• With A Whimper, Not A Bang: New York's Top Court Rules on LLC Promoter Liability
  • December 28, 2011 | Author: Peter A. Mahler
  • Law Firm: Farrell Fritz, P.C. - New York Office
  • Last week the judges of the New York Court of Appeals unanimously affirmed the Appellate Division, First Department's interlocutory order in Roni LLC v. Arfa denying a motion to dismiss investors' claim for breach of fiduciary duty against the organizers or "promoters" of a series of real estate holding limited liability companies allegedly for failing to disclose, prior to formation of the LLCs, millions of dollars in brokerage commissions to be paid to the promoters. Roni LLC v. Arfa, 2011 NY Slip Op 09163 (Ct App Dec. 20, 2011).

    The First Department's controversial ruling held, by analogy to 19th century cases imposing fiduciary obligations on stock corporation promoters, that promoters of LLCs by virtue of their status as such also take on fiduciary duties of disclosure to prospective investors. Before reaching the issue, the court specifically found that the complaint failed to allege, as an alternative basis for finding a fiduciary duty, that the defendants possessed superior expertise or knowledge about the real estate transactions coupled with false representations concerning that subject, or that defendants' personal connections with the plaintiffs established a fiduciary relationship.

    When the case was argued before the Court of Appeals last month, a number of the judges' questions suggested discomfort with the First Department's status-based rationale for promoter liability, while others suggested an approach to the fiduciary question not tied to promoter status but instead based on the more traditional approach keyed to the defendants' control and domination over the pre-formation enterprise.

    Those hoping for a big showdown on the status-based rationale adopted by the First Department will be disappointed to read the Court of Appeals' decision. Stating that a fiduciary relationship exists "when confidence is reposed on one side and there is resulting superiority and influence on the other," the Court holds that the plaintiffs' complaint adequately alleges that "defendants planned the business venture, organized the limited liability companies, solicited their involvement and exercised control over the invested funds." The Court explains further:

    We agree with plaintiffs that the promoters of a limited liability company are in the best position to disclose material facts to investors and can reveal those facts more efficiently than individual investors, who would otherwise incur expense investigating what the promoters already know. In addition, the complaint alleges that the promoter defendants represented to the foreign investors that they had "particular experience and expertise" in the New York real estate market. Although the promoter defendants describe plaintiffs as "sophisticated prospective investors," the complaint paints a different picture, stating that they were "overseas investors who had little or limited knowledge of New York real estate or United States laws, customs or business practices with respect to real estate or investments." Moreover, plaintiffs contend that the promoter defendants assumed a position of trust and confidence, in part, by "playing upon the cultural identities and friendship" of plaintiffs. Accepting the totality of these allegations to be true, as we must at this early stage of the litigation, the complaint adequately pleads a fiduciary relationship.

    Trust and confidence? Playing upon the friendship of plaintiffs? Didn't the First Department hold that the complaint failed to plead a fiduciary relationship on those bases? The Court of Appeals makes no mention of it, nor does it acknowledge the defendants' argument that the Court of Appeals lacks jurisdiction on an interlocutory appeal to upset the First Department's holding on those points.

    And what of the First Department's holding based on promoter status? The Court essentially punts the question whether a promoter as such owes a fiduciary duty, writing in a footnote that "[b]ased on the foregoing analysis, we need not decide the question of whether the promoter defendants' status as organizers of the limited liability companies, standing alone, was sufficient to allege a fiduciary relationship."

    The late Professor Ribstein, who filed an amicus brief in the case supporting defendants' position, commented in one of his last blog posts that "the Court of Appeals, without saying so directly, effectively rejected the lower court’s determination that the complaint had not alleged a fiduciary relationship. The Court did so in order to avoid a holding in favor of promoter liability that would, I argued, 'make a mess out of NY LLC law.'" Professor Ribstein also took satisfaction from another footnote in the Court of Appeals' decision:

    In its opinion, the Court recognized (n. 1) that “[c]ertainly, there are differences between limited liability companies and traditional corporations, but the distinctions are not relevant to the allegations in this case.” They were not relevant because the Court strained to accept the alternative basis for a fiduciary duty the lower court had rejected. In short, I invited the Court not to wreck NY LLC law by imposing open-ended pre-formation promoter liability. The Court accepted my invitation although this forced it to weave a circuitous course around the lower court’s opinion.

    Doubtless there's some future plaintiff out there who, undeterred by the Court of Appeals' inconclusive handling of the issue, will bring another LLC promoter liability case based solely on promoter status. And when that happens, we shall see if Professor Ribstein's assessment proves correct.