Attorney Elizabeth Spencer
As the member of one successful LLC you may be considering striking out on your own or starting another company. While you are planning to start that new business, you should be aware of the duties you owe your current LLC.
A member of a Wisconsin LLC that starts a competing business may open themselves up to claims from the other members for violating their fiduciary duties by violating Wis. Stat. 183.0402, breaching the terms of an operating agreement, or for reasons based in common law.
First, Wisconsin LLCs are governed by the Wisconsin Limited Liability Company Act (the “Act”) and typically by operating agreements between the members. The Act imposes duties on LLC members unless the members agree otherwise in the operating agreement. These duties include that:
“(1) No member or manager shall act or fail to act in a manner that constitutes any of the following:
(a) 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.
(b) A violation of criminal law, unless the member or manager had reasonable cause to believe that the person’s conduct was lawful or no reasonable cause to believe that the conduct was unlawful.
(c) A transaction from which the member or manager derived an improper personal profit.
(d) Willful misconduct.”
Wis. Stat. 183.0402(1)
Second, decisions by the courts resulting in case law can affect the duties of members. Unlike with corporations, the Wisconsin case law on the fiduciary duties of LLC members is limited. Since the inception of LLCs, there has been confusion over whether common law fiduciary duties apply to LLC members. In Gottsacker v. Monnier, the Wisconsin Supreme Court reasoned that the Act prohibits willful acts that have injurious effect on the LLC or its members.
Subsequently, the Wisconsin Court of Appeals, in an unpublished decision, provided that common law fiduciary duties did apply. In Smith v. Kleynerman, the owner of a fifty percent interest in an LLC sued the company’s other fifty percent owner, alleging breach of fiduciary duty in connection with the sale of the company’s assets. Smith v. Kleynerman, 2016 WI App 57, ¶ 1, 370 Wis.2d 786, 882 N.W.2d 870 (unpublished). The jury found in favor of the plaintiff and awarded compensatory damages. Id. at ¶ 2. The defendant appealed. The Court of Appeals affirmed, stating that, by being a corporate officer of the LLC, the defendant owed a fiduciary duty to the plaintiff in conducting corporate business. Id. at ¶ 24. The Wisconsin Supreme Court accepted the case but divided equally, affirming the decision without decision. Smith v. Kleynerman, 2017 WI 22, 374 Wis.2d 1, 892 N.W.2d 734.
Most recently in Marx v. Morris, a case addressing numerous facets of LLCs, the Wisconsin Supreme Court addressed whether common law duties, imposed by the formation of an LLC, were recognized. Marx v. Morris, 2019 WI 34, ¶ 47, 386 Wis. 2d 122, 151, 925 N.W.2d 112, 126, reconsideration denied, 2019 WI 84, ¶ 47, 931 N.W.2d 538. The defendant argued that Chapter 183 eliminated an LLC member’s common law duties and thus, he only owed the duties defined in the statute. The Court held that LLC members may still bring a claim based on common law duties arising from the relationship between the members. The Court explained that the LLC law does not explicitly state or imply that it is the only measurement of obligations owed by members and managers to the fellow owners. Id. at ¶53. Therefore, the Court held that LLC members and managers can be sued for a breach of such duty. However, according to the court, whether Chapter 183 preempts common law claims “depends on the specific common law claims a member brings and the facts attendant to those claims.” Id. at ¶47.
The U.S. District Court for the Eastern District of Wisconsin has also addressed whether common law fiduciary duties apply, most recently in Raab v. Wendel, No. 16-CV-1396, 2019 WL 3001632 (E.D. Wis. July 10, 2019). Relying on Marx, the Court stated,
“[t]o the extent that this court held that one member of a limited liability company can never bring a common law breach of fiduciary duty claim against another member of an LLC, that decision cannot stand in light of Marx. However, merely because a common law breach of fiduciary duty claim is not categorically precluded does not mean that the defendants are not entitled to summary judgment in light of the facts presented.”
Id. at 7.
The duties that come along with being a member of an LLC are extensive. Before embarking on a new venture consider consulting with an attorney to ensure that you are not putting yourself at risk for disputes with your business partners.