In a recent ruling in Marx v. Morris,1 the Wisconsin Supreme Court weighed in on the rights and obligations of members in a limited liability company. The court issued two main holdings:
that LLC members themselves have standing to sue other members or the managers of the LLC, based on harm to the members or harm to the LLC; and
that members owe common law duties to other members, unless they are specifically overridden in the LLC’s operating agreement.
Background
North Star Sand LLC was a manager-managed LLC managed by Richard Morris, its sole manager. R.L. Co. LLC, whose sole member was Morris, was one of six members of North Star.
North Star was formed for the sole purpose of owning and mining land containing silica sand used in fracking operations. Several members and their ultimate owners sued Morris and R.L. Co. LLC, after North Star sold valuable assets of the company to another entity owned by Morris, all while Morris maintained his status as manager of North Star.
The plaintiffs alleged that Morris “willfully failed to deal fairly with them while having a material conflict of interest,” and asserted several other common-law claims related to Morris’s improper self-dealing relating to his management of North Star.
Holding: Member’s Standing to Sue
In ruling that individual members have standing to sue one another for harms inflicted upon them or the LLC, the supreme court declined to apply to LLCs Wisconsin’s corporate derivative standing provisions in Wis. Stat. chapter 180, which give majority shareholders more control over litigation by or on behalf of the corporation.
The court applied this line of reasoning because LLCs were developed as a combination of corporate and partnership law principles. LLCs maintain corporate-style investor liability protection, limiting a member’s losses to the amount invested, and more informal, contract-oriented, direct participation by members akin to partnerships.2
Wisconsin’s corporate law requires shareholders to sue on behalf of the corporation for an injury that is primarily to the corporation, which would include issues that affect the corporation’s assets.3
Chapter 180 includes requirements for derivative claims, including a notice period for the corporation to act,4 and dismissal rights by the corporation upon a vote of a majority of independent directors (or a separate independent panel proposed by the corporation and approved by the court).5
After determining that corporate derivative action rules don’t apply to LLCs, the court stated that the “the only provisions of Ch. 183 relating to suits in the name of an LLC is Wis. Stat. § 183.1101.”6
Prior to this decision, before a member could bring an action of this type on behalf of the LLC, the action needed to be authorized by members who own 50% or more of the membership interests in the LLC.7
The decision in Marx, however, reasoned that section 183.1101 did not require claims against members to be brought in the name of the LLC – similar to corporations – or specifically prohibit members from suing each other or managers individually.8 Thus, it appears that members may now bring causes of action individually, bypassing the majority vote requirement by not naming the LLC as a party to the litigation at all.
Interestingly, the court did not address Wis. Stat. section 183.0305, which seems to limit certain member lawsuits. Section 183.0305 states that a member of an LLC is not a proper party to a proceeding by or against an LLC, unless the proceeding is to enforce the member’s rights against the LLC, or if the action is brought pursuant to Wis. Stat. section 183.1101. Based on the court’s ruling, it is unclear if section 183.0305 still holds any value.
As part of her reasoning in the majority opinion granting standing to members to sue, Chief Justice Patience Roggensack referred to the concept of flow-through taxation, stating "there is generally a much closer financial connection between harm to an LLC and harm to its members than between harm to a corporation and harm to its shareholders."9
This language raises concerns that courts could use the tax status of entities, namely LLCs taxed as partnerships, to justify other unintended rights and obligations among the members and the LLC.
In fact, Marx has prompted proposed legislation to specifically prohibit the use of an entity’s tax classification in interpreting the rights and obligations of members, managers, and the LLC. Several other states have introduced similar legislation recently, with Colorado’s 2016 revised LLC statute providing that “a limited liability company's status for federal tax purposes does not affect its status as a distinct entity organized and existing under this article.”10
The main concern here is that any misinterpretation of this holding could jeopardize the foundation of the limited liability company framework – namely the concept of limited liability for members.
Holding: Common Law Claims
The other main holding in Marx was that the members of an LLC may sue other members and managers of the LLC for breaches of certain common-law duties (including fiduciary duties), unless those rights are limited in an operating agreement.
The court held that Wis. Stat. section 183.1302(2) was drafted broadly to grant members common-law claims and defenses that are not limited elsewhere, and that Wis. Stat. section 183.0402 (which enumerates certain fiduciary duties) is not the definitive list of obligations between the members and the LLC.
Therefore, by just disclaiming these provisions of Chapter 183, the operating agreement is not eliminating all common law duties that members may owe to each other and the LLC.
Proposed Legislation
The State Bar of Wisconsin Business Law Section Subcommittee on LLCs has been working on revising Wisconsin’s LLC law for several years, to address any perceived limitations and adapt to current trends across the country, including the Revised Uniform Limited Liability Company Act that was finalized in 2006.
The issues of waiver of fiduciary duties and clarification of who has the right to sue in the LLC context will be addressed in these revised statutes. The proposed legislations is still being finalized, but it is expected to be introduced to the legislature in December 2019.
A Takeaway
In the meantime, what does this ruling mean for you, your clients, your company, or the other members of an LLC?
One clear takeaway is that, as with many issues relating to LLCs, members should consider clearly documenting their intentions in an operating agreement. Specifying which duties and obligations members owe to each other and to the LLC can be difficult, but the process will be vital as member disputes could become more common after the decision in Marx.
Section members: Stay on top of legislation proposed during the current legislative session with the BillTrack50 feature on the Business Law Section webpage, under the heading "Wisconsin Legislation." Click on the bill heading for full details of the bill.
This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership.
Endnotes
1 Marx v. Morris, 2019 WI 34, ¶ 2.
2 Joseph W. Boucher, et al., LLCs and LLPs: A Wisconsin Handbook, § 1.4 (6th ed. 2018).
3 See Borne v. Gonstead Advanced Techniques, Inc., 2003 WI App 135, ¶ 15.
4 Wis. Stat. § 180.0742.
5 Wis. Stat. § 180.0744.
6 Marx v. Morris, 2019 WI 34, ¶ 39.
7 Wis. Stat. § 183.1101 and Wis. Stat. § 183.0404.
8 Marx v. Morris, 2019 WI 34, ¶ 40.
9 Id., ¶ 45.
10 Colo. Rev. Stat. Ann. § 7-80-107.
