Many, if not most, legal claims of an LLC must be filed directly by the LLC itself and cannot be filed by someone acting on its behalf. The Tennessee Revised Limited Liability Company Act, however, permits a member of an LLC, in certain circumstances, to bring a derivative action on behalf of the LLC. Very generally speaking, derivative actions are permitted when the LLC has a valid cause of action, but is not likely to pursue it itself because its current management will not do so.
Before a member or holder of financial rights of a limited liability company may bring a derivative action in Tennessee, the member or financial rights holder must establish that a demand has been made on the LLC’s management to take the necessary action to address the conduct at issue, and that the demand was denied. In some cases, a member bringing a derivative action may be excused from having made a demand on the LLC’s management before filing the derivative action. In so-called “demand excused” cases, a plaintiff bringing a derivative action on behalf of the LLC may be excused from having made a demand on management if the plaintiff ‘s complaint alleges, “with particularity,” facts that establish that a demand would have been futile.
A derivative action may be dismissed if the complaint filed by the plaintiff does not establish either, that a demand was made and denied, or that it should be excused because it would have been futile. Therefore, ensuring that there are adequate grounds to support a claim of demand futility is important where the plaintiff has proceeded with filing a derivative case without making demand on the LLC’s management.
A recent LLC derivative case is illustrative of what type of allegations in a derivative action complaint are insufficient to prove demand futility. Here are the key facts of the case:
- Gary Miller was a member of an LLC (the “LLC”)
- There were six members of the LLC
- The opinion does not state whether the LLC was member-managed or director- managed, but it was apparently member-managed
- Barbara Miller was another member of the LLC
- Gary Miller alleged that Barbara Miller sold and leased real properties owned by the LLC and kept the proceeds
- In his Complaint against Barbara Miller, the only allegations Gary Miller made to support a position that demand on the LLC’s management would have been futile were that: (1) He and Barbara Miller had been engaged in other legal disputes and were not on speaking terms; and, (2) that he was involved in other legal disputes with other members of the LLC.
The trial court dismissed Gary Miller’s complaint, finding that he had not pled sufficient facts to support the conclusion that, had he made a demand on the LLC’s management to bring claims against Barbara Miller, it would not have done so.
On appeal, the Court of Appeals of Tennessee observed that, to establish demand futility, a plaintiff must prove two elements: (1) That the LLC’s management has an interest in the litigation such that it cannot exercise independent judgment; and (2) that the transaction challenged by the plaintiff is not protected by the business judgment rule. The business judgment rule protects the decisions and actions of officers, managers, and directors by presuming that, even if a decision or action turned out badly for the LLC, nevertheless, the officers, managers and directors are not liable for it absent a showing of gross negligence, self-dealing or other similar conduct. Because Gary Miller’s Complaint was devoid of any facts establishing either of the above elements, the Court of Appeals affirmed the decision of the trial court.
In my experience, if the defendants named in a derivative lawsuit control the ability of the LLC to bring a lawsuit, it is a certainty that a demand on them to sue themselves will be excused. Closer cases are those in which the defendants are some, but not all, of the officers, managers, or directors of the LLC. Under Tennessee law, even if the officers, managers, or directors are not themselves defendants, if the complaint contains allegations that they were in collusion with, or controlled by, the named defendants, the complaint should survive a motion to dismiss.
For Tennessee LLC lawyers, when in doubt, make a demand on the LLC to bring the lawsuit, and wait for it to decline to do so or to fail to do so (after a reasonable period of time) before filing a derivative action.