Creditors of a Limited Partnership or a Limited Liability Company Lack Standing to Sue Derivatively Under Certain State Laws

The Bottom Line

In Gavin/Solmonese LLC, Liquidation Trustee for the Citadel Creditors’ Grantor Trust, successor to Citadel Watford City Disposal Partners, L.P., et al. v. Citadel Energy Partners, LLC, et al., Ch. 11 Case No. 15-11323; Adv. Proc. No. 17-50024 (Bankr. D. Del. May 2, 2019) (“Citadel”), the Bankruptcy Court for the District of Delaware held that creditors of insolvent limited partnerships and limited liability companies do not have standing to sue derivatively on behalf of the company under applicable state law.

What Happened?

The debtors, consisting of four entities formed under the laws of different states — Citadel Watford City Disposal Partners, LP (Delaware), Citadel Energy SWD Holdings LLC (North Dakota), Citadel Energy Services LLC (Wyoming) and Pembroke Fields LLC (North Dakota) — filed voluntary Chapter 11 petitions. The Official Committee of Unsecured Creditors (the “Committee”) commenced an adversary proceeding by filing a complaint (the “Complaint”) against general partner Mark Dunaway (“Dunaway”) for breach of fiduciary duty. After a Chapter 11 plan of liquidation was confirmed and the Committee was dissolved, the court granted the Liquidation Trustee’s motion to amend the caption on the Complaint (the “Amended Complaint”) and substitute the Liquidation Trustee as plaintiff instead of the Committee. Dunaway then filed a motion to dismiss the Amended Complaint pursuant to Fed. R. Civ. P. 12(b)(6). The Liquidation Trustee objected. The court entered an order denying the Dunaway motion, but granted the movants, including Dunaway, leave to file motions to dismiss pursuant to Fed. R. Civ. P. 12(b)(1) (providing that a court may dismiss a complaint for lack of subject matter jurisdiction).

In two recent decisions from the Bankruptcy Court for the District of Delaware, the court held that under Delaware law, creditors of insolvent limited liability companies do not have standing to sue derivatively on behalf of the company. In In re HH Liquidation, the court held that “distinguishing between insolvent corporations, where creditors can sue derivatively, and insolvent LLCs, where they cannot, does not produce an absurd result as different legal principles apply to different corporate entities.” 590 B.R. 211, 283-85 (Bankr. D. Del. 2018). The court in In re PennySaver USA Publishing, LLC reached the same conclusion, while recognizing the confusion between the different treatment of corporations and LLCs. 587 B.R. 445, 466-67 (Bankr. D. Del. 2018).

Importantly, the Delaware Limited Liability Company Act and the Delaware Limited Partnership Act contain substantially similar provisions regarding standing, the only difference being substituting terms relevant to the entity, such as “member” for “partner” and “limited liability company” for “limited partnership.” See 6 Del. C. §§ 17-1001, 17-1002; 6 Del. C. § 18-1001; 6 Del. C. § 18-1002.

Following the Delaware precedent and recognizing the similarities between the standing provisions of the Delaware Limited Partnership Act and the Delaware Limited Liability Company Act, the Citadel court held the same result should apply to limited partnerships, and thus the Committee does not have derivative standing under Delaware law. Moreover, because the Wyoming and North Dakota derivative statutes are also substantially similar to that of Delaware, the court dismissed the remaining claims regarding fiduciary duties for lack of standing as well.

Why This Case is Interesting

This case follows recent Delaware precedent — In re HH Liquidation and In re PennySaver USA Publishing, LLC — in holding that creditors of insolvent limited partnerships and limited liability companies lack standing to sue derivatively on behalf of the company. This case confirms that the same standing requirements for limited liability companies apply to limited partnerships as well. Notably, the court points out that LP and LLC creditors are presumed to be capable of protecting themselves through the contractual agreements that govern their relationships. Creditors’ committees and liquidating trustees (or other persons tasked with pursuing estate causes of action) should be aware of these decisions to ensure valuable assets preserved for the benefit of creditors can be liquidated and realized.