As we have written about previously, shareholders in a corporation have two different types of claims they can assert, direct claims and derivative claims. Direct claims are filed by the shareholder for the benefit of the shareholder. Derivative claims are filed by a shareholder but for the benefit of the corporation itself. An Illinois appellate court recently considered the issue of whether a successful shareholder in a derivative action can obtain an award of attorney fees directly from the defendants personally, as opposed to from the common fund created by the judgment.
The parties were investors in a business known as 15th Street Blue Island, LLC (15BI). The plaintiffs made financial contributions totaling approximately $3.7 million to become members of 15BI. The plaintiffs received 47% interest in 15BI as “Class A Members.” An entity owned by defendants Jerry Karlik and Keith Giles, Kargil Blue Island, LLC (KBI), received a 53% interest in the company as a “Class B Member,” and was named as the manager of 15BI.
15BI was formed in 2006 for the purpose of developing condominiums on a vacant parking lot located in Chicago. After the economic crash of the global recession that began shortly thereafter, the original business plan was scrapped for a new one that involved developing rental residences, which was considered a more feasible plan under the economic conditions.
In 2006, another entity jointly owned by Jerry Karlik and Giles, Kargil Development Partners (KDP), entered into a contract to purchase a vacant parking lot (15BI Property) located at 15th Street and Blue Island Avenue in Chicago for $3.72 million. Pursuant to that agreement, KDP deposited an initial earnest money payment of $100,000 from 15BI accounts into an escrow account. In June 2007, Karlik signed a purchase agreement on behalf of 15BI to acquire property known as the Testa Parcel, for $6,250,000. This purchase agreement also required a $100,000 earnest money deposit from 15BI. In an unusual move for a buyer, Karlik later negotiated a $250,000 increase in the purchase price and provided for payment of a commission to yet another company that he and Giles jointly owned. 15BI later abandoned its efforts to buy the Testa Parcel, resulting in 15BI losing 70% of its earnest money deposit.
In 2008, Karlik and Giles sold a portion of KBI, which managed and owned a percentage of 15BI, to new investors, Gangas and Housakos, for approximately $750,000. Karlik testified that the law firm of Branson & Kahn invoiced 15BI and 15BI paid for its work on that sale.
Defendants stipulated that work “should not have been billed through 15B1.”
Throughout 15BI’s existence, Karlik and Giles caused the company to pay hundreds of thousands of dollars to entities owned by Karlik and Giles and at least one member of Karlik’s family. Between May 2007 and January 2011, at least $375,000 was transferred from 15BI to entities jointly owned by Jerry Karlik and Giles.
The plaintiffs accused Karlik and Giles of self-dealing and misfeasance in their roles as manager of 15BI and filed a nine-count complaint. At a bench trial, the trial court found that defendants breached their duty of loyalty in pursuing the Testa deal, making payments to “affiliate entities,” and selling a portion of KBI to new investors. The trial court then awarded the plaintiffs $1.6 million in compensatory damages, dissociated defendant KBI as a member and the manager of 15BI, and ordered the forfeiture of KBI’s interest in 15BI.
The trial court denied plaintiffs’ request for punitive damages. The plaintiffs sough an award of attorney fees, but the trial court bifurcated the issue of attorney fees from the original judgment and conducted a hearing on attorney fees while the defendants appealed the original judgment. In that hearing the trial court ruled that the conduct of defendants was fraudulent and oppressive and granted plaintiffs’ petition for attorney fees against the individual defendants.
The trial court found that defendants’ “intentional wrongdoing, oppressive conduct, fraud, and multiple breaches of fiduciary duty justify an assessment for Plaintiffs’ attorneys’ fees and costs against Defendants personally.” (Emphasis in original.) The trial court’s written judgment listed “45 distinct actions by Defendants that are fraudulent and/or oppressive.” The trial court ultimately entered a written judgment setting the matter for an evidentiary hearing on the reasonableness of the attorney fees in this case or ordering defendants to pay approximately $1.2 million in plaintiffs’ attorney fees if no evidentiary hearing is requested. The defendants appealed.
The Court began its analysis by reciting the default position known as the American Rule. Under the American rule, absent statutory authority or a contractual agreement, each party must bear its own attorney fees and costs. In shareholder derivative lawsuits, the Court noted, courts are authorized to make an award of attorney fees under the common fund doctrine.
The issue raised by the defendants on appeal was whether the trial court had the authority to assess the attorney fees against the defendants individually. The Court first noted that generally awards under the common fund doctrine are not assessed against the defendants individually but rather the attorney fees are deducted from the judgment amount. The common fund doctrine, the Court explained, is codified in Section 40-15 of the Illinois Limited Liability Company Act, 805 ILCS 180/40-15, which provides that, “if a derivative action is successful, in whole or in part, or if anything is received by the plaintiff…, the court may award the plaintiff reasonable expenses, including reasonable attorney’s fees, and shall direct the plaintiff to remit to the limited liability company the remainder of those proceeds received by the plaintiff.”
Despite this language, the Court noted that prior courts considering the issue have held that “under the equitable rules and principles…individual defendants could properly be required to pay all or part of plaintiff’s costs and fees.” This precedent, the Court explained, has created an equitable extension of the common fund doctrine under which fees can be assessed against the defendants personally where the defendants’ conduct in a shareholder derivative suit is fraudulent or oppressive. The Court found that the trial court’s findings of fact made it abundantly clear that this case fit into that equitable extension.
The Court’s full opinion is available here.
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