In Marx v. Morris (Wis. 2019), the Wisconsin Supreme Court described a broad scope of potential liability for members of limited liability companies and the members' affiliates. Although the Marx decision is binding precedent only for Wisconsin courts, it serves as a reminder that members of LLCs, including LLCs that are family-owned, should address the potential liability of members and managers in their charters and LLC agreement, rather than relying on default provisions of statute and common law.
What Happened in Marx v. Morris?
North Star, LLC ("North Star") was a Wisconsin LLC. North Star had six members (i.e., owners). Each member was an LLC that was solely owned by a natural person. (For clarity, the six LLCs that owned North Star are referred to as "Member LLCs.") North Star was managed by a board of directors, composed of the owners of the Member LLCs, including Marx, Murray, and Morris. Morris also may have been North Star's attorney.
At a board meeting, Morris informed the other directors that DSJ Holdings, LLC, a company that Morris owned with a couple other investors, wanted to buy some of North Star's assets. Marx and Murray objected on substantive and procedural grounds, but the other directors approved the transaction. Apparently, Marx and Murray believed that the purchase price was too low. Marx and Murray, on behalf of themselves and their respective Member LLCs (collectively, the "Plaintiffs"), brought suit against Morris and his Member LLC (collectively, the "Defendants").
In the law suit, the Plaintiffs argued that the Defendants had violated Wisconsin statutes, which prohibit members and managers from engaging in activity that constitutes "a willful failure to deal fairly with the limited liability company or its members in connection with a matter in which the member or manager has a material conflict of interest." Wis. Stats. s. 183.0402(1)(a). The Plaintiffs also asserted a number of common law claims (i.e., claims not based on statutes) against the Defendants, such as breach of fiduciary duties and unjust enrichment.
Here is a link to Wisconsin's LLC statutes:
http://docs.legis.wisconsin.gov/statutes/statutes/183
The Defendants moved for summary judgment, asking the circuit court to decide the case in favor of the Defendants without a trial. The circuit court denied the motion. The Defendants appealed that decision. The appeal went to the Wisconsin Supreme Court.
What Did the Wisconsin Supreme Court Decide?
The Wisconsin Supreme Court affirmed the circuit court's decision denying the Defendants' motion for summary judgment and sent the case back to the circuit court for further proceedings, presumably a trial on the merits. Justice Daniel Kelly wrote an insightful and convincing dissenting opinion.
Here is a link to the Court's opinion and Justice Kelly's opinion:
https://www.wicourts.gov/sc/opinion/DisplayDocument.pdf?content=pdf&seqNo=238475
The Court outlined the issues as follows:
1. Can a member of an LLC bring a lawsuit against another member or manager for harm that is caused solely to the LLC, rather than to the member individually?
The Court decided yes, Wisconsin statutes permit a member, individually, to bring a lawsuit even when the harm is caused solely to the LLC.
2. Do the statutory causes or action preempt the common law causes of action for lawsuits by an LLC member against another member?
The Court decided no, Wisconsin statutes do not prevent a member from bringing a lawsuit under common law causes of action, in addition to the statutory causes of action.
The Court, however, made the point that many of the rules established by Wisconsin's LLC statutes are only default rules that members can reject or alter when they adopt their LLC agreement (in Wisconsin, an "operating agreement").
What Is the Effect of the Decision?
As Justice Kelly pointed out in his dissent, the Court's decision substantially broadens the potential liability and lawsuits that may be brought against LLC managers, members, and their affiliates. Justice Kelly wrote that this expansion was unwarranted and unsupported by Wisconsin's LLC statute.
In particular, Justice Kelly was bothered by the Court's decision to treat the owners of the Member LLCs (i.e., Marx, Murray, and Morris) as though they themselves were North Star's members. Justice Kelly wrote that the Court's decision erroneously broadened liability as follows:
"1. A non-member may sue an LLC's members based on the LLC's management decisions.
2. A non-member may sue another non-member based on an LLC's management decisions.
3. A member of an LLC may sue a non-member for the LLC's management decisions.
4. One LLC member may pursue a claim against another LLC member (or a member of the member) without regard to whether the plaintiff actually owns the claim.
5. Members of an LLC owe each other fiduciary duties.
6. An attorney owes fiduciary duties not just to the organization it represents, but also to the constituent members of that organization."
Justice Kelly's first three points identify a common dilemma regarding the rights and duties of decision makers and beneficial owners when a company's ownership is formally held by other business entities. It is tempting to look through or ignore those other entities when applying statutes, common law, and contract terms.
Consider the following hypothetical:
Wild Board LLC ("WB LLC") is a member-managed limited liability company that sells hover boards in a shop on Main Street. WB LLC has two members: Meg LLC, a single-member LLC owned by Margaret; and Pete One LLC, a single-member LLC owned by Peter. The LLC agreement for WB LLC says that a member of WB LLC cannot compete with WB LLC.
If Peter forms Pete Two LLC, which opens another store to sell hover boards on Main Street, has Peter violated the noncompetition provision in WB LLC's LLC agreement? Peter is not a member of WB LLC. Does the noncompetition provision in WB LLC's LLC agreement apply to Peter or Pete Two LLC, or only to Pete One LLC? Should Peter's actions somehow be attributed to Pete One LLC? Can Margaret bring suit against Peter or does the claim—if there is one—belong to Meg LLC or only to WB LLC? What if WB LLC is not a party to the LLC agreement?
A similar kind of confusion can arise when trusts, but not their beneficiaries, are the members of an LLC.
What Should Family Business Owners Do?
Family businesses owners and managers often have a heightened exposure for legal claims arising out of apparent conflicts of interest because of the many related-party transactions in which they engage. Often, the same family members occupy multiple roles and may have legal duties or beneficial interests on both sides of a family business transaction.
For example, one family member may be an owner of voting units, a manager or director, and an executive of the family business, while, at the same time, having a relationship with the family business as a vendor, lessor, or creditor. In some cases, the family member's ownership interest in the family business may be held in trust or the family member may engage in business transactions with the family business through a trust, LLC, or corporation.
The Wisconsin Supreme Court's decision in Marx v. Morris illustrates the confusion that can arise when a court ignores the formal structure of a company's ownership in order to confer or impose legal rights and duties on the human actors behind that formal structure. In some cases, this approach could lead to a common sense result; in others, it could wreak havoc. It cannot, however, accomplish a primary goal of the law, which is to inform people how they should behave.
Fortunately, family business owners can take control of the situation by expressly addressing the duties, obligations, and rights of the human decision makers and beneficial owners of family business entities.
First, in most cases, family business owners can choose which state's laws apply to the operation of their corporations, LLCs, trusts, and other entities.
Second, they can draft their companies' charters, bylaws, voting agreements, buy-sell agreements, LLC agreements, and other related-party contracts to broaden or narrow the duties and rights of the individuals involved, including express instances when the acts of an intervening ownership entity should be attributable to such individuals.
Third, as discussed in a blog post dated June 27, 2020, the family's agreements should contain alternative dispute resolution mechanisms to help ensure that the "judges" in any formal dispute under the agreement are individuals who have expertise in the law relevant to the substance of the dispute.
Gregory Monday
gmonday@reinhartlaw.com
8/3/2020