A client calls with a question: “What duties do I owe to an equal member of my LLC?” A straightforward question, but even after hours of research, a clear and definitive answer is elusive. The history of the Wisconsin Limited Liability Company Law (WLLCL) suggests that the drafters intended for members to have fiduciary duties to one another akin to the duties owed between partners. For example, partners owe the fiduciary duties of loyalty and care to both the partnership itself and the other partners.1 However, cases interpreting the WLLCL have not set any bright-line definitions of the duties of LLC members and managers.
Most recently, the Wisconsin Supreme Court had the opportunity to weigh in on the issue of LLC member fiduciary duties to other members in Smith v. Kleynerman, but was unable to get beyond a 3-3 tie vote.2 As a result, confusion continues regarding the application of fiduciary duty principles to Wisconsin LLCs despite evidence that the WLLCL’s drafters intended for LLC members’ duties to mirror common-law and statutory duties within a partnership.
The supreme court’s recent inability to reach a consensus on this issue suggests that updated legislation should address the issue more directly. In the interim, Wisconsin lawyers should advise clients intending to form an LLC that the best practice is to use an operating agreement to clearly define members’ duties.
The LLC in Historical Context
Before delving further into the Smith case, here are a few reflections on the historical context of the Wisconsin LLC law. Wyoming passed the first U.S. version of the LLC law in 1977.3 It did so to provide an entity with single flow-through-level income taxes and limited liability. To confirm that it had achieved this objective, Wyoming requested an IRS ruling, which was published 10 years later. This ruling clarified that LLCs would be taxed as partnerships unless the entity opted out.
com jboucher neiderboucher Joseph W. Boucher, U.W. 1978, CPA, MBA, is a founding shareholder of the Madison law firm of Neider & Boucher S.C. His practice emphasizes business legal and tax planning for closely held businesses. He was a co-drafter of the original Wis. Stat. chapter 183 for LLCs, the amendments to chapter 183, the Next Economy Legislation of 2002, and the limited liability partnership law. He is a member of a committee revising Wisconsin’s LLC statute.
com akramer hansenreynolds Andrew J. Kramer, U.W. 2006, is a partner with Hansen Reynolds LLC, Milwaukee. His practice focuses on complex business litigation, appellate advocacy, and assisting clients with government investigations and regulatory enforcement. He served as lead appellate counsel for the plaintiff-respondent and argued before the Wisconsin Supreme Court in Smith v. Kleynerman, the most recent Wisconsin case touching on LLC members’ fiduciary duties.
What difference does it make if an entity is taxed as a partnership or corporation? It makes a substantial difference, as shown by the overwhelming transition to LLCs over the past two decades. Corporations pay an income tax on their income, a so-called double tax because the shareholder-owners will pay as well if they receive dividends from the corporation. At the same time, partnerships flow the income tax consequences through to their owners-members-partners, as the case may be, thus avoiding the double tax.
The Wisconsin LLC Law
In the early 1990s, several lawyers drafted the Wisconsin LLC law. Joe Boucher was privileged to chair this terrific group. The draft was completed, reviewed by the State Bar of Wisconsin, and enacted by the legislature in December 1993, effective Jan. 1, 1994. Since then LLCs have come to dominate entity formations in Wisconsin and the United States; they comprise nearly 90 percent of new Wisconsin entities.
The committee sought to ensure limited liability and partnership income tax treatment following the Wyoming pattern. This meant using partnership law principles, not corporate principles. Thus, to determine some of the key principles of Wisconsin LLC law, one needs to refer to Wisconsin partnership law at the time. This means that the existing partnership entity legal principles were the fundamental underlying premises for the original Wisconsin LLC law passed in 1993.4
Some lawyers, including this article’s authors, believe that Wisconsin partnership law imposes a fiduciary duty on all partners and thus that the WLLCL imposes a fiduciary duty on all members in member-managed LLCs. In manager-managed LLCs, the managers have fiduciary duties to the members and the LLC.5 The current LLC legislative committee is debating a legislative update that will, it is hoped, provide clarity on this issue.
Wisconsin Case Law Interpreting Wis. Stat. chapter 183
Wisconsin case law interpreting the fiduciary duties of LLC members is sparse. The first case to address this issue was Gottsacker v. Monnier,6 decided in 2005. In an article titled The First LLC Case, Joe Boucher and George Kamperschroer pointed out that “the safest route is for attorneys to advise their clients that in an appropriate case the courts will likely decide that the LLC members have a fiduciary duty to the LLC and other members.”7 As the authors stated, the safest bet is to assume the members have a fiduciary duty.
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Unfortunately,Gottsacker left several important questions unanswered, including the underlying issue of LLC members’ fiduciary duties to one another. Justice Roggensack’s concurring opinion stated a belief that LLCs are creatures of statute, and thus “[c]ommon law concepts such as the fiduciary duty of a majority shareholder of a corporation to a minority shareholder are replaced by statutory obligations.”8
In an accompanying footnote, Justice Roggensack also expressed the belief that “[t]he court of appeals improperly engrafted a common law fiduciary duty on [the litigants’] status as members. Members’ obligations are set by statute.”9 The Roggensack concurrence played a key role in the petitioner’s arguments in Smith v. Kleynerman.
More recently, in Executive Center III LLC v. Meieran, Judge Stadtmueller, in the U.S. District Court for the Eastern District of Wisconsin, examined whether an LLC may owe a fiduciary duty to a third party.10 The Executive Center III decision collected cases from across the country and suggested a growing trend toward applying fiduciary duties to the operation of LLCs. That decision was discussed in considerable detail in an excellent article by Zachary Willenbrink in the Wisconsin Lawyer in November 2012.11 Among other points, he stated the following:
“[A] lack of common-law fiduciary duties can have negative consequences for third parties that contract with an LLC. 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. This path would also follow well-established case law and practice from Wisconsin and other jurisdictions.” Willenbrink also noted that concerns about applying common-law fiduciary duties to statutorily created entities such as LLCs “have been shown to be unfounded as other jurisdictions have begun to apply fiduciary duties to LLCs.”
The Smith v. Kleynerman Decision
There have been oblique references to this issue in other cases that have come before Wisconsin’s appellate courts, but none have addressed it as directly as Smith v. Kleynerman, argued in January 2017.
Unfortunately, the Wisconsin Supreme Court’s decision in March 2017 included only one sentence: “The judgment is affirmed by an equally divided Court.”12 With that tie, the Wisconsin Supreme Court let stand the Wisconsin Court of Appeals decision, which decided the case without reaching the issue of LLC members’ fiduciary duties.
The court of appeals agreed with the circuit court that an LLC member had breached his fiduciary duty to the other member and affirmed the compensatory damages but struck down the punitive damages.13 Of note, the court of appeals based its finding that a fiduciary duty existed on the assumption of corporate executive positions by the members, not on an independent fiduciary duty arising from the LLC members’ status within the LLC.
An operating agreement can provide LLC members with
any agreeable arrangement, subject to a requirement of
reasonableness and good faith and fair dealing.
The primary question on appeal was whether one 50-percent member owed a fiduciary duty to the other 50-percent member of that LLC in the negotiation of an asset purchase agreement. The LLC had no written operating agreement, and the duties of the members to one another were not otherwise defined in writing. Accordingly, the parties and the court had to rely on statutes and existing case law, which did not provide definitive guidance on this issue.
Although Smith v. Kleynerman was decided on corporate fiduciary duty grounds in the court of appeals, Smith urged the supreme court to explicitly adopt common-law fiduciary duties between 50-percent members of an LLC, similar to the fiduciary duties of partners or joint venturers under common law.
Kleynerman, however, argued that the court should adopt the reasoning from Chief Justice Roggensack’s concurrence in Gottsacker, that all common-law duties had been replaced by statutory duties.
Kleynerman advocated adoption of a rule that the only obligations between members are those that are explicitly stated in Wis. Stat. section 183.0402. Section 183.0402 prohibits 1) a “willful failure to deal fairly” with the LLC or other members, when a member has a “material conflict of interest”; 2) violations of criminal law; 3) transactions from which a member “derived an improper personal profit”; and 4) “willful misconduct.” These statutory obligations incorporate some but not all of the traditional aspects of the fiduciary duties of loyalty and care.
The confusion remains regarding whether Wis. Stat. section 183.0402 is the ceiling or the floor when it comes to member duties. Do the common-law principles applicable in partnerships provide additional protections for LLC members as the drafters intended or are LLCs a “fiduciary duty-free” zone with spare minimum standards of conduct? The supreme court’s tie vote in Smith v. Kleynerman demonstrates that Wisconsin courts and lawyers need further legislative guidance on this issue.
Advising Clients While Law is in Flux
An update to the WLLCL may provide the opportunity for greater legislative clarity. A committee of the State Bar’s Business Law Section has been working on this update now for several years. It is anticipated that the Wisconsin Legislature will pass the legislation either this year or early next year. Some states have dealt with this issue by incorporating fiduciary duties by statute and allowing LLC members to alter or eliminate the duties via operating agreement.
Unless and until the legislature acts, lawyers should work with clients at the formation of an LLC to proactively define, modify, or limit fiduciary duties among the members by using operating agreements to make the preferred level of duty explicit. An operating agreement can provide LLC members with any agreeable arrangement, subject to a requirement of reasonableness and good faith and fair dealing. Members who wish to ensure a fiduciary relationship between themselves can use operating agreement language that mirrors Wis. Stat. section 178.0409 (part of the partnership statutes), explicitly incorporate partnership style common-law duties, or both.
Because of the widespread popularity of the LLC as a business entity, lawyers involved in both entity formation and business litigation should take note of the existing ambiguity in the WLLCL regarding fiduciary duties so they can properly advise clients.
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What was your oddest experience in a legal context?
I lived through the absolute media circus that was the Drew Peterson murder trial in Joliet, Ill., in the summer of 2012. For those blissfully unaware, Drew Peterson was a police officer who was a suspect in the disappearance of his fourth wife and was charged and convicted for the murder of his third wife. The disappearance was extensively covered in the media. Peterson was even depicted by Rob Lowe in a Lifetime television movie.
Peterson’s brash personality and the salacious details of the cases inspired hordes of local and national media to descend on the courthouse during the trial. Court TV built a set on the lawn of the courthouse and reported live updates throughout the trial. A well-known television judge even made a few appearances.
I worked as a prosecutor, and although I wasn’t prosecuting the Peterson case, I was fighting through the throngs of reporters to go to court every day. I even found a picture of myself in the Chicago Tribune, unfortunately caught in the background as the defense team walked to court. Every night, I watched as lawyers and judges I saw everyday were depicted in courtroom sketches and video clips. It was an odd and surreal experience to say the least.
com akramer hansenreynolds Andrew J. Kramer, Hansen Reynolds LLC, Milwaukee.
Your practice focuses on business law. What drew you to that practice area?
I grew up in Marinette, Wis., in the 1950s and 1960s. My mother was an insurance agency professional until marrying my father while in her late 20s, and my dad started a bakery after World War II. They put me to work in the family bakery when I was very young, cleaning, handling inventory supplies, delivering baked goods to wholesale customers, collecting delinquent accounts, and baking, too. Then my dad died when I was a senior in high school. Mom kept operating the business and involved me in more duties, including financial matters.
While attending the U.W. Law School, I worked on the staff of a state senator and in the Legal Assistance to Institutionalized Persons program and the Center for Public Representation. These were all great experiences but they reinforced my interest in being a business lawyer focusing on closely held businesses. I have never regretted it. Working with small business owners to help plan new ventures, solve business legal dilemmas, or provide effective ownership succession of their operations is very fulfilling. This has been a meaningful and enjoyable career.
com jboucher neiderboucher Joseph W. Boucher, Neider & Boucher S.C., Madison.
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