LLC transactions must be fair for all members

Limited liability companies first arrived on the scene in 1994. Since then, they have become the most popular form of business entity in Wisconsin, making up close to 80 percent of all new entities created.

In September, the Wisconsin Supreme Court decided its first case dealing with LLCs: Gottsacker v. Monnier (2005 WI 69, 697 N. W. 2d 436). The case dealt with how LLCs are governed. It comes at the same time as more nationally famous cases involving corporate governance, such as Enron, World Com, Tyco, Health South, Adelphia and others.

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The Supreme Court has given us some guidance on what needs to be done when there is a transaction between an LLC and some of its owners. (In an LLC, they are called "members.") In those situations, there is an inherent conflict of interest between the members involved in the transaction and the other members of the LLC.

The court's decision is very logical, makes good sense and, it is hoped, will provide a strong precedent for future cases.

The LLC in Gottsacker had three owners. Two brothers, Paul and Gregory Gottsacker, together owned 50 percent, and Julie Monnier owned the other 50 percent. The company owned two parcels of real estate in Sheboygan. It sold one parcel and properly distributed the proceeds to the owners. At some point, the brothers became estranged and were not speaking to each other. After that occurred, Monnier and Paul, without telling Gregory, transferred the remaining real estate to an entity owned solely by them and sent Gregory a check for his share at a price determined by them.

Gregory sued. The trial court decided the case in favor of Gregory, concluding that Monnier and Paul had a material conflict of interest and therefore did not have the ability to vote to transfer the real estate.

On appeal, the Court of Appeals left the decision in place but changed the reasoning, saying that members of an LLC with a conflict of interest like Paul and Monnier could vote but only if they acted "fairly." The court also decided that Paul and Monnier had in fact not acted fairly.

Monnier and Paul appealed to the Wisconsin Supreme Court. It concluded that members with a conflict of interest can vote, but they "may not willfully act or fail to act in a manner that will have the effect of injuring the LLC or its other members."

However, the court reversed the decision and sent it back to the Circuit Court to decide if in fact Monnier and Paul treated Gregory unfairly, something that the Court of Appeals had decided but did not have authority to do.

The governance model adopted by the Supreme Court is similar to the rules for conflicts of interest that have been applied to corporations for many years. Corporate directors must disclose conflicts. Having done so, they can vote, and the action can be overturned only if it was unfair to the corporation.

What messages did the Supreme Court send? On one level is the important but limited conclusion that members of an LLC can transact business with the LLC as long as the transaction is fair. In the Gottsacker case, the solution probably would have been simple: have the property appraised before selling it to ensure that everyone is treated fairly. In other cases, fairness may be harder to define, but at least now we know what the test will be.

On another level, the court showed that it understands LLCs and will apply good, well-reasoned decision-making to cases relating to them.