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.
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.