Derivative Claim Upheld for Estate of Deceased LLC Member
Asserting claims derivatively on behalf of an LLC, as opposed to directly on behalf of an LLC member, can be tricky business for even experienced litigators. The requirements for derivative claims have been explored in previous LLC Jungle posts — for example, see here and here.
In a case recently decided by California’s Fourth Appellate District — Stahl v. Cross — the Court of Appeal affirmed a judgment in favor of the estate of a deceased LLC member on a derivative claim. While the case is unpublished and therefore cannot be cited as precedent, it is nonetheless instructive.
Facts: majority members saddle LLC with debt from unauthorized insider loans
Terry Cross was a member of Range of Motion Products, LLC (“the LLC”). Other members of the LLC included Brian Stahl, Nic Bartolotta, and All Together Assets LLC. The LLC was formed to promote, sell, and market the Rolflex, a self-massage therapy device that Cross invented. Cross assigned all of his intellectual property rights to the Rolflex to the LLC.
The LLC’s Operating Agreement provided that members were allowed to engage in separate business activities without the other members’ consent. The Operating Agreement also required unanimous member consent for any loans to the LLC from any member.
Disputes arose between the members. The other members accused Cross of wrongdoing by his operation of a separate company (Armaid Company) that produced an arm massage device. Cross accused the other members of making substantial unauthorized loans to the LLC that Cross never approved.
The other members filed a complaint against Cross and his separate company Armaid, and Cross filed a cross-complaint against the other members and the LLC. The cross-complaint apparently did not specify whether it alleged the cross-claims directly or derivatively.
Trial court: judgment for LLC member’s estate on derivative claim
The case went to trial. During a short break in the trial, Cross unexpectedly passed away and his Estate (through its personal representative) continued on with the case in Cross’ place.
The court issued a statement of decision and judgment in favor of Cross’ Estate, finding that the other members clearly breached the Operating Agreement by making loans to the LLC without Cross’ consent. The court also held that the Estate had standing to proceed with the cross-complaint, and the cross-complaint asserted derivative claims on behalf of the LLC. As to the “continuous ownership” requirements for derivative standing set forth in Corporations Code section 17709.02, the court concluded that the Estate held a continuous ownership interest in the LLC, first through Cross and then through the Estate upon Cross’ death.
Because the Estate did not prove injury to the LLC as a result of the loans, the trial court awarded only nominal damages in the amount of $1 to be paid by each cross-defendant. The court explained that nominal damages are warranted even where actual damages are not shown because the “failure to perform a contractual duty is a legal wrong that is fully distinct from actual damages.” However, the court also awarded the Estate over $400,000 in prevailing party costs and attorney fees. (This case is a prime example of the attorney fee tail wagging the dog!)
The other members appealed, challenging only the trial court’s determination that the cross-complaint alleged a derivative claim.
Court of Appeal: affirmed
The Court of Appeal affirmed the trial court’s judgment.
The appellants’ main argument was that “they were prejudiced because they did not know the Estate was bringing a derivative action.” Rather than address the technical aspects of whether the Estate’s claims were really direct or derivative in nature, or whether the cross-complaint’s allegations were sufficient to state a derivative claim, the Court of Appeal focused on the basic rule that to obtain reversal of a judgment, the appellant must show that any error was prejudicial.
Here, the Court concluded that the appellants failed to show any prejudice. The Court stated: “After all, the wrongdoing alleged and proved at trial remained the same under the cross-complaint whether it was a derivative or individual action. … Alternatively stated, Appellants’ acts breaching the [Operating] Agreement and violating their fiduciary duties were identical whether the Estate or the [LLC] was the cross-complainant.” The appellants failed to explain how they would have conducted discovery or the trial any differently if they were aware that the cross-complaint would be construed as a derivative action.
Finally, given the “monstrous amount of evidence of Appellants’ multiple breaches of contract” the Court held that even if the trial court construed the cross-claims as direct instead of derivative, it would have awarded the same nominal damages to the Estate instead of the LLC. As such, the appellants could not prove any prejudice caused by the error they asserted.
Lesson
In the unpublished Stahl case, the Court of Appeal upheld a judgment in favor of a deceased member’s estate, which the trial court held satisfied the requirements for derivative claim standing. The Court of Appeal held that the appellants could not establish prejudice because the wrongdoing was clear and would have resulted in a similar award even if the claim was direct instead of derivative.