In Arndt v. Nardulli, 2018 IL App. (1st) 173044-U, the First District of the Appellate Court of Illinois held that shareholders in a closely held corporation owe each other fiduciary duties even when they have sued each other and are represented by their own counsel. In fact, any settlement of such a lawsuit must be “just and equitable” and the parties must make “full and frank disclosure of all material facts.” Id. ¶ 30.
Arndt v. Nardulli actually concerns two separate lawsuits. In 2012, the closely held corporation called Redhawk Financial Services Inc. (“Redhawk”) sued Arndt for misappropriating and diverting corporate funds. Arndt filed counterclaims against Redhawk and claims against his co- shareholders, Nardulli and Johnson, for breach of fiduciary duty, minority oppression, an accounting and dissolution of the corporation.
The parties to the 2012 lawsuit, who were all represented by counsel, eventually settled the case pursuant to a written agreement. The settlement agreement provided that Arndt would assign his shares in the company to Nardulli for no compensation, and Arndt would release his co-shareholders and Redhawk from all claims that he had against them. The settlement agreement also included a “non-reliance clause” which provided that in entering into the settlement agreement, the parties were not relying on any representations or warranties other than those set forth in writing in the agreement. A non-reliance clause is a significant deterrent to claims that a written agreement was induced by fraud.
Arndt later claimed that during negotiations of the settlement, Nardulli’s counsel misrepresented that Redhawk was operating at a loss, and Arndt relied on that information when he entered into the settlement agreement. Arndt claimed that shortly after signing the settlement agreement, he learned that Redhawk was actually profitable, and had he known this, he would not have agreed to the settlement.
Therefore, in 2015, Arndt filed the second lawsuit. In the 2015 lawsuit, Arndt alleged that during negotiations of the settlement, his co-shareholders breached their fiduciary duties to him by misrepresenting and failing to disclose the true financial condition of Redhawk. Therefore, they fraudulently induced him to enter the settlement agreement.
The trial court dismissed Arndt’s 2015 lawsuit. In doing so, the trial court reasoned that the parties to the 2012 lawsuit were involved in adversarial litigation and represented by their own counsel while negotiating an end to their fiduciary relationship. Therefore, they no longer owed fiduciary duties to each other at the time the settlement negotiations took place.
The Illinois Appellate Court for the First District reversed the trial court’s ruling. The appellate court held that a settlement and release among fiduciaries must be evaluated in the context of the fiduciary relationship. Further, in the context of evaluating the validity of a release among fiduciaries, the defendant has the burden of showing by clear and convincing evidence that the release was “just and equitable” and a “full and frank disclosure” of all relevant information was made to the other party. Id. ¶ 30. The appellate court further ruled that at the time the trial court dismissed Arndt’s complaint, the defendants had not yet satisfied this burden. Accordingly, the settlement agreement and its release and non-reliance provisions did not defeat Arndt’s claims that the defendants had breached their fiduciary duties to him and committed fraud in obtaining those provisions. 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 Arndt case is notable because it stands for the proposition that even in litigation, shareholders still owe each other fiduciary duties, and the defendant-fiduciary has the burden to show by clear and convincing evidence that a settlement was just and equitable and full and frank disclosure was made in negotiations.
At Novack and Macey, we have extensive experience advising shareholders involved in closely held company disputes, as well as advising companies on how to avoid disputes in the first place. For more information about our services, please contact Monte Mann at 312.419.6900 or firstname.lastname@example.org.