Chancery Bars Derivative Actions By Creditors Of LLCs and LPs

For several years it has been established that creditors of Delaware corporations have standing to bring derivative actions when the debtor corporation is insolvent.  A recent Court of Chancery opinion, however,  CML V, LLC v. Bax, C.A. No. 5373-VLC (Del. Ch. Nov. 3, 2010), has held that that is not the case with respect to Delaware  limited liability companies (LLCs) – and implicitly Delaware limited partnerships (LPs).

In 2007, the Delaware Supreme Court had held that creditors had standing to bring derivative actions in the name of debtor insolvent Delaware corporations.   N. Am. Catholic Educ. Prog. Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007) (“Gheewalla”).  Late last year, the Court of Chancery held in Bax that creditors of Delaware LLCs cannot bring such derivative actions.  The Court did so based on a provision of the Delaware LLC Act requiring contemporaneous ownership of membership interests.  6 Del. C. § 18-1002.  Section 18-1002, unlike the equivalent corporation law provision,  states that plaintiff “must” be a “member or an assignee” of the LLC “at the time of the transaction of which the plaintiff complains” (known as the contemporaneous ownership requirement).  The Delaware LP Act contains substantively identical language.  While the Delaware General Corporation Law also contains a contemporaneous ownership provision, it is not worded to expressly require a derivative plaintiff to be a stockholder.  See 8 Del. C. § 327 (“In any derivative suit instituted by a stockholder of a corporation, it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction . . . .).

The Court was apparently not entirely comfortable with either of the two conflicting rules of Delaware law from which the holding in Bax resulted.  Vice Chancellor J. Travis Laster noted his prior criticism of the contemporaneous ownership requirement.  In justifying its decision, the Court noted the methods LLC creditors have to protect themselves, such as requiring protection in an LLC agreement.  The Court also referenced the criticism of creditor derivative standing itself by another member of the Court, though acknowledging that such standing is now the law under Gheewalla at least with respect to insolvent Delaware corporations.

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Filed under: Court of Chancery, Derivative Actions, Derivative Standing