Minority Oppression and the Right to Dividends

Generally, state law, including Illinois law, does not require a company to issue dividends.  Moreover, it normally is within the discretion of the board of directors of a company to decide whether to issue a dividend and their discretion is protected by the “business judgment rule.”  On the other hand, the right to receive dividends is one of the fundamental benefits of being an equity holder.  In the case of a closely held company, where there is no public market for a dissatisfied equity holder to sell his or her shares, claims for shareholder oppression and breach of fiduciary duty will come into play and offer some protection to a minority interest holder where the majority holder is improperly denying the right to dividends by: (a) stock piling cash; or (b) manipulating the company’s finances to eliminate cash through excessive salaries and bonuses, reimbursement of personal expenses, misappropriation and self-dealing transactions.

The business judgment rule is often inapplicable in withheld dividend cases for closely held companies because it typically applies only where the decision maker is a disinterested party, which is rare in closely held companies.  Likewise, a company’s interest in managing its own affairs does not include the right to substantially defeat the reasonable expectations of a minority equity holder.

Nevertheless, courts in Illinois and elsewhere have struggled with the task of balancing the competing interests of deferring to the dividend decisions of those in control on the one hand, and minority shareholders, on the other.  For example, much has been written about seemingly inconsistent rulings on this topic by courts in Texas, in particular.  See www.txbusinessdivorce.com.  For more on the subject, see Douglas K. Moll, Shareholder Oppression & Dividend Policy in the Close Corporation, 60 Wash. & Lee L. Rev. 841 (2003), http://scholarlycommons.law.wlu.edu.

(This is for informational purposes and not legal advice.)

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The Intersection of Business Divorce and Marital Divorce

stock-photo-quarryOn occasion, the worlds of business divorce and marital divorce intersect. One such case is In re Marriage of Schlichting, 2014 IL App (2d) 140158 (2014). There, the divorce court was dividing the marital property of Larisa and Bruce Schlichting, and questions arose about how to value and divide Larisa’s ownership interest in an LLC that owned and operated a quarry. Larisa owned a 20% interest, and several of Bruce’s family members also owned interests. The record did not specify why Bruce was not a member. However, Bruce had a history of litigating against his family.

The LLC’s operating agreement had a buyout procedure in the event a member was forced to sell his or her interest as part of a divorce. It provided that the value of the interest would be the greater of the member’s pro rata portion of the overall value of the LLC, as determined by (1) the LLC’s accountant; and (2) the divorce court. Larisa wanted to keep her interest in the LLC despite the divorce, whereas Bruce wanted to force the sale of her interest under the provision in the operating agreement. However, Bruce believed the value of the interest was significantly higher than the LLC’s accountant had provided.

Still, he did not introduce any evidence or otherwise attempt to convince the divorce court that the accountant’s value was too low. Although the LLC’s operating agreement restricted the sale of membership interests to outsiders, the divorce court ordered Larisa to sell her interest to Bruce at a price based on the accountant’s value, which in turn would allow Bruce, as a member of the LLC, to pursue a higher valuation at a later date in order to effectuate a higher cash distribution.

In doing so, the divorce court relied on the well established principle that where marital property such as a business is not susceptible to division, the court may award the property to one spouse, subject to payment to the nonacquiring spouse for the interest lost, either by offsetting other marital property or by cash.

The appellate court reversed, holding that the trial court abused its discretion in ordering Larisa to violate the LLC’s operating agreement and sell her interests to Bruce. If Bruce believed the interest was worth more than the accountant’s valuation, he had the right to have the divorce court set a higher valuation. Moreover, the divorce court abused its discretion by encouraging Bruce — who already had a history of litigation with his family — to pursue future litigation as a new member of the LLC.

(This is for informational purposes and is not legal advice.)

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Two-Member LLC Deadlock

Stock Photo - GunfightPeter Mahler’s blog on New York Business Divorce recently ran an excellent feature on Avoiding Deadlock in Two-Member LLCs, based on insight from New Hampshire Lawyer John Cunningham.

The post focuses on four types of deadlock-avoidance provisions espoused by Cunningham: dispute resolution, “shotgun” or “Texas shoot-out” buy sells, sales of business, and drag along/tag-a-long provisions.

If you are in the formation stage of your LLC, or considering amendments, Mahler’s post is an excellent read. In addition, Cunningham has his own blog on operating agreements, appropriately called Cunningham on Operating Agreements.

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Individual’s Use of Company Funds to Defend Business Divorce Cases

Cash Register Photo for MM BlogUnfortunately, corporate officers and directors and LLC managers and members may find themselves involved in business divorce cases. Until these lawsuits reach their ultimate conclusion, these individuals may steadily accrue significant legal fees and, when they do, they will inevitably turn to the corporation or LLC for payment of these fees.

In this context, the term “indemnification” refers to the right of the individual to ultimately be reimbursed for these legal fees. In contrast, the term “advancement” refers to immediate interim relief for ongoing legal expenses, where the funds are advanced on credit while awaiting a final determination on indemnification.


Typically, a corporation’s bylaws provide that the corporation may indemnify an officer or director for legal fees incurred as a result of actions taken in the individual’s role as officer or director. Consequently, individual clients often ask whether the business can pay the legal fees that they are incurring while defending a business divorce case — as those fees are accruing and before a final disposition of the case.

First, corporate officers and directors may be indemnified in situations where they acted in good faith and in a manner they reasonably believed to be in, or not opposed to, the best interests of the company. 805 ILCS 5/8.75(a). However, the determination of whether indemnification is proper under this standard must be made by: (a) the majority vote of the directors who are not parties to such suit, even though less than a quorum; (b) by a committee of such directors, even though less than a quorum, designated by a majority vote of such directors; (c) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion; or (d) by the shareholders. 805 ILCS 5/8.75(d).

Second, attorneys’ fees incurred by an officer or director in defending a civil suit may be paid by the corporation in advance of the final disposition of the case upon receipt of an undertaking — such as a promissory note — by the officer or director to repay the advanced funds if it is ultimately determined that he or she is not entitled to be indemnified by the corporation. 805 ILCS 5/8.75(e). The advancement of funds is not preconditioned on a finding of the directors, independent counsel, or shareholders that indemnification is proper. Johnson v. Gene’s Supermarket, Inc., 117 Ill. App. 3d 295 (4th Dist. 1983).


The Illinois LLC Act provides that an LLC may reimburse a member or manager for liabilities incurred by him or her in the ordinary course of business or for the preservation of the LLC’s business or property. 805 ILCS 180/15-7. However, in contrast to the Business Corporation Act, the LLC Act does not address: (a) the requisite standard for determining whether indemnification is proper; or (b) advances prior to a final determination.

It is often said that LLC’s are “creatures of contract” because state LLC acts give maximum effect to the principle of freedom of contract and the enforceability of limited liability agreements. Therefore, these issues, which are not expressly covered in the Illinois LLC Act, should be expressly covered in the LLC’s operating agreement. E.g., Fillip v. Centerstone Linen Services, LLC, 2014 WL 793123 (Del. Ch. Feb. 20, 2014) (applying Delaware law and requiring advances to former manager and officer of LLC).

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Lessons for Business Partners Who Own Real Estate Together to House their Professional Practices

A great article on lessons in partnership law (link), especially for partners who own real estate together and use it to house their professional practices, appears in a recent issue of the Chicago Daily Law Bulletin. It was written by my partner Mitchell L. Marinello on Vedam v. Reddi, 2013 Ill. App. 113803-U (1st Dist) and the case’s lessons which include:

  • First, “that partners, through their actions, can terminate a written partnership agreement though silent abandonment or can extend a partnership agreement that would otherwise be expired by continuing to adhere to its provisions.”
  • Second, “a co-tenant who voluntarily abandons real property is generally not entitled to rent from a co-tenant who continues to occupy the premises.”
  • Third, “litigants need to be vigilant in defending their rights,” through appeals and cross-appeals if necessary.
  • Fourth, “there are obvious advantages to hiring a professional accountant to prepare financial figures” and whoever prepares financial claims should include their calculations.

(This is for informational purposes and is not legal advice.)

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A Court Has Wide Discretion in Granting Relief from Oppressive or Illegal Conduct by a Majority Shareholder

Stock Photo - Options 041516When a minority shareholder in a closely held corporation seeks relief from oppressive or illegal conduct by the majority shareholder, a court has wide discretion in deciding what type of relief is appropriate. The Illinois Supreme Court explored what options are available in Schirmer v. Bear, 174 Ill.2d 63 (1996).

In Schirmer, the plaintiff owned 38.9% (187 shares) of the outstanding shares of an insurance agency (the “Agency”), and one of the defendants — William — owned the other 61.1% (294 shares). For about eight years, plaintiff and William had a good working relationship, but things took a turn for the worse after that. Among other things, William refused to allow plaintiff to exercise his option to purchase additional shares, refused to pay bonuses or profit sharing for the year, amended the bylaws to reduce the number of directors on the board of the Agency from three to one, and then nominated and elected himself the sole director. As sole director, William appointed himself president and treasurer of the Agency, and appointed his wife secretary. William removed plaintiff’s name from all the corporate accounts. Plaintiff received no further income, bonuses or other benefits from the Agency. The Agency did offer to purchase plaintiff’s shares, but for less than half of what plaintiff believed they were worth. Plaintiff was informed that if he refused to sell his shares, he faced the possibility of remaining a minority shareholder for quite some time with no input on how the Agency was run.

As a result of William’s conduct, plaintiff sued, alleging that the defendants (including William) wasted corporate assets and acted in an illegal, oppressive and fraudulent manner. Plaintiff requested dissolution of the Agency, or in the alternative, an order requiring the Agency to buy his shares.

After trial, the court concluded that plaintiff’s removal was obviously illegal but that plaintiff failed to prove he was harmed by it. The court declined to exercise its discretion under Section 12.50 of the Illinois Business Corporation Act (the “Act”) to dissolve the corporation, but initially held that Plaintiff could recover the fair value of his shares pursuant to Section 12.55 of the Act. However, the trial court later reversed itself, and held that the remedy of share purchase could not be awarded unless plaintiff had proven that the Agency should be dissolved, which he had not.

Plaintiff appealed. The appellate court reversed, and held that plaintiff did not have to establish that dissolution is justified before the alternative remedy of a forced purchase of shares could be granted under Section 12.55 of the Act.

Defendants appealed. The Illinois Supreme Court affirmed the appellate court, and held that Section 12.55 of the Act provides a basis for relief independent of dissolution pursuant to Section 12.50. The Court went on to explain that before the enactment of Section 12.55, minority shareholders were left without a remedy in those instances where the majority shareholders’ conduct, while wrongful, did not justify dissolving the corporation. Section 12.55 was specifically enacted to correct this problem, by increasing the remedies available to minority shareholders and by enlarging the discretionary authority of trial courts to award relief in situations which do not warrant dissolution, but which do warrant some other, less severe remedy. Therefore, Section 12.55 affords trial courts broad discretion in deciding to award forced purchase of shares, so long as the minority shareholder can prove that the majority shareholder engaged in misconduct under the Act.

While the Schirmer appeal was pending, the Illinois General Assembly revised the Act to afford courts even more remedies to address, among other things, actions by directors or shareholders that are found to be illegal, oppressive or fraudulent, or the misapplication or wasting of corporate assets. Section 12.55 of the Act now applies to public corporations. An additional section — Section 12.56 of the Act — was enacted to govern shareholder remedies for nonpublic corporations. Section 12.56(b) provides a broader range of remedies than the Schirmer court had available to it, including, but not limited to:

• The performance, prohibition, alteration, or setting aside of any action of the corporation or of its shareholders, directors, or officers of or any other party to the proceedings;

• The cancellation or alteration of any provision in the corporation’s articles of incorporation or by-laws;

• The removal from office of any director or officer;

• The appointment of any individual as a director or officer;

• An accounting with respect to any matter in dispute;

• The appointment of a custodian to manage the business and affairs of the corporation to serve for the term and under the conditions prescribed by the court;

• The appointment of a provisional director to serve for the term and under the conditions prescribed by the court;

• The submission of the dispute to mediation or other forms of non-binding alternative dispute resolution;

• The payment of dividends;

• The award of damages to any aggrieved party;

• The purchase by the corporation or one or more other shareholders of all, but not less than all, of the shares of the petitioning shareholder for their fair value; or

• The dissolution of the corporation if the court determines that no remedy specified in subdivisions (1) through (11) [of Section 12.56(b)] or other alternative remedy is sufficient to resolve the matters in dispute. In determining whether to dissolve the corporation, the court shall consider among other relevant evidence the financial condition of the corporation but may not refuse to dissolve the corporation solely because it has accumulated earnings or current operating profits.

Further, Section 12.56(c) of the Act makes clear that the above remedies are not exclusive of other legal or equitable remedies which the court may, in its discretion, impose. Thus, after Schirmer and the amendment, it is clear that a trial court has great discretion in granting a minority shareholder relief for oppressive or illegal conduct by a majority shareholder.

Julie Johnston-Ahlen, Contributing Author

(This is for informational purposes and is not legal advice.)


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Judicial Expulsion of a Member-Manager Triggers Dissolution

Stock Photo - Manager OutAre you a member-manager of an LLC in Illinois? Your expulsion as a member of the LLC may result in your removal from “manager” status and may even bring about the dissolution of the LLC. The Illinois appellate court provided a cautionary example of such a situation in Tully v. McLean, 409 Ill. App. 3d 659 (2011). The court held that the judicial expulsion of a member from a LLC amounted to the “removal” of a manager of that LLC. That removal, the court held, triggered the dissolution provision in the LLC’s operating agreement.

Plaintiff Thomas M. Tully (“Plaintiff”), a member of the member-managed limited liability company, Old Town Development Associates (“OTD”), brought an action for breach of fiduciary duty and fraud arising from Defendants’ management of OTD. One defendant was OTD’s Managing Member (or the “Manager”).

According to its operating agreement, OTD’s business was to be conducted by a manager and that the manager also had to be a member. The operating agreement provided for the dissolution of OTD “only in the event … [o]f the death, removal, liquidation, dissolution, withdrawal or bankruptcy of a Manager.”

Plaintiff noticed transfers between OTD and unrelated entities affiliated with Defendants. Plaintiff confronted Defendants about the transfers, and Defendants admitted that it was their regular practice to move funds among the other business entities they managed, and that no interest was paid on the transfers. Defendants told Plaintiff that the transfers were recorded on the books and were periodically returned or paid back. Plaintiff requested that Defendants stop the practice. Defendants agreed.

However, a few years later, Plaintiff learned that the transfers were still occurring and, instead of noting the transfers on OTD’s books, Defendants had been hiding them. Plaintiff demanded that the Manager step down as manager of OTD and that all Defendants cease involvement with OTD. Defendants refused and Plaintiff filed his complaint.

In his complaint, Plaintiff sought the expulsion of the Manager as both a member and the LLC’s manager pursuant to section 35-45(6) of the Illinois Limited Liability Company Act (805 ILCS 180/1-1 et seq) (the “Act”). The trial court first ordered the Manager to give up its control of OTD and appointed Plaintiff as the sole manager for the duration of the litigation. In a counterclaim, Defendants sought the dissolution of OTD because, they argued, the termination of the Manager’s member status necessarily terminated its manager status, which, in turn, triggered the above-quoted dissolution provision in the operating agreement.

The trial court then held a hearing on Plaintiff’s request to expel the Manager and on Defendants’ counterclaim to dissolve OTD. The court resolved both issues in favor of Plaintiff. It ordered the Manager to be “judicially expelled and disassociated from OTD.” Notably, the court found that the dissolution of OTD was not warranted.

Defendants appealed the trial court’s denial of their request to dissolve OTD, arguing that the judicial expulsion of the Manager necessarily triggered the dissolution provision in the operating agreement.

To decide the dissolution question, the appellate court noted that the operating agreement provided that OTD would be dissolved “only in the event … [o]f the death, removal, liquidation, dissolution, withdrawal or bankruptcy of a Manager.” The operating agreement was silent on what constituted a “removal” of a manager. Turning to the Act, the court explained that a member is dissociated from a limited liability company upon a “member’s expulsion by judicial determination.” The court found that the judicial expulsion of the Manager as a member constituted its “removal” as manager under OTD’s operating agreement, which, in turn, triggered the dissolution provision in the operating agreement. Accordingly, the appellate court remanded the case for dissolution proceedings.

There are at least two lessons to be learned from Tully. First, as a member-manager, one should refrain from any conduct that jeopardizes your member status. Any wrongful conduct may end not only your member status, but your status as manager as well. Second, a court may strictly enforce the dissolution provisions of your operating agreement, even if the dissolution is sought by the wrongdoer, as was the case in Tully.

Eileen E. Boyle, Contributing Author

(This is for informational purposes and is not legal advice.)

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In Which Court?

Supreme Court Image for MM BlogAn involuntary judicial dissolution is one of the most powerful tools available to a lawyer advising a client seeking a business divorce. Once the client decides to pursue an involuntary judicial dissolution, an attorney’s first question should be: in which court? It is often the case that even if all of the parties are citizens of the same state, those parties formed their entity under the laws of another state. Under those circumstances, can the parties ask their home state court to judicially dissolve an entity formed under the laws of a foreign state?

This issue was recently raised with respect to a business divorce among the owners of the Delaware LLC that owned the Philadelphia Inquirer and Philadelphia Daily News newspapers. Certain members sought judicial dissolution in Pennsylvania state court on the grounds that business’s operations were in Pennsylvania, whereas other owners sought judicial dissolution in Delaware state court on the grounds that the LLC was a creation of Delaware law. Ultimately, the Pennsylvania court declined to exercise jurisdiction, and the Delaware court presided over the proceedings.

Two Illinois Supreme Court cases from 1910 provide that Illinois courts lack the power to dissolve a business entity created under the law of another state and, therefore, they should decline to exercise jurisdiction over a claim for judicial dissolution over a foreign entity. Consequently, if the business at issue is a Delaware corporation or Delaware LLC, it is likely that an action to judicially dissolve that business should be filed in Delaware — even if the business is owned by Illinois citizens and operated in Illinois.

This topic is discussed in considerable detail in an excellent article written by friends Peter B. Ladig and Kyle Evans Gay called Judicial Dissolution: Are the Courts of the State that Brought You In the Only Courts that Can Take You Out? The Business Lawyer; Vol. 70, Fall 2015.  Link.

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Dissolution and the End of Partners’ Fiduciary Duties

Stock Photo Partnership

Sirazi v. Panda Express, Inc., No. 08 C 2345, 2011 WL 6182424 (N.D. Ill. Dec. 13, 2011), affirms that “[t]he partnership relationship does not extend to all affairs and transactions between the partners . . . and when the partners have entered into an arm’s length transaction in order to effect dissolution, their relationship is not fiduciary in nature.”

At the center of Sirazi is a partnership originally entered into by and between Rezko Concessions, Inc. (“Concessions”), which was controlled by Antonin “Tony” Rezko (“Rezko”), and Panda Express.  In 1998, a few years after the partnership was formed, Concessions transferred its interest to PE Chicago, LLC (“PE Chicago”), another entity controlled by Rezko.  The court in Sirazi considered whether Panda Express breached its fiduciary duty to PE Chicago when, in 2006, it bought out PE Chicago’s interest in the partnership.

By 2006, Panda Express wanted to be rid of Rezko as a partner.  Rezko was facing dire legal and financial threats, including his indictment (and subsequent conviction) on a variety of criminal charges, and he and his companies owed more than $6 million to Panda Express.  After Panda Express declined Rezko’s request for yet another loan, Rezko and Panda Express agreed that Rezko would sell PE Chicago’s fifty-percent partnership interest to Panda Express at the price proposed by Panda Express.  Rezko did not have counsel representing him in this transaction, but the contract executed by the parties contained a statement that each party had a full opportunity to seek advice of counsel.

After Rezko was no longer in control of PE Chicago, PE Chicago claimed, among other things, that Panda Express violated a fiduciary duty it owed to PE Chicago by paying a low price for PE Chicago’s interest.  Panda Express argued that it did not owe fiduciary duties to PE Chicago at the time the sale was negotiated and carried out.  Specifically, Panda Express argued that even though partners typically owe each other fiduciary duties under Illinois law, those duties cease to exist once the partnership has been dissolved and the partners have adverse interests.  The court agreed with Panda Express, holding that Panda Express did not owe a fiduciary duty to PE Chicago — and thus could not have breached a fiduciary duty by offering PE Chicago a low price or by taking advantage of Rezko’s financial distress — because the sale would terminate the partnership and the parties had directly adverse interests.

Accordingly, it is important for partners to be aware that if they engage in an arm’s length transaction with each other, and the transaction involves adverse interests and results in a dissolved partnership, they are no more responsible to each other than they would be to any other third party.

Amanda M.H. Wolfman, Contributing Author

(This is for informational purposes and is not legal advice.)

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Can an LLC Sue or Be Sued Based on Events That Occurred When It Was Dissolved?

Stock Photo - Reinstated 070915According to at least one Illinois Appellate Court, an LLC can sue or be sued based on events that occurred when it was dissolved if the LLC is later reinstated.

In Revolution Madison, LLC v. Eccles, 2015 IL App (2d) 140876-U, the court analyzed a lawsuit filed by an LLC that was administratively dissolved in 2009 and reinstated as an LLC in 2013. The lawsuit was based on events that occurred in 2011, pursuant to a contract entered into by the plaintiff LLC and the defendant in 2007.

In the trial court, the defendant argued, unsuccessfully, that the plaintiff LLC’s original and amended complaints should be dismissed because the plaintiff was not reinstated as an LLC until after it filed its original complaint. The appellate court analyzed the reinstatement provisions of the Illinois Limited Liability Act (the “LLC Act”), 805 ILCS 180/35-40, and case law involving the dissolution and reinstatement of corporations, and affirmed the trial court’s rejection of the defendant’s argument.

The appellate court first noted that the reinstatement provisions of the LLC Act “are silent concerning claims that arise while an LLC is dissolved.” It then distinguished the plaintiff LLC from the corporation in A Plus Janitorial Company v. Group Fox, Inc., 2013 IL App (1st) 120245 — which was dissolved, never reinstated and not permitted to sue for claims that arose after it was dissolved — and analogized the plaintiff LLC to the corporation in Henderson-Smith & Associates v. Nahamani Family Service Center, Inc., 323 Ill. App. 3d 15 (1st Dist. 2001) — which was dissolved, later reinstated and permitted to sue for claims that arose while it was dissolved. The appellate court explained that while “[n]o Illinois case directly interprets” the relevant provision of the LLC Act, 805 ILCS 180/35-50(d), that provision “mirrors” the reinstatement provision of the Business Corporation Act of 1983, 805 ILCS 5/12.45(d), which was interpreted in Henderson-Smith.

Ultimately, the court in Revolution Madison held that the plaintiff LLC’s “subsequent reinstatement cured any defect in its capacity to maintain suit.” In so holding, the court expressed its view that “the fiction of uninterrupted corporate existence promotes stability, certainty and predictability in business transactions, as well as assuring that corporations cannot abuse administrative dissolution and subsequent reinstatement to avoid legitimate debts.”

Although Revolution Madison is an unpublished opinion and may yet be appealed, the appellate court’s reasoning provides some degree of guidance when considering litigation involving dissolved or formerly dissolved LLCs.

Contributing Author Amanda M.H. Wolfman

(This is for informational purposes and is not legal advice.)


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