LLC Manager’s Conduct Benefits Her Side Entity at the Expense of the LLC — Are the Claims Against Her Direct or Derivative?
The distinction between direct and derivative claims is a recurring theme on The LLC Jungle.
In a nutshell, under California law, an LLC (just like a corporation) is treated as a legal entity separate and distinct from its owners. When the LLC has been harmed and fails to sue (often because the wrongdoer is in charge), the other owners may bring derivative claims on the LLC’s behalf to enforce the LLC’s rights and redress its injuries. On the other hand, an owner may bring direct claims against the wrongdoer if the injury to the owner is not merely “incidental” to an injury to the LLC. The distinction is often fuzzy, and can be challenging for attorneys and courts alike.
In a case recently filed by California’s Second Appellate District — Gorian v. Spilker — the Court of Appeal addressed a plaintiff’s direct claims based on the LLC manager’s conduct benefitting her side company at the expense of the LLC. While the opinion is unpublished and therefore not precedential, it provides insight as to how courts handle the distinction between direct and derivative claims.
Facts: LLC manager throws LLC under the bus to benefit her side company; LLC member sues
Plaintiff Gary Gorian owned a 50% interest in Old Parker Ranch, LLC (“OPR”). Defendant Elise Sinay Spilker served as the LLC’s manager. Three trusts affiliated with Spilker collectively held the remaining interests totaling 50%.
Separately, Spilker or her family owned 100% of the interests in a different entity named LASIV, LLC (“LASIV”).
OPR held a 25% interest in ESG Properties I, LLC (“ESG”), which owned a multifamily apartment project. At one point, LASIV owned a “put” option that effectively granted LASIV the right to redeem a 25% interest in ESG by acquiring stock in one of ESG’s other owners, affiliates of well-known multi-family developer Essex. However, LASIV failed to exercise its put option before its expiration. The fair market value of the Essex stock that LASIV would have received had it timely exercised its option was approximately $5 million.
Spilker (for LASIV) and Essex reached a compromise — Essex agreed to honor the expired LASIV put option, and in exchange, Spilker agreed to accept a below-market price for OPR’s interest in ESG.
After discovering this deal, Gorian sued, alleging both direct and derivative claims against Spilker, LASIV, and others.
Trial court: direct claims dismissed
Spilker and LASIV filed motions to strike Gorian’s direct claims, arguing the claims could only be pursued derivatively on behalf of OPR. The trial court agreed, and dismissed the direct claims.
Gorian appealed.
Court of Appeal: affirmed; claims were only derivative
The Court of Appeal affirmed the trial court’s ruling.
After reciting the general distinction between direct and derivative claims, the court held that based on Gorian’s allegations, “the gravamen of his complaint is injury to the entirety of OPR.” Specifically, Spilker sold OPR’s interest in ESG at below market value. Gorian did not assert that only his 50% interest in OPR sustained harm. Instead, “the below-market sale to Essex injured all OPR interests equivalently.”
The court concluded that Gorian’s “claimed injury is incidental to the injury OPR, as a distinct legal entity, suffered. Thus, plaintiff may bring only derivative, not individual, claims.” The fact that “the Spilker family, through its LASIV interest, benefitted collaterally from the below-market sale of OPR does not change the analysis. All OPR interests suffered proportionally. OPR, not LASIV nor any natural person, is the proper focus when considering whether an action is derivative of an OPR interest.”
The court noted that it is possible for direct and derivative claims to coexist in the same action, but here Gorian’s allegations supported only derivative claims.
Lesson
Under the unpublished Gorian opinion, the LLC member’s claims were only derivative where the LLC manager’s conduct harmed the entire LLC and all members’ interests in the LLC equally.