Non-Member of LLC Lacks Standing to Pursue Statutory and Common Law Claims against LLC Manager – IL First District

Doherty v. Country Faire Conversion, LLC, 2020 IL App (1st) 192385, a dispute concerning a limited liability company (LLC) provides a useful summary of the difference between a company (a) member and (b) transferee of a member’s economic company interest and the financial impact flowing from that distinction.

The plaintiff purchased what she believed was a 25% interest in the LLC at a foreclosure sale for $20,000. Plaintiff claimed that her quarter-interest in the LLC was worth nearly $2M based on the capital contribution made by the entity whose interest Plaintiff purchased.

Plaintiff sued when the LLC sold its lone asset for approximately $5M and refused to distribute any of the sale proceeds to the Plaintiff.

Plaintiff filed suit for declaratory relief, equitable accounting, and breach of fiduciary duty against the LLC’s manager. Her declaratory judgment count sought a court order that she was a 25% member of the LLC, that she was entitled to 25% of the sale proceeds of the LLC’s asset, and that as a member she had a statutory right to inspect the LLC’s books and records.

The trial court entered partial summary judgment that the plaintiff did not own a membership interest in LLC but instead owned only an economic interest in the business. Because of this, the trial court later ruled that plaintiff lacked standing to pursue her accounting and breach of fiduciary duty claims and had no right to inspect the LLC’s books and records.

After a bench trial, the court ruled that the plaintiff held a 13.75% interest (as opposed to the claimed 25% interest) in the proceeds of the LLC’s asset sale and further reduced plaintiff’s share by the defendant LLC manager’s attorneys’ fees incurred in litigating the plaintiff’s claims.

Standing: The Member v. Transferee Difference

The First District affirmed the trial court’s finding that Plaintiff was not a member but had only a 13.75% interest in the sale proceeds and therefore lacked standing to sue for breach of fiduciary duty or to obtain an accounting of the LLC’s business records.

Rejecting the plaintiff’s breach of fiduciary duty claim, the Court noted that  Section 15-20 of the Illinois LLC Act, 805 ILCS 180/1-1 et seq. (the Act), permits an LLC member to sue the company, a manager, or another member for legal or equitable relief to enforce the member’s rights under (i) the operating agreement, (ii) the Act, and (iii) rights arising independently of the member’s relationship to the company.

The Act also provides that a transferee of a distributional interest in an LLC is not entitled to become or exercise rights of a member and has no related right to participate in the management or conduct of the LLC or to demand access to company information.  805 ILCS 180/15-20, 30-5, 30-10.

The Court found that under both the Act and the LLC’s amended operating agreement, plaintiff was only an Economic Interest Holder and not a member. As a result, plaintiff lacked standing to assert its breach of fiduciary duty and accounting claims against the manager and also could not demand production of company records or contest the trial court’s awarding attorneys’ fees to the manager based on indemnification language in the operating agreement.

Distribution of Plaintiff’s Share of LLC Asset Sale Proceeds

The First District also affirmed the trial court’s ruling that plaintiff had a 13.75% interest in the LLC’s profits and losses, as opposed to the 25% membership interest pressed by the plaintiff.

The Court looked to the plain language of the LLC’s amended operating agreement which specifically delineated the Plaintiff’s 13.75% interest in the LLC’s profits and losses.

The First District also affirmed the trial court’s ruling that the LLC manager’s expert witness was more believable than the plaintiff’s. The court ruled that the trial judge was in superior position to rule on the credibility of the parties’ warring expert witnesses and noted that the plaintiff’s expert’s opinions were based on the faulty premise that plaintiff was a 25% member of the LLC (as opposed to a 13.75% interest holder).

Afterwords:

Doherty cements Illinois courts’ continued recognition of the key distinction between a limited liability company’s member and economic interest holder. Only the former has standing to pursue statutory and common law claims against an LLC’s manager. The latter’s interest, by contrast, is relatively passive and consists only of a right to receive monetary disbursements.

Another case lesson is that business litigators should carefully parse the controlling operating agreement and the LLC Act when litigating claims involving LLC members or manager.

Other important take-aways include that a trial court’s finding on credibility of dueling expert witnesses is entitled to deference by an appeals court and attorneys’ fees are only awarded where a contract or statute so provides.

 

R. Kelly’s Royalty Account Nabbed by Sex Assault Judgment Creditor

Midwest Commercial Funding, LLC v. Kelly, 2022 IL App (1st) 210644 shows the harsh results that can flow from the failure to follow a statute’s service requirements to the letter.

There, dueling creditors fought over song royalties paid to disgraced R&B singer R. Kelly. Heather Williams sued the singer for sexual abuse and obtained a $4M default judgment against him in March 2020. About four months later, Midwest Commercial Funding, LLC (“MCF”), a commercial landlord, was awarded a $3.5M judgment for unpaid rent under a commercial lease against the singer.

Both creditors issued supplementary proceedings to enforce their respective judgments.

The Chronology

On August 17, 2020, Williams mailed a citation to discover assets to Sony – the music company that held a royalty account for the singer. Two days later, MCF sent its own citation by both regular mail and e-mail. MCF e-mailed the citation to one of Sony’s in-house lawyers with whom MCF had prior dealings.

On August 24, 2020, Sony’s in-house lawyer acknowledged receipt of MCF’s citation. (The record is unclear whether Sony’s counsel meant the August 19, 2020 e-mailed or regularly mailed citation.) August 24, 2020 is also the date that Williams mailed citation was delivered to Sony.

When MCF and Williams learned they had served simultaneous citations, they each filed adverse claims in their respective cases: Williams’s personal injury case and MCF’s lease breach action.

Trial Court Ruling

The trial court found that based on Supreme Court Rule 12(c), MCF’s electronic service was complete on day of transmission (August 19, 2020) while William’s “snail-mail” service was complete August 21, 2020 – four days after mailing. Because of this, the supplementary proceedings court found that MCF’s citation lien took precedence over Williams’s and ordered Sony to pay MCF (to the exclusion of Williams) until the judgment was satisfied.

The First District’s Reversal

Williams’s key argument on appeal was that she had a superior lien to Kelly’s royalty account as plaintiff’s e-mail citation did not perfect service under the law.

Reversing the trial court, the First District noted that once a citation is served on a judgment debtor, a judgment lien is perfected on all assets of the debtor that are not otherwise exempt under the law. The Court then wrote that when a citation is served on a third party, the judgment liens all assets of the debtor in the third party’s possession or control. A perfected lien is superior to any later-attaching lien. [Para 7]

The Court rejected MCF’s argument that Williams lacked standing to challenge service of MCF’s citation on Sony. It found Williams was not trying to vicariously assert Sony’s right to proper notice of the citations. Instead, Williams was asserting her prior interest in Kelly’s royalty account because Plaintiff’s e-mailed citation did not perfect service of its citation under Illinois law. The Court added that a contrary ruling would deprive any creditor of a chance to assert a paramount lien upon assets in a third-party respondent’s possession and allow a citation respondent to arbitrarily decide priority among competing creditors. [¶ 14]

The Court then analyzed Supreme Court Rule 11’s text to determine if e-mail service can perfect a citation lien. Under a plain reading of the Rule – titled “Manner of Serving Documents Other Than Process and Complaint on Parties Not in Default in the Trial and Reviewing Courts” – the Court found it contemplates e-mail service of documents only after a party has appeared. As a result, Rule 11 does not provide for e-mail service of documents on a party who has not appeared in the case before the court. Here, Sony had not appeared in either underlying case. [¶ 19]

Looking to Black’s Law Dictionary for guidance, the Court defined the “process” referenced in Rule 11’s title as an initiating case document, like a summons or writ, which triggers a party’s duty to respond.

The Court likened a third-party citation to discover assets to a summons. It held that “absent service of the citation, such party has no duty to appear, nor could the court subject such party to the sanctions provided in Section 2-1402 for noncompliance.”

Since the failure to respond to a third-party citation subjects a respondent to the threat of contempt and sanctions, the Court found that supplementary proceedings against a third party like Sony must be accompanied by service of process and statutory special notices. [¶ 20] As a result, MCF’s e-mailed citation was not proper service under Illinois law and did not lien the royalty account. Since Williams mailed her citation to Sony two days before MCF mailed its citation, Williams’s lien on the account trumped MCF’s.

Conclusion

This case illustrates in sharp relief how a judgment creditor plays with proverbial fire by not personally serving a citation (or at least serving it by certified mail – return receipt requested)

Since a citation to discover assets is the opening, operative document that first activates a recipient’s duty to respond, the citation is tantamount to a summons or writ and beyond the scope of Rule 11’s e-mail service provisions.

 

 

Missing Contingent-Fee Term Doesn’t Doom Law Firm’s Quantum Meruit Claim

Reversing a trial court’s dismissal of a law firm’s quasi-contract claims against a former client, the First District recently considered the enforceability of a contingency fee contract that was missing a material term.

The plaintiff law firm in Seiden Law Group, P.C. v. Segal, 2021 IL App (1st) 200877 sued the defendant, an ex-client, for quantum meruit and unjust enrichment to recover the value of its fees and costs incurred in a prior lawsuit.

Key Facts

In 2013, the client defendant hired the plaintiff law firm to petition the U.S. government in Federal court for the return of personal property the government confiscated after her ex-husband’s 2004 criminal racketeering conviction.

The contingent fee contract, drafted by the plaintiff firm, was silent on the percentage of recovery that would go to the firm if the suit was successful. It read: “_____% of recovered funds…. pursuant to a forfeiture resulting from a matter concerning [defendant’s ex-husband].” The contract also provided that in the event of discharge, the firm could recover pre-firing accrued fees and expenses advanced in the lawsuit.

In 2016, the client fired the law firm. At the time of its firing, the law firm had not recovered any property on the defendant’s (then, the plaintiff’s) behalf.

The law firm then sent defendant a bill for nearly $100,000 based on its assessed value of the legal services provided to the plaintiff in the case against the government. Plaintiff sued when defendant refused to pay under quantum meruit and unjust enrichment theories of recovery.

The basis for plaintiff’s claims was that since the underlying fee agreement was unenforceable since it was missing an essential price term, it could sue alternatively for quantum meruit and unjust enrichment.

The trial court dismissed the suit. It found that the existence of an express contract – the contingency agreement – precluded the law firm’s quantum meruit and unjust enrichment claims. That the contingent-fee contract was missing a recovery percentage, did not render the contract unenforceable. The trial court noted that courts routinely supplied missing price terms in a variety of contexts. And since the contract was enforceable, it defeated plaintiff’s claims.

Reversing, the First District first noted that under Illinois law, a contract’s material terms must be definite enough so that its terms are reasonably certain and able to be determined.

Where a contract lacks a term, a court can supply one where there is a reasonable basis for it. But where the absent term is essential or so uncertain that there is no basis for deciding whether an agreement has been kept or broken, there is no contract.

Illinois courts routinely scrutinize the reasonableness of attorney fees and contingent-fee contracts to ensure that collected fees are not excessive. Illinois courts have found contingency fees ranging from 25% – 40% to be reasonable. There are even statutory benchmarks for certain fee agreements. Code Section 2-1114 (735 ILCS 5/2-1114), for example, caps contingent agreements at 33.3% of total recovery in a medical malpractice case.

However, the Court held that in an arcane case involving recovery of assets seized by the government, there is no industry standard contingent fee amount. Because of this, the Court held that the trial court could not supply a missing percentage recovery term. [19-20]

The First District also noted the contingent-fee contract ran afoul of Illinois Rule of Professional Conduct 1.5(c) which requires that contingent-fee agreements specify the method by which the fee is to be determined, and the percentage accruing to the lawyer after trial or settlement. RPC 1.5(c) [21]

The Court ultimately found that the trial court should not have dismissed the plaintiff’s quantum meruit and unjust enrichment claims.

Quantum Meruit

In Illinois, a plaintiff can sue for quantum meruit where there is no enforceable contract between the parties. But quantum meruit is not available where the underlying contract is unenforceable as a matter of public policy; such as where a contract is illegal or violates a statute. The rationale is that a party to a contract that violates public policy should not be able to circumvent the offending contract by relying on quantum meruit.

But where a contract is unenforceable for violating an ethical rule that does not involve public policy, it will not bar quantum meruit recovery.

A contract only violates public policy where it “has a tendency to injure the public welfare.”  Here, the court found the omission of the percentage recovery an “innocuous omission” that was the product of “carelessness and sloppy contract formation.”  In the Court’s view, this did not rise to the level of a public policy violation. [28]

Because the contract’s missing percentage recovery term did not implicate public policy concerns, the First District held that the law firm could assert a successful quantum meruit claim. [24]

Unjust Enrichment

The Court then considered the Plaintiff’s unjust enrichment complaint count. To state a valid unjust enrichment claim in Illinois, a plaintiff must allege (1) an enrichment, (2) an impoverishment, (3) a relation between the enrichment and impoverishment, (4) absence of justification and (5) the absence of a remedy provided by law. [31]

While similar in that they both aim to provide a plaintiff with restitution where no contract exists, quantum meruit and unjust enrichment differ in their respective recoverable damages. The former measures recovery by the reasonable value of work and material provided while the latter considers the benefit received and retained because of the improvement provided.

The Court sustained plaintiff’s unjust enrichment claim for the same reason it found plaintiff’s quantum meruit cause was prematurely dismissed.

Afterwords:

Seiden Law’s lessons are many for commercial litigators. For one, a missing contractual term cannot always be supplied by a court; especially if contract involves specialized subject matter.

The case also makes clear that a breach of RPC 1.5’s contingency fee strictures will not automatically void a contract. It is only when an ethical violation rises to the level of a public policy breach, that a court will nullify a contract.

This case also solidifies the proposition that, when faced with an unenforceable contract that does not implicate public policy concerns, a plaintiff can still bring alternative and equitable claims for quantum meruit and unjust enrichment.