Tag: standing

Binding LLC to Operating Agreement A Substantive Change in Illinois Law; No Retroactive Effect – IL Court

The summer of 2017 ushered in a slew of changes, to Illinois’ limited liability company statute, 805 ILCS 180/15-1 et seq. (the “Act”).  Some of the key Act amendments included clarifying LLC member rights to access company records, explaining if and when a member or manager’s fiduciary duties can be eliminated or reduced, tweaking the Act’s judgment creditor remedies section, and changing the Act’s conversion (e.g. partnership to LLC or vice versa) and domestication rules.

Q Restaurant Group Holdings, LLC v. Lapidus, 2017 IL App (2d) 170804-U, examines another statutory change – one that binds an LLC to an operating agreement (OA) even where the LLC doesn’t sign it. See 805 ILCS 180/15-5.

The OA is the LLC’s governing document that sets forth each member’s (or manager’s) respective rights and obligations concerning contribution, distribution, voting rights and the like. The OA’s signing parties are typically the LLC members/managers – not the LLC itself.  Legally, this is significant because under privity of contract principles – only a party to a written agreement can sue to enforce it.

2017’s LLC Act changes make it clear that the LLC entity has standing to sue and be sued under the OA regardless of whether or not the LLC signed it.

The plaintiff in Lapidus sued the defendant for various business torts including conversion and tortious interference with contract. The defendant moved to dismiss the suit based on mandatory arbitration language in the OA.  Denying defendant’s Section 2-619 motion, the Court held that since the amended Section 15-5 of the Act worked a substantive change to the former LLC Act section, it didn’t apply retroactively. (The OA in Lapidus preceded the 2017 amendments.)

Rules/reasoning:

Affirming the trial court, the First District examined the dichotomy between procedural and substantive changes to legislation.  Where a statutory amendment is enacted after a lawsuit is filed, the Court looks to whether the legislature specified the reach (i.e. does it apply retroactively?) of the amendment.  Where new legislation is silent on its scope, the Court determines whether a given amendment is procedural or substantive.  If procedural, the amendment has retroactive effect.  If the change is substantive, however, it will only apply prospectively.

A procedural change is one that “prescribes the method of enforcing rights or obtaining redress” such as pleadings, evidence and practice.  A substantive change, by contrast, is one that establishes, creates or defines legal rights.  (¶¶ 15-16; citing to Landgraf v. USI Film Products, 511 U.S. 244, 280 (1994); 5 ILCS 70/4 (Illinois’s Statute on Statutes))

In finding that amended Section 15-5 was a substantive change to Illinois’ LLC Act (and therefore couldn’t be applied retroactively) the court noted the amended statute “established a contractual right” by binding the LLC to an OA it never signed.

Since the plaintiff LLC in Lapidus never signed the OA, the Court couldn’t require the plaintiff to follow the OA’s arbitration clause without substantially altering the LLC’s contract rights.  As a result, the Court held that amended Section 15-5 did not apply to the pre-amendment OA and the plaintiff didn’t have to adhere to the arbitration clause.t have to adhere to the OA’s arbitration provisions. (¶¶ 18-19).

Afterwords:

I. To decide if a statutory amendment applies retroactively (as opposed to only being forward-looking), the court considers whether the change is procedural or substantive.

II. While the distinction between procedural and substantive isn’t always clear, Lapidus stands for proposition a change in the law that alters a parties basic contract rights (such as by making a non-party a party to an operating agreement) is substantive and will only apply in the future.

III.  And though the case is unpublished, Lapidus still makes for interesting reading in light of Illinois’ manifold LLC Act changes.  With so many recent statutory changes (see here_for example), this case likely augurs an uptick in cases interpreting the 2017 LLC Act amendments.

12(b)(6) Motions and Fraud Pleading Rules – A Case Note

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Wojcik v. Interarch, Inc., 2013 WL 5904996 (N.D.Ill. 2013), provides a good summary of the factual allegations required to allege fraud and civil conspiracy claims.

The plaintiffs sued a national franchisor and its site development consultant for fraud and other business torts when their Saladworks franchise failed.  Defendants moved to dismiss all claims.

Held: motion granted in part; denied in part.

Reasons:  The Court first recited some key Federal court pleadings and motions rules:

– A 12(b)(6) motion tests whether the complaint state a claim on which relief can be granted;

–  FRCP 8 notice pleading requires a complaint to contain sufficient factual matter that states a claim that is plausible on its face;

– a plaintiff doesn’t have to plead facts in his complaint that anticipate possible affirmative defenses  (FRCP 8(c)(1);

– FRCP 9(b) requires heightened pleading specificity for fraud and civil conspiracy claims including the ‘who, what, where, when and how’ of the fraud and the conspiracy;

– FRCP 9’s pleading specificity rules are designed to discourage a ‘sue first, ask questions later’ mentality and to account for the stigma attached to fraud-based claims;

– a negligent misrepresentation claim is not subject to FRCP 9’s elevated pleading rules;

– FRCP 12(b)(6) generally only looks at a complaint’s four corners except where the complaint either attaches or specifically refers to outside documents;

–  a court may consider exhibits to a 12(b)(6) motion if the exhibit supplements a document attached to the complaint or where the defendant relies on the exhibit for the ‘same purpose’ as a document attached to the complaint

*5-6, 11; FRCP 8, 9, 12.

Applying these rules, the Court struck several of defendants’ motion exhibits that either weren’t attached to or incorporated by reference in plaintiffs’ complaint. *8.

The Court then sustained the plaintiffs’ fraud claims against the franchisor defendants.

While a fraud plaintiff must specifically plead the “who, what, when, where and how” of the fraud, allegations of malice, intent, knowledge of falsity and subjective matters can be alleged generally.  FRCP 9(b).

Here, the plaintiffs fraud claims were detailed.  They specifically pled the defendants knowingly misrepresented and omitted material facts involving the restaurant’s projected profits, build-out and construction costs, and general operating expenses.  Taken together, the allegations satisfied the pleading requirements for a valid fraud claim.  Wojcik, *11.

The plaintiffs’ civil  conspiracy claims failed.

An Illinois civil conspiracy plaintiff must plead and prove: (1) an agreement to accomplish an unlawful purpose or a lawful purpose by unlawful means, (2) a wrongful act in furtherance of the agreement, and (3) injury to the plaintiff.  Wojcik, *11.

The agreement is the foundation of the conspiracy and requires proof of a defendant’s knowing and voluntary participation in a “common scheme” to commit an unlawful act or lawful act in an unlawful manner. 

Accidental, inadvertent, negligent or haphazard conduct is not enough to impose conspiracy liability on a defendant.  The plaintiff must plead the agreement’s critical details – including the “who, what, where, when and how” – to survive a motion to dismiss.  *12.

The Court held that plaintiffs’ conspiracy claims were too conclusory.  The plaintiffs merely parroted the elements of conspiracy and failed to plead critical details of the defendants’ agreement or their “common scheme” to harm the plaintiffs.  At most, plaintiffs pled negligence or breach of contract; not a conspiracy. *12.

Take-aways:

A court can consider external submissions on a 12(b)(6) motion where the challenged complaint incorporates or relies on an external document.  Wojcik also illustrates the required factual allegations that will satisfy Illinois state law fraud and civil conspiracy claims under Federal pleading rules.