GEORGE WASSERMAN & JANICE WASSERMAN GOLDSTEN FAMILY LLC. v. Kay
197 Md. App. 586, 2011 Md. App. LEXIS 19, 14 A.3d 1193 (2011)
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Rule of Law:
A partner in a general partnership or a member of an LLC may bring a direct, individual action against a managing partner or member for financial losses when the alleged misconduct causes a direct injury to the individual, such as the loss of funds required to be distributed or the depletion of reserves that must be replenished by forgoing future distributions.
Facts:
- The George Wasserman and Janice Wasserman Goldsten Family Limited Liability Company ('WGF') and the Lisa W. Gill Trust ('Gill Trust') were partners or members in seven real estate investment vehicles.
- Jack Kay served as the de facto managing partner or member for these investment vehicles.
- Kay's separate company, Kay Management Company, Inc., managed the funds for most of the investment vehicles under agreements requiring funds to be kept in safe investments like bank accounts or U.S. government securities.
- Beginning in 2003, Kay, without the knowledge or consent of the other partners, transferred reserve funds and funds designated for distribution from the investment vehicles to another entity he controlled, Kay Investment Group, LLC.
- Kay Investment then invested these commingled funds with Bernard Madoff's investment firm.
- Kay Management charged the investment vehicles an administrative fee of 4.5% to 5% based on the fictitious profits reported by Madoff.
- The investment vehicles' funds were completely lost when Madoff's Ponzi scheme was exposed in 2008.
- In January 2009, Kay informed WGF and the Gill Trust that their individual shares of the losses exceeded $3.8 million.
Procedural Posture:
- Appellants (WGF and Gill Trust) filed a complaint asserting both direct and derivative claims against Appellees (Jack Kay and his companies) in the Circuit Court for Montgomery County, the trial court.
- Appellees filed motions to dismiss, arguing all claims were exclusively derivative and were procedurally barred.
- The circuit court granted the motions, ruling that all claims were derivative.
- The court dismissed the derivative claims for the partnerships, holding that partners cannot bring derivative suits.
- The court also dismissed the derivative claims for the LLCs because appellants failed to make a pre-suit demand on the other members, and the failure was not excused as futile.
- After the court's oral ruling, appellants filed a motion for reconsideration and a proposed amended complaint, which the circuit court struck and denied.
- The circuit court entered a final judgment of dismissal.
- Appellants, as the appellants, appealed the circuit court's dismissal to the Court of Special Appeals of Maryland.
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Issue:
Does a managing partner or member's alleged unauthorized investment and loss of company funds, which were either required to be distributed or were held as reserves that must be replenished by withholding future distributions, give rise to a direct, individual cause of action for the other partners or members?
Opinions:
Majority - Eyler, James R., J.
Yes, a managing partner's or member's alleged misconduct gives rise to a direct, individual cause of action under these circumstances. A partner or member may bring a direct action when they suffer harm directly, or when a duty is owed directly to them. Here, the appellants sufficiently alleged both direct harm and the breach of a direct duty. The loss of funds that were either required to be distributed or were held in reserve constitutes a direct injury, because a dollar taken from reserves must be replaced by a dollar that would otherwise be available for distribution to the individual partners. Furthermore, as a managing partner/member, Kay owed direct contractual and fiduciary duties to the other individual partners and members, not just to the business entities themselves. While the court permitted the direct claims for fraud, tortious interference, breach of contract, and negligence to proceed, it affirmed the dismissal of other claims, holding that breach of fiduciary duty is not a standalone tort for damages in Maryland and that an action for conversion of money is not viable unless the funds are specific and segregated.
Analysis:
This decision significantly clarifies the distinction between direct and derivative actions for partners and LLC members in Maryland. By extending the rationale from the corporate context in Shenker v. Laureate, the court empowers minority investors in closely-held partnerships and LLCs to seek redress for managerial misconduct without the procedural hurdles of derivative litigation, such as the demand requirement. The ruling establishes that financial harm is considered 'direct' when it immediately affects a partner's distributions, either by diverting funds meant for payment or by depleting reserves that must be replenished from future payments. This precedent provides a more accessible path for individual partners to hold managing partners accountable for breaches of duty that directly impact their personal financial returns.
