Lenders Beware: Delaware Supreme Court Holds Creditors of Insolvent LLC Lack Derivative Standing

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The Delaware Supreme Court recently held that creditors lack standing to bring a derivative suit on behalf of an insolvent Delaware limited liability company (an “LLC”) under the Delaware Limited Liability Company Act (the “LLC Act”). CML V, LLC v. Bax, No. 735, 2011 WL 3863132 (Del. Sept. 2, 2011, corrected Sept. 6, 2011). In an opinion written by Chief Justice Steele, the Delaware Supreme Court affirmed the Court of Chancery’s dismissal of claims brought by a junior secured creditor against the LLC’s present and former officers directly and derivatively for breaching their fiduciary duties. The Delaware Supreme Court’s holding was based on a plain reading of 6 Del. C. § 18-1002 which requires that a plaintiff be a “member” or an “assignee” of a limited liability company interest to bring a derivative action on behalf of an LLC.

Defendant JetDirect Aviation Holdings, LLC (“JetDirect”), a Delaware limited liability company, was a private jet management and charter company. In 2005, JetDirect began a series of transactions to acquire small and midsized competitor and charter service companies which left the company heavily leveraged. Between 2006 and 2007, JetDirect’s officers and board of managers learned of “serious deficiencies” in the company’s accounting system and internal controls. Nevertheless, the board continued its aggressive acquisition strategy. In April 2007, on the basis of outdated information, CML V, LLC (“CML”) made a loan to JetDirect of approximately $26 million, which later increased to approximately $34 million. Shortly thereafter, in June 2007, JetDirect defaulted on its loan obligations to CML, and by January 2008, JetDirect was insolvent and began to liquidate its assets.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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