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.

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.

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.

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 12.56 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.