Lio v Mingyi Zhong
Annotate this CaseDecided on January 6, 2006
Supreme Court, New York County
DOMINICK LIO, Plaintiff,
against
MINGYI ZHONG, ROBERT KASWELL, WILLIAM DEMPSEY and MITCHELL R. SCHRAGE & ASSOCIATES, LLC, Defendants.
600455/05
Judith J. Gische, J.
Defendants Mingyi Zhong ("Zhong") and William Dempsey ("Dempsey") have brought a pre-answer motion to dismiss the amended complaint (mot. seq. No.1). Defendant Robert Kaswell ("Kaswell") has cross moved for the same relief as to him. Defendant Mitchell R. Schrage & Associates, LLC ("Schrage") has separately moved to dismiss the amended complaint (mot. seq. #
2). Zhong, Kaswell and Dempsey alternatively ask that if any part of the complaint survives, that the action be transferred to Westchester County. By short form order, dated October 27, 2005, this court consolidated the two motions and cross-motion for disposition.
It is black letter law that when considering a motion to dismiss, the court is required to [*2]presume the truth of all allegations contained in the challenged pleadings and resolve all inferences which may reasonably flow therefrom in favor of the non-movant. Cron v. Hargro Fabrics, Inc., 91 NY2d 362 (1998); Sanders v. Winship, 57 NY2d 391 (1982). The sole criterion is whether the pleading states a cause of action, and if from its four corners factual allegations are discerned which when taken together manifest any cause of action cognizable at law, the motion for dismissal will fail. The courts inquiry is whether the plaintiff has a cause of action, not whether he has stated one. Guggenheimer v. Ginzberg, 43 NY2d 268 (1977).
Briefly stated the allegations in the complaint are as follows:
Plaintiff Lio (sometimes "Lio") and defendants Zhong and Kaswell formed a New York Limited Liability Company known as 80 Water View ("Water View"). Articles of Organization were filed and an Operating Agreement was signed. Each member has a
33 1/3% interest in Water View and each made an initial capital contribution of $500,000. According to the Operating Agreement, Water View's stated business purpose is to: acquire real property located at 80 Main Street in Ossining New York, enter into a construction agreement with DPMP (Lio's construction company) to construct a condominium comprised of 26 units; market and sell the units and to engage, in any, and all activities which are necessary, convenient, desirable or incidental to accomplish the foregoing. Under the operating agreement, the "powers of the company" include general powers to acquire real property as may be "necessary, convenient or incidental" to the purpose of the company. [Operating Agreement Section 2.4 (ii)].
Plaintiff Lio alleges that at all relevant times defendant Schrage acted as Water View's attorney and the 80 Main Street property was acquired. Defendant Dempsey, who is also Zhong's spouse, was then hired as the construction manager of the Water View project. There was never any written agreement with Dempsey.
A short time later, Water View began negotiating to purchase a second near by parcel of real property located at 121 Main Street in Ossining ("121 Main Street"), New York. Lio alleges that the purchase of such property was to facilitate the construction and sale of condominium units at 80 Main Street. Lio claims that Dempsey, without authorization, attempted to renegotiate the terms of the agreement to purchase 121 Main Street, which caused the deal to fail. Lio claims that defendants, or any one of them, thereafter, purchased 121 Main Street in their own right or through a nominee.
Relations between Water Views' members became increasingly strained. This resulted in a series of meetings, in which Dempsey resigned and then sought to again act as construction manager of the project. As part of those meetings and in subsequent communications Zhong and Kaswell negotiated to sell their membership interest in Water View to Lio. Zhong attempted to resign from the LLC. No buy out agreement was ever reached and the LLC was never dissolved or reconstituted.[FN1] During these failed negotiations, attorney Schrage represented Zhong personally.
Lio also alleges that during this time Zhong and Kaswell began taking actions on behalf of Water View without his consent, and contrary to his personal financial interests in the LLC. Among other things, he claims that they improperly made capital calls and then misstated his [*3]capital account. Lio claims that wasteful payments were made, including payments to attorney Schrage. He claims that Zhong and Kaswell refused to give him a survey for the 80 Main Street property. Lio claims that attorney Schrage also improperly withheld the property survey from him. Lio claims further that Zhong and Kaswell improperly told architects and governmental agencies that he had no authority to make decisions on the Water View project. He claims as well that defendant Zhong hired Water View employees as her own.
Plaintiff Lio has asserted seven causes of action. The first cause of action is for breach of fiduciary duty and is asserted against defendants Zhong and Kaswell only. The second cause of action is for Waste of Corporate Assets/ Corporate Opportunity and is asserted only against defendants Zhong and Kaswell. The third cause of action is for gross mismanagement and it also is asserted only against defendants Zhong and Kaswell. The fourth cause of action is for misappropriation and conversion and it is asserted against defendants Zhong, Kaswell and Schrage. The fifth cause of action is for an accounting and is asserted only against defendants Zhong and Kaswell. The sixth cause of action is for tortious interference with prospective economic advantage and is asserted only against defendant Dempsey. The seventh cause of action is for collusion/breach of duty and aiding and abetting and is asserted only against defendant Schrage.
Discussion
In 1994 New York State enacted the Limited Liability Company Law. An "LLC" is a type of business entity that is considered a cross-breed of a corporation and a partnership, having attributes of both. Its owners consist of "members" and the primary document defining the rights of members, the duties of managers and the financial arrangements is the operating agreement. McKinney's Practice Commentaries, 32A Limited Liability Company Law, p. 4 Section 1.A (Rich, 2005). If the operating agreement is silent on a particular matter, then the provisions of Limited Liability Company Law ("LLCL") control. McKinneys Practice Commentaries, 32A Limited Liability Company Law, p. 4 Section 1.A (Rich, 2005).
Under the parties' operating agreement, the members are also the "managers." The agreement enumerates those business decisions which require all three members to agree. (Operating Agreement Section 5.1.1.2). All other decisions require that only 50% of the members agree. (Operating Agreement Section 5.1.1.1). Given that there are only three members, each with an equal interest, on all decisions that do not require unanimous consent, two of the three partners can act together to make such decisions. In this regard, two members acting together, without the consent of the third, would be the "managing members" of the LLC. Under the parties' operating agreement, two members acting together could (among other things) compel a mandatory capital call.
1. Motion to dismiss
Derivative Nature of Claims
An overarching dispute between the parties is whether plaintiff is improperly trying to assert claims that belong to Water View. In other words, defendants argue that many claims asserted in the amended complaint are "derivative" claims that Lio has no right to personally assert.
When the Limited Liability Company Law was enacted in New York State in 1994 a [*4]conscious decision was made to eliminate the right of its individual members to bring derivative actions. Prior drafts of the bill had included such a right, but such provisions were eliminated as a means of getting the bill passed. The omission of such provision has created controversy, particularly where, as here, allegations are made that those in control are acting contrary to the interests of the other members of the LLC.
While some courts have held that the failure to include the right to bring a derivative action in the statute itself, does not prevent the court from relying on common law, which supports such a right [Weber v. King, 110 FS2d 124 (EDNY 2000)], most courts have held that the deliberate omission of such a remedy in the statute means that there is no such right at all. Hoffman v. Unterberg, 9 AD2d 386 (2nd dept. 2004); Schindler v. Niche Media Holdings LLC, 772 NYS2d 781 (Sup. Ct. NY Co. 2003, Kornreich, J. [nor]). See also: Bishop & Kleinberger, Limited Liability Companies: Tax and Business Law (2005); 1998 WL 1169428 (WG & L). The more persuasive authority is that there is no such right, and this court concurs with this analysis.
The issue before this court is not really whether Lio can bring a derivative claim that belongs to Water View. The parties and the court agrees there is no such right.[FN2] The issue is whether the claims asserted, in whole or part, belong to Lio personally.
While the LLC law is still in its infancy [FN3], the courts have recognized the right of a member of an LLC to sue other managing members, based upon claims of breach of fiduciary duty. Such claims are a personal right that belongs to the minority member. See: LLC Member and Limited Partner Breach of fiduciary duty Claims: Direct or Derivative Actions, Burkhard, J Small and Emerging Business L, v. 19 (Spring 2003).
Indeed, manager members have statutory and common law fiduciary duties in connection with their operation of the LLC. LLCL § 409; Nathanson v. Nathanson, 20 AD3d 403 (2nd dept. 2005); TIC Holdings LLC v. HR Softwear, 194 Misc 2d 106 affd. 301 AD2d 414 (1st dept. 2003 ); In re Die Fliedermaus LLC, 323 BR 101 (2005). These rights often appear in the LLC operating agreements.
Less clear, however, is the right of an individual member to sue a third party for some "wrong" claimed to the members of LLC interest. Such an action would appear to be solely derivative in nature, and thus prohibited under the statutory scheme. The decision of the LLC to directly sue any third party remains with the managers, who would in turn are responsible to the LLC members by virtue of their fiduciary duties.
Within this framework the court will examine each asserted cause of action along with [*5]the additional arguments advanced by defendants for dismissal.
Breach of Fiduciary Duty (1st cause of action)
The first cause of action for breach of fiduciary duty is asserted by Lio against the other members of Water View. As already addressed, a cause of action for breach of fiduciary duty between LLC members is a legally cognizable personal claim of an LLC member. Zhong and Kaswell claim that the facts alleged, however, do not amount to a breach of fiduciary duty. In any event, they claim that their actions are protected by the business judgment rule.
Defendants argue that the factual allegations, while wide ranging, fall into discrete categories. Insofar as relevant here, those categories involve the unsuccessful attempt to purchase 121 Main Street; the failed buy out negotiations and the improper capital calls. There were, however, other allegations related to management of the LLC including (but not limited to) the withholding of the survey and interference with governmental agencies.
With respect to the real estate opportunity, defendants claim that it was not within Water View's stated purpose to acquire 121 Main Street and that, in any event, the consent of all three members was required to purchase such real estate.
While operating agreement expressly identifies the development of 80 Main Street as its purpose, it also has the power to purchase other real estate that may be "necessary, convenient, desirable or incidental" to accomplish this purpose. Lio alleges that 121 Main Street was being considered for purchase as a sales office for the 80 Main Street condo project and/or that this adjacent property was being considered for purchase by Water View for development incidental to 80 Main Street. From a pleading standpoint, this survives dismissal under the purpose provisions of the operating agreement.
There is no dispute that all three members would have been required to consent to any purchase. Indeed, it would mostly likely have required further capital contributions, possibly in excess of what is currently authorized under the existing operating agreement. On the other hand, the operating agreement itself contains restrictions on managing members other business ventures, that they not be competing or otherwise in conflict with the agreement. (Operating Agreement Section 5.1.2). Moreover, in business contexts, fiduciary duties have traditionally included the duty to communicate business opportunities to one another and not to exclude partners from such opportunities while a venture is ongoing. Meinhard v. Salmon, 249 NY 458, 465 (1928); Madison Hudson Associates LLC v. Newmann, 8 Misc 3d 1025 (A); 2005 WL 1941229 (Sup. Ct. NY Co., Ramos, J.).
The allegations pled are that the other members took the opportunity to purchase 121 Main Street for themselves. This may have been directly or indirectly, by placing title in the name of one of the member's spouses. While a members withholding consent to purchase 121 Main Street for Water View would not in itself support a claim for breach of fiduciary duty, the further allegation that the opportunity was thereafter taken personally by the other member, or members, is enough to support such a claim, particularly when done without disclosure.
Allegations related to failed buy out negotiations, however, do not support any breach of fiduciary duty claims. These were negotiations clearly undertaken as a way for the parties to settle their emerging differences in connection with the Water View project. That the negotiations did not come to fruition, is not a basis for legal action.
The allegations regarding other management issues, including wrongful capital calls, [*6]improper credits, and the personal acting of Water View employees do, however, withstand dismissal at the pleading stage. These actions were undertaken by two of three members acting in concert on matters. Thus, the two member defendants acted in a management capacity and their actions may have been in derogation of their fiduciary duties.
While the business judgment rule may ultimately provide defendants protection for some or all of their actions, application of the rule does not require dismissal at the pleading stage of this action. The business judgment rule will not protect those decisions having no relationship to the business or which are beyond the scope of authority. Levandusky v. One Fifth Avenue Apartment Corp., 75 NY2d 530 (1990).
At bar, the allegations refer to conduct seemingly outside the scope of protection of the business judgment rule. Thus, for example, there is an allegation that Zhong hired employees away from Water View for her own business dealings. This allegation clearly relates to decisions without authority, since such action is expressly prohibited in the operating agreement.
In accordance herewith the first cause of action for breach of fiduciary duty survives, except to the extent it relies upon allegations concerning failed buy out negotiations.
Waste of Corporate Assets/ Corporate Opportunities
The second cause of action is against defendants Zhong and Kaswell only. Defendants claim that this cause of action is a right that belongs to Water View only and not Lio individually. They claim that it should be dismissed as an improperly brought derivative action.
Many of the claims alleged in the cause of action belong to Water View. The allegations, however, also claim a breach of fiduciary obligations between the members. As already indicated, claims of breach of fiduciary obligations against LLC members are personal claims to the other LLC members. Given, however, the inclusion of all the same factual allegations in both the "first" and "second" causes of action, to the extent any part of the second cause of action contains Lio's personal claims for breach of fiduciary duty, it is subsumed in the first cause of action. What remains of the second cause of action is, therefore only the rights of Water View itself, which cannot be derivatively asserted by Lio. The second cause of action is, therefore, dismissed.
Gross Mismanagement (3rd cause of action)
The third cause of action is for gross mismanagement and it is asserted against Zhong and Kaswell only. Certainly Lio has the right to sue the managing members of an LLC for gross mismanagement. This claim, however, is premised on the intra member fiduciary obligations owed in an LLC. This claim, while personal to Lio, is subsumed in the first cause of action for breach of fiduciary duty.
The third cause of action is, therefore, dismissed.
Conversion and Misaapropriation (4th cause of action)
The fourth cause of action is for conversion and misappropriation. It is asserted against Zhong, Kaswell and the Schrage firm. The cause of action is based upon Lio's claims that he was wrongfully prevented from obtaining a survey of 80 Main Street. Defendants argue that the survey belongs to Water View and not Lio personally. Thus, he has no personal claim of conversion relative to the survey. Schrage additionally argues that he never had possession of the survey. [*7]
Conversion is the wrongful interference with the property of another. Republic of Haiti v. Duvalier, 211 AD2d 379 (1st dept. 1995). In order to assert conversion, a plaintiff must demonstrate an ownership interest in the property alleged to be converted State v. Seventh Regiment Fund, Inc., 98 NY2d 249 (2002).
At bar, the survey does not belong to Lio personally. It belongs to Water View. His membership interest does not give him a personal right to possession of the survey. While Lio does have a right to access to the books and records of Water View (LLCL § 1102) he does not have the right to personal possession.
Thus, there is no right to assert a claim of "conversion" or "misappropriation" of the survey under the facts alleged. This is without prejudice, however, to whatever claims Lio may have based upon Zhong and Kaswell's alleged failure to provide Lio access to the books and records of Water View, including the survey.
Since the court holds that Lio has no personal right of conversion, the court does not reach Schrage's additional argument that he never possessed the survey.
The fourth cause of action is, therefore, dismissed.
Accounting (5th cause of action)
The fifth cause of action is for an accounting and it is asserted against Zhong and Kaswell only.
A cause of action for an accounting is an equitable remedy, where the essential elements are an allegation of a fiduciary relationship and a charge of wrongdoing against the parties having the duty. Hamilton v. Patrolman's Benevolent Association of City of New York, 88 NYS2d 683 (Sup. Ct. Queens Co. 1949). An accounting is available by a member of an LLC against a managing member. KSI Rockville, LLC v. Eichengrun, 305 AD2d 681 (2nd dept. 2003).
Defendants argue that the cause of action for an accounting is premature because it first requires a finding of wrongdoing. While wrongdoing by someone in a fiduciary capacity is an element of the claim, it need not be established before the cause of action is plead. It is sufficient that wrongful conduct is plead, which if established, would trigger the right to an accounting.
The court finds Plaintiff has asserted a valid cause of action for an accounting against the other members of the LLC. They stand in a fiduciary capacity to him and he has accused them of mismanagement, including the understatement of his capital account.
The motion to dismiss the fifth cause of action is, therefore, denied.
Tortious Interference with prospective economic advantage (6th cause of action)
The sixth cause of action is for tortious interference with prospective economic advantage. It is asserted against Dempsey only.
The tort of intentional interference with prospective economic advantage, requires a showing that through the intentional and wrongful acts of defendant, identified third parties were prevented from entering into a business relationship with plaintiff. Levy v. P & R Dental Strategies, Inc., 302 AD2d 255 (1st dept. 2003); Joan Hansen & Company, Inc. v. Everlast World's Boxing Headquarters Corp., 296 AD2d 103 (1st dept. 2002).
The economic transaction relied upon by Lio in support of this cause of action is the one to purchase 121 Main Street. Lio never had any personal opportunity thwarted by Dempsey. The interest in purchasing 121 Main Street belonged to Water View. Lio's personal interests in this matter are limited to his claims of breach of fiduciary duty against the managing members. He [*8]has no personal right against a third party.
The sixth cause of action is, therefore, dismissed.
Collusion/ Breach of Duty/ Aiding and Abetting (7th cause of action)
The seventh cause of action is for collusion, breach of duty and aiding and abetting. It is asserted against defendant Schrage only.
Attorney Schrage moves to dismiss the cause of action because he argues that he had no personal attorney client relationship with Lio. While attorney Schrage denies that he had any conflict of interest in representing both Water View and Zhong, he argues that such claim, in any event belongs to Water View.
The facts alleged do not support any conclusion that Schrage was ever Lio's personal attorney. Absent an attorney client relationship, an attorney does not owe Lio any duty giving rise to a cause of action. Associated Factors Corp. v. O'Neill Detective Agency, 146 AD2d 728 (2nd dept. 1989).
The law recognizes, however, that there is a tort for aiding and abetting a breach of a fiduciary duty. Such tort requires a breach of a fiduciary duty by another, that the defendant knowingly induced or participated in the breach and that plaintiff suffered damage as a result of the breach. Kaufman v. Cohen, 307 AD2d 113 (1st dept. 2003).
To the extent, the allegations rest upon Schrage's representation of defendant Dempsey's interests that Lio alleges conflicted with his own, it must be dismissed out of hand, because Dempsey owes no fiduciary duty to Lio. Thus, attorney Schrage could not have aided and abetted any breach of a duty.
This court has already held that defendants Zhong and Kaswell owe Lio fiduciary duties and there are sufficient allegations alleging a breach thereof. In order to implicate a third party who otherwise owes no fiduciary duty under an aiding and abetting claim, however, there must be allegations from which to conclude that such third party knowingly participated in the breach by providing substantial assistance to the primary violator. Kaufman v. Cohen, supra . Conclusory allegations will not suffice. Kaufman v. Cohen, supra .
The allegations against Schrage appear to hinge on his dual representation of Zhong and Water View in connection with the failed negotiations at the buy out. The court has already held that these failed negotiations did not implicate Zhong or Kaswell's fiduciary duties to Lio. Thus, they do not serve as the basis for the aiding and abetting a breach of duty claim.
While the court holds Lio has no legal claims against Schrage based on the conflict allegations, this does not impact one way or the other on the pending disciplinary charges that such dual representation may implicate professional ethical issues.
The cause of action is otherwise too general on the aiding and abetting claim to withstand dismissal.
The seventh cause of action is, therefore, dismissed.
2. Motion to Change Venue
All of the defendants agree venue should be changed to Westchester County. Defendants Zhong, Kaswell and Dempsey have formally moved for such alternative relief. They argue that pursuant to CPLR § 510 this matter should be heard in Westchester County because the purpose of the operating agreement was to acquire real estate in Westchester; the second parcel of real [*9]estate is located in Westchester; Water View's principal place of business is in Westchester and most of the parties reside in Westchester.
Initially the selection of New York County was a proper venue because two parties reside in New York County. CPLR § 503. The issue is whether, as a matter of discretion, Westchester County is a better venue for the dispute. The court perceives no appreciable benefit in moving the action to Westchester.
This case is about LLC governance and duties. The fact that the LLC owns Westchester real estate is not particularly significant to the dispute. Given the relative proximity of the venues involved, there is no discernable impact on the production of witnesses, whichever county in which the case is tried. Given the lack of appreciable benefit, the court upholds plaintiff's otherwise proper designation of venue.
Conclusion
In accordance with the foregoing decision it is hereby:
ORDERED that the motion to dismiss the first cause of action in the amended complaint is GRANTED only to the extent it is based upon allegations of failed negotiations by the parties to buy out each others interests in 80 Water View LLC; and it is further
ORDERED that the motion to dismiss the first cause of action in the amended complaint is otherwise DENIED, and it is further
ORDERED that the motion to dismiss the second, third, fourth, sixth and seventh causes of action in the amended complaint are hereby GRANTED in their entirety; and it is further
ORDERED that the motion to dismiss the fifth cause of action in the amended complaint is hereby DENIED in its entirety; and it is further
ORDERED that the motion to change venue is denied; and it is further
ORDERED that this matter shall appear on the courts calendar on February 2, 2006 at 9:30 a.m., for a preliminary conference.
Any relief not expressly granted herein is hereby denied.
This shall constitute the decision and order of the Court.
Dated: New York, New YorkSo Ordered
January 6, 2006
___________________________
HON. JUDITH J. GISCHE, J.S.C.
Footnotes
Footnote 1:No claim in this action seeks judicial dissolution of Water View. Limited Liability Company Law § 702.
Footnote 2:The complaint was originally drafted with some claims being asserted derivatively. Defendants then successfully urged plaintiff to withdraw such claims, under threat of seeking sanctions because there is no right to bring derivative claims on behalf of a Limited Liability Company in New York. Plaintiff agreed, and amended his complaint to assert all claims as personal ones.
Footnote 3:While the law was enacted 11 years ago, there are relatively few reported cases regarding governance and intra member disputes.
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