Shareholders begin new businesses full of hope and the promise of success, but can face difficult choices when they encounter unexpected operational challenges or they discover that they are not really compatible as "partners" with their felllow-shareholders. This is particularly true in closely-held businesses, where there may be no market for company shares and an absence of potential buyers that might provide an exit mechanism, resulting in valuation disputes. In addition, ownership of closely-held businesses is often structured in such a way that results in paralyzing operational deadlocks when the owners disagree.
The Illinois Business Corporation Act (the "Act") provides remedies to address operational deadlocks, including those available under Section 12.56, which was devised specifically to deal with situations where, among other things, the directors or shareholders are deadlocked, or those in control of the corporation have acted or are acting in a manner that is illegal, oppressive, or fraudulent with respect to the shareholder, director or officer seeking relief. Such remedies include court-supervised buy-outs of one shareholder by another. However, care is required in exercising rights under Section 12.56 as an exercise of rights may generate unintended results and inattention to specific notice and other requirements or procedures may bar Section 12.56 remedies.
A frustrated shareholder who seeks simply to be bought out should understand that filing a petition for a court-ordered sale of his shares under Section 12.56 may saddle him with a court-determined valuation that he may consider inadequate. In addition, if he changes his mind, he may be forced to sell his shares if the corporation or another shareholder elects to purchase his shares at fair value within 90 days after he files his petition, since his election to sell the shares is irrevocable.
A shareholder who invokes Section 12.56 remedies but does not seek a buy-out of his shares may avoid a forced sale to another shareholder. Prior to the 2005 amendment of Section 12.56, other shareholders could demand to purchase the shares of any shareholder who filed a petition for any relief under Section 12.56. The 2005 amendment bars such a demand by defendant shareholders unless the petitioning shareholder includes a buy-out among the remedies sought. Commentators have noted that the amendment removes some flexibility in resolving shareholder disputes since it deprives defendant shareholders one means of addressing a complainant.
Notice and procedural issues can also create a problem, as illustrated by the recent decision in Lohr v. Havens, et. al. Charles Lohr and Terry Havens organized Phoenix Paper Products, Inc. ("Phoenix"), a closely-held company. Lohr and Havens owned 44 and 56 shares, respectively. Two other shareholders owned 5 shares each. Lohr and one of the other two shareholders questioned certain accounting methods and handling of operations. After months of haggling, they concluded that Havens was acting in an illegal and oppressive manner. Lohr filed suit under Section 12.56 and requested that the court order Phoenix, or one or more of its shareholders, to purchase all of his shares for fair value, or alternatively, order dissolution of the corporation.
Havens filed a timely election to purchase Lohr’s shares, as required by Section 12.56, and specified four alternate buy-out proposals. Lohr responded within 30 days as required by the Act, but he noted that the Act required Phoenix to provide notice of the election to all shareholders within 10 days of its receipt. Lohr requested proof that such notice was given. Following two years of discovery, Lohr, for some unknown reason, moved that the buy-out proceedings be dismissed. His reason was that he never received the requested evidence of Phoenix’s 10-day notice to the shareholders.
Havens objected to Lohr’s motion. The trial and appellate courts both ruled in Lohr’s favor. According to the courts, the language of Section 12.56 was clear and unambiguous. It requires a corporation to provide all shareholders written notice of a shareholder’s election to purchase the shares of a complainant within 10 days following the filing of an election under Section 12.56. The courts noted that the notice requirement is mandatory, not permissive. The purpose of the notice is to enable each remaining shareholder an opportunity to buy a proportionate number of shares from the departing shareholder so as to preserve the relative share ownership percentages. If the corporation fails to provide the required notice, the election to purchase is invalid and unenforceable. Lohr prevailed on his motion and was successful in obtaining an order dismissing the buy-out count of his complaint.
This case illustrates how a statutory remedy intended to help one shareholder may create extreme results against another. If you face a potential forced buy-out situation, please confer with counsel to ensure you understand available remedies and the appropriate steps necessary to reach your desired result.
* * * * *
We represent shareholders in their closely-held business issues. Please do not hesitate to contact us if you have any questions about the Illinois Business Corporation Act, shareholder disputes, the reported case, or any other matter.