Carefully Drafting ….or Else!

By Washington State Business and Real Estate Lawyer David C. Tingstad

Draft carefully, because ambiguous drafting may leave you at the mercy of default rules of the LLC Act.  A recent Wisconsin Supreme Court decision, Marx v. Morris, 925 N.W.2d 112 (Wisc. 2019), illustrates the need for careful drafting.

The Case’s Significance

Before delving into the facts and dispute arising out of Marx, it is important to note the rich treatise-like material found in the opinion. The Wisconsin Supreme Court embarks on a thorough discussion of the history of the LLC, its purpose, and the significance of default rules in relation to LLC agreements. I highly recommend practitioners read the case (notwithstanding the interesting issues discussed below) for greater insight into today’s most utilized business entity.

Facts

The main issue in Marx was whether the defendant Morris breached the LLC agreement and violated Wisconsin law by engaging in another business venture, DSJ Holdings, LLC, while concurrently a member of North Star LLC. North Star was owned by six individuals for purposes of owning and mining land. North Star also owned a subsidiary entity known as Westar Proppants, LLC for purposes of controlling the purchase agreements for certain properties.

North Star’s operating agreement provided members the right to “engage independently or with others in other business ventures of every nature and description,” which is fairly common language.

At a meeting of all the members, Morris informed the members of his ownership of another entity, DSJ Holdings, LLC, and his intent to purchase Westar from North Star. The sale of Westar was brought to a vote and the members refused 4-2. Immediately afterwards, Morris apparently threw a fit. Morris indicated he may withdraw from North Star, became very aggressive with the other members, and told the other members that they were “going to lose your million bucks.”

After Morris’ outburst, the members voted again on the matter, this time approving the sale of Westar to DSJ. Soon thereafter, Marx, a member of North Star brought suit against Morris alleging breaches of the LLC agreement and a violation of Wisconsin’s LLC statute as a result of Morris’ actions.

LLC Agreement vs. LLC Statute

The Wisconsin Supreme Court then embarked on an analysis as to whether Marx’s claims were preempted on account of North Star’s LLC agreement. Key to this analysis is a principle certain to apply to nearly all LLC disputes, regardless of the jurisdiction: “The default rules [of the LLC statute] apply unless an operating agreement unambiguously states otherwise.”

Based on this principle, the Court examined the “business venture” clause against the Wisconsin LLC statute. The statute, Wisc. Stat. § 183.0402(1)(a) provided that “[n]o member or manager shall act or fail to act in a manner that constitutes … A willful failure to deal fairly with the limited liability company or its members in connection with a matter in which the member or manager has a material conflict of interest.” (Emphasis added). On the other hand, North Star’s LLC agreement  permitted members to engage “in other business ventures of every nature and description.”

Morris argued that his actions in acquiring Westar through DSJ were permitted under the North Star LLC agreement’s “business venture” clause. Marx, on the other hand, argued that the clause did not entirely supplant the Wisconsin statute as Morris, according to Marx, was dealing unfairly with North Star. As such, Morris’ unfair actions were a violation of Wisconsin law. Ultimately, the Supreme Court agreed with Marx. Even though the LLC agreement permitted Morris to engage with other business ventures, it did not provide Morris the ability to unfairly engage. Marx maintained that Morris unfairly engaged with other ventures. As such, the LLC agreement did not unambiguously supplant all of the Wisconsin LLC statute, and Marx’s claims were not preempted by the LLC agreement’s “business venture” clause.

Takeaways

Entities draft and enter into LLC agreements specifically to avoid some default provisions contained within a state’s LLC Act. However, if an LLC agreement does not unambiguously supplant the default rules of the relevant statute, then the default rules will control.

The remedy to this issue is two-fold: draft clear and unambiguous LLC agreements, and periodically review existing LLC agreements with your clients to ensure the LLC agreement contains no ambiguities based on the conduct of the LLC.

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