dismissed for lack of capacity to bring same, the requested relief was granted.

      The Court began by citing what it described as “Hornbook law” that an individual member of an LLC “has no interest in specific LLC property, and only has standing to bring a derivative action.”  In this instance, the LLC, organized in Nevada, had no separate operating agreement, and as such was governed by the default rules of the Nevada LLC Act.  Thereunder, management of an LLC is vested in the members in proportion to their capital contributions as adjusted from time to time.  In order to bring suit on the LLC’s behalf against the defendant, Carter “had two options: (1) obtain approval for this lawsuit from [the] LLC’s members based on their proportional interest; or (2) bring a derivative lawsuit on behalf of the corporation (sic – LLC).”  Holding only 44% of the interest in the LLC, and not having acquired the approval of any other members to bring the lawsuit, Carter did not have authority to so act.  While the Nevada LLC Act provides for the bringing of derivative actions, there is a demand/utility requirement.  The complaint did not indicate either the demand had been made or why a demand would be futile.  As such:

Carter’s Complaint fails to plead facts sufficient to demonstrate that [the] LLC’s management brought this lawsuit on behalf of the corporation (sic – LLC) or that Carter satisfied the prerequisites for bringing this lawsuit as a derivative action.  Accordingly, the Complaint must be dismissed.

      Under the Kentucky LLC Act as adopted in 1994, KRS § 275.340 provided, inter alia, that a lawsuit could not be challenged on the basis that the party or parties initiating it lacked actual authority to do so.  This provision, as is made by clear to the comments to section 1102 of the Prototype LLC Act, upon which KRS § 275.340 is referenced, was intended to apply exclusively to suits between an LLC and a third-party.  The only time this provision was, however, applied by a Kentucky Court, it was used inter-se the LLC to avoid dismissal of the lawsuit brought by one member against another member when that suit was clearly barred by the controlling operating agreement.  In consequence thereto, KRS § 275.340 was deleted.  Still, while suit may be initiated by the LLC pursuant to KRS § 275.335, a third-party may question the authority of those bringing the suit, in which their capacity will be ascertained under general applicable rules.  While Kentucky’s LLC Act is silent as to derivative actions, such necessarily exists under the rules of equity, equity being incorporated expressly into the LLC Act.  See KRS § 275.003(1).