Creditors of LPs or LLCs Can’t Sue for Breach of Fiduciary Duty

Guess what! Creditors of a limited partnership or a limited liability company can’t sue for breach of fiduciary duty in Delaware and states with similar laws. The law isn’t new, nor are decisions dismissing lawsuits by creditors’ committees for lack of standing.

The Four Debtors

Four related companies were in chapter 11. One debtor was a Delaware limited partnership, and the other three were limited liability companies organized under the laws of North Dakota and Wyoming.

Before confirmation, the official creditors’ committee obtained court authority and sued an officer for breach of fiduciary duty. The plan created a liquidating trust to pursue causes of action and to be substituted as plaintiff in suits commenced by the committee.

After confirmation, the bankruptcy court granted a motion to change the caption and substitute the liquidating trust as plaintiff in the committee’s fiduciary duty suit.

Later, the defendant filed a motion to dismiss under Rule 12(b)(1), contending the court lacked subject matter jurisdiction because the liquidating trustee had no standing.

The Statutes

The corporate governance statutes in the three states are similar. The state statutes governing LPs and LLCs are likewise similar.

A limited partner of an LP or a member of an LLC may bring a derivative action under Delaware law on behalf of the LP or LLC if those in authority have refused or if a demand would be futile.

The Delaware statutes go on to define a “proper plaintiff” as someone who, “at the time of bringing the action,” was a “partner or an assignee of a partnership interest” or was a “member or an assignee of a limited company interest.”

The Prior Delaware Decisions

Bankruptcy Judge Kevin J. Carey of Delaware granted the motion to dismiss in an opinion on May 2. He followed decisions by colleagues in Delaware.

Interpreting the plain meaning of the Delaware statute, Bankruptcy Judge Kevin Gross ruled in 2018 that an unsecured creditors’ committee of an LLC had no standing to sue for breach of fiduciary duty because none of the creditors was a member of the LLC. Thus, there was no “proper plaintiff.” For lack of a plaintiff with standing, the court lacked subject matter jurisdiction. In re HH Liquidation, LLC, 590 B.R. 211, 283-85 (Bankr. D. Del. 2018).

With insolvent corporations, creditors can pursue derivative actions. According Judge Carey, Judge Gross said that the different outcomes do “not produce an absurd result as different legal principles apply to different corporate entities.” Judge Carey paraphrased Judge Gross as explaining how “LLCs are creatures of maximum flexibility, and creditors are presumed to be capable of protecting themselves through the contractual agreements that govern their relationships.”

Judge Carey therefore said that “limiting a creditor’s right to sue derivatively is in accord with the parties’ bargained for rights and principles of freedom of contract,” citing HH.

Chief Bankruptcy Judge Christopher S. Sontchi of Delaware reached the same result last year when he dismissed a chapter 7 trustee’s derivative claims for lack of standing, because the plaintiff was not a member or an assignee of a member of an LLC. In re PennySaver USA Publishing LLC, 587 B.R. 445, 466-67 (Bankr. D. Del. 2018).

Judge Carey interpreted both decisions to mean that “creditors of insolvent limited liability companies do not have standing to sue derivatively on behalf of the company.”

Given the similarity between Delaware’s LLC and LP statutes, Judge Carey dismissed the derivative suit against the officer of the Delaware limited partnership.

The Wyoming and North Dakota Entities

The Wyoming and North Dakota entities were all LLCs. Judge Carey said that the LLC statutes in those states are “substantively similar to that of Delaware, have been interpreted consistently with Delaware decisions and limit derivative actions . . . to members at the time an action is commenced.” He went on to cite a Wyoming Supreme Court decision “holding that an insolvent LLC’s managers do not owe fiduciary duties to the LLC’s creditors.”

Likewise, Judge Carey said, the Colorado Supreme Court refused to extend fiduciary duties to creditors of insolvent LLCs, “regardless of standing.”

Because none of the creditors was a member of the LLCs, Judge Carey dismissed the suits for lack of standing.

Question: Does the opinion imply that a fiduciary duty lawsuit would survive a motion to dismiss if the plaintiff were the LLC or LP or its assignee?