From Professor Ann Conaway
Widener University School of Law
In a case of first impression, the Delaware Supreme Court in CML V LLC v. Bax, (Del. Sept. 2, 2011,) has held that creditors do not have derivative standing to bring a fiduciary duty claim against present or former managers of an insolvent Delaware LLC under statutory provisions of the Delaware Limited Liability Company Act (DLLCA). The statutory preclusions on which the Supreme Court relied are found at 6 Del. Code §§ 18-1001-1002. In its opinion, the Delaware Supreme Court set forth the language of § 18-1002, stating that: “the plain language [of the statutory provisions] is unambiguous and limits derivative standing to “member[s] or assignee[s]” and that exclusive limitation is constitutional.” (Emphasis in the original). Indeed, § 18-1002 defines a “Proper plaintiff” as: “ In a derivative action, a plaintiff must be a member or an assignee of a limited liability company interest at the time of bringing the action….” (Emphasis added)
CML had entered a loan transaction with JetDirect at a time when the company’s finances were uncertain and the company’s financial situation somewhat unclear. However, CML was always free to contract for any terms it desired if greater financial security was sought. Shortly after the loan agreement by CML, JetDirect became insolvent and failed to pay CML. CML brought suit in the Court of Chancery for derivative and direct claims, including breach of the duty of care. The Court of Chancery dismissed the derivative claims and the case was appealed to the Delaware Supreme Court.
On appeal, the Vice Chancellor’s interpretation of DLLCA §§ 18-1001-1002 was disputed. In addition, counsel for CML argued that the Vice Chancellor’s interpretation rendered the statutory provisions of DLLCA unconstitutional on the grounds that they stripped the Court of Chancery of its traditional power to do “equity.” The Supreme Court quickly disposed of the constitutionality argument on the basis that the equitable derivative suit for stockholders from English common law was grounded in corporate – not LLC law. The Supreme Court continued that the Delaware General Assembly was free to legislate exceptions from the common law and did so with the enactment of the DLLCA in 1992.
The Supreme Court’s opinion in CML v. Bax is a beacon of hope for the law of Delaware unincorporated entities for its uncontroverted stance in line drawing between Delaware corporations and LLCs. In this opinion, the Supreme Court refuses, through the doctrine of equity, to infuse corporate principles into Delaware’s unambiguous, contractually based alternative entity statutes. With this opinion comes greater clarity and lower agency costs in the law of Delaware LLCs. Hopefully, the opinion will serve as a harbinger for the abandonment of corporate principles to define the rights of members, managers and other parties to a Delaware operating agreement. Five stars to the Delaware Supreme Court!