Shareholder Disputes

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

June 15, 2011 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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. 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.

NPR Reports “Courts Consider Blocking Massey Mine Merger”

June 11, 2011 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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.

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

June 1, 2011 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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 Lubin Austermuehle 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.

In 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.

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

March 10, 2011 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

The 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.

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

February 6, 2011 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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:

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

December 12, 2010 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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).

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

December 1, 2010 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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.

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

October 26, 2010 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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.

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

September 28, 2010 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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.

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

September 8, 2010 | Peter S. Lubin, Patrick Austermuehle and James V. DiTommaso

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.