Chicago Business Litigation Lawyer Blog

As Chicago shareholder dispute attorneys, we noted with interest a recent decision on calculating fair market value of stock owned by a dissenting shareholder. Brynwood Company v. Schweisberger, No. 02-06-1178, (Ill. 2nd Dist. July 23, 2009) pitted a corporation against its co-founder and majority shareholder. The Brynwood Company, which is now dissolved, was an Illinois C corporation organized in 1979. It existed only for the purpose of owning and administering an office building in Rockford, Ill. Stuart Schweisberger was a founder of Brynwood, the president, a member of the board of directors until 2000 and a tenant with an accounting firm in the building. He was also the accountant for Brynwood until 1994.

Schweisberger retired in 1996 with 26% of the company’s stock. In 1999 and 2000, the Brynwood board began to consider ways to change the corporation, including selling the building and dissolving the corporation. In 2001, Schweisberger negotiated with Brynwood to sell his shares, but negotiations ultimately faltered. In 2002, Brynwood notified Schweisberger that it had an offer to sell the building to a third party, but wanted to convert to an S corporation to avoid income tax liability instead and hold on to it for 10 more years. Schweisberger did not consent to the conversion, in part because it would require changes to his IRA. When Brynwood failed to get his consent, it held a meeting at which shareholders agreed to sell the building and dissolve the corporation.

The building was sold for $1.4 million, with $959,282 in capital gains. The mortgage of $353,080 was paid from the proceeds, and another $446,593 was paid in taxes, professional fees and other costs. A bit more than a week after the sale, Schweisberger filed a notice objecting to the sale and demanding payment of the “fair value” of his shares under the Illinois Business Corporation Act of 1983. When Brynwood dissolved, it estimated fair value of the shares at $30.08; Schweisberger estimated fair value at $66.31 and also demanded 6.75% interest, which was the former mortgage’s interest rate. In October, Schweisberger surrendered his shares in exchange for the $30.08 price plus a much lower interest rate based on the interest earned on the certificate of deposit holding the proceeds of the sale. However, in December of 2002, Brynwood filed for a judicial determination of the fair value of Schweisberger’s stock and interest due to him.

At trial, the basis for the difference between Schweisberger’s and Brynwood’s valuations became clear. Schweisberger testified as his own expert witness, saying he came to the $66.31 valuation by excluding the costs of capital gains taxes, fees and costs. Because he objected to the sale, he said, he thought his shares should be calculated without those costs. Brynwood’s expert, accountant Gary Randle, testified that the fair valuation should be calculated according to what each individual shareholder eventually received from the liquidation, which he put at $36.15 per share. He said if Schweisberger had actually received his requested $66.31 per share, other shareholders would have received about $25 a share. Another expert witness for Schweisberger, accountant Mark Patterson, testified that he believed the value could also be calculated as a “going concern,” cutting out the taxes, fees and costs from the sale.

Before and during trial, Brynwood objected to Patterson’s presence and testimony. It said Patterson was unqualified to give testimony because he had admittedly never valued this type of company before. It also contended that his testimony was nothing more than a definition of the legal term “fair value.” The court twice dismissed these objections.

The trial court found that Schweisberger timely exercised his right to dissent and that the board knew the sale would trigger taxes, fees and costs. Because of that, and because the only reason for the sale was the majority’s preference, it found that Schweisberger’s shares should be calculated without taking those costs into account. It also found that the interest rate should be the 6.75% interest Schweisberger had requested, giving rise to a share value of $60.68. This gave Schweisberger a judgment of $181,130.45. Brynwood appealed.

The Second District started by addressing Brynwood’s concerns at trial: that Patterson should not have been allowed to testify as an expert because he had never valued this type of company, and that admitting his testimony was an abuse of discretion because he was doing nothing more than interpreting the words “fair value.” The appeals court disagreed. Valuation is part of the business of accounting, it said, and experience in valuing a particular type of business is unnecessary. Furthermore, a review of Patterson’s testimony shows that it included reasons for his opinions, not just the definitions of terms. Thus, the trial court did not abuse its discretion in admitting the testimony, the Second said.

Brynwood had more luck with its argument that the trial court’s valuation decision was against the manifest weight of the evidence. The company argued that by subtracting taxes, costs and fees, the court artificially inflated the value of Schweisberger’s shares at the expense of the majority of shareholders. The court agreed, saying that excluding those costs did not meet the Business Corporation Act’s goal of fair and equal treatment for all shareholders. Capital gains taxes and other costs are intrinsically tied to the value of a closely held real estate company like Brynwood, the court wrote, and thus to its stock’s value. This made the trial court’s decision against the manifest weight of the evidence. Thus, the appeals court overturned that decision and sent it back to trial court for a new determination of value, taking taxes, costs and fees into account.

Continue reading "Second District Reverses Trial Court’s Judicial Determination of Fair Market Value in Shareholder Dispute" »

A group of Chicago condo owners may proceed with a derivative lawsuit against their homeowners’ association’s Board of Directors, the First District Court of Appeal has ruled. In Davis v. Dyson, No. 1-07-2927 (Ill. 1st Dec. 19, 2008), twelve condo owners sued individuals formerly on the board of directors after the board members failed to detect embezzlement by an outside property manager. Furthermore, the homeowners alleged, the former board members failed to get enough insurance or get an attorney's advice on their duty to do so, resulting in losses and out-of-pocket costs of more than $800,000 after the embezzlement was detected.

The homeowner plaintiffs sued for breach of fiduciary duty under two counts -- one derivative claim on behalf of the association and one claim as individual homeowners whose property values were allegedly harmed by the directors' inaction. In response, board members argued that the homeowners lacked standing to sue in both claims -- for the individual claim, because the property value claim did not constitute a separate and distinct harm to the individual homeowners. For the derivative claim, the board members argued that only the board itself may bring a derivative action against third parties. The trial court agreed and dismissed both claims; the homeowners appealed.

In its analysis, the appeals court pointed out that shareholders have an undisputed right to sue their own boards of directors; the question was whether they may file a derivative claim against third parties (in this case, the former directors). The court concluded that they could, pointing out that the right to file a derivative suit puts homeowners into the association's shoes. This means that they are acting on behalf of the association, the opinion said, not usurping its undisputed right to sue third parties. The relevant section of the Illinois Condominium Property Act does not prevent derivative claims by homeowners, the court wrote, so it saw no reason to deviate from caselaw on derivative actions.

However, the individual claims by the homeowners, that their properties' values had declined because of the board's inaction, still failed, the court decided. It found that damage to property values can be separate and distinct even if it's the same kind of damage -- ownership is separate, and thus harm to ownership is separate. More persuasive to the court was the defendants' argument that the damage to the units' value was not direct damage, but an indirect result of damage done to the entire building by the embezzlement. Again relying on caselaw on derivative actions, the court pointed out that shareholders may not sue as individuals when the harm they allege is indirect and shared by all shareholders.

Finally, the court ruled that alleging violations of the Condo Act and the association's bylaws was sufficient to allege breach of fiduciary duty. It also dismissed the defendants' contention that allowing the suit would impermissibly interfere with directors' business judgment, because directors must exercise due care, and whether they did so is a question of fact that should be tried. Thus, the appeals court affirmed the dismissal of the individual claims but reversed the dismissal of the derivative claim and sent it back to the trial court.

With offices in Chicago and Oakbrook Terrace, Illinois, DiTommaso-Lubin represents shareholders, homeowners and others who need help asserting their rights after a board refuses to do so. Our Chicago and Naperville area real-estate trial attorneys handle many different types of real-estate litigation. We handle both individual consumer protection lawsuits and consumer class actions on behalf of clients throughout Illinois, as well as in partnership with firms in other states. If you would like to learn more, please contact us to set up a consultation.

A small business may not sue a bank for allowing a minority shareholder to embezzle, the Illinois Second District Court of Appeal has ruled. In Time Savers, Inc. v. LaSalle Bank, N.A., 02-06-0198 (Feb. 28, 2007), the company had sued its bank for breach of contract, common-law fraud, conspiracy to defraud, aiding and abetting and violating the Illinois Fiduciary Obligations Act.

The case stems from bad loans taken out by the minority shareholder in construction and maintenance equipment supplier Time Savers (TSI), Stephen Harrison. He owned 20% of the company and shareholder Lawrence Kozlicki owned the remaining 80%. Harrison also owned another business, RDSJH Equipment Venture, that does the same kind of equipment supply business. Kozlicki has no ownership interest in RDSJH, but the two companies did business together. Between 1997 and 2001, Harrison, through TSI, refinanced existing loans and took out new ones with LaSalle Bank seven times. With these loans, Harrison financed new equipment purchases for RDSJH; the equipment was then rented to TSI, allowing RDSJH to enrich itself at TSI's expense.

Kozlicki and TSI contended that LaSalle suspected or knew that the loans were for Harrison's personal benefit, but failed to alert Kozlicki or investigate further. TSI pointed to various documents and communications, as well as the fact that some funds were deposited into an RDSJH account. The complaint at issue in this appeal is the third amended complaint by TSI; the company voluntarily dismissed the original complaint and the DuPage County trial court dismissed the first, second and third amended complaints at LaSalle's request. (The bank also moved for sanctions after the third amended complaint was dismissed.) The final dismissal is the subject of this appeal.

In its analysis, the Second District sided with the trial court. Most importantly, it found that TSI had failed to show that LaSalle or its employees had actual knowledge of Harrison's embezzlement. Documents cited did not demonstrate Harrison's wrongdoing, and because the bank knew Harrison was a shareholder in both TSI and RDSJH and the two companies did business together, there was no reason that the bank should have suspected anything unusual from the entanglement of the companies' finances. For the same reasons, the court said, the bank knew nothing that would have obligated it to investigate the situation further, and the plaintiff could not show that it deliberately failed to investigate.

Thus, the charges of conspiracy, aiding and abetting and violation of the Fiduciary Obligations Act failed. The common-law fraud count failed, wrote the court, because TSI failed to cite specific examples of false representations made by LaSalle. Thus, the appeals court upheld the trial court's dismissal of TSI's complaint with prejudice.

The Chicago business trial attorneys and commercial litigation lawyers at DiTommaso-Lubin represent businesses and individuals in Chicago and throughout the Midwest who are seeking to recoup the costs of fraud, embezzlement and other financial crimes. To learn more about our firm and see our favorable results in past cases, please visit our Web site.

As Chicago business, shareholder rights and commercial law litigators, we frequently handle cases involving allegations of business fraud or financial mismanagement, often as part of complex business dispute, that require significant expertise in financial issues. When handling a divorce involving a family business or other closely held company, we also sometimes find we need an expert's help properly valuing the business, so we can help our clients get the most equitable possible distribution of marital property.

Our Chicago, Oak Brook, Wheaton and Naperville business trial attorneys have handled many complex business and commecial law litigation matters which have involved presenting or cross-examining accounting witnesses.

While we're confident in our legal skills, these situations call for specialized financial skills. To give our clients the best possible representation in business, shareholder and other commercial disputes, we sometimes retain a forensic accountant or fraud examiner. Both of these jobs are twofold: They help attorneys and their clients understand the complex financial aspects of their cases, and they may also be called to testify as expert witnesses. A forensic accountant's job is to examine a person or corporation's accounts "cold," from the outside; the subject isn’t generally expected to cooperate. Similarly, a fraud examiner delves deep into a company's finances, looking for the source of anything that seems inconsistent or suspicious. Both can serve as expert witnesses who help establish the value of a business or testify to the existence of fraud.

The goal for both forensic accountants and fraud examiners is to make sure the other side of the case is being completely truthful about its income and accounting practices. As you might imagine, this is a frequent concern in divorces involving a spouse who’s part of a small or closely held business, which may need to be properly valued for the divorce. The company may also need to be investigated when the owning spouse is believed to be hiding assets. However, this concern also comes up in business disputes, such as breach of fiduciary duty lawsuits. When minority shareholders believe the majority is withholding important financial information, using a forensic accountant or fraud examiner may be the most reliable way to discover and prove the truth.

This practice is relatively recent but growing; a simple Web search turns up many accountants and examiners who regularly serve as expert witnesses. Two legal journals serving our Midwestern neighbors, The Wisconsin Law Journal and Michigan Lawyers Weekly, offer online articles on the subject for lawyers who want to learn more.

In a shareholder derivative action related to 2004's merger between Bank One and J.P. Morgan Chase, the Illinois First District Court of Appeal upheld the dismissal with prejudice of a complaint filed by Bank One shareholders. Shaper v. Bryan, No. 1-05-3849 (March 8, 2007).

The dispute grew out of the high-profile merger of Bank One with J.P. Morgan Chase. As part of the deal, J.P. Morgan agreed to issue stock to each Bank One shareholder worth 14% more than the Bank One shares' closing price on the day of the merger. In other words, Bank One shareholders received extra value as part of the deal. Bank One CEO James Dimon would serve as president and COO of J.P. Morgan Chase for two years, after which he would take over for the existing CEO. These two men negotiated both the premium and the succession plan themselves.

Media reports soon appeared, suggesting that Bank One shareholders could have gotten a much larger premium from another company or through another negotiator. The media also reported that Dimon was eager to move to New York and take over as the leader of J.P. Morgan Chase, offering to do the deal for no premium at all if he could start as CEO without waiting the two years.

Shareholders for Bank One filed suit, alleging that officers and directors breached their fiduciary duty to shareholders by accepting a lower price than they would likely have gotten by opening bidding to other companies. They also alleged that Dimon had a conflict of interests during the negotiations because he stood to gain higher compensation and CEO status. Finally, they alleged that termination fees that were part of the deal created an insurmountable obstacle to any higher offer. The trial court dismissed their complaint, and the appeals court affirmed.

In its opinion, the justices wrote that Dimon didn't meet the classic examples of a self-interested officer director -- someone on both sides of the transaction or someone who stood to gain a personal benefit. Furthermore, they said, the courts of Delaware, which govern this transaction, have routinely rejected the argument that maintaining an officer position is a debilitating factor in negotiations. Similarly, the board in the transaction didn't breach its duty of care, they wrote, because it had no special obligation to inform itself of Dimon's no-premium offer, nor is there anything to suggest it didn't know about that offer.

Finally, the shareholders argued that termination fees built into the merger made it impossible to entertain another offer, which constituted a breach of the board's duty of care. Importantly for Illinois business litigators, the justices also wrote that the two-stage test required by the Delaware Supreme Court in Unocal Corporation v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003) didn't apply. The court pointed out that the board retained a "fiduciary out," termination fees were reciprocal and the shareholders retained the right to vote against the merger. Thus, the appeals court upheld dismissal of the case with prejudice.

In a shareholder and breach of fiduciary duty dispute arising from a probate case involving a closely held corporation with two shareholders, the Illinois Third District Court of Appeal has ruled that a shareholder agreement made by a decedent does not allow the remaining shareholder to execute the decedent's will in bad faith. In re Estate of Talty, No. 3–06–0669 (Oct. 29, 2007).

Thomas Talty owned 50% of a closely held corporation (an auto dealership in Morris, Illinois), with his brother William Talty. They each also owned half of the land the dealership was built on, and had an interest in half of an adjoining parcel of land owned by a land trust. Thomas wrote a will in 2000 naming William as executor and naming Thomas's wife, Helen Talty, as sole residual beneficiary of the estate.

The will gave William the right to purchase Thomas's shares of the dealership from his estate, but required that the purchase price be determined by an independent appraiser appointed by the probate court. Similarly, it gave William the right to purchase Thomas's half of the land, but at fair market value set by an independent appraiser approved by the probate court. Separately, in 2001, William and Thomas made a corporate agreement allowing their company to buy the shares of any deceased shareholder. It specified that the fair market value of the shares should be determined by an accountant agreed on by the company and the decedent's representative, or, if they couldn't agree, appointed by the probate court.

After Thomas's death in 2001, William, acting as executor, agreed with the company that Robert Gordon would be the accountant to value the stock. Gordon was already the corporation's accountant, Thomas and Helen Talty's personal accountant, and Thomas and William Talty's cousin. A non-relative recommended by William's lawyer appraised the land. In neither case was Helen or the probate court consulted. Both assessed their respective properties considerably less than what they were later revealed to be worth. The closing date for the sales was set for six days from the day Helen's attorney received a letter notifying him; he filed an emergency motion with the probate court to stop the closing as soon as he read the letter. The probate court denied Helen's motion and proceeded with the sales.

Four months later, Helen filed a petition to set those sales aside and remove William as executor. At that trial, the court found that Thomas had waived William's clear conflict of interests, but William acted in bad faith and abused his discretion. Thus, the trial court removed William as executor, set aside the sales, appointed independent appraisers and awarded Helen attorney fees and other costs. The total of the balance of the sales, rents from the land, and fees and costs due to Helen totaled nearly $2 million.

William appealed on a variety of grounds, but the appellate court affirmed. In its analysis, the court noted that the stock agreement may well have superseded Thomas's will, but it was irrelevant -- William breached his fiduciary duty as executor when he failed to make complete disclosures to Helen. Because William admitted to not disclosing important information and their attorneys had minimal contact, the appeals court declined to overturn the trial court's determination of bad faith.

A minority shareholder may withdraw his complaint under the Illinois Business Corporation Act of 1983, because the majority shareholder failed to meet requirements of that law, the Illinois Third District Court of Appeal ruled in an Illinois shareholder dispute lawsuit. Lohr v. Havens, 3-06-0930 (Nov. 11, 2007).

Charles Lohr owned a large minority of the stock in Phoenix Paper Products, Inc., a closely held private corporation in Illinois. He and another shareholder, James Durham, became concerned about possible financial mismanagement by the majority shareholder and president, Terry Havens, and their accountant, Samuel Morris. In months of correspondence, they accused Havens and Morris of taking unspecified inappropriate actions without shareholder approval.

This culminated in a 2003 lawsuit by Lohr alleging that Havens and Morris were misusing the company’s resources and acting illegally. Count I of the suit asked the court to either order a buyout of all Lohr’s stock or dissolve the company. Havens filed a timely election to buy Lohr’s shares, but Lohr accused Havens of illegally doing this without shareholder approval. After two years of discovery, Lohr asked to withdraw Count I and its associated demands, but Havens objected. The trial court found that because Havens hadn’t notified shareholders about the election, it was invalid, allowing Lohr to dismiss Count I of his complaint. Havens appealed.

The Illinois Third District Court of Appeal ruled that because Havens did not notify other shareholders of the election, the election was invalid, leaving Lohr free to drop his claim. In its analysis, the court noted that a proper election would stop a shareholder in Lohr’s position from dismissing a petition -- but the plain language and the intent of the law both require notice of an election to shareholders within ten days. For the same reasons, the court also disagreed with Havens’s contention that the trial court was required to hold a hearing to assess equities before allowing Lohr to dismiss his petition.

As Chicago, Oak Brook and Naperville business and shareholder rights litigators with a substantial practice in business and shareholder disputes we’re always pleased to see clarifications of Illinois business law from the courts.

Only managers in manager-operated limited liability corporations have a fiduciary duty to the company or to other members, the First District Court of Appeal ruled in a usurpation of corporate opportunity lawsuit involving a closely held LLC. Katris v. Carroll, No. 1-04-3639 (Dec. 23, 2005).

Peter Katris was one of four members/officers and two managers of an Illinois limited liability corporation, Viper Execution Systems LLC. Viper LLC was formed to market a type of options-related software, also called Viper, written by LLC member Stephen Doherty for member Lester Szlendak. Its articles of organization specified that management was vested in Katris and the other manager, William Hamburg.

Defendant Patrick Carroll employed Doherty before and during the organization, and defendant Ernst & Company later hired Doherty to work with Carroll. Their work included the writing of another software program, WWOW, which Katris believed was functionally similar to Viper. Five years after the organization, Katris sued Carroll and Ernst for collusion and usurpation of corporate opportunity because of WWOW’s similarity to Viper. (He also sued Doherty for collusion and breach of fiduciary duty, claims they later settled.)

Carroll and Ernst moved for summary judgment, arguing that collusion didn’t exist because it depended on Doherty’s fiduciary duty to Viper LLC. As a non-manager of the manager-managed Viper LLC, they argued, he had no such duty. Katris argued that Doherty’s written agreement to form Viper LLC and officer role left him subject to a manager’s duties. The trial court disagreed, granting summary judgment, and the appeals court upheld that decision.

In its analysis, the court noted that Article 15 of the Illinois Limited Liability Company Act explicitly says that a member of a manager-managed LLC in Illinois "who is not also a manager owes no duties to the company or to the other members solely by reason of being a member." Katris agreed with the law, but asserted that different language in the law gave Doherty managerial status because he fulfilled some of the duties of a manager as director of technology:

In a manager‑managed company:
...
(3) a member who pursuant to the operating agreement exercises some or all of the authority of a manager in the management and conduct of the company's business is held to the standards of conduct in subsections (b), (c), (d), and (e) of this Section [manager’s duties of loyalty and care] to the extent that the member exercises the managerial authority vested in a manager by this Act...

The appeals court found that the plain language of the statute giving no liability to non-managers was clear and perfectly adequate for determining the intent of the Illinois legislature in enacting the law, so it declined to reverse the trial court. Furthermore, it said, Doherty’s position as director of technology didn’t elevate him to a manager because the two managers, Katris and Hamburg, didn’t have a majority vote when they gave Doherty that role, meaning they couldn’t amend the operating agreement to make Doherty a manager. And furthermore, the court argued, Katris and Hamburg signed that agreement as “all the managers” of Viper LLC, undermining Katris’s argument that Doherty was given a managerial role:

The undisputed facts of this case show that Doherty was a member of a manager-managed LLC and exercised no managerial authority pursuant to the LLC's operating agreement. Accordingly, the undisputed facts show that Doherty owed no fiduciary duties to Katris or the LLC pursuant to the Act and Katris' collusion claim against Carroll and Ernst fails as a matter of law.

Experienced Illinois business litigators probably recognize Professor Charles W. Murdock of the Loyola University Chicago School of Law as a former Illinois Deputy Attorney General, former Loyola Dean and expert on Illinois business law. Given his status, it was with great interest that we read some of his scholarship on the concept of fairness in conflicts between shareholders or other parties interested in a business, especially in situations where the majority is using its greater power against a minority. These papers are a few years old, but they directly address some of the issues that are important to our firm and our clients in corporate freeze-out or squeeze-out litigation, breach of fiduciary duty and other internal business disputes in closely held companies.

In Fairness and Good Faith as a Precept in the Law of Corporations and Other Business Organizations, 36 Loy.U.Chi. L.J. 551 (2005), Murdock addresses the fiduciary duty of good faith and fairness that controlling interests of a business owe to minority interests. Noting that this internal duty is a fairly recent legal phenomenon, he surveys caselaw on the subject from around the country that applies to closely held corporations, public corporations and LLCs. Noting that the Uniform Limited Liability Company Act (ULLCA), a model law adopted by several states, doesn't include language that gives members of an LLC fiduciary duties to one another, he praises Illinois for modifying that language to protect members in the updated Limited Liability Company Act.

Another of Murdock's articles that directly addresses issues important to us is 2004's Squeeze-outs, Freeze-outs and Discounts: Why Is Illinois in the Minority in Protecting Shareholder Interests?, 35 Loyola Chicago L.J.737 (2004). As you might expect from the title, Murdock argues in the article that Illinois business law, despite its "pro-shareholder" reputation, fails to protect minority shareholders in "fair value" proceedings. (Fair value proceedings are intended to resolve conflicts when majority shareholders want to do something that would harm the minority shareholders.) Until recently, those proceedings often led to marketability and liquidity discounts imposed on minorities, and the courts usually allowed it -- giving rise to Murdock's criticism. However, amendments to the Illinois Business Corporation Act in 2007 prohibited these discounts "absent extraordinary circumstances." While the article is now out of date, fortunately for minority shareholders in Illinois, it still provides good arguments for the change and a survey of common circumstances under which fair value proceedings might arise.