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First Department Holds That “Sole and Absolute Discretion” Clause Does Not Preclude Breach of Fiduciary Duty Claim

In Shatz v. Chertok, the First Department affirmed in part and reversed in part a decision by Justice Jennifer G. Schechter of the Commercial Division. The key issue on appeal was whether a New York limited liability company’s operating agreement that provided the managing member “sole and absolute discretion” over investment decisions barred a derivative claim for breach of fiduciary duty.  The First Department held that this contractual language did not bar a breach of fiduciary duty claim against the company’s manager.

The Dispute

The dispute in Shatz concerned plaintiff’s membership in a manager-managed limited liability company, Vast Ventures VI LLC (the “LLC”).[1]  Plaintiff alleged nineteen causes of actions, including a claim for breach of fiduciary duty against the manager of the LLC. 

As to that claim, the plaintiff alleged that the manager breached its duties by, among other things, (i) failing to pursue a previously-agreed upon investment opportunity, (ii) diverting that opportunity to another entity in which one of the defendants has an interest; and (iii) failing to disclose to the LLC the renewed availability of the investment opportunity. 

In June 2019, Justice Schechter granted the defendants’ motion to dismiss eighteen of plaintiff’s claims, but allowed plaintiff to proceed with “a single derivative claim for breach of fiduciary duty.”[2]  As to the fiduciary duty claim, Justice Schechter rejected the manager’s argument that the claim is barred because the LLC’s operating agreement gives the manager “sole and absolute discretion” over investment decisions. The plaintiff and defendants cross-appealed certain aspects of the trial court’s ruling.  This post only discusses the First Department’s ruling as to the breach of fiduciary duty claim.   

The First Department’s Ruling

In its ruling, the First Department affirmed Justice Schechter’s decision denying the claim for breach of fiduciary duty.  The First Department ruled that the LLC’s operating agreement term that gave the manager “sole and absolute discretion” over the organization’s investment decisions does not foreclose the plaintiff’s claim.

The First Department analogized the case to its holding in Richbell Info. Servs. v. Jupiter Partners.[3]  In Richbell, the First Department held that a contractual agreement providing the defendant an “apparently unfettered” right to veto transactions did not foreclose plaintiff from alleging breach of fiduciary duty claims against defendant for exercising that veto power in bad faith.[4]

Defendants argued that Richbell was distinguishable because the contract at issue in that case did not contain the contractual language at issue in this case—“sole and absolute discretion.”[5]  The First Department rejected that argument, explaining that Richbell did not turn on the precise language in the contract, but “instead stands for the general principle that an ‘explicitly discretionary contract right’ cannot be ‘exercised in bad faith’ so as to deprive the other party of the benefit of the bargain.”[6]

The First Department also rejected the defendants’ reliance upon another First Department decision—Sullivan v. Harnisch.[7]  Sullivan concerned a discretionary provision in an operating agreement that permitted the manager of a limited liability company to determine a members’ sharing ratio retroactively.[8]  The Sullivan court ruled that “[p]laintiff’s breach of fiduciary duty claim should have been dismissed, since plaintiff has not even alleged a duty separate and apart from defendants’ duties under the terms of the operating agreements.”[9]  The Shatz court distinguished Sullivan on the ground that it “did not involve allegations of bad faith or self dealing.”[10] 

In sum, the First Department’s decision in Schatz held that language giving an LLC manager discretionary authority will not preclude a derivative claim against that manager for breach of fiduciary duty based on the allegation that the manager exercised its discretionary authority in bad faith.

By Danielle C. Quinn and Muhammad U. Faridi

[1] Complaint, Shatz v. Chertok et al., No. 655620/2018, NYSCEF Doc. No. 1 (Nov. 12, 2018) (“Complaint”).

[2]  Re-argument Decision, Shatz v. Chertok et al., No. 655620/2018, 2019 WL 3457255 (Sup. Ct. N.Y. Cty. July 30, 2019)

[3] Richbell Info. Servs. v. Jupiter Partners, 309 A.D.2d 228 (1st Dep’t 2003).

[4] Id. at 302.

[5] Shatz v. Chertok et al., , 180 A.D.3d 609(1st Dept’t 2020).

[6] Id. at 610.

[7] Sullivan v. Harnisch, 96 A.D.3d 667 (1st Dep’t 2012).

[8] 667-68.

[9] Id. at 668.

[10] Shatz, 180 A.D.3d at 610.