Shareholder Disputes

Treasurer Cannot Commit Resources of Family Business Without Board Authorization, Court Finds

September 7, 2010 | Peter S. Lubin and Patrick Austermuehle

As Illinois closely held business dispute attorneys, we read with interest an appellate decision in a dispute over the extent to which a company officer can act without the board’s approval. In Fritzsche v. LaPlante, No. 2-09-0329 (Ill. 2nd March 2010), the “rogue” officer was M. Christine Rock, the secretary/treasurer for family business Fritzsche Industrial Park, Inc. (FIP), which leases real estate at an industrial park in Lakemoor, Ill. Rock also had power of attorney for her father, Herbert Fritzsche, and those two roles allowed her to lease property to Gregory LaPlante, her longtime live-in boyfriend. Separately, Rock also signed a promissory note to Gerald Shaver as payment for work he had done for FIP. This led to a lawsuit by other family members and corporate members, who alleged that she acted without authorization from the board and that the note and lease were invalid.

FIP was incorporated in 2005, although the family had owned the property for decades before. The other corporate officers were Herbert Fritzsche, president, and Scot Fritzsche, vice president and son of Herbert Fritzsche. Shares of stock were divided among the officers and other sons, daughters and grandchildren, with Herbert Fritzsche getting 68 percent. In July of 2006, Herbert Fritzsche suffered a brain hemorrhage, which affected his health and may have compromised his mental capacity. One result of this was that Rock and LaPlante moved into Herbert Fritzsche’s home after he moved in with another sibling. On the first day of August, Rock signed the lease to LaPlante, which gave him 16 properties at Fritzsche Industrial Park and 10 more owned by Herbert Fritzsche individually. LaPlante was to pay rent in the amount of the property taxes, plus 10 percent of his income, although it was not clear what that income referred to.

A week later, on August 8, Rock signed the promissory note to Shaver in exchange for work done on the property, possibly through his trucking and excavating business. It obligated FIP and Park National Bank, trustee of Herbert Fritzsche’s properties, to pay $450,000 by putting a lien on the properties they owned. Park National Bank did not sign. Three months later, Herbert Fritzsche, FIP, Park National Bank and First Midwest Bank, a trustee for some FIP properties, sued Rock and LaPlante, alleging Rock was not authorized to commit the company’s or her father’s resources. The complaint alleged that Rock was suspected of stealing rents from FIP to pay her personal expenses and refused to provide documentation of rental income, which led to a shareholder decision to remove her as secretary/treasurer in May of that year. After his illness, Herbert also allegedly revoked her power of attorney. Therefore, plaintiffs alleged, Rock had no authority to enter into the lease or the note, and they were invalid. They also claimed the rental agreement was too vague to be enforced.

During the next two years, discovery in the case moved very slowly, possibly because Rock and LaPlante also faced criminal prosecution for theft, conspiracy and financial exploitation of an elderly person. In December of 2008, the plaintiffs moved for summary judgment. They argued that even if Rock was not properly removed as power of attorney and a corporate officer, Illinois law does not allow her to enter into the lease or the note without the board’s approval. They also argued that FIP’s bylaws required approval of the note because it was a form of debt. Defendants responded that the board knew about the lease through e-mails sent among the members, and that no board approval was necessary for the lease and the note because Rock was exercising Herbert’s executive authority through the POA, and because many properties were owned by individual family members rather than the board. After oral arguments, the board granted summary judgment to the plaintiffs, saying Rock did not have the authority to act unilaterally as a matter of law. This appeal followed.

Because it was an appeal of a summary judgment order, the Second noted, it had only to decide whether there were genuine issues of material fact to try. Nonetheless, it found that the defendants failed to meet that standard. Under common law, the court said, the highest officer of a corporation must still get board approval to make contracts, especially ones that are unusual or extraordinary. The lease is such an unusual contract, it wrote, because it involved no trustees for the properties and provided LaPlante with the land for little or nothing. Rock also needed board approval for the lease under the Illinois Business Corporation Act, which requires corporate formalities for transactions involving “substantially all” the corporation’s assets. The lease covered all of the property in the industrial park, the court noted, thus making it impossible for FIP to continue its business.

The court came to similar conclusions about the note. However, in this case, the main support for voiding the note came from FIP’s bylaws. Those bylaws say loans and other forms of indebtedness must be authorized by a board resolution. No such resolution exists, the court said, but the note clearly puts a $450,000 lien on FIP. The appeals court noted that the Business Corporations Act requires board approval for actions outside the ordinary course of business, but believed that the bylaws argument was stronger. Thus, the appeals court upheld the trial court’s grant of summary judgment to the plaintiffs.

Supreme Court Upholds Arm’s Length Standard for Setting Fees for Mutual Fund

May 29, 2010 | Peter S. Lubin and Patrick Austermuehle

Our Chicago business law lawyers were very interested in a recent Supreme Court decision upholding an established standard for determining when a mutual fund’s investment advisor has breached his or her fiduciary duty to shareholders. In Jones et al. v. Harris Associates L.P., No. 08-586 (March 30, 2010), three shareholders in the Oakmark family of mutual funds sued the funds’ investment manager, Harris Associates. They alleged that Harris charged the Oakmark funds twice as much as it did other funds, but did the same work. The situation was not challenged by the funds’ board members because they were all appointed by Harris Associates, the shareholders claimed. As a result, they said, the Oakmark funds paid $37 million to $58 million more than other funds for the services of Harris Associates in just one year.

Mutual funds typically use outside investment advisors to manage all of their affairs, including picking board members. Because this creates the potential for abuse, Congress enacted the Investment Company Act of 1940 to protect mutual fund shareholders. Among other things, that act creates a fiduciary duty for investment advisors with respect to their compensation, and allows shareholders to sue if that duty was breached. The plaintiff shareholders in this case sued Harris Associates in Chicago federal court for a breach of that fiduciary duty, alleging that it charged fees disproportionate to the services rendered and that were not equivalent to fees negotiated at arm’s length. Harris Associates successfully moved for summary judgment. The trial court, applying the standard laid down in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F. 2d 923 (CA2 1982), held that there was no evidence that the fees were outside a range that could have been produced by arm’s length negotiations.

Plaintiffs appealed to the Seventh Circuit, where their claim still failed, but for different reasons. The Seventh rejected the Gartenberg standard, saying it relied too little on markets. Instead, the panel applied a standard from trust law, saying a trustee is free to negotiate any compensation that the trust is willing to pay. Similarly, a fiduciary’s compensation need not be limited by an arbitrary cap, the panel wrote. It suggested that market forces would help keep fees reasonable and noted that comparing fees for other Harris Associates clients is unfair because different clients require different amounts of work. An investment advisor’s compensation would only be subject to interference, the Seventh wrote, if the amount was so out of the ordinary that observers might think “that deceit must have occurred, or that the persons responsible for decision have abdicated.”
After the Seventh denied an en banc rehearing, with a dissent by Judge Posner, the Supreme Court took up the case to resolve a split in the circuits over the standards used to judge breaches of the Investment Company Act. In its unanimous opinion, the court found that Gartenberg was indeed the correct standard, reversing the Seventh Circuit. That standard has been adopted by other federal appeals courts, the high court noted, as well as by the SEC. The opinion, authored by Justice Alito, quoted at length from the Second Circuit’s decision in Gartenberg, which among other things said that “[t]o be guilty of a violation of [the Act], … the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” This approach is consistent with other protections in the Act and the Act’s role in federal regulations.

The Seventh Circuit erred by focusing almost entirely on full disclosure to determine a breach of fiduciary duty, the Supreme Court wrote. Courts should take a more nuanced look, giving deference to well-informed, independent board decisions and avoiding over-reliance on market comparisons. Thus, the court vacated the Seventh Circuit’s decision and sent the case back to trial court.

Second District Reverses Trial Court’s Judicial Determination of Fair Market Value in Shareholder Dispute

September 23, 2009 | Peter S. Lubin and Patrick Austermuehle

As Chicago shareholder dispute attorneys, we noted with interest a recent decision on calculating fair market value of stock owned by a dissenting shareholder. Brynwood Company v. Schweisberger, No. 02-06-1178, (Ill. 2nd Dist. July 23, 2009) pitted a corporation against its co-founder and majority shareholder. The Brynwood Company, which is now dissolved, was an Illinois C corporation organized in 1979. It existed only for the purpose of owning and administering an office building in Rockford, Ill. Stuart Schweisberger was a founder of Brynwood, the president, a member of the board of directors until 2000 and a tenant with an accounting firm in the building. He was also the accountant for Brynwood until 1994.

Schweisberger retired in 1996 with 26% of the company’s stock. In 1999 and 2000, the Brynwood board began to consider ways to change the corporation, including selling the building and dissolving the corporation. In 2001, Schweisberger negotiated with Brynwood to sell his shares, but negotiations ultimately faltered. In 2002, Brynwood notified Schweisberger that it had an offer to sell the building to a third party, but wanted to convert to an S corporation to avoid income tax liability instead and hold on to it for 10 more years. Schweisberger did not consent to the conversion, in part because it would require changes to his IRA. When Brynwood failed to get his consent, it held a meeting at which shareholders agreed to sell the building and dissolve the corporation.

The building was sold for $1.4 million, with $959,282 in capital gains. The mortgage of $353,080 was paid from the proceeds, and another $446,593 was paid in taxes, professional fees and other costs. A bit more than a week after the sale, Schweisberger filed a notice objecting to the sale and demanding payment of the “fair value” of his shares under the Illinois Business Corporation Act of 1983. When Brynwood dissolved, it estimated fair value of the shares at $30.08; Schweisberger estimated fair value at $66.31 and also demanded 6.75% interest, which was the former mortgage’s interest rate. In October, Schweisberger surrendered his shares in exchange for the $30.08 price plus a much lower interest rate based on the interest earned on the certificate of deposit holding the proceeds of the sale. However, in December of 2002, Brynwood filed for a judicial determination of the fair value of Schweisberger’s stock and interest due to him.

At trial, the basis for the difference between Schweisberger’s and Brynwood’s valuations became clear. Schweisberger testified as his own expert witness, saying he came to the $66.31 valuation by excluding the costs of capital gains taxes, fees and costs. Because he objected to the sale, he said, he thought his shares should be calculated without those costs. Brynwood’s expert, accountant Gary Randle, testified that the fair valuation should be calculated according to what each individual shareholder eventually received from the liquidation, which he put at $36.15 per share. He said if Schweisberger had actually received his requested $66.31 per share, other shareholders would have received about $25 a share. Another expert witness for Schweisberger, accountant Mark Patterson, testified that he believed the value could also be calculated as a “going concern,” cutting out the taxes, fees and costs from the sale.

Before and during trial, Brynwood objected to Patterson’s presence and testimony. It said Patterson was unqualified to give testimony because he had admittedly never valued this type of company before. It also contended that his testimony was nothing more than a definition of the legal term “fair value.” The court twice dismissed these objections.

The trial court found that Schweisberger timely exercised his right to dissent and that the board knew the sale would trigger taxes, fees and costs. Because of that, and because the only reason for the sale was the majority’s preference, it found that Schweisberger’s shares should be calculated without taking those costs into account. It also found that the interest rate should be the 6.75% interest Schweisberger had requested, giving rise to a share value of $60.68. This gave Schweisberger a judgment of $181,130.45. Brynwood appealed.

The Second District started by addressing Brynwood’s concerns at trial: that Patterson should not have been allowed to testify as an expert because he had never valued this type of company, and that admitting his testimony was an abuse of discretion because he was doing nothing more than interpreting the words “fair value.” The appeals court disagreed. Valuation is part of the business of accounting, it said, and experience in valuing a particular type of business is unnecessary. Furthermore, a review of Patterson’s testimony shows that it included reasons for his opinions, not just the definitions of terms. Thus, the trial court did not abuse its discretion in admitting the testimony, the Second said.

Brynwood had more luck with its argument that the trial court’s valuation decision was against the manifest weight of the evidence. The company argued that by subtracting taxes, costs and fees, the court artificially inflated the value of Schweisberger’s shares at the expense of the majority of shareholders. The court agreed, saying that excluding those costs did not meet the Business Corporation Act’s goal of fair and equal treatment for all shareholders. Capital gains taxes and other costs are intrinsically tied to the value of a closely held real estate company like Brynwood, the court wrote, and thus to its stock’s value. This made the trial court’s decision against the manifest weight of the evidence. Thus, the appeals court overturned that decision and sent it back to trial court for a new determination of value, taking taxes, costs and fees into account.

Homeowners May Bring Derivative Claim Against Association’s Board of Directors, Appeals Court Rules

June 7, 2009 | Peter S. Lubin and Patrick Austermuehle

A group of Chicago condo owners may proceed with a derivative lawsuit against their homeowners’ association’s Board of Directors, the First District Court of Appeal has ruled. In Davis v. Dyson, No. 1-07-2927 (Ill. 1st Dec. 19, 2008), twelve condo owners sued individuals formerly on the board of directors after the board members failed to detect embezzlement by an outside property manager. Furthermore, the homeowners alleged, the former board members failed to get enough insurance or get an attorney’s advice on their duty to do so, resulting in losses and out-of-pocket costs of more than $800,000 after the embezzlement was detected.

The homeowner plaintiffs sued for breach of fiduciary duty under two counts — one derivative claim on behalf of the association and one claim as individual homeowners whose property values were allegedly harmed by the directors’ inaction. In response, board members argued that the homeowners lacked standing to sue in both claims — for the individual claim, because the property value claim did not constitute a separate and distinct harm to the individual homeowners. For the derivative claim, the board members argued that only the board itself may bring a derivative action against third parties. The trial court agreed and dismissed both claims; the homeowners appealed.

In its analysis, the appeals court pointed out that shareholders have an undisputed right to sue their own boards of directors; the question was whether they may file a derivative claim against third parties (in this case, the former directors). The court concluded that they could, pointing out that the right to file a derivative suit puts homeowners into the association’s shoes. This means that they are acting on behalf of the association, the opinion said, not usurping its undisputed right to sue third parties. The relevant section of the Illinois Condominium Property Act does not prevent derivative claims by homeowners, the court wrote, so it saw no reason to deviate from caselaw on derivative actions.

Appeals Court Rules Small Business Cannot Sue Bank Over Embezzlement

January 8, 2009 | Peter S. Lubin and Patrick Austermuehle

A small business may not sue a bank for allowing a minority shareholder to embezzle, the Illinois Second District Court of Appeal has ruled. In Time Savers, Inc. v. LaSalle Bank, N.A., 02-06-0198 (Feb. 28, 2007), the company had sued its bank for breach of contract, common-law fraud, conspiracy to defraud, aiding and abetting and violating the Illinois Fiduciary Obligations Act.

The case stems from bad loans taken out by the minority shareholder in construction and maintenance equipment supplier Time Savers (TSI), Stephen Harrison. He owned 20% of the company and shareholder Lawrence Kozlicki owned the remaining 80%. Harrison also owned another business, RDSJH Equipment Venture, that does the same kind of equipment supply business. Kozlicki has no ownership interest in RDSJH, but the two companies did business together. Between 1997 and 2001, Harrison, through TSI, refinanced existing loans and took out new ones with LaSalle Bank seven times. With these loans, Harrison financed new equipment purchases for RDSJH; the equipment was then rented to TSI, allowing RDSJH to enrich itself at TSI’s expense.

Kozlicki and TSI contended that LaSalle suspected or knew that the loans were for Harrison’s personal benefit, but failed to alert Kozlicki or investigate further. TSI pointed to various documents and communications, as well as the fact that some funds were deposited into an RDSJH account. The complaint at issue in this appeal is the third amended complaint by TSI; the company voluntarily dismissed the original complaint and the DuPage County trial court dismissed the first, second and third amended complaints at LaSalle’s request. (The bank also moved for sanctions after the third amended complaint was dismissed.) The final dismissal is the subject of this appeal.

Using Forensic Accountants and Certified Fraud Examiners in Shareholder, Business, Divorce and Commerical Litigation

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

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.

Shareholders Cannot Sue Bank One Officers, Appeals Court Decides

July 22, 2008 | Peter S. Lubin and Patrick Austermuehle

In a shareholder derivative action related to 2004’s merger between Bank One and J.P. Morgan Chase, the Illinois First District Court of Appeal upheld the dismissal with prejudice of a complaint filed by Bank One shareholders. Shaper v. Bryan, No. 1-05-3849 (March 8, 2007).

The dispute grew out of the high-profile merger of Bank One with J.P. Morgan Chase. As part of the deal, J.P. Morgan agreed to issue stock to each Bank One shareholder worth 14% more than the Bank One shares’ closing price on the day of the merger. In other words, Bank One shareholders received extra value as part of the deal. Bank One CEO James Dimon would serve as president and COO of J.P. Morgan Chase for two years, after which he would take over for the existing CEO. These two men negotiated both the premium and the succession plan themselves.

Media reports soon appeared, suggesting that Bank One shareholders could have gotten a much larger premium from another company or through another negotiator. The media also reported that Dimon was eager to move to New York and take over as the leader of J.P. Morgan Chase, offering to do the deal for no premium at all if he could start as CEO without waiting the two years.

Will Executor’s Bad Faith Trumps Shareholder Stock Redemption Agreement By Decedent

July 21, 2008 | Peter S. Lubin and Patrick Austermuehle

In a shareholder and breach of fiduciary duty dispute arising from a probate case involving a closely held corporation with two shareholders, the Illinois Third District Court of Appeal has ruled that a shareholder agreement made by a decedent does not allow the remaining shareholder to execute the decedent’s will in bad faith. In re Estate of Talty, No. 3–06–0669 (Oct. 29, 2007).

Thomas Talty owned 50% of a closely held corporation (an auto dealership in Morris, Illinois), with his brother William Talty. They each also owned half of the land the dealership was built on, and had an interest in half of an adjoining parcel of land owned by a land trust. Thomas wrote a will in 2000 naming William as executor and naming Thomas’s wife, Helen Talty, as sole residual beneficiary of the estate.

The will gave William the right to purchase Thomas’s shares of the dealership from his estate, but required that the purchase price be determined by an independent appraiser appointed by the probate court. Similarly, it gave William the right to purchase Thomas’s half of the land, but at fair market value set by an independent appraiser approved by the probate court. Separately, in 2001, William and Thomas made a corporate agreement allowing their company to buy the shares of any deceased shareholder. It specified that the fair market value of the shares should be determined by an accountant agreed on by the company and the decedent’s representative, or, if they couldn’t agree, appointed by the probate court.

Shareholder May Withdraw Complaint, Appeals Court Rules in Corporate Dispute

July 18, 2008 | Peter S. Lubin and Patrick Austermuehle

A minority shareholder may withdraw his complaint under the Illinois Business Corporation Act of 1983, because the majority shareholder failed to meet requirements of that law, the Illinois Third District Court of Appeal ruled in an Illinois shareholder dispute lawsuit. Lohr v. Havens, 3-06-0930 (Nov. 11, 2007).

Charles Lohr owned a large minority of the stock in Phoenix Paper Products, Inc., a closely held private corporation in Illinois. He and another shareholder, James Durham, became concerned about possible financial mismanagement by the majority shareholder and president, Terry Havens, and their accountant, Samuel Morris. In months of correspondence, they accused Havens and Morris of taking unspecified inappropriate actions without shareholder approval.

This culminated in a 2003 lawsuit by Lohr alleging that Havens and Morris were misusing the company’s resources and acting illegally. Count I of the suit asked the court to either order a buyout of all Lohr’s stock or dissolve the company. Havens filed a timely election to buy Lohr’s shares, but Lohr accused Havens of illegally doing this without shareholder approval. After two years of discovery, Lohr asked to withdraw Count I and its associated demands, but Havens objected. The trial court found that because Havens hadn’t notified shareholders about the election, it was invalid, allowing Lohr to dismiss Count I of his complaint. Havens appealed.

LLC Members Owe Company, Manager No Fiduciary Duty, Appeals Court Rules

July 17, 2008 | Peter S. Lubin and Patrick Austermuehle

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.)