November 8, 2010
Freedom of Contract in Delaware LLCs: Use It or Lose It
As Francis Pileggi and Larry Ribstein have already more than amply explained, the Delaware Court of Chancery has determined that creditors of an insolvent LLC do not have standing to pursue a derivative claim against the LLC. CML V, LLC v. Bax, C.A. No. 5373-VCL (Del.Ch. Nov. 3, 2010) (pdf here). The court determined that, unlike similarly situated creditors of Delaware corporations, LLC creditors have no such right.
As Mr. Pileggi explained, the court acknowledged that other courts have allowed creditor suits against insolvent LLCs, but Vice Chancellor Laster declined to follow along with that determination. This seems like the right outcome to me. If the legislature intended to put that language into the statute they could have, but they didn't. Or they could have at least used language that parallels the corporation law, but again they did not.
This is reminiscent of some of the LLC veil piercing statutes and cases. Minnesota and North Dakota, for example, specifically incorporate the state's corporate veil piercing laws. Wyoming, at least as of 2002, did not have such language in the statute, but the state's court nonetheless incorporated veil piercing principles. (H/T Profs. Klein, Ramseyer, & Bainbridge) But they probably shouldn't have.
In my first summer law firm job, one of the partners I worked with was skeptical of LLCs because he didn't trust the body of law and whether the entity would be treated like a partnership or a corporation(and when). I have retained that skepticism, even though there is significantly more law on the subject today than there was ten years ago.
My skepticism doesn't mean I don't like LLCs. In fact, I think they often make a lot of sense. I just think lawyers (and their clients) should be a lot more careful about considering what they want when they enter contracts. I always tell my students -- don't rely on veil piercing if you want a personal guarantee. At least at negotiation, insist on a personal guarantee. If you can't get one, then assess the situation and move forward with eyes wide open. Same here -- as both VC Laster and Prof. Ribstein explain, there are contractual options to protect LLC creditors in Delaware. Don't forget to use them if you want them.
That, or try to persuade your Delaware legislator to change the law.
On a similar note, Federal Courts have recently been issuing orders dismissing cases based on diversity in federal courts because of the distinction between partnerships and corporations who are sued. If a plaintiff brings a claim based on diversity in Federal court against a partnership entity, court's have recognized that, similar to how partnerships are treated in the federal tax code, each individual of the partnership must have complete diversity with the plaintiff to maintain federal jurisdiction. Conversely, claims against a corporation are still maintained as the principal place of business for diversity purposes.
Posted by: Nate P. | Nov 10, 2010 7:06:44 AM