Can you have a default entered against you if you aren’t a proper party to the lawsuit? The answer is yes, at least on the unique facts before the Business Court in its opinion Friday in the derivative action Regional Property Development Corp. v. Carpenter.
Regional Property, a member of Lancaster Industrial Park, LLC, had filed a derivative action on behalf of the LLC against three other members of Lancaster, and also the lender to the LLC, Regions Bank.
In a March 25th Order, the Business Court dismissed the derivative claims, ruling that Regional Property wasn’t entitled to sue on behalf of Lancaster because of it hadn’t made a demand on the managers of the LLC to file the suit. The Court allowed Regional Property leave to amend to assert demand futility.
But right before that ruling, Regions Bank had counterclaimed against Lancaster, asserting that Lancaster was in default on its loan obligations to the Bank. Lancaster, whose derivative claim had been dismissed by the time the answer deadline had run, didn’t answer. (Or rather, Regional Property, which had brought the lawsuit, didn’t answer on behalf of the LLC). Regions Bank then moved for entry of default.
The other defendants, the members who had moved to dismiss the derivative action, objected to the Motion for Entry of Default and said that default was not proper because the LLC wasn’t a party to the litigation. They said in their Opposition that "Lancaster cannot be in default in this matter for the simple reason that it is not a party." They also argued that Regions Bank should be estopped from arguing that Lancaster was a party, because it also had taken the position there was no authority for Regional Property to file the lawsuit on behalf of Lancaster.
Judge Diaz entered default over that objection. He said that once the counterclaims were filed, Lancaster "was bound to respond to the counterclaims or risk default, regardless of whether it should have appeared in the action to begin with." Also, given that Regional Property had moved after the dismissal of its derivative action to amend the Complaint to excuse its lack of demand, the Court held:
where a party seeks to pursue a claim derivatively on behalf of a limited liability company, the LLC is a necessary party and is normally joined as a defendant. See generally Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 17.05 (7th ed. 2008) (citing relevant cases with respect to derivative actions filed on behalf of a corporation). Thus, even if Lancaster now disavows any role in this case as a party-plaintiff, because Regional Property’s Second Amended Complaint asserts derivative claims on Lancaster’s behalf, Lancaster remains a party.
If you are going to fire off a derivative action, you need to be prepared to defend against whatever might get shot back in the way of a counterclaim.
[Update: The Court set aside this entry of default in an Order dated September 23, 2009, permitting the members of the LLC to adopt after the fact a response to the counterclaims filed by the Plaintiff when it did not have authority to act for the LLC in filing the lawsuit].