The Delaware Court of Chancery recently addressed the attempts of a creditor to sue the controlling members of an LLC for breach of fiduciary duty and related claims in connection with allegations that those members deceived the creditor into lending money on false pretenses. In Trusa v. Nepo, C.A. No. 12071-VCMR (Del. Ch. April 13, 2017), the court determined that the creditor had no standing for such claims – – nor did a power of attorney provide a basis for standing.
Background: The creditor involved in this matter was verbally seduced into making an investment in the LLC and was made to believe that his investments would be secured. One of the provisions in the loan documents was a power of attorney that allowed for certain default remedies. After the LLC defaulted on the loans, the creditor learned of various dishonest dealings and misrepresentations regarding the status of the company and what the funds were used for.
Before the Chancery suit was filed, a complaint was filed in the Delaware Superior Court and a default judgment was entered. This Chancery suit was brought claiming that the managing members breached their fiduciary duties. The creditor also sought a dissolution of the LLC in addition to asserting fraud and related claims.
Key Legal Principles
The most noteworthy aspect of this decision is the court’s holding that a creditor has no standing to bring derivative claims on behalf of an LLC for breach of fiduciary duty, based primarily on Section 18-1002 of the Delaware LLC Act. Together with Section 18-1001 of the Act, it remains unambiguous that only members and assignees can assert derivative claims on behalf of an LLC. Prior opinions by Chancery and the Delaware Supreme Court endorsed the foregoing interpretation of the Act. See CML V, LLC v. Bax (“Bax I”) 6 A.3d 238 Del. Ch. 2010) aff’d CML V, LLC v. Bax (“Bax II”), 28 A.3d 1037, 1043 (Del. 2011), highlighted on these pages. See also In Re Carlisle Etcetera LLC, 114 A. 3d 592, 604 (Del. Ch. 2015) (explaining that although they are barred from derivative actions, creditors have adequate remedies at law to protect their interests such as liens on assets. This case also addresses equitable dissolution.)
The court also explained that the creditor’s power of attorney does not and cannot provide standing that is otherwise denied for derivative claims attempted by him. The court observed that such a contrary argument ignores the fact that the power of attorney is expressly limited to pursuing remedies provided in the loan agreement.
No Standing for Dissolution Either
Regarding the dissolution claims, Section 18-802 of the Act limits a request for dissolution of an LLC to either a member or a manager. The creditor in this case likewise failed to establish standing for his request for dissolution. Section 18-203(a) of the Act provides 7 ways that a certificate of cancellation of an LLC may be filed. The ability to file such a certificate did not help this creditor because only after dissolution and winding up of an LLC may a creditor seek appointment of a trustee or a receiver in connection with a prior dissolution.
Regarding the extreme remedy of “equitable dissolution,” the court found insufficient facts in the record to justify such an exercise of the court’s authority.
Fraud Claim Fails
The court emphasized the truism that: a simple breach of contract cannot be bootstrapped into a fraud claim. For example, the court quoted from prior case law holding that: “a party’s failure to keep a promise does not prove the promise was false when made, and that the plaintiff did not adduce evidence showing that the defendant intended to renege as of the time it made the promise.” See footnote 94 (citation omitted).
The fraud claims also failed to satisfy the particularity requirements of Rule 9(b).
The court found that the claim that a material omission amounted to fraud was not adequately alleged for several reasons. The court explained that in an arm’s length negotiation: “where no special relationship between the parties exists, a party has no affirmative duty to speak and is under no duty to disclose facts of which he knows the other is ignorant even if he further knows the other, if he knew of them, would regard them as material in determining his course of action in the transaction in question.” See footnotes 96 and 97.
The court further reasoned that a fraud claim cannot start from an omission in an arm’s length setting. Rather, if a party chooses to speak then he cannot lie, and “once the party speaks, it also cannot do so partially or obliquely such that what the party conveys becomes misleading.” See footnotes 98 and 99.