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Kovac v. Barron

Court of Appeals of Illinois, Second District

March 7, 2014

F. GARY KOVAC, Plaintiff and Counterdefendant-Appellee and Cross-Appellant,
SANDRA L. BARRON, Individually and as Independent Administrator of the Estate of Kenneth L. Barron, Jr., Deceased, Defendant and Cross-Defendant and Counterplaintiff-Appellant and Cross-Appellee, (Repair Services, Inc., Defendant; Pinnacle Systems, Inc., Press Room Electronics, Inc., and Triad Controls, Inc., Defendants and Cross-Plaintiffs-Appellees and Cross-Appellants)

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[Copyrighted Material Omitted]

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Appeal from the Circuit Court of Kane County. No. 07-CH-1886. Honorable Thomas E. Mueller and Michael J. Colwell, Judges, Presiding.

Affirmed in part and reversed in part; cause remanded with directions.


In an action arising from a dispute between the shareholders of a group of businesses they operated over a period of several years during which plaintiff suffered the loss of a large amount of money through the fraudulent practices of defendant's deceased husband, the evidence supported the trial court's finding that defendant's husband was guilty of constructive fraud, especially in view of his payment of excessive compensation to himself and defendant; furthermore, a constructive trust was properly imposed as part of the judgment on the fraud count, the judgment entered for plaintiff on the count alleging misuse of corporate assets was not against the manifest weight of the evidence, the judgment on the breach of fiduciary duty count entered for plaintiff was reversed and reentered by the appellate court in favor of the corporate entities, and the award of punitive damages was not an abuse of discretion, but plaintiff's counts alleging conversion and civil conspiracy were properly dismissed.

Michael Resis, of SmithAmundsen LLC, of Chicago, and Ellen L. Green, of SmithAmundsen LLC, of St. Charles, for appellants.

Nancy G. Lischer, of Hinshaw & Culbertson LLP, of Chicago, Michael J. Denker, of Denker & Muscarello, LLC, of St. Charles, and John D. Eddy, of Eddy, DeLuca, Gravina & Townsend, of Pittsburgh, Pennsylvania, for appellee F. Gary Kovac.

Stephen M. Cooper, Peter M. Storm, and Philip J. Piscopo, all of Cooper, Storm & Piscopo, of Geneva, for other appellees.

PRESIDING JUSTICE BURKE delivered the judgment of the court, with opinion. Justices McLaren and Schostok concurred in the judgment and opinion.



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[¶1] This appeal involves a dispute between plaintiff, F. Gary Kovac, a 50% shareholder of defendants Pinnacle Systems, Inc., Triad Controls, Inc., and Pressroom Electronics, Inc. (Operating Companies), and Kenneth L. Barron, Jr. (deceased), the other 50% shareholder. Kovac alleged that Barron had secretly arranged, through the use of a payroll servicing company (KES), wholly owned by Barron, to pay himself substantially more in salary despite an agreement that Kovac and Barron would take the same salaries and bonuses. Kovac further alleged that Barron formed Repair Services, Inc., a separate company wholly owned by

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him, and diverted the income from the Operating Companies' repair business to Repair Services without the knowledge or consent of the Operating Companies' boards of directors. The Operating Companies filed their own cross-complaint against Barron alleging mismanagement, excessive compensation, and the diversion of repair business income through Repair Services.

[¶2] All defendants filed a motion to dismiss the conversion and conspiracy counts (counts IV, VII, VIII, IX, and X) alleged in Kovac's second amended complaint, pursuant to section 2-615 of the Code of Civil Procedure (Code) (735 ILCS 5/2-615 (West 2008)). The trial court granted the motion. Barron's wife, Sandra, as independent administrator of Barron's estate, filed a motion to dismiss the cross-complaint pursuant to section 2-619.1 of the Code (735 ILCS 5/2-619.1 (West 2008)). The trial court granted the motion and dismissed the cross-clomplaint pursuant to section 2-619(a)(3) of the Code (735 ILCS 5/2-619(a)(3) (West 2008)).

[¶3] Following a bench trial, the trial court entered judgment in favor of Kovac as to count V (fraud), awarding him $3,220,702, and the court imposed a constructive trust on Barron's estate. The trial court further entered judgment in favor of Kovac as to count VI (breach of an oral agreement to lease property to the Operating Companies and share equally in the rental profits) and awarded Kovac $45,981. As to count II (breach of fiduciary duty to the Operating Companies and their shareholders by diverting repair business income from the Operating Companies to Repair Services), the trial court entered judgment in favor of the Operating Companies and awarded damages in the amount of $327,790. Finally, the court awarded Kovac $450,000 in punitive damages against the estate.

[¶4] On reconsideration, the court entered judgment in favor of Kovac on count I (breach of fiduciary duty for mismanagement, pursuant to section 12.56 of the Illinois Business Corporation Act of 1983 (Business Corporation Act) (805 ILCS 5/12.56 (West 2008))), but it did not award additional damages as they would be duplicative of those awarded under count V. As to count II, the court found that the relief Kovac sought was on behalf of the Operating Companies and entered judgment in favor of the Operating Companies.

[¶5] Sandra appeals, arguing that (1) the trial court's judgment on count V was against the manifest weight of the evidence; (2) the trial court's judgment on count I was against the manifest weight of the evidence; (3) Kovac could not assert counts II and V as direct claims in his individual capacity and they should have been brought as derivative claims on behalf of the Operating Companies; (4) the judgment on count II must be vacated since the Operating Companies had no action pending against Barron at the time of trial; and (5) the trial court erred in awarding punitive damages.

[¶6] Kovac cross-appeals the dismissal of the conversion and conspiracy claims. The Operating Companies also cross-appeal the dismissal of their cross-complaint. We affirm in part, reverse in part, and remand the cause with directions.

[¶7] I. FACTS

[¶8] A. Pleadings

[¶9] On September 12, 2007, Kovac sued Barron, the Operating Companies, and Repair Services. On November 6, 2007, Barron, the Operating Companies, and Repair Services filed a motion for leave to file a counterclaim against Kovac. Two days later, the trial court entered an agreed order in which it appears that the defendants

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abandoned the motion for leave to file a counterclaim.

[¶10] On April 18, 2008, Kovac filed a first amended complaint and, on May 15, 2008, he filed a second amended complaint. The second amended complaint was brought against Barron, Sandra, the Operating Companies, and Repair Services. Specifically, count I, against Barron and the Operating Companies, alleged a violation of the Business Corporation Act and gross mismanagement of the business. Count II, against Barron, alleged that he had breached his fiduciary duty to the Operating Companies and their shareholders by diverting repair business income from the Operating Companies to Repair Services. Count III, against Barron and Repair Services, alleged tortious interference with economic advantage in connection with the diversion of income. Count IV, against Barron, alleged that Barron misappropriated funds through KES. Count V, against Barron, alleged fraud for secretly paying himself and Sandra unauthorized and excessive salaries and bonuses. Count VI, against Barron, alleged breach of contract for his failure to pay Kovac half of the rental profits from their property.[1] Count VII, against Barron, alleged that Barron's refusal to pay Kovac those rental profits constituted conversion. Count VIII, against Sandra, alleged that Sandra's excessive compensation from KES for the bookkeeping services she performed for the Operating Companies constituted conversion. Both counts IX and X, against Barron and Sandra, alleged that they conspired to convert funds belonging to Kovac by transferring those funds from the Operating Companies to KES and by keeping 100% of the rental profits.

[¶11] The defendants filed a motion to dismiss Kovac's second amended complaint, pursuant to section 2-615 of the Code, on several grounds, including that counts II through V, VIII, and IX could be brought only as derivative claims on behalf of the Operating Companies. Following a hearing, the trial court granted the defendants' motion to dismiss counts IV, VII, VIII, IX, and X with prejudice, which included all claims pleaded against Sandra individually. As a result, Sandra was dismissed as a defendant. The trial court later dismissed count III of the second amended complaint with prejudice and dismissed Repair Services as a defendant.

[¶12] Barron was adjudicated a disabled person on November 19, 2008. Sandra, not individually, but solely as plenary guardian for the person and estate of Barron, was substituted as a party in place of Barron. On November 17, Sandra, as guardian, filed a counterclaim against Kovac for breach of fiduciary duty.

[¶13] On April 30, 2009, the Operating Companies filed a cross-complaint against Sandra, as guardian, for Barron's alleged breaches of fiduciary duties arising out of the alleged gross mismanagement of the Operating Companies (count I), payment of excessive compensation and unauthorized distributions (count II), and engaging in a competing business and diverting repair business income from the Operating Companies (count III).

[¶14] On June 29, 2009, Sandra filed a motion to dismiss the cross-complaint, pursuant to section 2-619.1 of the Code. Sandra argued that all of the cross-claims constituted the " same action" by the " same party" as in Kovac's complaint and were therefore barred under section 2-619(a)(3) of the Code. The Operating Companies argued that they were not the same parties, because Kovac was the shareholder while the Operating Companies were the

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corporations. Following a hearing, the trial court dismissed the Operating Companies' cross-complaint with prejudice pursuant to section 2-619(a)(3). The record does not contain a transcript from the hearing.

[¶15] On February 29, 2012, Barron died. On March 21, 2012, the trial court granted Kovac leave to file a third amended complaint against Sandra, as administrator of the estate, and the Operating Companies. Kovac re-alleged counts I, II, V, and VI. In count I he further alleged that he suffered financial loss in his capacity as a 50% shareholder in the Operating Companies and sought compensation. In count II he sought judgment in the amount of $350,134, " plus interest, costs of suit, punitive damages, reasonable attorney's fees, and further orders that such amounts be returned to the Operating Companies." In count V, Kovac maintained that he and Barron had an oral agreement to receive equal annual compensation and profit distributions and that Barron's mischaracterization of excess compensation as for " contract labor" paid through KES was part of a scheme to convert funds belonging to Kovac. In count VI, Kovac alleged that he and Barron orally agreed to lease the property they co-owned to the Operating Companies and share equally in the rental profits. Kovac also specifically reserved for appeal counts IV (conversion against Barron), VII (conversion against Barron), VIII (conversion against Sandra, individually), IX (civil conspiracy against Barron and Sandra, individually), and X (civil conspiracy against Barron and Sandra, individually), which had been previously dismissed by the trial court with prejudice.

[¶16] B. Pretrial Proceedings

[¶17] Sandra filed a motion to bar certain evidence under the Dead-Man's Act (735 ILCS 5/8-201 (West 2010)). Sandra also filed a supplemental memorandum addressing testimony from Barron's discovery deposition in which Barron stated that " apparently" he and Kovac had agreed that they would be paid the same amount in salary and bonuses. Sandra asserted that this did not qualify as an admission. The trial court ruled that the statement was an admission against interest that would be admissible at trial. Kovac subsequently filed a motion in limine to enter into evidence certain of Barron's deposition testimony, including the statement that he and Kovac " apparently" agreed to equal compensation. The trial court granted the motion.

[¶18] C. Bench Trial

[¶19] On April 30, 2012, the matter proceeded to a bench trial at which the following evidence was presented. Triad Controls was formed by Barron, Kovac, and Ron Cejer in 1980, when they began developing a design for a safety light curtain, a type of manufacturing safety device. The first sale occurred in 1981. At the time, Cejer was president, Kovac was in sales, and Barron was in manufacturing. Triad moved into a facility in 1984, and then into a larger facility in 1987, after it began hiring technical personnel. In 1986 or 1987, Kovac and Barron bought out Cejer, and Kovac and Barron each became a 50% owner in the company. Triad moved again in 1994 to the facility located in St. Charles.

[¶20] The other two Operating Companies, Pinnacle Systems and Press Room Electronics, were established in 2001 and 2002, respectively, by Kovac and Barron, as equal owners. Each of the Operating Companies was set up as a subchapter S corporation. Each company was designed to run in a specific marketplace. Triad is in the metal fabrication industry. Press Room is in the metal stamping industry. Pinnacle manufactures other types of safety devices used in manufacturing. Each corporation had a board of directors composed

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of Kovac and Barron. Barron became president of Triad in 1986 and of Pinnacle and Press Room when they were formed, and he remained in those positions until March 2009. Kovac served as vice president. Kovac conducted marketing and branding operations in Pittsburgh, Pennsylvania, while Barron conducted manufacturing operations and order fulfillment in St. Charles. Accounts receivable and payable, payroll, and bookkeeping were also handled in St. Charles.

[¶21] Barron formed KES around 1985 by Barron to administer and pay payroll taxes and employment benefits for individuals in Illinois who provided labor and services to the Operating Companies. The actual paychecks were handled by ADP, an independent payroll company. KES did not generate any revenue; rather, the funds to administer the payroll for the Illinois employees came from the Operating Companies, which allegedly provided only those funds necessary. Sandra was employed by KES since its inception. Personnel in the Pittsburgh sales office, including Kovac, were paid initially through Triad and later through Pinnacle.

[¶22] Kovac works with Darrin Kohn, the Operating Companies' production engineer in St. Charles, to develop new products requested by customers. Kovac is responsible for compliance with Occupational Safety and Health Administration and American National Standards Institute requirements, performing research, and creating design criteria. After machines undergo a risk assessment, the type of safety device is selected, and the design criteria and desired functions are specified. The order is then filled in St. Charles.

[¶23] Kohn and Marilyn Jacobsen, the Operating Companies' office manager, testified that Barron worked only half days. Barron allegedly had not worked a full day since the 1980s, and he admitted in his deposition that he left work each day around noon.

[¶24] Barron's primary responsibility consisted of data processing. Jacobsen explained that Barron typed orders and gave them to her to take to the back room where the product would be made. Kovac presented Barron's deposition testimony regarding these matters, and Sandra did not object. Barron had testified that his duties included billing, handling payables, processing orders, evaluating personnel, and granting raises. Barron acknowledged that he typed orders into the computer " like a data processing clerk would do." Kovac opined that, given these duties, Barron did not provide any service that justified greater compensation than Kovac's.

[¶25] Kovac testified that he had believed that he always received the same salary and bonus as Barron. Kovac sued Barron when he learned that he was not receiving equal compensation. At the time in question, the board of directors for each Operating Company consisted solely of Kovac and Barron, and the boards never authorized the payment of unequal compensation.

[¶26] Kovac submitted Barron's deposition testimony regarding Barron's and Kovac's compensation, without objection, despite the trial court's ruling that objections were to be made at trial. Barron was asked whether he and Kovac agreed that they would be paid the same amount in salary, and Barron responded " apparently, yes." Barron was then asked about the past practice that he and Kovac received equal salaries and bonuses. Barron was asked: " You always pulled the same salary out, didn't you?" Barron answered " yes." When asked " if there was a bonus at the end of the year," and whether Barron and Kovac paid themselves equal bonuses, Barron responded " yes." Barron then was

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asked when this practice of equal compensation stopped, but he could not recall.

[¶27] Sandra testified at trial regarding the compensation that Barron and Kovac received. First, she testified that they never received the same salary and bonus and that their compensation was not even " pretty close." She admitted that this differed from her deposition testimony, where she had stated that Kovac and Barron were paid about the same salary and bonus every year. At trial, she eventually agreed that Kovac and Barron made " pretty much the same bonus every year."

[¶28] Sandra, who had taken a single accounting class in high school, worked for the Operating Companies part-time, around six to eight hours a week. Her responsibilities included bookkeeping, check writing, and some purchasing. She also handled payroll for KES, which involved calculating the Illinois employees' hours and submitting both the Illinois and Pennsylvania payrolls to ADP. Sandra also recorded payments and moved funds from the Operating Companies to KES to cover payroll. She testified that she probably handled the bookkeeping of Repair Services. Between 1999 and 2007, Barron unilaterally set Sandra's annual salary for her part-time work. During those years, her annual salary ranged from $172,800 to $272,800.

[¶29] Kovac expected that Sandra would be paid a reasonable salary for her part-time bookkeeping services. However, compensation was set " in a manner consistent with maximizing the 401k benefits" for both Sandra and Barron. The Operating Companies' boards never authorized compensation consistent with maximizing 401k benefits. Without objection, Barron's deposition testimony that he never told Kovac the amount that ...

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