The opinion of the court was delivered by: Elaine E. Bucklo United States District Judge
MEMORANDUM OPINION AND ORDER
Plaintiffs Jan Domanus and Andrew Kozlowski are shareholders of a Polish corporation, Krakow Business Park SP. Z O.O. ("KBP"), who allege that certain Defendants looted the company and improperly wrested it from Plaintiffs' control. Plaintiffs have named the corporation and its wholly owned subsidiaries (the "KBP entities") as derivative defendants in this action. As explained in my previous rulings in this case, Plaintiffs allege a complex and on-going racketeering and fraud scheme that has spanned more than 10 years.
Plaintiffs seek to disqualify counsel for the KBP entities, arguing that they have violated the rule of corporate neutrality by siding with the direct defendants in this litigation. Counsel for the KBP entities assert that they are appropriately trying to protect the interests of the corporations, and seek leave to file a cross-claim against Plaintiffs. For the reasons stated, I grant the motion to disqualify counsel and deny the KBP entities' motion to file a cross-claim.
The facts underlying Plaintiffs' complaint have been laid out in an opinion denying Defendants' motion to dismiss. See Domanus v. Lewicki, 779 F. Supp. 2d 739 (N.D. Ill. 2011). However, an overview of the complaint and the procedural posture of this case is necessary to place the present motions in context. In their Third Amended Complaint("Complaint"), Plaintiffs contend that the direct defendants, led by Derek Lewicki, Richard Swiech and his brother, Adam Swiech, have worked together and with corporations under their control to loot the KBP entities of their assets. They allege the direct defendants used the funds to finance real estate developments in suburban Chicago. Defendants, according to the Complaint, also put stolen funds back into the companies as "capital contributions" by Adam Swiech, who then claimed to be the majority shareholder of KBP. These sham contributions diluted the shareholdings of Domanus and Kozlowski, who contend that they are the rightful majority shareholders of KBP, although they appear on the books as minority shareholders. The complaint outlines four types of misconduct: (1) sham contracts and payments for inadequate consideration; (2) self-dealing leases; (3) land misappropriation; and (4) construction kickbacks.
As part of their suit, Plaintiffs have brought derivative claims on behalf of the KBP entities, but seek no relief from these entities. The KBP entities sought to dismiss the Third Amended Complaint on grounds of improper service and a lack of personal jurisdiction, but I denied that motion. See Domanus, 779 F. Supp. 2d at 750--52. Following the denial of that motion, counsel for the KBP entities was given leave to withdraw from the case, and attorneys from Locke Lord LLP were given leave to substitute as counsel.*fn1
On Feb. 8, 2012, Plaintiffs filed a motion to disqualify Locke Lord in which it argued that the KBP entities had violated the corporate neutrality rule by siding with the direct defendants on the merits of the claims. On March 8, 2012, while briefing on that motion was pending, the KBP entities filed a motion for leave to file a cross-claim against Plaintiffs, arguing in essence that the actions taken by Plaintiffs in this litigation threatened to harm the derivative defendants.
In April, I granted Plaintiffs' motion for a preliminary injunction preventing Defendant Adam Swiech from voting his shares to approve any issuance of shares that would reduce Plaintiffs' shareholdings below 25 percent. See Domanus v. Lewicki, --- F. Supp. 2d ---, 2012 WL 1247102 (N.D. Ill. April 13, 2012). In so ruling, I noted that Plaintiffs had identified extensive evidence supporting their claims of misconduct by the direct defendants. Id. at *3--*4. The KBP entities opposed the preliminary injunction, arguing it would block the KBP entities from raising funds for their operations. As I explained in my ruling, however, the injunction simply blocked the KBP entities from raising funds through "one discrete avenue," a capital call that would so dilute Plaintiffs' interest in the entities that they would be unable to block a future merger. Id. at *5.
Although the corporation is nominally a defendant, a shareholder suit such as the one brought by Domanus and Kozlowski is effectively brought by the corporation, with the shareholders as its representatives.*fn2 Sobba v. Elmen, 462 F. Supp. 2d 944, 946--47 (E.D. Ark. 2006). Any recovery Plaintiffs obtain would go to the KBP entities. Id. at 947 (citing Bell Atl. Corp. V. Bolger, 2 F.3d 1304, 1307 n.4 (3d Cir. 1993)). Because the corporation is the real party in interest, the general rule is that a corporation may not participate in a derivative action on the merits unless it threatens rather than advances the corporate interest. Id., see Patrick v. Alacer Corp., 84 Cal. Rptr. 3d 642, 652 (Cal. Ct. App. 2009). This is known as the rule of corporate neutrality, see Sobba, 462 F. Supp. at 946, and neither side contests its applicability here.
Both sides agree that Locke Lord has a duty to protect the interests of the KBP entities. See Cannon v. U.S. Acoustics Corp., 398 F. Supp. 209, 216 (N.D. Ill. 1975), rev. in part on other grounds, 532 F.2d 1118 (7th Cir. 1976). ("The interest of the corporate client is paramount and should not be influenced by any interest of the individual corporate officials."). The question here is whether Locke Lord's efforts in this litigation have been unduly influenced by the direct defendants. For the reasons that follow, I find that they have.
Locke Lord contends that after an independent investigation, it has determined that Plaintiffs' actions "threaten the profitability, business and the very existence of the companies." Mot. by KBP Entities for Leave to File Cross-claim Against Plaintiffs Instanter, at 3 (Dkt. No. 465). To apply the rule of corporate neutrality, at least as interpreted by Plaintiffs, would render the corporations unable to protect their own interests, the KBP entities contend. Plaintiffs, however, argue convincingly that although the "actual" (i.e., the direct) defendants are nominally represented in this ...