When can a shareholder or member sue on the company's behalf in New York?

This page explains New York law on derivative actions: lawsuits an owner brings in the company's name to recover for wrongs done to the company, usually by its own managers, directors or controlling owners. It covers corporations under the Business Corporation Law, LLCs under the Court of Appeals' decision in Tzolis v Wolff, and limited partnerships under Partnership Law 115-a. KOR Law LLP's business divorce and shareholder litigation practice handles minority and majority shareholder disputes, including derivative actions, oppression claims and litigation over corporate governance.

What makes a claim derivative instead of personal?

The question is whose loss it is. When an insider diverts company money, sells a company asset to a friend below value, or pays himself excessive compensation, the business suffers the loss, and each owner is hurt only indirectly through the value of the ownership interest. Those claims belong to the company. When the people in control refuse to pursue them, the law lets an owner step in. In Tzolis v Wolff, the Court of Appeals described the derivative suit as part of New York's general corporate law "at least since 1832," created by courts so that shareholders would have recourse when those in control betrayed their duty.

Tzolis also explains why the line matters. The court asked what would happen if a fiduciary stole a hundred dollars from an LLC's treasury: the fiduciary is liable to the LLC, and allowing every member to also sue directly for a share of the same money would raise questions of double liability. Keeping the claim with the company avoids that. Claims for harm suffered by an owner personally, such as being denied a vote or a contractual payment, may be brought directly. The duties that are usually at stake are described in what duties business partners and LLC managers owe each other in New York.

How does a derivative case proceed, step by step?

1. Confirm standing. The plaintiff must hold shares (or voting trust certificates or a beneficial interest) when the action is brought, and must have held them at the time of the transaction complained of, unless the shares passed by operation of law (BCL 626(a), (b)). Limited partners face a parallel rule (Partnership Law 115-a(2)).
2. Gather the facts. Records rights help here; see how to get access to company books and records in New York. The complaint must be specific, so documents matter more than suspicions.
3. Make a demand, or decide not to. The complaint must "set forth with particularity" the plaintiff's efforts to get the board to bring the action, or the reasons for not making the effort (BCL 626(c)). Limited partners must address the general partners the same way (Partnership Law 115-a(3)).
4. File in the right court. Shareholder derivative actions can be heard in the Commercial Division of the Supreme Court without regard to the dollar threshold (22 NYCRR 202.70(b)(4)); see whether your business dispute belongs in the New York Commercial Division.
5. Expect an early motion. Defendants often move to dismiss for failure to make a demand. In Danzy v NIA Abstract (2007), the Second Department held that conclusory allegations of wrongdoing and control were insufficient and that the trial court should have decided futility first.
6. Security for expenses. Unless the plaintiffs hold 5% or more of a class of shares, or shares worth more than $50,000, the corporation may require security for its reasonable expenses, including attorney's fees (BCL 627).
7. Settlement or judgment. The case cannot be discontinued, compromised or settled without court approval, and the court may order notice to affected shareholders (BCL 626(d)). If the action succeeds in whole or part, the court may award the plaintiff reasonable expenses, including attorney's fees, and the plaintiff must account to the company for the rest (BCL 626(e)).

When is a demand on the board excused as futile?

The Court of Appeals set out the test in Bansbach v Zinn (2003), quoting its earlier decision in Marx v Akers. Demand is futile, and excused, "when the directors are incapable of making an impartial decision as to whether to bring suit." That occurs when the complaint alleges with particularity that:

• a majority of the board is interested in the challenged transaction, either through self-interest or because a director without a direct interest is controlled by a self-interested director;
• the board did not fully inform itself about the transaction to the extent reasonably appropriate; or
• the transaction was so egregious on its face that it could not have been the product of sound business judgment.

Bansbach also warned that "simply naming a majority of the board as defendants with conclusory allegations of wrongdoing or control is insufficient." The court explained the reason for the demand rule: management is entrusted to the board, which is often in a position to correct abuses without a lawsuit, and the rule discourages suits brought for personal rather than corporate benefit. When a board does consider a demand, or forms a committee of independent directors to review a pending suit, courts look closely at the committee's independence and investigation, as the discussion of the earlier Lichtenberg litigation in Bansbach shows.

Can LLC members and limited partners sue derivatively?

Yes. The LLC Law says nothing about derivative suits, and some lower courts had held that members could not bring them. In Tzolis v Wolff (2008), the Court of Appeals held that "members of a limited liability company (LLC) may bring derivative suits on the LLC's behalf, even though there are no provisions governing such suits in the Limited Liability Company Law." The court noted that the right to sue derivatively has never been "unfettered": since the earliest cases, a plaintiff had to show a sufficient excuse, such as those in control refusing to sue because they were the wrongdoers. The Second Department later observed in Matter of 1545 Ocean Ave. (2010), citing Tzolis, that a member aggrieved by a manager's conduct may have a derivative claim instead of a dissolution remedy. For limited partnerships, Partnership Law 115-a sets out the rules in statute, including contemporaneous ownership, particularized demand, court approval of settlements and expense awards.

What changes the answer?

• When you became an owner. Buying in after the wrong generally defeats standing (BCL 626(b); Partnership Law 115-a(2)).
• The board's makeup. Futility depends on whether a majority is interested or controlled (Bansbach v Zinn).
• How specific the complaint is. Particularity is required; conclusory claims fail (BCL 626(c); Danzy).
• Your stake. Below 5% and $50,000 in value, the corporation can demand security for expenses (BCL 627).
• The entity. Corporations follow BCL 626 and 627; LLCs follow Tzolis; limited partnerships follow Partnership Law 115-a.
• The kind of wrong. BCL 720 lets an action be brought against directors and officers to account for neglect or waste and to set aside or stop unlawful transfers of corporate assets, and BCL 720(b) lets a shareholder bring it under section 626.
• The deadline. The limitations period follows the underlying claim and the remedy sought (IDT Corp. v Morgan Stanley); see how long you have to sue for breach of contract, fraud, or a sale of goods in New York.

For example: a corporation that pays a board member's company for services never delivered

Common mistakes

• Pleading a company loss as a personal claim. The claim belongs to the company and must follow the derivative rules (Tzolis v Wolff).
• Generic futility allegations. Naming the board as defendants is not enough (Bansbach v Zinn; Danzy).
• Losing the paper trail on ownership. Standing depends on holding shares both when the wrong occurred and when suing (BCL 626(b)), so keep the documents that prove both dates.
• Ignoring the security rule. Small holders may be asked to post security for expenses (BCL 627).
• Settling privately. A derivative case cannot be settled without court approval (BCL 626(d)).
• Overlooking a better exit. Sometimes a buyout or dissolution fits the goal better than years of litigation.

What to do this week

1. Confirm the dates you acquired your shares or membership interest, with documents.
2. Collect the bylaws, operating agreement or partnership agreement.
3. Send a records demand for minutes, financial statements and the documents behind the transaction.
4. List each director or manager and any personal or business tie to the person accused.
5. Note when each transaction happened, to measure the limitations period.
6. Speak with counsel about whether to make a demand or plead futility.

If the goal is to leave the company rather than fix it, compare whether a minority shareholder can force a buyout or dissolution in New York.

Frequently asked questions

Do I need a lawyer's demand letter to the board?

The statute requires only that the complaint describe your efforts to get the board to act, or the reasons you did not try (BCL 626(c)). A written demand creates a clear record of what was asked and how the board responded.

Who pays the legal fees in a derivative case?

If the case succeeds in whole or part, or produces a recovery, the court may award the plaintiff reasonable expenses, including attorney's fees, from the proceeds (BCL 626(e)). A plaintiff below the 5% and $50,000 thresholds may have to post security for the company's expenses (BCL 627).

Can the board stop my lawsuit?

A board's decision not to sue is a key issue, which is why futility is litigated early. Bansbach v Zinn describes how courts scrutinize the independence and investigation of directors who review a derivative claim.

Can I sue derivatively for a subsidiary's losses?

New York courts have recognized "double" derivative actions where a parent controls a subsidiary, as the First Department noted in a 2016 records decision discussed in our page on inspecting company books.

Can a derivative claim be part of a dissolution case?

They are separate remedies, but they often travel together. For LLCs, see how to dissolve a New York LLC when the members cannot agree, where the Second Department pointed to the derivative claim as an alternative.

Is a derivative case the same as a fraud case?

No. A derivative case is about who sues and for whom; the underlying claim may be breach of duty, waste or fraud. Fraud's elements are covered in what you have to prove to win a fraud claim in a New York business case.