The Commercial Division recently ruled, in a case captioned as Hopkins v. Ackerman,[1] that derivative claims on behalf of an LLC need to be brought before the LLC ceases to exist.  In Hopkins, Justice Saliann Scarpulla granted a motion to dismiss several derivative claims involving now-cancelled Delaware LLCs because, under Delaware law, a cancelled LLC does not have the ability to bring legal claims.  The Court also rejected the plaintiffs’ efforts to cast most of the claims as direct claims on behalf of a specific member in the LLCs. 

Background

Hopkins involved a dispute over the management of a defunct litigation funding entity.  Plaintiff Robert Hopkins was a member who held one-fourth of the interest in Plaintiff Funding America LLC (the “Fund”) and its manager, Plaintiff Funding America Management LLC (“Management”)—two Delaware LLCs that were cancelled in 2017.[2]  Defendant Kenneth Ackerman had assigned his one-fourth interest in the Fund to Defendant Sunrise Consulting LLC (“Sunrise”).  In their Complaint, Plaintiffs alleged that Ackerman had caused the Fund to make distributions to Sunrise that exceeded Sunrise’s capital contribution.[3] 

Plaintiffs also alleged that Ackerman engaged in a litany of other misconduct related to the Fund and Management.  Specifically, Plaintiffs alleged that Ackerman diverted the Fund’s website and phone numbers to Ackerman Fine Arts, an LLC that he controlled himself.  They also alleged that Ackerman accepted write-offs and steep discounts on the repayment of litigation funding contracts without consulting the Fund’s partners.  In addition, the Plaintiffs claimed that Ackerman mismanaged Management’s tax matters.  Finally, Hopkins alleged that Ackerman did not allow Hopkins to access the LLCs’ books and records.[4]

Plaintiffs brought claims for breach of fiduciary duty, conversion, corporate waste, breach of contract, and declaratory judgment in 2018.  The claims were filed after the Fund’s and Management’s LLC statuses were cancelled.

Motion to Dismiss

Defendants filed a motion to dismiss all of Plaintiffs’ claims, arguing that the claims were derivative and, as such, they cannot be brought on behalf of a cancelled LLC.[5]  Plaintiffs responded by alleging that the entities had been illegally cancelled, and further, that Hopkins had later revived the entities.  Hopkins argued in the alternative that the claims were, in fact, his own direct claims that were unaffected by the cancellation of the Fund’s and Management’s LLC statuses.[6]  The parties did not dispute that no claims could be brought on behalf of either entity if they entities were validly cancelled.

LLC Cancellation Bars Derivative Claims

The Court swiftly rejected Plaintiffs’ arguments challenging the entities’ status.  The Court pointed to Delaware Department of State Certifications showing that the Fund and Management had been cancelled in November 2017 and remained cancelled as of March 2019—which was after the date that Hopkins claimed to have revived the LLCs.  Based on these certifications, the Court found that the entities were validly cancelled and, therefore, “plaintiffs lack standing to assert claims on their behalf.”[7]   

Derivative v. Direct Claims

The Commercial Division then considered Hopkins’s arguments that he could bring the claims directly.  The Court based its analysis on Tooley v. Donaldson, Lufkin & Jenrette, Inc., the seminal Delaware Supreme Court case describing the framework for determining whether a claim is direct or derivative.  Tooley directs courts to analyze “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually), and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually).” [8]

Turning first to Plaintiffs’ conversion and waste claims, Justice Scarpulla determined that the allegations “plead harm or injury to all of the members of the Fund and Management, not simply to Hopkins.”[9]  This was true because the alleged diversion of assets, write-offs, and discounts would, if true, constitute harm shared equally by all members of the entities, and not uniquely felt by Hopkins.[10]

The Court then examined Hopkins’s breach of contract claim, which was based on allegations that Ackerman failed to maintain appropriate books and records, failed to properly manage Management’s tax matters, and denied him access to the entities’ books and records.  The Court concluded that the portion of Hopkins’s claim that rests on alleged misappropriation or misdirection of investment proceeds was derivative because “[t]he harm from these alleged actions is to the Fund and Management and recovery would be on behalf of all the members of the LLCs.”[11]  However, the Court found that the allegations that Hopkins was denied access to the entities’ books and records articulated an injury to Hopkins himself.[12]  This portion of Hopkins’s contract claim was allowed to proceed.

The Commercial Division’s analysis of Hopkins’s breach of fiduciary duty claims mirrored the analysis for the breach of contract claim.  To the extent that the claims alleged diversion of entity funds or neglecting valuable receivables, the claims were found to be derivative and therefore dismissed.[13]  The portion of Hopkins’s breach of fiduciary duty claim resting on allegations related to books and records was found to be direct, but the Court concluded that it was duplicative of his breach of contract claim and dismissed it on that basis.[14]

The Court then concluded that Hopkins’s claim for a declaratory judgment was both derivative and entirely duplicative of his other claims.  It was therefore dismissed on those grounds.[15]

Thus, the only surviving claim was the portion of Hopkins’s claims arising from an alleged denial of his access to the books and records of both entities.

Conclusion

In Hopkins, the Court ruled that claims alleging mismanagement or diversion of funds from an LLC must be brought as derivative claims on behalf of that LLC—even if the LLC no longer exists and thus cannot bring the claims under the law of the state where it was organized.