Direct Versus Derivative and the Law of Limited Liability Companies

Abstract

The hybrid nature of limited liability companies causes us to re-invent, or at least re-examine, many doctrinal wheels. This Article re-examines one of the most practical of those wheels - the distinction between direct and derivative claims in the context of a closely-held LLC.

Case law concerning the direct/derivative distinction is still overwhelmingly from the law of corporations, although LLC cases are now being reported with some frequency. LLC cases routinely analogize to, or borrow from, the corporate law. This Article encompasses that law, analyzes LLC developments, criticize the ALI approach to closely held corporations, and argues that courts should (i) avoid the special injury rule, (ii) embrace the direct harm approach, and (iii) engraft to the direct harm approach an exception applicable when those in control of a LLC harm the company with the purpose and effect of injuring a particular member.

The Article first demonstrates the relevance of corporate case law to the realm of LLCs and then establishes why the direct/derivative distinction matters practically. The discussion then switches to the more theoretical, elaborating the conceptual fundamentals for making the distinction between direct and derivative claims without regard to closely held character and then advancing a special rule for closely held entities.

The Article then considers a series of LLC-specific questions, including whether the pivotal role of the LLC operating agreement changes or at least confuses the direct/derivative analysis and whether the LLC's partnership heritage has liberated courts to find a new kind of direct injury.

Keywords: limited liability company, direct, derivative, close corporation, closely held, partnership, oppression, diversity, dissolution, standing