Romanik v. Lurie Home Supply Center, Inc.
435 N.E.2d 712, 61 Ill. Dec. 871, 105 Ill.App.3d 1118 (1982)
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Rule of Law:
Directors and officers of a corporation who engage in self-dealing transactions bear the burden of proving the fairness of those transactions to the corporation. When evaluating fairness, courts consider factors including whether the transaction was at market price, the corporation’s need, and whether the transaction diverts corporate assets for personal gain.
Facts:
- In 1958, Lurie’s Home Supply, Inc. was incorporated, with Peter Lurie holding 50% of the stock and his brothers, Dan and Bernard, each holding 25%.
- Peter Lurie was the only shareholder who actively participated in the management of the corporation.
- In 1968, Peter Lurie personally purchased the building and property where the corporation was located and leased it to the corporation under an oral agreement.
- On May 30, 1974, Peter Lurie purchased the shares of Bernard's widow, increasing his ownership to 75% of the corporation's stock.
- On June 1, 1974, Peter Lurie, acting on behalf of the corporation, entered into a written lease with himself that significantly increased the rent paid by the corporation for the property he owned.
- On the same day, the corporation entered into an employment agreement with Peter Lurie that increased his salary, provided for a 10-year deferred compensation plan upon his death, and gave him personal veto power over the declaration of dividends.
- In 1977, the corporation authorized 10,000 shares of preferred stock to be issued to Peter Lurie as consideration for future consulting services, but Peter died before the consulting agreement was signed or any services were performed.
- Following Peter's death in 1977, the corporation made three unsecured loans to the Peter Lurie Revocable Trust for the purpose of paying his estate taxes.
Procedural Posture:
- The minority shareholders (plaintiffs) filed a shareholder derivative suit against the corporation and its majority shareholder, Peter Lurie (defendants), in the circuit court of St. Clair County.
- Plaintiffs filed several amended complaints to challenge additional transactions as they occurred.
- Following a trial, the circuit court (trial court) entered a judgment granting partial relief, declaring the preferred stock amendment, the corporate loans, and a $5,000 gift to be void.
- The trial court denied plaintiffs' requests to void a lease and an employment agreement and to compel the declaration of a dividend.
- Plaintiffs appealed to the appellate court, seeking the complete relief they had originally requested.
- Defendants filed a cross-appeal, asking the appellate court to reverse the parts of the trial court's order that were unfavorable to them.
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Issue:
In a close corporation, must a majority shareholder and director engaging in self-dealing transactions prove that those transactions are fair to the corporation?
Opinions:
Majority - Presiding Justice Karns
Yes, in a close corporation, a majority shareholder and director engaging in self-dealing transactions must prove that those transactions are fair to the corporation. The fiduciary duty of undivided loyalty requires that such transactions be scrupulously fair, and the burden of demonstrating fairness rests on the interested director. The court found that the defendants failed to carry this burden with respect to the lease, the issuance of preferred stock, and two of the three loans. The lease terms were not at market rate, and a fair inference was that Peter Lurie was shifting the burden of his poor personal investment onto the corporation. The preferred stock was issued without valid consideration, as the consulting services for which it was intended were never performed. While the first loan was at the prime interest rate, the subsequent two loans were made at a below-market rate while the first was delinquent, constituting a breach of fiduciary duty. However, the court found Peter Lurie's salary increase was reasonable based on his service and the company's success, and the refusal to declare dividends was a valid exercise of business judgment.
Analysis:
This case reinforces the high standard of fiduciary duty, particularly the duty of loyalty, owed by directors and majority shareholders in a close corporation. It demonstrates that while the business judgment rule protects most directorial decisions, it does not shield self-dealing transactions from strict judicial scrutiny under a fairness standard. The court's willingness to parse through multiple transactions—upholding some, voiding others, and modifying the terms of another—shows that courts will intervene to protect minority shareholders from specific acts of oppression rather than simply deferring to the majority's control. This approach provides a blueprint for how courts can remedy breaches of loyalty without unwinding every decision made by interested directors.
