An Illinois Appellate Court recently revived a breach of fiduciary duty and shareholder oppression lawsuit filed by minority shareholders against the president, director, and majority shareholder of a lumber company. The suit accused the majority shareholder of diverting nearly a million dollars from the lumber company to a separate company owned by the majority shareholder’s son. The trial court dismissed several of the minority shareholders’ claims and ruled in favor of the majority shareholder following a trial on the breach of fiduciary duty claims. In a blow to the majority shareholder, the Second District appeals court reversed the trial court finding that the majority shareholder did breach his fiduciary duties to the company and engaged in shareholder oppression.
The case provides practitioners and shareholders a useful primer on pleading and evidence requirements for successfully asserting breach of fiduciary duty and shareholder oppression claims against a corporate officer. It also sheds light on the contours and limits of a key legal doctrine implicated in such claims: the business judgment rule doctrine.
The case, Roberts v. Zimmerman, involved four separate but related lumber companies: Our Wood Loft, Inc. (OWL), Outstanding, 3 Corp. Lumber Company, and Lake City Hardwood. The plaintiffs in the case were minority shareholders who collectively owned one-third of OWL, with the defendant, Stefan Zimmerman, owning the other two-thirds of the company. Zimmerman’s son, Thomas, owned Lake City.
The plaintiffs’ complaint alleged that Zimmerman initially sought to have his son buy shares in OWL but the minority shareholders refused. Instead, the plaintiffs agreed to allow Thomas to work as a manager at OWL. While working at OWL, Thomas started Lake City. Shortly thereafter, Lake City began purchasing lumber and re-selling it to OWL at a profit. The complaint alleged that Zimmerman did not reveal the relationship between OWL and Lake City and that Thomas owned Lake City until several years after OWL started buying lumber from Lake City.
The plaintiffs’ primary claims were that Zimmerman breached his fiduciary duties to the company and the minority shareholders by buying lumber from Lake City at higher prices than necessary and failing to disclose his conflict of interest as required by section 8.60 of the Illinois Business Corporations Act and that buying the lumber constituted oppressive conduct under the Illinois Business Corporations Act. The trial court dismissed the shareholder oppression claims but let the breach of fiduciary duty claim proceed to trial.
After a bench trial, the trial court found in favor of Zimmerman on the basis that the minority shareholders had failed to prove compensable damages. The plaintiffs then appealed the judgment as well as the earlier dismissal of their shareholder oppression claims.
In reversing the trial court, the Second District first examined the breach of fiduciary claims in light of Illinois breach of fiduciary duty law in the context of a close corporation shareholder dispute. As the Court explained, majority shareholders and officers owe a fiduciary duty of loyalty to the corporation and are precluded from actively exploiting their positions within the corporation for their own personal benefit or impeding the corporation’s ability to conduct the business for which it was developed. The Court had little trouble finding that Zimmerman had engaged in disloyal conduct that harmed OWL.
As the Court explained, Zimmerman had a duty to act in OWL’s best interest and to maximize OWL’s profits. The Court then outlined how Zimmerman failed to do so. Zimmerman hired his son to purchase lumber for OWL at the best possible price. Instead of buying lumber for OWL, however, Thomas purchased lumber for Lake City and then re-sold the lumber to OWL at a higher price. By approving the transactions between Lake City and OWL, Zimmerman approved paying higher lumber prices than could have been achieved if Thomas had bought the lumber directly for OWL. This, the Court found, breached Zimmerman’s fiduciary duty of loyalty.
In finding that Zimmerman breached his fiduciary duty of loyalty, the Court considered and rejected Zimmerman’s argument that his decision to buy from Lake City was protected by the business judgment rule. Generally speaking, the business judgment rule provides that courts will give deference to and not interfere with properly considered business decisions of a corporate officer even if the decision turns out to be wrong in hindsight. But as the Court explained, the business judgment rule does not apply to situations where the challenged action is subversive to the rights and interests of the corporation such as when the challenged action involves the diversion of profits. Though Zimmerman had discretion to make business judgments, the Court acknowledged, he did not have the discretion to divert profits.
Next, the Court turned to the shareholder oppression claims under Section 12.56 of the Illinois Business Corporations Act which provides remedies to shareholders who are oppressed by the conduct of their fellow shareholders. The Court noted, as we have done previously, shareholders in non-public, closely held corporations are especially vulnerable to acts of shareholder oppression, because they are likely to have a heavy personal investment in the corporation and cannot easily sell their stock and leave the company.
In reversing the dismissal of these oppression claims, the Court noted that shareholder oppression is not limited to actions where the alleged oppressor has acted illegally, fraudulently, or has mismanaged funds. Instead, shareholder oppression includes a wide gamut of conduct including a course of heavy-handed and exclusionary conduct. The Court concluded that the minority shareholders sufficiently alleged enough facts to sustain a claim for oppression. They alleged that Zimmerman engaged in heavy-handed conduct by overpaying for lumber at OWL’s expense and to his son’s benefit.
This case makes it clear that an officer’s or majority shareholder’s actions do not have to benefit the majority shareholder directly to constitute a breach of the duty of loyalty and oppressive conduct. Benefiting a family member at the expense of the corporation can support both a breach of fiduciary duty claim and a statutory shareholder oppression action. It also makes clear that allegations of illegal or fraudulent conduct or mismanagement of funds are not required to sustain a claim of shareholder oppression. Claims that the majority shareholder knowingly caused the corporation to overpay for materials will suffice to state a claim.
The Court’s full opinion can be found here.
Our Chicago breach of fiduciary duty and business litigation attorneys have defended and prosecuted minority oppression, business divorce, stolen corporate opportunity and breach of fiduciary duty lawsuits for more than three decades. Super Lawyers named Chicago and Elmhurst business litigation and fiduciary duty attorneys Peter Lubin and Patrick Austermuehle a Super Lawyer and Rising Star respectively in the Categories of Business Litigation, Class Action, and Consumer Rights Litigation. If you’d like to discuss how the experienced Illinois breach of fiduciary duty attorneys at Lubin Austermuehle 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 locally at 630-333-0333 or contact us online.