September 29, 2011
CML V, LLC v. Bax: In Defense of (My Read of) DGCL Section 327
A little while back I wrote that section 327 of the Delaware General Corporate Law, as written, excluded the right to a derivative action for anyone but a shareholder. (In CML V v. Bax, the court determined that the Delaware Limited Liability Company Act, 6 Del. C. § 18-1002, does not permit creditor-based derivative actions for LLCs, despite the argument that the LLC Act was meant to track the court's interpretation of the DGCL.) Obviously, the Delaware Supreme Court does not agree with me about section 327, as the Court granted creditors the rights to proceed in a derivative suit where the company is insolvent. N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007).
A comment to my prior post also takes issue with my read of section 327. Ht4 says:
You're putting the rabbit in the hat.
This is where your analysis breaks down: "My reading of section 327 is that derivative claims are unambiguously reserved to shareholders." I disagree. 327 applies it restrictions to "derivative suit[s] instituted by a stockholder of a corporation." It does not purport to apply its restrictions to all derivative actions and, therefore, leaves open the possibility of other derivative suits. 18-1002, on the other hand, is written in exclusive language; it applies to ALL derivative actions. It does not leave open the possibility of other proper plaintiffs. That is the crutial difference.
I appreciate the comment, and I guess we'll have to agree to disagree. I concede that ht4's interpretation is plausible, especially in light of current Delaware law. (And, after all, there is a maxim or canon of construction that can help lead to most any conclusion on this.) Still, I think that inherent in section 327 was the assumption that only a shareholder could bring a derivative action. Section 327 explains which shareholders have such a right of action. The failure to mention in the statute any other type of derivative action tells me that no other type was contemplated. Section 327 simply limits the scope of shareholder derivative actions that are permitted.
It is certainly plausible that the drafters intended to allow creditors or even other stakeholders to have a right to a derivative action, but then why not have some mention, or some prerequisite, as provided for shareholder actions in section 327, to allow the suit to proceed? It is hard for me to imagine a legislature contemplating an easier road to a derivative action for someone other than shareholders, and yet that's what is implied (or at least permitted) if section 327 is not exclusive to shareholder actions.
Further, in affirming the right of derivative actions for creditors, the Delaware Supreme Court provided a prerequisite for creditor standing: insolvency (or, arguably, a company close to insolvency). N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007). The Court determined that "equitable considerations," and not the DGCL, "give creditors standing to pursue derivative claims against the directors of an insolvent corporation." Id. Thus, the DGCL provides the scope of shareholders who can bring such suits, and equity (via the Court) does the same for creditors. Although this outcome is one reasonable interpretation, it is hardly required.
I'm of a mixed mind about whether creditors should have a right bring a derivative suit against an insolvent corporation or LLC. I am, however, reasonably certain that if there is to be such a right, it should be created via statute. In Delaware, I maintain that, as drafted, neither the DGCL or the LLC Act permit such rights to creditors. Obviously, the Court has spoken, and there is now a body of law that makes the law clear in both instances. But section 327 still looks exclusive to me.