United States: Creditors Have No Right To Derivative Suit Against Managers Of Insolvent Delaware LLC

SUMMARY

The Delaware Court of Chancery sided with LLC managers in denying the right of creditors to sue them derivatively, highlighting an additional benefit of using the LLC to limit liability.

The Delaware Court of Chancery, in CML V, LLC v. Bax, C.A., No. 5373-VCL (Nov. 3, 2010), has provided yet another reason why Delaware may be the state of choice for organizing an LLC from the standpoint of those governing its affairs.

In Bax, creditors of JetDirect, a Delaware LLC, had filed a derivative suit against JetDirect's managers, claiming that the managers had breached their duty of care by approving certain acquisitions, at a time when JetDirect was insolvent or in the range of insolvency, without informing themselves of critical information concerning JetDirect's financial condition.

As a defense to the suit, JetDirect's managers asserted that JetDirect's creditors lacked standing to bring the suit because, under Sections 18-101 and 18-1002 of the Delaware LLC Act, only members or assignees of a limited liability company interest are permitted to bring an action in the Court of Chancery in the right of a limited liability company to recover a judgment in its favor. Creditors, according to the managers, did not come within the literal umbrella of these Sections.

In a clear and well-reasoned opinion, Vice Chancellor J. Travis Laster reviewed the creditors' argument that, despite its clear language, the Delaware LLC Act should be interpreted the same way that Delaware law applicable to corporate derivative suits is interpreted. That is, according to the creditors, because Delaware corporate law permits creditors to bring a derivative suit in the case of a breach of fiduciary duty by directors of a corporation that is insolvent or in the range of insolvency, creditors of an LLC should have the same right.

Reciting the history of corporate derivative actions, the history of derivative actions in the case of limited partnerships, and the history of the Delaware LLC Act, the Vice Chancellor sided with JetDirect's managers and concluded that the Act reserves the right to bring a derivative action exclusively to LLC members and their assignees, thus rejecting the claim of JetDirect's creditors.

The case is significant both for managers and creditors of limited liability companies. For managers, the case highlights the possible benefit of using the LLC form to limit their liability, not just in Delaware but also in states whose statutes follow Delaware's statute concerning derivative actions. From the creditor's standpoint, Bax demonstrates the need of creditors specifically to negotiate the right to bring a derivative action should the creditor believe that right to be important.

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