Can Former Minority Owners of an LLC Bring a Legal Malpractice Claim Against Company’s Law Firm?

by Brian C. Haussmann

In Stevens v. McGuireWoods LLP, 2015 IL 118652 (Thomas, J.), the Illinois Supreme Court was called upon to decide whether former minority members of an LLC could bring a legal malpractice action against the LLC’s litigation law firm for allegedly failing to timely file a derivative action against the company’s former corporate law firm.  In the end, the Court ruled that such an action did not belong to the former owners and was therefore barred.  While the case was perhaps uniquely complex, its holding affects practitioners and litigants faced with a derivative action, a legal malpractice claim or, as in this case, both.

The case began when the minority members of Beeland Management LLC (Beeland), a commodities trading firm, hired the law firm McGuireWoods LLP to prosecute claims against Beeland’s managers and its majority owner.  The minority members alleged that the majority had misappropriated Beeland’s trademarks and other intellectual property.  Plaintiffs sought relief both directly and derivatively, i.e., on behalf of Beeland.  The court dismissed most of those claims on motion, but without prejudice to the plaintiffs’ right to refile them. 

Plaintiffs then retained new counsel, who added claims against Beeland’s corporate law firm, Sidley Austin LLP (Sidley).  Sidley moved to dismiss on a number of grounds, including (1) that the claims were time-barred under the statute governing claims against attorneys, 735 ILCS 5/13-214.3, and (2) that plaintiffs lacked standing to sue Sidley in their individual capacity because Sidley’s duty ran only to the company.  The trial court granted Sidley’s motion on both grounds.  Shortly thereafter, plaintiffs reached a settlement with the majority shareholder, the only remaining defendant, and as part of the settlement, plaintiffs gave up their remaining ownership interest in Beeland.

But plaintiffs weren’t finished.  Plaintiffs then filed a one-count complaint against McGuireWoods, alleging that the firm committed malpractice by “failing to assert obvious claims against Sidley in a timely manner.”  Id. at ¶ 6.  Because they no longer had an ownership interest in Beeland, plaintiffs brought the case in their individual capacities.  The trial court granted McGuireWoods summary judgment, ruling that because plaintiffs lacked standing to sue Sidley in their individual capacities, there was no harm in failing to timely sue Sidley.  The appellate court reversed in part, pointing out that plaintiffs were still LLC members and owners at the time of McGuireWoods’ representation, and thus could have brought derivative claims against Sidley. 

The Illinois Supreme Court reversed the appellate court and reinstated the ruling of the circuit court.  The Court first quickly dispatched with plaintiffs’ individual claims, reaffirming the holding of the circuit and appellate courts that plaintiffs lacked standing at any time to sue the company’s lawyers as individuals, rather than on the company’s behalf. 

The Court’s remaining analysis focused primarily on the nature of direct versus derivative damages.  After acknowledging that plaintiffs had standing to bring derivative claims against Sidley at the time of plaintiffs’ representation by McGuireWoods, the Court nonetheless stated:

“That said, plaintiffs have an insurmountable problem even as to their derivative claims.  And the insurmountable problem is that, even assuming that McGuireWoods had successfully prosecuted plaintiffs’ derivative claims against Sidley, plaintiffs would not have recovered anything from the resulting judgment in their individual capacities.  This is because derivative claims always and only belong to the corporation on whose behalf they are brought, and any damages awarded in a derivative suit flow exclusively and directly to the corporation, not to the nominal plaintiffs.”

Id. at ¶ 15 (Court’s emphasis).  For this reason, the Court said, plaintiffs had no recoverable damages in their legal malpractice action.

The Court added that, because plaintiffs had divested themselves of their ownership interest in Beeland before suing McGuireWoods, they also lacked standing to file such a suit derivatively on behalf of Beeland.  To have standing, the Court ruled, plaintiffs would have had to maintain their status as LLC members throughout the litigation.  Id. at ¶ 21 (citing the Limited Liability Company Act, 805 ILCS 180/40-5). 

Finally, the Court rejected the argument by plaintiffs that its ruling would immunize lawyers for minority shareholders and owners in derivative actions from legal malpractice claims.  The Court held that such actions could be brought by existing owners of the company, but not by its former owners.

The Court’s ruling in Stevens makes clear that practitioners and companies should take careful note of the nature of the relief sought in any litigation brought against a third party by, or on behalf of, the company, and that owners should make sure they understand the nature of any legal claims they may be giving up before selling their interest in any corporation or LLC.  As demonstrated by Stevens, the answer to these questions may well have lasting implications for all of the stakeholders in the company, and for both the parties and lawyers in any company litigation.