In Trusa v. Nepo, et al. (Xion Management, LLC), Del. Ch. C.A. No. 12071-VCMR (April 13, 2107), the Delaware Court of Chancery again fortified the Delaware limited liability company against growing attacks by creditors claiming a grievance sounding in fiduciary duty. Trusa, an ordinary promissory note creditor, brought direct and derivative claims against Xion Management, LLC (Xion) and its managing members Norman Nepo (Nepo), Bryan Collins (Collins) and Farhaan Mir (Mir), alleging breach of fiduciary duties associated with the use of funds Trusa loaned to Xion. Trusa also sought statutory dissolution of Xion. The Court dismissed Trusa’s claims entirely.

The background facts are somewhat complicated but familiar in the context of a failed high-yield creditor venture. Xion was formed to make debt investments in U.S. publicly traded companies using funds loaned to Xion pursuant to short-term secured notes. Loaned funds in turn would be invested in corporate bonds convertible into the common stock of those publicly traded companies. Trusa made a significant “anchor” loan to Xion in anticipation of Xion making good on repaying Trusa’s high-yield anchor loan. Trusa alleged his anchor loan was made sound by the existence of other Xion debentures which also were to provide additional cash streams designed to mitigate all noteholder risk and to help service Xion’s overall debt load. Central to Trusa’s anchor investment were alleged representations by Nepo, Collins and Mir regarding extensive investment experience, ability to negotiate favorable debenture conversion terms, managing legal drafting and costs associated therewith, and supervising converted share liquidation (and thus the generation of proceeds needed to service the Xion notes) through Xion’s institutional trading accounts. Xion also allegedly committed to investing one hundred percent of all loan proceeds such that Xion’s operations and profits were to be funded by the prowess of Xion’s management, not by the debt intended for investment activities. Xion allegedly raised $1.1 million by issuing several notes, including to Trusa.

Trusa’s note matured and Xion defaulted. Xion immediately blamed Collins, claiming that he, through two investment entities, shadowed Xion’s investments in convertible bonds in the same companies, which resulted in significantly lower returns to Xion. Trusa alleged Nepo and Mir were long aware of Collins’ disloyal intent, saying and doing nothing. Xion, alleged Trusa, then failed to mitigate any Xion losses, while Collins’ own actions regarding his mirror investments made money. Trusa also alleged that Xion failed to invest one hundred percent of the loan proceeds, instead paying Nepo, Collins and Mir, and funneling some of the loaned funds away from Xion into other investments controlled by the managing members, all to the detriment of Xion. Trusa allegedly did not receive any of the promised monthly financial status reports. Xion’s financial position collapsed, and it had little ability to service its debt.

Xion communicated to Trusa that it was reviewing litigation options, including against Collins, in an effort to recover monies due to Xion and its lenders. Xion’s effort on that front waned, and by April 2015, Trusa filed a complaint in the Delaware Superior Court, Xion defaulted and Trusa was awarded judgment on the note. In March 2016, Trusa brought suit in the Delaware Court of Chancery, directly and derivatively on behalf of Xion, against Nepo, Collins and Mir.

Trusa sought declaratory judgments that (1) Nepo, Collins and Mir breached fiduciary duties to Xion; (2) Trusa had standing as a judgment creditor to pursue fiduciary claims; (3) Xion was insolvent, cannot carry on business and must be dissolved under the statute or at equity; and (4) a trustee appointment was appropriate to wind up the affairs of Xion. In Count II Trusa alleged derivative fiduciary duty of care claims against Nepo, Collins and Mir, and by Count III Trusa alleged a duty of loyalty claim against Collins. Trusa’s Count IV sought, as the petitioning party, statutory or equitable dissolution of Xion. Count V was Trusa’s direct claim against Nepo, Collins and Mir for fraud and concealment. Count VI invoked Delaware’s Fraudulent Conveyance Act. Counts VII and VIII alleged conspiracy and aiding and abetting the commission of fraud.

Trusa argued that the foundation of his derivative standing was statutory, equitable given Xion’s insolvency, or by grant of power of attorney via Trusa’s contract rights under the anchor loan note. The Court, relying upon the plain language of the Delaware Limited Liability Company Act, held that Trusa lacked standing to assert any derivative claims on behalf of Xion. Trusa’s creditor status was given no additional weight; citing the Delaware Supreme Court’s seminal holding in CML V, LLC v. Bax, 28 A.3d 1037, 1043 (Del. 2011), the Court summarily sustained Delaware’s bright-line rule that “[o]nly LLC members and assignees of LLC interests have derivative standing to sue on behalf of an LLC—creditors do not.”

The Court was equally unimpressed with Trusa’s power of attorney argument whereby Trusa alleged that language in his promissory note granting him authority to “execute any instrument” included a right to sign a derivative complaint where he “deem[ed such] reasonably necessary or advisable in pursuing [his] remedies…”

Trusa’s dissolution claim fared no better. The Court was steadfast; Trusa lacked standing to seek statutory dissolution because the plain language of 6 Del. C. §18-802 directs that only a member or manager of an LLC can make an application to the court for dissolution. Trusa also argued that the resignation of Xion’s registered agent and subsequent cancellation of Xion’s certificate of good standing vindicated his right to step in and seek dissolution. Not so, said the Court: “[A] creditor may only seek the appointment of a trustee or receiver when a certificate of cancellation is filed after the dissolution and winding up of the company, not where the certificate of formation has been cancelled by operation of law for want of a registered agent.” If the company does not initiate the dissolution process, no other party has statutory standing to intervene or seek dissolution.

Trusa next attempted to invoke equitable dissolution by asserting that Xion’s managing members drove the company into insolvency and then abandoned it. The Court, however, declined to grant the “extreme” remedy of equitable dissolution, especially where Trusa’s verified complaint was replete with allegations regarding the efforts of Nepo and Mir to investigate Collins and accumulate evidence against him, to engage counsel on behalf of Xion to pursue potential claims, and to attempt to negotiate amicable settlements with other creditors. The fact that Xion ultimately was not financially able to engage counsel or that the company did not ultimately resolve outstanding claims was no “basis for [equitable] dissolution.” Trusa’s naked allegations of insolvency, abandonment and managerial dysfunction, said the Court, did not give rise to an equitable intervention that “should be granted sparingly.”

The Court dismissed the remainder of Trusa’s direct fraud, fraudulent transfer and conspiracy claims. The Court held: (1) The Complaint failed to allege any specifics about alleged false statements, times, dates, locations or parties making such statements; (2) the Complaint failed to identify any loan provision requiring Xion to invest one hundred percent of loan money; and (3) the Complaint failed to articulate any material Xion omission because it found that the loan documents did not require Nepo or others to disclose Collins’ potentially disloyal intentions. The Court concluded that the Complaint failed to articulate any specific fraudulent transfer of Xion funds meeting the conditions of the Delaware Fraudulent Transfer Act, and held that Trusa’s loan documents offered no special right for him to pursue claims for Xion’s use of loan funds for operations. As a result, the Court concluded that Trusa had failed to allege an underlying tortious or unlawful act required in support of aiding and abetting and the civil conspiracy claim.

This decision is noteworthy in several respects. First, Delaware courts remain steadfast against the growing trend in other jurisdictions permitting creditor suits against LLCs and their members, the increasing majority of such suits asserting quasi-standing for derivative claims where the LLC approaches insolvency. The growing use of LLCs as debt-funded investment vehicles often requires close scrutiny by lawyers guiding LLC managers and members through complex fiduciary analyses related to the use of investment funds. Thankfully, Delaware remains a key safe haven against the proliferation of creeping quasi-standing arguments that greatly complicate that fiduciary analysis. Second, lawyers advising clients involved with high-yield creditor ventures should pay close attention to agreements and create specific contract rights related to management duties to creditors, including potentially heighted duties as the venture approaches insolvency. Conversion rights upon default coupled with close contract protections should be considered carefully given Delaware’s bright-line rule.