In litigation, the plaintiff must include as parties to the action all persons or entities whose interests are so directly involved that the court cannot render a fair adjudication in their absence. If the plaintiff fails to include such “indispensable parties,” the case can be dismissed.
In a recent order filed by the United States District Court for the Northern District of California in the case Kanaan v. Yaqub, the court addressed the issue of whether the LLC is an “indispensable party” where the claims involved allegations of wrongdoing between the LLC’s members.
While federal cases are not necessarily binding on California state courts, California courts have acknowledged that California’s “compulsory joinder” requirements in Code of Civil Procedure section 389 are modeled after Rule 19 of the Federal Rules of Civil Procedure, and federal cases are therefore pertinent.
Facts: LLC member sues other member for attempted “squeeze out”
According to the complaint:
Plaintiff Nabih Kanaan and Defendant Nizar Yaqub were the sole members of The Inn at Del Monte Beach, LLC. Kanaan claimed that Yaqub engaged in fraud and breached fiduciary duties in order to “squeeze him out of the company.” Yaqub allegedly:
- amended the LLC’s Operating Agreement without giving required notice to Kanaan even though the agreement required unanimous approval of the LLC’s members for such amendments
- falsified documents to make it appear as if Kanaan’s ownership interest had been substantially reduced
- scheduled a capital call without notice to Kanaan
- falsified LLC minutes
- misused LLC funds for personal expenses
Yaqub filed a motion to dismiss the case, arguing that Kanaan’s lawsuit failed to include the LLC and the LLC was an indispensable party.
The Court’s Order: motion denied; LLC is not an indispensable party to direct claims between LLC members
The court denied Yaqub’s motion to dismiss, concluding that the LLC was not an indispensable party. Critical to the court’s reasoning was the distinction between derivative and direct claims.
The court noted that for derivative claims, the entity is always an indispensable party. “The action is derivative, i.e., in the corporate right, if the gravamen of the complaint is injury to the corporation, or to the whole body of its stock and property without any severance or distribution among individual holders, or it seeks to recover assets for the corporation or to prevent the dissipation of its assets.” Because those claims belong to the entity, the entity must be a party to the litigation. (If the entity fails to pursue the claim on its own, then the plaintiff may sue derivatively on the entity’s behalf, but must name the entity as a “nominal” defendant in the case.)
But direct claims, in contrast, seek to enforce a right “which the stockholder possesses as an individual” where injury to the individual is personal and not merely “incidental” to injury to the entity. For direct claims, the entity is not an indispensable party.
Turning to Kanaan’s claims, the court held the gravamen of the complaint was direct, not derivative. The court held: “All of these claims assert wrongful conduct by Yaqub that caused harm to Kanaan individually — divestiture of the majority of his interest in the LLC — which is separate and apart from any harm caused to the LLC itself.”
While the complaint also contained other allegations of Yaqub’s use of LLC funds for personal expenses (which would be derivative if pursued), the court held these allegations were “not central to Kanaan’s claims.” Since the gravamen of the complaint focused on Yaqub’s “attempt to squeeze Kanaan out of the LLC,” the claims were direct and the LLC was not an indispensable party.
Lesson
Under the district court’s holding in the Kanaan case, an LLC is not an “indispensable party” where the case features direct (not derivative) claims between the LLC’s members.
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