Use of LLC Funds in Legal Disputes

Can an LLC Memeber Use LLC Funds in a Lawsuit Against Other LLC Members?

Can a Minority Member of the LLC Stop a Majority Member from Defending a Lawsuit Against Him/Her With LLC Funds?

An interesting question isn’t it? Let’s consider a hypothetical case:

Member A is a minority member of an LLC which has no operating agreement. Member A file’s a lawsuit against Member B, the LLC’s managing majority member, alleging fraud, excessive salary and compensation and other wrongful behavior with respect to the LLC. Member B is paying for his/her defense by using LLC’s funds, claiming he or she is entitled to defend themself and be indemnified by the LLC under New Jersey Law. Member A is concerned that all or a substantial portion of the LLC’s funds will be used up by this indemnity, including paying Member A’s lawyer, defense costs and litigation expenses.

If this company wasn’t an LLC but instead a “C” corporation or a close corporation, New Jersey law would not entitle Member B to be indemnified for a derivative shareholder claim unless Member A was not acting in good faith and in a manner reasonably believed to be in (or not against) the best interest of the corporation. And, in any case, Member B would (generally) not be entitled to indemnity to the extent that a judge found that Member A’s claims against him/her were meritless. But because your business is not a “C” Corp or “S” Corp but instead is an “LLC”, your rights are less clear.

Can LLC Funds Be Used to Cover the Costs Associated with a Lawsuit?

The only section of the current NJ LLC Act dealing with indemnification by an LLC of its managers, members and other agents reads as follows:

“Subject to such standards and restrictions, if any, as are set forth in its operating agreement, a limited liability company may, and shall have the power to, indemnify and hold harmless any member or manager or other Member from and against any and all claims whatsoever”.

There appears to be no reported cases in New Jersey interpreting this statute, and thus no clear guidance can be offered.

Member A can assert that Member B’s decision to indemnify himself/herself constitutes a breach of fiduciary duty or a waste of corporate assets, and can file a motion before a court to restrain and stop Member A from wasting corporate assets by paying for his/her legal expenses until the end of the case or some showing of good faith, but again there appears to be no NJ case law on point.

Fredrick P. Niemann Esq.

If you are a majority member of an LLC defending yourself against a minority member or a minority member looking to protect your rights under your New Jersey LLC against oppression by the majority members, contact me personally today to discuss your matter. I am easy to talk to, very experienced in New Jersey business and you will find me to be highly approachable. Allow me to offer you practical, legal ways to handle all of your LLC matters. Call me toll free at (855) 376-5291 or e-mail me at fniemann@hnlawfirm.com.

 

 

 

Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey LLC Law Attorney