Illinois Court Dismisses Putative Shareholder Class Action, Finding Lack of Alleged Injuries - Noble v. AAR Corp.

Delegative_democracy%2C_proxy_voting%2C_liquid_democracy.svg.pngAn Illinois federal court granted a motion to dismiss in a putative shareholder derivative class action, having already denied the plaintiff’s application for a temporary restraining order (TRO). Noble v. AAR Corp., et al, No. 12 C 7973, memorandum and order (E.D. Ill., Apr. 3, 2013). The plaintiff asserted causes of action for various alleged breaches of fiduciary duty on behalf of the corporation, but the court found that the lawsuit was a direct action, primarily for the plaintiff’s benefit as a shareholder, rather than a derivative one.

The dispute related to a recommendation by the Board of Directors to the shareholders of AAR Corporation, a publicly-traded company, regarding an executive compensation plan. The Board made a unanimous proposal regarding the corporation’s “say on pay” plan, which allowed the shareholders to vote on executive pay as required by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), 15 U.S.C. § 78n-1. In a seventy-page proxy statement, the Board asked the shareholders to approve an advisory resolution regarding executive compensation at the corporation’s annual shareholder meeting, which was scheduled for October 10, 2012.

The plaintiff filed suit against the corporation and individual Board members, alleging that the Proxy Statement failed to disclose various details about what the Board considered before making its proposal. Noble, memorandum at 5. He claimed that the individual defendants breached their fiduciary duties of good faith, care, and loyalty to the shareholders, and that the corporation aided and abetted these breaches. Id. at 5-6. The defendants removed the case to federal court on October 4, 2012. The following day, the plaintiff filed a motion for a TRO, asking the court to stop the shareholder vote. The court held a hearing on October 9 and denied the motion. On October 10, the shareholders approved the Board’s proposal, with seventy-seven percent of the shares voting in favor. Id. at 1-2.

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New Jersey Court Dismisses Claim for Violation of Corporate Opportunity Doctrine in Closely-Held Business Dispute - Egersheim v. Gaud

670845_63861360.jpgTwo shareholders and former officers of a closely-held New Jersey company, DAG Entertainment, Inc., sued two fellow shareholders, the company, and a new company formed by the defendant shareholders in U.S. District Court. The suit, Egersheim, et al v. Gaud, et al, alleged eighteen causes of action related to alleged usurpation of corporate opportunities. The defendants moved for summary judgment as to fifteen of the eighteen causes of action, and the district court ruled that those causes of action amounted to a single cause of action under the Corporate Opportunity Doctrine. The court granted summary judgment on the fifteen causes of action, allowing three causes to proceed.

Plaintiff Kathleen Egersheim owned a three percent shareholder interest in DAG and was its former Vice President and Assistant Secretary. Plaintiff Christopher Woods owned 22.5% interest and was the former Creative Director. Defendants Luis Anthonio Gaud and Philip DiBartolo owned or controlled most of the remaining stock of the company. According to the plaintiffs, DAG began exploring an opportunity to partner with the media conglomerate Comcast in 2001. The plaintiffs claim they developed characters and show ideas for children’s television programming through 2004.

In 2005, the defendant shareholders allegedly began excluding the plaintiffs from meetings and decisions regarding DAG’s activities, and also allegedly created a new business entity called Remix, LLC without plaintiffs’ knowledge. Remix entered into a formal joint venture with Comcast. The defendants proposed ceasing DAG’s major business operations, according to the plaintiffs, and the defendants voted them out of their officer positions when they objected to this plan in September 2007. DAG essentially stopped operating at that point.

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Jury Sides With Goldman Sachs in Dragon Lawsuit


While the internet boom led to a lot of money in a very short amount of time for many people and businesses, it is important to remember that developing a business and making business deals are two very different things. The makers of Dragon Systems, a company that sold speech recognition software, learned this the hard way after they sold the company to Lernout & Hauspie in exchange for $580 million in Lernout stock. The deal was made in 2000 and, in 2001, Lernout's accounting was exposed as a huge fraud. The company collapsed into bankruptcy, taking with it Dragon's shareholders, including James and Janet Baker, the founders of Dragon and owners of 51% of its stock.

Since then, the Bakers have spent the better part of the past 12 years in litigation against several parties, taking about $70 million in court. In 2009, they turned their legal sights on Goldman Sachs, who had helped negotiate the deal. According to the Bakers, the advice they were given came from a team of four investors who they referred to as the "Goldman 4". Their testimony presented this team as a group of inexperienced young bankers who had failed to properly perform their jobs. Their inadequacies allegedly cost the Baker's a fortune while making a pretty $5 million for Goldman Sachs.

The Goldman Sachs side however, tells a very different story. Their financial engagement letter, which was heavily negotiated by high-powered lawyers on both sides, required that it provide nothing more than "financial advice and assistance in connection with the transaction". As an investment bank, its job did not include that kind of research and due diligence. According to Goldman Sachs, that part of the deal was up to Dragon and its accountants. The firm was responsible only for coordinating the sale, negotiating the price and evaluating growth prospects for Lernout.

In its briefs, Goldman refuted the depiction of the "Goldman 4". During the trial, the firm provided testimony saying that the Bakers were in a rush to sell Dragon, in part because it was in financial trouble. (Dragon was later sold out of the Lernout bankruptcy for $33 million). Goldman Sachs also pointed out that there were warning signs about Lernout, including news reports about Lernout's questionable accounting practices. Goldman even provided a memo to Dragon warning that, for these reasons, it should conduct extensive research on Lernout before making the deal.

One of the "Goldman 4", Richard Wayner, testified voluntarily in order to clear his name. He testified that, after Goldman Sach's memo warning Dragon about the possible risks involved in selling to Lernout, he had "a very heated conversation" with Ellen Chamberlain, Dragon's CFO. In this conversation, Chamberlain allegedly said that "Dragon did not want to do this additional level of detail."

Other problems included Dragon choosing to take an all-stock deal instead of the standard half-stock and half-cash. This was arranged during a meeting which did not include Goldman Sachs (the bank says it was never invited, whereas the Bakers called the bank a no-show). Once the stock was received, the Bakers allegedly did not take steps to hedge the Lernout stock they received, even after they were advised to do so.

After 16 days of trial, the jury sided with Goldman Sachs on all counts and also found that the Bakers had breached their fiduciary duties to the board in failing to inform it of Lernout's issues.

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DiTommaso-Lubin's Oak Brook and Chicago Attorneys Peter Lubin and Vincent DiTommaso Named 2013 Illinois Super Lawyers as Class-Action, Business Litigation and Consumer Rights Attorneys

Super Lawyers named Chicago and Oak Brook business trial attorneys Peter Lubin and Vincent DiTommaso Super Lawyers in the Categories of Class Action, Business Litigation and Consumer Rights Litigation. DiTommaso-Lubin's Oak Brook and Chicago business trial lawyers have over a quarter of century of experience in litigating complex class action, consumer rights and business and commercial litigation disputes. We handle emergency business law suits involving injunctions, and TROS, covenant not to compete, franchise, distributor and dealer wrongful termination and trade secret lawsuits and many different kinds of business disputes involving shareholders, partnerships, closely held businesses and employee breaches of fiduciary duty. We also assist businesses and business owners who are victims of fraud.

DiTommaso-Lubin's Wheaton, Naperville, and Aurora litigation attorneys have more than two and half decades of experience helping business clients unravel the complexities of Illinois and out-of-state business laws. Our Chicago business, commercial, class-action and consumer litigation lawyers represent individuals, family businesses and enterprises of all sizes in a variety of legal disputes, including disputes among partners and shareholders as well as lawsuits between businesses and and consumer rights, auto fraud, and wage claim individual and class action cases. In every case, our goal is to resolve disputes as quickly and successfully as possible, helping business clients protect their investments and get back to business as usual. From offices in Oak Brook, near Aurora and Elgin, we serve clients throughout Illinois and the Midwest.

If you’re facing a business or class-action lawsuit, or the possibility of one, and you’d like to discuss how the experienced Illinois business dispute attorneys at DiTommaso-Lubin can help, we would like to hear from you. To set up a consultation with one of our Chicago class action attorneys and Chicago business trial lawyers, please call us toll-free at 1-877-990-4990 or contact us through the Internet.

Court of Appeals Upholds Bonus Award Against Suit by Minority Shareholders, Applying Safe Harbor and Business Judgment Rules - Warren v. Campbell Farming Corp.

1381825_45117768.jpgThe Tenth Circuit Court of Appeals reviewed a dispute among shareholders of a closely-held corporation in Warren v. Campbell Farming Corporation. It affirmed a district court ruling that the majority shareholder did not breach fiduciary or statutory duties to the corporation by approving a bonus proposal over the minority shareholders’ objections. The court considered arguments relating to conflicts of interest and fairness, the business judgment rule, and the majority shareholder’s fiduciary duty.

Campbell Farming Corporation is a closely-held Montana corporation whose principal place of business is in New Mexico. The plaintiffs, H. Robert Warren and Joan Crocker, were minority shareholders with 49% of the shares, while defendant Stephanie Gately controlled 51%. Warren and Gately served as directors with Gately’s son, Robert Gately, who also served as the president. Stephanie Gately proposed a bonus to her son totalling $1.2 million in cash and company stock, in part to prevent him from leaving the company. Stephanie Gately voted all of her shares in favor of the proposal, so it passed despite Warren and Crocker’s votes in opposition.

Warren and Crocker filed suit in New Mexico federal court, asserting breach of fiduciary duties and various common law claims. The district court ruled in favor of the defendants after a bench trial. It found that, while the bonus met Montana’s definition of a “conflict of interest,” it was permissible under a safe-harbor statute that allowed conflict-of-interest transactions if they were “fair to the corporation.” Mont. Code. Ann. §§ 35-1-461(2), 35-1-462(2)(c). The court also found that the bonus was permitted by the business judgment rule and that the defendants did not breach any fiduciary duties. The plaintiffs appealed to the Tenth Circuit.

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The Illinois Securities Act of 1953 Does not Apply to Common Law Damages Claims for Breach of Fiduciary Duty by Sellers of Securities

As a Chicago law firm that focuses on business litigation, DiTommaso-Lubin pays close attention to shareholder lawsuits filed in Illinois' courts. Our Elmhurst business attorneys discovered a case filed in the Appellate Court of Illinois, First District, Fourth Division that answers questions regarding the appropriate statute of limitations to apply in a shareholder action for common law damages.

1065245_handshake.jpgCarpenter v. Exelon Enterprises Co. is a case filed by multiple minority shareholders against the majority shareholder, Exelon, for breach of fiduciary duty and civil conspiracy. Defendant Exelon owned 97% of InfraSource, and Plaintiffs owned a portion of the remaining 3% of the company. Defendant then allegedly decided to divest its interest in the company through a series of complex merger transactions. The alleged end result of these transactions was to grant all shareholders in InfraSource would receive a pro rata share of the net proceeds. Using its majority stake in InfraSource, Defendant allegedly voted its shares in favor of the merger transactions, which was subsequently executed according to Defendant's plan. After the merger, Plaintiffs filed suit against Exelon alleging breach of fiduciary duty and civil conspiracy that caused the minority shareholders to be inadequately compensated for their shares in InfraSource. Defendant then moved to dismiss the action because Plaintiffs' claims were barred under the three year statute of limitations in the Illinois Securities Law of 1953. The trial court denied Defendant's motion, stated that the applicable statute of limitations was the five year period contained in section 13-205 of the Illinois Code of Civil Procedure. The trial court then stayed the matter and certified the statute of limitations issue for an interlocutory appeal to the Appellate Court.

On appeal, the Court examined Defendant's argument that, despite the fact that Plaintiffs did not allege specific statutory violations, Plaintiffs' claims fell within the scope of the Illinois Securities Law and its three year statute of limitations. Plaintiffs argued that, because of the similarities between Illinois and federal securities law, federal case law should be utilized by the Court. Plaintiffs' cited federal cases holding that securities fraud does not include the oppression of minority shareholders nor does it include oppressive corporate reorganizations, and thus the case did not fall within the purview of the Illinois statute. The Court performed a statutory analysis and determined that subsection 13(A) of the Law did not apply to Plaintiffs because their claims did not arise out of Plaintiffs' role as purchasers of securities. The Court went on to explain that Defendant's argument based upon subsection 13(G), which provides a remedy to any party in interest in the unlawful sale of securities, was unpersuasive. Instead, the Court held that subsection 13 of the Illinois Securities Law of 1953 does not “concern retroactive common law damages claims for breach of fiduciary duty brought by sellers of securities in general, or minority shareholders in particular.” By so holding, the Court declared that the three year statute of limitations did not apply and remanded the case back to the trial court.

Carpenter v. Exelon Enterprises Co. provides potential shareholder litigants with a ruling that gives them an additional two years to bring their claims. Conversely, those facing liability in a common law action surrounding a securities transaction should be aware that such claims are viable for a longer period of time than they may have previously thought.

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Northern District of Illinois Federal Court Dismisses Double Derivative Shareholder Action Due to Lack of Parent / Subsidiary Corporate Relationship

550152_diabetes.jpgMembers of the board of directors of a corporation have the responsibility to orchestrate the business in such a way that is advantageous to the shareholders and the continued growth and prosperity of the company. However, there are times when those directors may act in a way that serves their own interests, and the only way to protect the business is for shareholders to file a derivative suit on behalf of the company. DiTommaso-Lubin is always researching new developments in this field of law, and our Chicago shareholder derivative action attorneys recently came across one such case filed here in the Northern District of Illinois, Eastern District federal court.

Reiniche v. Martin is a double derivative suit brought by individual plaintiffs who are shareholders of a corporation, Health Alliance Holdings (HAH), that itself is a primary shareholder of HA Holdings (Holdings), another corporation. Plaintiffs allege that Defendants sought to freeze them and other HAH shareholders out through a series of illegal and wasteful acts that resulted in an insider transaction to sell Holdings for $10 and debt relief to another company in which Defendants had an interest. That transaction was approved by Holdings’ board of directors in spite of the fact that there was no quorum present to do so, and HAH was denied its right to sit on the board. In doing so, Plaintiffs alleged that the Defendant directors and other shareholders of Holdings breached their fiduciary duties to the company. Defendants then moved to dismiss the suit under Federal Rule of Civil Procedure 12(b)(6), claiming that Plaintiffs lacked standing, their claim was untimely, and the claims are insufficient under the law and barred by the business judgment rule.

The Court held that Plaintiffs did not have double derivative standing because such standing is only granted in the context of a parent/subsidiary relationship, and HAH was only a shareholder in Holdings – it was not a parent or holding company of Holdings. The Court went on to say that because the individual Defendant shareholders were each minority owners, none of them had a controlling interest in Holdings, and therefore did not owe a fiduciary duty to the Plaintiffs. As such, the Court found no policy reason for invoking a double derivative action and granted Defendants’ motions to dismiss.

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NPR Reports "Courts Consider Blocking Massey Mine Merger"

NPR reports:

Courts in West Virginia and Delaware will consider preliminary injunctions Tuesday against Wednesday's expected merger of coal mine giants Massey Energy and Alpha Natural Resources.

Massey owns the Upper Big Branch mine in West Virginia where 29 mine workers died in a massive explosion last year. The disaster figures heavily into the attempts to block the merger by large institutional investors.

"The mine explosion last year was not some bolt of lightning hitting a corporate factory where there's really nobody to blame," says Mark Lebovitch, an attorney representing the New Jersey Building Laborers Pension Fund and other institutional Massey shareholders with a lawsuit pending in Delaware.

"What you had with Massey was a board and a senior management team that over the course of years put profits above safety," Lebovitch contends. "[They] really showed contempt for anyone on the outside warning them, saying 'You are running this business in a way that is dangerous and you are going to harm people, kill people and, frankly, destroy corporate value.'"

Massey's stock price plummeted after the April 2010 explosion, generating strong interest in a takeover from several rivals. The company owns deposits of metallurgical coal used for making steel. Met coal, as it's called, is in great demand and is fetching high prices.

Some shareholders had so-called "derivative" lawsuits pending against Massey long before the Upper Big Branch explosion. They cited lax safety oversight and won a court-ordered settlement requiring specific "corporate governance enhancements" designed to improve safety and restore the company's value.

But the Upper Big Branch explosion prompted those shareholders to seek a contempt of court citation against the company. Their case is in West Virginia courts.

In both cases, the shareholders say the Massey board and company executives agreed to a takeover by Alpha Natural Resources to shield them from liability in the lawsuits. Massey and its board would cease to exist after a merger and the lawsuits would presumably become moot.

Alpha could continue the lawsuits but it benefited from the diminished value created by Massey's poor safety record and the Upper Big Branch explosion. Alpha has also announced that it will fold into its new management team several Massey executives, including Chief Operating Officer Chris Adkins.

Adkins will assist in the integration of Alpha's safety program, called Running Right, across the merged companies.

That makes it unlikely that Alpha will continue the shareholder claims after the merger, says Badge Humphries, an attorney representing the California State Teachers Retirement System and other institutional shareholders in the West Virginia lawsuit.

Humphries says he finds it difficult to believe that Alpha will make "a claim against their new co-head of safety asserting that he's responsible for the Upper Big Branch disaster. It's just not going to happen," he says.

Also moving to Alpha if the merger is approved is Shane Harvey, Massey's general counsel. Harvey, Humphries says, was responsible for making sure Massey met the terms of the safety settlement.

The suing shareholders want preliminary injunctions to block a planned merger vote among all Massey and Alpha shareholders Wednesday morning.

"Trying to undo a merger after it is closed is a difficult task," Humphries adds. "The courts have compared it to unscrambling an egg."

The West Virginia Supreme Court of Appeals will also consider Tuesday a request from NPR and the Charleston Gazette to unseal documents in the case in that state, which include depositions from Massey and Alpha executives.

Humphries suggests the sealed documents show that Massey agreed to the sale so that its board of directors and executives would be free of liability in the lawsuits. He declined to provide details given a confidentiality agreement that made the depositions possible.

The sealed depositions include statements from Massey executives who declined to testify in the joint state and federal investigations into the cause of the Upper Big Branch explosion.

"Certainly the public [and] shareholders have a right to know what impact the Upper Big Branch tragedy has on this proposed merger," says attorney Sean McGinley, who represents NPR and the Charleston Gazette in the case.

Davitt McAteer led an independent investigation of the Upper Big Branch explosion and noted in the group's final report two weeks ago that the failure of the Massey executives to testify keeps the probe from being complete.

"The fact that they failed to provide testimony made it more difficult for us to understand the thinking that was going on prior to and during the course of the disaster," McAteer says. "The opening of the sealed transcripts and sealed depositions will be helpful to us to try to understand...the actions of [Massey] management."

Massey Energy did not respond to an NPR request for comment for this story but has said it operated its mines safely. The company also blames the Upper Big Branch explosion on a natural, unpredictable and unpreventable infusion of explosive natural or methane gas. McAteer contests that in his report.

Massey asked the West Virginia Supreme Court to keep documents sealed at least until 5 p.m. EST Tuesday. That would leave little time for review by Massey and Alpha shareholders before they're scheduled to vote on the merger at 9:30 am EST Wednesday morning.

A spokesman for Alpha Natural Resources says the company will not comment "while the litigation is playing out." But Alpha has said in court documents that it believes Massey shareholders are getting a good price in the takeover. The company also insists its board will consider continuing the shareholders lawsuits.

In a hearing in the Delaware case last week, Judge Leo Strine referred to Massey stockholders as "the least sympathetic characters" in the case.

"Any investor who invested in Massey...knew the managerial culture it was buying into," Strine said. "And knew that you had people who believed that their way of doing it was better than the people charged with enforcing the law."

Strine unsealed some documents in the case last week. He may issue a ruling Tuesday. West Virginia's Supreme Court considers Tuesday the shareholders' request for an injunction and the request by NPR and the Charleston Gazette to unseal court records.

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Northern District of Illinois Federal Court Denies Motion to Stay Shareholder Derivative Suit Under Abstention Doctrine

Many corporations are owned by a group of shareholders, but the business decisions are made by a Board of Directors. Shareholders trust that the board will make decisions that are in the best interests of the business, but when directors fail to do so, shareholders can bring a derivative lawsuit on behalf of the company itself. The Arlington Heights shareholder lawsuit attorneys at DiTommaso-Lubin have been involved with many shareholder disputes, and our attorneys recently uncovered a decision in the field handed down by the Northern District of Illinois Federal District Court that we found quite interesting.

282848_law_library.jpgIn Oakland County Employees Retirement System v. Massaro, the plaintiff shareholders brought a derivative action on behalf of nominal defendant Huron Consulting Group against Huron’s Board of Directors and executive officers. Plaintiffs brought the suit because they believed that Defendants overstated Huron’s revenue for years, which artificially inflated the value of Huron stock. Plaintiff brought suit for violations of the Securities Exchange Act, breach of fiduciary duty, waste of corporate assets, and unjust enrichment. However, in addition to the suit brought by Oakland County Employees Retirement System in federal court, two separate state court actions were previously filed by other individual Huron shareholders. Because of these state court actions, the Defendants in Oakland County filed a motion to stay the federal proceedings pending the outcome of the lawsuits filed in state court. Defendants argued that the federal action should be stayed under the abstention doctrine because the state and federal lawsuits were parallel actions.

The Court stated that for the lawsuits to be deemed parallel, they must involve substantially the same parties and substantially the same issues. Upon evaluating the pleadings, the Court held that because Plaintiffs brought a federal claim under section 14(a) of the Securities and Exchange Act -- and no such claim was included in either of the Illinois state litigations -- the state and federal actions were not parallel. The Court thusly denied the motion to stay, and went on to state that even in the absence of the 14(a) claim, Defendants did not show that exceptional circumstances existed to justify the court abstaining from ruling in the case.

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If You Have a Business Agreement, Get It in Writing!

1186845_pen-friend.jpgThe issues faced by our clients, and particularly our business clients, are often complex both factually and legally. Our Palatine business lawyers recently discovered a case filed in Du Page county that illustrates how business legal issues can, and often do, dovetail with personal legal issues. Prignano v. Prignano demonstrates the importance of obtaining legal advice before making business agreements and contracts that include will and probate issues.

In Prignano v. Prignano, the widow of George Prignano, a man who owned several businesses with his brother Louis, sued that brother for allegedly failing to honor an agreement that the survivor of the two brothers would buy the decedent brother's share of their co-owned businesses. The Prignano brothers jointly owned two corporations, Sunrise Homes and Rainbow Installations, and were equal partners in 710 Building Partnership. The Plaintiff widow alleged that the Defendant had an oral agreement with her deceased husband George whereupon Louis would purchase George's share of their three businesses with the proceeds from life insurance policies purchased for that purpose. Plaintiff also alleged that she and Defendant had an oral agreement that Defendant would purchase his brother's share of the businesses from Plaintiff.

After George's death, Defendant, who was the executor of George's estate, allegedly kept George's share of the businesses and the life insurance payments for himself unbeknownst to Plaintiff. When Plaintiff discovered this, she filed suit against him for fraud, breach of fiduciary duty, breach of contract, and unjust enrichment. The trial court ruled in her favor on all counts and awarded her damages and prejudgment interest. Defendant then appealed the trial court's finding of liability and the award of prejudgment interest.

On appeal, the Second District of the Appellate Court of Illinois reaffirmed the trial court's finding that both oral agreements (between the brothers and between Plaintiff and Defendant) were valid and enforceable due to the testimony of third parties who were aware of the oral agreement between the brothers, and the existence of a written agreement that was drawn up after the oral contract between Plaintiff and Defendant was initially formed. The Court also found that Defendant owed a fiduciary duty to Plaintiff as he was a corporate officer and partner in the businesses, and upon George's death, his interest in the businesses was transferred to Plaintiff. As such, the Court held that Defendant owed Plaintiff a duty to exercise “the highest degree of honesty and good faith” in dealing with Plaintiff, and Defendant breached that duty. The Court then vacated the trial court's judgment on the unjust enrichment claim because Plaintiff was victorious on her breach of contract claim. The Court stated that unjust enrichment does not apply when there is a breach of contract under Illinois law. Finally, the Court reaffirmed the award of prejudgment interest because Plaintiff had been deprived of money that was rightfully hers, and Defendant should not profit from his wrongful retention of the funds.

Prignano v. Prignano exemplifies why business owners should have all of their business agreements and contracts reviewed by a trained legal professional. Family business owners, in particular, should guard against casual or oral agreements, as personal relationships can be strained when there is a misunderstanding regarding such agreements. If you are unsure about the legality or legitimacy of your business agreements, or are currently in a dispute, you should consult a discerning Chicago and Naperville business attorney to determine your rights.

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A New Article in the Illinois Bar Journal: "Officers and Directors Can Require Their Corporation to Pay Their Legal Fees"


A new article in the Illinois Bar Journal explains officers and directors rights to the corporation paying for their legal fees and costs when they face litigation for corporate related activities.

The article focuses on corporations’ contractual obligations to advance litigation expenses to its directors and officers--even where the corporation has sued the director or officer. As explained in the article, most states allow companies to provide their officers and directors a right to advancement of litigation expenses in suits filed by reason of their corporate poistion.

The article states:

Officers or directors of corporations who wind up defending themselves in litigation or corporate investigations are sometimes unaware of a valuable perk – the corporation’s obligation, either through indemnification agreements or bylaws, to advance litigation expenses to key employees. Even eligible employees (as defined by the contract) who recall that they are covered by an advancement provision may not fully appreciate how broad that right can be.

To read the full article click here.

The Chicago business dispute lawyers at DiTommaso-Lubin handle all types of disputes among shareholders, and officers and directors of corporations. We have defended officers and directors in many types of lawsuits including claims that the officers and directors of small or large publicly traded corporations breached fiduciary duties. Our Chicago officer and director litigation attorneys have more than two and half decades of experience in Illinois business litigation. We understand what behaviors constitute a breach of fiduciary duty, misappropriation of assets, breach of business agreement and other common causes of action. Our goal as Chicago commercial trial lawyers is always to resolve our clients’ cases favorably and as quickly as reasonable, so clients can get back to their businesses.

If you’re an officer or director of a corporation facing suit and you’re looking for experienced legal counsel who have sucessfully defended other officers or directors, call DiTommaso-Lubin for a consultation at 1-877-990-4990 or send us an email today.

Court Orders Managing Disputed Family Business Not Appealable as Injunctions, First District Rules


Our Oak Brook, Ill. shareholder dispute attorneys and Chicago business law lawyers took note of a recent appeals court decision in a heavily disputed case involving a family business. In Santella v. Kolton and Food Groupie Inc., Nos. 1-08-1329, 08-1357 & 08-1847 consolidated (Ill. 1st July 31, 2009), Rick Santella accused his sister, Mary Kolton, and her husband William of undermining the family’s business to enrich themselves once they became majority shareholders. The business is Food Groupie, Inc., which markets and sells use of anthropomorphic food characters and educational products that promote healthy eating. According to Santella, the intellectual property is the collective work of the family.

When Food Groupie was originally formed in 1987, Santella held a 35% interest; Mary and William Kolton held 25% each; and a non-party, their brother Ron Santella, held 15%. All four were named directors. In 1988, the plaintiff bought Ron Santella’s interest, giving him a 50% interest in the corporation to match the Koltons’ combined 50%. Shortly afterward, plaintiff transferred 1% of his interest to Mary Kolton, with the understanding that William Kolton would transfer his 25% to Mary, giving her a majority 51% interest with the idea that Food Groupie would be more successful if it was known as a woman-owned company. In exchange for this transfer, Santella claims, the parties executed an agreement that company decisions would be made only by a unanimous vote.

The business ran without incident until 2002. During that time, Santella claims Food Groupie made a profit each year between 1992 and 2001 and the three shareholders always unanimously approved compensation. But in 2002, Santella alleges that the Koltons called a shareholders’ meeting without him or Ron Santella, and gave themselves salary increases, bonuses and 401(k) contributions. This cost Food Groupie a total of 45% of gross company sales, despite a profit that year of only $15,000. The alleged ruse was repeated in 2003 and 2004. As a result, Santella claims, he was paid only one dividend of $1,470 during that time, rather than the $28,808 he believes he was entitled to as a 49% shareholder.

When he confronted his sister about this in 2003, he says she froze him out of the business decisions, changed the locks on the office and was interested only in buying him out. He further claims she usurped Food Groupie’s intellectual property by trademarking characters in her own name, and inappropriately licensed the company’s intellectual property without his consent. Finally, he claims the Koltons held a secret shareholder meeting in 2004 at which they voted to replace him with William’s brother, Anthony Kolton. He sued the Koltons, individually and as a shareholder derivative claim, for breach of the shareholder agreement, breach of fiduciary duty, usurpation of corporate opportunities and violations of the Illinois Business Corporations Act.

In 2005, that lawsuit resulted in the court’s appointment of John Ashendon as custodian of Food Groupie. In 2008, Santella filed an emergency motion to stop what he claimed was his sister’s plan to liquidate the company and move its misappropriated intellectual property to a similar business called Healthypalooza. He also alleged that the couple had continued to pay themselves inappropriately high salaries and commissions, and use the company’s profits for their personal legal defense. He sought to remove the Koltons as officers and enjoin them from using the company’s assets or competing with it, among other things. The court eventually found for Santella on some issues, removing the Koltons and ordering them to return the $144,019 in commissions they had been paid in 2005, 2005 and 2007. It said the court would appoint new officers and directors. It did not say any of these remedies were interlocutory or time limited.

The Koltons filed an interlocutory appeal in 2008, but failed to move to stay the repayment order or actually repay the $144,019. The trial court found them in contempt and ordered them to pay a fine for every day they were late. They eventually paid back the $144,019, but not the roughly $20,000 or so in fines.

On appeal, the Koltons argued that the relief granted to Santella was not supported by sufficient evidence or proof. Specifically, they argued that the Business Corporations Act requires a plaintiff like Santella to prove his claims of improper conduct before the court may order return of the allegedly improper bonuses or their removal as corporate officers. For that reason, they said, the court orders must be reversed. Santella made several arguments against the appeal, most notably that the appeals court lacked subject matter jurisdiction over the non-financial claims. The defendants filed their appeal pursuant to Rule 307(a)(1), which applies to appeals concerning injunctions, and Santella argued that the trial court’s orders removing and replacing directors and officers were not injunctions.

The First agreed with this, saying it lacked subject matter jurisdiction over those orders because they were not direct orders to the Koltons “to do a particular thing, or to refrain from doing a particular thing.” In fact, it took the analysis a step further and examined whether it had jurisdiction over the repayment order. That order was an injunction, the First wrote, but it also must be interlocutory to fall under Rule 307(a)(1). If it was a permanent order, it was outside the scope of the rule. The appeals court found that it was a permanent order, because it did not preserve the status quo. In fact, the court noted, the trial judge had specifically said so when she made her contempt ruling. The trial court had also made conclusions about the rights of the parties and had not time-limited the order. For those reasons, the First found that it also lacked subject matter jurisdiction over the repayment order, and dismissed the appeal entirely. The opinion noted that appellants may still seek a finding from the trial court under Rule 304(a).

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Court Rules Quantum Meruit Is Appropriate Standard in Dispute Between Former Law Partners


As Chicago corporate dispute lawyers, we were interested to see a ruling in a dispute between former law partners. In Bernstein and Grazian, P.C. v. Grazian and Volpe, P.C., No. 1-09-0149 (Ill. 1st June 25, 2010), both firms, and the individual partners, accused each other of breach of contract and breach of fiduciary duty in a dispute about how to allocate payment on cases that were pending during the breakup of their first firm. At trial, the trial court found no breach of any duty. It also found that quantum meruit was the correct standard to apply and awarded Bernstein 10 percent of attorney fees generated from those cases by Grazian and Volpe. Both Bernstein and Grazian appealed this ruling, and the First District Court of Appeal made no changes except to vacate the 10 percent fees awarded to Bernstein.

Isadore Bernstein hired John Grazian in the 1990s as an independent contractor to Bernstein’s law practice. They eventually formed the law firm of Bernstein & Grazian, P.C., which focused its practice on personal injury and workers’ compensation cases. Bernstein was president and 70 percent owner, who provided the office, cases and money; Grazian was a salaried employee and vice president. They later hired Richard Volpe as an employee to handle workers’ compensation cases. In January of 2003, they agreed to change the firm’s structure and compensation scheme. The agreement said the three would split the office overhead equally. Bernstein and Volpe were to split expenses of workers’ compensation cases equally and split the fees equally. Similarly, Bernstein and Grazian were to equally split expenses and fees for personal injury cases.

In 2005, Grazian and Volpe decided to leave and form their own firm. The three attorneys agreed that Grazian & Volpe would take over Bernstein & Grazian’s open cases, but they disagreed on how they were to split the fees. Bernstein testified that he was promised 50 percent of the coming fees, but Grazian testified that he offered, and Bernstein accepted, only one-third of the fees. They also disagreed about whether they intended to file forms to substitute attorneys in the open cases before there was a formal separation and exit agreement. Bernstein and his firm sued Grazian, Volpe and their firm, alleging breach of contract and breach of fiduciary duty and demanding an accounting; defendants filed a counterclaim for breach of fiduciary duty.

At a bench trial, the court dismissed every claim but breach of contract. It found that the agreement to dissolve the firm was the controlling contract. But since that document was silent on compensation, the court found that Bernstein should receive compensation under quantum meruit -- that is, he should be paid according to the value of his actual services. Noting that it was difficult to determine this from the record, the trial court nonetheless awarded Bernstein 10 percent of the fees. Bernstein and Grazian appealed. Volpe is not a party to the appeal. Because Bernstein died during the pendency of the case, his estate was the appellant.

The appeals court started by dismissing Bernstein’s entire appeal for lack of jurisdiction. Bernstein filed in trial court to dismiss his appeal about two months after filing it. This was granted. About six weeks later, he moved in the appeals court to vacate that dismissal and reinstate the appeal, saying his attorney had made a mistake. This was granted as well. But according to the First, it had no authority to grant that motion, because an order dismissing an appeal is final under Physicians Insurance Exchange v. Jennings, 316 Ill. App. 3d 443, 456 (2000) and Rickard v. Pozdal, 31 Ill. App. 3d 542 (1975). Thus, Bernstein’s entire appeal was dismissed.

On cross-appeal, Grazian argued that the trial court was improper in finding no breach of fiduciary duty by Bernstein. Bernstein had formed a separate law firm in 2004, after the revenue-splitting agreement but before Grazian & Volpe was formed. Isadore M. Bernstein & Associates P.C. (IMB) existed to refer medical malpractice claims to other attorneys. Bernstein bought television advertisement time for both firms, but claimed he paid for the IMB commercial himself. Grazian claimed he had never been told about IMB and its advertisements. The commercials resulted in many new inquiries for both firms, but Bernstein claimed he did not spend a lot of extra time or firm resources on IMB-related work. Grazian disagreed, testifying that this cost the firm resources but did not generate income for him or Volpe, and caused Bernstein’s fee income to drop dramatically. This was the basis for the breach of fiduciary duty claim.

The First did not accept Grazian’s argument. The standard for overturning the trial court was “the manifest weight of the evidence,” it noted -- and much of the evidence is unclear because Bernstein and Grazian had sharply conflicting accounts of this situation. What evidence there is does not lead to a conclusion that Bernstein clearly breached his fiduciary duty, the court said. Thus, it could not find that the trial court’s finding on fiduciary duty was against the manifest weight of the evidence.

Grazian had more luck with his argument that while quantum meruit was proper, it should have led to an award of nothing rather than of 10 percent of the attorney fees, because Bernstein provided no evidence required for recovery. Under caselaw including Hayes Mechanical, Inc. v. First Industrial, L.P., 351 Ill. App. 3d 1, 9 (2004), the burden is on Bernstein to show that he provided services of reasonable value to the defendants, and at least some evidence to prove that value. The First found that Bernstein had never provided any such evidence; testimony at trial showed that he did not do several major duties of an attorney, such as going to court, on those cases. In fact, he admitted that his fee generation dropped sharply. Having done “something” is not enough by itself to support a quantum meruit award, the First wrote. Therefore, it vacated the trial court’s 10 percent award to Bernstein.

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Fifth District Court of Appeal Declines to Compel Arbitration in Shareholder Derivative Claim


Our Aurora, Ill. shareholder derivative claim lawyers were interested to see an appellate case that examined whether a limited liability corporation can be a party to a case brought under its own operating agreement. In Trover v. 419 OCR Inc. et al., No. 5-09-0145 (Ill. 5th, January 12, 2010), Joseph Trover sued 419 OCR Inc., O’Fallon Development Group LLC, Mark Halloran and Steve Macaluso, alleging a variety of shareholder complaints and fraud claims over a real estate deal that had gone sour. Trover, individually and as the trustee of a trust in his name, was part of a limited liability company called the Far Oaks Development Group. Other members of Far Oaks were defendants Halloran and Macaluso as well as non-defendant Garrett Reuter. Far Oaks owned land around a golf course that the members wished to develop. Reuter, Halloran and Trover also were part of a business called Far Oaks Golf Club, LLC.

In 2005, members of FODG agreed to sell and assign the company’s interest in the land to 419 OCR Inc., which was owned by Halloran and Macaluso, in order to gain a tax advantage. Trover claims he relied on the defendants and the advice of an attorney when he agreed to this. Halloran and Macaluso allegedly made an oral promise to pay the Golf Club the price of land to be sold, as well as a sum to be determined. Trover claims this was supposed to be put into writing. However, it was not included in the contract that transferred the land to 419 OCR, and it was never put into writing in other ways.

Halloran and Macaluso then proceeded to develop the land, sell lots and make a profit. Part of the interest in the land was transferred to another business called the O’Fallon Development Group. Trover’s lawsuit claims that FODG never received any money based on that land sale. Count I alleged breach of the oral contract against 419 OCR; Count II alleged breach of contract against the O’Fallon Group, which assumed obligations under the contract because of unity of ownership. Count III was a shareholder derivative action brought by Trover on behalf of FODG, alleging breach of fiduciary duty and corporate waste by Macaluso and Halloran. Count IV was a similar shareholder derivative action, brought by the Golf Club against Halloran only. Count V alleged fraud by Halloran and Macaluso individually, accusing them of making false representations when they said the sale price of the land would be paid back to the Golf Club.

After the lawsuit was filed, the defendants filed a motion to compel arbitration as required by the broadly worded operating agreements behind FODG and the Golf Club. The trial court denied this motion, and the defendants filed the interlocutory appeal that went before the Fifth District.

The appeals court upheld the trial court’s decision on four of the five counts. The transfer of the land from FODG to 419 OCR was within the scope of the operating agreements, the court found, but 419 OCR and O’Fallon were not parties to that agreement. Illinois law does not allow courts to compel arbitration among entities that were not parties to the arbitration agreement, the court wrote. Thus the trial court was correct to deny arbitration as to Counts I and II.

Counts III and IV are shareholder derivative actions, the court wrote, so compelling arbitration would require a finding that an LLC is a party to the agreement that creates itself. This is an issue of first impression in Illinois, the court noted. Relying on language in the Illinois Limited Liability Company Act, the court found that LLCs are not parties to their own agreements, because “A limited liability company is a legal entity distinct from its members.” The operating agreement specifies that it is between the signers, and the signers did not indicate that they were signing on behalf of either LLC in the case. And the agreement specifically states what actions members must take to legally bind the LLC. That shows that members knew how to do so but did not. Thus, the appeals court upheld the trial court on Counts III and IV as well.

The defendants were luckier with Count V, which named Halloran and Macaluso as individuals. Because both Halloran and the plaintiff signed the operating agreement with the arbitration clause, the court wrote, they are bound by it. Macaluso did not sign the original operating agreement, but he did buy 100 shares of each LLC after the fact. That makes him a member under the Illinois LLC Act, the court wrote, and binds him to everything in the agreement. Thus, he has the right to compel arbitration. For all of those reasons, the appeals court reversed the trial court as to Count V but upheld on the other counts, and sent the case back to trial.

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Illinois Securities Law Statute of Limitation Does Not Apply to Breach of Fiduciary Duty Claim


Our Chicago business litigation lawyers were interested in a recent decision from the First District Court of Appeal. Carpenter et al. v. Exelon Enterprises Company, No. 1-09-1222 (Ill. 1st March 18, 2010) posed a certified question to the court: Does the three-year statute of limitations established by the Illinois Securities Law apply to a claim that a majority shareholder breached its fiduciary duty to minority shareholders? In this case, the First decided that it does not, allowing Timothy Carpenter and seven co-plaintiffs to pursue a claim under a more generous five-year statute of limitations under the Illinois Code of Civil Procedure. Their victory in this interlocutory appeal allows them to continue their claim at the trial court level.

The plaintiffs all held minority shares of InfraSource, Inc., a Delaware corporation. The majority shareholder at 97% was Exelon, a Pennsylvania corporation. In 2003, Exelon created a new company for the purpose of divesting its interest in InfraSource, which allowed it to merge InfraSource with the new company. The resulting corporation sold some of its (formerly InfraSource’s) assets and business units to Exelon and others to GFI Energy Ventures, an independent third party. InfraSource would continue as a company, but the former minority shareholders were paid a pro-rated share of the proceeds. In 2007, the plaintiffs sued Exelon, alleging that it abused its power as majority shareholder. They accused Exelon of structuring the transaction in a way that did not adequately compensate them for the market value of their shares.

A second amended complaint said Exelon sold itself the InfraSource assets at an artificially low price and awarded itself preferred stock. It alleged causes of action for breach of fiduciary duty, civil conspiracy, and, against Exelon’s parent company, aiding and abetting those actions. Exelon moved to dismiss the second complaint based on the three-year statute of limitations in the Illinois Securities Law. The trial court denied this, finding that the five-year statute of limitations applied. However, it stayed further proceedings until the instant interlocutory appeal had been decided, answering the question of which statute of limitations is correct.

The First District started its analysis by examining the statue of limitations portion of the Illinois Securities Law. That language says plaintiffs have three years from the date of the relevant sale to bring claims under the Act, or on matters for which the Act grants relief. Plaintiffs specifically stated their claim under Delaware law in order to distance themselves from this statute of limitations, but Exelon argued that the statute still applies under the language allowing its use for matters for which the Act grants relief, and cited two cases in support. The plaintiffs countered that Illinois courts found that because the Act is modeled after federal securities laws, courts should look at how those laws are interpreted for guidance in interpreting the Act. Tirapelli v. Advanced Equities, Inc., 351 Ill. App. 3d 450, 455 (2004).

The First rejected both lines of case law, saying that the decision “actually depends on the resolution of a straightforward and fundamental question of statutory construction.” The relevant portion of the Illinois Securities Law gives any party in interest the right to bring legal action to enforce compliance or stop a violation. Exelon relies on that language to place the plaintiffs’ complaint under the Act, the court wrote, but incorrectly. When the Legislature added this language to the Act, it explicitly said it was trying to give Illinois security holders the right to stop illegal acts. It included the right to sue for rescission, the court said, but only to enforce the remedy the law provides. In fact, Guy v. Duff & Phelps, Inc., 628 F. Supp. 252 (N.D. Ill. 1985) explicitly examined whether the law gives a retrospective right of rescission to securities sellers and concluded that it should not be interpreted that way.

The First agreed, saying another reading would make other sections of the law irrelevant. It then dismissed arguments based on the Seventh Circuit’s finding in Klein v. George G. Kerasotes Corp., 500 F.3d 669 (7th Cir. 2007), saying the arguments that led to its contradictory conclusion did not apply, for all of the reasons discussed above. Because there is no retrospective right of rescission in the Act, the First said, the plaintiffs are not seeking relief on any matter for which the Act grants relief. Nor, as noted earlier, are they seeking relief under the Act itself. For that reason, the three-year statute of limitations provided by the Act does not apply, the court concluded. It answered the certified question posed by the trial court in the negative, essentially upholding that court’s decision, and remanded it for further proceedings.

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Investors May Not Go Forward With Flawed Fraud Claim, Seventh Circuit Rules


Our Illinois class action attorneys recently noted a Seventh Circuit decision ending a class-action case in the difficult realm of securities fraud. In Re Guidant Corporation, No. 08-2429 (7th Cir. Oct. 21, 2009), is a securities class action stemming from allegedly misleading statements Guidant Corp. made about its implanted defibrillators. A design flaw with certain lines of defibrillators was discovered in February of 2002, and by April, Guidant had corrected the problem in all of the new devices it made. However, the problem remained in machines already made, and Guidant failed to recall them or warn the public. All in all, Guidant knew in 2002 of at least 25 reports of short-circuiting from the older defibrillators. More reports emerged later.

Two years after this redesign, Guidant entered into merger talks with Johnson & Johnson. As part of these negotiations, it issued a press release expressing confidence about its growth prospects in the implanted defibrillator market. In their claim, plaintiffs said this was false and misleading because Guidant knew it still had liability for the Ventak defibrillators. Subsequent press releases on the merger also omitted this information, as were three merger-related forms Guidant filed with the SEC. However, in March of 2005, a young man died after his Guidant defibrillator short-circuited. Guidant issued several other SEC filings and press releases without disclosing this before it finally sent a letter to doctors in May of 2005 disclosing reported problems, an act prompted by an article about to be published in the New York Times.

The FDA recalled the defibrillators the next month, and Guidant’s stock dropped immediately. It dropped further when Johnson & Johnson announced that it was reconsidering the merger. All in all, the stock fluctuated between $63 a share and $80 a share until Guidant was purchased by Boston Scientific. The instant case is a consolidated class action filed against Guidant and eleven officers and directors as a result of these drops. In addition to alleging that all defendants made false and misleading statements about the company and omitted material information from their statements, it alleged that the individual defendants used insider knowledge and the approval of the Johnson & Johnson merger to sell stock during the period at issue.

Over the course of pre-trial motions, the plaintiffs attempted to amend their complaint at least three times, twice because of new information revealed in related product liability cases. At some point, Guidant moved to dismiss the complaint for failure to state a claim. The claims were brought under the Securities Exchange Act, which requires heightened pleading standards for plaintiffs alleging securities fraud. Specifically, the court found that the plaintiffs’ pleadings were not particular enough and failed to include facts showing that defendants knowingly and with malice misled investors. It dismissed the case with prejudice. It also declined to reconsider based on new evidence from a products liability case, and declined a motion to amend their complaint based on the same evidence. The plaintiffs appealed all three decisions.

In its analysis, the Seventh started by noting that plaintiffs had ample time to make changes to their complaint. In addition to the consolidated complaint from individual claims, it allowed an amendment at the start to change the class period. Plaintiffs notified the court twice of new evidence from other cases, but failed to amend their complaint with that evidence. The Seventh found that this was ample time for plaintiffs to amend their complaint to meet the admittedly strict standards provided for securities cases by the Private Securities Litigation Reform Act.

It then moved to the trial court’s denial of reconsideration of the dismissal. The plaintiffs claimed that it should have been reconsidered because they had new evidence from product liability cases, a standard ground for reconsideration. They acknowledged that those facts were older, but said the trial court stymied them by refusing to lift a stay of discovery. The Seventh found this unpersuasive, saying the trial court could have ruled either way without abusing its discretion. The trial court must have assessed the new evidence, it wrote, and decided that a new amended complaint would still have lacked the necessary specific facts and evidence of scienter. And the plaintiffs could have entered the new evidence into the record earlier. Thus, the district court did not abuse its discretion by denying reconsideration. For the same reasons, it was also not an abuse of discretion to deny the motion to amend, the Seventh said. Thus, all of the district court’s rulings were affirmed.

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Treasurer Cannot Commit Resources of Family Business Without Board Authorization, Court Finds


As Illinois closely held business dispute attorneys, we read with interest an appellate decision in a dispute over the extent to which a company officer can act without the board’s approval. In Fritzsche v. LaPlante, No. 2-09-0329 (Ill. 2nd March 2010), the “rogue” officer was M. Christine Rock, the secretary/treasurer for family business Fritzsche Industrial Park, Inc. (FIP), which leases real estate at an industrial park in Lakemoor, Ill. Rock also had power of attorney for her father, Herbert Fritzsche, and those two roles allowed her to lease property to Gregory LaPlante, her longtime live-in boyfriend. Separately, Rock also signed a promissory note to Gerald Shaver as payment for work he had done for FIP. This led to a lawsuit by other family members and corporate members, who alleged that she acted without authorization from the board and that the note and lease were invalid.

FIP was incorporated in 2005, although the family had owned the property for decades before. The other corporate officers were Herbert Fritzsche, president, and Scot Fritzsche, vice president and son of Herbert Fritzsche. Shares of stock were divided among the officers and other sons, daughters and grandchildren, with Herbert Fritzsche getting 68 percent. In July of 2006, Herbert Fritzsche suffered a brain hemorrhage, which affected his health and may have compromised his mental capacity. One result of this was that Rock and LaPlante moved into Herbert Fritzsche’s home after he moved in with another sibling. On the first day of August, Rock signed the lease to LaPlante, which gave him 16 properties at Fritzsche Industrial Park and 10 more owned by Herbert Fritzsche individually. LaPlante was to pay rent in the amount of the property taxes, plus 10 percent of his income, although it was not clear what that income referred to.

A week later, on August 8, Rock signed the promissory note to Shaver in exchange for work done on the property, possibly through his trucking and excavating business. It obligated FIP and Park National Bank, trustee of Herbert Fritzsche’s properties, to pay $450,000 by putting a lien on the properties they owned. Park National Bank did not sign. Three months later, Herbert Fritzsche, FIP, Park National Bank and First Midwest Bank, a trustee for some FIP properties, sued Rock and LaPlante, alleging Rock was not authorized to commit the company’s or her father’s resources. The complaint alleged that Rock was suspected of stealing rents from FIP to pay her personal expenses and refused to provide documentation of rental income, which led to a shareholder decision to remove her as secretary/treasurer in May of that year. After his illness, Herbert also allegedly revoked her power of attorney. Therefore, plaintiffs alleged, Rock had no authority to enter into the lease or the note, and they were invalid. They also claimed the rental agreement was too vague to be enforced.

During the next two years, discovery in the case moved very slowly, possibly because Rock and LaPlante also faced criminal prosecution for theft, conspiracy and financial exploitation of an elderly person. In December of 2008, the plaintiffs moved for summary judgment. They argued that even if Rock was not properly removed as power of attorney and a corporate officer, Illinois law does not allow her to enter into the lease or the note without the board’s approval. They also argued that FIP’s bylaws required approval of the note because it was a form of debt. Defendants responded that the board knew about the lease through e-mails sent among the members, and that no board approval was necessary for the lease and the note because Rock was exercising Herbert’s executive authority through the POA, and because many properties were owned by individual family members rather than the board. After oral arguments, the board granted summary judgment to the plaintiffs, saying Rock did not have the authority to act unilaterally as a matter of law. This appeal followed.

Because it was an appeal of a summary judgment order, the Second noted, it had only to decide whether there were genuine issues of material fact to try. Nonetheless, it found that the defendants failed to meet that standard. Under common law, the court said, the highest officer of a corporation must still get board approval to make contracts, especially ones that are unusual or extraordinary. The lease is such an unusual contract, it wrote, because it involved no trustees for the properties and provided LaPlante with the land for little or nothing. Rock also needed board approval for the lease under the Illinois Business Corporation Act, which requires corporate formalities for transactions involving “substantially all” the corporation’s assets. The lease covered all of the property in the industrial park, the court noted, thus making it impossible for FIP to continue its business.

The court came to similar conclusions about the note. However, in this case, the main support for voiding the note came from FIP’s bylaws. Those bylaws say loans and other forms of indebtedness must be authorized by a board resolution. No such resolution exists, the court said, but the note clearly puts a $450,000 lien on FIP. The appeals court noted that the Business Corporations Act requires board approval for actions outside the ordinary course of business, but believed that the bylaws argument was stronger. Thus, the appeals court upheld the trial court’s grant of summary judgment to the plaintiffs.

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Supreme Court Upholds Arm’s Length Standard for Setting Fees for Mutual Fund


Our Chicago business law lawyers were very interested in a recent Supreme Court decision upholding an established standard for determining when a mutual fund’s investment advisor has breached his or her fiduciary duty to shareholders. In Jones et al. v. Harris Associates L.P., No. 08-586 (March 30, 2010), three shareholders in the Oakmark family of mutual funds sued the funds’ investment manager, Harris Associates. They alleged that Harris charged the Oakmark funds twice as much as it did other funds, but did the same work. The situation was not challenged by the funds’ board members because they were all appointed by Harris Associates, the shareholders claimed. As a result, they said, the Oakmark funds paid $37 million to $58 million more than other funds for the services of Harris Associates in just one year.

Mutual funds typically use outside investment advisors to manage all of their affairs, including picking board members. Because this creates the potential for abuse, Congress enacted the Investment Company Act of 1940 to protect mutual fund shareholders. Among other things, that act creates a fiduciary duty for investment advisors with respect to their compensation, and allows shareholders to sue if that duty was breached. The plaintiff shareholders in this case sued Harris Associates in Chicago federal court for a breach of that fiduciary duty, alleging that it charged fees disproportionate to the services rendered and that were not equivalent to fees negotiated at arm’s length. Harris Associates successfully moved for summary judgment. The trial court, applying the standard laid down in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F. 2d 923 (CA2 1982), held that there was no evidence that the fees were outside a range that could have been produced by arm’s length negotiations.

Plaintiffs appealed to the Seventh Circuit, where their claim still failed, but for different reasons. The Seventh rejected the Gartenberg standard, saying it relied too little on markets. Instead, the panel applied a standard from trust law, saying a trustee is free to negotiate any compensation that the trust is willing to pay. Similarly, a fiduciary’s compensation need not be limited by an arbitrary cap, the panel wrote. It suggested that market forces would help keep fees reasonable and noted that comparing fees for other Harris Associates clients is unfair because different clients require different amounts of work. An investment advisor’s compensation would only be subject to interference, the Seventh wrote, if the amount was so out of the ordinary that observers might think “that deceit must have occurred, or that the persons responsible for decision have abdicated.”

After the Seventh denied an en banc rehearing, with a dissent by Judge Posner, the Supreme Court took up the case to resolve a split in the circuits over the standards used to judge breaches of the Investment Company Act. In its unanimous opinion, the court found that Gartenberg was indeed the correct standard, reversing the Seventh Circuit. That standard has been adopted by other federal appeals courts, the high court noted, as well as by the SEC. The opinion, authored by Justice Alito, quoted at length from the Second Circuit’s decision in Gartenberg, which among other things said that “[t]o be guilty of a violation of [the Act], ... the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” This approach is consistent with other protections in the Act and the Act’s role in federal regulations.

The Seventh Circuit erred by focusing almost entirely on full disclosure to determine a breach of fiduciary duty, the Supreme Court wrote. Courts should take a more nuanced look, giving deference to well-informed, independent board decisions and avoiding over-reliance on market comparisons. Thus, the court vacated the Seventh Circuit’s decision and sent the case back to trial court.

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


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.

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Homeowners May Bring Derivative Claim Against Association’s Board of Directors, Appeals Court Rules


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.