Little rights for non-member LLC owners
A recent case decision shows the risk involved in acquiring an ownership interest in a Limited Liability Company (LLC) but not being admitted as a member.
Mary Doherty v Country Faire Conversion, LLC, 2020 IL App (1st) 192385 involved an LLC membership interest that was foreclosed on and the interest holder’s rights after that in the LLC. An initial member of the LLC pledged its membership interest to a lender for a loan. The lender foreclosed on the loan. The bank sold this interest at an auction. After the sale, the other LLC members did not approve the purchaser to be a member. As a non-member of the LLC, the purchaser could not sue for breach of fiduciary duty against the manger, nor demand an accounting, nor review the financial records of the LLC, nor recoup her attorney’s fees after suing the LLC to secure her proceeds but had to contribute to the LLC’s legal expenses involved in her suit.
The Country Faire LLC acquired an apartment complex in Grayslake the consisted of four members. Only two members are relevant for this case: the manager of Country Faire and one of its members Grayslake Investment LLC. Grayslake Investment LLC borrowed money to obtain its initial investment in the venture.. The lender filed its UCC-1 with the Secretary of State. The other three members of County Faire knew this at the time. Eventually, the lender foreclosed on its lien. The lender then conducted a UCC-1 sale of its membership interest in Country Faire. The wife (Mary) of Grayslake Investment’s original owner was the high bidder at this UCC-1 sale. After the sale, the other members of Country Faire did not agree to let Mary become a member of it.
Later, Country Faire sold the apartment complex and liquidated the sales proceeds. The manager distributed the proceeds to the remaining three members and left the amount due to Mary in its bank account as Country Faire was unsure who was entitled to this money.
Mary’s husband—as the lawyer for Mary—demanded to inspect Country Faire LLC’s records. Country Faire refused. It claimed that Mary not a member of the LLC but was an economic interest owner. Under the LLC statutes, economic interest owners very few rights. Mary sued Country Faire and the manager seeking her share of the proceeds, a declaratory judgment allowing her to inspect the records of Country Faire, breach of fiduciary duty against the manager, an action for an accounting.
The court held that Mary’s interest in Country Faire was just an economic interest owner as, under the operating agreement, all members had to agree to the admission of a new member. Because Mary was not an LLC member, she could not sue the manager for breach of fiduciary duty. Mary claimed that the recent revision to the law allowed her to sue for breach of fiduciary duty.
To plea a breach of fiduciary duty claim, one must allege a fiduciary duty exists, that fiduciary duty was breached, and such breach proximately caused the injury that the party complains about. Where a fiduciary duty does not exist as a matter of law, fiduciary relationships must be pleaded and proved by clear and convincing evidence.
The legislature’s recent modification to the LLC Act §10-10 exculpatory provision did not apply here as the LLC Act governed the parties’ relationship. Effective January 1, 2020, the legislature amended Section 805 ILCS 180/10-10— the portion of the LLC Act that a member or manager is not personally liable for their actions while acting for the LLC—to state this exculpatory provision does not apply to other legal liabilities one may be responsible for outside the LLC Act. The Court held this provision is inapplicable to Mary as the LLC Act itself limits transferee’s rights. This amendment to the LLC Act addressed the manager’s personal liability on other legal theories independent of the LLC Act.
The LLC Act has multiple provisions regarding non-member’s rights. Mary was not a member, and she was not entitled to sue for breach of fiduciary duty, review the business records, or demand an accounting.
The case also reinforced the American Rule regarding attorney’s fees. Since no law or contract allowed Mary to recoup her attorney’s fees, she was barred from seeking it from Country Faire. However, under the operating agreement, Country Faire was entitled to be reimbursed its attorney’s fees for this litigation. Ultimately, the Court entered judgment for Mary for her portion of the proceeds minus her share for the manager and Country Faire’s legal expenses in this litigation.