Derivative Actions – II

In last February’s issue of the Newsletter we touched on the right of a shareholder of a corporation to bring a lawsuit on behalf of the corporation against a third party, when the corporation refused to do so. These so-called derivative lawsuits are most often used when a third party in the form of a director or officer of a corporation engages in some form of wrong-doing that harms the corporation. Because the third party wrong-doer is in a position of power, he can often block the corporation’s efforts to bring a lawsuit against him. In such circumstances, a derivative lawsuit may be appropriate and may be the only means available to vindicate the corporation’s rights against the third party.
We revisit this topic now, because the Pennsylvania legislature has stepped in to make clear that a member of a limited liability company may also bring such a derivative action on behalf of a limited liability company. Act 170 of 2017, which came into effect on February 21, 2017 ensures this derivative action right to a properly situated member of a limited liability company and further sets forth the procedure that member is required to follow.
The member must first make a demand that the company bring a lawsuit against the proposed defendant. This demand must be made on the other members in the case of a member managed company or on the manager(s) in the case of a manager managed company. This demand requirement may be waived in the event that irreparable harm could befall the company (because the matter is urgent).
Generally, speaking, upon receipt of such a demand the company must set up a “special litigation committee.” If the company does not establish in a reasonable time such a committee or if such a committee is established and the committee determines that the company does not object to the lawsuit, then the member may move ahead with the lawsuit. Additionally, in the event the committee objects to the lawsuit by the member, the local county Court of Common Pleas may allow the member to nevertheless bring the lawsuit.
In addition to the new rules establishing a procedure for bringing such a derivative action, Act 170 also now expressly provides that a manager of a limited liability company owes the fiduciary duties of loyalty, good faith and fair dealing, and care to the company. When these new provisions are read together with the new derivative action provisions, the new law provides a clearer path for an aggrieved member of a company to bring a derivative action against a manager of that company who has breached his fiduciary duties. Given these changes it seems likely that we will see an up-tick in derivative fiduciary litigation in the limited liability company context.

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