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A frozen-out member of a Delaware LLC who lent money to the company can pursue three paths around derivative defenses: a contract claim for loan repayment, a direct claim under Section 18-502(b) to enforce the partner’s contribution obligation, and a statutory creditor claim that cannot be waived by the operating agreement.
In the October 22, 2026 edition of The Legal Intelligencer, Edward Kang writes, “Three Routes Around the Derivative Trap: Litigating the Shortchanged Member’s Claim After ‘Hassanein v. NTO Fund I’.”
A member of a Delaware limited liability company lends it nearly $2 million so it can invest in a startup that his business partner co-founded. The LLC agreement requires the partner to contribute sufficient capital within six months so the company can repay the loan. Five years later, apart from sporadic payments, the loan remains unpaid. The partner is the sole manager, removable only for cause and only by his own class of units. When the member sues, the defendants argue that the money was equity, not debt, and that any claim to compel the partner’s contribution belongs to the company. A magistrate in the Court of Chancery accepted enough of those arguments to recommend dismissing every count. Vice Chancellor J. Travis Laster did not. In Hassanein v. NTO Fund I, 2026 WL 2240127 (Del. Ch. Aug. 4, 2026), the court declined to adopt the magistrate’s report, Hassanein v. NTO Fund I, 2026 WL 206873 (Del. Ch. Jan. 27, 2026), and let all three contested counts proceed. For lawyers representing a frozen-out or shortchanged member of a Delaware LLC, the opinion maps three routes around the defenses that so often end these cases at the pleading stage. It also delivers a correction both sides need to absorb: an LLC is primarily, but not wholly, a creature of contract.
The Derivative Trap
Every business divorce lawyer knows the pattern. The controlling member runs the company and shuts out the other member. The frozen-out member wants to sue, but the harm he describes, money that should have flowed into the company and did not, sounds like harm to the entity. Under Tooley v. Donaldson, Lufkin & Jenrette, 845 A.2d 1031, 1033 (Del. 2004), a claim is derivative if the entity suffered the injury and would receive the recovery. Delaware courts apply that test to LLCs, and the LLC Act codifies the derivative action at 6 Del. C. Section 18-1001.
The consequences are severe. A derivative plaintiff must plead demand futility with particularity under Delaware Court of Chancery Rule 23.1, and any recovery flows to the company the defendant still controls. Defense counsel lead with these arguments because they work. Hassanein’s complaint pleaded no count as derivative and had no demand-futility section, and the defendants treated those omissions as fatal.
Three Routes Past the Motion to Dismiss
The first route was a contract claim for repayment against the company. The LLC agreement, which the court said had “the look and feel of a document drafted without lawyer input,” called the advance both a “Class B Loan” and a capital contribution. The court reasoned that a loan on advantageous terms can be both a loan and an implicit capital contribution equal to the value of the subsidy. Here, the advance carried no interest for six months and only 6% simple interest after that, when a venture lender, the court estimated, would have charged at least 25 to 30% a year. At a minimum, it was reasonably conceivable that the advance was a loan, and the court could not resolve the ambiguity against the plaintiff on a motion to dismiss. See BitGo Holdings v. Galaxy Digital Holdings, 319 A.3d 310, 329-33 (Del. 2024). Because the manager’s own breach prevented the repayment condition from occurring, the prevention doctrine excused it, and repayment came due on the maturity date. See Restatement (Second) of Contracts Section 245 (Am. L. Inst. 1981).
The second route was a direct claim against the manager for failing to contribute capital. Under Tooley, that claim looked derivative, and Chancellor Allen had said as much in dictum in a limited partnership case. Murphy v. Bay Shores Six, 1987 WL 5776, at *5 (Del. Ch. Jan. 26, 1987). But 6 Del. C. Section 18-502(b) provides that, unless the LLC agreement says otherwise, a member’s obligation to contribute “may be compromised only by consent of all the members.” If the claim were derivative, the court reasoned, the manager could compromise it unilaterally by declining to sue, nullifying the unanimity default. Any member may therefore enforce the obligation directly, as the Superior Court had held on contract grounds in Vinton v. Grayson, 189 A.3d 695, 701 (Del. Super. 2018). A generic grant of management authority does not opt out; if it did, the court observed, every LLC would have opted out. The agreement must do more, such as expressly permitting a lesser vote.
Even if the claim were derivative, the court held, the plaintiff could pursue it. Borrowing the framework of United Food & Commercial Workers Union v. Zuckerberg, 262 A.3d 1034, 1059 (Del. 2021), which no Delaware court had yet applied to an LLC, the court concluded that a sole manager who is the obligor faces a substantial likelihood of liability and cannot validly consider a demand to sue himself. Nor did the exculpation clause save him. The clause carved out intentional wrongdoing, and a failure to make a mandatory contribution is conceivably intentional. And Rule 23.1 requires particularized facts, not headings.
The third route was a statutory creditor claim. Because the advance was a loan, the member was also a creditor. The act gives a member who lends to the company the same rights as an outside lender. See 6 Del. C. Section 18-107. Section 18-502(b) lets a creditor enforce a member’s contribution obligation, see CML V v. Bax, 6 A.3d 238, 252 (Del. Ch. 2010), aff’d, 28 A.3d 1037 (Del. 2011), and reliance matters only if the obligation has been compromised, which had not happened here. Importantly for drafters, the court called the creditor’s right one of the Act’s “mandatory, non-waivable provisions.” An agreement can change the vote needed to compromise a contribution obligation, but it cannot foreclose a creditor’s suit to enforce it.
Primarily, Not Wholly, a Creature of Contract
The defendants, like the magistrate judge, leaned on the familiar phrase that LLCs are “creatures of contract.” The court answered that “LLCs are primarily creatures of contract, and the adverb ‘primarily’ should not be overlooked.” The Vice Chancellor had made the point before, see In re Carlisle Etcetera, 114 A.3d 592, 605-06 (Del. Ch. 2015), but this time he listed “at least a score of reasons why LLCs are not wholly contractual,” twenty-one if you are counting, from formation by state filing, to default fiduciary duties, to mandatory limits on distributions.
The practical instruction is a three-step hierarchy. First, the agreement presumptively controls unless it violates one of the act’s few mandatory provisions. Second, if the agreement is silent, the Act’s default rules apply. Third, if neither speaks, 6 Del. C. Section 18-1104 directs the court to “the rules of law and equity.” See Elf Atochem North America. v. Jaffari, 727 A.2d 286, 291 (Del. 1999). A defendant who stops at step one has skipped two-thirds of the analysis. A plaintiff who pleads only the agreement has left the statute and equity on the table.
The Litigator’s Playbook
For plaintiff’s counsel, Hassanein rewards pleading in layers. Plead a contract claim against the defaulting member to enforce the contribution obligation and, where the client advanced money, a contract claim against the company for repayment and a statutory creditor claim under Section 18-502(b). Brief Section 18-502(b) as the basis for direct standing. The court raised the statute sua sponte, and the next court may not. Plead the economics of the advance: a maturity date and repayment mechanism show a loan, and below-market terms explain away a “capital contribution” label. Plead the facts that excuse demand even if every count is framed as direct. And invoke the prevention doctrine wherever the defendant’s own breach kept a condition to payment from occurring.
For defense counsel, the derivative defense to a contribution claim is now hard to sustain without two things: an agreement that expressly permits a lesser vote to compromise the obligation, and a decision-maker other than the obligor who could consider a demand. Drafting can supply the first. It can also head off the debt-equity fight. If the parties intend equity, the advance should be structured as equity, with no maturity date, interest, or repayment right. A label will not do. No drafting, however, can eliminate the creditor claim. The 2026 amendments to the LLC Act, House Bill 352, predate the decision and leave Section 18-502(b) untouched. Until agreements are amended, the default governs, and many closely held LLCs in this region operate under agreements signed years ago and never revisited.
Takeaways
Hassanein is a pleading-stage decision on unusual facts, and the plaintiff must still prove his case. But its reasoning is general. A member who advanced money to a Delaware LLC may have three routes to recovery: a contract claim against the company, a direct claim against the defaulting member, and a creditor claim under § 18-502(b) that, on the court’s reading, no operating agreement can eliminate. Drafting ambiguities will not be resolved against the plaintiff at the pleading stage. And the operating agreement is the beginning of the analysis, not the end. Lawyers litigating closely held entity disputes in this region, where Delaware law so often governs even when the parties sit in Philadelphia or Newark, should build these arguments into their pleadings now, before drafters close the doors that can still be closed.
Edward T. Kang is the managing member of Kang Haggerty. He devotes the majority of his practice to business litigation and other litigation involving business entities. Contact him at ekang@kanghaggerty.com.
Reprinted with permission from the November 4, 2026 edition of “The Legal Intelligencer” © 2026 ALM Global, LLC. All rights reserved. Further duplication without permission is prohibited. Request academic re-use from www.copyright.com. All other uses, submit a request to asset-and-logo-licensing@alm.com. For more information visit Asset & Logo Licensing.