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CML V, LLC v. Bax, No. 735, 2010 (Del. Sept. 2, 2011) (Steele, C.J.)

September 2, 2011

In this en banc decision, the Delaware Supreme Court affirmed the Court of Chancery’s decision that, under Section 18-1002 of the Delaware Limited Liability Company Act (the “LLC Act”), creditors of a limited liability company lack standing to sue derivatively and, thus, upheld the dismissal of the plaintiff’s claims on the basis that the plaintiff lacked standing.
In April 2007, the plaintiff, CML V, LLC (“CML”), loaned funds to JetDirect Aviation Holdings, LLC (“JetDirect”), a private jet management and charter company, and became a junior secured lender of JetDirect. Before receiving those funds, JetDirect’s board of managers (the “Board”) became aware of serious deficiencies in JetDirect’s internal accounting systems. In late 2007, despite lacking current information about JetDirect’s financial condition, the Board approved several major acquisitions (the “Acquisitions”). Thereafter, JetDirect defaulted on its loan obligations to CML, became insolvent, and began liquidating its assets to reduce its debt burden.  In March 2010, CML filed suit in the Court of Chancery asserting derivative and direct claims against JetDirect’s present and former managers. CML asserted derivatively that the defendants: (i) breached their duty of care by approving the Acquisitions, (ii) acted in bad faith by consciously failing to implement and monitor an adequate system of internal controls, and (iii) breached their duty of loyalty by benefiting from self-interested asset sales in connection with JetDirect’s asset liquidation. CML asserted directly that JetDirect breached the loan agreement between the parties and sought money damages. CML claimed that the Court of Chancery had jurisdiction over the direct claim under the clean-up doctrine. In May 2010, the defendants moved to dismiss all four claims. The Court of Chancery dismissed CML’s claims holding that, as a creditor, CML lacked standing to pursue derivative claims against JetDirect, and, absent such standing, the Court of Chancery also lacked jurisdiction over the direct claim. CML appealed the judgment.

The Delaware Supreme Court first addressed CML’s contention that, in drafting Sections 18-1001 and 18-1002 of the LLC Act, the Delaware General Assembly intended to take the corporate rule of derivative standing, which does not preclude derivative standing for creditors of insolvent corporations, and apply it in the LLC context. Section 18-1002 of the LLC Act, however, differs from the less restrictive language contained in the corporate statute, and provides that the plaintiff in a derivative action “must be a member or an assignee of a limited liability company interest.” The Court found that this language was clear, unequivocal, and not susceptible to more than one reasonable interpretation. The Court, therefore, found that, under the plain language of Section 18-1002 of the LLC Act, derivative standing is limited exclusively to LLC “member[s]” and “assignee[s]” of an LLC interest.

Though CML contended that, given the policy underlying derivative standing, this result was absurd because there should be no difference between LLCs and corporations, the Court disagreed. The Court stated that LLCs and corporations are different and offer different bundles of rights. Because the structure of the LLC Act gives creditors flexibility to protect their unique interests by contract, the Court found it logical for the Delaware General Assembly to limit LLC derivative standing and exclude creditors. Therefore, the Court held that Section 18- 1002 of the LLC Act precluded CML from suing derivatively and that the Court of Chancery properly granted the defendants’ motion to dismiss. 

The Court then turned to CML’s argument that, if Section 18-1002 exclusively limits derivative standing to LLC members and assignees of an LLC interest, it amounts to an unconstitutional curtailment of the Court of Chancery’s equity jurisdiction. Under the Delaware Constitution, the General Assembly may not limit the Court of Chancery’s equity jurisdiction to less than the general equity jurisdiction of the High Court of Chancery of Great Britain existing in 1792, the time of separation from Great Britain. However, in 1792, the High Court of Chancery of Great Britain did not have equitable jurisdiction to grant or extend derivative standing absent a threat to justice in the corporate context. Since this case dealt with an LLC, an entity form that did not exist in 1792, instead of a corporation, the Court held that nothing in the Delaware Constitution precluded the Delaware General Assembly from limiting the scope of LLC derivative standing in Section 18-1002 of the LLC Act. Thus, the Court found that limiting LLC derivative standing to LLC members or assignees of an LLC interest was constitutional.

The full opinion is available here