Jaffe Commercial Finance Co. v. Harris

• Decision Date: 01 November 1983
• Docket Number: No. 82-2334,82-2334
• Citation: 74 Ill.Dec. 722,456 N.E.2d 224,119 Ill.App.3d 136
• Parties: , 74 Ill.Dec. 722 JAFFE COMMERCIAL FINANCE COMPANY, Plaintiff-Appellant, v. Paul P. HARRIS, Ruben Harris and Harris Loan and Mortgage Corp., Defendants- Appellees.
• Court: United States Appellate Court of Illinois

Page 224

456 N.E.2d 224

119 Ill.App.3d 136, 74 Ill.Dec. 722

JAFFE COMMERCIAL FINANCE COMPANY, Plaintiff-Appellant, v. Paul P. HARRIS, Ruben Harris and Harris Loan and Mortgage Corp., Defendants- Appellees.

No. 82-2334.

Appellate Court of Illinois First District, Second Division.

Nov. 1, 1983.

Roger B. Harris and Judy B. Ludwig of Altheimer & Gray, Chicago, for plaintiff-appellant.

Glenn A. Schwartz and Mavis Hamilton of Landesman & Schwartz, Chicago, for defendants-appellees.

DOWNING, Presiding Justice:

The issue in this case is whether a minority shareholder in a close corporation is entitled to any relief from an alleged freeze-out. Plaintiff, Jaffe Commercial Finance Company, ¹ contests the propriety of the trial court's judgment holding that: (1) plaintiff was barred from equitable relief under the "unclean hands" doctrine; (2) the evidence failed to show a pattern of practice and an oral agreement between plaintiff's principal shareholder, Joel Salk, and the individually named defendants, Paul and Ruben Harris ("the Harris brothers") regarding their participation in and earnings from the defendant corporation, Harris Loan and Mortgage Corp. ("Harris Loan"); and (3) the evidence failed to establish a breach of fiduciary duty, or oppressive conduct, sufficient to warrant liquidation of the assets and business of Harris Loan. Plaintiff contends that these findings were contrary to the manifest weight of the evidence.

In the spring of 1972, the Harris brothers decided to incorporate Harris Loan, a retail installment loan business. They met with Joel Salk to discuss the formation aspects of this new venture, for Salk had acquaintances in the banking community who would operate as a beneficial source for lines of credit essential to the loan business; moreover, Salk had invaluable experience with regard to management systems, internal controls and other operational aspects of the consumer finance industry.

On June 2, 1972, Harris Loan was incorporated with an initial capitalization of $100,000. Salk and the Harris brothers each invested $30,000 in this new business venture ($7,500 in common stock and $22,500 in subordinated debentures). A third Harris brother, Joel Harris, originally invested $10,000 ($2,500 in common stock and $7,500 in subordinated debentures); however, his interest was redeemed at an early stage because of his failure to assist in the arrangement for additional bank lines of credit.

At the formation of Harris Loan, it was agreed that Paul Harris would be president, and Ruben Harris would be vice-president and treasurer, and Joel Salk would be secretary. Thereupon, each was elected to his agreed-upon corporate office; each became a director of the Harris Loan Board; and, each was reelected annually from 1972 to 1978, when the events took place which culminated in this lawsuit. In addition, it was agreed that the Harris brothers were to conduct the day-to-day operations of the business on a full-time basis. Salk was to advise and consult as an outside director, set up administrative and accounting systems, and arrange for the procurement of bank lines of credit. As for compensation, it was determined that each of the Harris brothers was to receive a salary of $25,000 for the first year. There was no discussion with regard to dividends.

In 1977, negotiations took place for the purchase of the River Oaks Bank and Trust Company. Contracts of purchase for the bank's stock were signed by Salk and the Harris brothers; however, a disagreement arose with respect to the proposed merger of plaintiff corporation and Harris Loan, harsh words were exchanged, and the Harris brothers were subsequently released from the bank acquisition. Salk then proceeded with the bank purchase, and informed the Harris brothers that he wished to sell plaintiff's shares in Harris Loan. The Harris brothers, referring to a 1972 "buy/sell" agreement, offered to buy out plaintiff's equity at $35,000, a price equal to the 1977 book value of the shares. However, Salk declined the offer, refusing to give up the stock for a price less than the alleged fair market value of approximately $300,000.

In an attempt to persuade the Harris brothers to buy plaintiff out at the fair market price, Salk informed them that the institution of a lawsuit would have a chilling effect on their bank lines of credit. As a result, the Harris brothers terminated further consulting services on the part of Salk; and, at a special meeting of Harris Loan shareholders on May 30, 1978, they voted him out as a corporate director. Leah Harris, the wife of one of the Harris brothers, was subsequently elected to replace Salk on the Harris Loan Board; and, on June 26, 1978, Ruben Harris was elected to the office of corporate secretary, thereby effectively ousting Salk from participation in the business of Harris Loan.

Five days prior to the June 26 Harris Loan Board meeting, plaintiff filed an action in equity to enforce an alleged agreement between the Harris brothers and Salk. Plaintiff averred that the three men agreed, at the formation of Harris Loan in 1972, to share equally the rights and responsibilities of ownership and management of Harris Loan; to each occupy, at all times, a seat on its board of directors; to invest approximately equal sums in its common stock, and much larger, but still approximately equal, sums in the subordinated debentures of Harris Loan; and, to receive equal returns on their investments, subject to the rights of the Harris brothers to receive reasonable compensation for their active management of the business. There were also allegations of a further agreement between the parties that Salk would be readily available for consultation, and that he would occupy, at all times, the office of secretary to Harris Loan.

Initially, plaintiff sought a preliminary injunction; however, on March 21, 1980, plaintiff was granted leave to file an amended complaint, which asserted that the Harris brothers' conduct in freezing Salk out was "oppressive" within the meaning of Ill.Rev.Stat.1979, ch. 32, par. 157.86. Plaintiff thereby requested the entry of a decree liquidating the assets and business of Harris Loan; or, in the alternative, ordering the Harris brothers to vote for and restore Salk to his officership and directorship, and restraining the Harris brothers from interfering with Salk's participation in the management of Harris Loan.

At the conclusion of trial, the court ruled that the exclusion of Salk by the Harris brothers was not a breach of fiduciary duty or oppression, but merely an exercise of their right as majority shareholders to "vote their strength." Moreover, regarding the operation of Harris Loan, participation in it, and payment of income from it, the court held that plaintiff had not proved an oral agreement and, thus, was not entitled to equitable relief. Based on these findings, judgment was thereupon entered in favor of defendants on September 1, 1982. It is the propriety of this judgment which plaintiff now contests on appeal.

I.

The threshold issue is whether the trial court erroneously concluded that plaintiff was barred from equitable relief under the doctrine of "unclean hands."

It is a fundamental rule that one seeking equity cannot take advantage of his own wrong or, as otherwise stated, "[h]e who comes into equity must come with clean hands." (See generally, 2 Pomeroy Equity Jurisprudence § 397 et seq. (5th ed. 1941).) The application of this equitable maxim lies within the sound discretion of the trial court; the doctrine is not concerned so much with the effect of plaintiff's conduct, but with the intent with which the acts were performed. Regional Transportation Authority v. Burlington Northern Inc. (1st Dist. 1981), 100 Ill.App.3d 779, 786, 55 Ill.Dec. 818, 426 N.E.2d 1143.

Traditionally, the "unclean hands" doctrine has not been favored by the courts, for it is not a judicial straightjacket intended to prevent equity from doing complete justice. (Shadden v. Zimmerlee (1948), 401 Ill. 118, 127-28, 81 N.E.2d 477; Mascenic v. Anderson (1st Dist.1977), 53 Ill.App.3d 971, 972, 11 Ill.Dec. 718, 369 N.E.2d 172.) Furthermore, Illinois decisional law provides that the misconduct on the part of a plaintiff which will defeat recovery in a court of equity under this rule must have been fraud or bad faith directed toward the defendant in the very transaction being considered. Mills v. Susanka (1946), 394 Ill. 439, 445-46, 68 N.E.2d 904; Baal v. McDonald's Corp. (1st Dist.1981), 97 Ill.App.3d 495, 500-01, 52 Ill.Dec. 957, 422 N.E.2d 1166, appeal denied, 85 Ill.2d 563.

In the present case, it was argued by defendants at trial that lump sum amounts paid to Salk annually from 1973 through 1977 were, essentially, bill payments to Salk for his services as a consultant to Harris Loan. However, Salk characterized these bills as "shams," admitting that they were prepared after payment had already been made so as to provide Harris Loan's accountants with "back-up" or documentation. By the use of this procedure, plaintiff asserted that Harris Loan was able to deduct the payments to Salk as fees or commissions; and, as a consequence, the company paid less in taxes than it would have had the payments to Salk been made as dividends. The trial court, nonetheless, regarded this sham procedure as "deplorable"; thus, it concluded sua sponte that plaintiff was barred from equitable relief under the doctrine of "unclean hands."

Defendants concede that Salk's participation in this misconduct was not directed toward any one of them; rather, they urge that Salk's acts were illegal and a violation of public policy. We are of the opinion that it is this concession which proves fatal to defendants' argument for the application of the "unclean hands" rule. For, since plaintiff, through its principal shareholder Salk, has defrauded neither the defendant corporation nor the individual defendants, the "unclean hands"...