Drafters should strongly consider including prophylactic language in future operating agreements, or when amending existing agreements, to minimize litigation risk.
The Delaware Court of Chancery’s recent decision in Tamer Hassanein v. NTO Fund I, et. al., C.A. No. 2025-0299, has pointed out a rarely invoked provision of the Delaware LLC Act and Delaware LP Act with the potential to generate unwanted and hard-to-settle litigation. Drafters should strongly consider including prophylactic language in future operating agreements, or when amending existing agreements, to minimize litigation risk.
Management’s control of litigation rights—that is, the power to decide whether the company should sue, settle or ignore a right—is a key attribute of managerial power. In Delaware entity law, this issue arises under the so-called Tooley test for distinguishing direct and derivative rights. If a right is derivative, a plaintiff must justify why management’s business judgment should be bypassed or the action will be dismissed at the pleading stage, minimizing the cost and duration of litigation. Under Tooley, an action is derivative and therefore falls under these protections if the obligation is owed to, and recovery for successful prosecution of the suit would go to, the company itself.
In Hassanein, however, the court found that Delaware LLCs and LPs depart from this general Tooley framework in certain circumstances. Section 502(b) of the Delaware LLC Act requires unanimous member agreement to compromise any member’s obligation to make a contribution or return a distribution. Because both contributions and the return of a distribution would go to the company, Tooley analysis would call them derivative and place the matter firmly under management’s control. But, the court reasoned that the ability of any member to veto a compromise implies a unilateral ability to initiate an action in the first place. The Delaware LP Act has an analogous rule for limited partnerships, but the statutes for other entity forms (corporations, statutory trusts and general partnerships) lack such a provision. As a result, the Hassanein decision held that in the absence of language in the operating agreement to the contrary, the obligation to make a contribution or return a distribution can be directly pursued by any member (or limited partner) unilaterally and without the limitations imposed on derivative litigation.
Because LLCs and LPs are “primarily creatures of statute,” the Hassanein decision emphasized that parties can override the statutory defaults. However, the court reasoned that an override of Section 502(b) must be specific and cannot be accomplished by a general grant of managerial authority. Because Hassanein’s application of Section 502(b) would allow an investor-plaintiff to bypass management and initiate litigation on otherwise-derivative claims so long as the claims can be framed as contribution obligations or the return of a distribution, and because the unanimity rule may complicate efforts to resolve such litigation, stakeholders in LLCs and LPs may want to address the issues raised by Hassanein promptly.
Parties seeking to maintain management’s sole control of litigation rights in an LLC or LP may wish to amend their operating agreements to include provisions specifically addressing capital contributions and the return of distributions as well as providing management with sole authority to sue and greater authority to settle those obligations.
The 64-page opinion was issued by Vice Chancellor J. Travis Laster on August 4 and overruled Magistrate David Hume IV’s recommendation of dismissal last December.
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