In CML V, LLC v. Bax, No. 735, 2010 (Del. Supr. Sept. 2, 2011) (click here for .pdf of opinion), the Delaware Supreme Court addressed the questions of whether a creditor can file a derivative action against a limited liability company. Plaintiff CML asserted the following derivative claims against the present and former members of JetDirect Aviation Holdings, LLC:
(1) the individual defendants breached their duty of care by approving the late 2007 acquisitions (of other entities) without informing themselves of JetDirect’s true financial condition,
(2) the individual defendants acted in bad faith by consciously failing to implement and monitor an adequate system of internal controls and—with respect to one specific individual defendant—hiding critical information from the board, and
(3) certain individual defendants breached their duty of loyalty by benefitting from self interested asset sales upon JetDirect’s asset liquidation in 2008.
The defendant managers sought dismissal of the derivative claims on the grounds that CML, as a creditor, did not have standing. The Court of Chancery dismissed the claims and CML appealed. On appeal, the Delaware Supreme Court affirmed.
The central provision at issue is 6 Del. C. § 18-1002, entitled “Proper plaintiff.” That provision reads:
In a derivative action, the plaintiff must be a member or an assignee of a limited liability company interest at the time of bringing the action and:
(1) At the time of the transaction of which the plaintiff complains;
(2) The plaintiff’s status as a member or an assignee of a limited liability company interest had devolved upon the plaintiff by operation of law or pursuant to the terms of a limited liability company agreement from a person who was a member or an assignee of a limited liability company interest at the time of the transaction.
This provision is unambiguous on its face; therefore, its plain language controls...
Because section 18-1002 is unambiguous, is susceptible of only one reasonable interpretation, and does not yield an absurd or unreasonable result, we apply its plain language. Only LLC members or assignees of LLC interests have derivative standing to sue on behalf of an LLC—creditors do not. Therefore, section 18-1002 precludes CML from suing derivatively, and the Vice Chancellor properly granted the motion to dismiss.
The Delaware Court was not persuaded that LLCs should be compared with corporations:
CML contends that this result is absurd because, given the policy underlying derivative standing, there should be no difference between LLCs and corporations. CML argues that unless the Court of Chancery can vest creditors of insolvent LLCs with derivative standing in equity, there will exist no stakeholders with incentive to enforce fiduciary duties through legal action. CML may be correct that in insolvency creditors become the ultimate risk bearers in LLCs. But, the General Assembly is free to elect a statutory limitation on derivative standing for LLCs that is different than that for corporations, and thereby preclude creditors from attaining standing. The General Assembly is well suited to make that policy choice and we must honor that choice. In this respect, it is hardly absurd for the General Assembly to design a system promoting maximum business entity diversity. Ultimately, LLCs and corporations are different; investors can choose to invest in an LLC, which offers one bundle of rights, or in a corporation, which offers an entirely separate bundle of rights.
Professor Larry Ribstein has a thorough analysis of the case at his Truth on the Market Blog.
How does this case apply in Georgia, if at all, since Georgia and most other states look to decisions of Delaware Courts for corporate matters? The rule is essentially the same in Georgia. O.C.G.A. § 14-11-801 (2011) provides the following:
A member may commence a derivative action in the right of the limited liability company to recover a judgment in its favor if all of the following conditions are met:
(1) Either management of the limited liability company is vested in a manager or managers who have the sole authority to cause the limited liability company to sue in its own right or management of the limited liability company is vested in the members but the plaintiff does not have the authority to cause the limited liability company to sue in its own right under the provisions of the articles of organization or a written operating agreement;
(2) The plaintiff has made written demand on those managers or those members with such authority requesting that such managers or such members take suitable action;
(3) Ninety days have expired from the date the demand was made unless the member has earlier been notified that the demand has been rejected by the limited liability company or unless irreparable injury to the limited liability company would result by waiting for the expiration of the 90 day period;
(4) The plaintiff (A) is a member of the limited liability company at the time of bringing the action, and (B) was a member of the limited liability company at the time of the transaction of which he or she complains, or his or her status as a member of the limited liability company has devolved upon him or her by operation of law from a person who was a member at the time of the transaction; and
(5) The plaintiff fairly and adequately represents the interests of the limited liability company in enforcing the right of the limited liability company.
(emphasis added). See also Ledford v. Smith, 274 Ga. App. 714 (Ga. Ct. App. 2005) (company that was not member did not have derivative standing).