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Shareholders Can Now Claim Derivative Suits Against Insolvent Companies in Illinois

On June 24, 2016, in a case of first impression in Illinois, the Illinois Appellate Court, First District, in Caulfield v. The Packer Group, Inc. held that shareholders have standing to pursue a shareholder derivative suit against an insolvent corporation. This development offers a means for a corporation to recoup - for the benefit of its shareholders and creditors - assets lost as a result of management's waste and fiduciary breaches. Shareholders can now claim derivative suits against insolvent companies in Illinois. 

The Packer Group (TPG) was a closely held corporation composed of three wholly owned subsidiaries: Packer Engineering Inc. (PEI), Packer Environmental and Facility Consultants Inc., and Packer Technologies International Inc. The two plaintiffs were PEI's president/chief technical officer and its CEO. They filed a shareholder derivative suit on behalf of TPG and PEI against the inside directors of TPG, alleging that the inside directors misappropriated and wasted TPG's assets for their own benefit. The inside directors were TPG's founder and chairman of the board of directors, its executive vice president of finance and secretary of the board and two members of TPG's board. Shareholders can now claim derivative suits against insolvent companies to right previous loopholes.

The allegations of misappropriation and waste of TPG's assets included that TPG's board chairman transferred debt from another business he owned to TPG without the knowledge or approval of the plaintiffs. They also alleged that he sent PEI employees to work at his other business while they were on the PEI payroll and that TPG made payments on behalf of his other business in excess of $1.2 million.

When the suit was filed, TPG companies were insolvent. As a result, the trial court dismissed the shareholder derivative case on the grounds that because TPG companies were insolvent, only their creditors could pursue derivative claims.

As the court explained, a derivative action is an action a corporate shareholder brings on behalf of a corporation to seek relief for injuries done to that corporation, where the corporation cannot or will not assert its own rights. Derivative actions are one of the remedies for situations in which the management - through fraud, neglect of duty or other cause - declines to take the proper and necessary steps to assert the corporation's rights. The stockholders are then allowed to take the initiative and institute the suit the management should have started.

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