In Delaware, to assert a derivative action against company management, either a presuit demand must be made, or plaintiff must allege that demand would be futile because the board is not disinterested. For derivative actions asserted by shareholder against a corporation or of an unincorporated association, Court of Chancery Rule 23.1 requires that the complaint “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.” Ct. Ch. R. 23.1.
The Delaware Limited Liability Act similarly requires that a complaint must “set forth with particularity the effort, if any, of the plaintiff to secure initiation of the action by a manager or member or the reasons for not making the effort.” 6 Del. C. § 18-1003. Thus, members of a Delaware LLC must likewise allege presuit demand, or demand futility.
An interesting question becomes whether this requirement applies to 50/50 “joint venture” limited liability companies, in which two 50/50 managing members have equal control over the company. The recent decision of Diestrichson v. Knott, et al., C.A. No. 11965-VCMR (Del. Ch. Apr. 19, 2017) answers in the affirmative. There, a managing member who held a 50% interest in the entity asserted claims against the other 50% owner for breach of fiduciary duty by paying himself an unauthorized salary and misappropriating the proceeds of an asset sale. Plaintiff also brought claims for breach of the operating agreement and the implied covenant of good faith and fair dealing.
Vice Chancellor Montgomery-Reeves rejected plaintiff’s reliance upon El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248 (Del. 2016), in support of the proposition that the fiduciary duty claims were “dual-natured”, i.e., possessing both derivative and direct qualities. The Court noted that in Brinckerhoff, the Delaware High Court stated that in “unique circumstances” it has recognized that certain claims have both direct and derivative aspects. This namely occurs when the action involves a controlling stockholder and transactions “that resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.” Brinckerhoff, 152 A.3d at 1262.
Because plaintiff did not allege any dilution of voting power in the case, the Court found that Brinckerhoff did not apply. And because plaintiff did not alleged demand futility or that demand was made and wrongfully refused, the derivative claims were dismissed.
Key Takeaway: In actions between two managing members of a 50/50 limited liability company, a common assumption is that any traditionally derivative claims, such as breach of fiduciary duty, would be direct given the bilateral composition of the LLC. Such an assumption could be problematic and may lead to dismissal of such claims, if plaintiff fails to allege facts that a direct harm was likewise incurred, such as dilution of voting power.
Carl D. Neff is a partner with the law firm of Fox Rothschild LLP. Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at email@example.com.