Articles Posted in Shareholder Freeze Out

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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 Austermuehle’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.

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Members 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 Austermuehle 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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Our Chicago, Naperville, Wheaton and Oak Brook business trial lawyers won an important procedural victory in a business dispute involving a closely held business. In short, we were able to convince an Illinois trial court that an attorney’s appearance should be stricken after being added to a case, we argued, because it appeared the new attorney could have been added to force the recusal of the judge, the attorney’s former law partner.

The underlying case was a high-stakes financial dispute in a closely held business. It had been litigated for six years, but was delayed when the defendants added a new lawyer to their team. This lawyer was the former law partner of the judge assigned to the case, who had already put substantial time and effort into the matter. However, to avoid any appearance of impropriety, the judge immediately recused himself when the new lawyer, the former partner, was added. Our position was that it could appear that this was precisely what the defense had intended. In fact, the new lawyer was added two days after three rulings on motions that the new judge called “hotly contested,” including rulings unfavorable to the defense.

Another attorney for the defense was a recognized expert in legal ethics, we argued, so the defense clearly must have known that the judge might recuse himself. Furthermore, the defense admitted that it had discussed the possibility of recusal with the client. And finally, the new lawyer had chosen what we alleged was a non-standard way to notify the court of his addition. Rather than asking for leave of court to move for the addition, which would have allowed the parties to discuss the addition in open court, he simply sent his appearance directly to the judge. The trial court held this was contrary to both the rules of court and the usual practice. All of this showed that it appeared that the attorney might have been added to force a change of judges, we argued. For those reasons, we moved to disqualify the new attorney.

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A recent case of ours includes a motion to disqualify attorneys for the defense under Rule 3.7 of the Illinois Rules of Professional Conduct. Part (b) of that rule states that a lawyer may not represent a client in a case where he or she may be called as a witness to give testimony prejudicial to the client. We moved for an evidentiary hearing on this subject, because our underlying contentions included the contention that the lawyers for the defense witnessed the intentional torts that underlay the case.

Illinois law takes a motion to disqualify an attorney very seriously. Disqualifying a lawyer is considered drastic under state law, because it touches on basic rights by destroying the client’s relationship with the lawyer of his or her choosing. Schwartz v. Cortelloni, 177 Ill.2d 166 (1997). For that reason, an evidentiary hearing to determine what evidence is relevant and admissible is generally either necessary or wise. City of Kalamazoo v. Michigan Disposal Service, 125 FSupp2d 219 (WD Mich 2000). In fact, some appeals courts have found that a lack of an evidentiary hearing is sufficient to allow them to question a trial court’s decision.

However, Illinois and federal courts have held that an evidentiary hearing is unnecessary when the facts are not disputed, or when investigation is unlikely to provoke an admission that one side has ulterior motives. Robinson v. Boeing Co., 79 F3d 1053 (11th Cir 1996). The Eleventh Circuit’s decision in In Re BellSouth Corp., 334 F3d 941, 962 (11th Cir 2003), supporting Robinson, laid down factors for judges to consider when considering disqualifying an attorney for alleged “judge shopping.” These include “the fundamental right to counsel, the court’s docket, the injury to the plaintiff, the delay in reaching decision, the judicial time invested, the expense to the parties objecting and the potential for manipulation or impropriety.”

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Our Chicago business litigation firm recently handled a case in which one 50% shareholder allegedly tried to freeze out the other using lawyers hired by the companies owned equally by both. When our clients filed a shareholder freeze-out and breach of fiduciary duty claim and began discovery, the defendants balked, citing the attorney-client privilege to explain why they should not be required to turn over important and incriminating information.

As experienced business litigators know, this is no defense at all. Because our clients were equal shareholders in the business, we argued they were entitled to access to certain attorney communications. Furthermore, there is well-established law showing that the attorney-client privilege cannot be misused to deny discovery when the company or its officer is accused of breaching its fiduciary duty to stockholders. In other words, fiduciary duty trumps the privilege. Caselaw says a corporation may not use the privilege to shield relevant communications from discovery in an action by its own stockholders, unless there is good cause. The multipart test for good cause developed by the courts takes into account the nature of the communication, the seriousness of the allegations and other factors. Garner v. Wolfinbarger, 430 F2d 1093 (5th Cir. 1970).

The attorney-client privilege also cannot be raised when the disputed communications were made after the date the attorney and client began a fraudulent or criminal scheme that was part of the lawsuit. That is, communications about crime, fraud or torts are excepted from the attorney-client privilege. Cleveland Hair Clinic, Inc. v. Puig, 968 FSupp 1227, 1241 (ND Ill 1996). Unfortunately, we believed this to be the situation in our case.

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

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

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

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

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

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

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

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

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