Authority to Sue on Behalf of a Wisconsin LLC After Marx V Morris
Jeff Storch | 03.30.21
In Marx v. Morris, 2019 WI 34, 386 Wis. 2d 122, 925 N.W.2d 112, the Wisconsin Supreme Court addressed the question of whether an LLC member has standing to assert a claim against another member of the same LLC based on an injury suffered primarily by the LLC (rather than by the individual member asserting the claim). That is, can an LLC member bring a claim on behalf of the LLC itself, or are they limited to “derivative claims,” as are shareholders in a corporation? The court concluded that members do have standing to assert individual claims against other members and managers of the LLC based on harm to the LLC itself (in addition to claims based on harm to the individual member) and are not limited to derivative claims.
As background, Wisconsin Statutes Section 183.0305 provides that an LLC member is not a proper party to a proceeding by or against the LLC solely by reason of being a member, unless the proceeding is brought to enforce the member’s right against or liability to the LLC or the action is brought under Wisconsin Statutes Section 183.1101.
Section 183.1101 provides that, unless otherwise provided in an operating agreement, one or more members of an LLC may bring an action on behalf of the LLC in its name if members owning more than 50% of the value of the total contributions to the LLC affirmatively authorize the action. In calculating the “more than 50%” threshold, the vote of any member whose interest in the outcome of the action is adverse to the interest of the LLC is excluded; that is, the vote must be approved by a majority of the “disinterested” members. The member bringing the action must be a member both at the time of bringing the action and also at the time of the transaction that is the subject of the action (or the person’s status as a member devolved upon that person by operation of law or under the terms of an operating agreement from a person who was a member at the time of the transaction). The complaint must describe with particularity the member’s authorization to bring the action and how that authorization was determined. If the action is successful, the court may award the member bringing the action reasonable expenses, including reasonable attorney fees, from any recovery in the action or from the LLC itself.
In Marx v. Morris, the Wisconsin Supreme Court was presented with the question, “Does a member of a limited liability company (LLC) have standing to assert a claim against another member of the same LLC based on an injury suffered primarily by the LLC, rather than the individual member asserting the claim?” The court concluded such members do have standing, stating, “[c]orporate principles of derivative standing do not apply to the distinct business form of an LLC.”
The court started its analysis by first comparing Chapter 180 of the Wisconsin Statutes, which governs corporations, to Chapter 183 (which governs LLCs). The court stated that Chapter 180 sets forth a detailed list of procedures and requirements for corporate shareholders seeking to bring claims on behalf of the corporation as derivative actions, citing Wisconsin Statutes Sections 180.0740 through 180.0747. It explained that, in the corporate context, individual shareholders cannot directly sue a corporation’s directors or officers when the “primary injury” resulting from the actor’s wrong is to the corporation itself, but instead shareholders must bring a derivative action.
The court found it significant that Chapter 183 did not have similar statutory procedures that limit actions against others for injuries to the LLC itself and therefore declined to “import” corporate principles of derivative standing into Chapter 183. The court noted that Section 183.1101 does not require that claims against LLC members be brought in the name of the LLC or otherwise limit a member’s ability to sue other members or managers in their individual capacities, but instead Section 183.1101 merely requires that, if an action of any kind is to be brought in the name of the LLC, it must be authorized by a majority vote of disinterested members.
The court also looked at other states’ LLC statutes, finding that some states have effectively written corporation standing rules into their LLC statutes, citing Michigan and Connecticut. The court continued that, since Wisconsin’s legislature had not done so with Wisconsin’s Chapter 183, the court would not “judicially import” corporate derivative standing provisions into Chapter 183.
As further support for its decision, the court raised the issue that in a corporation, gains and losses do not flow through to the individual shareholders, but instead the corporation’s income is first taxed at the entity level; in contrast, here the LLC was taxed as a partnership and so the company’s gains and losses flowed through to individual members. The court found that “there is generally a much closer financial connection between harm to an LLC and harm to its members than between harm to a corporation and harm to its shareholders” as additional support for declining to import corporate derivative standing rules to the Act.
However, Justice Kelly’s dissent took issue with this finding, stating correctly that an LLC may choose to be taxed at either the entity or member level (i.e., by making an election to be taxed as a C or S corporation or by accepting the default flow-through tax treatment). The dissent effectively asked, if an LLC’s tax election is relevant whether derivative standing rules should apply to an LLC, will derivative standing rules apply when an LLC chooses taxation at the entity level (i.e., is taxed as a corporation), but not when it chooses taxation at the member level (i.e., taxed as a partnership)?
In addition, the dissent suggested that Section 183.0305 serves to “import” derivative standing principles Chapter 183 and the court ignored that statute. As stated above, Section 183.0305 states that an LLC member is not a proper party to a proceeding by or against the LLC solely by reason of being a member, unless the proceeding is brought to enforce the member’s right against or liability to the LLC or the action is brought under Section 183.1101.
The dissent said that Section 183.0305 “stands as a bar against members suing on behalf of their LLC unless they satisfy the terms of § 183.1101.” It continued that the court never mentioned Section 183.0305 in concluding that the provisions of Section 183.1101 were optional and “silent on a member’s right to sue on his own behalf.” The dissent posited that Section 183.1101 “simply operates as an exception to the rule in § 183.0305 that a member has no standing to sue on behalf of his LLC.”
For now, Marx allows members to bring claims on behalf of an LLC itself, without being subject to the “derivative claim” limitations as are shareholders in a corporation. However, the full scope of a member’s right to bring claims on behalf of an LLC for injuries to it (including whether the same rule applies to LLCs taxed as corporations) is yet to be determined. Members and practitioners who wish to provide more clarity on members’ rights to bring claims on behalf of the LLC should include provisions in the operating agreement specifying who may bring claims on behalf of the LLC.
DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.