News

The Law Surrounding the Standing of LLC Minority Members to Bring Suit Still Taking Shape

Posted by Samuel Morris | Oct 08, 2021 | 0 Comments

Unlike corporations, which have been around for centuries, limited liability companies (LLC's) are a relatively recent phenomenon, first coming into existence in Wyoming in 1977 but not taking hold nationally until the late 1980's and early 1990's. As such, whereas much of corporate law has been well-settled for decades, the exact contours of the law surrounding LLC's is still taking shape. Though courts often borrow principles of corporate law when deciding LLC cases, at times, a court will find the differences between the two types of entities to be so vast that it will hold that traditional corporate law is inapplicable to LLC's.

One example of the differences between corporations and LLC's in Wisconsin is the difference in the ability of the members of an LLC to bring a lawsuit for an injury that member allegedly suffered versus the ability of a shareholder in a corporation to do so under the exact same set of facts. Specifically, the Wisconsin Supreme Court recently held in Marx v. Morris, that a member[1] of an LLC has standing to bring suit for an injury that member allegedly suffered in her individual capacity as an LLC member whereas a shareholder in a corporation does not have standing to sue when he has allegedly been injured in his individual capacity as a shareholder. 2019 WI 34, ¶ 46, 386 Wis. 2d 122, 925 N.W.2d 112. However, the court's rationale behind its decision in Marx does not necessarily hold true in every circumstance, and, in fact, there is room to argue that there are many instances where an LLC member should not have standing to sue for an injury he/she allegedly suffered.

By way of background, corporations[2] are business entities that file Articles of Incorporation with the state in which they are registered and are subject to what is referred to as “double taxation.” Double taxation refers to the fact that the income of a corporation is taxed first to the corporation itself and is taxed again to the individual shareholder when it reaches him/her in the form of a dividend.[3] LLC's[4], on the other hand, are “pass-through” entities, meaning that the business' income is not taxed to the LLC but rather is only taxed to the individual member (i.e. the taxes “pass through” the entity directly to the individual).

  For corporations, courts have long held that individual shareholders cannot sue a corporation's directors or officers when the "primary injury" resulting from the actor's wrong is to the corporation itself. See, e.g., Rose v. Schantz, 56 Wis. 2d 222, 229-30, 201 N.W.2d 593 (1972). Rather, the shareholder must attempt to bring a derivative action on behalf of the corporation, a difficult process. See Notz v. Everett Smith Grp., Ltd., 2009 WI 30, ¶ 20, 316 Wis. 2d 640, 764 N.W.2d 904.

In Marx, the Wisconsin Supreme Court held that the framework governing corporate standing was inapplicable to LLC's. In that case, minority members in an LLC attempted to bring an action against the majority members, alleging that the majority members sold the main assets of the LLC without a proper vote of the members, as required by the LLC's operating agreement. Marx, 2019 WI 34, ¶¶ 13-19. The court first held that the minority members did not have standing to bring a suit in the name of the LLC as the plain terms of Wis. Stat. § 183.1101 require that by a majority of disinterested members vote to authorize a suit on behalf of the LLC itself. However, the court went on to hold that the minority members could sue in their individual capacity as members. Id. ¶ 46. The court reasoned that LLC's are flow-through entities in which all of the profits would go directly to the members and so the LLC members individually suffered a potential loss of profits when the company's main assets were sold. Id. ¶¶ 43-46. Thus, the court held that the minority members had suffered a compensable injury for which they had standing to sue. Id.

Though Marx stands for the proposition that LLC members can sue in their individual capacity, the court's rationale does not hold true in every instance. Rather, the Marx court also made clear that any personal property transferred to an LLC is owned by the LLC as an entity. See id. ¶ 31. As such, when an LLC spends its own money in an expenditure that an individual member disagrees with, that member may not have standing to sue. For example, if an LLC spent $100,000 of its own money on renovations to its office and a member of that LLC disagrees with that decision, she might not be able to sue over this investment because the invested money belonged to the LLC, not the member, and this investment would not seem to have an impact on the member's ability to obtain future profits, making the rationale of Marx seem inapplicable. As Marx is a relatively recent decision, however, there are no published decisions in Wisconsin on this issue.

_______________________________

[1] A “member” of an LLC is the equivalent to a shareholder in a corporation. A member invests in an LLC for shares of the company's stock, which gives her an ownership stake in the LLC in proportion to the amount of total shares the LLC has. For example, if an LLC has one hundred shares of stock and an investor buys twenty-five of those shares, the investor now owns twenty-five percent of the LLC

[2] All references to “corporations” in this article are to “C-corporations,” which, as is discussed in the article, are subject to double taxation. The logic of this article does not necessarily apply to “S-corporations,” which, in exchange for compliance with a number of federal tax code requirements, are pass-through entities like LLCs.

[3] A dividend is simply a payment, usually in cash, from a corporation to its shareholders calculated on a per-share basis.

[4] All references to LLCs in this article refer to “member-managed” LLCs, which are similar to corporations in their structure. The logic of this article does not necessarily apply to “manager-managed” LLCs, which are similar in structure to a general partnership.

About the Author

Samuel Morris

Sam Morris was born and raised in St. Louis, Missouri. After completing high school, Sam attended the school he dreamt about going since he was eight years old: The University of Wisconsin-Madison. Sam then graduated from UW in three years, earning a...

Comments

There are no comments for this post. Be the first and Add your Comment below.

Leave a Comment