What can a member of an LLC do when another member is mismanaging company money, using it to support his other failing business ventures, and (allegedly) spending it on personal expenses like exotic travel and polo ponies?
This is not theoretical; these are some of the facts in the 2024 South Carolina Court of Appeals case The Boathouse at Breach Inlet, LLC v. Richard W. Stoney (find it here). In it, one LLC member brought a derivative action, a lawsuit brought on behalf of a company/LLC by one or more of its shareholders/members, against another member.
A derivative action is often the only remedy shareholders/members have when management has failed to take action to protect the company. That’s why the Boathouse decision is important: It now gives standing to bring a derivative action to a “class of one” even if he or she is not “similarly situated” to other shareholders/members. It also looks at factors for determining whether the individual can maintain the claim.
We’ll look at what this all means and how the court came to its decision below.
(Note that a petition to rehear the case is currently pending before the Supreme Court of South Carolina. We will update this article with any new information.)
Very Brief Background of Boathouse
The background to this case is extremely detailed so this summary gives the broad strokes only. In short:
Richard Stoney (Richard) founded a number of interrelated LLCs starting in the 1990s. One was an LLC for the Boathouse on Breach Inlet (the Boathouse), a popular restaurant in the Charleston area, which he co-owned with other family members and business partners. Another was Crew Carolina, LLC (Crew Carolina), solely owned by Richard, which managed his other LLCs and restaurants. Using a sweep account for banking, revenue from the Boathouse and other restaurants went into the Crew Carolina bank account each night.
The Boathouse did well, but Richard’s other ventures did not. He began taking money from the Boathouse via Crew Carolina and using it to keep other enterprises afloat, as he later admitted to in divorce proceedings (Stoney v Stoney, 2018). Others testified that his misuse of company funds, including use for personal expenses, led to instances of not being able to make payroll, owing the IRS money, and incurring late fees. Richard was advised to stop these practices, yet they continued until at least May 2019.
Eventually, Crew Carolina owed the Boathouse LLC over $4 million.
No Support for Laurance’s Derivative Action
In October 2015, Laurance Stoney brought a derivative action on behalf of the Boathouse against Richard and Crew Carolina (collectively, Defendants). Laurance is Richard’s first cousin and one of the original co-owners of the Boathouse at Breach Inlet, LLC, owning 5%.
The derivative action asserted:
- Breach of fiduciary duty
- Conversion
- Unlawful distributions
- An accounting
- Unjust enrichment
Understandably, the Defendants asserted various claims against the action. In addition, two other members opposed the derivative action and moved to intervene.
In a non-jury trial, the circuit court issued an order holding that Laurence was not a “fair and adequate” representative to bring the action, saying that his motivations for doing so were vindictive and personal, rather than seeking to correct a corporate wrong. Further, it said the equitable remedy he sought was tainted by his own inappropriate conduct, especially since 90% of the Boathouse LLC’s membership opposed the action.
This appeal followed.
The Court Finds a “Class of One” Who Is Not “Similarly Situated” Has Standing To Bring a Derivative Action
The plain language of both South Carolina Code Section 33-44-1101 and rule 23(b)(1) of the South Carolina Rules of Civil Procedure allow for an individual to bring a derivative action.
However, the latter also specifies “The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association.” (Emphasis added.)
And here’s where the court’s decision becomes interesting. The court notes that “The parties stipulated Laurence was not similarly situated to the other members, and Laurence admitted that no other members officially supported his action.” Yet it looks to other jurisdictions for guidance on interpreting “similarly situated” and how to determine what makes a valid “class of one” plaintiff. Among others, the court cites:
*A Utah Supreme Court case (Angel Invs. LLC v. Garrity, Utah 2009) holding that a single shareholder could maintain a derivative action as a “class of one” when the shareholder:
- Seeks by its pleading[s] to enforce a right of the corporation and
- Does not appear to be similarly situated to any other shareholder
(Emphasis added.)
And
*A Texas Supreme Court case (Eye Site, Inc. v. Blackburn, Texas 1990), which found that the rule guiding who may bring a derivative action “does not place any minimum numerical limits on the number of shareholders who must be ‘similarly situated.’ It follows that if the plaintiff is the only shareholder ‘similarly situated,’ he is in compliance with both the letter and the purpose of the rule.”
The South Carolina Court of Appeals found that even though, by the admission of multiple parties, Laurence was not “similarly situated” to other LLC members, he did have standing to bring a derivative action. “We agree with the above cases and hold that under the appropriate circumstances, a single member of a limited liability company may ‘fairly and adequately represent the interests of’ a class of one and have standing to maintain a derivative action. To hold otherwise would be to deprive a sole dissenting shareholder from seeking relief from another shareholder’s wrongdoing.”
Davis Factors and Requirements for Representation
Standing to bring a claim is one thing. Being able to maintain the claim is another.
The court looks to the Sixth Circuit Court of Appeals case Davis v. Comed, Inc. (1990), which set forth the following factors for evaluating whether a plaintiff meets the requirements for representation:
- Economic antagonisms between representative and class
- The remedy sought by plaintiff in the derivative action
- Indications that the named plaintiff was not the driving force behind the litigation
- Plaintiff’s unfamiliarity with the litigation
- Other litigation pending between plaintiff and defendants
- The relative magnitude of plaintiff’s personal interests as compared to his interest in the derivative action itself
- Plaintiff’s vindictiveness toward the defendants
- The degree of support plaintiff was receiving from the shareholder he purported to represent
These factors are not exclusive, and the court must consider the totality of the circumstances.
To determine whether Laurance is a good representative of the company who can maintain the action, the Appeals Court of South Carolina addresses these factors, with particular emphasis on the two cited in the circuit court’s decision:
Lack of support: The court said it must consider the motives of the other LLC members for opposing the action. Based on the evidence, the court determined it was “evident” that Richard and the other co-owners opposing the action were “motivated by their individual interests.”
Vindictiveness: The circuit court found that Laurance was motivated by vindictiveness. But the appeals court notes that high emotions are common in such disputes in closely held corporations, and that the hostility between the parties in this case is “not fatal” to Laurance maintaining the derivative action.
“We further hold the remaining Davis factors support Laurence’s standing to bring this action,” the court says.
(Read the opinion for the specifics on why the court came to these conclusions.)
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