Notwithstanding Fiduciary Duties Amongst Members, Direct Suit Dismissed; Complaint Should Have Been Brought as a Derivative Action

Notwithstanding Fiduciary Duties Amongst Members, Direct Suit Dismissed; Complaint Should Have Been Brought as a Derivative Action

      In a recent decision from Connecticut, the court considered and applied the direct versus derivative distinction in a dispute between two equal members of an LLC.  Notwithstanding the fact that the two members of the LLC stood in a fiduciary relationship with one another, the court found that the plaintiff’s claims should have been brought as a derivative action on behalf of the LLC.  In that it had been brought as a direct action, the suit was dismissed.  Scarfo v. Snow, No. AC37794, 2016 WL 5037389, ___A.3d ___ (Conn. Ct. App. Sept. 27, 2016).

      Scarfo and Snow formed Cider Hill Associates, LLC as the vehicle through which to develop certain real property into a subdivision.  Snow devoted his full-time efforts to the development while Scarfo was passive.  Ultimately, the project was both over budget and a loss, an outcome no doubt facilitated by the Great Recession.  Ultimately, Scarfo sued Snow, alleging a variety of claims including breach of fiduciary duty.  

      On appeal, the parties were directed to submit supplemental briefings addressing “whether the plaintiff has standing to maintain this suit in his individual capacity.”  The court would find that, notwithstanding the fiduciary duties that might exist amongst members in LLC, the claims were derivative.  Rather, notwithstanding the fact that Snow pointed to specific provisions of the operating agreement that he says were violated:

We conclude that the plaintiff did not have standing in his individual capacity to maintain his various causes of action and that the trial court should have dismissed his case.

       In support of this determination, the court relied upon the fact that an LLC is legally distinct from its members and that, like a corporation, a derivative action is the proper means for redressing injury to the entity.

In the present case, the plaintiff brought a direct action against the only other member of Cider Hill, again Cider Hill itself, and against other companies in which Snow had an interest.  He alleges various causes of action flowing from an alleged breach of fiduciary type duty and a breach of the amended operating agreement, which was signed by the plaintiff and Snow.

….

The plaintiff contends that Snow essentially mismanaged the Evergreen Project.  Although the plaintiff contends that he suffered direct injury by the alleged action or inaction of Snow, any benefit he would have received from the Evergreen Project, were it not for the alleged improprieties of Snow, would have flowed to him only through Cider Hill, first benefiting Cider Hill.  Accordingly, if there was an injury, that injury was sustained by Cider Hill and then sustained by the plaintiff.  Thus, the plaintiff’s injury is not direct, and he has no standing to sue in his individual capacity.

….

The form of the judgment is improper, the judgment is reversed, and the case is remanded with direction to dismiss the case for lack of subject matter jurisdiction.