The Unfortunate Role of Special Litigation Committees in LLCs

Abstract

Recent LLC acts impose upon LLCs the rule developed for public corporations that most owner claims against managers or other owners are merely “derivative” rather than “direct.” They also give the firm the right to appoint special litigation committees (“SLCs”) to decide how to dispose of derivative claims. This article begins with the two basic paradigms of judicial review of SLCs that emerged in corporate law: New York applies the deferential business judgment rule to SLCs whereas Delaware offers the possibility of enhanced scrutiny in equity even if the technical requirements of the business judgment rule are met. It then considers LLCs directly, beginning with recent LLC acts that subject LLCs to the derivative litigation machinery developed for the public corporation. It also considers recent LLC case law applying aspects of derivative law according to the presumptive intent of the members. As in the public corporation arena, SLCs in LLCs present the risk that insiders are deciding what to do about claims brought against “one of their own.” Unlike public corporations, LLCs generally are not managed by boards of directors and have relatively few members. The imposition of the complexities of derivative litigation upon these firms imposes significant transaction costs that cannot be spread and that typically serve no purpose. It is also contrary to the presumptive intent of members, who presumably do not intend to burden themselves with the dispute resolution machinery of public corporations. Rather, their presumptive intent is to treat themselves as contracting parties with the normal remedies for breach, as in the case of partners. Legislatures should permit LLCs to “opt in” to the complexities of derivative litigation rather than force them to “opt out” of it. They should consider the Texas example that allows closely held corporations and LLCs to opt out of the derivative litigation rules when the claim is made against an insider. Under this approach, LLC members may once again directly sue one another or their firm as if they were partners. Short of that, legislatures should amend the rule that permits a majority of derivative defendants to appoint the SLC that resolves the claims against them. Even in the absence of legislative change, courts should adopt the Delaware approach that offers the possibility that the composition, work, and recommendations of SLCs may receive enhanced scrutiny in equity. At the very least, courts should follow Delaware precedent raising the bar for independence by requiring SLC members to be personally, socially, and financially neutral.