LLC Member Disputes in New York

The operating agreement controls almost everything

New York’s LLC Law was designed to be a default. The Legislature’s intent was that LLC members would write their own rules in an operating agreement, and the statute would only fill in the gaps. That makes the operating agreement the single most important document in almost every LLC dispute.

Read it carefully before you do anything else. Common provisions that quietly determine the outcome of a dispute include:

Mandatory buy-sell clauses that trigger on specified events, sometimes including events you didn’t realize you had caused.

Valuation formulas that lock in a price for a member’s interest, often at a number well below fair market value.

Mandatory mediation or arbitration provisions that push you out of court for months and limit your discovery rights.

Forum selection clauses that send the dispute to a different state.

Expulsion provisions, vesting schedules, and consequences for resignation or default.

Even an informal or unsigned document can qualify as an operating agreement under New York law in some circumstances. So can a course of conduct between the members. If you’re not sure whether anything you signed counts, bring it to a consultation and we’ll figure it out.

If there is no operating agreement at all, as is often the case with small LLCs, the default rules of the New York LLC Law govern. Those rules are not friendly to minority members.

Books and records under Section 1102

Every LLC member has a statutory right to inspect the company’s books and records under Section 1102 of the LLC Law. If your fellow members are stonewalling you on financials, this is almost always the first move.

The mechanics matter. You start with a written demand to the LLC. The demand needs to identify what you want to see and why you want to see it (the “proper purpose” requirement). If the LLC refuses or ignores the demand, you bring a special proceeding under CPLR Article 4. This is an expedited proceeding, meaning months, not years. That speed is part of why §1102 is such an effective opening move: it forces information out into the open quickly and often pushes the other side to the negotiating table.

Section 1102 lists specific records the LLC must keep and produce: a list of members, copies of the articles of organization and any operating agreement, tax returns for the last three years, and financial statements. Courts also have discretion to order disclosure of “other information regarding the affairs of the limited liability company as is just and reasonable.” In practice, that opens the door to bank statements, accounting records, contracts, and other documents underlying the LLC’s business, depending on the facts.

For a full walkthrough of how a §1102 petition works, see my page on access to LLC books and records.

Fiduciary duties under Section 409, and the derivative vs. direct distinction

Section 409 of the LLC Law requires LLC managers (and member-managers) to act “in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances.” Courts have layered onto this statute a broader common-law duty of loyalty: LLC members owe each other and the LLC the same kind of undivided loyalty that partners owe each other.

In practice, that means a member or manager cannot:

Divert business opportunities to themselves or to a side entity they control.

Compete with the LLC while still inside it.

Pay themselves compensation so large that it swallows the distributions other members were supposed to receive.

Use LLC funds, property, or credit for personal purposes.

Transact business with the LLC on terms they would never accept at arm’s length.

When this happens, you may have a claim for breach of fiduciary duty. The remedies include money damages, disgorgement of what the bad actor took, and in some cases removal.

Direct claim or derivative claim?

This is where LLC fiduciary-duty cases get technical, and where pro se litigants and inexperienced lawyers most often go wrong.

If the wrongful conduct harmed the LLC itself, like a member draining the bank account or stealing customers, the lawsuit has to be brought derivatively, on behalf of the LLC. Any recovery goes to the LLC, not to you personally. The reasoning is that the harm was to the company, so the company is the proper plaintiff. You sue as the company’s representative.

If the wrongful conduct harmed you personally and not the LLC, like being frozen out of your management role or denied distributions everyone else received, you bring a direct claim in your own name. The recovery goes to you. See also my post on whether you get damages when a co-LLC member mismanages the LLC.

Courts dismiss claims that get this wrong, so the distinction is worth taking seriously. Many LLC disputes involve both kinds of harm, and the complaint has to plead them separately.

The business judgment rule

Not every decision you disagree with is a breach of fiduciary duty. Courts will not second-guess business decisions that were made in good faith, in the exercise of honest judgment, and in furtherance of legitimate business purposes. This is called the business judgment rule, and it gives the people running an LLC meaningful leeway to make calls you wouldn’t have made.

The rule doesn’t protect bad-faith decisions, self-dealing, or decisions that benefit one member at another’s expense. But it does protect ordinary business judgment, even when it turns out badly.

Judicial dissolution under Section 702

The only statutory path to forced dissolution of a New York LLC is Section 702. The standard is whether it is “not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.”

New York courts read that standard narrowly. The leading case, 1545 Ocean Avenue, established that a petitioner has to show either that the LLC’s management structure has failed in a way that prevents the business from operating, or that the LLC can no longer achieve its stated purpose. Deadlock and personal animosity are usually not enough on their own. Neither is a member simply being unhappy with the other members’ decisions.

That makes §702 a harder remedy than the corresponding dissolution remedies for corporations and partnerships. There is no LLC equivalent to the oppression-based dissolution that minority shareholders can pursue under Section 1104-a of the Business Corporation Law.

There is, however, an important workaround. In cases where dissolution is justified, courts have granted what they call an “equitable buyout,” in which one member is allowed to purchase the other member’s interest in the LLC at fair value. The LLC continues to exist; the parties separate. The road to an equitable buyout is uncertain, but the credible threat of dissolution often produces a settlement in that shape.

In my experience, many §702 petitions never reach a ruling. They settle, often into a buyout, once the parties realize what continued litigation will cost relative to a negotiated exit.

What minority LLC members don’t get that shareholders do

Most clients in an LLC dispute assume their legal position is roughly the same as a minority shareholder in a corporation. It is not, and the gap matters.

A minority shareholder in a closely held New York corporation has two powerful remedies that a minority LLC member simply does not have:

First, under Section 1104-a of the Business Corporation Law, a shareholder with at least 20% of the shares can petition for dissolution on grounds of oppression, fraud, illegality, or waste. There is no LLC counterpart to this remedy. New York courts have specifically rejected the idea that oppressive conduct, on its own, justifies dissolving an LLC under §702.

Second, under Section 1118 of the Business Corporation Law, the corporation or the other shareholders can stop a §1104-a dissolution by electing to buy the petitioning shareholder out at fair value, determined by the court. This buyout election is one of the most important features of New York minority-shareholder law. Most §1104-a petitions end in a §1118 buyout, not actual dissolution. There is no LLC equivalent.

The practical effect is that a bullied minority LLC member has to be more strategic and more creative than a bullied minority shareholder. The legal pressure points are different, and they are fewer.

Freeze-out mergers

New York law does not allow majority members to simply vote a minority member out of an LLC unless the operating agreement specifically authorizes expulsion. But there is a legal mechanism that achieves something close: the freeze-out merger, sometimes called a cash-out merger.

In a freeze-out merger, the majority members vote to merge the existing LLC into a new entity. The agreement of merger provides that the majority members will own the new entity and the minority member will receive only cash for their former interest. The minority member’s only real remedy is to challenge the valuation through a statutory appraisal proceeding.

This is the kind of thing that’s done to you, not the kind of thing you negotiate around once it’s started. If you suspect a freeze-out merger is being planned, the time to act is before it closes. If it has already happened, the appraisal remedy is what’s left, and getting the valuation right is what matters most.

If you’re in an LLC dispute right now

Every LLC dispute looks different, but the early questions are usually the same: what does the operating agreement say, what are the financials hiding, and what kind of leverage do you actually have. I work through those questions with clients in a free initial consultation. For a broader overview of how I approach partnership and LLC disputes generally, including the first thirty days, fees, and what working together looks like, see the partnership disputes page.

Call 212-253-1027 or email imke.ratschko@ratschko.com to set up a call.