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In Re Marriage of Jennifer Steel

November 21, 2011


Appeal from the Circuit Court of Du Page County. No. 06-D-614 Honorable Rodney W. Equi, Judge, Presiding.

The opinion of the court was delivered by: Justice Birkett

JUSTICE BIRKETT delivered the judgment of the court, with opinion. Justices Zenoff and Schostok concurred in the judgment and opinion.


¶ 1 Petitioner, Jennifer Steel, appeals from the order of the trial court dissolving her marriage to respondent, Robert Steel. Petitioner raises three main claims: (1) the trial court erred by classifying as non-marital property certain of respondent's corporate interests; (2) the court erred in valuating one of the marital assets, a vacation home in Michigan (Michigan home), which it awarded to petitioner as part of the property division; and (3) the court erred in determining respondent's annual income. Respondent cross-appeals, arguing that (1) the trial court's property division did not account for respondent's payment of attorney fees, both his and petitioner's; (2) the court erred by directing respondent to reimburse the marital estate in the amount of $289,666.74; and (3) the court erred by holding that respondent was estopped from claiming at trial that certain investments of his were non-marital property. For the following reasons, we affirm in part, vacate in part, and remand.

¶ 2 We note first that petitioner has filed a motion to strike respondent's reply brief in support of his cross-appeal. Petitioner's sole complaint is that the brief's cover was the wrong color (respondent, as petitioner acknowledges, has since remedied the infraction by submitting a proper cover). Without further comment, we deny the motion.

¶ 3 The parties were married on May 9, 1987, and have four children: Michael, born February 13, 1989; Connor, born March 15, 1991; Katheryn, born January 9, 1995; and Kiernan, born August 22, 1996. The parties separated on March 9, 2006, and petitioner filed for divorce on March 16. On February 7, 2007, respondent moved for summary judgment regarding the property classification of his interests in three privately held companies: KA Steel Company (KASC), Montana Metals Products LLC (MM Products), and Montana Metals Properties LLC (MM Properties). On June 7, 2007, the trial court granted in part and denied in part respondent's summary judgment motion. The case proceeded to an eight-day trial in November 2007. On March 29, 2008, the trial court issued a letter ruling on the contested issues. On May 22, 2008, the court issued a judgment for dissolution of marriage. Both parties filed motions to reconsider, which the court denied. Petitioner filed an appeal, and respondent filed a cross-appeal. We provide additional background as we discuss each issue.

¶ 4 I. Property Classification and Reimbursement of the Marital Estate

¶ 5 A. Background

¶ 6 1. Procedural History

¶ 7 The first issues we address implicate both the appeal and the cross-appeal. Petitioner argues that the trial court erred in classifying as non-marital respondent's interests in KASC, MM Products, MM Properties, and two additional privately held companies, San Francisco Foods, Inc. (SFF Inc.) and San Francisco Foods LLC (SFF LLC). In his cross-appeal, respondent challenges the trial court's order that he reimburse the marital estate for sums he used to purchase some of his shares in KASC. He also contests the trial court's holding that he was estopped from claiming at trial that his interests in certain private placements are non-marital.

¶ 8 First, we provide further background on these issues. Respondent's summary judgment motion addressed, inter alia, his present 50% ownership of all KASC outstanding stock. Specifically, respondent possessed at the time of summary judgment (and still at the time of trial) 1,164.75 shares of Class A common stock and 10,482.75 shares of Class B common stock. For purposes of his motion, respondent identified three phases of his ownership of KASC stock. The first phase was his acquisition, prior to marriage, of 776.5 shares of KASC common stock, which represented one-third of the total stock of the company, with the remaining two-thirds, or 1553 shares, divided equally between respondent's brothers, Kenneth and Richard. The second phase was respondent's July 2004 purchase of 50%, or 388.25 shares, of Richard's KASC stock, with Kenneth purchasing the remaining 388.25 shares. The third phase was KASC's January 2007 stock dividend, whereby KASC issued nine shares of Class B common stock for each share of existing common stock, and the existing common stock was renamed Class A common stock.

¶ 9 The trial court found no material factual dispute that the 776.25 shares respondent acquired prior to the marriage were non-marital property. The court did, however, find a material factual dispute regarding the classification of the 388.25 shares respondent acquired in July 2004.

Specifically, the court found it disputable whether the funds with which respondent purchased the shares-namely, monies from KASC itself-were themselves marital or non-marital. The court further reasoned that, since a fact dispute existed as to the classification of the shares acquired in July 2004, there existed, a fortiori, a fact question as to the proportion of the new stock issued in January 2007 that corresponded to the 388.25 shares respondent acquired from Richard.

¶ 10 As for respondent's interests in MM Products and MM Properties, the trial court likewise found a material factual dispute whether the funds used to acquire those interests-again, monies from KASC-were themselves non-marital or marital. Consequently, the trial court granted summary judgment for respondent as to his shares of KASC acquired before the marriage, but it denied summary judgment as to the shares of KASC he subsequently acquired and his shares of MM Products and MM Properties.

¶ 11 Neither party contests the trial court's summary judgment ruling, but both direct their challenges to the trial court's ultimate ruling on those issues after trial. We set forth the relevant evidence, most of which is undisputed.

¶ 12 2. Respondent's Use of the "Due from Officers" Account at KASC

¶ 13 In 1977, respondent began employment with KASC, where his father was president and chief executive officer (CEO). In 1982, respondent himself became president and CEO of KASC. At the time of trial, respondent was still CEO of KASC and was also chairman of the board of directors, while Kenneth was president. In July 2004, Richard retired from KASC and sold his shares to respondent and Kenneth. For as long as respondent has worked at KASC, he has received a regular salary.

¶ 14 In her claims about property classification (which we describe in full below), petitioner stresses the liberality with which respondent was loaned money by KASC through the "Due from Officers" account (DFO), which was initiated sometime in the 1980s. Various witnesses testified to the account, including respondent, Kenneth, and Bernard Ludwig, vice president of finance at KASC. The DFO allows certain KASC officers to take personal advances from the company. DFO use has been restricted to respondent, Kenneth, and Richard. The DFO is enabled by a revolving line of credit with a lending institution, which at the time of trial was Chase Bank. The collateral for the DFO is KASC stock. The brothers' DFO advances are recorded separately, and they need not keep their balances equal. When a DFO advance is given, the DFO balance increases, and when an advance is repaid, the DFO balance decreases. The DFO is treated by KASC as an asset, specifically as an account receivable. KASC charges interest on the advances, which it treats as interest income for tax purposes. DFO borrowers deduct the DFO interest on their individual tax returns.

¶ 15 There was evidence as to restrictions on DFO advances. Chase is the latest in a series of firms that have funded the line of credit enabling the DFO account. The record contains a long string of bank covenants, and amendments to these covenants, to which the lenders have succeeded in interest. Ludwig testified that the bank covenants formerly specified a flat cap on DFO advances (flat cap), but that the cap was recently removed. The bank covenants in the record corroborate Ludwig's testimony. Of these, the three most recent are dated July 22, 2005, March 8, 2006, and July 25, 2006. The July 2005 covenant provided that KASC shall not, except with the written consent of the lender, "permit as of each fiscal quarter end, its DFO to be not less than $3,000,000.00." The March 2006 amendment modified the flat cap to "$4,500,000.00 from the date hereof [March 8, 2006] to April 30, 2006, and *** $3,000,000.00 from May 1, 2006, and thereafter."

The July 2006 amendment provided that it was "delet[ing] in [its] entirety" the flat cap. Ludwig testified that there was a more recent amendment in force as of the time of trial, but he confirmed that this amendment did not reimpose the flat cap. Ludwig testified that, though the flat cap is no longer in place, Chase enforces a cap keyed to the tangible net worth of KASC (net-worth cap). Ludwig explained that the lender treats a DFO advance as a shareholder distribution that applies against KASC's tangible net worth. Respondent confirmed that there is a "relationship" between the DFO balance and KASC's net worth. The lender, respondent explained, "reduces the tangible net worth [of KASC] by the dollar amount of the aggregate DFO." Asked why KASC must "maintain an equity position," respondent explained, "It's an acutely capital intensive business. It has a very large asset base with a very high level of depreciation. And these assets have to be replaced on a very regular basis." The current net-worth cap, which fluctuates as KASC's tangible net worth fluctuates, is $10 million.

¶ 16 Ludwig recounted occasions when KASC exceeded the flat cap for the quarter and only afterwards applied for an exception from the cap. No lender refused to grant an exception. In 2000, KASC's current lender required KASC to pay down the DFO balance. KASC subsequently did so through shareholder distributions in 2000, 2001, and 2002, which totaled $13 million and reduced KASC's net worth by an identical amount. The distributions reduced the net worth of the ownership interests of Kenneth, Richard, and respondent by $4.3 million each. Ludwig noted that Kenneth, Richard, and respondent have also occasionally paid down the DFO balance with personal funds. Respondent denied that he has used "personal monies to pay down the DFO," though evidence at trial was to the contrary.

¶ 17 The witnesses agreed that the bank restrictions are the only limitations on DFO usage and that KASC has no internal policies concerning the amounts or uses of DFO advances or schedules for repayment. Ludwig administers the DFO account, and respondent testified that, to receive a DFO advance, he "simply pick[s] up the phone or e-mail[s] [Ludwig] and tell[s] him that [he] need[s] money and [Ludwig] either wires it or sends him a check." Respondent and Kenneth both testified that the DFO account is an appealing resource because the interest rate charged by KASC is less than the commercial rate and KASC does not require officers to complete paperwork for the advances. Ludwig could recall no instance when KASC has required officers to sign a promissory note regarding DFO advances.

¶ 18 Respondent and Kenneth testified that they have put DFO advances to personal use. For instance, each has used DFO funds for personal investments. Respondent acknowledged that in 2007 he made "close to" $300,000 in investments using DFO advances. The documentary evidence shows that respondent used at least $250,000 in DFO advances for investments in 2006 and 2007. Respondent identified several other personal uses to which he has put DFO funds. In 2003, respondent borrowed $11,000 to pay property taxes on the Michigan home and $22,000 to pay property taxes on the parties' former home at 445 East 4th Street in Hinsdale. In 2005, respondent used DFO funds to make a down payment on the parties' former residence at 325 East 8th Street in Hinsdale, which the parties purchased for $4.1 million. For several months during 2003, respondent took DFO advances to pay an interior designer for work on the Michigan home. Respondent acknowledged that he has never repaid KASC for the down payment on the 8th Street home. As will be detailed below, respondent also used DFO funds to acquire stock in KASC, MM Products, MM Properties, SFF Inc., and SFF LLC.

¶ 19 Ludwig was shown DFO ledgers from several recent years. As Ludwig noted, the ledgers typically do not reflect the purpose for which the recipient intended to use the DFO advance.

¶ 20 Respondent and Kenneth claimed that there were occasions when KASC refused their requests for DFO advances. Kenneth could not, however, recall a specific instance when his request was refused. Respondent testified that he has never been refused a DFO request "up to the limits set by the bank, self-imposed limits." Respondent recalled an instance in 2004 or 2005 when, in a matter of months, KASC went from a "cash position to over 18 million in debt." At that point, the lender "cut [the DFO] off." Respondent testified that the bank is "very strict" with the "three million limit" on the DFO. (Possibly, the $3 million cap that respondent mentioned here was the same $3 million cap he said was placed on the DFO at its "inception." There is no dispute, however, that the flat cap was lifted in 2006.) Respondent recalled that there were eight or nine occasions within the last three years when he was refused an advance. According to respondent, he is currently "tapped out" on his DFO and is not able to take advantage of a current investment opportunity he finds appealing. This exchange followed:

"Q. So is it your testimony, as you sit here today, [that] you cannot access any more money against your DFO?

A. I am currently beyond my limit on my DFO. Let's put it this way. The-

Q. Well-

A. The legal limit is 3 million. I am greater than 1.5 million, you know, slightly greater than that amount. But-

Q. Well, that's different because, in the past, you have exceeded your limit-

A. Right.

Q. -but still been able to borrow, right?

A. Right.

Q. And so, my question to you specifically is, even though you believe that you may have exceeded some limit are you testifying today you have no more access to your DFO?

A. I have limitations right now. I have hit my limit." (Again, it is unclear which $3 million cap respondent referred to.) Respondent testified elsewhere, however, that he had taken a DFO advance of $8,000 that very day. Ludwig agreed that respondent is presently "tapped out" under the net-worth cap. Ludwig was also asked:

"Q. Now does [respondent], in 2006, did he discuss with you any of the uses of the advances that he requested?

A. Yes.

Q. And regardless of what [respondent] uses the money for, if he asked you for an advance, have you ever refused to give him an advance?

A. No. (Ludwig was not asked a similar question regarding Kenneth's or Richard's requests for DFO advances.)

¶ 21 The record shows the following DFO activity by respondent for the years 2001 though 2005.

Description 2001 2002 2003 2004 2005

Beg. Balance 12/31 $3,142,837.89 $649,550.41 $1,606,621.33 $1,383,612.96 $1,658,517.32 Total Advances $919,654.56 $1,711,693.43 $421,194.72 $834,963.20 $595,442.33 Total Paydowns $3,577,926.86 $772,046.93 $661,084.46 $578,631.82 $813,854.65 End Balance 12/31 $649,550.41 $1,606,621.33 $1,380,657.61 $1,658,517.32 $1,491,507.34 Change in Balance $2,493,287.48 -$957,070.92 $225,963.72 -$274,904.36 $167,009.89

(The adjustment in the opening balance for 2004 is not explained by the record.) The record does not reflect the purposes for most of these advances. The DFO ledgers from several years are in the record, but as Ludwig acknowledged, the ledgers often do not indicate the intended purposes for the advances. Ludwig testified that, as of trial, respondent's DFO balance was $1.6 million.

¶ 22 Several witnesses testified to KASC's status under federal income tax laws. These witnesses included Ludwig; Alan Alport, who provided accounting services to respondent, KASC, SFF Inc., and SFF LLC; and Dennis Czurylo, a forensic accountant who was petitioner's expert witness. According to these witnesses, KASC is a subchapter S corporation and, consequently, the earnings of KASC are taxed not to the corporation but to the shareholders, who report on their individual tax returns the earnings proportionate to their ownership shares in the corporation. See 26 U.S.C. § 1366 (2000) (explaining tax consequences for a subchapter S corporation). As Alport explained, respondent is taxed on the earnings of KASC whether they are distributed to him or retained by the corporation. Thus, KASC's retained earnings are, as Alport described them, "phantom income" to the shareholders of KASC. See Hill v. Commissioner of Internal Revenue, 100 T.C.M. (CCH) 513 (2010) ("An S corporation is not subject to the Federal corporate income tax. [Citation.] Instead, an S corporation's items of income, gain, loss, deduction, and credit-whether or not distributed-flow through to the shareholders, who must report their pro rata shares of such items on their individual income tax returns for the shareholder taxable year within which the S corporation's taxable year ends."). KASC makes payments to its shareholders to cover the tax due on the retained earnings. Until 2002, KASC designated these payments as shareholder distributions. From 2002 to the time of trial, KASC has designated the payments as bonuses, to be included in the shareholder's W-2 income. According to Ludwig, KASC changed the designation on the advice of its accountants.

¶ 23 There was also testimony as to respondent's salary at KASC. Respondent's yearly base salary in the years 2001 through 2006 ranged from $400,000 to $600,000. According to Kenneth, he and respondent mutually decided on their salaries and based them on industry standards. They also obtained "the approval of the bank" for the salaries. Ludwig explained that, because salaries, like all of KASC's expenses, reduce the tangible net worth of the company, the net-worth cap necessarily limits the salaries of KASC officers.

¶ 24 Evidence was also adduced on the matter of distributions or dividends from KASC. Ludwig testified that, like DFO advances and officers' salaries, shareholder distributions or dividends are limited by the net-worth cap. Moreover, distributions or dividends must be disbursed equally to all shareholders.

ΒΆ 25 Also relevant is the process by which respondent acquired his shares in KASC and the other companies. We discuss that process at length in the next section. As will be seen, respondent relied extensively on DFO advances and shareholder distributions from KASC in making these acquisitions. Further, some of these funds from KASC were deposited into respondent's account at Northern Trust Company (NT account) before he disbursed them to make the purchases. The NT account, which is held in respondent's name alone, is part of a revocable trust of which he is trustee and petitioner is beneficiary. The record does not show when respondent opened the NT account, but it contains account statements dated as far back as 2001. Respondent testified that he alone was responsible for handling the family finances and that, from 2001 through 2006, he used the NT account exclusively for both family expenses and personal financial transactions. KASC deposited respondent's salary directly into the NT account. Any DFO advances or shareholder ...

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