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In Clifford Paper, Inc. v. WPP Investors, LLC, 2021 WL 2211694 (Del. Ch. Jun. 1, 2021), the Delaware Court of Chancery rejected an argument that the distinction between direct and derivative claims is irrelevant in a dispute between the members of a two-member LLC, and the court held that claims alleging wrongful disposition of corporate resources or assets were essentially derivative in nature, meaning that a former member of a two-member LLC lacked standing to assert such derivative claims and could not do so after failing to make a litigation demand or plead demand futility.

Case background

The plaintiff in Clifford Paper, Inc. v. WPP Investors, LLC, Clifford Paper, Inc. (CPI), formed World Pac Paper, LLC (WPP) in 2004 along with the defendants, WPP Investors, LLC (Investors) and its owners, Edgard L. Smith and Richard A. Baptiste (collectively, Defendants). WPP was a distributor of paper and packaging products and provider of printing, shipping and warehousing consignment services to commercial and retail clients. CPI and Investors owned 45 percent and 55 percent of WPP, respectively. Under WPP’s operating agreement (the Operating Agreement), CPI and Defendants shared management duties of WPP – specifically, Smith, Baptise, and CPI’s president John Clifford were designated as WPP managers. CPI separately performed services for WPP.

CPI and Investors remained the only two members of WPP until 2018, when CPI withdrew from WPP after relationships between the parties deteriorated. CPI initiated the lawsuit in the Delaware Court of Chancery in 2020, alleging various breaches of the Operating Agreement, including that it had been disenfranchised, and a breach of the fiduciary duty of loyalty. Among other things, CPI claimed Defendants breached the Operating Agreement by hiring a family member to a lucrative position within WPP that would perform duties already held by CPI, cancelling CPI’s contract with WPP, excluding CPI’s management designee from key decisions, and diverting business to Investors. Defendants moved to dismiss the theory that CPI lacked standing because its claims were derivative and that, under Section 18-1001 of Delaware’s Limited Liability Company Act (the Delaware LLC Act), former members do not have standing to bring derivative claims.

At the threshold, CPI insisted that it brought direct (as opposed to derivative) claims because it was challenging wrongful acts that have denied CPI rights under the Operating Agreement to vote on key decisions affecting WPP. CPI also argued that the Tooley two-part test—which differentiates between direct and derivative claims—could not apply because WPP was a two-member limited liability company, and the Tooley test ignores the reality that harm to the limited liability company caused by one member flows directly to the other member. The Tooley test asks whether (i) the company or the individual suffered the harm, and (ii) the company or the individual would receive the benefit of any remedy.