When one member of a limited liability company has a claim against another member or a manager of the limited liability company (LLC), it can be classified as direct or derivative. A direct claim is one where the individual member is negatively affected by an action of the LLC, but the whole LLC is not injured. A derivative suit is one in which the entire LLC is affected by a decision of one of it’s managers or members. In these derivative cases, a member usually brings suit on behalf of the LLC. Determining the classification is important, because it reveals how the procedure of the claim will be handled
For the LLC, a derivative suit is preferable because there are many opportunities in the procedure which allow for the claim to be dismissed. However, the plaintiff (LLC member) would rather the claim be direct, so they can avoid procedural obstacles and take have their claim proceed much easier. For more detail, including implications of both cases, see direct and derivative suits.
Though the differences between direct and derivative claims may be clear, which category the claim falls under might be difficult to discern. This is especially true for LLCs, because they do not have a long history of these types of cases. The Arkansas Supreme Court dealt with this issue in Muccio v. Hunt. Here, minority members of an LLC sued the other members and managers. They alleged that these majority members committed fraud, breached their duty to disclose information, and converted their membership interests.
The trial court found that the claim was derivative. This meant that the minority members of the LLC had no standing because the LLC itself was the proper party to bring this complaint. However, the Supreme Court of Arkansas reversed, holding that the claim may proceed in the members’ names, stating that the members themselves were injured; and therefore, the claim was direct. The court addressed the fraud, breach of duty to disclose, and conversion separately.
Regarding fraud, the court first noted these types of suits are normally derivative. The court noted that direct suits are appropriate, however, when the member shows an injury that is unique to the member, and not applicable only to the LLC. In applying this rule to the present situation, the court found that the minority members suffered loss of their ownership. The court further noted that the fraud being alleged by plaintiffs was not fraud that harmed only the LLC. This resulted in the claim of fraud to be classified as direct, not derivative.
When analyzing the duty to disclose, the Arkansas Supreme Court noted their LLC statute. This requires the LLC managing members to make available full and true information that reasonably affects any member. The court later stated that these statutory rights of members supported individual claims, not claims made by the LLC. This led the court to rule that this claim was also direct.
Finally, the court addressed the claim of conversion (wrongful possession of another person’s property). In this case, the plaintiffs contended that the LLC converted the minority member’s interests. In their complaint, the plaintiffs stated the the managing members did this through fraudulent misrepresentation. The court agreed that the conversion was tied to the fraud; since the fraud claim was direct, then the conversion claim was also direct.
Throughout the opinion, the Arkansas Supreme Court constantly compared LLC and corporate law. The court even mentioned corporate case law and applied it to the LLC case at hand. This was a surprise to many, and appeared to blur the line between the two business entities. By ruling that these types of claims were direct, the Arkansas Supreme Court made it easier for a disgruntled LLC member to bring a suit against the other members. If this type of ruling becomes a trend for other states, it means that the LLC may have to take more steps to protect themselves from liability.