Creditors of Insolvent Delaware Limited Liability Companies Lack Standing to Pursue Derivative Claims

Relying on the plain language of Delaware’s Limited Liability Company Act, the Delaware Supreme Court, in CML V, LLC v. John Bax, et al., recently ruled that creditors of insolvent Delaware limited liability companies lack standing to sue derivatively for their managers’ alleged breach of their fiduciary duties.

According to Chief Justice Myron T. Steele, writing for the Court, 6 Del. C. § 18-1002 of Delaware’s Limited Liability Company Act is “unambiguous and limits derivative standing in LLCs exclusively to ‘member[s]’ or ‘assignee[s].’” In so holding, the Court distinguished insolvent LLCs from insolvent corporations, which are subject to derivative claims by creditors, noting that “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 Court further noted that “the structure of LLCs affords creditors significant contractual flexibility to protect their unique, distinct interests” and suggested that LLC creditors have the option to negotiate contractual provisions to protect them in the event of an LLC’s insolvency. For example, creditors can seek provisions in their credit agreements automatically assigning membership interests to them upon an LLC’s insolvency and requiring that the LLC agreement be amended accordingly.

The Court also found the LLC Act’s limitation on LLC derivative standing to be constitutional, because the Delaware Constitution guarantees the Court of Chancery the equity jurisdiction to extend derivative standing to prevent failures of justice only in cases involving the corporate form, which existed at common law in 1792 when Delaware first ratified its constitution, as distinguished from the LLC, which came into existence in Delaware only by virtue of the passage of the LLC Act in 1992. The Court emphasized, “when adjudicating the rights, remedies, and obligations associated with Delaware LLCs, courts must look to the LLC Act because it is only the statute that creates those rights, remedies, and obligations.”

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