NY: Underlying real estate investments
Facts: This action arose from a series of business transactions in which investors acquired membership interests in limited liability companies that purchased and managed multi-family residential buildings in NY. The Defendants, either directly or through their wholly owned companies, located the properties, arranged financing, organized the limited liability companies, and managed the properties. Plaintiffs alleged, amongst other things, that Defendants made a secret profit at the expense of Plaintiffs’ and their LLCs. While Defendants allegedly disclosed some of the profits made from the business venture, they allegedly concealed that property sellers and mortgage brokers directly or indirectly paid them commissions of up to 15% of the purchase price of the property.
Plaintiffs asserted claims of breach of fiduciary duty, fraud (both actual and constructive) and waste. Defendants filed a motion to dismiss for, among other things, failure to state a cause of action and failure to plead actual fraud and breach of fiduciary duty with specificity.
Issue: Whether a fiduciary duty claim had been sufficiently pled based on both the parties’ relationship and on the defendants’ status as the organizers of the business venture?
Ruling: The parties business or personal relationship is not sufficient to establish a fiduciary relationship. A conventional business relationship between parties dealing at arms length does not give rise to fiduciary duties, unless the plaintiff shows the defendant “had superior expertise or knowledge about some subject and misled the plaintiff by false representations concerning that subject”. While Defendants held themselves out to be experts, Plaintiffs did not allege that Defendants misled them in any way that would affect the transactions.
It is well settled that before and after a corporation comes into existence, a promoter, much like Defendants’ role in this case, acts as the fiduciary to the corporation and its present and anticipated shareholder. By extension, the organizer of an LLC is a fiduciary of the investors it solicits to become members. Therefore, Plaintiffs’ allegations that the Defendants planned the business venture, solicited plaintiffs to invest and organized the LLC are sufficient to establish a fiduciary relationship.
The fiduciary duty includes the obligation to fully disclose any interests of the promoter that might affect the company and its members, including profits. Therefore, Plaintiffs’ allegations that the Defendants: failed to reveal that they would receive commissions from sellers and mortgage brokers in addition to their other, disclosed profit from the venture was sufficient to establish a cause of action for breach of fiduciary.
Lesson: In order to establish a breach of fiduciary duty claim between promoters and investors, there must be sufficient facts alleged to establish the fiduciary relationship as well as the duties owed within that relationship.