LLC Can Sue Malfeasant Member After Obtaining Permission from All Disinterested Members

On January 24, 2024, the Iowa Court of Appeals, in a split decision, overturned a district court’s ruling that an Iowa Limited Liability Company (LLC) lacked standing to sue one of its members when it did not obtain defendant member’s consent to sue. After reviewing Iowa’s LLC statute and other states’ case law about direct actions against a member, the majority held that an LLC is authorized to bring a direct lawsuit against a member with the consent of all disinterested members when there are “exceptional circumstances.” The dissent found that the plain language of Iowa’s LLC statute requires consent from all members and does not authorize the exceptional circumstances exception. Further, the dissent found a derivative action by the members was the appropriate course of action.

Facts

Richard, Robert, and Gary Hunter are three farmer brothers. As part of their farming operation, they formed Hunter Farms, LLC and placed some of their farmland into the LLC. Each brother owns a third of the total voting interest. The LLC does not have an operating agreement, but does have a Statement of Authority filed with the Iowa Secretary of State. The fourth paragraph of the statement reads, “A majority of the voting membership interests are authorized to make ordinary business decisions. All other decisions, including any change to this statement of authority, will require the consent of all members.” Usually, Gary and Robert would make all the decisions for the LLC. They would keep Richard informed, but he “did not participate in the decision making.”

In 2018, Richard applied to claim compensation in a class action lawsuit related to certain Syngenta seed corn under the LLC’s name. He listed his personal address on the claim form, used the LLC’s tax identification number, and signed a declaration that stated, “If the Producer is a business or other legal entity, I certify that I am authorized to act on behalf of the Producer submitting this Claim Form.” Richard did not tell the other members about this transaction and received a $62,467.01 settlement payment. He deposited the settlement payment into a bank account that the LLC did not have access to or own.

Robert and Gary discovered the payment when they learned the LLC had to pay income tax on the payment. They sent Richard a letter by certified mail demanding that Richard deposit the settlement payment into the LLC’s bank account or divide the payment three ways and pay the cost of any tax consequences. Richard responded by saying he only applied for “his third” of the available settlement payments and therefore did nothing wrong.

Robert and Gary then decided the LLC would directly sue Richard, both personally and as an LLC member. In its petition, the LLC alleged that Richard breached his fiduciary duty and his duty of good faith and fair dealing. It also asserted claims of conversion and unjust enrichment. Richard denied the claims and filed a motion for summary judgment arguing that the LLC lacked standing to bring the lawsuit. He claimed that the LLC could not sue one its members without a unanimous vote that included him because the statement of authority required unanimous consent to bring a lawsuit since a lawsuit against a member is not an ordinary business activity.

The district court granted Richard’s motion for summary judgment finding that the LLC did not have standing because the LLC required the consent of all members prior to filing the direct lawsuit. Robert and Gary appealed the decision. Richard fought the appeal, arguing that Robert and Gary needed to bring a derivative action.

Majority Opinion

The Court first addressed Richard’s argument that the court of appeals did not need to address the merits of the appeal because Robert and Gary needed to bring a derivative action against him. Derivative lawsuits usually arise from a minority interest holder claiming the LLC’s managers are not acting in the LLC’s best interest. The court noted the irregularity of forcing Robert and Gary, who together constituted a super-majority, to file a derivative action. Even so, the court offered no opinion on whether this action could have been brought as a derivative suit. Instead, it held that the theoretical availability of a derivative action did not preclude a direct suit brought by the LLC itself.

The court then addressed whether the direct lawsuit against Richard was properly authorized by the interest-holders of the LLC. The court held that the statement of authority does not “regulate the internal decision-making of an LLC.” Instead, it informs third parties interacting with an LLC member what authority that LLC member has. Since the LLC had no operating agreement, the Uniform Limited Liability Company Act (Iowa Code Chapter 489) governed the relationship between the  LLC members. Therefore, whether the LLC was authorized to bring a direct action against Richard was an issue of statutory interpretation.

The court found that both the plain language and legislative intent of Chapter 489 authorize a lawsuit by an LLC without unanimous consent. First, Iowa Code §489.105(1) specifically authorizes an LLC to bring any lawsuit and does not have a precondition for bringing suit. The court noted there is no unanimous consent requirement within that provision. Further, §489.409 expressly authorize direct suits by the LLC against interest holders for breach of fiduciary duties and also does not have a unanimous consent requirement. Finally, the court found that requiring unanimity of members for an LLC to bring a lawsuit was not intended by the Iowa Legislature. The court bluntly stated that a unanimous consent requirement would be granting an “unreviewable veto power to every LLC member-manager who engages in misconduct[,]“ and it is clear that was not the intent of the legislature.

The court then determined what internal action is required to authorize a direct suit against a “malfeasant” member. It first examined §489.407, which provides that an issue “in the ordinary course” is decided by a majority of the members, but an LLC issue “outside the ordinary course” requires “consent of all members.” The court found that a direct suit against a member is outside of the ordinary course. However, the court also stated a review of partnership case law can help inform what internal action within an LLC is necessary. After reviewing national partnership and LLC case law, the court found that  non-Iowa case law allows a partnership or LLC to directly sue once all disinterested members vote in favor of bringing a lawsuit because of the “exceptional circumstances” that occur with an alleged breach of fiduciary duty. Ultimately, the court held, “an LLC may bring direct litigation against a member-manager under exceptional circumstances with the consent of all disinterested member-managers.”  

Dissent

The dissent found that the majority’s reliance on out-of-state partnership and case law was erroneous. Instead, they argued the majority’s analysis should have ended once it found a direct lawsuit to be outside the ordinary course of business. The language of §489.407(2)(d) requires all members to consent to a direct action and the “exceptional circumstances” rule established in the majority’s opinion is improperly “outside the text.” Further, the dissent argued that a derivative lawsuit would be authorized under applicable LLC law. The dissent thus reasoned that there was no “unreviewable veto power” held by Richard since there was a legal remedy available to Robert and Gary. The correct action for Robert and Gary was a derivative action against the LLC, not the LLC bringing lawsuit against Richard without his consent.

Finally, the dissent concluded that the legislature intended derivative lawsuits to be the remedy since the legislature chose the Uniform Commission’s LLC statutory scheme over the American Bar Association’s Prototype LLC Act (ABA Act). The ABA act does not have derivative suits and instead has the disinterested member standard found by the majority. The dissent reasoned that the legislature rejected the majority’s holding when it chose to enact the Uniform Commission’s LLC Act instead of the ABA Act.