From fake loans to $80,000 bonuses to certain shareholders in lieu of dividends to all, the defendants in Chomiak v. Kasian provided a variety of avenues for a successful shareholder oppression action. On August 3, 2017, the Appellate Division of the New York Supreme Court issued an opinion affirming the lower court's ruling for the plaintiffs, who were the defendants' relatives and co-shareholders.
The defendants owned 52% of the business at issue, Twin Bay Village, and the plaintiffs owned 48%. The plaintiffs' involvement in the business was limited, at least recently, and the defendants ran the business, which had been in the family since 1957.
In 2009, the defendants determined that the fair value of the corporation's shares was $1,139 and demanded that the plaintiff's sell their shares. The plaintiffs instead filed suit for shareholder oppression in the form of a breach of fiduciary duty and statutory action.
The New York court applied the reasonable expectations standard and found that the plaintiffs' reasonable expectations that the defendants would protect the interests of all shareholders had been frustrated. The Appellate Court affirmed.
The takeaway of Chomiak is, as in many shareholder or "partnership disputes", that when your business is organized as a corporation, you are not acting for yourself, but for the corporation and its shareholders. The fact that the controlling shareholders operate or manage the corporation does not diminish the rights of the minority shareholders.
In a recent order, the Appellate Court affirmed a Cook County trial court decision finding that a de facto LLC manager in a manager-managed LLC: (1) had fiduciary duties to the other members despite not being the legal manager; and (2) breached his fiduciary duties to his co-owners by running the business and finances without regard for the other members. Kenny v. Fulton Assocs., LLC, 2016 IL App (1st) 152536-U.
The de facto manager had a 50% interest in the company, and two other members shared the remaining 50% interest.
After an eleven-day trial, the trial court found that the de facto manager breached his fiduciary duties by making "unilateral, unauthorized decisions," including: (1) hiring an attorney in the litigation and paying him with company funds; (2) compensating another business of his with company funds; (3) falsifying articles of amendment to the operating agreement; (4) opening bank accounts, funded with company money, accessible only by him and his son by not his co-owners; and (5) directing the company's accountant to file tax returns that ignored the other members' ownership interests in the company. Id. ¶ 34.
On appeal, the de facto manager argued that he was not the legal manager and therefore had no fiduciary duties. See Id. ¶¶ 63, 66. He also argued that if he have did have fiduciary duties, the trial court erred by deciding that he had breached them. Id. The Appellate Court rejected the de facto manager's argument regarding the existence of fiduciary duties because under the Illinois LLC Act, a member in a manager-managed LLC may have fiduciary duties to other members "if the member 'exercises the managerial authority vested in a manger by the Act." Id. ¶ 67 (citing 805 ILCS 180/15-3(g).)
The Appellate Court also affirmed the trial court's finding that the de facto manager breached his fiduciary duties to the other members by unilaterally making decisions to the detriment of the other members without their authorization, as described above. Id. ¶ 69. Further, the other members were damaged by the de facto manager's payment of his own attorney fees in the litigation with company money. Id. ¶ 71.
Corporation, Not 50/50 Shareholders, Responsible for Provisional Director Fees in Shareholder Dispute
In a recent order, the Illinois Appellate Court held that Section 12.56(g) of the Business Corporation Act of 1983 (the “Act”) must be read to provide compensation for provisional directors by the corporation as opposed to it shareholders. Sinkus v. BTE, 2016 IL App (1st) 152135-U. In Sinkus, the plaintiff, Sinkus, and one of the defendants, Carl Thomas (“Thomas”), were 50/50 shareholders of BTE. Id. at ¶ 5. Sinkus and Thomas could not reach an agreement on the dissolution and liquidation of BTE, which led Sinkus to resign as an officer and director of BTE, leaving Thomas to manage the corporation. Shortly thereafter, Sinkus learned of Thomas’ solicitation of BTE’s business and sale of all corporate assets for his own benefit. Sinkus brought derivative and direct claims for breach of fiduciary duties, conspiracy to breach fiduciary duties, and minority shareholder oppression. Id. at ¶ 5.
The trial court appointed retired judge Daniel J. Kelley (“Kelley”) as “a provisional director of BTE pursuant to sections 12.56(b)(4) and 12.56(c) of the Act” to “direct the litigation” and “ensure that Thomas does not unduly influence” BTE’s counsel. Id. at ¶ 6. In order to compensate Kelley for his time as BTE’s provisional director, Kelley made capital calls from each shareholder for $25,000.00 and later $30,000.00. Id. at ¶¶ 8-10. Sinkus refused to make either capital contribution stating that he was under no obligation to make additional capital contributions and “that he was not responsible for BTE’s debts.” Id. at ¶ 8. The trial court ordered Sinkus to make both capital contributions, but he continued to refuse and was eventually held in indirect civil contempt. Id. at ¶¶ 9-10.
On appeal, the Court analyzed whether the trial court had the authority to order the shareholders to compensate a provisional director under the Act. Id. at ¶ 14. Section 12.56(b) of the Act provides for several remedies the court may order, including the appointment of a provisional director. Section 12.56(g) of the Act, however, states:
"the court shall allow reasonable compensation to the custodian, provisional director, appraiser, or other such person appointed by the court for services rendered and reimbursement or direct payment of reasonable costs and expenses, which amounts shall be paid by the corporation."
805 ILCS 5/12.56(g).
BTE argued that Sections 12.56(b)(1) and 12.56(c) give the trial court the authority to order shareholders to pay a provisional director’s fee. Sinkus, 2016 IL App (1st) 152135-U, ¶ 19. Section 12.56(b)(1) of provides the trial court authority to order the “performance . . . of its shareholders” and Section 12.56(c) provides the court authority to fashion “equitable remedies.” See 805 ILCS 5/12.56(b)(1), (c).
The Appellate Court rejected BTE’s argument because if Sections 12.56(b)(1) and 12.56(c) were interpreted to provide trial courts authority to order shareholders to compensate a provisional director, then the “specific directive of section 12.56(g) that the provisional director be compensated by the corporation is rendered meaningless.” Sinkus, 2016 IL App (1st) 152135-U, at ¶ 20. Any interpretation that would render a portion of a statute meaningless must be avoided. Id. at ¶ 15. Therefore, the Appellate Court concluded that Section 12.56(g) of the Act controls and the trial court erred by ordering the shareholders to compensate a provisional director. Id. at ¶ 20.
In sum, pursuant to Section 12.56(g), the coporation itself, and not its shareholders, must must compensate a provisional director appointed pursuant to Section 12.56 of the Business Corporation Act.
Illinois Court Orders 51% Shareholder to Pay 49% Shareholder's Attorneys' Fees in Case Involving Misuse of Corporate Funds and Bad Faith Counterclaim
The Appellate Court of Illinois recently affirmed an award of attorney fees in a Section 12.56 proceedings. In Thazhathuputhenpurac v. JT Enterprises of Chicago, the Court held that minority shareholder was entitled to reasonable attorney fees due to the 51% shareholder’s failure to act in good faith in “filing a frivolous counterclaim and forcing [the 49% shareholder] to defend himself against the accusations contained therein.” 2016 IL App (1st) 130775-U, ¶ 47. The Court further affirmed that in the case of two separate claims where only one claim is covered by a fee-shifting provision, the recovering party is still entitled to attorney fees where the issues are “so intertwined that the time spent on each issue cannot and should not be distinguished.” Id.
In Thazhathuputhenpurac, the parties were former investors and shareholders of JT Enterprises of Chicago, Inc., a corporation which operated a Shell service station. Id. at ¶ 5. The shareholders each invested $115,000 of their own money in the corporation, but Shell insisted that one party be the majority shareholder. Id. The parties agreed that defendant would hold 51% of the shares. Id. Shortly thereafter, defendant formed two more service station corporations, TVA and G&P, in which he was the sole shareholder. Id. at ¶ 6.
From 1997 through 2002, the minority, 49% shareholder solely managed JT, though he frequently met with the 51% shareholder to discuss the business. Id. at ¶ 7. In 2002, due to health issues and a disagreement with defendant, plaintiff stopped working at JT and eventually relocated to Florida. Id. at ¶ 8. Prior to his relocation, Shell had substantially increased JT’s rent, and the parties had agreed to sue on behalf of JT. Id. at ¶ 9. Defendant also independently sued Shell on behalf of TVA. Id. Both cases settled in 2005, and defendant signed on behalf of both JT and TVA. Id. Defendant had agreed to surrender “JT to Shell, for a credit of $225,000” and defendant applied the entirety of JT’s credit – excluding the 49% shareholder – to his purchase of the TVA property. Id. at ¶ 9-10.
At no point did the 51% owner discuss or inform the 49% owner of this settlement offer. It was later determined that the 51% owner had also been transferring substantial sums of money between all three entities throughout the years without notifying the 49% owner. Id. at ¶ 12-13. In 2006, the 49% owner sued the 51% owner under Section 12.56 of the Act, tortious interference, and for an accounting, and defendant counterclaimed for breach of fiduciary duty. Id. at ¶ 14. The court awarded the 49% owner $158,699.73 and reasonable attorney fees “as he was successful on his claim brought under the Act,” and found against the 51% owner for his counterclaim. Id. at ¶ 15.
Following a motion to reconsider, the court found that the 49% partner’s award should not be reduced by 49% of the attorney fees incurred by the 51% partner in the settlement with Shell as “there is no evidence that the attorney fees reduced the $225,000 benefit as opposed to being just another cost associated with the closing.” Id. at ¶ 17. The court further held that the 51% partner’s counterclaim “was not litigated in good faith and pursuant to section 12.60(j) of the Act, [and] awarded attorney fees to [the 49% partner] for defending the counterclaim” despite the fact that only one of the claims was covered. Id. The court affirmed that “in fee shifting cases, such as this one, where there are covered and non-covered claims, a party is entitled to fees on a non-covered claim where the two claims ‘arise out of a common core of facts and related legal theories.’” Id. at ¶ 19 (citing Hensley v. Eckerhart, 461 U.S. 424, 435 (1983)).
On appeal, the Appellate Court affirmed the circuit court’s award of reasonable attorney fees to the 49% partner pursuant to Section 5/12.60(j), finding that the 51% partner’s counterclaim was not brought in good faith. Further, the Appellate Court held that the fees should not be limited to the defense of the counterclaim because the claims were “so intertwined that the time that [the 49% shareholder’s] attorney spent on each issue cannot and should not be distinguished.” Id. at ¶ 47.
Thazhathuputhenpurac serves as a warning to business owners and attorneys litigating cases under the Illinois Business Corporation Act. First, despite the emotional nature of “business divorces,” it is prudent for shareholders and their attorneys to carefully consider the strength of their claims before proceeding all the way through a trial. Second, litigants and attorneys should be careful to avoid the unfortunately common litigation practice of lodging weak counterclaims as a strategic counterbalance to plaintiffs' counts. In a Business Corporation Act case, doing so may be costly.
A non-public corporation is a corporation that has no shares listed on a national securities exchange or regularly traded in a market maintained by one or members of a national or affiliated securities association. In a shareholder action in a non-public corporation, circuit courts may order one of several remedies listed in Section 12.56 of the Business Corporation Act of 1983. 805 ILCS 5/12.56.
Section 12.56(f) allows the corporation or shareholders being sued to purchase the petitioner’s shares if it is requested as relief by the petition. The corporation or one or more shareholders can choose to purchase all of the shares owned by the petitioning shareholder for their fair value either within 90 days after filing the petition under Section 12.56 or within a length of time the court finds to be equitable. 805 ILCS 5/12.56.
The provisions regarding a buyout of the petitioner’s shares pursuant to Section 12.56(f) are as follows:
If the parties reach an agreement on the fair value and terms of the buyout within 30 days of filing the election to purchase, then the court will enter an order directing the purchase upon the terms and conditions agreed to by the parties. 805 ILCS 5/12.56(f)(5). If the parties are unable to reach an agreement within 30 days of filing, the court will determine the fair value of the shares as of the day before the date the petition was filed or as of another date that the court deems appropriate. 805 ILCS 5/12.56(f)(6).
Section 12.56(a) does not define “fair value” but simply states that the negative impact the complained of conduct had on the value of the petitioner’s shares should be factored into the determination of “fair value.” Section 11.70(j) of the Business Corporation Act defines “fair value” as “the value of the shares immediately before the consummation of the corporation action to which the dissenter objects excluding any appreciation or depreciation in anticipation of the corporate action, unless exclusion would be inequitable.” 805 ILCS 5/11.70.
Illinois case law also demonstrates that the Illinois legislature wanted to give courts broad discretion in determining fair value and that it should be distinguished from “fair market value,” although fair market value may be used in a fair-value determination. John T. Schriver & Paul J. Much, Determining Fair Value for Minority Shareholders Who Sue for Corporate Wrongdoing, 91 Ill. B.J. 199, 200 (2003). Thus, there is broad latitude given to the court and parties when determining the shareholder buyout price.
A limited liability company (“LLC”) allows members limited liability, but LLCs aren't perpetual. Section 180/35-1 of the Limited Liability Company Act details the events that cause the dissolution of LLCs. 805 ILCS 180/35-1. Section 180/35-1(4)(E) indicates that LLCs can be dissolved “on application by a member or a disassociated member, upon entry of a judicial degree that the manager or members in control of the company have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent with respect to the petitioner.” 805 ILCS 180/35-1(4)(E).
This article addresses members' rights to wind up a LLC’s business post-dissolution as well as the liabilities and rights during winding up of a LLC. Aside from administrative winding up of a LLC’s affairs under judicial supervision, individuals can wind up the LLC’s business. The individuals who have the right to wind up a LLC’s business after dissolution are: (a) members who have not wrongfully dissociated from the LLC; and (b) legal representatives of the last surviving member of the LLC. 805 ILCS 180/35-4.
The persons winding up a LLC’s affairs may preserve the company’s business or property for a reasonable time as well as prosecute and defend actions and proceedings on behalf of the LLC. These persons may also settle and close the company’s business, dispose of and transfer the company’s property, discharge the company’s liabilities, distribute the assets of the company, settle disputes by mediation or arbitration, and perform other necessary acts. 805 ILCS 180/35-4(c).
Although members of LLCs are generally not personally liable for the debts or obligations of the company, courts in some states have held that a LLC member or manager may be held individually liable during the winding up process post-dissolution. 49 A.L.R. 6th 1 §64 (2009). Examples of winding up situations in which LLC members can be held individually liable include:
Dissolution of an LLC, on its own, however, does not make members personally liable for debts, obligations, or liabilities of the LLC. That is, solely being a member or manager of the LLC or having the authority to wind up the company’s business following its dissolution does not place the individual under any obligation or liability. 49 A.L.R. 6th 1 §65 (2009).
Section 12.30 of the Illinois Business Corporation Act of 1983 (“Act”) (805 ILCS 5/12.30) explains the effects of corporate dissolution. Section 12.75 of the Act (805 ILCS 5/12.75) details the notice requirements a dissolved corporation must comply with in order to remove its liabilities. These sections of the Act give shareholders expectation guidelines following their decisions to dissolve a corporation.
Section 12.30 mandates that a dissolved corporation shall not carry on any business other than what is necessary to liquidate its business and affairs, including:
A dissolved corporation may bar known claims against it, its directors, officers, employers or agents, or its shareholders or their transferees. If the dissolved corporation wishes to discharge or make provisions to discharge its liabilities, it must send a notification to the claimant within 60 days of the effective date of dissolution, relaying the following information:
If the dissolved corporation complies with the above procedures and then chooses to reject the claim entirely or in part, the corporation must notify the claimant of the rejection. The corporation must also notify the claimant that the claim shall be barred unless the claimant files suit to enforce the claim within a deadline not less than 90 days from the date of the rejection notice.
To employ this section of the Business Corporation Act, corporations should identify potential claimants and give them notice under the aforementioned procedures. A 12.75 notice is not required, but if it is given, it must be given to all known creditors, or else the director of the corporation will be at risk of personal liability in accordance with Section 8.65 of the Act. Kennedy v. Four Boys Labor Serv., Inc., 279 Ill. App. 3d 361, 664 (2d Dist. 1996); Lin Hanson, The Business Corporation Act’s “Quickie” Claim Bar Dissolving Corporations Can Use This Technique to Sharply Reduce the Period During Which They Remain Liable for Claims Against Them. But Beware Its Risks and Limitations, 96 Ill. B.J. 480 (2008).
The most important factor to keep in mind is that Section 12.75 is not a “catch-all” claim bar. A “claim” under Section 12.75 does not include contingent liability, claims arising after the effective date of dissolution, claims arising from the failure of the corporation to pay any tax or penalty, and claims arising out of criminal law violations. Nonetheless, Section 12.75 gives corporations an inexpensive option to bar known claims.
In a shareholder action against a co-shareholder (co-owners or incorporated business partners, colloquially), a court may order one of the remedies provided for in 805 ILCS 5/12.56(b) if the shareholder shows that “the directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent with respect to the petitioning shareholder whether in his or her capacity as a shareholder, director, or officer.”
805 ILCS 5/12.56(a)
This article briefly examines what types of conduct constitute “oppressive” conduct under Illinois case law.
As a preliminary matter, it is important to note that the oppressive conduct must be directed toward the shareholder as a shareholder, director, or officer. Oppression directed to the shareholder as an employee, for example, does not satisfy Section 12.56. See Dady v. Healy, 407 Ill. App. 3d 1191 (2d Dist. 2011) (unpublished).
Black’s Law Dictionary defines oppression as the “act or an instance of unjustly exercising authority or power.” The Illinois Appellate Court has described oppression as conduct that is “arbitrary, overbearing and heavy-handed.” Iverson v. C.J.C Auto Parts & Tires, Inc., 2014 IL App (2d) 130706-U, ¶ 28 (citing Hager-Freeman v. Spircoff, 229 Ill. App. 3d 262 (1992), Compton v. Paul K. Harding Realty Co., 6 Ill. App. 3d 488, 499 (1972)). “Arbitrary, overbearing, and heavy-handed” provides little more guidance than “unjustly exercising authority”, but “oppression” under either definition is a broad, fluid concept.
The Illinois Appellate Court has only addressed the type of oppressive conduct that may entitle a shareholder to Section 12.56 remedies in a limited number of opinions. Examples of conduct deemed oppressive include:
Conduct found not be oppressive includes:
The above list demonstrates types of shareholder action that are considered oppressive. While conduct similar to that listed may give shareholders remedies under Section 12.56, this list is not all-inclusive, and depending on the circumstances of the specific case, a myriad of conduct may be considered oppressive under Section 12.56.
It is useful to bear in mind that the word “oppressive” as used in Section 12.56 does not require a threat of imminent disaster. “Oppressive” is also not synonymous with “illegal” and “fraudulent.” Thus, if shareholder rights have been abused and denied, it is not necessary to show fraud, illegality, or even loss to exhibit shareholder oppression. Gidilitz, 20 Ill. 2d 208.
Illinois law offers a number of remedies for closely held or private corporation shareholders trapped in toxic or dysfunctional relationships with their corporations or fellow shareholders (co-owners). Given the structure of most corporations, 50/50 shareholders and minority shareholders are the most apt to find themselves in these situations.
Section 12.56 of the Illinois Business Corporations Act of 1983 provides shareholders of closely held, or non-public, corporations a number of remedies to resolve corporate conflicts. Under Section 12.56 a non-public corporation is one that unlisted on the exchange and is not traded by members of a “national or affiliated securities association.” In other words, shareholders of family businesses, partnerships structured as corporations, medical corporations, and other non-publicly traded corporations may find relief under Section 12.56.
In order to obtain the remedies provided by Section 12.56, a shareholder filing suit must prove one of the following:
If a shareholder establishes one of the above corporate shortcomings, a court may then award one or more of the twelve remedies set forth in Section 12.56(b). These remedies are remarkably flexible and provide a wide range of options to correct a dysfunctional or oppressive corporate situation. The enumerated remedies are:
The breadth of the remedies under Section 12.56 is extensive. The result is a legal out for shareholders trapped in dysfunctional corporations, a situation common in closely held corporations owing to the unmarketability of shares and/or restrictions on transfers of ownership. Rather than being frozen out of a corporation, waiting it out on the sidelines, and hoping for an eventual sale, a shareholder may avail herself to the remedies set forth in Section 12.56, force the issue, and either rectify the situation or force a takeover or buyout.
Owners of closely held corporations, including family businesses, are often concerned that a member’s spouse may pursue or obtain shares in a divorce. Their unease is warranted. If shares are at issue in a divorce, the value of the company is at issue, and valuation litigation is often time-consuming, intrusive, and expensive, even for a third party. A member’s ex-spouse gaining an ownership interest may also pose problems, particularly in the case of family businesses. Because of these potential problems, as many businesses owners know, it is advisable to include terms addressing member divorce in the transferability and buyout provisions of the company’s operating agreement.
Illinois divorce courts have traditionally and prudently avoided property allocations that conflict with operating agreements, a fact supported by the lack of Illinois case law on the issue. The Illinois Appellate Court, Second District, recently addressed this issue and provided a degree of predictability to business owners, holding that a trial court abuses its discretion by ignoring reasonable transfer restrictions in an operating agreement when addressing the allocation of shares in a divorce.
In In re Marriage of Schlichting, 2014 IL App (2d) 140158, the wife owned shares, ironically, in the husband’s family’s quarry business, Rockton Rock, LLC. The shares were marital property (in her name, but, presumably, acquired during the marriage). The Rockton Rock operating agreement contained a transfer provision barring any member from transferring any interest in Rockton Rock without the consent of all members. Id. at ¶ 5.
The operating agreement also included within its buyout provision terms for valuing Rockton Rock in the event of a member’s divorce. Id. at ¶ 53. Specifically, the agreement provided that the buyout value would be the greater of the company’s accountant’s valuation and the court’s valuation, and that the shareholder-spouse would pay the difference to the company. In other words, upon the court’s order, the company would buy the shares from the member-spouse at the litigated value, and the member-spouse would be required reimburse the company for any overage beyond the company’s valuation. See id. at ¶ 7. The only valuation presented at trial was the company’s accountant’s. The husband did not present a competing valuation. See id. at ¶ 54.
Despite the operating agreement’s transfer restrictions and the buyout provision, the trial court ordered the wife to sell her shares to the husband, without the unanimous consent of the other members. See id. at ¶ 23, 47. On appeal, the court noted that “no Illinois case requires a court to distribute marital property in accordance with an operating agreement…” Id. at ¶ 60. It also found that Illinois appellate courts had not reached holdings regarding conflicts between divorce orders and operating agreements. See id. ¶ 66.
Because the operating agreement barred the transfer of shares to the husband and provided a buyout provision permitting a court-ordered valuation and distribution, the appellate court held that the trial court abused its discretion by ordering the transfer of shares. See id. ¶ 69.
The Schlichting court could have reached the same result even if the buyout provision for valuation did not exist. The trial court would have had the ability to effectuate a fair allocation of marital property by valuing the property and ordering the wife to sell, or by allocating an offsetting amount of other property to the husband, regardless of the transfer restrictions. The buyout provision in Schlichting did not impose a value on the court or the non-spouse. In fact, the buyout language disadvantaged the member-spouse because it incentivized the company to value low and obligated the member-spouse to make up the difference. Given these circumstances, the appellate court was correct to reverse the court for disregarding the operating agreement and provided precedence supporting such agreements in future cases.