LLCs are sufficiently new that issues of first impression continue to come up in various states. One of those issues is whether common law fiduciary duties apply to LLCs, when the state statute is silent or unclear. That was the situation in Wisconsin, when the defendants in a case before the U.S. District Court for the Eastern District of Wisconsin contended that common law fiduciary duties do not apply to Wisconsin LLCs and that they therefore owed no fiduciary duties to the plaintiff. Executive Ctr. III, LLC v. Meieran, No. 10-CV-263-JPS, 2011 WL 4704274 (E.D. Wis. Oct. 4, 2011).
The dispute arose out of the plaintiff’s $1.2 million purchase of an office building from BRIC Executive, LLC. In connection with the sale, BRIC agreed to lease office space back from the plaintiff (Executive Center). But BRIC defaulted on its lease obligations almost immediately and made no rent payments. Executive Center sued BRIC on the lease and obtained a judgment for $152,000, but BRIC was insolvent and never paid on the judgment.
Executive Center then investigated and learned that the defendants, part owners of BRIC, had been paid $400,000 by BRIC immediately after the closing of the real estate sale. BRIC paid the $400,000 to the defendants in order to redeem their part ownership in BRIC, under an agreement made by BRIC and the defendants 11 months before Executive Center’s real estate purchase.
Executive Center next sued the defendants in federal court, challenging the $400,000 transfer from BRIC to the defendants and seeking an award of damages. (The case was filed in federal court on the basis of diversity jurisdiction; no federal law issues were involved.) Executive Center claimed that by accepting the $400,000, the defendants (1) violated portions of Wisconsin’s Uniform Fraudulent Transfer Act; (2) breached a fiduciary duty they owed to the plaintiff; and (3) benefited from an inequitable preference. Id. at *2.
After pretrial discovery the defendants moved for summary judgment on all of Executive Center’s claims. The court granted summary judgment to the defendants on the fraudulent transfer claim and on the inequitable preference claim, but denied summary judgment on the fiduciary duty claim.
The gist of Executive Center’s fiduciary duty claim was that the defendants breached fiduciary duties they owed to Executive Center, a BRIC creditor, when they accepted BRIC’s payment of $400,000 at a time when BRIC was insolvent. The defendants argued that “common law fiduciary duties do not apply to Wisconsin LLCs because LLCs are purely statutory creatures that have their duties defined entirely by statute.” Id. at *7 (citing Gottsacker v. Monnier, 697 N.W.2d 436, 447 (Wis. 2005)). The defendants also pointed out that Wisconsin’s LLC Act does not expressly state that common law fiduciary duties apply to LLCs, other than referring to the Act’s incorporation of veil-piercing principles. Id.
The District Court distinguished Gottsacker, however, pointing out that its only discussion of the applicability of common law fiduciary duties to LLCs was in one Justice’s concurring opinion. The court then examined precedent from other jurisdictions, finding it persuasive: “In fact, there is growing consensus that common law fiduciary duties should apply to the operations of LLCs.” Id. at *8 (citing seven cases from Indiana, Kentucky, California, Connecticut, and Idaho). The court also looked to the policy supported by fiduciary duty rules. “Fiduciary duties exist to protect people who are affected by the actions of those who control businesses. Therefore, it would not make any sense if the expectation for a business to act fairly were to be different simply due to the business owners’ choice of form – an LLC, in this case.” Id. at *9 (citation omitted). The court concluded that common law fiduciary duties apply to Wisconsin LLCs. Id.
The court next considered whether any duties were owed to Executive Center in particular. (Executive Center was a creditor of BRIC, not a member.) Under Wisconsin case law, the defendants would owe a fiduciary duty to Executive Center if (a) BRIC was insolvent at the time of the $400,000 transfer, and (b) BRIC had ceased to act as a going concern. The court had already found that BRIC was insolvent at the time of the transfer, and defendants had conceded that there was an issue of fact regarding whether BRIC was no longer a going concern at the time of the transfer. The court therefore found that genuine issues of material fact remained, and denied defendants’ summary judgment motion on the fiduciary duty claim, which meant that the issue could go to trial.
This case is a nice example of a court resolving a question left unanswered by the state’s LLC Act. (I have written about this issue before, in connection with the Idaho case cited by the Executive Center opinion, here.) It’s also not a surprising result – it’s difficult to imagine a court finding that fiduciary duties do not in general apply to LLCs.