The Delaware limited liability company (LLC) is a popular form of business organization in the New York real estate industry. The reasons for this are probably as numerous and varied as the real estate projects in New York, but chief among them is a view that Delaware law offers more flexibility in certain key respects, including the extent to which members may contractually vary the obligations of managers.

For Delaware LLCs that own or manage New York real estate, disputes over the rights and obligations of members and managers are often litigated in the courts of New York—where the property is located, and where often the conduct at issue has occurred. Faced with such disputes, New York courts apply Delaware substantive law in determining those rights and obligations, but apply New York law to procedural matters. See, e.g., Lerner v. Prince, 119 A.D.3d 122, 127-29 (1st Dept. 2014).

Will the choice of a New York forum for such a dispute make a difference in the outcome? As a general matter, it should not. But the courts' efforts to ensure that it does not can sometimes lead to results that seem counter-intuitive. Some recent examples of this involve the procedure on motions to dismiss, the standard of appellate review, and the availability of an accounting.

Motions to Dismiss

Litigation concerning LLCs frequently includes derivative claims, where a member attempts to sue on behalf of the company—often seeking to hold managers liable for alleged breaches of their obligations to the company. To bring such a claim, the member must either demand that the LLC bring the claim itself and show that the demand was improperly refused, or show that such a demand would have been futile. See Wandel v. Dimon, 135 A.D.3d 515, 516 (1st Dept. 2016) (applying Delaware law).

Where a demand has been made and refused, the derivative plaintiff must meet a “heightened pleading standard” that requires particularized allegations showing that the refusal was wrongful and was not protected by the business judgment rule. See Lerner, 119 A.D. at 126. Those allegations are almost always met with a motion to dismiss based on an argument that the plaintiff has not met that standard.

Here, Delaware substantive law and New York procedural law appear to collide. Under the New York Civil Practice Law and Rules (CPLR), a motion to dismiss may be denied where “affidavits submitted in opposition” indicate “that facts essential to justify opposition may exist but cannot then be stated.” CPLR 3211(d). Under those circumstances, the court may “order a continuance to permit … disclosure to be had.” Id. Under Delaware law, however, a derivative plaintiff in a demand-refused case is “not entitled to discovery” in order to meet the applicable pleading requirements. See Scattered Corp. v. Chicago Stock Exch., Inc., 701 A.2d 70, 77 (Del. 1997), overruled in part on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000).

What happens in a New York court when a pre-answer motion to dismiss a demand-refused derivative claim governed by Delaware law is met with a request for discovery under CPLR 3211(d)? In Lerner, supra, the court held that Delaware law applied; on that basis, it affirmed the lower court's denial of the plaintiff's request for discovery. 119 A.D.3d at 127-29.

Because CPLR 3211 is on its face a rule of procedure, this might seem unusual at first blush. The court reasoned, however, that “[a]lthough New York courts have applied the law of the forum when deciding matters, such as discovery, affecting the conduct of the litigation … Delaware law on discovery is an integral part of the legal framework governing derivative proceedings … .” 119 A.D.3d at 128 (citations omitted). To allow discovery under CPLR 3211(d) with respect to a derivative claim governed by Delaware law would therefore “almost certainly lead future plaintiffs to forum shop in an effort to circumvent the Delaware prohibition against discovery.” Id. at 129. The court therefore held that Delaware law on discovery was substantive and CPLR 3211(d) should not displace it.

Standard of Review

Another area that has generated recent case law on the distinction between substance and procedure in derivative claims relates to the standard of review on an appeal from a dismissal for failure to make a demand. Under New York law, such a dismissal is reviewed for abuse of discretion. See Marx v. Akers, 88 N.Y.2d 189, 192 (1996); accord Deckter v. Andreotti, 170 A.D.3d 486, 487 (1st Dept. 2019); PDK Labs, Inc. v. Krape, 277 A.D.2d 212 (2d Dept. 2000). Under Delaware law, however, “appellate review of a lower court's decision to dismiss on the ground that demand was not excused 'is de novo and plenary.'” Deckter, 170 A.D.3d at 486 (quoting Brehm, 746 A.2d at 253).

Which standard applies if Delaware law governs substance but New York law governs procedure? In Deckter, the court chose Delaware law and reviewed the lower court's determination de novo.

As a practical matter, this may not have made much difference at the Appellate Division level. “The Appellate Division, as a branch of the Supreme Court, is vested with the same discretionary power and may exercise that power, even when there has been no abuse of discretion as a matter of law by the nisi prius court.” Small v. Lorillard Tobacco Co., Inc., 94 N.Y.2d 43, 52-53 (1999) (citation omitted). If a matter reaches the Court of Appeals, however, the difference in the standard of review could impact the outcome. See id. Treating it as substantive rather than procedural ensures that the choice of forum has as little effect on the outcome as possible. The overall result here is thus to the same effect as Lerner.

Accounting

A third area where procedural differences between Delaware law and New York law have recently been explored in the context of claims involving an LLC is the availability of an accounting. Under Delaware law, accounting is only an “equitable remedy” for a breach of duty; it is not a cause of action in itself. Garza v. Citigroup, Inc., 192 F. Supp. 3d 508, 511-12 (D. Del. 2016). In contrast, under New York law a request for an accounting may proceed as an independent cause of action. See generally 1 N.Y. Jur. 2d Accounts and Accounting §37.

What happens when a New York court is called upon to adjudicate a claim for an accounting against a manager of a Delaware LLC? In Estate of Calderwood v. ACR Group Int'l LLC, 157 A.D.3d 190, 198-99 (1st Dept. 2017), lv. dism'd, 31 N.Y.3d 1111 (2018), the court held that the availability of an accounting is a “matter[] of procedure” governed by New York law even where Delaware law governs on substance. Accordingly, a plaintiff suing in a New York court under Delaware law can seek an accounting as a freestanding claim, even though such a claim could not proceed in a Delaware court.

In Calderwood, the application of New York law on a “procedural” matter technically meant that the plaintiff could assert a cause of action that did not exist under Delaware law. That sounds like a substantive difference. Importantly, however, it did not actually change the outcome: The court went on to dismiss the accounting claim based on the absence of a fiduciary relationship. 157 A.D.3d at 198-99. This is consistent with New York law: A claim for an accounting requires “a confidential or fiduciary relationship and a breach of the duty imposed by that relationship” (or, at the very least, “some other special circumstances”). Adam v. Cutner & Rathkopf, 238 A.D.2d 234, 242 (1st Dept. 1997) (citations and internal quotations omitted).

Under these principles, the theoretical ability to bring a free-standing accounting claim will generally add nothing if the plaintiff does not also have a claim for breach of fiduciary duty. Since such a claim is exactly what the plaintiff would need in order to be able to seek an accounting as part of its remedy in a Delaware court, the procedural difference once again does not change the result.

Conclusion

There is a unifying principle in these cases: The courts attempted to ensure that the application of New York procedural rules would not change the outcome. This is significant, because a member of a Delaware LLC that owns or manages New York real estate will often have a choice as to whether to bring claims in New York or in Delaware.

The choice of forum is a weighty decision that should be very carefully considered. In some cases, it may make a real difference. But choosing a New York forum for a Delaware dispute will not automatically subject the dispute to New York procedural rules that differ from Delaware law. As these cases make clear, the analysis is more nuanced and looks to obviate those differences.

Adrienne B. Koch is a litigation partner with Katsky Korins in New York.