A year ago, in Tzolis v. Wolff, 10 NY3d 100 (2008), New York’s highest court recognized the common law right of LLC members to bring a derivative action on the LLC’s behalf.   Late last month, in Gottlieb v. Northriver Trading Co., LLC, 58 AD3d 550 (1st Dept 2009), an intermediate appellate court cited Tzolis in support of its decision recognizing the right of LLC members to seek an equitable accounting under common law.

The “equitable action on account” has a rich legal history in early English and American law, reflecting a time when forms of pleading and the scope of judicial powers made sharp distinctions between actions “at law” and those “in equity.”  In modern usage, the accounting action allows a trust beneficiary, partner, etc. to compel a fiduciary entrusted with property to render an account of his or her actions and for the recovery of any balance found to be due.  The accounting involves more than simply turning over existing financial records.  In New York practice, if the court grants an accounting, it may order the fiduciary to prepare a “long accounting” with detailed schedules of income and expenses over a defined period, followed by the filing of objections to the accounting, followed by proceedings before a court-appointed referee to hear and determine the accounting.

In the partnership setting, the partner’s common law right to an equitable accounting also is codified in New York’s Partnership Law Section 44 (derived from Section 22 of the Uniform Partnership Act) stating that “any partner shall have the right to a formal account as to partnership affairs” under broadly defined circumstances.  In the business corporation setting, Section 720 of the Business Corporation Law authorizes a shareholder’s derivative action against directors or officers to compel an accounting.

New York’s LLC Law contains no provision authorizing a judicial accounting remedy.  The Gottlieb case appears to be the first one to address the availability of an equitable accounting remedy in the LLC setting.

According to plaintiff Helene Gottlieb’s complaint, Northriver Trading Co., LLC was in the securities trading business from 1994 through 2000.  She initially held a 50% interest reduced to 20.6% in 1999.  Defendant Steven Schlam is the managing member.  The complaint alleges that at the time it ceased doing business, Northriver “had substantial assets, the precise value of which is unknown to plaintiff, but upon information and belief, exceeded $2,000,000.”

Gottlieb alleges that, beginning in 2001, she unsuccessfully sought an accounting of Northriver’s financial affairs and the “net amount due plaintiff”; that the defendants “wrongfully failed and refused” to provide her with the requested accounting; and that they imposed “onerous and unreasonable preconditions on an accounting, beyond the means of [Gottlieb] to satisfy, such as the requirement that any accounting must be conducted by an accountant approved in advance by defendants.”

The single-count complaint alleges that Gottlieb “has no adequate remedy at law” and demands a judgment

compelling defendants [Northriver and Schlam] to provide plaintiff with a full and complete accounting of the financial affairs of defendant [Northriver] including but not limited to income and expenses, profits and losses, overpayment of trading commissions, the amount of accounts receivable and efforts being made to collect the same, and the net amount due to plaintiff.

The defendants asked the trial court to dismiss the complaint.  They argued that Northriver provided Gottlieb with all documents pertaining to its finances — including balance sheets, income statements, tax returns, bank statements, canceled checks, vendor invoices, correspondence, detailed brokerage statements and work papers — and thereby satisfied its obligations under Section 1102 of the LLC Law to provide member access to company records.  (The decision does not indicate whether the information was given to Gottlieb pre-litigation or post-litigation in discovery.)

In a decision dated May 9, 2007, written by New York County Supreme Court Justice Jane S. Solomon, the trial court agreed with the defendants and dismissed the complaint.  The court found that Northriver “has provided all of the documents that it is required to provide” under LLC Law Section 1102.  It further held that the “plaintiff is not entitled to an accounting merely by virtue of her status as a member of the limited liability company” and that “there is nothing in the LLC Law to suggest otherwise.”  The court distinguished Gottlieb’s case authorities “because they do not involve limited liability companies.”

On appeal, Gottlieb won a reversal.  Devoting all of three sentences to the issue, the Appellate Division, First Department wrote as follows:

Contrary to the court’s ruling, members of a limited liability company may seek an equitable accounting under common law.  The assertion that such members are limited to statutory remedies with regard to potential fraud is inconsistent with the reasoning in Tzolis v Wolff (10 NY3d 100 [2008]).  Furthermore, while plaintiff’s sole claim was for an accounting, the ad damnum of her complaint did seek monetary damages based on misallocation of the company’s assets, and the case should thus be permitted to go forward.

In Tzolis, by a vote of 4-3, the Court of Appeals ruled that the legislature’s deliberate omission from the LLC Law of proposed language authorizing derivative actions by LLC members did not preclude the courts from finding a right to bring derivative claims under common law.  Whether one agrees or disagrees with Tzolis, it’s hard to quarrel with the First Department’s implied prediction that the Court of Appeals likely would apply similar reasoning to uphold an LLC member’s common law right to an accounting.

Gottlieb can be viewed as another step toward New York’s judicial homogenization of the closely held business entity, in which court-imposed fiduciary obligations and common law remedies are imported and spread evenly across partnerships, business corporations and now limited liability companies.  For better or worse, this is in sharp contrast to the emerging Delaware model in which LLCs are “creatures of contract” and the courts are loathe to impose duties or create remedies outside the four corners of the members’ operating agreement.

For Professor Larry Ribstein’s decidedly negative take on Gottlieb, see here.  For a spirited defense of Gottlieb, read the below comment by the attorney who argued the appeal.