Derivative Actions And LLCs

This post keeps with the theme developed over the past couple weeks of derivative actions, this time in their application to limited liability companies. Interestingly, Washington’s Division Three Court of Appeals threw practitioners a “derivative action curveball” in the 2016 opinion Holman v. Brady, No. 33114-8-III, 2016 WL 4921457 (Wn. App. Sep. 13, 2016). This post will dissect this curveball and consider its implications for practitioners facing derivative action issues throughout Washington State.

The Curveball

To put it simply, the Holman “curveball” provided that a limited liability company is NOT an unincorporated association for purposes of the pleading requirements under CR 23.1. I referenced CR 23.1 as a supplement to the rules of pleading derivative actions a couple weeks ago. Notably, CR 23.1 applies to “a corporation or [] an unincorporated association.” However, by holding that an LLC is not an unincorporated association, the Holman court determined the pleading rules under CR 23.1 do not apply to LLCs.

This significant holding has miffed me for some time, especially since numerous states recognize an LLC as an unincorporated association. See Gottsacker v. Monnier, 697 N.W.2d 436, 440 (2005) (Wisconsin Supreme Court: “A limited liability company (LLC) has been described as “an unincorporated association of investors.”); Nunez v. Pinnacle Homes, L.L.C., 180 So.3d 285, n. 2 (2015) (Louisiana Supreme Court, quoting the Louisiana LLC statute: “Limited liability company … means an entity that is an unincorporated association.”); Hagan v. Adams Property Associates, Inc., 482 S.E.2d 805, 807 (1997) (Virginia Supreme Court: “[A] limited liability company is an unincorporated association.”).

Even Delaware takes the exact opposite approach regarding LLCs and CR 23.1. The Delaware Court of Chancery has explicitly stated that “[c]ase law applying Rule 23.1 in the corporate context has been deemed instructive to interpreting the LLC Act’s demand requirements.” Stone & Paper Investors, LLC v. Blanch, 2018-0394-TMR, 2019 WL 2374005, at *4 (Del. Ct. Ch. May 31, 2019). Delaware’s chancery court expounded on this idea:

The right of a member of a Delaware LLC to bring a derivative claim is governed by 6 Del. C. § 18-1000 …. This provision originates from the well-developed body of Delaware law governing derivative suits by stockholders of a corporation. Accordingly, case law governing corporate derivative suits is equally applicable to suits on behalf of an LLC.

VGS, Inc. v. Castiel, C.A. 17995, 2003 WL 723285, at *11 (Del. Ct. Ch. Feb. 28, 2003) (emphasis added).

What to do about Holman?

Given the wealth of case law contradicting the Holman curveball, practitioners may find themselves in a pickle regarding how to plead LLC derivative actions. In light of this, there are three significant points worth noting.

First, Holman is unpublished. As such, the case is nonbinding, persuasive authority under GR 14.1. This means courts may elect not to take Holman into consideration.

Second, Holman is from Division Three in Washington. As such, practitioners in Divisions One and Two may have an even easier time getting around the Holman curveball considering opinions from division to division are not binding on one another.

Third, Holman has yet to be cited authoritatively in any other Washington opinion for the proposition that LLCs are not unincorporated business entities under CR 23.1. This may or may not be relevant considering the minimal amount of business entity (and LLC) cases our state sees. Nevertheless, it is important to keep in mind as practitioners proceed.

Considerations

Business entity case law in Washington is a burgeoning organism incurring growing pains along the way. I see Holman has one of those growing pains. In the years since the opinion was released, I have discussed the decision with other practitioners. We arrive at the same conclusion: Holman is an outlier in the realm of business entity case law throughout the country. Nevertheless, it is an outlier that practitioners need to be prepared for and potentially meet head on should the issue arise.

For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.

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