Heller Equity Capital Corp. v. Clem Environmental Corp.

• Decision Date: 10 July 1992
• Docket Number: No. 1-91-2778,1-91-2778
• Citation: 173 Ill.Dec. 396,232 Ill.App.3d 173,596 N.E.2d 1275
• Parties: , 173 Ill.Dec. 396 HELLER EQUITY CAPITAL CORPORATION, an Illinois corporation, Plaintiff-Appellee, v. CLEM ENVIRONMENTAL CORPORATION, an Illinois corporation, Defendant-Appellant.
• Court: United States Appellate Court of Illinois

Page 1275

596 N.E.2d 1275

232 Ill.App.3d 173, 173 Ill.Dec. 396

HELLER EQUITY CAPITAL CORPORATION, an Illinois corporation Plaintiff-Appellee, v. CLEM ENVIRONMENTAL CORPORATION, an Illinois corporation Defendant-Appellant.

No. 1-91-2778.

Appellate Court of Illinois First District, Sixth Division.

July 10, 1992.

Thomas R. Mulroy, Susan B. Cohen, Debbie L. Moeckler, Jenner & Block, Chicago, for defendant-appellant.

Terry M. Grimm, Paul P. Biebel, Jr., Timothy J. Rivelli, Julie A. Bauer, Winston & Strawn, Chicago, for plaintiff-appellee.

Justice McNAMARA delivered the opinion of the court:

Plaintiff, Heller Equity Capital Corporation ("HECC"), as assignee of Heller Financial, Inc. ("Heller") filed an action in the circuit court of Cook County seeking: (1) a declaratory judgment that a letter agreement ("agreement") entered into between Heller and defendant, Clem Environmental Corporation, in connection with certain financing Heller provided to defendant was valid and enforceable; and (2) specific performance of the agreement requiring defendant to issue 2,000 shares of preferred stock to HECC. Defendant pled an affirmative defense maintaining that the letter agreement was void and unenforceable because performance under the agreement would violate the Bank Holding Company Act of 1956 as amended ("BHC Act"), and later moved to stay the proceedings pending referral to the Federal Reserve Board ("FRB").

The trial court struck defendant's affirmative defenses, and denied defendant's motion for a stay of proceedings pending referral to the FRB. Summary judgment was granted in favor of HECC, and the judge ordered specific performance for the issuance of the stock. On appeal, defendant challenges each ruling made by the trial court.

We adduce the following factual background from the affidavits, pleadings, and documents filed. HECC, an affiliate of Heller, is a commercial finance small business investment company ("SBIC") licensed under the Small Business Investment Act ("SBI Act"). Subsequent to the transaction at issue, Heller became a commercial finance subsidiary of Fuji Bank, a registered bank holding company. Defendant is a small, closely-held corporation engaged in the manufacture of bentonite fibermat liners used for landfills. Heller and defendant had extensive financial dealings with each other prior to the execution of this agreement.

It is undisputed that on December 28, 1982, as partial consideration for a loan made by Heller to finance defendant's business, the parties entered into an agreement which provided for: (1) the sale of 1,000 shares of preferred stock to Heller for a purchase price of $1,000; (2) granted Heller an irrevocable option to purchase an additional 1,000 shares of preferred stock for a purchase price of $1,000 to remain in effect for five years; (3) the amendment of defendant's articles of incorporation and by-laws to authorize the issuance of the preferred stock; and (4) the conversion of the preferred stock into common stock, which upon issuance thereof, shall equal twenty-five percent of the issued common stock of the company any time subsequent to January 1, 1986. The agreement also provided that it would be binding upon the successors and assigns of defendant and Heller, and did not require the consent of the parties to transfer those rights.

On February 25, 1986, defendant sought to borrow an additional $100,000 from Heller. A second agreement was executed in which Heller exercised its option to purchase the additional shares of preferred stock, and the parties agreed to change the date after which the preferred stock could be converted to common stock from January 1, 1986 to January 1, 1987. At the time of the second agreement, defendant acknowledged that its liabilities under the loan agreement equalled $1,665,053.

On June 26, 1990, Heller contributed its rights to the convertible preferred stock by way of a capital contribution to HECC. The record reveals that pursuant to an informal conversation between representatives from Heller and the Small Business Administration ("SBA"), such a transfer was permissible so long as HECC did not try to count the shares as capital for purposes of leverage until the shares were actually sold for cash. Defendant meets the requirements of a small business concern under the SBI Act. Despite numerous requests from both Heller and later from HECC, defendant refused to issue the stock.

As its first affirmative defense in this cause, defendant argued that the BHC Act prohibits a direct or indirect subsidiary of a bank holding company from acquiring more than five percent of the voting shares of a company, or more than twenty-five percent of the total equity or total outstanding shares of a company. (12 U.S.C. § 1843(c)(6) (1989); 12 C.F.R. § 225.22(c)(5) (1990); 12 C.F.R. § 225.143 (1990).) Defendant maintained that on January 1, 1987, the preferred stock became automatically convertible to common stock representing fifty percent of defendant's then outstanding voting common stock, which is impermissible under Section 4 of the BHC Act. Secondly, defendant alleged that the agreement violated the SBI Act, which prohibits a small business investment company from owning fifty percent or more of the outstanding voting securities of a small business concern.

On May 25, 1990, defendant contacted the FRB and requested an investigation of whether a demand by Heller that defendant issue preferred stock representing fifty percent of its equity violated the provisions of the BHC Act. On July 10, 1990, Heller responded to the FRB's inquiry and offered two points for its consideration: (1) that Fuji Bank and new Heller management played no significant role in the transaction at issue; and (2) defendant was a qualifying small business corporation, and the rights to defendant's preferred stock could have been structured as an SBIC investment. Heller further stated that as soon as the problem came to its attention in 1988, it attempted to negotiate in good faith with defendant to cure the problem. After defendant refused to negotiate in good faith, Heller transferred its rights to defendant's preferred stock to its SBIC affiliate, HECC.

On December 5, 1990, defendant also requested review by the SBA of the propriety of the issuance of the stock. On December 7, 1990, defendant advised the FRB of the pendency of this lawsuit. On May 14 and June 14, 1991, defendant requested a status report of the FRB's review of the matter. To date, defendant has received no further communication from the FRB.

On April 30, 1991, defendant filed a motion to stay these proceedings pending referral to the FRB and the SBA. In that motion, defendant contended that the FRB and the SBA were currently investigating the permissibility of the stock transfer under the BHC Act and the SBI Act. (The SBA has since informed defendant that the issuance of the 2,000 shares of stock does not violate the SBI Act so long as the preferred stock is not converted into voting stock. Defendant does not intend to appeal the SBA's determination.)

On July 25, 1991, the trial court entered an order striking defendant's affirmative defenses. Specifically, the trial judge concluded that: (1) the BHC Act does not expressly declare contracts in violation of the BHC Act void; (2) the FRB has exclusive jurisdiction over original BHC Act claims; (3) Heller's assignment of its rights under the agreement to HECC cured any violation of the BHC Act; and (4) defendant would benefit if the agreement is deemed void. The trial court denied defendant's motion for a stay pending appeal.

On appeal, defendant first argues that the court erred in striking its affirmative defense of illegality because performance of the agreement would violate the BHC Act. Defendant asserts that section 4(c)(6) of the BHC Act prohibits a bank holding company from acquiring more than five percent of the outstanding voting shares of non-banking companies. Defendant contends that Heller made this concession in its July 10, 1990, letter to the FRB when it admitted that the issuance of the stock would create "problems" under the BHC Act. Also, the trial judge stated that "under the original matter with Walter Heller it would appear that it does violate the BHC Act."

Defendant further contends that the fact that the BHC Act does not declare a contract in violation of the Act is irrelevant. Defendant relies upon E & B Marketing Enterprises, Inc. v. Ryan (1991), 209 Ill.App.3d 626, 154 Ill.Dec. 339, 568 N.E.2d 339 (parties' contract amounted to illegal fee-splitting agreement and was therefore void) and American Buyers Club, Inc. v. Grayling (1977), 53 Ill.App.3d 611, 11 Ill.Dec. 449, 368 N.E.2d 1057 (contract and note executed by members of buyers' club were void as violating Regulation Z promulgated under Truth in Lending Act) as support for its position that because the agreement violates the BHC Act it is unenforceable, regardless of whether the BHC Act explicitly declares that it is void. Relatedly, defendant argues that even if the FRB has exclusive jurisdiction over BHC Act claims, defendant may still assert an alleged violation as an affirmative defense.

In Orbanco, Inc. v. Security Bank of Oregon (D.Or.1974), 371 F.Supp. 125, the U.S. district court determined that the FRB had primary jurisdiction to consider possible violations of the BHC Act. The Orbanco court offered the following explanation as the rationale behind investing primary jurisdiction in the FRB:

"The Board is qualified to make the economic decisions demanded by the...