Commercial Division Reiterates That Claims Based on Harm to All Members of LLC are Derivative

The issues related to the bringing of claims involving a cancelled LLC were addressed in the Commercial Division’s recent decision in Hopkins v. Ackerman.  In November 2019, Justice Saliann Scarpulla dismissed most of Hopkins’s and his co-plaintiffs’ claims as derivative, and therefore unable to be brought on behalf of a cancelled LLC.  We covered that decision here.  Following that decision, Hopkins sought leave to bring additional direct claims, but Justice Scarpulla’s recent decision rejected all but one of the proposed claims—a breach of fiduciary duty claim based on allegations that Hopkins was frozen out of decision-making and membership rights.  The other claims were rejected as derivative because they concerned the alleged failure to distribute the LLCs’ assets, a harm felt equally by all members.  Justice Scarpulla also reaffirmed her earlier ruling that a challenge to an LLC’s cancellation status (which could re-open the door to derivative claims) must be brought in Delaware, where the entities were established and cancelled.

Background

Hopkins involved a dispute over the management of a defunct litigation funding LLC known as Funding America LLC (the “Fund”).  Plaintiff Robert Hopkins held one-fourth of the interest in the Fund and also one-fourth of the interest in the Fund’s manager, Plaintiff Funding America Management LLC (“Management”).  Both LLCs were formed in Delaware LLCs, and they were both cancelled in 2017.[1]  Prior to the commence of the litigation, Defendant Kenneth Ackerman had assigned his one-fourth interest in the Fund to Defendant Sunrise Consulting LLC (“Sunrise”).

Plaintiffs’ original complaint alleged that Ackerman had funneled the Fund’s assets and business to Sunrise, as well as other actions that depleted the Fund’s assets without consulting the Fund’s other partners.[2]  In a decision we covered here, Justice Scarpulla ruled that most of Plaintiffs’ claims for breach of fiduciary duty, conversion, corporate waste, and breach of contract were derivative because the alleged misconduct was directed at the entire Fund, and not uniquely at Hopkins. [3]  

Justice Scarpulla also ruled that, under Delaware law, Plaintiffs could not bring derivative claims on the Fund’s and Manager’s behalf because the entities had been cancelled.[4]  The only claim to survive the initial motion to dismiss was the portion of Hopkins’s contract claim alleging that he was denied access to the entities’ books and records.[5]

After the court’s ruling, Hopkins sought to amend the complaint in several respects.  First, he sought to assert a claim that Defendants directly breached the operating agreement as to him by refusing to pay distributions to him.[6]  Second, he also proposed a breach of contract claim based on the allegedly improper dissolution of the entities.[7]  Third, he sought to assert a breach of fiduciary duty claim based on two allegations:  (1) that Ackerman “froze out” Hopkins from the daily operations, decision making, inclusion in K-1s, and all membership rights in the Fund; and (2) that Ackerman illegally dissolved the entities to misappropriate the assets that should have been paid to Hopkins in distributions.[8]  Fourth, he sought to add a claim for fraudulent conveyance on the theory that Ackerman transferred Fund assets to himself and deliberately dissolved the Fund to prevent Hopkins from obtaining his distributions.[9]  Finally, Hopkins sought to add accountant Al Reda (“Reda”) and his firm Reda Remano & Co., LLC (“Remano”) as defendants based on the theory that Reda aided and abetted Ackerman’s breach of fiduciary duty.[10]

Motion to Dismiss and for Default Judgment

Defendants opposed Plaintiffs’ motion to amend on the same basis the original claims were dismissed, arguing that the claims were derivative because they allege misconduct directed at the Fund as a whole, and not individually at Hopkins.  Defendants also sought default judgment against Plaintiffs due to a lack of response to certain counterclaims.

Derivative v. Direct Analysis Again Bars Most of Hopkins’s Claims

The Commercial Division ruled that most of the amended claims were derivative claims that could not be brought because the entities were cancelled, but allowed Hopkins to proceed on the portion of his breach of fiduciary duty claim based on allegations that he was “frozen out” of his rights as an LLC member.

With respect to the proposed contract claims, Justice Scarpulla held that claims based on the failure to pay distributions are derivative and thus cannot be brought due to the entities’ cancellation.  In reaching this conclusion, the court referred to its reasoning in dismissing the original claims, namely that distributions would be due to all members and thus any recovery would be on behalf of all members.[11]  The court also held that a contract-based claim for improper dissolution was derivative, and reaffirmed its prior ruling that any challenges to the propriety of the entities’ cancellation must be brought in Delaware, where the companies were formed.[12]

Justice Scarpulla also dismissed the proposed fraudulent conveyance claim.  The court ruled that Hopkins failed to plead the requisite “badges of fraud,” but rather “merely plead[ed] that defendants transferred certain assets to themselves during the dissolution, even though they had ‘actual or constructive’ knowledge that monies were owed to Hopkins.”[13]  In the court’s view, such allegations were “bare-boned” and “conclusory,” and they failed to identify specific facts to support the allegations of fraudulent conveyance.[14]

Next, the court turned to the fiduciary duty claim.  Here, Hopkins found his only successful bid at amendment.  Justice Scarpulla granted leave to amend the complaint to add allegations that Defendants froze Hopkins out of his rights regarding the daily operation of the Fund, decision making, inclusion in K-1s, and membership rights.  Since this claim identified “harm independent of any injury to the corporation,” which would entitle Hopkins to “an individualized recovery” under Delaware law, the court concluded that the claim was direct and could be asserted by Hopkins himself.[15]  The portion of the breach of fiduciary duty claim based on illegal dissolution and failure to pay distributions, however, was not permitted to proceed because the court ruled that it, like the distribution-based contract claim, was derivative.[16]

Finally, the court did not permit that claims against accountant Reda and his firm Remano proceed.  The court reasoned that the proposed claims “do not set forth any non-conclusory allegations of providing substantial assistance to any purported breach of fiduciary duty.”[17]

Default Judgement Denied to Defendants

Justice Scarpulla denied Defendants’ motion for default judgment on their counterclaims.  She noted that “Hopkins has been actively and vigorously litigating this action and there is absolutely no indication that he does not intend to defend the counterclaims.”[18]  She then ordered Hopkins to serve his amended complaint consistent with her decision.

Conclusion

In Hopkins II, the Commercial Division reiterated that claims concerning alleged failure to distribute a Delaware LLC’s proceeds are derivative.  This ruling has particular force in light of the court’s earlier ruling that derivative claims cannot be brought on behalf of a cancelled Delaware LLC and that any challenges to the cancellation must be brought in Delaware. 

By A. Robert Quirk and Muhammad U. Faridi