Background
Between 2017 and 2020, AMF Trust Ventures LLC and related plaintiffs purchased Class B membership interests in i80 Group LLC and i80 Group Lending Opportunities GP LLC (together, the Management Entities), Delaware limited liability companies that managed a private credit fund. The LLC agreements entitled Class B members to receive a share of management fees and incentive revenue generated by the fund.
In 2021, the Management Entities received a $450 million investment from Iconiq Capital, which resulted in the creation of a new fund with a new manager and new general partner. The Manager of the Management Entities, Marc Helwani, offered plaintiffs the option to roll over their interests into the new entities on less favorable economic terms. Plaintiffs objected and, in response, Helwani exercised his contractual authority to require their complete withdrawal from the Management Entities.
Plaintiffs filed suit in Supreme Court, New York County asserting direct and derivative claims. After an initial round of litigation, they sought to file a second amended complaint that added additional derivative claims on behalf of the Management Entities. Supreme Court granted leave to amend. Defendants appealed.
The Court’s Holding
The First Department reversed, holding that Supreme Court improvidently exercised its discretion in permitting the second amended complaint. The proposed amendment was patently devoid of merit because plaintiffs lacked standing under Delaware law to bring derivative claims on behalf of the Management Entities.
The court applied the choice-of-law rule that standing to bring a derivative action on behalf of a business entity is governed by the law of the state of organization. Because the Management Entities are Delaware LLCs, Delaware law governs. Delaware’s LLC Act requires a derivative plaintiff to have been a member “at the time of the transaction of which the plaintiff complains” and at the time suit was filed — the so-called continuous ownership requirement (6 Del. C. § 18-1002). It was undisputed that plaintiffs were no longer members when they filed suit because Helwani had exercised his contractual right to require their withdrawal.
Plaintiffs argued that two recognized exceptions to the continuous ownership requirement applied. The reorganization exception was conceded to be inapplicable. The fraud exception — which applies when a plaintiff loses standing through a transaction that was perpetrated solely to deprive them of derivative standing — also failed: plaintiffs could not plead sufficient facts showing that the Iconiq investment and resulting restructuring was fraudulently designed solely to strip them of derivative standing, as distinct from a bona fide business transaction that had the incidental effect of ending their membership.
Key Takeaways
- Whether a plaintiff has standing to sue derivatively on behalf of an LLC is governed by the law of the state of organization — for Delaware LLCs, that means Delaware law applies even when the case is litigated in New York courts.
- Delaware’s continuous ownership requirement (6 Del. C. § 18-1002) bars derivative claims by former members who were not members at the time of filing suit and at the time of the challenged transaction.
- The fraud exception to continuous ownership requires pleading specific facts showing the transaction was perpetrated solely to deprive plaintiffs of derivative standing — a high bar that cannot be met by alleging the transaction was generally wrongful.
- Leave to amend to add derivative claims will be denied when the proposed claims are patently devoid of merit due to standing defects apparent on the face of the pleading.
Why It Matters
This decision has direct relevance to New York practitioners advising investors in Delaware-organized private funds and management companies. When a limited partner or Class B member is forced out of a Delaware LLC — whether through contractual withdrawal provisions, merger, or restructuring — they generally lose the right to bring derivative claims on behalf of the entity. The fraud exception offers a narrow escape valve, but this case confirms that it requires more than general allegations of wrongdoing: plaintiffs must plead specific facts showing the challenged transaction was a scheme designed primarily to eliminate their derivative standing.
For fund managers and management company advisors, the decision reinforces that carefully drafted contractual withdrawal rights — which operate under Delaware law — can effectively foreclose derivative litigation by disgruntled investors. New York courts applying Delaware LLC law will enforce those provisions. Investors who believe they may face involuntary withdrawal should consider bringing derivative claims before the withdrawal is effectuated, not after.