Waiving the Right to Bring a Derivative Action

Waiving the Right to Bring a Derivative Action

In a pair of recent cases involving, respectively, Delaware and Nevada LLCs, the courts were called upon to determine whether each LLC’s operating agreement waived the ability of the minority members to bring a derivative action.

Both suits were decided in New York.  In the case involving the Delaware LLC, Talking Capital LLC v. Omanoff, the court rejected the assertion that the structure of the operating agreement, which utilized a board with broad powers, was sufficient to eliminate the ability to bring a derivative action. It was noted as well that, were that argument accepted, it “would inherently immunize managing members who commit wrongdoing.” That decision as well noted that the provision of the Delaware LLC Act addressing derivative actions was not qualified by “unless otherwise provided in the operating agreement”, noting that this left open the question as to whether § 18-1001 of the Delaware LLC Act is mandatory or subject to modification by the members.

In the case involving the Nevada LLC, Human Nature Las Vegas Inc. v. Gildea, the New York Court was reviewing an operating agreement for a Nevada LLC. Under the Nevada LLC Act, the right to bring a derivative action is clearly subject to modification, the statute providing “unless otherwise prohibited by the… operating agreements.” In that instance, while the operating agreement required that at least a majority of the three members approve certain key decisions including whether to “commence or settle any litigation or arbitration or hire or terminate any counsel in connection with such litigation or arbitration,” that language was insufficient to eliminate the ability to bring a derivative action.

These two cases have been reviewed by Peter Mahler in his blog New York Business Divorce in an April 23, 2018 posting titled Can LLC Agreement Waive Right to Sue Derivatively? Not in these two cases; HERE IS A LINK to that posting.

While neither of these courts found it necessary to reach the ultimate question, namely can the right to bring a derivative action be waived, there is a Kentucky trial cout decision to that effect. In J & B Energy, Inc. v. Caldwell, the Kentucky Court of Appeals was focused upon whether or not one of the participants in a particular transaction was acting as the attorney for the other members. Unfortunately, not appealed in that case was a determination by the trial court that certain language in the operating agreement was sufficient to waive the right to bring a derivative action. I reviewed that issue in a blog posting on October 6, 2014 titled Waiver of the Right to Bring a Derivative Action? HERE IS A LINK to that discussion. I have otherwise taken the position that the capacity to bring a derivative action is not subject to modification in the operating agreement. For example, I blogged on that issue on May 19, 2015 in a posting On Further Reflection, “No”; HERE IS A LINK to that posting.