Ill. LLCs Beware: Minority Owners May Use Privileged Docs

Issues of attorney-client privilege can be especially important in situations involving business divorces, because business divorces are often messy. Owners of private businesses sometimes seek to force out their co-owners.

The reasons for a business divorce vary, but they often relate to control and money, personality-driven conflict, disagreements over business direction, or disputes about the distribution of earnings.

In other circumstances, majority owners may want to push out a minority owner because of alleged misconduct, including embezzlement, fraud or self-dealing.

When majority owners seek the legal advice of the company’s attorney to formulate and execute a plan to force out a minority owner, the company wants and expects this advice to be shielded from disclosure by the attorney-client privilege.

Contrary to this expectation, minority owners — i.e., members — of Illinois limited liability companies may be able to obtain copies of communications between the LLC’s managers and its attorneys, including emails — even when the subject matter of the emails leads to litigation between the LLC and a minority member. These communications can play a critical role in an ownership dispute.

This article explains how minority members of Illinois LLCs may be able to obtain and use at trial these otherwise privileged communications.

It also sets forth actions that Illinois LLCs and their majority members can take to protect a company’s privileged communications from disclosure to minority members in advance of and during litigation.

Finally, this article discusses the rules that apply to Illinois corporations and to business entities organized under the laws of other jurisdictions.

LLC Members Usually Have the Right to Inspect Company Records

Consider this hypothetical scenario: An Illinois LLC has a majority member and several minority members. The majority member also happens to be the LLC’s manager.

The manager wants to remove one of the minority members as a member, and instructs the LLC’s attorney to develop a plan. Can this minority member obtain copies of emails between the manager and the LLC’s attorney, either through a books and records request or through the discovery process in a lawsuit?

Unless the LLC’s operating agreement states otherwise, the minority member may be able to obtain those emails.

An LLC is a common structure used to organize a privately owned business. LLCs are owned by members, who generally either appoint managers to manage the business, or manage the business themselves, effectively functioning as managers.

The Illinois Limited Liability Company Act establishes default rules, most of which can be superseded by an LLC’s operating agreement.

Under the Illinois LLC Act, members of an LLC have the right to inspect the company’s books and records.[1] While an operating agreement can restrict member access of the LLC’s records to certain categories, the restrictions must be reasonable.

The default rule, however, is that members have broad rights to demand records concerning the company’s activities, finances and other circumstances concerning the company’s business.

The term “books and records” is defined broadly, and even includes communications between an LLC’s managers and its attorneys.

When an LLC’s operating agreement does not restrict members’ rights to inspect the company’s records, a member likely has the right to obtain the company’s attorney-client communications under Illinois law.

Minority Members of Illinois LLCs May Be Able to Access LLC-Attorney Communications

In the scenario that we outlined above, the manager and LLC’s attorneys executed a plan to force out the minority member. The minority member then brought a lawsuit against the LLC. In the lawsuit, the minority member sought to obtain communications between the LLC and its attorneys regarding the subject of the dispute.

Ordinarily, an LLC’s manager expects that communications with the LLC’s attorneys seeking legal advice will be protected from disclosure by the attorney-client privilege. But the attorney-client privilege applies only to communications between a client and its attorney that seek legal advice and are made with a reasonable expectation of confidentiality.

When a minority member has the right to access certain records under the Illinois LLC Act, the company probably cannot invoke the attorney-client privilege to conceal those records from its members.

As a result, many members of Illinois LLCs may have the right to obtain copies of otherwise privileged communications, even when the nature of the communications concerns a potential dispute between the member and the company itself.[2]

In an attempt to obtain otherwise privileged communications, the minority member in this scenario should request in discovery any communications between the LLC’s representatives, including the manager, and LLC’s attorneys regarding the plan to force out the minority member.

If the operating agreement does not restrict the minority member’s right to inspect company records, the minority member may be able to obtain emails that the LLC’s management had previously assumed would be protected by the attorney-client privilege.

How Illinois LLC Minority Members Can Use Privileged Documents at Trial 

If the minority member obtains LLC’s otherwise-privileged documents in discovery, perhaps through a motion to compel, they can likely use those documents as evidence at trial, notwithstanding the fact that they are attorney-client communications.

Illinois Supreme Court Rule 201 provides that all

matters that are privileged against disclosure on the trial, including privileged communications between a party or his agent and the attorney for the party, are privileged against disclosure through any discovery procedure.[3]

Therefore, if the minority member obtained the documents in discovery notwithstanding LLC’s privilege objection, the minority member can likely use those documents as evidence at trial.

How Illinois LLCs Can Protect Privileged Documents From Disclosure

Although the Illinois LLC Act contains permissive rules regarding minority member access to privileged company documents, Illinois LLCs and their managers and majority members can take action to protect those documents from disclosure to minority members in advance of and during litigation.

First, Illinois LLCs should consider drafting operating agreements that protect attorney-client communications from disclosure to members.

Second, Illinois LLCs should consider whether they can invoke the work-product doctrine to protect their attorney-client communications from disclosure in litigation.

Drafting Operating Agreements That Protect Attorney-Client Communications From Disclosure to Members

In our scenario, the LLC can prevent the minority member from accessing its attorney-client communications if its operating agreement allows it to do so.

Under the default rules established by the Illinois LLC Act, members of an Illinois LLC have broad rights to access the LLC’s books and records, including communications between the LLC’s manager and its attorney.

But the LLC could supersede those default rules by restricting the minority member’s access to company records in its operating agreement, so long as the restrictions are reasonable.

If the LLC’s operating agreement does not limit the minority member’s rights to inspect the LLC’s records, the LLC should consider amending it to expressly give the manager the authority to restrict member access to communications between the LLC and its attorneys, especially in the case of a dispute or litigation between a member and the LLC.

Alternatively, the LLC could amend its operating agreement to attempt to authorize the manager to restrict member access to company records if the manager believes that disclosure of certain information to a member would not be in the LLC’s best interest, which is permitted in other jurisdictions.

Invoking the Work-Product Doctrine

Even if the operating agreement does not restrict the minority member’s access to company records, the LLC and manager may still be able to shield some of the LLC’s records from disclosure to the minority member under the litigation work-product doctrine.

This doctrine protects from disclosure documents that are created in anticipation of litigation and that contain the theories, mental impressions or litigation plan of an LLC’s attorneys.

Unlike the attorney-client privilege — which, in our scenario, protects communications between the LLC and its attorneys concerning legal advice — the work-product doctrine shields material created for those on one side of a lawsuit.

Under the default rules supplied by the Illinois LLC Act, the minority member probably cannot obtain company documents that are protected by the work-product doctrine.

The Rules in Other Jurisdictions

While Illinois law may permit minority members of Illinois LLCs to access the company’s privileged communications, that is not the case in every jurisdiction.

Rather, in most jurisdictions, a member of an LLC or a shareholder of a corporation generally cannot access the privileged communications of their LLC or corporation.

Only in rare circumstances can a member or shareholder demonstrate, after a fact-intensive analysis, that they have good cause to access those communications.

Majority Approach: The Garner Fiduciary Exception

In most jurisdictions, a shareholder of a corporation or a member of an LLC can obtain the corporation’s or LLC’s attorney-client privileged communications only if they can satisfy the Garner test,[4] which is also known as the fiduciary exception to the attorney-client privilege. This test comes from the U.S. Court of Appeals for the Fifth Circuit’s 1970 decision in Garner v. Wolfinbarger.

Where a fiduciary duty is owed to the shareholder or member, they may obtain the corporation’s privileged documents only if they show good cause that the attorney-client privilege should not protect those communications from disclosure.

Courts consider several factors in determining whether the shareholder or member has shown good cause, typically conducting a document-by-document analysis. The Garner test is difficult for shareholders to satisfy.

Delaware courts apply the Garner test to determine whether members of Delaware LLCs can discover their LLCs’ privileged communications.[5] For Delaware corporations, see the section on minority approaches below.

New York courts take a slightly different approach in the context of LLCs. If a member of a New York LLC attempts to discover the LLC’s privileged communications, that member must first show that she is not acting adverse to the LLC.[6]

If she is acting adverse to the LLC, she probably cannot discover the privileged communications; if she can show that she is not acting adverse to the LLC, she must also satisfy the Garner test before she can access the privileged communications.

Minority Approaches

Other jurisdictions have declined to apply the Garner test. California and Illinois courts have explicitly decided not to apply the fiduciary exception in the context of litigation between shareholders and their corporations.[7]

California courts have also suggested that the fiduciary exception does not apply where members attempt to discover their LLCs’ privileged communications in litigation.

Consequently, shareholders of Illinois and California corporations, and members of California LLCs, probably cannot obtain their companies’ privileged communications, absent waiver or another applicable exception.

In contrast, a shareholder of a Delaware or New York corporation may access the corporation’s privileged communications, but only if the shareholder is also a director and can show a proper purpose related to their duty as a director to protect the corporation.[8]

Courts are unlikely to permit a shareholder to access a Delaware corporation’s privileged communications where the shareholder is acting in a self-serving manner.

Likewise, if a shareholder of a New York or Massachusetts corporation is acting adverse to the corporation, the shareholder likely cannot access the corporation’s privileged communications.[9]

Conclusion

Because privileged communications are often candid and may even be inflammatory, minority owners can gain a significant advantage in an ownership dispute by obtaining a company’s privileged communications and, where relevant, using them at trial.

Those communications may critically undermine a company and its majority owners’ legal position. Companies and their owners should carefully draft and review their governing documents to avoid surprises regarding the disclosure of attorney-client communications.

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_{[1] 805 ILCS 180/10-15.}

_{[2] See generally Janousek v. Slotky , 2012 IL App (1st) 113432.}

_{[3] Ill. R. S. Ct. 201(b)(2).} 

_{[4] The Garner test comes from the case Garner v. Wolfinbarger , 430 F.2d 1093, 1103-1104 (5th Cir. 1970) (holding that a corporation’s shareholders have the right to “show cause” why the corporation should not invoke the attorney-client privilege to protect its communications in a suit alleging that the corporation has acted against shareholder interests).}

_{[5] See, e.g., De Vries v. Diamante Del Mar LLC , 2015 WL 3534073 (Del. Ch. June 3, 2015) (unpublished).}

_{[6] See NAMA Holdings LLC v. Greenberg Traurig LLP , 18 N.Y.S.3d 1, 10-12 (N.Y. App. Ct. 2015).}

_{[7] See Nat’l Football League Props., Inc. v. Superior Court , 65 Cal. App. 4th 100, 107 (Cal. Ct. App. 1998); Mueller Industries, Inc. v. Berkman , 399 Ill. App. 3d 456 (2d Dist. 2010) (abrogated on other grounds by People v. Radojcic , 2013 IL 114197 (2013)).}

_{[8] See State ex rel. Miller v. Loft, Inc. , 156 A. 170, 172 (Del. Super. Ct. 1931); Henshaw v. American Cement Corp. , 252 A.2d 125, 129 (Del. Ch. 1969); People ex rel. Spitzer v. Greenberg , 851 N.Y.S.2d 196, 199, 201 (N.Y. App. Div. 2008).}

_{[9] See Barasch v. Williams Real Estate Co., Inc. , 961 N.Y.S.2d 125, 129 (N.Y. App. Ct. 2013); Seaside Psych Health & Wellness, LLC v. Blue Hills Therapeutics, Inc. , No. 1984CV01632BLS2, 2021 WL 5630787, at *2 (Mass. Super. Ct. Apr. 27, 2021) (citing Chambers v. Gold Medal Bakery , Inc., 464 Mass. 383, 395 (2013)).}