Roberts v. Zimmerman, et al., 2021 IL App (2d) 191088-U provides a useful primer on the pleadings and evidence required to sustain a breach of fiduciary duty and shareholder oppression claim against a corporate officer and the contours of the business judgment rule defense to those claims.
The case involved three separate but related lumber buying companies: Outstanding, Our Wood Loft, Inc. (“OWL”), and Lake City Hardwood (“Lake City”). OWL is owned 1/3 by the two plaintiffs and 2/3 by the defendant majority shareholder. Lake City is owned by the majority shareholder’s son.
Plaintiffs’ salient claim was that OWL’s majority shareholder breached his fiduciary duties to the company and minority shareholders by buying lumber from Lake City at a higher price than he could have paid other vendors. According to the plaintiffs, the net result of the majority shareholder’s actions was a depletion in OWL profits over a multi-year span. The fact that the director was paying the increased lumber prices to his son’s company created additional bad optics and provided more ammunition for the plaintiffs’ lawsuit.
Plaintiffs’ alleged breach of fiduciary duty and shareholder oppression under Sections 12.56(a)(3)(oppressive conduct) and 12.56(a)(4)(misapplication of corporate funds and/or waste) of the BCA. Plaintiffs also joined an aiding-and – abetting claims against the majority shareholder’s son and wife. Plaintiffs alleged these latter defendants were complicit in the majority shareholder’s scheme to enrich his son’s Lake City business to the detriment of OWL.
The trial court dismissed all claims except for the breach of duty claim premised on diversion of profits. After a bench trial, the trial court found in favor of the majority shareholder on this surviving claim on the basis that Plaintiffs failed to prove compensable damages. Plaintiffs appealed.
Reversing, the appeals court first examined Illinois breach of fiduciary principles in the context of a close corporation shareholder dispute.
Breach of Fiduciary Duty
Corporate officers owe a fiduciary duty of loyalty to the corporation and are precluded from actively exploiting their positions within the corporation for their own personal benefit or impeding the corporation’s ability to conduct the business for which it was formed.
Here, the Court found the majority shareholder owed a fiduciary duty of loyalty to act in OWL’s best interest, to deal on behalf of OWL fairly and honestly, and seek to maximize OWL’s profits. This duty included ensuring that OWL got the best price for lumber it bought from third parties.
The Court held that the majority shareholder breached his fiduciary duty by paying inflated lumber prices to his son’s company – Lake City.
The Court rejected Defendant’s business judgment rule (BJR) defense. Under the BJR, courts will not interfere with business decisions of a corporate officer even if it seems that a more prudent decision could have been made. However, a corporate officer cannot use the rule as a shield for conduct that does not rise to the level of due care.
Here, the court gave the BJR a cramped construction: it found that the rule only applies to honest mistakes in judgment and activities over which a corporate officer has discretion – such as whether an officer spent too much or too little on advertising, salaries, and the like. The Rule does not apply to situations where challenged conduct subverts the rights of a corporation. A corporate officer does not have discretion to divert profits from a corporation.
According to the Court, with minimal investigation, the majority shareholder would have discovered that Lake City was profiting at the expense of OWL by selling lumber at inflated prices to OWL. [¶ 71]
Shareholder Oppression and Aiding-and-Abetting Claims
Reversing the Section 2-615 dismissal of the Plaintiffs’ shareholder oppression and aiding-and-abetting claims, the Court noted that shareholder oppression is not limited to acts that are illegal, fraudulent, or that involve mismanaged funds. Instead, shareholder oppression applies to a wide gamut of conduct including a course of heavy-handed and exclusionary conduct and self-dealing.
To state a colorable aiding-and-abetting claim in Illinois, a plaintiff must allege (1) the party whom the defendant aids performed a wrongful act that caused an injury, (2) the defendant is generally aware in his or her role as part of the overall or tortious activity at the time or she provides assistance; and (3) defendant must knowingly and substantially assist the principal violation.
Here, Plaintiffs sufficiently alleged enough facts to sustain both claims. The allegations that the majority shareholder overpaid for lumber at OWL’s expense and to his son’s/Lake City’s benefit sufficiently pled an actionable oppression claim.
The Court similarly held that the Plaintiffs adequately pled Lake City’s active participation in the underlying lumber purchasing scheme in the aiding-and-abetting Complaint count.
Afterwords:
Roberts cements the proposition that a majority shareholder’s diversion of corporate profits to another entity can support both a breach of fiduciary duty claim and a statutory shareholder oppression action.
The case also makes clear that shareholder oppression is not limited to acts that are illegal, fraudulent, or that involve mismanaged funds. Here, Plaintiffs allegation that the majority shareholder used an unnecessary middleman – Lake City – to which the company overpaid for lumber and lost resultant profits – was enough to make out a colorable oppression claim.
Finally, Roberts clarifies that a successful aiding-and-abetting a breach of fiduciary duty claim requires allegations of a defendant’s active participation and knowledge in/of underlying wrongful conduct. Constructive knowledge is not enough.