The Smith case, pending in the U.S. District Court for the Eastern District of Michigan, involves issues that regularly present in shareholder oppression cases. First, despite corporate success and the controlling shareholders receiving millions through compensation and self-dealing, the minority shareholder receives nothing of value. Second, the controlling shareholders provide inadequate information for the minority shareholder to recognize the controlling shareholders’ actionable conduct and take legal action.

Judge Mark A. Goldsmith recently issued an opinion touching on these themes in the course of ruling on the parties’ motions for partial summary judgment in Smith. This paper synthesizes the parties’ positions and the court’s analysis of those positions, which provide an illustration of how minority shareholders, majority shareholders, and courts address common issues in shareholder disputes.

Martin Smith, the plaintiff, is a 48.5% shareholder in E&E Manufacturing Corporation, Inc. 2020 U.S. Dist. LEXIS, 81240 at *2. Wallace Smith and his wife, Joan Smith, own 51.5% of E&E’s stock. Id. Wallace and Joan are E&E’s sole directors and Wallace is E&E’s president, secretary, and treasurer. Id. Martin is not employed by E&E. Id. at *28.

Between 2012 and 2018, E&E generated annual net income of approximately $3.5 million to $5.0 million. Id. *3. Despite the considerable profits, Wallace and Joan did not make any dividend distributions to E&E’s shareholders. Id. Martin alleges that Wallace and Joan also caused E&E to enter into various transactions, including leases in which E&E paid millions, to companies owned by Wallace, Joan, and their children. Id. at *3-4. Martin also alleges that Wallace received, on average, approximately $1.8 million dollars annually in compensation. Id.*28.

Martin filed suit against Wallace, Joan, and others for shareholder oppression, breach of fiduciary duty, and other statutory relief under Michigan’s corporate statutory scheme. Id. at *5. He seeks a buyout of his shares in E&E, payment of dividends, removal of Wallace and Joan from management, an accounting, profit disgorgement, and damages. Id.*28

The defendants argued that Martin’s claims should be subject to Michigan statutes of limitations of two and three years. Id. at *9-10. The court held that only Martin’s damages claims were subject to those statutes whereas his equitable claims, i.e. all relief other than money damages, were subject to a six-year statute of limitations. Id. at 10-11.

Crucially, the court reserved for trial the issue of whether any application of the statute of limitations should be tolled based on fraudulent concealment. Id. *17-18. Under Michigan law, “fraudulent concealment must be manifested by some affirmative act or misrepresentation, an exception to this rule applies when there is an affirmative duty to disclose material information by virtue of a fiduciary relationship.” Id. at *15. As directors and majority shareholders, Wallace and Joan owed Martin fiduciary duties. Id. at *16.

Martin alleged Wallace and Joan failed to disclose “information bearing on his present claims”, including the sum of Wallace’s compensation, the terms of self-dealing lease agreements, and the value of distributions Wallace, Joan, and their children received through entities receiving rent from E&E. Id. at *16. Additionally, Martin alleges the defendants provided incomplete annual financial reports that excluded information that would have provided notice to Martin of some of his claims. Id. The court agreed with Martin, concluding that “[i]f Wallace and Joan had a fiduciary obligation to disclose this information to Martin—including the information in the full balance sheets—their failure to do so would be consistent with fraudulent concealment.” Id. at *19.

In essence, the court decided which statutes of limitations apply to Martin’s claims with the caveat that whether the statute of limitations are offset by fraudulent concealment for trial. This being a pretrial decision on summary judgment, the final result of the Smith case is as yet undetermined. The opinion nevertheless provides shareholders a case study in the legal issues that arise in what is a remarkably typical shareholder oppression case fact pattern.

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:

• The amount the electing party will pay for the shares must be in writing. This notice of election can be a formula for determining the purchase price, rather than a specific numerical figure. Midkiff v. Gingrich, 355 Ill. App. 3d 857, 863 (2005);
• The election to purchase shares is irrevocable unless otherwise determined by the court that it is equitable to set aside or modify the election;
• If the election to buy shares is filed by one or more shareholders, the corporation must give notice to all shareholders within 10 days. The notice must state the name and number of shares owned by the petitioner, the name and number of shares owned by each electing shareholder, the amount each electing party will pay for the shares, and advise the recipients of their right to join in the election to buy shares. Shareholders have 30 days after the date of notice to file notice of their intention to join in a purchase. Shareholders who file a notice of their intention to participate in the election become parties and must participate in the purchase in proportion to their ownership of shares at the time the first election was filed. If the corporation does not give notice to all shareholders within 10 days, the corporation or non-petitioning shareholders cannot purchase the petitioning shareholder’s shares in lieu of corporate dissolution. Lohr v. Havens, 377 Ill. App. 3d 233, 235 (2007).
• The court can allow the corporation and non-petitioning shareholders to file an election to purchase the petitioning shareholder’s shares at a higher price. 805 ILCS 5/12.56(f).

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.

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:

1. Collecting its assets.
2. Disposing of its assets that will not be distributed to its shareholders.
3. Giving notice in accordance with Section 12.75 and discharging or making provisions to discharge its liabilities.
4. Distributing its remaining assets among its shareholders according to their interests.

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:

1. The corporation has been dissolved and the effective date of dissolution.
2. The mailing address to which the claimant must send its claim and the essential information to be submitted with the claim.
3. The deadline, not less than 120 days from the effective date of dissolution, by which the dissolved corporation must receive the claim.
4. A statement that the claim will be barred if not received by the deadline.

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.

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:

• Deprivation of participation in the management of the corporation;
• Failure to invite a shareholder to meetings he or she is entitled to attend;
• Denying a shareholder control proportionate to his or her stocks in the business;
• Failing to consult with co-shareholders on corporate policy decisions;
• Organizing another corporation with business funds without consulting co-shareholders;
• Loaning money in the name of the business without co-shareholder approval;
• Unfair and arbitrary hiring and setting of salaries and/or terms of employment;
• Lack of annual shareholder meetings as required by Section 26 of the Business Corporation Act;
• Ignoring a shareholder’s request for financial documents; and
• Failure to share profits.

See Murchie v. Sorenson, 2015 IL App (1st) 133719-U; Gidilitz v. Lanzit Corrugated Box Co., 20 Ill. 2d 208 (1960).

Conduct found not be oppressive includes:

• Launching the dissolution of the corporation backed by a shareholder vote. Brynwood Co. v. Schweisberger, 393 Ill. App. 3d 339 (2d Dist. 2009);
• Refusing to approve a share sale to an outsider when not required by the corporation’s governing documents. Iverson v. C.J.C. Auto Parts & Tires, 2014 IL App (2d) 130706-U.

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.

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:

1. that the corporation is deadlocked in the “management of corporate affairs”, that the shareholders cannot resolve the deadlock, and that the deadlock threatens irreparable harm to the business, or that the corporation cannot continue business for the “general advantage of the shareholders”, including the petitioning shareholder;
2. that the shareholders are deadlocked (e.g., two 50/50 shareholders with opposing positions) and have failed for two consecutive annual meetings to elect new directors after prior directors’ terms have expired, and the deadlock threatens irreparable harm to the business or its ability to continue business for the “general advantage of the shareholders”;
3. that the controlling directors or shareholders have, are, or will act illegally, oppressively, or fraudulently toward the petitioning shareholder; or
4. that the corporation’s assets are being misapplied or wasted.

805 ILCS 5/12.56(a).

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:

1. A court may order the “performance, prohibition, alteration, or setting aside of any action of the corporation or of its shareholders, directors, or officers…”;
2. The alteration or termination of the corporation’s governing documents;
3. The removal of a director or officer;
4. The appointment of a director or officer;
5. An accounting;
6. The assignment of a custodian to manage the business pursuant to conditions set by the court;
7. The appointment of a temporary director to serve under conditions set by the court;
8. Submission of the dispute to non-binding dispute resolution, such as mediation;
9. The issuance of dividends to the shareholder or shareholders;
10. An award of damages to the wronged shareholder;
11. The purchase of the petitioning shareholder’s shares for fair value by the corporation or other shareholders; or
12. The dissolution of the corporation.

805 ILCS 5/12.56(b).

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.