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.

 

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PaulP

Litigation attorney representing businesses and individuals in business litigation, post-judgment enforcement, collections and real estate litigation.