Purchaser of Economic Interest in LLC Lacks Standing to Bring Breach of Fiduciary Duty Claim

After the plaintiff purchased an economic interest in an LLC at a UCC sale, she brought claims for breach of fiduciary duty and breach of good faith and fair dealing against the manager of the LLC. The plaintiff alleged that she was entitled to inspect the books and financial documents of the LLC under the membership agreement, and that the LLC had not properly distributed her share of the profits of the sale of its sole asset. The trial court rejected the plaintiff’s arguments, finding that she had only an economic interest, and not a membership interest, in the LLC. The appellate court affirmed, finding that the plaintiff lacked the standing to bring her claims as she was not a member of the LLC under the LLC Act or the amended operating agreement

CFC is an Illinois limited liability corporation created to manage, convert, and sell an apartment complex in Grayslake. The original members of CFC executed an operating agreement which provided that each member’s ownership interest depended on their capital contributions. The Stanley A. Smagala Revocable Trust contributed $3,465,000 and owned 45%, the McGlynn Trust and Grayslake Investments each contributed $1,925,000 and each owned 25%, and John R. Kelly contributed $385,000 and owned a 5% interest.

Smagala was the manager of CFC and had full authority to direct, manage, and control the business of CFC and also to employ accountants, legal counsel, managing agents, and other experts to perform services for CFC. At the end of 2006, the members signed an amended agreement changing their interests from a capital contribution interest to an “economic interest” in the company’s profits and losses.

To fund its $1,925,000 contribution, Grayslake Investments had borrowed $1,500,000 from Founders Bank. Founders Bank filed a UCC-1 to secure its interest in CFC. In July 2009, the Illinois Department of Financial and Professional Regulation of Banking closed Founders Bank, and the Federal Deposit Insurance Company was named receiver. Some assets, including the loan made to Grayslake and its security interest, were sold to Private Bank. Private Bank then renewed its UCC-1 and the note matured in January 2010. Grayslake was unable to refinance or repay the balance of the note, and Private Bank began foreclosure proceedings.

After obtaining a judgment of foreclosure, Private Bank sold Grayslake’s interest in CFC to Mary Doherty at a UCC auction for $20,000. Mary Doherty is the wife of Patrick J. Doherty, an owner of Grayslake. Patrick Doherty, acting as Mary’s attorney, then sent a letter to Smagala, stating that, as a member of CFC, Mary Doherty requested copies of CFC’s financial records. Smagala denied the request, stating that Mary Doherty was not a member of CFC but merely an economic interest owner who did not have rights under the operating agreement to inspect the company’s books and records.

In January 2016, CFC sold its sole asset for $27 million, netting just over $4 million for CFC in the process. Smagala then distributed the proceeds to all members except Doherty, as he believed she did not own a valid interest. Smagala left an amount of money he reasonably believed was due to Grayslake or Doherty in CFC’s bank account. Doherty sued, seeking a declaratory judgment that she owned a membership interest in CFC, as well as a judgment that she can inspect CFC’s accounts, books, and records. Doherty also brought a claim for breach of fiduciary duty against Smagala.

After a hearing, the trial court found that Doherty had a 25% economic interest in CFC but was not a member of CFC. Discovery then continued and Doherty requested financial documents relating to CFC dating back to its inception. The court granted this request. Before trial, the case was reassigned to a new judge. CFC then moved for summary judgment which was granted. Doherty then appealed.

The appellate panel began by addressing the issue of summary judgment. The panel stated that it agreed with the trial court’s finding that Doherty lacked standing under the LLC Act and the amended operating agreement to bring a breach of fiduciary duty claim. The panel found that, under both the amended operating agreement and the LLC Act, Doherty could not be a member of CFC, as unanimous consent was not given by all members of CFC to grant Doherty participation rights in CFC as a transfer of an economic interest. Therefore, the panel reasoned, Doherty was unable to bring a breach of fiduciary duty or breach of good faith and fair dealing claim against Smagala. Finally, the panel determined that the trial court did not err in calculating that Doherty owned only a 13.75% interest in the profits and loss of CFC. The panel, therefore, affirmed the decision of the trial court.

You can read the full opinion here.

With indisputable convenience for clients, we cover Chicagoland and beyond with offices in Chicago, Elmhurst and Wilmette. Keep in mind that Lubin Austermuehle also assists businesses and business owners who are accused or victims of minority shareholder oppression.

Minority Oppression Lawyers Near Chicago and Naperville

At Lubin Austermuehle, we focus on relationships and are driven by results. When it comes to unraveling complex business disputes, we are proud of our track record of outright victories in court or substantial and lucrative settlements for our valued clients. In every case, our goal is to resolve disputes as quickly and successfully as possible, helping business clients protect their investments and get back to business as usual. We serve clients throughout Illinois and the Chicagoland area. You can contact us online here or call us on our locally at 630-333-0333.

Contact Information