Monday, November 21, 2011

Wisconsin Court Misses the Point of Choice of Entity

Wisconsin Court Misses the Point of Choice of Entity
            In a recent decision interpreting and applying the Wisconsin LLC Act, the Court, sadly, missed the point of choice of entity, suggesting that the fiduciary obligations amongst all businesses or organizations not only are but should be the same.  Executive Center III LLC v. Meieran, 2011 WL 4704274 (E.D. Wisc. Oct. 4, 2011).
            Meieran bought a 12.5% interest in BRIC Executive, LLC (“BRIC”) for $250,000 pursuant to an agreement under which that 12.5% interest would be redeemed by a date certain with penalties and additional expenses incurred for any delayed redemption.  A year and one-half after that agreement was entered into, and when the repurchase obligation was already in default, the Plaintiff entered into an agreement with BRIC for the sale/leaseback of a BRIC-owned building.  BRIC received approximately $1.3 million from that transaction and entered into a 3-year lease for one unit in the building.  BRIC distributed the $1.3 million it received to pay off various debts, including its redemption obligation to Meieran.  The redemption price had by then swelled to $425,000 – Meieran accepted $400,000 in full satisfaction thereon.  At that point, BRIC had no other assets, and immediately defaulted on its lease obligation to the Plaintiff.  They brought suit against Meieran, alleging a number of counts including fraudulent conveyance of the $400,000 paid to the Defendants, breach of fiduciary duty owed to the Plaintiff and receiving an improper inequitable distribution from BRIC. 
      My concern is with the statements made as to fiduciary duties. 
      After engaging in an effort to distinguish Gottsacker v. Monnier, 697 N.W.2d 436 (Wis. 2005), the Court discussed whether or not common law fiduciary duties exist in addition to those imposed by statute.  Apparently working from the positions that fiduciary duties amongst business owners are normative and that the fiduciary duties that are owed are equivalent amongst business organizations, the Court wrote:
In fact, there is growing consensus that common law fiduciary duties should apply to the operations of LLCs….  Logic dictates the same. Fiduciary duties exist to protect people who are affected by the actions of those who control businesses.  Therefore, it would not make any sense if the expectation for a business to act fairly were to be different simply due to the business owners’ choice of form – an LLC in this case.  If that were so, every dishonest owner could simply elect to operate its business as an LLC and claim that no fiduciary duties applied to its actions. 
For these reasons, the Court finds that common law fiduciary duties apply to LLCs.  2011 WL 4704274, *8-9. 
       Initially, there is a significant question, not addressed by the Court, as to why fiduciary duties are even being contemplated in this situation.  The suit here is filed by the purchaser of a commercial building who is, no doubt justifiably, upset that the seller has, in the capacity of a tenant, breached their obligations.  This appears to be, and the Court does not indicate anything to the contrary, an arms-length transaction.  Buyer is not a member of BRIC.  Setting aside the question of what are the fiduciary duties, there is no indication of a relationship from which the Plaintiff could assert there to have arisen a fiduciary obligation that was violated.  The opinion recites that the payment to Meieran rendered BRIC insolvent.  If the basis of the claim is a fiduciary shift on insolvency to the benefit of the creditors, that would be nice to know.
       Returning to the mindset issue, the dual suggestions by the Court that (a) as a normative matter fiduciary duties exist in business organizations and (b) that fiduciary duties do not change between organizations, are both demonstratively incorrect and indeed misleading. 
       The first proposition, namely that fiduciary duties are normative, is disproven by the fact that many statues expressly permit either the restriction or the elimination of fiduciary duties and/or permit the elimination of culpability for the breach of a fiduciary obligation.  See, e.g., Del. Code Ann. tit. 6, § 18-1101(c) (permitting an operating agreement to eliminate all fiduciary duties); KRS § 275.170 (permitting the statutory default fiduciary duties of care and loyalty to be altered in a written operating agreement); and id. § 275.185 (permitting a written operating agreement to eliminate culpability for breach of fiduciary duties of care and loyalty).  Ergo, the premise that all business organizations must impose upon their constituents fiduciary obligations is manifestly incorrect.
          Perhaps even more troubling is the Court’s suggestion that fiduciary duties are a constant across business organizations.  This is simply not the case.  As the U.S. Supreme Court stated so eloquently in SEC v. Cheney Corp., 318 U.S. 80, 85-86 (1945):
But to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry.  To whom is he a fiduciary?  What obligations does he owe as a fiduciary?  In what respect has he failed to discharge these obligations?  And what are the consequences of his deviation from duty?

       Different expectations and limits are placed upon different fiduciaries.  Simple paid agents are held to a care standard of simple negligence.  See Restatement (Third) of Agency § 8.08 (2006).  In contrast, corporate directors are held to a wanton or reckless standard.  See, e.g., KRS § 271B.8-300(5)(b).  Members of a Wisconsin LLC are held to a “willfull misconduct” standard.  Wisc. Code § 183.0402(1)(d). 
       Turning to the obligation of loyalty, partners, trustees and members of a member-managed are precluded from benefitting from a self-dealing transaction with the trust/partnership/LLC or the use of its assets.  See Restatement (Second) of Trusts § 203 (1959); Wisc. Code § 183.0402(2); KRS § 275.170(2); UPA § 21(1).  In contrast, corporate directors are permitted to enter into conflict of interest transactions and to utilize corporate assets for personal benefit provided the terms of the transaction are “fair” to the corporation.  See, e.g., KRS § 271B.8-310(1)(c).  Some jurisdictions even go so far as to remove from that director the burden of proving fairness, requiring, rather, that the complaining shareholder prove lack of fairness. 
         Clearly not every “fiduciary” is held to the same standard.  The failure to recognize this crucial aspect of business organization law generally and the entire point of the choice of entity calculus is the fundamental failure of Executive Center III LLC v. Meieran.

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