Illinois Appellate Courts

Respected Law Professor’s Insights on Corporate Freeze-Out Litigation

July 16, 2008 | Peter S. Lubin and Patrick Austermuehle

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.

Missed Deadline Bars Stolen Corporate Opportunities Claim, Appeals Court Rules

July 15, 2008 | Peter S. Lubin and Patrick Austermuehle

The doctrine of laches bars a plaintiff from bringing a stolen corporate opportunities lawsuit, the Illinois First District Court of Appeal has ruled. Lozman v. Putnam, No. 1- 06-0861 (February 18, 2008).

Plaintiff Fane Lozman and defendant Gerald Putnam met in 1986 as employees of the same Chicago securities firm. Eight years later, Lozman came up with an idea for a new type of software for traders, and hired another defendant, Townsend Analytics Inc., to program it. To market the software, Lozman and Putnam formed Blue Water Partners, Inc., an Illinois corporation, in 1994. Each was a 50% shareholder and a director. The plan was to barter the software for a share of a brokerage firm’s commissions on trades. Townsend Analytics and its owners, Stuart and Marrgwen Townsend, were offered 15% equity in Blue Water but no director or officer positions.

Later that year, Putnam formed Terra Nova Trading, LLC, with himself as 100% shareholder, to route profits from Blue Water. Another company, Analytic Services, LLC, was formed to sell the software, with Samuel Long as president. In April of 1995, Putnam and Lozman signed an agreement to share commissions generated through or paid by Townsend and its software. For a variety of personal and professional reasons, the relationship between Lozman and Putnam went sour, and they voluntarily dissolved the agreement six months later. A later termination agreement, back-dated to the day of the dissolution, preserved any legal claims. Putnam went on to form three more companies that used the same office and brokerage license as Blue Water, subcontracted with the Townsends and/or competed with Blue Water.

Court of Appeal Allows Retroactive Rule Change in Junk Fax Insurance Case

July 14, 2008 | Peter S. Lubin and Patrick Austermuehle

Over at the Illinois Appellate Lawyer Blog, our colleague Steven R. Merican recently called our attention to an appeals court decision related to insurance coverage for “junk fax” class actions — an important practice for our firm. Eclipse Manufacturing v. United States Compliance, Nos. 2-06-0825, 2-06-0889 (11/30/07).

In the underlying case, Eclipse Manufacturing Co. filed a class-action lawsuit against United States Compliance for sending Eclipse unsolicited “blast faxes” in violation of the federal Telephone Consumer Protection Act and the Illinois Consumer Fraud and Deceptive Practices Act. Compliance’s insurer, Hartford Casualty Insurance Co., declined to cover the defense. Compliance later settled with Eclipse by simply assigning its right to the full limits of its coverage under the policy. In order to collect this settlement, Eclipse then filed a third-party citation against Hartford.

In part because Hartford hadn’t sought a declaratory judgment on its obligation to defend Compliance, estopping it from raising policy defenses, the trial court sided with Eclipse. Hartford later filed for declaratory judgment in Minnesota, where Compliance is based, but its claim was dismissed for lack of jurisdiction. Hartford appealed, arguing that it was not estopped because the trial court should have applied Minnesota law, which it argued conflicts with Illinois law on estoppel. Furthermore, Hartford argued, its policy doesn’t cover the underlying lawsuit under either state’s law. The Illinois Second District Court of Appeal affirmed the trial court, saying there was no conflict in outcomes between Illinois and Minnesota laws of estoppel. Thus, Hartford was estopped from raising policy arguments — making them irrelevant.

Without Written Confidentiality Agreement, Competing Does Not Breach Fiduciary Duty, Court Rules

July 11, 2008 | Peter S. Lubin and Patrick Austermuehle

A former shareholder, officer and director did not breach his fiduciary duty to a corporation when he started a competing company, and a former employee did not breach his duty of loyalty by joining, the First District Court of Appeal has ruled. Cooper Linse Hallman v. Hallman, No. 1-05-0597 (2006).

Plaintiff Cooper Linse Capital Management, a closely held financial services company, brought on Thomas Hallman in 1994 as a shareholder with 20% of stock shares. The remainder were divided evenly between Lori Cooper and Don Linse. Hallman served as vice president and CFO as well as an employee. Two years later, the company hired James McQuinn as an employee only. Neither man signed a written confidentiality agreement, and both disputed Cooper Linse’s contention that they entered into an oral confidentiality agreement. All parties agreed that Linse and Cooper made all of the business decisions.

In 2000, the company that held Cooper Linse’s clients’ accounts in trust got into financial trouble and had its assets frozen, leaving clients unable to access their accounts and Cooper Linse unable to pay its employees. Linse began negotiations to take over that company’s trust business; McQuinn and Hallman quietly began planning to start a business competing with Cooper Linse.

Earnings of Closely Held Company Are Not Marital Property, Appeals Court Says

July 10, 2008 | Peter S. Lubin and Patrick Austermuehle

In an issue of first impression in Illinois, the Third District Court of Appeal ruled in a divorce business dispute that retained earnings from a closely held corporation are non-marital property. In re Marriage of Joynt, No. 3-06-0919 (Aug. 16, 2007).

Michael Joynt was president of Mississippi Valley Stihl, Inc. (MVS), a family-owned subchapter S corporation in Illinois, when his former wife, Theresa, filed for divorce. He also owned 33% of the stock; his father and sister were the remaining shareholders. During the divorce trial, both spouses stipulated that Michael’s stock was non-marital property. However, the company’s accountant testified that MVS had $3.75 million in retained earnings that year, which were set aside for future expenses and not paid as dividends to shareholders. If they had been paid during the trial, Michael would have had an additional $1.25 million in income. The trial court concluded that Michael’s interest in the retained earnings were non-marital property. Theresa appealed, contending that the retained earnings were income available to her former husband.

The appeals court affirmed the trial court’s decision, noting that the company, not the spouses, paid taxes on retained earnings. Noting that Illinois courts hadn’t addressed the issue before, the judges surveyed decisions from several other states ruling that retained earnings are non-marital property. However, they wrote, that’s not always true when the shareholder spouse has full power to decide whether to pay dividends, or substantial influence over that decision. Furthermore, Michael was fairly compensated for his role as president of MVS, and there was no evidence showing that Michael was using MVS to hide marital assets.

Company President Has No Standing to Sue Alleged Alter Ego, Appeals Court Rules

July 8, 2008 | Peter S. Lubin and Patrick Austermuehle

In an Illinois business contract lawsuit, the Third District Court of Appeal has ruled that a company’s president may not hold his financer and business partner liable for the company’s debts as an alter ego. Semade v. Estes, 05–CH–31 (June 29, 2007).

Charles Semade and Nicholas Estes formed a private corporation, Heartland Pottery Company, in 1995. Estes provided financing; Semade served as president and CEO. Unfortunately, the company did not succeed. Semade filed a lawsuit against Heartland in 1998 for unpaid salary and expense reimbursements. In that case, he won a judgment of more than $294,000, only to discover that Heartland had no assets.

Semade then filed a complaint against Estes himself, contending that Estes should be liable for the judgment because he was the company’s alter ego. Under the law, that means he alleged that Estes and Heartland were the same person for all practical purposes, allowing Semade to “pierce the corporate veil” of limited liability. Semade alleged that Estes controlled all parts of the company and put income and assets in his personal accounts. However, Estes moved for summary judgment, saying Semade lacked standing because he was a director and officer of the company. The trial court agreed, and on appeal, the Third District Court of Appeal agreed.

Bond Filing Absolutely Must Precede Attachment Order Under Illinois Attachment Act, Appeals Court Rules

May 24, 2008 | Peter S. Lubin and Patrick Austermuehle

In a business fraud lawsuit pitting a bank against its security vendor, the Illinois Appellate Court for the 1st District ruled May 1 that an attachment order must be voided under the Illinois Attachment Act if plaintiffs fail to file an attachment bond beforehand. In ABN Amro Services Company, Inc. v. Navarrete Industries, Inc., No. 1-07-0089 (Ill. App. 2008), the appeals court voided such an order and remanded it to the trial court.

The case arose from alleged fraud by INS, which provided security for multiple Chicago-area La Salle Bank branches. A fraud investigator discovered that Armando Navarrete of INS was fraudulently overbilling the banks by an alleged $15.9 million, then paying kickbacks to the banks’ vice president for security, George Konjuch. The bank filed a lawsuit in September of 2006 against INS, Konjuch, Navarrete and another INS employee, alleging fraud, civil conspiracy and constructive trust, plus breach of fiduciary duty against Konjuch. (Konjuch and Navarrete have since been indicted by a federal grand jury for the scheme.)

At the same time, plaintiffs asked for a temporary restraining order, a preliminary injunction and an order of statutory prejudgment attachment, all of which were attempts to keep the alleged conspirators from absconding with the money. Upon receiving notice of these filings, defendants immediately filed motions to void the restraining order and the prejudgment attachment. After hearings, the trial court dissolved the restraining order and denied the preliminary injunction, but declined to vacate the attachment order. Both sides appealed.

Tolling Agreement Supersedes Statute of Limitations in Legal Malpractice Case

May 23, 2008 | Peter S. Lubin and Patrick Austermuehle

The Illinois Appellate Court for the 1st District ruled May 7 that a legal malpractice class action against the law firm DLA Piper Rudnick Gray Cary could not go on because it was filed well after a tolling agreement ended. In Joyce v. DLA Piper Rudnick Gray Cary LLP, 1-07-1966 (Ill.App. May 7, 2008), the court upheld the dismissal of a purported class action by stockholders of 21st Century Telecom Group, a Chicago telephone company, pursuant to a tolling agreement between 21st Century and DLA Piper.

The underlying dispute started in 1999, when 21st Century agreed to merge with competitor RCN. DLA Piper attorneys drafted a merger agreement with a mistake that lowered the price of the stock 21st Century shareholders were to receive by $19 million. In response, Edward Joyce, the stockholders’ representative, made a tolling agreement with DLA Piper, in which the statute of limitations was tolled unless a stockholder lawsuit was filed against the firm on or before December 31, 2002. The firm agreed not to avail itself of any statute of limitations defense until after that day. This agreement was amended four times, each time altering only the date. The last agreement set that date at August 21, 2005.

Joyce filed a legal malpractice class action in Cook County against DLA Piper on August 30, 2006. After some procedural disputes, including a finding by the trial court that the filing was timely, the firm won a motion to dismiss based on plaintiff’s lack of standing as a non-client. The plaintiffs appealed and the defendant cross-appealed on the trial court’s decision that the suit was timely.

The Chicago Consumer Attorneys at Lubin Austermuehle Win Precedent In Hotel Billing Fraud Case

May 23, 2008 | Peter S. Lubin and Patrick Austermuehle

Our firm obtained a favorable verdict in a consumer fraud case with Terrill v. Oakbrook Hilton Suites & Garden Inn 788 NE2d 789 (2nd Dist 2003). In that case, our client, Cathy Terrill, was overcharged for a hotel room; her bill contained a charge for “taxes” that included an undisclosed non-tax charge for security services. This case was part of a set of class actions in Du Page County from 2000 to 2007 (Oakbrook Terrance Hotel Overcharge Class Actions), all of which alleged that hotels misled and overcharged their customers by including non-tax charges as “taxes” on their bills.

In Terrill, the Oakbrook Terrace Hilton moved for summary judgment at the trial court, claiming the Hotel Operators Occupation Tax Act (35 ILCS 145/3(f)) and Illinois Supreme Court precedent barred Terrill’s suit. The trial judge denied that motion and the hotel appealed. It claimed that because the security fees paid for extra security from Oakbrook Terrace law enforcement — a local government entity with the power to collect taxes — it had already paid the extra money to the state Department of Revenue and could not be sued.

The Illinois Second District Court of Appeal rejected that argument, calling it “untenable at best”: