Shareholder Disputes

Can You Sue the Company Lawyer in a Derivative Action?

May 10, 2023 | Peter S. Lubin and Patrick Austermuehle

Yes, it is possible to sue a lawyer in a shareholder derivative action in certain jurisdictions including Illinois. A shareholder derivative action is a lawsuit brought by a shareholder on behalf of a corporation against a third party. The lawsuit is typically brought when the corporation has been harmed by the actions of a third party, but the corporation’s management has failed to take action.

In a shareholder derivative action, the shareholder acts as a representative of the corporation and brings the lawsuit on the corporation’s behalf. If the shareholder is successful in the lawsuit, any damages or remedies awarded go to the corporation, not to the individual shareholder.

In some cases, the corporation’s harm may be caused by the actions of the corporation’s own lawyers. For example, if a lawyer provides negligent or inadequate legal advice to the corporation, causing the corporation to suffer damages, the corporation’s shareholders may be able to bring a shareholder derivative action against the lawyer on behalf of the corporation.

In order to bring a successful shareholder derivative action against a lawyer, the shareholders must be able to show that the lawyer breached their duty of care to the corporation and that this breach caused harm to the corporation. The shareholders must also show that they have exhausted all other available remedies, such as asking the corporation’s management to take action against the lawyer.

In conclusion, it is possible to sue a lawyer in a shareholder derivative action if the lawyer’s actions have harmed the corporation. However, such lawsuits can be complex and challenging, and it is important to seek the advice of a qualified attorney before pursuing this type of legal action. Continue reading ›

The Importance of Careful Pre-Suit Decision Making in Shareholder Disputes: Warrington v. Rocky Patel Premium Cigars, Inc.

April 18, 2023 | Peter S. Lubin and Patrick Austermuehle

In a recent 11th Circuit Court of Appeals decision, Warrington v. Rocky Patel Premium Cigars, Inc., No. 22-12575, 2023 WL 1818920 (11th Cir. Feb. 8, 2023), the court provided valuable lessons for partners, shareholders, and small business owners who may find themselves in disputes. This case serves as a cautionary tale, highlighting the importance of careful strategy and legal counsel when pursuing litigation or arbitration.

The dispute centered on Brad Warrington, a minority shareholder in Rocky Patel Premium Cigars, who wanted to divest from his holdings in the company. The buy-sell agreement between Warrington and Rakesh Patel, the majority shareholder, included an arbitration provision for any disputes arising out of the agreement. However, the case demonstrates how mistakes made during litigation can result in a waiver of the right to arbitration.

After years of disagreement over the value of Warrington’s shares and alleged improprieties by Patel, Warrington found a private buyer and notified Patel of his intention to sell. Patel refused to acknowledge the notice and subsequently sued Warrington in Florida state court, seeking a declaratory judgment and alleging breach of contract, among other claims.

While the state action was pending, Warrington sued Patel in federal court, bringing several counts, including breach of contract and breach of fiduciary duty. Patel moved to dismiss, remand, or stay the federal action, but the district court denied his motion. It wasn’t until June 2022 that Patel moved to stay and compel arbitration under the agreement. However, the district court denied this motion, finding that Patel had waived his right to arbitrate by initially filing in state court and moving to dismiss or remand Warrington’s federal action. Continue reading ›

Entrepreneur Allegedly Overpromised and Underdelivered So She Could Sell Her Company for Millions

February 26, 2023 | Peter S. Lubin and Patrick Austermuehle

We’ve all heard stories of the plucky entrepreneur who started a game-changing business and managed to sell it for millions of dollars. It’s a great rags-to-riches story, and it proves the American Dream is real. But what if the business is fake?

Charlie Javice was one of those young entrepreneurs. The company she started was called Frank, and the idea was to simplify the financial aid process for college students. When JP Morgan bought the company from Javice in 2021, it was valued at $175 million, and Javice was made managing director for student solutions. Now JP Morgan is suing her for allegedly exaggerating the company’s value … by a lot.

College students are a goldmine for banks. Almost all college students need to take out a loan in order to pay for their higher education, loans they spend decades paying off while the banks collect interest.

A lot of college students are also taking out credit cards for the first time, and most of them have not been taught how to use credit cards to their advantage. Instead, they’re more likely to end up in debt to the credit card companies.

According to court documents, when JP Morgan bought Frank, Javice allegedly told the bank’s executives that the company had more than 4 million users. The idea was that, by buying Frank, JP Morgan would gain access to a database containing the names and contact details of all those users who would no doubt be in need of financial assistance and a bank to provide its services. Continue reading ›

Former McDonald’s CEO Charged with Lying to Investors

January 14, 2023 | Peter S. Lubin and Patrick Austermuehle

When Stephen Easterbrook was first fired from his position as CEO of McDonald’s, the firing was listed as “without cause,” which allowed Easterbrook to keep his severance pay, including shares in the company. But that was before McDonald’s found out about the extent of Easterbrook’s alleged misconduct.

At the time he was fired, Easterbrook allegedly denied having any inappropriate relationships with any of his employees, except for one relationship, which he claimed had not been physical. Afterwards, an internal investigation found emails that allegedly revealed Easterbrook’s sexual relationships with multiple McDonald’s employees during his time as CEO. Once these emails were uncovered, the company sued Easterbrook in 2020.

The lawsuit resulted in Easterbrook returning his shares in the company, as well as cash, the combined value of which was about $105 million at the time he returned it. Continue reading ›

Buyout Rights of Oppressed Minority Shareholders or LLC Members

December 7, 2022 | Peter S. Lubin and Patrick Austermuehle

When starting a business, co-owners envision the best—working together productively and profitably. But it is all too common for business partners to encounter a serious impasse over how to operate the business. When partners are unable to work through a dispute, it may be time for one partner to exit the company via a buyout of their interest. It is not uncommon for this scenario to arise in conjunction with claims that the majority shareholder or shareholders are oppressing the minority shareholder or shareholders.

For Illinois corporations, the Illinois Business Corporation Act of 1983 (BCA) permits shareholders to pursue legal action against each other based on allegations of fraud, illegal activity, corporate waste or other disruptive conduct. The BCA provides for 12 categories of relief that a court may order as an alternative to dissolving the business. Minority shareholders frequently opt to pursue the remedy of a buyout, in which the exiting shareholder’s interest is purchased by the remaining shareholders for “fair value.” Similarly for Illinois LLCs, the Illinois Limited Liability Company Act provides that a court may order the entity or the remaining members to purchase the interest of the outgoing member.

The BCA defines “fair value” as the value of the shares “taking into account any impact on the value of the shares resulting from the actions giving rise to a petition under this Section.” The statute goes on the explain that “‘fair value,’ with respect to a petitioning shareholder’s shares, means the proportionate interest of the shareholder in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability.” For many companies, this provides a much more favorable valuation to a minority shareholder than selling shares for fair market value or any other metric of value normally employed when selling an interest in a small business. This is particularly true for closed (or closely held) corporations where a market for the minority’s shares might not otherwise exist since the statutory valuation does not generally speaking allow for a discount for the lack of marketability of the minority’s shares. Continue reading ›

Changes to Delaware Corporate Law Concerning Officer Liability for Breach of Fiduciary Duties

November 9, 2022 | Peter S. Lubin and Patrick Austermuehle

Earlier this year, the governor of Delaware signed Senate bill 273 which amended various provisions of the Delaware General Corporation Law (GCL). The changes became effective August 1, 2022. Most notable among the changes was the amendment of Section 102(b)(7) of the GCL to allow corporations to exclude or limit certain officers from personal liability for breaches of their fiduciary duty of care. In order for corporations to take advantage of this change in the law, companies must include a provision in their certificate of incorporation eliminating or limiting its officers from personal liability for breaches of the duty of care.

Under Delaware corporate law, directors and officers of Delaware corporations owe the corporation and its shareholders certain fiduciary duties. One of the two chief fiduciary duties that directors and officers owe to the corporation and shareholders is called the duty of care. The duty of care requires directors and officers to exercise care and act in an informed manner when acting for the corporation and making decisions on its behalf.

Since 1986, with the addition of Section 102(b)(7) to the GCL, corporations have been authorized to eliminate or limit the personal liability of directors for monetary damages for breaches of the duty of care. However, until passage of the amended Section 102(b)(7) this year, corporations could not do the same for its officers, even though the Delaware Supreme Court repeatedly affirmed that officers owe the same fiduciary duties as directors. Now corporations can insulate its officers as well as directors from personal liability for breaches of the duty of care.

It is important to understand the limits of this newly amended Section 102(b)(7). First, it doesn’t apply to all officers but only to those officers “deemed to have consented to service by the delivery of process to the registered agent of the corporation pursuant to § 3114(b) of Title 10” which includes the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer, or chief accounting officer along with anyone identified in the corporation’s SEC filing as one of the most highly compensated executive officers, or anyone who has, by agreement with the corporation, consented to be identified as an officer for the purposes of Section 3114(b) of the GCL. Continue reading ›

Illinois Court Rules that Attorney Fee Award in Shareholder Derivative Suit Can Be Assessed against Defendants Personally

July 11, 2022 | Peter S. Lubin and Patrick Austermuehle

As we have written about previously, shareholders in a corporation have two different types of claims they can assert, direct claims and derivative claims. Direct claims are filed by the shareholder for the benefit of the shareholder. Derivative claims are filed by a shareholder but for the benefit of the corporation itself. An Illinois appellate court recently considered the issue of whether a successful shareholder in a derivative action can obtain an award of attorney fees directly from the defendants personally, as opposed to from the common fund created by the judgment.

The parties were investors in a business known as 15th Street Blue Island, LLC (15BI). The plaintiffs made financial contributions totaling approximately $3.7 million to become members of 15BI. The plaintiffs received 47% interest in 15BI as “Class A Members.” An entity owned by defendants Jerry Karlik and Keith Giles, Kargil Blue Island, LLC (KBI), received a 53% interest in the company as a “Class B Member,” and was named as the manager of 15BI.

15BI was formed in 2006 for the purpose of developing condominiums on a vacant parking lot located in Chicago. After the economic crash of the global recession that began shortly thereafter, the original business plan was scrapped for a new one that involved developing rental residences, which was considered a more feasible plan under the economic conditions.

In 2006, another entity jointly owned by Jerry Karlik and Giles, Kargil Development Partners (KDP), entered into a contract to purchase a vacant parking lot (15BI Property) located at 15th Street and Blue Island Avenue in Chicago for $3.72 million. Pursuant to that agreement, KDP deposited an initial earnest money payment of $100,000 from 15BI accounts into an escrow account. In June 2007, Karlik signed a purchase agreement on behalf of 15BI to acquire property known as the Testa Parcel, for $6,250,000. This purchase agreement also required a $100,000 earnest money deposit from 15BI. In an unusual move for a buyer, Karlik later negotiated a $250,000 increase in the purchase price and provided for payment of a commission to yet another company that he and Giles jointly owned. 15BI later abandoned its efforts to buy the Testa Parcel, resulting in 15BI losing 70% of its earnest money deposit.

In 2008, Karlik and Giles sold a portion of KBI, which managed and owned a percentage of 15BI, to new investors, Gangas and Housakos, for approximately $750,000. Karlik testified that the law firm of Branson & Kahn invoiced 15BI and 15BI paid for its work on that sale.

Defendants stipulated that work “should not have been billed through 15B1.” Continue reading ›

Securities-Fraud Lawsuit Against Goldman Sachs Could Shape the Future of Securities Lawsuits

April 28, 2021 | Peter S. Lubin and Patrick Austermuehle

While most securities fraud lawsuits accuse the defendant of manipulating their stock prices to keep them artificially high, the current lawsuit against Goldman Sachs alleges the company lied to maintain its high stock prices, rather than lying to cause the prices to rise. It’s a unique allegation, and one the U.S. Supreme Court has not yet recognized, but two lower courts have already upheld it as a valid claim.

Goldman appealed the decision made by the district court and the Second U.S. Circuit Court of Appeals to the Supreme Court. The company alleges that, if the Supreme Court were to allow the securities lawsuit against it to proceed, the result would be devastating for public companies all over the country.

Goldman is arguing that the allegations against it are too weak to be valid. The allegations made by the shareholders rely on Goldman’s advertising claims that included words like “honesty” and “integrity” and claimed the company always prioritized the interests of its clients, when the opposite turned out to be true.

According to Goldman, the statements cited by the lawsuit are too vague to make the basis of a securities-fraud case. The company has also denied the statements had any effect on its stock price. If the lawsuit is allowed to proceed through the courts, the bank alleges it will allow shareholders to file securities-fraud lawsuits in the future simply by pointing to any kind of aspirational statement that nearly all companies make in their marketing materials. Continue reading ›

Suing for Shareholder Oppression Over Other Allegations the Right Move for These Lawyers

January 1, 2021 | Peter S. Lubin and Patrick Austermuehle

After discussions about going public, Promega Corp., a privately-held biotech company based in Wisconsin, decided instead to remain a privately held company back in 2014 and tried to buy back the stock owned by its minority shareholders and regain a controlling interest in the company. Those minority shareholders claimed the price at which Promega wanted to buy back their shares was deeply discounted, and when they tried to negotiate for a higher price point, Promega allegedly refused, which ultimately led to the massive lawsuit between the company and its minority shareholders that dragged on for about five years.

The team of attorneys arguing the case for the minority shareholders was headed by James Southwick and Alex Kaplan, two partners of the Susman Godfrey law firm in Houston, Texas. They recently announced that the lawsuit settled for $300 million, a victory to which they attribute their months of research and preparation leading up to the trial, as well as their decision to stick to one main allegation: shareholder oppression.

Other attorneys might have argued that the defendants had breached their fiduciary duty to their shareholders, or they would have alternated between making the case for shareholder oppression, arguing breach of fiduciary duty, and making the case for other allegations throughout the course of the trial. Instead, Southwick and Kaplan decided their best bet was to argue that Promega had tried to oppress its shareholders and to continue to make that case throughout the month-long bench trial. It was an unusual strategy, but one that ultimately paid off. Continue reading ›

Court Dismisses Shareholder Oppression and Breach of Fiduciary Duty Claims against Illinois Snack Food Company

December 16, 2020 | Peter S. Lubin and Patrick Austermuehle

In a recent decision, the Delaware Court of Chancery granted a motion to dismiss filed by the defendants in response to a shareholder’s lawsuit requesting to compel the company to pay a dividend and also seeking to find that the board of directors breached their fiduciary duty of care.

The plaintiff in the case of Buckley Family Trust v. Charles Patrick McCleary, was the Buckley Family Trust. The trust was one of seven stockholders of McCleary, Inc., a privately held snack food company headquartered in South Beloit, Illinois near Rockford, and only one of two stockholders that were not family members of the Company’s founder, Eugene “Mac” McCleary. Neither of the two non-family member shareholders served on the Company’s board of directors.

Unhappy with the direction of the Company and the decisions being made by the Company’s board of directors, the Plaintiff filed a two-count complaint against the Company and the five family members who served on the Company’s board of directors. In its first count, the Trust alleged that the board of directors engaged in minority shareholder oppression by failing to declare a dividend for seven years. In its complaint, the Trust argued that the Company had the funds to pay a dividend but refused to in an effort to squeeze-out the Trust and force it to sell its shares to the defendants at a steep discount.

In its second count, the Trust sought to bring a shareholder derivative action against the board of directors for allegedly breaching their fiduciary duties when it approved certain actions and failed to act on other occasions. In particular, the Trust sought to challenge the Company’s decisions to transition away from the grocer Aldi, a key customer; to authorize building a new warehouse; and to improve the Company’s production facilities to do business with a competitor. The Trust also challenged various non-actions by the board members including their failure to authorize improvements to the Company’s existing food production facilities or to manage the Company’s tax obligations and to observe corporate formalities.

In deciding the motion to dismiss, it reviewed the requirements for adequately pleading each of the Trust’s claims. With regard to the shareholder oppression claim, the Court found that the Trust failed to demonstrate that the board member’s actions were part of a squeeze-out scheme. For one, the Court pointed to the fact that the decision affected the Trust and the members of the board equally as they were all holders of common stock and would share equally on a pro rata basis any dividend paid by the Company. The Court also pointed to the fact that the “steep discount” referenced by the Trust in the Complaint was a contractually agreed to “discount of thirty (30%) percent applicable to all non-voting shares for lack of marketability and control” found in the Common Stock Purchase and Restriction Agreement to which the shareholders were a party. Consequently, the Court dismissed the claim concluding that the lack of dividend was not an abuse of discretion and that there was no evidence of self-interest.

In turning to the second claim, the Court noted that the Trust did not make a pre-suit demand on the board members before filing the derivative action on behalf of the Company. Consequently, the Court was required to analyze whether failing to make such a demand was excused under the demand futility exception to the demand requirement, which excuses the failure to make such a demand if it would have been futile to do so. The Trust argued that a demand would have been futile because the board members faced significant likelihood of personal liability under any such suit brought by the Company, a recognized exception to the demand requirement.

The Court reviewed various board meeting minutes and other documents presented by the parties to determine if the board members sought to properly educate themselves before making decisions or whether they acted with reckless indifference or without the bounds of reason, which would open them up to a substantial risk of personal liability. The Court determined that this evidence did not establish that the board acted recklessly or outside the ordinary bounds of reason. As such, the Court concluded that the Trust failed to demonstrate that making a demand on the board before filing the lawsuit would have been futile, and dismissed the Trust’s derivative claim.

The Court’s full opinion can be found here. Continue reading ›