"There is only going to be one winner here, and it's not going to be you—give in while there is something still left in it for you," said one LLC member to the other. With co-owners like that, who needs enemies?
In addition to cinematic threats, the subject of this week's post, In re 305 E. 61st St. Group LLC, 130 F4th 272, 277 (2d Cir 2025), has it all: emergency court orders, changed locks, an intentional foreclosure, a tactical bankruptcy filing, and a trip to the Second Circuit Court of Appeals. The resulting opinion is equally satisfying: the Second Circuit delivers new guidance on the thorny direct vs. derivative distinction and offers a potential boost to implied contractual claims in intra-company disputes.
Let's dive in.
The Project: A Manhattan Warehouse Condominium Conversion.
In 2016, Mitchell Marks organized a group of investors to purchase a warehouse in Manhattan and convert it to a condominium. The investors formed 305 East 61st Street Group LLC (the "Company"), with four members, each taking a different ownership percentage based on the size of their investment: (1) Marks' family LLC, Little Hearts, held 30%; (2) an LLC owned by Defendant Jason Carter, 61 Prime LLC, held 50%; and (3-4) two other "silent investors," Onestone 305 and Thaddeus Pollock, each held 10%.
The parties' Operating Agreement made Little Hearts the manager of the Company, but in the event that Little Hearts resigned or was removed as manager, Carter's 61 Prime held the right to assume the manager duties.
The Operating Agreement also gave each member certain rights to independently develop and use or—upon successful conversion to a condominium—sell different spaces within the building. Marks was given additional rights to the cellar and first floor.
The First Litigation Strike: Broad TRO Installs 61 Prime as Manager.
In July of 2018, Carter commenced an action in NY State Court seeking to remove Marks' Little Hearts as the Manager of the Company. Carter alleged that Little Hearts had violated the major decisions provision of the Operating Agreement, had refused to cede control of the Company despite a valid members' vote to remove it as manager, and was subjecting the Company to liability by attempting to sell condominium units without a valid offering plan.
We often blog about the value of immediate injunctive relief in business divorce litigation: it's the first major skirmish, and it sets the tone for the litigation going forward. In this case, Carter's allegations got him perhaps the broadest temporary restraining order I've ever seen in an intra-company dispute. More than two pages long, the TRO gave Carter's 61 Prime unfettered control of the Company and enjoined Little Hearts from virtually any action inconsistent with Carter's exclusive right to manage and control the Company.
And the wheels of justice turn slowly. That TRO remained in effect for almost a year. During that time, Little Hearts alleges, Carter interfered with Little Hearts' right to develop its units, and it locked out the building's only tenant—a spa that operated out of the ground floor unit.
The Tactical Bankruptcy Petition: Carter Stays the State Court Proceedings Before the TRO Can Be Undone.
It was May of 2019 by the time the parties finally got to a hearing on 61 Prime's preliminary injunction application. By that time, the Company had defaulted on its obligations to its lender, and the parties had filed 11 other motions or orders to show cause—most seeking the upper hand in the battle for immediate control of the Company.
At a May 2019 Hearing, Justice Lebovits strongly suggested that Carter would not get his injunction, that the TRO would be vacated, and a receiver would be appointed—as Little Hearts requested. He told Carter's counsel: "In two days, all you did was prove that you don't have a case."
But before Justice Lebovits could issue his ruling, Carter caused the Company to file for bankruptcy. The bankruptcy petition stayed the state court action before the TRO could be undone.
The Coup de Grâce: Carter Buys the Building in Bankruptcy.
A bankruptcy trustee was appointed and submitted a plan of liquidation, which called for the sale of the building and established a creditor trust to liquidate the remaining assets of the Company—including legal claims. And, lo and behold, at the bankruptcy sale, Carter's newly formed LLC, aptly named Lazarus 5, acquired the building.
The Early Dismissals: Marks' Claims Dismissed as Derivative.
Following the sale, Marks' Little Hearts commenced a state court action accusing Carter of initiating the bankruptcy proceeding solely to forestall an adverse ruling in the state court litigation. The Bankruptcy petition, Marks alleged, was neither necessary nor appropriate because the value of the building far exceeded the Company's liabilities.
Marks brought three claims against 61 Prime relevant here: (i) for breach of fiduciary duty arising from Carter's scheme to send the Company into bankruptcy and buy the building in the liquidation sale, (ii) for breach of the operating agreement and (iii) for breach of the implied duty of good faith and fair dealing arising from 61 Prime's alleged abuse of its powers as manager to squeeze Little Hearts out of the Company and the building itself. Marks' complaint sought damages of at least $48,052,000.
Carter removed the complaint to Bankruptcy Court, which dismissed Marks' claims. The Bankruptcy Court held that Marks' claims were derivative ones—claims that sought redress for injury to the Company, rather than to Marks individually—and under the confirmed bankruptcy plan, the only party who could bring those claims was the creditor trustee.
The United States District Court for the Southern District of New York affirmed the Bankruptcy Court's characterization of Marks' claims as derivative and their dismissal.
The Reversal: Second Circuit Holds that the Implied Covenant Claim is Direct.
About 18 months ago, we blogged about the Second Circuit's decision in Miller v Brightstar Asia, Ltd., 43 F4th 112 (2d Cir 2022) which held under Delaware Law that a claim for breach of the implied duty of good faith and fair dealing in a shareholders' agreement was properly pled as a direct claim, not a derivative one, even though the harm alleged was a diminution in the value of the Company (read here). The Brightstar Asia Court reasoned that because the shareholders' agreement gave the plaintiff individual buy-sell rights, the plaintiff could state a direct claim for the defendants' alleged impairment of those rights.
The same reasoning carried the day here. Though it affirmed dismissal of Marks' breach of fiduciary duty claims, the Second Circuit reinstated Marks' claims for breach of the operating agreement and breach of the implied covenant of good faith and fair dealing, holding that those claims were direct, not derivative. Specifically, the Operating Agreement granted Marks the individual right to "retain, use, occupy, develop, and acquire" specific units in the building—rights separate from those attendant to his membership. And as pled, Carter's alleged bad faith scheme to squeeze Marks out of the building interfered with those individual rights—whether express or implied:
We have previously explained that 'when a plaintiff asserts a claim based on the plaintiff's own right, such as a claim for breach of a commercial contract,' the claim is direct regardless of the Tooley test. Brightstar Asia, 43 F.4th at 122. In this case, the claims for breach of contract and for breach of the implied covenant of good faith and fair dealing belong to Little Hearts, not to the creditor trust."
The Power of the Implied Covenant Claim.
Even as the end remains unwritten, there are a few morals to the story here. The case offers more helpful guidance on the sometimes elusive direct vs. derivative question and the Tooley test for resolving that question. It also highlights the limits of a "tactical" bankruptcy petition. Yes, Carter's broad TRO and subsequent bankruptcy petition bought him time and got him the building, but it did not allow him to escape the $48 million lawsuit from Marks.
But most of all, In re 305 E. 61st St. Group LLC highlights—again—the power in the business divorce context of a claim for breach of the implied covenant of good faith and fair dealing. In contrast to fiduciary duty-based claims, the implied covenant claim cannot be waived and can (at least in certain circumstances) be asserted directly rather than derivatively—a critical distinction here, since the bankruptcy plan foreclosed Marks from bringing derivative claims.
For these reasons, the implied covenant claim can be a valuable tool in the business divorce litigator's toolbox. Former Delaware Chancellor William B. Chandler once remarked that, "it is the unwaivable protection of the implied covenant that allows the vast majority of the remainder of the LLC Act to be so flexible" (R & R Capital, LLC v Buck & Doe Run Val. Farms, LLC, CIV.A. 3803-CC [Del Ch Aug. 19, 2008]).
To be sure, the claim has its limitations. It does not apply where the operating agreement expressly contemplates the circumstance at issue (Cohen PDC, LLC v Cheslock-Bakker Opportunity Fund, LP, 94 AD3d 539, 540 [1st Dept 2012]), nor can it be used to "rewrite or supply omitted provisions to a written contract" (Lard-PT, LLC v Seokoh, Inc., 69 Misc 3d 1207(A) [NY County 2020] [discussed here]). Those limitations make many skeptical about the claim's potency in intra-LLC disputes (see Peter Molk, Protecting LLC Owners While Preserving LLC Flexibility, 51 UC Davis L Rev 2129, 2181 [2018]). Professor Bainbridge's criticism (here) is perhaps the most colorful.
And let's not forget that Marks needs to prove that claim before he sees any of the $48 million he demands (KSFB Mgt., LLC v Focus Fin. Partners, 2025 NY Slip. Op. 50061 [NY County 2025] ["Ultimately, a party who asserts the existence of an implied-in-fact covenant bears a heavy burden to prove not merely that it would have been better or more sensible to include such a covenant, but rather that the particular unexpressed promise sought to be enforced is in fact implicit in the agreement viewed as a whole."]).
But despite its limitations and critics, for as long as the claim remains unwaivable and direct, cases like this one ensure that the implied covenant claim will have a unique and—at least sometimes—powerful role in business divorce litigation.
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