Disputes between members of limited liability companies can get messy fast. A recent decision by the Illinois Appellate Court for the First District illustrates the importance of treating the limited liability company as a separate entity in disputes between members. The attorney-client privilege may hang in the balance.
In Janousek v. Slotky, 2012 IL App (1st) 113432 (2012), the plaintiff was a forty-percent member of a member-managed limited liability company (the “LLC”) when the individual defendants, a father and son who held the remaining sixty-percent interest, excluded the plaintiff from the LLC and started a competing business. The plaintiff sued the individual defendants and the LLC, both individually and derivatively on behalf of the LLC, claiming breaches of fiduciary duties and violations of the Illinois Limited Liability Company Act (the “Act”) and seeking an accounting.
The individual defendants (improperly) retained one law firm to represent them individually and the LLC in response to the plaintiff’s claims. In this case, the individual defendants retained counsel that purported to represent them and to represent the LLC. The plaintiff sought access to the LLC’s communications with counsel for the defendants. He contended that he was entitled to communications with the LLC’s counsel because he was a member of the LLC. And, since the same counsel also represented the individuals, he contended that they had inherently waived any claim to privilege by seeking individual representation from the LLC’s counsel. A discovery dispute arose after the individual defendants and the LLC refused to produce communications with their attorneys regarding the LLC. The defendants argued that those communications were protected by the attorney-client privilege and that the plaintiff had to establish that he was a member of the limited liability company before he had a right to review those communications. The trial court, after motion practice, ordered the defendants to produce the communications withheld as privileged, finding that the plaintiff had a right to discover those communications to support his claims. The defendants refused to produce the communications, and, instead, chose to take a friendly contempt and have the Appellate Court decide the issue.
The Appellate Court noted that the attorney-client privilege is an exception to Illinois’ policy of broad discovery and only applies if the communications were expressly made privileged or the party claiming privilege reasonably believed that the communications would be kept confidential. The Appellate Court further noted that both the LLC’s operating agreement and the Act granted all members of the LLC the right to review the LLC’s records and that the Act even granted former members the right to review records in certain circumstances. The Court concluded that, in light of the fact that the plaintiff had a contractual and statutory right to review the LLC’s records, the individual defendants could not have reasonably believed that communications with their attorneys regarding the LLC would be kept confidential.
The Court held that the plaintiff had the right to review all of the LLC’s records in discovery and that such records included communications between the individual defendants and their attorneys. The Court also held that the communications were not privileged because the individual defendants and the LLC were being defended by the same attorneys. The Court concluded that the individual defendants could not have reasonably believed that communications with their attorneys regarding the LLC would be kept confidential because their attorneys simultaneously represented the LLC in the same dispute.
For limited liability company members and managers, the take away from the Appellate Court’s decision is to remember that a limited liability company is a separate legal entity apart from its members. Always observe formalities. If a dispute between members arises, retain separate counsel to defend the limited liability company and never use limited liability company funds to pay for the defense of a member.