Vincent Di Lorenzo ()
Real estate owners and developers often form limited liability companies (LLCs) to shield themselves from liability. Is this an effective means to accomplish this purpose? Curiously, the New York case law had little to say on this issue until a 2016 Second Department decision. In Board of Managers of Beacon Tower Condominium v. 85 Adams Street, 136 A.D.3d 680 (2d Dep’t 2016), the court refused to dismiss an action in common law fraud against the managing member of the sponsor LLC, as well as its principal, because the plaintiff had sufficiently pleaded they directly participated in the commission of the alleged tort.
New York Limited Liability Company Law provides that “[n]either a member, a manager nor an agent of a limited liability company … is liable for any debts, obligations or liabilities of the limited liability company …, whether arising in tort, contract or otherwise, solely by reason of being such member, manager or agent or acting … in such capacities or participating … in the conduct of the business of the limited liability company.” This provision appears to provide a shield from liability, until the common law “participation” standard for individual liability for tortious conduct is considered.
The participation standard has long provided that officers and directors of a corporation are personally liable for “all torts they authorize, direct or participate, notwithstanding that they acted as agents of the corporation and not in their own behalf.” James D. Cox and Thomas Lee Hazen, Cox & Hazen on Corporations 370-71 (2d ed. 2003). See, e.g., Espinosa v. Rand, 24 A.D.3d 102 (1st Dep’t 2005); Rajeev Sindhwani, M.D., PLLC v. Coe Business Service, Inc., 52 A.D.3d 674 (2d Dep’t 2008); Van Wormer v. McCasland Truck Center, Inc., 163 A.D.2d 632 (3d Dep’t 1990); Clarke V. Pine Hill Homes, Inc., 112 A.D.2d 755 (4th Dep’t 1985). The participation standard for individual liability is distinct from a standard that seeks to pierce the corporate veil.
The issue is whether members of a limited liability company that manage its affairs, as officers and directors do in a corporation, are also personally liable for all tortious acts in which they participate even when acting on behalf of the LLC. On close reading, the New York statute does not necessarily foreclose application of the participation standard by the courts, as the statute shields a member from liability arising “solely” by reason of being a member.
Case law interpreting similar limited liability company statutes in other states explored this issue earlier. The case law in other states is divided. Some states impose personal liability on members of an LLC even if they are acting on behalf of the LLC. The phrase “solely by reason” is interpreted as preventing imposition of liability based only on the status of being a member of an LLC. Others states interpret the phrase “solely by reason” as shielding members from personal liability when the actions of the member were taken in the management of the company’s affairs. See Jeffrey S. Quinn, Note, “Allen v. Dackmann: Doing Away with Limited Liability in Maryland,” 70 Md. L. Rev. 1171, 1188-95 (2011) (summarizing state decisions).
Based on the terms of the New York statute, it is not clear if the courts should impose liability when the tortious conduct occurred in the management of the LLC’s business. Many state statutes stipulate only that a member is not liable “solely by reason of being a member or acting as a manager …” E.g. Delaware Limited Liability Act, 6 Del. C. §18-303 (a); Uniform Limited Liability Company Act §303(a). The New York statute includes this language and then adds that there shall be no liability “solely by reason of … participating in the conduct of the business of the limited liability company.” N.Y. Limited Liability Company Law §609 (a).
Appellate decisions in New York have ruled that members of an LLC that directly participate in a tort can be held individually liable. Haire v. Bonelli, 57 A.D.3d 1354 (3d Dep’t 2008); Kew Gardens Hills Apartment Owners, Inc. v. Horing Welikson & Rosen, P.C., 35 A.D.3d 383 (2d Dep’t 2006); Rothstein v. Equity Ventures, LLC, 299 A.D.2d 472 (2d Dep’t 2002) (involving managing members, but insufficient allegations of common law fraud). Courts have also applied that participation standard to hold principals of an LLC individually liable. 277 Mott Street v. Fountainhead Construction LLC, 83 A.D.3d 541 (1st Dep’t 2011).
All of these earlier decisions were conclusory. None of these decisions explored the meaning of “participation.” If a state applies a participation standard to hold members liable even when acting on behalf of the LLC, it must then address the issue of whether “participation” encompasses only acts of malfeasance or also encompasses acts of nonfeasance. None of these earlier decisions considered if a member can be held liable based on nonfeasance—perhaps based on knowledge of a tortious act, power to prevent the act, and a failure to do so.
In 2016, the court in Beacon Tower applied the participation standard in a less conclusory manner. Beacon Tower was an action by the board of managers of a condominium against the sponsor, which was an LLC formed solely to develop the condominium and sell the units, alleging breach of contract and fraud. Additional defendants were the managing member of the sponsor, the sole members of the managing member, which was itself an LLC, as well as the individual that was the controlling principal of the sponsor and general manager of the managing member. The court refused to dismiss the complaint against the principal and the managing member of the sponsor. The court noted that they “executed the certification page of the offering plan, and … directly participated in the transactions at issue by virtue of their control of the sponsor. Such allegations are sufficient to support a claim that Jeshayahu and Managers participated in the commission of a tort as alleged, and that they are therefore not insulated from liability by Limited Liability Company Law §609(a) …” Id. at 682. However, the court did dismiss the action against the two members of the managing member because the allegation that they also directly participated in the transaction at issue was conclusory at best.
The court in Beacon Tower recognized liability based on two factual allegations: (a) execution of the certification page of the offering plan, and (b) control of the sponsor. The former has been utilized to hold the principal of the sponsor personally liable when the principal has signed the certification page in an individual capacity. The view embraced is that the certification advanced the alleged misrepresentations in the offering plan. E.g., Residential Board of Managers of Zeckendorf Towers v. Union Square-14 Street Associates, 190 A.D.2d 636 (1st Dep’t 1993). However, in Beacon Tower, the managing member did not execute the certification page in an individual capacity. Reply Brief for Defendants-Appellants, 2014 WL 10354506 (2014).
The latter basis for liability, i.e., liability of a managing member by virtue of “control” of the sponsor LLC, can be interpreted as a broad viewpoint of what suffices as “participation.” The brief for defendants in the case argued against liability because “only Sponsor drafted and distributed the offering plan and entered into each Purchase Agreement with unit owners. Respondent admits that only sponsor was responsible for the marketing and distribution of the Offering Plan and the sale of the individual units.” Brief for Defendants-Appellants, 2013 WL 10967370 (2013). Yet the court ruled the principal of the sponsor and the managing member could be held personally liable for their participation in the fraud “by virtue of their control of the sponsor.”
Earlier, New York appellate decisions recognizing liability based on a participation standard made it clear that the member in question committed or must commit affirmative acts that were tortious. E.g., Haire v. Bonelli, supra (members reduced or eliminated mall security to maximize profits); Rothstein v. Equity Ventures, LLC, supra (plaintiffs did not state a viable claim against two of the managing members as they failed to allege those defendants knowingly made false representations). It is not clear if the court in Beacon Tower intended to broaden the potential basis for liability when applying the participation standard.
It may be useful to examine case law involving corporate owners and officers, as opposed to members and principals of LLCs, to determine whether or when the participation standard allows liability based on inaction. The New York courts have made it clear that no liability is imposed on corporate officers based solely on their authority. E.g. Robles v. Palazzolo Realty Corp., 66 A.D.3d 417 (1st Dep’t 2009) (corporate officer liable for nothing more than nonfeasance in action alleging negligent maintenance of apartment building). However, corporate officers have been held liable if they are aware of the potential tort and declined to exercise their power to prevent or to remedy the wrongdoing. E.g., American Feeds and Livestock Company, Inc. v. Kalfco, Inc, 149 A.D.2d 836 (3d Dep’t 1989) (president was on notice of conversion by corporation and declined to exercise her ability to set it right); Matter of Carney’s Restaurant, Inc. v. State of New York, 89 A.D.3d 1250 (3d Dep’t 2011) (sole shareholder, officer and director knew of violations of Environmental Conservation Law and did not take action to remedy them). Thus it seems likely that Beacon Tower’s “control” language will be similarly applied to impose personal liability on principals and members of an LLC not merely based on the power to control corporate actions. Rather, what will be required is awareness of tortious activity and a failure to exercise the power to control such wrongdoing.