The opinion issued by the Delaware Supreme Court (the “Court”) in the matter of CML V, LLC v. Bax, No. 735, 2010 (Del. Supr. Sept. 2, 2011)1 on September 2, 2011 will generally impact the relationa Delaware limited liability company’s relationship with its non-member contractual parties, and specifically its lenders.2 The facts of the case centered around CML V, LLC (“CML”), a junior secured creditor of Jet Direct Aviation Holdings, LLC (“JetDirect”), that sued JetDirect’s present and former officers directly and derivatively for breaching their fiduciary duties in connection with the non-payment of a loan from CML to JetDirect. At the heart of the case was the juxtaposition of Sections 18-10013 and 10024 of the Delaware Limited Liability Company Act (the “LLC Act”), and previous Delaware Supreme Court opinions that held that creditors possessed standing to maintain derivative claims on behalf of Delaware corporations.5
The Court’s Analysis
The Court noted that CML maintained that the LLC Act language did not eliminate standing of a creditor to pursue a derivative claim on behalf of a limited liability company (“LLC”), and that if that were in fact to be determined to be the case, such a determination would be an unconstitutional limitation of the Delaware Court of Chancery’s equity powers.6
Although the Court noted that “[t]he creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties” (emphasis in original),7 a creditor did not have standing where the insolvent entity is a Delaware LLC.
Regarding Section 18-1001 and 1002 of the LLC Act, the Court noted that the language was unambiguous and therefore controlling and in no need of any further interpretation. Specifically in respect of Section 18- 1002 of the LLC Act, the Court wrote:
“This provision is unambiguous on its face; therefore, its plain language controls. In as many words, the provision dictates that a proper derivative action plaintiff “must be a member or an assignee of a limited liability company interest . . .” The statutory language is clear, unequivocal, and exclusive, and operates to deny derivative standing to creditors who are not members or assignees of membership interests.”8
In response to CML’s argument that reading Section 18-1001 and 1002 of the LLC Act together demonstrates that the Delaware General Assembly was only rephrasing analogous Delaware Corporate Law Statutes,9 and thereby permitting creditor derivative actions in an insolvent LLC context as well, the Court was direct in its rebuttal:
“We disagree. 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.”10
Which brings us to the crux of the matter and what may be the most important paragraph of the Court’s opinion as it relates to what may happen in the future between a Delaware LLC and its lenders (and all of its contractual parties for that matter). The Court wrote:
“CML contends that this result is absurd because, given the policy underlying derivative standing, there should be no difference between LLCs and corporations. CML argues that unless the Court of Chancery can vest creditors of insolvent LLCs with derivative standing in equity, there will exist no stakeholders with incentive to enforce fiduciary duties through legal action. CML may be correct that in insolvency creditors become the ultimate risk bearers in LLCs. But, the General Assembly is free to elect a statutory limitation on derivative standing for LLCs that is different than that for corporations, and thereby preclude creditors from attaining standing. The General Assembly is well suited to make that policy choice and we must honor that choice. In this respect, it is hardly absurd for the General Assembly to design a system promoting maximum business entity diversity. 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”.11
In short, intellectually stimulating musings in the context of a Delaware LLC are best left to the members of the LLC when drafting an operating agreement, and the review and comment of such agreement by its lenders. The likely result of the Court’s decision will be a reexamination by lenders of their manner of reviewing the operating agreements of their Delaware LLC borrowers, and will force both potential borrowers and lenders to conduct a state-by-state review of LLC statutes to determine if other jurisdiction’s statutes are drafted in a similar fashion.
Also, as the Court highlighted, the LLC structure is contractual in nature, and Delaware LLC borrowers will no doubt be faced with requests from lenders to amend their operating agreements to address the issues raised in CML v Bax. The Court noted that these might include:
- providing for an automatic assignment of membership interests upon insolvency provision in loan documents and requiring the members of the LLC and the LLC’s governing board to amend the operating agreement accordingly;12 and
- including a creditor derivative claim provision in the LLC’s operating agreement to grant creditors standing to maintain derivative actions against the LLC in the event of insolvency.13
Additionally, the Court correctly noted that addressing the issues raised in their opinion will have an impact on loan pricing, although maybe not in the manner that the Court envisioned.14 And although CML v. Bax involved a traditional lending transaction, the opinion impacts all types of debt instruments, including seller paper, and any party entering into a debtor/creditor relationship with a Delaware LLC will be examining operating agreements to ensure that the rights they currently enjoy in a transaction with a Delaware corporation also apply to the same type of transaction with a Delaware LLC.
The Court, however, was clear in advising that LLCs are different from corporations, that “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.”15 As such, any transaction involving a Delaware LLC will need to be examined to ensure the applicable operating agreement incorporates any necessary provisions so that a party has the same rights against a Delaware LLC that it would have against a Delaware corporation.