Shareholders in Closed Corporations Owe Fiduciary Duties Even When Litigating against One Another
As we have written about before, shareholders in a closely held corporation owe each other fiduciary duties to one another. An Illinois appellate court has interpreted this principle to apply even when disputing shareholders sue each other concluding that the partners must make “full and frank disclosure of all material facts” during litigation and that any settlement of such a lawsuit must be “just and equitable.”
In Arndt v. Nardulli, the appellate court declared that a minority shareholder could sue the majority owner for breach of fiduciary duties that allegedly occurred during the settlement of a lawsuit. The dispute giving rise to the lawsuit arose out of a settlement agreement entered into by the parties in a separate breach of fiduciary duty and shareholder oppression lawsuit. The plaintiff, Samuel Arndt, and defendants, Nicholas Nardulli and Diana Johnson, were the sole shareholders in a corporation, Redhawk Financial Services, Inc. Arndt owned 49 percent of Redhawk’s shares. Nardulli was the controlling shareholder, a director, and the president of Redhawk. Johnson was a shareholder, a director, and the secretary of Redhawk.
Redhawk, through Nardulli and Johnson, sued Arndt for breach of fiduciary duty alleging that he withdrew over $100,000 from Redhawk without an apparent business justification and diverted Redhawk’s commissions into his personal bank account. Arndt responded by countersuing Redhawk and Nardulli and Johnson for breach of fiduciary duty, shareholder oppression, an accounting and dissolution of the corporation. After years of litigation, the parties, who were all represented by counsel, eventually entered a written settlement agreement.
That settlement agreement required Arndt to assign his shares in the company to Nardulli for no compensation and release all claims he had against Redhawk, Nardulli and Johnson. Among the terms of the settlement agreement was a “non-reliance clause” which provided that the parties were not relying on any representations not included in the settlement agreement.
In a letter concerning settlement, Nardulli and Johnson’s attorney allegedly misrepresented that Redhawk was operating at a loss. Arndt allegedly relied on this representation when deciding to enter into the settlement agreement. Arndt alleged in the complaint that, in reality, Redhawk was not operating at a loss but realized a profit. Approximately a week after signing the settlement agreement, Arndt received an IRS Schedule K-1 Form reporting his personal tax liability of $79,181.
Shortly after receiving the K-1, Arndt filed suit alleging that Nardulli and Johnson owed him fiduciary duties while negotiating the settlement, and that they breached their fiduciary duties to him by misrepresenting and failing to disclose the true financial condition of Redhawk. Arndt alleged that this rendered the release in the settlement agreement voidable.
Nardulli and Johnson moved to dismiss the complaint arguing that Arndt’s breach of fiduciary duty claims failed because they no longer owed fiduciary duties to each other at the time the settlement agreement negotiations took place as the parties were involved in adversarial litigation and were represented by separate counsel while negotiating to end their relationship. The trial court agreed and dismissed the complaint with prejudice.
The appellate court reversed. The crux of the dispute, the appellate court identified, was the point at which the parties’ fiduciary relationship ceased. The court reviewed past decisions that examined the point at which partners stop owing fiduciary duties to each other. From these decisions, the court concluded that partners owe fiduciary duties to each other at least up to the point of dissolution of the partnership and potentially beyond as it relates to winding up the affairs of the business. Because Arndt, Nardulli, and Johnson had not dissolved the corporation prior to their settlement negotiations, the court held that they maintained a fiduciary relationship at the time of the alleged misrepresentation. Accordingly, the settlement agreement and its release and non-reliance provisions did not defeat Arndt’s claims for fraud and breach of fiduciary duty. The appellate court sent the case back to the trial court to allow the defendants the opportunity to prove that the settlement was just and equitable and they made full and frank disclosure.
The court’s full opinion is available here.
Our Chicago breach of fiduciary duty and business litigation attorneys have defended and prosecuted minority oppression, business divorce, stolen corporate opportunity and breach of fiduciary duty lawsuits for more than three decades.
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