On February 14, 2008, a divided New York Court of Appeals held that a member of a New York limited liability corporation (often referred to simply as a "LLC") could bring a derivative lawsuit on behalf of the LLC against the entity's managers. Tzolis v. Wolff A derivative lawsuit is typically brought by a shareholder of a corporation, on behalf of the corporation, to address wrongs committed by the corporation's directors or officers, which allegedly caused harm to the corporation. Prior to this decision, neither the legislature nor the courts of New York had addressed this issue.
In its opinion, the Court held that members of a LLC may bring bring derivative lawsuits on the LLC's behalf, even though there are no provisions governing such suits in the New York Limited Liability Company Law. In reaching its decision, the Court relied on "the long-recognized importance of derivative lawsuits in corporate law, and on the absence of evidence that the Legislature decide to abolish this remedy when it passed the Limited liability Company Law of 1994." The Court explained that "to hold that there is no remedy when corporate fiduciaries use corporate assets to enrich themselves was unacceptable in 1742 and in 1832, and it is still unacceptable today...to abolish them in the LLC context would be a radical step."
In light of this decision, LLCs in New York cannot ignore the threat of a derivative lawsuit. Derivative lawsuits can be expensive to defend, especially when many individuals are named and need to retain separate counsel based on potential conflicts. In most cases, a directors and officers liability (i.e., "D&O") policy will provide insurance coverage for derivative suits, depending on the wording of the applicable insured v. insured exclusion. Managers and controlling owners of LLCs also should evaluate their corporate documents to assure that indemnification and advancement provisions address the potential for derivative lawsuits and the financial protections available to the LLC's managers and controlling owners.