Commercial Division Blog
Plaintiff Lacked Standing to Bring Derivative Claims on Behalf of LLC
On April 12, 2017, Justice Oing of the New York County Commercial Division issued a decision in Pokoik v. Norsel Realties, 2017 NY Slip Op. 50459(U), dismissing claims as derivative claims on behalf of an LLC that the plaintiffs lacked standing to bring.
First, Justice Oing held that the plaintiffs' claims were derivative, rather than direct, explaining:
Under New York law, a shareholder lacks standing to pursue a direct cause of action to redress wrongs suffered by the corporation. Rather, such claims must be asserted derivatively, for the benefit of the corporation.
In general, a plaintiff asserting a derivative claim seeks to recover for injury to the business entity, while a plaintiff asserting a direct claim seeks redress for injury to him or herself individually. In analyzing whether a plaintiff's claim is truly direct or derivative, courts look at the nature of the harm alleged and who is principally harmed: the corporation or the individual shareholders.
New York courts have identified numerous categories of claims, including claims of mismanagement or diversion of assets for a manager's own benefit and excessive compensation, as derivative in nature, and, as such, they must be pleaded on behalf of the corporation. Furthermore, a claim that the shareholders have been injured by a diminution in the value of their stock is a derivative claim belonging to the corporation, and not a direct cause of action for the shareholders. Derivative claims which are improperly pleaded as direct claims must be dismissed for lack of standing.
Here, a review of all of plaintiffs' claims in a light most favorable to them unequivocally demonstrates that they are based on alleged injuries to Norsel purportedly caused by the decisions to adopt an apparently below-market ground lease rent, and to transfer its interest in the Property to Norsel LLC, as well as the transfer of the ground lease from Norsel Realties to Norsel LLC. In fact, plaintiffs allege that the acts underlying the amended complaint were directed at Norsel as an entity, repeatedly asserting that such acts were not in the best interests of Norsel, and that Norsel Realties as a whole is damaged $131,000,000. Plaintiffs also rely on the purported injury to Norsel as the basis for their individual claims in which they assert that they have been injured in an amount equal to their ownership percentage multiplied by the $131,000,000 allegedly loss to Norsel. Under these circumstances, plaintiffs' direct claims, which are based on allegations that their interests in Norsel have been diminished through the adoption of the ground rent at issue, are inherently derivative claims. Plaintiffs' remaining allegations that defendants mismanaged Norsel for their own benefit, i.e., by transferring ownership to Norsel LLC, are similarly derivative in nature. Accordingly, to the extent that plaintiffs attempt to bring direct claims against Norsel or its partners, they do not have standing to do so because the claims asserted in the amended complaint are strictly derivative in nature — the claims and damages alleged result from purported injuries to Norsel.
(Internal quotations and citations omitted). Next, Justice Oing examined whether the plaintiffs had standing to bring derivative claims on behalf of the LLC. He held that they did not, explaining:
New York courts have held that because derivative actions bind absent interest holders they take on the attributes of a class action and a plaintiff must therefore demonstrate that he will fairly and adequately represent the interests of the shareholders and the corporation, and that he is free of adverse personal interest or animus. If a plaintiff cannot demonstrate such representation, the derivative causes of action will be dismissed.
In the amended complaint, plaintiffs decided to name all interest holders other than plaintiffs themselves as defendants. Having brought their claims against all other Norsel partners, plaintiffs cannot purport to simultaneously represent the interests of these adverse defendant partners. Unlike plaintiffs' initial complaint, which named only Steinberg and Lieberman as interest holders in Norsel and commenced on behalf of Norsel and all of its partners, by naming all other Norsel partners in the amended complaint there cannot even be a theoretical group of interest holders left on whose behalf plaintiffs purport to act. Indeed, in this amended complaint, plaintiffs Leon Pokoik and his family own or otherwise control approximately 10% of Norsel but assert derivative claims against the partners representing the other approximately 90% of the ownership interests. This presents a prototypical conflict of interest.
Plaintiffs' inherent conflict of interest is also presented by the fact that because they own a 12.788% ownership interest in 575 Associates, which net leases the Property from 575 Realties, plaintiffs are attempting to double dip — they are simultaneously receiving funds from 575 Associates in the form rental income while suing Norsel over the same ground rent.
In addition, plaintiffs do not appear to have any genuine concern for Norsel or its related entities. While plaintiffs seek to extract monetary damages from their partners based upon their extremely high property appraisals, they do not request any relief, such as the revision of the subject ground lease rent or court oversight of the appraisal process, that would benefit Norsel. Indeed, plaintiffs ignore the fact that their $20 million proposed annual rent, an almost 90% increase, would make business operations more difficult for 575 Associates which, in turn, would jeopardize Norsel itself.
Lastly, plaintiffs failed to demonstrate on this record that they are free from personal animus. Lead plaintiff Leon Pokoik has repeatedly sued his business partners and his own family. The pleadings in each of Leon Pokoik's actions are filled with allegations of mismanagement and improper conduct allegedly perpetrated by numerous individuals and closely-held entities, similar to the allegations made here. Given Leon Pokoik's litigious nature, the totality of the circumstances constrains this Court to conclude that this action is a weapon in the total arsenal so as to gain leverage in the other disputes. Having named all of the Norsel partners with whom plaintiffs disagree as defendants in this action, and given Leon Pokoik's demonstrated animus, plaintiffs' self-interest is palpably obvious to the point that they are unable to show that they will adequately represent the interest of these defendants. Thus, the amended complaint must be dismissed.
(Internal quotations and citations omitted).