LLC, Direct or Derivative Claims and Ad Hoc Litigation Committees: A Lively Debate | Farrell Fritz, PC
The current problem of The business lawyer, a quarterly publication of the ABA’s Business Law Section that aptly bills itself as “the nation’s premier business law journal,” features a duel pair of articles of great interest to scholars. , practitioners and other students of the limited liability company. The authors of the articles, whom I had the good fortune to know during the annual meetings of the LLC Institute and who have guests posted on this blog (here and here) and spoke on my podcast (here), are among the nation’s leading authorities on closed business entities and, in particular, unincorporated entities, including partnerships and LLCs.
I’m talking about Donald J. Weidner (pictured left), Dean Emeritus and former Centennial Professor at Florida State University College of Law, and Daniel S. Kleinberger (pictured right), Professor Emeritus of Law at Mitchell Hamline School of Law. Law.
Among his many accomplishments outside of academia, Dean Weidner is co-author of The Revised Uniform Partnerships Act published by Thomson Reuters, was rapporteur for the Revised Uniform Partnerships Act (1994) and has written numerous articles on partnerships, limited liability companies and financial accounting (SSRN author page here).
Professor Kleinberger’s extracurricular contributions are no less impressive, including co-author of a leading treatise on limited liability companies published by Warren Gorham & Lamont, co-rapporteur and lead editor of legislative text and commentary officials on the Revised Limited Liability Companies Act (2006), and author of numerous articles in journals and law journals (SSRN author page here).
As any long-time reader of this blog knows, and as I wrote not long agoone of the most common issues debated early in corporate divorce litigation involving LLCs as well as private corporations are motions to dismiss direct claims by a minority member against executives who allegedly had to be carried in a derivative way under the law in force. Tools test of direct claims against derived claims. The two articles by Dean Weidner and Professor Kleinberger offer a lively debate between two schools of thought regarding the ability of LLC members to pursue and obtain effective remedies for wrongful claims against LLC officers, in the form of direct or derivative claims, and the ability (or not) of the conflicting LLC officers to gain control of those claims through the appointment of a substitute Special Litigation Committee (SLC) once the claims are qualified as direct (no SLC) or derived (yes SLC).
Article by Dean Weidner
Dean Weidner’s article, titled, The unfortunate role of special litigation committees in LLCs (available here), offers a scathing critique of what he calls “the imposition of derivative litigation complexities ‘derived from derivative public company law’ on limited liability companies [that] imposes significant transaction costs that cannot be allocated and are generally of no use.
Among other critics, acknowledging that the most common claims of manager misconduct lend themselves to characterization as derivative rather than direct, Dean Weidner takes aim at what he calls a misguided departure from the Revised Uniform LLC Act. 2006 to the partnership precepts of its 1996 ancestor by its importation of the direct derivative dichotomy and the ability for LLC managers to appoint Special Litigation Committees (SLCs) “to decide how to dispose of derivative claims “. This “dramatic reversal” from the original 1996 law – which he said created a set of default rules tailored to “small entrepreneurs” giving “easy access ‘to members’ remedies’ – in favor of the RULLCA’s adoption of the “large corporation model of derivative litigation”, has “severely restricted members’ rights to sue directly, while locking in their economic interests”.
His solution? Legislatures should amend their LLC statutes to allow LLCs to “join” the derivative litigation mechanism, rather than forcing them to “opt out,” or even exempting closely held LLCs from litigation restrictions If legislatures balk at such solutions, he writes, courts should move away from the “more lenient standard of review” of SLC decisions, including the decision of the New York Court of Appeals in Auerbach versus Bennett (1979) is paradigmatic, “essentially treating the SLC as exercising the business judgment of the entire board and deferring[ring] to that. Instead, he suggests, courts should follow Delaware’s lead in Zapata Corp. against Maldonado (Del. Sup. Ct. 1981) and In re Oracle Corp. Derivative dispute (Del Ch. 2003) by imposing a stricter and less deferential standard of review for SLC determinations and a “more onerous requirement of SLC independence that requires neutrality with respect to a wide variety of personal and social factors in addition to the factors economic”.
Reply from Professor Kleinberger
Professor Kleinberger’s counterpoint article, entitled The direct-derivative distinction, the special litigation commission and the uniform act: a response to Professor Weidner (available here), mounts a vigorous rebuttal of what he calls the “two key premises” underlying Dean Weidner’s arguments:. The first is that RULLCA “has deserted its appropriate target group”, a criticism which Professor Kleinberger writes, “misunderstands the evolution of uniform limited liability company laws”. The second is that RULLCA “destroyed a member’s easy access to legal remedies”, which Professor Kleinberger says understates both the remedies instituted by RULCCA regarding minority members, including the adding a judicial dissolution remedy for oppressive majority conduct, and erroneously postulates that the courts should put an inch heavier on the side of the scale for the aggrieved member of the minority. As Professor Kleinberger puts it, “some plaintiffs should win, and some certainly shouldn’t”.
After challenging the two assigned premises, Professor Kleinberger’s paper goes on to challenge what he classifies as Dean Weidner’s four main arguments:
- First, Professor Kleinberger argues a number of “flaws” in Dean Weidner’s “direct derivative distinction attack”, including his disagreement with Dean Weidner’s arguments that the distinction “unduly channels claims of violation of the operating agreement” in the derived category and that the status of the LLC” as a separate entity from its owners is irrelevant to the existence hell no of the direct derived distinction.
- Second, Professor Kleinberger takes issue with what he describes as “Dean Weidner’s attack on SLCs by linking SLCs to [the Uniform Law Commission’s] calamitous recognition of the direct derived distinction” in RULLCA (2006). Writes Professor Kleinberger, “The SLC reflects and results from basic governance principles applicable to any business entity defined as a legal person distinct from its owners”.
- Third, Professor Kleinberger defends RULLCA’s endorsement of the standard for reviewing SLC decisions set out in Auerbach on the “minority point of view” expressed in Zapata, describing Delaware case law on the issue as “notoriously unstable and demanding.”[ing] ongoing study,” and doubting the persuasiveness of the empirical evidence cited by Dean Weidner suggesting that SLCs are biased in favor of management.
- Fourth, Professor Kleinberger argues that RULLCA § 805 and its commentaries do not deserve criticism as setting a lax standard for the independence and disinterestedness of SLC members, and at odds with the fact that “disputed decision-makers should be irrefutably presumed incapable of appointing independent and disinterested persons”. surrogates, especially when the conflicting decision makers know that a court will scrutinize appointees for their independence and disinterestedness.
Let me be the first to admit that my summaries above barely scratch the surface of the scholarly professors’ carefully sculpted arguments and supporting documents cited for each. In this relatively short post I cannot do justice to their scholarship and for that I apologize to Dean Weidner and Professor Kleinberger. To my readers, all I can say is, read the articles, you will learn a lot.
The view from the trenches
I guess my own views on the subject of LLCs, Direct Derivative Distinction, and SLCs are heavily influenced by decades of litigation experience handling corporate divorce cases involving primarily businesses run by their member, owner-operated and family-owned, as opposed to large corporations. , capital-intensive, manager-run LLCs with both active owners and passive investors (the latter type is more like a Delaware LLC litigating in the Delaware Chancery Court). This is what I sometimes call the “Two worlds of SARLwhich, for better or worse, exist under the same set of default statutory rules.
Large, highly capitalized LLCs, more like the corporate model with different ownership classes and centralized management, also tend to have better access to sophisticated legal advice conducive to the conclusion of well-tailored and fully-fledged operating agreements. negotiated rules that can vary fail to suit the needs and desires of the company and its shareholders, including carefully crafted provisions for dispute resolution. Not so much in the world of smaller LLCs more like the partnership model in their management and less likely to benefit from a well-crafted operating agreement and therefore likely more dependent on statutory rules by default. Also, I almost never see the appointment of an SLC in such cases.
In other words, in my view, Dean Weidner’s views speak more pragmatically to the world of the smaller LLC, while Professor Kleinberger’s views speak more pragmatically to the world of the larger LLC. Is there an overlap between these two worlds? Sure.
Anyway, insofar as we have judges who understand the differences between these two worlds and the ramifications of these differences, I for one am not very concerned about the ability of our courts to reach fair decisions in cases involving disputes between LLC members of all kinds and sizes.