Derivative Action on Behalf of an LLC

Sometimes a LLC may refuse to take legal action to pursue a legal claim of the LLC. A derivative action allows a member of the LLC to sue on behalf of the LLC when it refuses to act.

The general rule is an individual member of an LLC cannot maintain a personal action against a manager or director or other third party whose action causes harm to the company. However, when the LLC refuses to act, an individual member can pursue a derivative lawsuit on behalf of the LLC. Colorado law requires:

  • 30-day demand to the LLC;
  • a verified complaint outlining the efforts made to force the LLC to act;
  • the plaintiff must fairly and adequately represent the other members; and
  • the derivative action must be in the best interests of the company

Colorado law further provides that the court can stay the lawsuit to allow the LLC to investigate the claim. The claim can be dismissed if one or more independent persons determines in good faith the derivative action is not in the best interests of the LLC. The lawsuit cannot be dismissed or settled without the approval of the court and notice to the other members.

While individual members may not assert individual claims based on wrongs to the LLC, there is an exception. The exception is a direct personal action by a member. A member may maintain a personal action in his capacity as a member only if the actions of the third party that injure the LLC result from a violation of a duty owed to them as a member and that causes them injury as a member, unique to them and not suffered by the other members. An example is when a member is denied a statutory right of redemption upon adoption of liquidation plan. There can be other instances when an individual member or shareholder, or a class of shareholders, are denied a specific right as to them that effects them individually.

While this blog post outlines the right of a derivative action by a member of an LLC, it equally applies to shareholders of a corporation. However, general partners may not bring a derivative action on behalf of the general partnership. Limited partners may have a right to pursue a derivative action in certain circumstances, although the requirements may be different depending on the partnership. Of course, in any lawsuit brought by, or on behalf of, a company or LLC, the plaintiff must be represented by counsel.