Shareholder and LLC Member Disputes

Most business partner disputes begin among owners, with majority control hiding information from those in the minority. Nearly all breaches of fiduciary duty amongst shareholders begin with someone hiding information. Shareholders of businesses of all sizes have a statutory right to know what is going on in the business they own part of. Fortunately, in Illinois, even a minority shareholder has a right to the records of a corporation. A shareholder has every right to examine corporate books and records to protect his interest so long as he has an honest motive and is not proceeding for vexatious or speculative reasons. If you are cut out of the operations of a business you own in Illinois you have a right to request full records of the business

When a business or its owner has a dispute with a business partner, it is important that the business and its owners obtain legal representation to protect their interests. It is also recommended that the business requires separate representation from the owner to protect its interest. We handle all aspects of shareholder, LLC member and partnership disputes defense and prosecution of claims involving:

• Breach of fiduciary duty
• Conflicts of interest and self-dealing
• Shareholder derivative actions
• Minority shareholder, LLC and partnership rights
• Excessive management compensation
• Shareholder oppression claims due to forced or unfair buy-out agreements and fair value calculations
• Failure to pay dividends or distributions
• Failure to pay earned wages or sales commissions
• Deadlocks and freeze-out disputes
• Appraisal rights

Attorney Loftus obtained a confidential settlement for the owner of 10% of a professional services practice netting nearly tens the original offer. He was able to maximize the settlement by securing the divorce file of one of the partners to prove the value of the business.

Most business partner disputes begin with the owners with majority control hiding information from those in the minority. Nearly all breaches of fiduciary duty amongst shareholders begin with someone hiding information. Shareholders of small businesses have a statutory right to know what is going on in the business they own part of. Fortunately, in Illinois, even a minority shareholder has a right to the records of a corporation. This right is stated in the Illinois Business Corporation Act which provides in 805 ILCS 5/7.75(b):

“Any person who is a shareholder of record shall have the right to examine, in person or by agent, at any reasonable time or times, the corporation’s books and records of account, minutes, voting trust agreements filed with the corporation and record of shareholders, and to make extracts therefrom, but only for a proper purpose. In order to exercise this right, a shareholder must make written demand upon the corporation, stating with particularity the records sought to be examined and the purpose therefor.”

A shareholder has every right to examine corporate books and records to protect his interest so long as he has an honest motive and is not proceeding for vexatious or speculative reasons.[1] If you are cut out of the operations of a business you own in Illinois you have a right to request full records of the business.[2] Plus the records that must be shared are not just limited to financial records or meeting minutes as the majority owners may tell you. Instead, once a purpose has been established, the shareholder’s right of inspection extends to all books and records necessary to make an intelligent and searching investigation, including all books, papers, contracts, minutes, or other instruments from which he can derive any information that will enable him to better protect his interests.[3] . “A proper purpose is one which seeks to protect the interests of the corporation as well as the interest of the shareholder seeking the information.”[4] A minority shareholder has the right to “internal investigatory reports and any and all documents received by any board member of the corporation relating to the federal investigation of the pharmaceutical company.”[5]

If the majority controlling partners fail to produce business records they face a stiff penalty. 805 ILCS 5/7.75(d) provides:

“Any officer, or agent, or a corporation which shall refuse to allow any shareholder or his or her agent so to examine and make extracts from its books and records of accounts, minutes and records of shareholders, for any proper purpose, shall be liable to such shareholder, in a penalty of up to ten per cent of the value of the shares owned by such shareholder, in addition to any other damages or remedy afforded him or her by law. …”(emphasis added)

If your partners are trying to cut you out of the business and you suspect they are up to something but have not acted yet you can file suit to obtain information and hopefully prevent the harm before it starts. Your partners will be punished with a penalty of up to ten percent the value of your ownership interest plus attorneys’ fees necessary to get a court order requiring them to provide the records requested.

Frequently our firm is retained in shareholder disputes or partnership disputes after a breach of fiduciary duty has occurred. We include a claim in our lawsuits for oppression or breach of fiduciary duty seeking relief pursuant to 805 ILCS 5/7.75(d) which helps our clients achieve complete relief faster and creates nearly automatic lability for attorney fees for the defendant.

The Illinois Business Corporation Act 805 ILCS 5/12.56 (“The Act”) allows for a minority shareholder to get paid the fair value of his or her ownership interest if he or she can prove oppression, waste, or deadlock. These claims are much easier to prove than fraud or fiduciary duty and if litigated properly can be employed to win a fair settlement quickly when alleged along with claims seeking harsh penalties.

Section 12.56(f)(6) provides that, if the parties are unable to reach an agreement on the value of the shares, the “court, upon application of any party, shall stay the proceeding under subsection (a) and shall determine the fair value of the petitioner’s shares.”[6] “The goals of dissenters’ rights statutes today are to protect minority shareholders from majority overreaching, self-dealing, and oppressive conduct in an attempt to eliminate a minority shareholder at a price below fair value, or in an attempt to transfer power to the majority.” Sitting in equity, the trial court is to ensure that the valuation conducted results in an outcome that is fair and equitable to all parties.”[7]

Section 12.56(a) of the Act provides that a shareholder may petition the circuit court for a variety of remedies if any of the following is established:

“(1) The directors are deadlocked, whether because of even division in the number of directors or because of greater than majority voting requirements in the articles of incorporation or the bylaws or otherwise, in the management of the corporate affairs; the shareholders are unable to break the deadlock; and either irreparable injury to the corporation is thereby caused or threatened or the business of the corporation can no longer be conducted to the general advantage of the shareholders; or

(2) The shareholders are deadlocked in voting power and have failed, for a period that includes at least 2 consecutive annual meeting dates, to elect successors to directors whose terms have expired and either irreparable injury to the corporation is thereby caused or threatened or the business of the corporation can no longer be conducted to the general advantage of the shareholders; or

(3) The directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent with respect to the petitioning shareholder whether in his or her capacity as a shareholder, director, or officer; or

(4) The corporation assets are being misapplied or wasted."[8]

The Illinois Supreme Court has held that the word “oppressive,” as used in the statute, does not carry an essential inference of imminent disaster, but can contemplate a continuing course of conduct. The word does not necessarily mean fraud, and even the absence of mismanagement or misapplication of assets does not prevent a finding that the conduct of the dominant director or officer has been “oppressive.” Such term is not synonymous with “illegal” and “fraudulent.”[9] “Oppressive” is defined by Webster’s Dictionary as “unreasonably burdensome; unjustly severe. Tyrannical. Overpowering to spirit or senses.”[10] The word “oppressive” is not synonymous with illegal or fraudulent.”[11] Specific instances of oppression may include testimony regarding the failure of defendant to consult with plaintiff regarding management of corporate affairs, an imperious attitude when questioned about the plaintiff’s salary and dilatory reaction to the plaintiffs’ requests.[12] Accordingly a shareholder oppression claim is easier to prove than any other business tort. When faced with a shareholder oppression claim, majority owners, officers, and controlling shareholders are left with the option of a long expensive fact intensive fight or settlement which bodes well for minority shareholders seeking to force a buyout.

When a minority shareholder is able to prove oppression as discussed above they can ask the court for several remedies the most profitable is usually the purchase of their shares for fair value.

“Fair value” as defined by statute is much more favorable to a minority shareholder than selling shares for fair market value or any other metric of value normally employed when selling an interest in a small business. The Illinois Business Corporations Act defines fair value as: “taking into account any impact on the value of the shares resulting from the actions giving rise to a petition under this Section.”[13]

The Illinois Business Corporations Act provides in pertinent part:

“(e) If the court orders a share purchase, it shall:

(i) Determine the fair value of the shares, with or without the assistance of appraisers, taking into account any impact on the value of the shares resulting from the actions giving rise to a petition under this Section…

For purposes of this subsection (e), “fair value”, with respect to a petitioning shareholder’s shares, means the proportionate interest of the shareholder in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability.

The purchase ordered pursuant to this subsection (e) shall be consummated within 20 days after the date the order becomes final unless before that time the corporation files with the court a notice of its intention to dissolve and articles of dissolution are properly filed with the Secretary of State within 50 days after filing the notice with the court.”[14]

The statute providing for this remedy uses the term “fair value” — rather than “fair market value” — as the standard used to determine the buyout price.[15] The statute further provides that “fair value” means “the proportionate interest of the shareholder in the corporation, without any discount for minority status or, absent extraordinary circumstances lack of marketability.”[16] This language is critical here where the majority owners frequently assert (likely based on outdated law) that they are entitled to a discount when purchasing the minority interest. Illinois law is clear that discounts at the shareholder level are disallowed because they result in undervaluing the dissenters’ shares while overvaluing the majority’s shares, thereby effectively punishing the minority shareholder for exercising his statutory right to dissent.[17] The whole purpose of the statute is to protect minority shareholders. A minority shareholder with competent counsel can be very powerful. Filing suit alleging shareholder oppression essentially turns the tables and puts the majority in the corner forcing settlement or an expensive fact intensive fight.

The section of the Illinois Business Corporations Act providing for this remedy uses the term “fair value” — rather than “fair market value” — as the standard used to determine the buyout price. 805 ILCS 180/35-65 The statute provides that “fair value” means “the proportionate interest of the shareholder in the corporation, without any discount for minority status or, absent extraordinary circumstances lack of marketability.”[18] This language is critical to maximizing settlement value for a partner who has been shut out of an Illinois small business. Discounts at the shareholder level are disallowed because they result in undervaluing the dissenters’ shares while overvaluing the majority’s shares, thereby effectively punishing the minority shareholder for exercising his or her statutory right to dissent.[19] The law is clear and when the issue is forced with a lawsuit the minority can take control of their financial interest.

The Illinois Business Corporations Act, (805 ILCS 5/12.56) provides:

“If the parties are unable to reach an agreement as provided for in paragraph (5) of this subsection (f), the court, upon application of any party, shall stay the proceeding under subsection (a) and shall determine the fair value of the petitioner’s shares pursuant to subsection (e) as of the day before the date on which the petition under subsection (a) was filed or as of such other date as the court deems appropriate under the circumstances.”[20]

Once a minority shareholder or partner in a business that has been locked out establishes a right to be bought out the next question is how much is the minority interest worth? This is a complex question that as a testifying expert in a case we recently tired explained, is ultimately more art than science.

Illinois courts have stated that there is no precise formula for valuing the stock in a corporation, and a trial court is to consider “[e]very relevant evidential fact and circumstance entering into the value of the corporate property and reflecting itself in the worth” of a dissenter’s shares.[21] A relevant factor is anything that might impact on the stock’s intrinsic value.[22] Some of the factors that may be relevant to a determination of fair value include the stock’s market price, the corporation’s earning capacity, the investment value of the shares, the nature of the business and its history, the economic outlook of the business and the industry, the book value of the corporation, the corporation’s dividend paying capacity, and the market price of stock of similar businesses in the industry.[23] Although “fair value” is not synonymous with “fair market value,” fair market value is another relevant factor to be considered.[24]

Ultimately, making a fair value determination is a fact-specific endeavor requiring the trial court to make an independent appraisal of the corporation, taking into account all recognized methods of valuation, whether or not advanced by the parties.[25]

According to Financial Accounting Standards Board (“FASB”)’s Accounting Standards Codification (“ASC”) 820, fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” An “orderly transaction” is a hypothetical transaction assumed to take place on the measurement date with the subject asset having been exposed to the market for the usual and customary period of time for transactions involving such assets in order to provide sufficient time for marketing activities. It is a sale where the seller is not under duress (e.g., a forced liquidation or distress sale). Fair value measurements are considered from the perspective of a market participant that already holds the asset or owes the liability. The objective of measuring fair value is to determine an exit price: the price that a known seller would receive to sell an asset or to transfer the liability to a market participant buyer.

The income approach generally relies on the expectation of future cash flows and/or earnings. In many cases we apply a Discounted Cash Flow Method (“DCF”) to estimate the Enterprise Value of the minority interest by discounting the projected future free cash flows from the business using an appropriate discount rate.

In practice, we are able to maximize settlement by engaging reputable business valuation experts early in the litigation to establish a value for the business. Settlements are achieved by establishing a clear, conservative, value for the business and not wavering from that position.

More often than not when a shareholder is locked out of a business they also are not paid their wages. Normally shareholders have agreements with the small business for regular pay in addition to the value of their ownership interest. When the business fails to pay the wages, this creates another potential claim for the oppressed shareholder or partner with stiff penalties that can be used to force an efficient resolution.

The Illinois Wage Payment and Collection Act requires that businesses promptly pay their employees earned wages and other compensation upon separation and provides employees, including executives, with enforcement tools to recover earned compensation from an employer.[26] The Act covers all employees who perform work in Illinois for an Illinois employer.[27] In order to establish a claim under the Wage Payment and Collection Act, an employee or ex-employee must prove that: (1) that the defendant was an “employer” under the Act; (2) that the parties entered into an “employment contract or agreement,” as defined in the Act; and (3) the employee is owed “final compensation” under the Act.[28] The Act empowers a judge hearing the employee’s claim to award attorney fees and costs to the employee, to be paid for by the employer.[29] The other owners of the business are personally liable because officers and directors are liable who knowingly aided or allowed a violation of the Act to occur.[30] The added element of personal liability can create tremendous leverage as part of a larger shareholder, member, or partnership claim.

The Wage Payment and Collection Act defines wages as follows: “[A]ny compensation owed an employee by an employer pursuant to an employment contract or agreement between the 2 parties, whether the amount is determined on a time, task, piece, or any other basis of calculation. Payments to separated employees shall be termed “final compensation” and shall be defined as wages, salaries, earned commissions, earned bonuses, and the monetary equivalent of earned vacation and earned holidays, and any other compensation owed the employee by the employer pursuant to an employment contract or agreement between the 2 parties.”[31] Plus severance pay is considered final compensation compensable under the Act.[32]

The Wage Payment and Collection Act includes a stiff penalty of 2% monthly interest and attorney fees.[33] The combination of personal liability for your former partners or majority shareholders and rapidly growing interest is another arrow in the quiver for an oppressed business partner.

In many small businesses in addition to having an ownership interest in the corporation the shareholders, partners, or LLC members also earn sales commissions. You are entitled to both the value of your ownership interest and your earned commissions when you leave the business.

The Illinois Sales Representative Act (“ISRA” or the “Act”, 820 ILCS 120.01 et seq.), is intended to protect the right of terminated independent sales representatives to receive timely payment of their commissions. ISRA is intended to apply to sales representative agreements that satisfy the “minimum contacts” test for jurisdiction in Illinois.[34]

The Illinois Sales Representative Act provides in pertinent part:

“(3) ‘Principal’ means a sole proprietorship, partnership, corporation or other business entity whether or not it has a permanent or fixed place of business in this State and which:

• (A) Manufactures, produces, imports, or distributes a product for sale;
• (B) Contracts with a sales representative to solicit orders for the product; and
• (C) Compensates the sales representative, in whole or in part, by commission.”[35]

The ISRA specifically provides that in cases where there is no written agreement: “If there is no contract, or if the terms of the contract do not provide when the commission becomes due, or the terms are ambiguous or unclear, the past practice used by the parties shall control” and “If neither [the contract or past practices] can be used to clearly ascertain when the commission becomes due, the custom and usage prevalent in this State for the parties’ particular industry shall control.”[36] So, even if you did not write down a separate sales commission agreement if you were paid sales commissions you are entitled to any earned commissions when you leave the business.

The penalties for a failure to pay commissions are harsh and do not require a showing of bad faith. The Illinois Sale Representative Act 820 ILCS 120/3 provides:

“A principal who fails to comply with the provisions of Section 2 concerning timely payment or with any contractual provision concerning timely payment of commissions due upon the termination of the contract with the sales representative, shall be liable in a civil action for exemplary damages in an amount which does not exceed 3 times the amount of the commissions owed to the sales representative. Additionally, such principal shall pay the sales representative’s reasonable attorney’s fees and court costs.” (emphasis added).

Just like a wage claim, a sales representative claim can be another arrow in the quiver of an oppressed minority business owner who has been locked out of business and is seeking a buyout.

• [1] Logal v. Inland Steel Industries, Inc., 209 Ill. App. 3d 304, 568 N.E.2d 152 (1st Dist. 1991).
• [2] See Hohman v. Illinois-Iowa Power Co., 305 Ill. App. 17, 26 N.E.2d 420 (Ill. App. Ct. 1940)
• [3] Weigel v. O’Connor, 57 Ill. App. 3d 1017, 373 N.E.2d 421 (1st Dist. 1978).
• [4] Logal v. Inland Steel Industries, Inc., 209 Ill. App. 3d 304, 568 N.E.2d 152 (1st Dist. 1991).
• [5] Corwin v. Abbott Labs., 353 Ill. App. 3d 848, 819 N.E.2d 1249 (2d Dist. 2004).
• [6] 805 ILCS 5/12.56(f)(6); Advanced Imaging Ctr. of N. Ill. Ltd. P’Ship v. Cassidy, 335 Ill. App. 3d 746, 749, 781 N.E.2d 664, 667, (2d Dist. 2002).
• [7] Brynwood v. Schweisberger, 393 Ill. App. 3d 339, 356, 913 N.E.2d 150, 165 (2d Dist. 2009).
• [8] 805 ILCS 5/12.56(a)
• [9] Central Standard Life Ins. Co. v. Davis, 134 N.E.2d 653, 658-659, 10 Ill. App. 2d 245, 255 (3d Dist. 1956).
• [10] Id.
• [11] Gidwitz v. Lanzit Corrugated Box Co., 170 N.E.2d 131, 135 (Ill. 1960).
• [12] Compton v. Paul K. Harding Realty Co., 6 Ill. App. 3d 488, 499, 285 N.E.2d 574, 581 (5th Dist. 1972).
• [13] 805 ILCS 5/12.56(e)(i).
• [14] 805 ILCS 5/12.56(e)
• [15] 805 ILCS 180/35-65.
• [16] 805 ILCS 5/12.56(e).
• [17] Brynwood v. Schweisberger, 393 Ill. App. 3d 339, 359 (2d Dist. 2009)
• [18] 805 ILCS 5/12.56(e) (emphasis added).
• [19] Brynwood, 393 Ill. App. 3d at 359.
• [20] 805 ILCS 5/12.56
• [21] Stewart v. D.J. Stewart & Co., 37 Ill. App. 3d 848, 853, 346 N.E.2d 475 (1976).
• [22] Independence Tube Corp. v. Levine, 179 Ill. App. 3d 911, 917, 535 N.E.2d 927 (1988).
• [23] Kalabogias v. Georgou, 254 Ill. App. 3d 740, 748, 627 N.E.2d 51 (1993).
• [24] Brynwood, 393 Ill. App. 3d at, 353.
• [25] M.G. Bancorporation v. Le Beau, 737 A.2d 513, 526-27 (Del. 1999) followed by Brynwood v. Schweisberger, 393 Ill. App. 3d 339, 353, 913 N.E.2d 150, 162 (2d Dist. 2009).
• [26] See 820 ILCS 115/1.
• [27] See §115/1; Khan v. Van Remmen, Inc., 325 Ill. App. 3d 49, 61 (2nd Dist. 2001).
• [28] See Catania v. Local 4250/5050 of the Comm’ns. Workers of Amer., 359 Ill. App. 3d 718, 722 (1st Dist. 2005); 820 ILCS 115/1
• [29] 820 ILCS 115/14.
• [30] 820 ILCS 115/13
• [31] 820 ILCS 115/4

[32] Swift v. DeliverCareRx, Inc., 2015 U.S. Dist. LEXIS 80807, *19-20, 2015 WL 3897046 (N.D. Ill. June 23, 2015) ( “Swift’s Consulting Agreement provided for Termination Payments, which fit the definition of severance. That the Termination Payments are defined—that is calculated—by reference to unpaid future wages is irrelevant. Swift is not asking for his salary as salary itself, he is asking for a payment that DeliverCare became obligated to pay when it terminated Swift. That is a severance payment; it just so happens that the severance amount is calculated by referring to his salary. The Termination Payments do count as final compensation under the Act. So if Swift can fix the complaint to plead a claim of termination without cause, then this claim can also be fixed.”)

• [33] 820 ILCS 115/14
• [34] Circuit Sys. v. Mescalero Sales, 925 F. Supp. 546 (N.D. Ill. 1996).
• [35] 820 ILCS 120/1(3)
• [36] 820 ILCS 120/1 (2)