CML V, LLC v. Bax Strikes An Ambiguously Unambiguous Tone

As I reported last week, the Supreme Court of Delaware decided CML V, LLC v. Bax on September 2, 2011. I promised a follow up with my take, so here it is:  The Court got the outcome right, but it relies too much on the wrong rationale for the outcome. 

On appeal, CML argued that the Delaware Limited Liability Company Act does not eliminate standing for creditors seeking to bring derivative actions on behalf of insolvent LLCs (in 6 Del. C. §§ 18-1001 and 18-1002). The defendants, in turn, asserted that the LLC Act exclusively limited standing to LLC  “member[s]” or “assignee[s]” as stated in 6 Del. C. § 18-1002.  The Delaware Supreme Court agreed with the defendants, finding that language of the LLC Act was clear and unambiguous, and thus deprived the creditors standing.  

I'm okay with that result, but I'm troubled by what I view is an overstatement of part of the rationale. The Court explains that CML claimed the legislature intended 6 Del. C. §§ 18-1001 and 18-1002 to rephrase the language of the Delaware General Corporate Law, which the Delaware Supreme Court has concluded does allow creditors standing to sue insolvent corporations derivatively.  CML was thus arguing that the Delaware legislature "merely intended to take the corporate rule of derivative standing for creditors of insolvent corporations and apply it in the LLC context."  The Court disagrees, and states: "When statutory text is unambiguous, we must apply the plain language without any extraneous contemplation of, or intellectually stimulating musings about, the General Assembly’s intent."

 The problem I have with that is that section 327 of the DGCL provides as follows:

In any derivative suit instituted by a stockholder of a corporation, it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction of which such stockholder complains or that such stockholder’s stock thereafter devolved upon such stockholder by operation of law.

To my knowledge, there is no "operation of law" that transfers shareholders' stock to creditors of an insolvent corporation. In fact, in determining that creditors of an insolvent corporation can bring a derivative suit, the Delaware Supreme Court explained: 

The corporation's insolvency “makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm's value.”  Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation.

N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 Del. 2007) (footnote omitted).  So the corporate creditors' right of standing is equitable, not statutory, under the DGCL.  My reading of section 327 is that derivative claims are unambiguously reserved to shareholders. Thus, in my view, the Court is either saying that Gheewalla is wrongly decided or the Court vastly overstates the case when it says that "section 18-1002 is unambiguous, is susceptible of only one reasonable interpretation, and does not yield an absurd or unreasonable result." Give the contours of the law, and Delaware law specifically, CML's interpretation is entirely reasonable.  CML's view is not right, in my view, but it is reasonable, because laws are should be considered in context.  

The Court should have stuck with its earlier analysis, and stopped there:

Ultimately, LLCs and corporations are different; investors can choose to invest in an LLC, which offers one bundle of rights, or in a corporation, which offers an entirely separate bundle of rights.

Moreover, in the LLC context specifically, the General Assembly has espoused its clear intent to allow interested parties to define the contours of their relationships with each other to the maximum extent possible. It is, therefore,logical for the General Assembly to limit LLC derivative standing and exclude creditors because the structure of LLCs affords creditors significant contractual flexibility to protect their unique, distinct interests.

I know it could be argued that I'm picking nits here, but I think the Court should have rested on the proposition that the language of the LLC Act clearly excludes creditors from derivative standing, while acknowledging the same is true of the DGCL. In the analogous situation in corporate law, the Court determined that creditors of insolvent corporations have standing to sue derivatively. Because LLCs are different, and intended to be distinct entities from corporations, the Court declined to do so here.  

It's not just that the statute is unambiguous; it's that LLCs are inherently different. And while a reasonable person may think LLCs should be analogous to corporations, the reality is that LLCs can be, but need not be, analogous to corporations. The nature of the LLC is such that those who form the LLC and do business with the LLC must contractually make the LLC analogous if that is what they desire. Default rules and gap fillers will not save the day in the LLC setting as they might in the corporate world.

I concede that my rationale leads to the same result, but the Delaware Supreme Court missed an opportunity to, once and for all, make clear that LLCs and corporations are wholly different entities. While it is of little consequence in this case, in future situations, courts may still miss that point, and again inappropriately apply corporate concepts where the statute is not so clear.  As such, while much of the language from Vice Chancellor Laster's opinion below remains intact, the Supreme Court's focus on the unambiguous nature of the statute diminishes the tone.  I would have stuck with the tone Vice Chancellor Laster captured in the last sentences explaining the rationale behind his opinion:

In light of the expansive contractual and statutory remedies that creditors of an LLC possess, it does not create an absurd or unreasonable result to deny derivative standing to creditors of an insolvent LLC. The outcome does not frustrate any legislative purpose of the LLC Act; it rather fulfills the statute’s contractarian spirit. 

--JPF