Derek P. Usman, The Usman Law Firm, P.A.


Effective January 1, 2007, amendments to the Illinois Business Corporation Act now provide a more precise definition of the fair value of minority interests. The new Illinois legislation is quite similar to the 1999 amendments to the Model Business Corporation Act. The Illinois Business Corporation Act now explicitly states that “fair value…means the proportionate interest of the shareholder in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability.”


Prior to 2007, “fair value” proceedings in Illinois courts have often resulted in the application of minority and marketability (liquidity) discounts. Even though the Illinois Supreme Court repeatedly discouraged the use of discounts, the position of trial courts remained inconsistent with the majority of courts throughout the country that disallowed discounts. Also, while other states considered discounts to be a question of law, Illinois considered the appropriateness of discounts as one of fact. During “fair value” proceedings, Illinois trial courts left the calculation of fair value to valuation experts and subsequently, the appellate courts deferred to the trial courts. Nevertheless, the newly enacted legislation explicitly prohibits the application of discounts in calculating the fair value of minority shares.


“Fair value” proceedings arise to resolve conflicts between the majority and minority shareholders where the controlling shareholders would benefit at the expenses of the minority shareholders. For example, a conflict is present when a minority interest is discounted in a merger or stock restructuring but the majority interest ends up retaining the discounted value after the reorganization. As a potential remedy, Section 8.60 of the Illinois Business Corporation Act requires the majority shareholders to demonstrate that a fair value was provided for the minority interests.


Sections 11.65 and 11.70 of the Illinois Business Corporation Act provide for dissenter’s rights to a shareholder of a corporation by allowing the shareholder to obtain payment for his shares in the event of certain corporate actions. Alternatively, the presence of oppressive conditions also avails remedies to an injured shareholder. Upon satisfying any of the conditions listed under Section 12.56(a)(1)(4), a petitioning shareholder of a private corporation may request judicial intervention. Subsequently, a possible remedy for the statutorily defined oppressive situations includes a court ordered share purchase after a determination of the fair value of shares.


As a starting point, the “fair value” standard must be distinguished from the “fair market value” standard in analyzing the reasoning behind prohibition of minority discounts in “fair value” proceedings. Illinois courts have stated that fair market value is “based on the price that would be agreed upon in an arms length transaction between a willing buyer and willing seller on the open market, neither under a compulsion to act, and both parties possessed of all relevant facts”. Furthermore, the fair market value standard is used in gift and estate tax valuations where minority and liquidity discounts are routine. On the other hand, fair value is often calculated for interests purchased by the remaining shareholders of an entity and the fair market value is inapplicable. The two standards are not analogous; nor are they utilized under similar circumstances. Therefore, the application of discounts is not necessarily appropriate under the “fair value” standard.


Still yet, a minority discount adjustment is based on the theory that non-controlling shares are not worth their proportionate share of the company’s value because they lack voting power to control corporate actions. On the other hand, a marketability discount is an adjustment for a lack of liquidity. Here the theory is that there are a limited number of potential buyers for the stock of a closely-held corporation. However, minority and marketability discounts are inappropriate when the purchaser of the stock is either the majority shareholder or the corporation itself. The application of a minority discount is not appropriate because different interests are present when a there is a sale to an outside third party. Upon a sale to a third party, the value of the shares remains constant or drop in value because the third party does not gain a right to control or manage the corporation. On the other hand, a sale to a majority shareholder or to the corporation increases the interests of those already in control. Consequently, the application of a minority discount in a sale to “insiders” would result in a windfall to the buyer.


Nevertheless, litigation is still inevitable because there is a lack of legislative history that discusses exactly when the statutory exception for “extraordinary circumstances” warranting a discount for lack of marketability arises. So, just what will these extraordinary circumstances entail? Even though the amended statutes are void of any guidance, the American Law Institutes’ Section 7.22 of the Principles on Corporate Governance is a good starting point. Illinois’ newly adopted definition of fair value mirrors the American Law Institute’s definition of fair value. The ALI endorses the national trend of interpreting fair value as the proportionate share of a going concern “without any discount for minority status or, absent extraordinary circumstances, lack of marketability.” The ALI has further recommended that to determine fair value, the trial court must determine the aggregate value for the firm as an entity, and then simply allocate that value pro rata in accordance with the shareholders’ percentage ownership.


Similar to Illinois, the ALI’s definition of fair value also includes the exception for “extraordinary circumstances”. Unlike the Illinois statute, the ALI provides guidance as to just when extraordinary circumstances might arise. Comment e to Section 7.22 clarifies that extraordinary circumstances must consist of more than an absence of a trading market in the shares. Furthermore, an ALI comment states that the extraordinary circumstances exception is “very limited” and is intended to apply only when the trial court “finds that the dissenting shareholder has held out in order to exploit the transaction giving rise to appraisal so as to divert value to itself that could not be made available proportionately to other shareholders.”


The comment also provides an example of “extraordinary circumstances”. In the example, a financially strained corporation lacking liquid assets makes relatively minor changes in its governance and structure which trigger appraisal rights. Since the corporation is financially troubled and only has illiquid assets, a fair value appraisal proceeding would likely result in a higher price per share than a market transaction for the shareholder’s shares. Furthermore, a shareholder dissents because he had been unsuccessfully attempting to persuade the other shareholders to purchase his shares. Therefore, the dissenting shareholder now has the opportunity to obtain a much higher price for his share by exploiting a relatively minor change. A marketability discount would be proper because the “fair value” proceeding is likely to produce an appraisal higher than the remaining shareholders could receive upon a sale of the corporation or its assets and the dissenter is taking advantage of a minor corporate change. Therefore, if a dissenting shareholder does not have a valid objection to the transaction, the shareholder is deemed to be exploiting a minor change in the charter. Consequently, a marketability discount should be applied to prevent an unfair wealth transfer to the dissenting shareholder. The comment does indicate that under identical facts, if the shareholder dissented to a fundamental corporate change, such as a merge, a marketability discount would be inappropriate.


In 2003, the Colorado Supreme Court analyzed the ALI’s definition and interpretation of “fair value” and “extraordinary circumstances” and asserted that that the “extraordinary circumstance” exception is intended to enable trial courts to utilize their equitable powers and provide a fair result when extraordinary circumstances are present. (For brevity’s sake I’m excluding a discussion of cases that analyze the applicability of the “extraordinary circumstance” exception. Nevertheless, all of those cases emphasize the limited nature of the exception.)


In addition to the strict statutory limitations on discounting minority shares, courts across the nation have recognized that discounts unjustly benefit the majority shareholders. As the Delaware Supreme Court stated in the leading “fair value” case in Cavalier Oil Corp. v. Harnett, “…to fail to accord to a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control, and enriches the majority shareholders who may reap a windfall from the appraisal process by chasing out a dissenting shareholder, a clearly undesirable result.”

A Matter of Trust: Closely-held derivative lawsuits

Derek P. Usman, The Usman Law Firm, P.A.


A shareholder may initiate a direct action lawsuit against a corporation to redress an injury inflicted by the corporation upon the shareholder. However, a shareholder may also assert a cause of action on behalf of the corporation. Such a suit, a derivative lawsuit, arises against officers or shareholders when the corporation has failed to commence suit for injuries to the corporation itself. The Illinois Business Corporations Act creates a statutory cause of action for such an event. Nevertheless, distinctive characteristics and needs of close corporations have resulted in these companies receiving disparate treatment upon litigation.


Foremost, derivative lawsuits must be distinguished for close corporations (and other closely-held firms) and widely-held and/or publicly held corporations. For the former, derivative lawsuits are categorized as “Closely-Held”. While public or widely-held corporation derivative lawsuits are designated either as “Corporate Impropriety” or “Exploitation of Control” derivative lawsuits. “Corporate Impropriety” includes derivative suits seeking to impose personal liability on the board for a discrete act of corporate wrongdoing (typically a violation of law or a regulatory requirement). Corporations in this category tend to be larger and shareholdings more widely dispersed. “Exploitation of Control” suits are limited to challenging transactions between the corporation and those who control it. The Exploitation of Control category involves corporate transactions with or on behalf of the persons who control it. For cases in this category, the corporations tend to be smaller, the plaintiffs tend to hold significant blocks of stock, and that stock tends to be thinly traded, especially compared to that of the corporations in the Corporate Impropriety category.


While public corporations tend to incorporate in Delaware, close corporations are incorporated in the state of their principal state of business. The unique treatment afforded close corporations is further evident in the adoption of special code sections governing close corporations. In Illinois, a corporation’s failure to elect close corporation status will not prevent the corporation to be treated as a close corporation if under common law principles it would qualify as a close corporation.


The most extreme statutory provision that impacts shareholders in close corporations is involuntary dissolution. The remedy of involuntary dissolution will be administered in derivative lawsuits if the defendant acts “oppressively”. While the Illinois statutes do not define oppression, the courts have supplied definitions of oppressive conduct in closely-held cases. In Illinois, there is an enhanced fiduciary duty to shareholders of a close corporation that is similar to that of partners in a partnership. The emphasis placed on fiduciary duties in closely-held cases negates a requirement of finding fraud or illegal conduct.


Close and public corporations differ in ways that make general corporate law ill suited to close corporations. A major distinction for close corporations is that shareholders of a close corporation often serve as the directors or officers. Corporate law gives controlling insiders considerable latitude to run the corporation as they see fit. Understandably, they will generally favor their own priorities and objectives over those of the minority. Aside from their investments, these shareholders are also actively managing the company. Unlike public corporation shareholders, most close corporation shareholders’ income derives solely from distributions from the corporations. Consequently, a minority shareholder is particularly vulnerable to the whims of the majority. A minority shareholder’s dependence on the corporation, lack of control and a lack of market for shares all create unique circumstances for the minority shareholder.


There are several recurring scenarios that lead to derivative litigation in the close-corporation context. For example, a “freeze-out” or exclusion of a minority shareholder from management of the corporation prompts litigation. Also, disparate treatment of different shareholders, e.g., purchase of one shareholder’s share for fair value and not the others. Another common scenario involves the frustration of “reasonable expectations” of a shareholder; often the minority shareholder is deprived of a prominent position (director, officer or employee). Still yet, a shareholder’s attempt at competing with the corporation in another business leads to litigation.


It should be noted that situations arise where majority shareholders are the ones with the scales tipping against them. Minority shareholders may have the capacity to overpower a controlling shareholder (especially where corporate actions require supermajority approval). Of course the share liquidity issue is just as relevant for majority shareholders. Also, it might very well be that the minority shareholder brings all the expertise to the table.


Generally, cases in the Exploitation of Control and Closely-Held categories involve applications of the duty owed to minority shareholders by the majority. Derivative litigation performs the task of translating the abstract concepts of fiduciary obligation, good faith and fairness into the specific limits on the insiders’ ability to favor themselves. To this end, Illinois courts have embraced the “enhanced fiduciary duty” as a solution. The expansion of the duties makes more sense since closely-held shareholders often neglect to have a shareholders’ agreement in place. Thus, the old adage, “an ounce of prevention is worth a pound of cure”, is quite relevant in the avoidance of derivative litigation. The presence of a shareholders’ agreement significantly reduces the likelihood of a corporate breakdown. Additionally, under a longstanding history of allowing the freedom to contract, courts traditionally uphold shareholder agreements. The trick is to balance the interests of the majority and the minority. A shareholders’ agreement requiring unanimous approval for corporate actions might curb arbitrary actions by the majority. Nevertheless, such a provision providing the minority with carte blanche veto power might result in the minority shareholders holding the majority shareholders hostage. Similarly, the emergence of venture capitalists as minority shareholders further necessitates the need for a well-drafted shareholders’ agreement to avoid litigation scenarios.


Shareholders would be wise to employ a competent legal draftsman to produce an explicit agreement that reflects acceptable conduct by close corporation shareholders. Practitioners must communicate to their clients that the presence of a shareholders’ agreement would reduce the risk of litigation. While courts navigate around the contours of fiduciary duties, a shareholders’ agreement goes a long way towards preventing inequitable treatment.


Effective July 1, 2011, changes in the Act create new statutory Power of Attorney (POA) forms for property and healthcare.  A Power of Attorney is a legal document that gives another person (your agent) the authority to make financial and other legal decisions on your behalf.

The revised act provides more guidance to the agent in the performance of his duties.  For example, the agent will now receive a notice describing his responsibilities.  As before, you, the principal, must decide whether the agent is granted the power immediately or at a later time.

The property and healthcare POA forms are essential estate planning tools for adults.  The forms allow your wishes for medical and financial decisions to be carried out by someone trustworthy if you were to become incapacitated.


A written document to memorialize terms of an agreement between two or more persons minimizes confusion and possibility of litigation. Even though an oral agreement is usually sufficient to form a legal binding contract, a written contract provides proof of the intentions of the parties.

To demonstrate a breach of contract, the aggrieved party must first show that a contract exists.  An offer and acceptance is the starting point for a contract to exist.   Since a written contract explicitly spells out the obligations of all the parties to the contract, a breach by one of the parties is easier to establish.  Then under the terms of the contract, the aggrieved party must have performed its obligations while the other party did not.  Finally, there must be damages resulting from the breach.  A written contract also allows the parties to stipulate specific damages upon the occurrence of a breach of the contract.


Since tax considerations are of utmost importance in choosing an entity form, entrepreneurs should determine the advantages of beginning their business as a LLC. In particular, the applicability of the LLC structure must be examined when the entity plans to go public or merge with a public corporation.

While enjoying the benefits of a LLC prior to “going public”, the conversion of a LLC to a corporation is quite seamless.

An incorporation of an LLC can follow three forms:
1. the LLC can transfer its assets to the corporation in exchange for stock;
2. the LLC can distribute its assets to its members who then contribute those assets to the corporation in exchange for stock and;
3. the members can contribute their interests to the corporation in exchange for stock.

Of course, the incorporation of the LLC can also take place as part of the initial public offering under Section 351.

Also, the LLC’s conversion to a corporation should not prevent a subsequent tax-free reorganization under Section 368 when the corporation is acquired by a public company.


Section 2-616 of the Illinois Civil Practice Law provides for amendments to pleadings on just and reasonable terms before final judgment.

Loyola Academy v. S & S Roof Maintenance, 146 Ill.2d 263 provides the standard for amending pleadings in Illinois. The Loyola Academy court looked to four factors in determining the appropriateness of allowing leave to file an amended pleading:

The four factors are the following:

  1. Whether the proposed amendment would cure the defective pleading;
  2. Whether other parties would sustain prejudice or surprise by virtue of the proposed amendment;
  3. Whether the proposed amendment is timely; and
  4. Whether previous opportunities to amend the pleadings could be identified.