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Commercial Division Holds That Fiduciary Duties Limit LLC Majority Members’ Ability to Adopt Amendments Aimed at Freezing Out Minority Members

Many LLC operating agreements expressly require the consent of all members to adopt or amend the operating agreement.  However, some LLC operating agreements do not contain such a provision, and instead simply require the consent of members holding a majority of the member interests.  But such agreements do not simply allow majority members to make any amendments that they may see fit, as shown by the Commercial Division’s recent decision in Yu v. Guard Hill Estates, LLC.[1] There, Justice Scarpulla explained that even amendments expressly authorized by an operating agreement can still give rise to breach of fiduciary duty claims if they are adopted for an illegitimate purpose.

Yu v. Guard Hill concerns a family dispute between the plaintiff, Patrick Yu, and his two siblings, Raymond Yu and Catherine Yu, all three of whom are members of Guard Hill Estates, LLC (“the LLC”).  The siblings are fighting over Patrick’s ownership of the LLC’s interest in the Yu family estate located in Bedford, New York.[2]  The LLC’s operating agreement permitted amendments to be made by a vote of 51% of the membership interests.  Raymond and Catherine allegedly sought to force Patrick to sell his shares of the family estate by taking several retaliatory actions, including amending the LLC’s operating agreement to remove Patrick as managing member, and adding a capital contribution provision to the operating agreement and then making a capital call knowing that Patrick could not afford to make the payment.[3]

Patrick filed suit in the Commercial Division, asserting claims for declaratory judgments for, inter alia, breach of fiduciary duty.[4]  Raymond and Catherine moved to dismiss the breach of fiduciary duty claims on the grounds that the operating agreement and New York’s LLC Law explicitly authorized the amendments and other conduct in question.[5]  Patrick countered that the amendments were not made in good faith and were pursued simply to freeze him out of the family business, rather than for a legitimate business purpose.

Justice Scarpulla sided with Patrick, refusing to dismiss the fiduciary duty claims. The Commercial Division reasoned that: “[w]hile Raymond and Catherine did have certain rights under the Guard Hill operating agreement, whether they exercised those rights in good faith and in an equitable manner is disputed and must be determined through the course of litigation.”[6]Justice Scarpulla explained that even if LLC members have a contractual right to amend the operating agreement, they must still not exercise that right “solely for personal gain in such a way as to deprive the other party of the fruits of the contract” or “in an unfair or inequitable manner.”[7]  Because Patrick alleged that his siblings’ actions “were taken as part of a family vendetta to oust him from the family entities” and “were in furtherance of the family's agenda, rather than to fulfill a need in the company,” the court held that he “sufficiently alleged facts to support a cause of action for breach of fiduciary duty.”[8]

Yu v. Guard Hill therefore shows that fiduciary duties may limit the ability of majority members to pursue amendments to LLC operating agreements that are designed to freeze out or punish minority members, even if the LLC operating agreement explicitly contemplates that such amendments may be made by majority vote.

By Benjamin F. Jackson and Stephen P. Younger

[1] No. 656510/2016, 2018 BL 366614 (Sup. Ct. Sept. 28, 2018).

[2] Id. at *1. Two other lawsuits were filed in the Commercial Division between the parties.

[3] Id.

[4] Id. at *2.

[5] See id. at *2.

[6] Id. at *4.

[7] Id. at *3-4 (quoting Richbell Info. Servs. v. Jupiter Partners, L.P., 765 N.Y.S.2d 575 (1st Dep’t2003); Lacher v. Engel, 817 N.Y.S.2d 37 (1st Dep’t 2006)).

[8] Id. at *4.