Business Law Section Blog: Off the Marx: Questions from the Wisconsin Supreme Court’s New Precedent for Limited Liability Companies, Part 2:

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  • Business Law Section Blog
    February
    27
    2020

    Off the Marx: Questions from the Wisconsin Supreme Court’s New Precedent for Limited Liability Companies, Part 2

    Andrew J. Parrish, Robb E. Leach

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    The Wisconsin Supreme Court’s recent decision in Marx v. Morris raises a number of questions surrounding limited liability companies. In this second of two articles, Drew Parrish and Robb Leach explore more questions in the wake of the Marx decision.

    In Marx v. Morris,1 the Wisconsin Supreme Court handed down one of the more notable Wisconsin business decisions in recent years: that limited liability company members have common law fiduciary duties, and that limited liability company members have standing to bring claims against other members for damages sustained by the LLC.

    See Part 1 for a background on the case and questions on rules of standing, tax elections, and damages resulting from the ruling.

    We continue here with questions on common law fiduciary duties, a non-LLC member’s ability to sue, the possible impact of operating agreements to prevent the application of Marx, and Marx’s apparent departure from Chief Justice Roggensack’s previous opinion in Gottsacker v. Monnier.

    The Questions, Part 2

    To whom are common law fiduciary duties owed in an LLC?

    The court’s finding that LLC members owe fiduciary duties was far less surprising than its decision on standing. As the majority noted, states are divided on the question of whether common law fiduciary duties apply to LLCs, with some states eliminating them statutorily and others supplementing statutory rights and duties with equitable fiduciary rules.

    Drew Parrish Drew Parrish, DePaul 2002, is an attorney with Wheeler, Van Sickle & Anderson, S.C. in Madison, where he practices in commercial transactions, energy law, and general business law.

    Robb Leach com rleach wheelerlaw Robb Leach, North Dakota 2015, is an associate with Wheeler, Van Sickle & Anderson, S.C. in Madison, where he practices in real estate and energy law.

    But, in conflating an LLC member’s losses with those of the company itself, the court also muddled the question of who benefits from the fiduciary duties owed by the members. Is a member’s fiduciary duty primarily for the benefit of the LLC, much like corporate directors’ primary duty is to the entity they serve rather than individual shareholders?

    Or, are the duties of LLC members like the duties of partners, owed primarily to each other individually? Does tax election affect the answer to this question?

    Can a nonmember of an LLC sue the LLC’s members or managers for harm incurred by the LLC as a result of those members/managers’ management decisions?

    The dissenting opinion noted that the majority’s decision seemingly imposes duties flowing from LLC members to nonmembers of the LLC, another doctrinally questionable result flowing from the majority’s conflation of the individual members and the LLC.

    As Justice Kelly pointed out, the majority largely ignored the fact that the plaintiffs included not only the LLCs who were the actual members of North Star Sand LLC, but also Marx and Murray, the individual members of those member LLCs.

    It is not clear how Marx and Murray possess standing to pursue claims for losses sustained by a company in which they were never members. However, the majority elided this point, and seemingly implied that the fiduciary duties owed by LLC members would extend to persons outside of the LLC.

    Can a nonmember of an LLC sue another nonmember for harm incurred by the LLC based on an LLC’s management decisions?

    The majority also allowed to go forward the claims brought against Morris personally, even though he was never a member of North Star. While a cogent argument could be made that, by serving as a “director” of North Star under the management structure established by the company’s operating agreement, Morris assumed fiduciary duties similar to a director of a corporation.

    But the majority made no such finding in its decision, instead implicitly merging the identities of Morris and his LLC that was the actual member of North Star. The end result is that the Marx majority allowed two nonmembers to sue another nonmember of the LLC for losses incurred by the LLC.

    Can LLC members prevent the application of Marx through an operating agreement?

    The majority discussed the possibility that an operating agreement or Wis. Stat. chapter 183 could displace the common law claims that the majority decided to impose on LLC members.

    But it remains an open question to what extent an operating agreement can also override the holding of Marx itself. Can members elect “pass through” partnership tax treatment while at the same time require that any claims for losses incurred by the company be brought only by the company itself or else through a corporation-like derivative proceeding?

    Why did Chief Justice Roggensack completely reverse her position about the application of common law fiduciary duties to LLCs?

    Although of little practical importance, we were equally intrigued by the Chief Justice’s change of heart regarding the imposition of common law fiduciary duties on LLC members.

    In Marx, the Chief Justice was adamant that the statutes governing LLCs do not purport to override common law fiduciary duties, stating that she “could identify no provision of Wisconsin’s LLC Act that specifically displaces all of the common law claims asserted by Marx and Murray. The Act does not state or imply that Wis. Stat. section 183.0402  constitutes the entirety of an LLC member's or manager's obligations to other members and to the LLC.”2

    But, in a previous opinion, the Chief Justice was equally adamant that the statutes do displace common law fiduciary duties. In an influential concurring opinion3 in Gottsacker v. Monnier,4 then-Justice Roggensack chided the court of appeals for applying common law fiduciary duties to LLC members, stating: “The court of appeals improperly engrafted a common law fiduciary duty on [the defendants’] status as members. Members' obligations are set by statute.”

    While justices are certainly entitled to change their views, the Chief Justice, despite citing to her own Gottsacker concurrence in her Marx opinion, did not acknowledge her earlier pronouncement that fiduciary duties do not apply to LLCs.5

    Thus, it is a complete mystery what led Chief Justice Roggensack to completely reverse herself on this fundamental issue in LLC governance.

    Conclusion: Address Issues in Operating Agreements

    Absent any legislative enactments clarifying these uncertainties, it is unclear how the appellate courts may resolve these issues in the future. In the wake of all this uncertainty, the best and likely only course of action is for LLCs to address as many issues as possible in an operating agreement.

    Given that the policy of the Wisconsin Limited Liability Company Act is “to give maximum effect to the principle of freedom of contract and to the enforceability of operating agreements,”6 the courts should arguably uphold any operating agreement provisions that are otherwise consistent with the enabling statutes. Marx suggests as much as well, indicating that even common law fiduciary duties that now govern LLC members as a default may be altered or overridden by an operating agreement.

    Counsel for limited liability companies should encourage their clients to address issues like member duties (including the content of such duties and to whom such duties are owed), standing, allocations of damage awards, and any other areas of uncertainty.

    Given the lack of case law on these topics, however, there is no certainty that the operating agreement will be enforceable on all of these questions. But, if Marx makes anything clear, it is that leaving these issues unaddressed in the operating agreement may result in the courts making new rules to fill the gaps (and perhaps changing their minds from time to time about what those rules should be).

    Some uncertainty is unavoidable in managing a company, but the fundamental rules that govern its members shouldn’t be in flux.

    Endnotes

    1 Marx v. Morris, 2019 WI 34.

    2 2019 WI 34, ¶ 53.

    3 See Raab v. Wendel, 2019 U.S. Dist. LEXIS 114361, at *19-20 (E.D. Wis. July 10, 2019), where the federal district court reversed its own position as to whether Wisconsin law imposes common law fiduciary duties on LLCs because “it appears that Justice Roggensack has changed her opinion” from the Gottsacker concurrence.

    4 Gottsacker v. Monnier, 2005 WI 69, ¶45 n.13, 281 Wis. 2d 361, 697 N.W.2d 436.

    5 2019 WI 34, ¶¶ 20, 45, 47 n 29.

    6 Wis. Stat. § 183.1302(1).





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