Wisconsin Lawyer: Viewpoint: LLCs: Exempt from Common-law Fiduciary Duties?:

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  • Wisconsin Lawyer
    November
    01
    2012

    Viewpoint: LLCs: Exempt from Common-law Fiduciary Duties?

    Zachary R. Willenbrink

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    LLCs are now the most common business form in Wisconsin, but the statutes and case law are silent on whether LLCs, like corporations and other businesses, are subject to common-law fiduciary duties.

    Wisconsin LawyerWisconsin Lawyer
    Vol. 85, No. 11, November 2012

     

    BoardroomA recent order issued by Judge J.P. Stadtmueller of the U.S. District Court for the Eastern District of Wisconsin, in Executive Center III LLC v. Meieran, raises an important and unresolved issue of state law: are limited liability companies (LLCs) formed in Wisconsin presumptively exempt from common-law fiduciary duties?1 The Wisconsin LLC statutes are silent on the issue.2 The Wisconsin Supreme Court has issued a single opinion that touches on the matter, but that opinion brushed past the topic, leaving a concurrence to make the firmest pronouncement (although even that is still somewhat ambiguous).3

    Despite the sparsely developed law on the topic, resolution of the issue is much needed, to provide certainty for lawyers working with LLCs, LLC members, and the LLCs themselves – both formed and yet to form. Over many years, the law concerning the fiduciary duties that apply to corporations (and their operators and owners) has developed; that common-law fiduciary duty sets a baseline level of conduct (good faith, fair dealing, and loyalty) below which corporation owners and operators may not act.4 But, if those well-developed concepts do not apply to LLCs, the baseline level of conduct for persons involved in LLCs is unclear and might even be nonexistent, as was argued by the parties in Executive Center.

    This article first examines Judge Stadtmueller's Executive Center opinion, noting the thorny issue of Wisconsin law it raised. Next, the article discusses the gap in Wisconsin's LLC law, under which it is unclear whether LLCs should be subject to common-law fiduciary duties. Finally, this article examines the wisdom of applying common-law fiduciary duties to LLCs.

    Executive Center III LLC v. Meieran

    Executive Center III LLC v. Meieran centered on a dispute between two members of BRIC Executive LLC (BRIC).5 BRIC was a real estate holding company, which held a single asset: an office building in Brookfield, Wis. In need of capital, BRIC approached investors and offered to sell a small percentage of its membership, which it would later repurchase (paying a high interest rate in the meantime).

    The defendants, Andrew Meieran and his family trust (collectively, Meieran), took BRIC up on this offer. Meieran originally purchased a 12.5 percent share of BRIC from Paula Heyes, on Nov. 1, 2007. In reaching that sale agreement (the Agreement), Meieran and Heyes agreed that BRIC would be required to repurchase Meieran's 12.5 percent interest by March 1, 2008, for $250,000 plus 12 percent interest. The agreement stated that if BRIC were unable to repurchase Meieran's interest by March 1, 2008, several penalties would be assessed against BRIC.

    BRIC was unable to repurchase Meieran's interest within the allotted time and thus was subject to the penalties set forth in the Agreement. After these penalties were assessed, BRIC owed Meieran a total of $400,000.

    During this same time, BRIC entered a sale and partial-leaseback contract for its Brookfield office building with Executive Center III LLC. Under the contract, BRIC sold its office building to Executive Center and agreed to lease a suite in the building, which would net Executive Center approximately $150,000. Before the BRIC-Executive Center contract was finalized, however, BRIC arranged with Meieran to repay the $400,000 owed to Meieran under the Agreement.

    Thus, when BRIC eventually sold its Brookfield office building to Executive Center, it used $400,000 of the sale proceeds to repay its $400,000 obligation to Meieran. The remainder of the sale proceeds was used to pay some of BRIC's other debts, for a second mortgage and other liabilities. Those payments left BRIC insolvent, causing BRIC to immediately default on its leaseback contract with Executive Center III. BRIC failed to pay even its first required lease payment.

    Executive Center secured a default judgment against BRIC, but given BRIC's insolvency, Executive Center could not recover. Thus, Executive Center sued Meieran, alleging two sets of violations based on Wisconsin law. First, Executive Center argued that BRIC's $400,000 transfer to Meieran was fraudulent under the Wisconsin Uniform Transfers Act (WUTA). Second, and more important for this article, Executive Center argued that, by receiving a transfer it knew would result in BRIC's insolvency, Meieran violated common-law fiduciary duties it owed to BRIC as a member.6

    Despite alleging only state law claims, Executive Center brought its case in federal court on diversity jurisdiction grounds: Executive Center is incorporated as an LLC in Wisconsin, while Meieran resides in California (also the location of the administration of the trust).7

    Judge Stadtmueller granted Meieran's summary judgment motion as to Executive Center's WUTA claims, for various reasons.8 Judge Stadtmueller's WUTA decision is ultimately unimportant, though, given that he relied on well-established case law in reaching his decision.9

    Much more intriguing was Judge Stadtmueller's refusal to grant summary judgment to Meieran on Executive Center's fiduciary duty claim.10 Meieran argued that common-law fiduciary duties do not apply to LLCs under Wisconsin law.11 Meieran relied primarily on a statement made by Justice Roggensack in her Gottsacker v. Monnier concurrence, in which she argued that the duties owed by LLC members to the LLC and to each other are set by statute, and that common-law concepts are replaced by statutory obligations.12 Meieran construed that statement to mean that, because no statute expressly states that common-law fiduciary duties apply to LLCs, LLCs should be presumed exempt from such duties, unless an LLC's members agreed to be bound by such duties.13

    The court, however, ultimately disagreed with Meieran, holding that common-law fiduciary duties presumptively apply to Wisconsin LLCs.14 Although Judge Stadtmueller seemed to agree with Meieran's interpretation of Justice Roggensack's statement, the court ultimately determined that the statement did not conclusively establish precedent that Wisconsin LLCs should be presumptively exempt from common-law fiduciary duties. Pointing out that Justice Roggensack's statement was made in a concurrence, Judge Stadtmueller found that the statement was not a part of the Wisconsin Supreme Court's holding in Gottsacker.15

    Thus, Judge Stadtmueller delved deeper into Wisconsin's statutes related to LLCs, ultimately determining that the absence of any express statement incorporating common-law fiduciary duties against LLCs should not be construed to mean that LLCs are presumptively exempt. He also noted the similarity between LLCs and corporations (which, of course, are presumptively subject to common-law fiduciary duties), the growing number of states that apply common-law fiduciary duties to LLCs, and finally the logical, public-policy need to apply such duties to LLCs.16

    But, of course, having been made in a federal court, Judge Stadtmueller's decision is not binding on Wisconsin's state courts. Further, the Executive Center case settled, thus depriving the Seventh Circuit of the opportunity to refer the case to the Wisconsin Supreme Court pursuant to Wis. Stat. section 821.01.17 Therefore, in Wisconsin the question whether LLCs are presumptively exempt from common-law fiduciary duties remains open.

    Ambiguity in Wisconsin's LLC Statutes and Case Law

    Since the inception of the LLC business form in Wisconsin in 1994, LLCs have quickly come to dominate new business filings.18 Yet, in that time, the LLC statutes have not been substantially refined by case law.

    For example, in Gottsacker v. Monnier, the Wisconsin Supreme Court left ambiguous the extent to which LLCs should be subject to the state's common law.19 In that case, the court was called upon to interpret pieces of Wisconsin's LLC statutes, specifically Wis. Stat. sections 183.0404 and 183.0402, which deal with voting and duties of members, respectively. Section 183.0402, the only statute dealing with the duties of LLC members, prohibits willful unfair and unlawful behavior toward the LLC. From that statute, the majority extrapolated that the statutes prohibit willful acts that have injurious effect on the LLC or its members.20

    In reality, that holding is extremely limited, applying a restricted duty to members of LLCs, while leaving ambiguous the extent to which LLCs and their members should be subject to Wisconsin's broader common law of fiduciary duties that applies to other, similar business entities.21 Justice Roggensack stated that the majority had failed to adequately clarify the duties of LLC members and argued that Wisconsin's LLC statutes effectively supplanted any application of common law to the LLC form.22

    Nonetheless, the court did not reach consensus on that issue, and in the years since Gottsacker, it has not revisited or refined its position.23 Thus, despite the minimal, statute-derived protections provided by the Gottsacker court to LLC members, the full extent of the duties of those members remains undefined.

    Considerations in Applying Fiduciary Law to LLCs

    The above-discussed gap in Wisconsin law potentially allows members of LLCs to act without regard to common-law fiduciary duties that members of other, non-LLC business forms are subject to. Thus, given that the LLC is now the most popular choice of business form for newly created businesses in Wisconsin, it is imperative for something to be done to close this hole in the law. Perhaps the easiest fix would be for the Wisconsin Legislature to add a provision to the LLC statutes that expressly imposes the well-developed corporate fiduciary duty on LLCs and their members.

    Another solution would be for the Wisconsin Supreme Court to take up the issue if presented with the opportunity to do so and either explicitly hold LLCs subject to the same common-law fiduciary obligations as corporations or, at the very least, clarify its earlier holdings, so that individuals creating LLCs are aware of the potential for abuse by fellow members. Further, as can be seen from the circumstances in Executive Center III, a lack of common-law fiduciary duties can have negative consequences for third parties that contract with an LLC.24 As Judge Stadtmueller pointed out in that case, if common-law fiduciary duties are not applied to LLCs as a matter of law, unscrupulous businesspeople may legally use the LLC form to operate in a dishonest manner – a result that defies logic.25

    Accordingly, the best route for the Wisconsin Supreme Court to take would be to decide that Wisconsin LLCs are subject to common-law fiduciary duties, as those duties have been determined to apply to corporations. This solution is practical, logical, and legal and would result in the best public policy for Wisconsin's businesses.

    This path is practical and logical. LLCs and corporations are similar in many important ways.26 Further, Wisconsin courts have developed a robust common law regarding the fiduciary duties owed by stakeholders in corporations.27 Thus, it would be extremely easy for the Wisconsin Supreme Court to simply impose on LLCs the fiduciary duties owed within corporations as a matter of common law. The courts would not need to separately draw the outline of the LLC fiduciary duty; they could simply apply the already well-developed corporate-fiduciary-duty law to a nearly analogous business form. Finally, many other jurisdictions take this course, and it seems to be the trend among courts considering the issue.28

    This path would also follow well-established case law and practice from Wisconsin and other jurisdictions. While the Gottsacker court seemed apprehensive about implying common law against the LLC because of the LLC's stance as a newly created creature of statute,29 such concerns have been shown to be unfounded as other jurisdictions have begun to apply fiduciary duties to LLCs.30 Furthermore, Wisconsin courts have imposed fiduciary duties on corporations for many years, and that approach has not hindered the corporate form from remaining a popular choice.31 The LLC would still fulfill its primary purposes: protection of its members from the debts of the business, and ease of formation and operation. And those advantages ensure that, regardless of whether common-law fiduciary duties apply to LLCs as a matter of law, the LLC will remain the most popular choice of business form in Wisconsin.

    Finally, imposition of corporate fiduciary duties on LLCs would best serve public policy. Under this scenario, all LLC members – whether involved in already formed businesses or contemplating formation – would be protected from the bad-faith acts of others. The concept of the fiduciary duty protects all individuals who want to form businesses from unscrupulous potential co-owners; Wisconsin case law implies those duties into the formation of corporations, and thus the Wisconsin Supreme Court should do the same for LLCs.

    Nonetheless, if the Wisconsin Supreme Court determines that Wisconsin LLCs are not subject to common-law fiduciary duties, it should – at the very least – clarify its reasoning for that decision and make clear that members of Wisconsin LLCs should ensure that their formation documents impose fiduciary duties on every member. It is possible that the court could determine that the controlling statutes prohibit the application of common law to LLCs. If that is the case, the court should clearly state so, and ask the legislature to pass a revised version of the LLC statutes, which should expressly incorporate fiduciary duties against LLCs. The court should also make clear to attorneys and the public that, unless the legislature acts to clarify the statute, LLCs will be governed solely by agreement of the parties; in such a scenario, attorneys and members of the public will have to ensure that their internal agreements impose duties on all members.

    Conclusion

    The wisest course would be for the Wisconsin Supreme Court to issue a decision holding that Wisconsin LLCs should not be presumed exempt from common-law fiduciary duties. Even more important is that the court at least address the issue if given the opportunity to do so. LLCs have become the most common business form in Wisconsin, and therefore the state's residents – especially its lawyers – need the court to clearly establish whether common-law fiduciary duties apply to LLCs, so that all involved can make more educated decisions on how to best form an LLC and structure duties therein.32

    Zachary R. WillenbrinkZachary R. Willenbrink, Marquette 2011, is law clerk to the Hon. J.P. Stadtmueller, U.S. District Court for the Eastern District of Wisconsin. He has written and submitted this article with permission of Judge Stadtmueller, who reviewed the article to ensure that it does not disclose any information not a matter of public record.

    In a 2005 Wisconsin Lawyer article, Joseph W. Boucher and George R. Kamperschroer stated that “the safest route is for attorneys to advise their clients that in an appropriate case the courts will likely decide that LLC members have a fiduciary duty to the LLC and other members....”33 That likelihood has not come to pass in the intervening years, and the state's attorneys and LLC members now need the Wisconsin Supreme Court to finally take up a case to decide the issue so that businesses can plan properly for contingencies and ensure that every LLC member is adequately protected. If the Wisconsin Supreme Court does not act, then the Wisconsin Legislature should make attempts to clarify the statute. In the meantime, until clarification of the law by judicial decision or legislation, lawyers should draft LLC operating agreements expressly incorporating fiduciary duties pending a decision by the Wisconsin Supreme Court on the topic.

    Endnotes

    1 Executive Ctr. III LLC v. Meieran, 823 F. Supp. 2d 883 (E.D. Wis. 2011).

    2 See, e.g., Wis. Stat. §§ 183.0102-.1305.

    3 Gottsacker v. Monnier, 2005 WI 69, 281 Wis. 2d 361, 697 N.W.2d 436.

    4 Wisconsin has extensively developed case law on the fiduciary duties of corporations. Recent decisions include Notz v. Everett Smith Group Ltd., 2009 WI 30, 316 Wis. 2d 640, 764 N.W.2d 904; Berner Cheese Corp. v. Krug, 2008 WI 95, 312 Wis. 2d 251, 752 N.W.2d 800; Zastrow v. Journal Communications Inc., 2006 WI 72, 291 Wis. 2d 426, 718 N.W.2d 51; and Beloit Liquidating Trust v. Grade, 2004 WI 39, 270 Wis. 2d 356, 677 N.W.2d 298.

    5 Executive Ctr. III, 823 F. Supp. 2d at 885-86.

    6 Id.

    7 Id. at 886.

    8 Id. at 887-93.

    9 Id. at 887-89.

    10 Id. at 890-92.

    11 See id. at 890.

    12 Id. (citing Gottsacker, 2005 WI 69, ¶ 45, 281 Wis. 2d 361) (Roggensack, J., concurring)).

    13 Id. at 890.

    14 Id. at 890-92.

    15 Id.

    16 Id.

    17 See, e.g., Parties' Stipulation of Dismissal at 55, Executive Ctr. III v. Meieran, No. 10-CV-0263-JPS (E.D. Wis. Feb. 2, 2012); Order of Dismissal at 56, Executive Ctr. III v. Meieran, No. 10-CV-0263-JPS (E.D. Wis. Feb. 3, 2012).

    18 See, e.g., Joseph W. Boucher & George R. Kamperschroer, The First LLC Case, 78 Wis. Law. 12, 13 (Sept. 2005); Wis. Dep't of Financial Institutions, 2008 Annual Report 7-8.

    19 2005 WI 69, ¶¶ 28-37, 281 Wis. 2d 361.

    20 Id.

    21 Id. ¶¶ 31, 37; see also Boucher & Kamperschroer, supra note 18, at 68.

    22 Gottsacker, 2005 WI 69, ¶ 45, 281 Wis. 2d 361.

    23 The Wisconsin Supreme Court has since determined that the parties to an LLC agreement may vary their duties by contract. Kasten v. Doral Dental USA LLC, 2007 WI 76, ¶ 40, 301 Wis. 2d 598, 733 N.W.2d 300. The Wisconsin Court of Appeals has also examined the contractual provisions of LLC operating agreements to determine whether the parties' actions violated those provisions but never to determine whether the parties breached common-law fiduciary duties. See, e.g., Decker v. Decker, 2006 WI App 247, ¶¶ 10-18, 298 Wis. 2d 141, 726 N.W.2d 664.

    24 823 F. Supp. 2d at 885-86, 890-92 (finding that a business that suffered injury as a result of LLC's insolvency, which had been caused by an alleged breach of fiduciary duty between a member and the LLC, would not have been able to recover for that breach in the absence of common-law fiduciary duties).

    25 Id. at 892 (“Logic dictates the same. Fiduciary duties exist to protect people who are affected by the actions of those who control businesses.... If [application of fiduciary duties rested on the choice of business form], every dishonest owner could simply elect to operate its business as an LLC and claim that no fiduciary duties applied to its actions.”).

    26 See, e.g., Gottsacker, 2005 WI 69, ¶¶ 14-19, 281 Wis. 2d 361; David J. Litvinoff, Comment, Wisconsin's Limited Liability Company: Emerging Issues and Prospects for the Future, 78 Marq. L. Rev. 757, 758-69 (1995) (discussing the then-newly created LLC in Wisconsin); Claire M. Dickerson, Equilibrium Destabilized: Fiduciary Duties Under the Uniform Limited Liability Company Act, 25 Stetson L. Rev. 417, 421-22 (1995) (discussing LLCs generally, at the broader national level).

    27 See, e.g., Zastrow, 2006 WI 72, 291 Wis. 2d 426 (discussing fiduciary duty of care); Berner Cheese Corp., 2005 WI 95, 312 Wis. 2d 251 (discussing fiduciary duty of loyalty).

    28 See, e.g., Pappas v. Tzolis, 932 N.Y.S.2d 439 (N.Y. App. Div. 2011); Fiederlein v. Boutselis, 952 N.E.2d 847, 860 (Ind. Ct. App. 2011); Tully v. McLean, 948 N.E.2d 714, 740 (Ill. App. Ct. 2011); Paton v. Hobbs, 280 S.W.3d 589, 594 (Ky. Ct. App. 2009); Purcell v. S. Hills Invs. LLC, 847 N.E.2d 991, 997 (Ind. Ct. App. 2006); Gottlieb v. Kest, 141 Cal. App. 4th 110, 152 (Cal. App. 2d Dist. 2006); People v. Pacific Landmark LLC, 129 Cal. App. 4th 1203, 1211-16 (Cal. App. 2d Dist. 2005); Maxemus Entertainment LLC v. Josey, 35 Conn. L. Rptr. 454, *3 & n.4 (Super. Ct. 2003). See also Sandra K. Miller, What Fiduciary Duties Should Apply to the LLC Manager After More than a Decade of Experimentation?, 32 Iowa J. Corp. L. 565, 611-12 (taking issue with Justice Roggensack's Gottsacker concurrence).

    29 Gottsacker, 2005 WI 69, ¶¶ 14-19, 281 Wis. 2d 361.

    30 In fact, as Judge Stadtmueller pointed out in Executive Center, the application of common-law fiduciary duties to the operations of LLCs is growing without indication of problems arising. 823 F. Supp. 2d at 891-92 (citing Credentials Plus LLC v. Calderone, 203 F. Supp. 2d 890, 899 (N.D. Ind. 2002); Purcell, 847 N.E.2d at 997; Patman, 280 S.W.3d at 594; Gottlieb, 141 Cal. App. 4th at 152; Pacific Landmark LLC, 35 Conn. L. Rptr. 454 at *3 & n.4; Bushi v. Sage Health Care PLLC, 203 P.3d 694, 699 (Idaho 2009); Miller, supra note 28, at 611-12)).

    31 See, e.g., Zastrow, 2006 WI 72, 291 Wis. 2d 426; Berner Cheese Corp., 2005 WI 95, 312 Wis. 2d 251.

    32 See, e.g., Wis. Dep't of Financial Institutions, supra note 18, at 7-8 (pointing out that LLCs accounted for 23,915 (more than 80 percent of Wisconsin's total 28,976 new business filings from July 1, 2008, through June 30, 2009).

    33 Boucher & Kamperschroer, supra note 18, at 68 (emphasis added).