A recent amendment1 to the Illinois Business Corporations Act has effectively destroyed the effectiveness of the election remedy under section 12.56(f) of the Illinois Business Corporations Act2 for defendants in shareholder suits involving closely held corporations. Section 12.56(f) of the Business Corporations Act provided a defendant in a suit brought by another shareholder of a closely held corporation an option to make an election to purchase the plaintiff’s stock ownership in the closely held corporation, which in effect could result in a forced buyout of the plaintiff. Effective August 1, 2005, however, the Business Corporations Act was amended to make the election remedy a defense only if the plaintiff’s complaint requests as part of its relief an order requiring the defendant to purchase the plaintiff’s shares.3 In other words, a defendant can only make an election to buy the plaintiff out if the plaintiff has asked for it. The following article will briefly discuss the election remedy and will outline the ramifications of this amendment to section 12.56(f).
The Business Corporations Act And The Election Remedy As A Defense.
The Illinois Business Corporations Act creates a statutory cause of action for a shareholder in a closely held corporation who wishes to bring suit against other shareholders or officers and directors. The circumstances under which a claim can be brought is set forth in section 12.56(a), such as where: (i) the directors or shareholders are deadlocked in the management of the corporate affairs and either irreparable injury will be caused to the corporation, or the business can no longer be conducted to the advantage of the shareholder; (ii) 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 plaintiff; or (iii) the corporation’s assets are being misapplied or wasted.4 There are twelve remedies provided for under section 12.56(b)(1)-(12). Among many other things, a plaintiff can ask for the appointment of a receiver and/or a provisional director or other person to run the corporation, can ask for access to books and records, can ask for removal of a director, and can ask for dissolution of the corporation and damages.
When applicable, section 12.56(f) of the Business Corporations Act allows a defendant shareholder who has been sued under section 12.56(a) to make an election to purchase all of the shares of stock owned by the plaintiff who is bringing the suit.5 The defendant must state in writing the amount which he or she will pay for the shares, and the purchase must be for the "fair value" of the shares. The following are some key points to remember with respect to the election to purchase:
• The making of an election to purchase the plaintiff’s shares will prohibit the plaintiff from dismissing the case or settling the case without court approval.6
• The plaintiff is prohibited from selling or disposing of his shares after an election is made.7
• The "amount" stated in the election to purchase can either be expressed as a formula or a specific dollar figure.8
• The election to purchase will be irrevocable unless the court determines it to be equitable to set the election aside.9
After an election is made, the parties have thirty days to agree upon a price. If no agreement is reached within thirty days, then the defendant can petition the court for a stay of the action so that the court can determine the fair value of the stock as of the date that the plaintiff filed his complaint.10 The court may also stay other claims that are brought in the action even if they are not brought under section 12.56, but the court is not required to do so.11 The court will thereafter engage in a "fair value hearing," with or without appraisers, and will order the plaintiff to sell his shares of stock to the defendant at the price determined at the fair value hearing.
As can easily be seen, the election remedy would effectively prohibit a plaintiff from selling his own shares or from backing out of the case; instead, the plaintiff will have to sell his stock at the price the court determines the defendant should pay. Once the plaintiff is bought out, it is most likely that most of the plaintiff’s claims (if not all) would disappear (such as any request for a receiver, for access to books and records, to remove a director, and things of that nature) because he would no longer have a right to such relief, as he is no longer a shareholder.
The Historical Purpose Behind The Election Remedy.
To understand the ramifications of the new amendment to section 12.56(f), a brief discussion of the historical purpose of the election remedy is necessary. Historically, the election remedy was created as an alternative to the drastic remedy of a dissolution.12 Section 12.56(f) of the Illinois Business Corporations Act was based upon section 14.34 of the ABA Model Business Corporation Act.13 Section 14.34 of the Model Act was entitled "Election to Purchase in Lieu of Dissolution."14 Pursuant to section 14.34 of the Model Act, one shareholder could elect to purchase the shares of another shareholder only if the shareholder had petitioned for dissolution.15 Thus, the election remedy was intended in part to reduce the risk that a dissolution proceeding was being used for some strategic purpose (as a plaintiff would have to think twice about petitioning for dissolution for the risk of losing his shares), and provided an alternative and a more orderly exit from the corporation for the dissatisfied plaintiff shareholder.16
Unlike section 12.56 of the Illinois Business Corporations Act, however, section 14.30(2) of the Model Act did not provide any remedy to an oppressed shareholder other than dissolution. Therefore, the Illinois Business Corporations Act granted circuit courts broader discretion and wider latitude in fashioning equitable remedies for plaintiffs in shareholder disputes involving closely held corporations.17 In other words, section 12.56 contains multiple remedies that are available to plaintiff shareholders, which remedies are alternatives to an absolute dissolution of the corporation. Thus, although the primary purpose of the election remedy under the Model Act was an alternative to dissolution, that was not the only purpose for the election remedy under the Illinois Act. The election remedy was one of many remedies that a court could chose to resolve corporate disputes and to achieve an equitable result.
Problems Existing Under Statutory Scheme Prior To Amendment of Section 12.56(f).
There were potential problems that existed with respect to the election remedy under the prior statutory scheme, however, and these problems may have been a reason for the amendment. The prior version of section 12.56(f) of the Business Corporations Act created potential absurd results because a defendant shareholder could file an election no matter what relief the plaintiff shareholder sought under section 12.56(a). A forced buy-out through the election remedy, like dissolution, is itself a drastic remedy.18 It was a way other shareholders could force a complaining shareholder out of the company. It makes sense for the election remedy to be available where a plaintiff shareholder is bringing suit because he does not like the way others are managing the affairs; the election remedy could then be used to stop the lawsuit and allow the other shareholders to continue operating without the dissenting shareholder. Also, a buy-out may be an obvious remedy when a shareholder wants to leave or dissolve the corporation. The same cannot be said, however, where the complaining shareholder intends to remain involved in the business.19 Where a complaining shareholder intends to remain involved, a mandatory buy-out would defeat the complaining shareholder’s rights, even if he has proven misconduct by the defendant.20
As a result, there clearly were potentials for absurd results. For instance, every time a shareholder sought to review the corporate books and records, or sought an accounting, or sought simply to remove a director for fraudulent conduct —all of which are remedies provided pursuant to section 12.56(b)—a wrongdoer defendant could have defeated the complaining shareholder’s statutory rights simply by making an election to purchase the plaintiff’s shares. So the drastic remedy of a forced buy-out could result when a shareholder simply petitions to review corporate books and records or asks for other benign relief. Accordingly, the election remedy under the pre-amendment section 12.56(f), while intended for dissolution proceedings to provide less drastic relief than dissolution, could be also applied to force a buy-out of the plaintiff even when lesser drastic remedies were being sought.
The Implications of the Amendment to Section 12.56(f).
The recent amendment to section 12.56(f) may have been intended to avoid the potential problems discussed above, but it has also drastically changed the playing field. The amendment added the words, "When the relief requested by the petition includes the purchase of the petitioner’s shares," thereby making the election remedy available to a defendant only if the plaintiff himself is specifically asking to be bought out. While this change eliminated the potential that the election remedy was sought when a plaintiff was seeking less drastic remedies than a corporate dissolution, it appears to have gone too far. The election remedy no longer serves the original purpose for which it was created: to be a reasonable alternative to a dissolution proceeding. A petitioner seeking to dissolve a corporation no longer faces the threat of a forced buy-out, and arguably can bring dissolution proceedings with impunity to gain some unfair advantage in the corporation.
There does not really appear to be any reasoned basis for this amendment. Basically, the election remedy is only available where the plaintiff asks for it himself. That probably will rarely occur, because most requests for a shareholder to exit a closely held corporation would likely be worked out without court intervention. On the other hand, the election remedy is not available where it is needed the most, when a party is seeking dissolution of the corporation. It remains to be seen how the courts will handle cases under this new amendment, or how it will actually change the landscape of disputes involving closely held corporations. On its face, as set forth above, the amendment is a drastic change of which most attorneys probably are not yet aware.
1 P.A. 94-394, §5.
2 805 ILCS 5/12.56(f)
3 P.A. 94-394, §5
4 805 ILCS 5/12.56(a)
5 805 ILCS 5/12.56(f)
6 805 ILCS 5/12.56(f)(4)
7 805 ILCS 5/12.56(f)(4)
8 Mid Kiff v. Gingrich, 355 Ill.App.3d 857, 824 N.E.2d 1144 (5th Dist. 2005).
9 805 ILCS 5/12.56(f)(1)
10 805 ILCS 5/12.56(f)(6)
11 See, e.g., Advanced Imaging Center v. Cassidy, 335 Ill.App.3d 746, 781 N.E.2d 664 (2d Dist. 2002); Hamlin v. Harbaugh Enterprises, Inc., 324 Ill.App.3d 612, 755 N.E.2d 993 (3d Dist. 2001).
12 See 3 ABA Model Business Corporations Act Annot., Official Commentary §14.34 at 14-147 (3d ed. Supp. 2002); 8 C Murdock, Illinois Practice §18.18, §18-21 (1996).
13 See Hamlin v. Harbaugh Enterprises, Inc., 324 Ill.App.3d 612, 618, 755 N.E. 2d 993 (3d Dist. 2001)
14 See 3 ABA Model Business Corporations Act Annot., Official Commentary §14.34 at 14-144 (3rd ed. Supp. 2002)
15 Id. at 14-147
16 Id. at 14-148 and 14-154
17 See Schirmer v. Bear, 174 Ill.2d 63, 74, 672 N.E.2d 1171 (1996) (discussing section 12.55, the predecessor section to section 12.56); see e.g., Kalabogias v. Georgou, 254 Ill.App.3d 740, 748, 672 N.E.2d 51 (1st Dist. 1993).
18 See, e.g., 4 ABA Model Business Corporations Act Annot., at §41 of the Statutory Close Corporation Supplement, Official Commentary at CC-5A (3d ed. Supp. 2002).
19 See Thomas J. Bamonte, Should The Illinois Courts Care About Corporate Deadlock?, 29 L. Univ. Chi. L.J. 625, 641 (1998)
20 See Id.
David M. Jenkins is a partner at Barone & Jenkins, P.C. He has extensive experience in civil litigation and appeals in both federal and state courts. His practice areas include appellate practice, commercial and tort litigation, construction law, professional liability (attorneys, architects, engineers), entertainment law, and intellectual property law. Mr. Jenkins graduated magna cum laude from The John Marshall Law School and was admitted to the Illinois bar in 1992. Mr. Jenkins can be contacted at Barone & Jenkins, P.C., 721 Enterprise Drive, Suite 200, Oak Brook, Illinois 60523, (630) 472-0037, email@example.com.