Urnest v. Forged Tooth Gear Co.

Citations: 243 N.E.2d 596; 102 Ill. App. 2d 178; 1968 Ill. App. LEXIS 1636Docket: Gen. 52,250

Court: Appellate Court of Illinois; November 14, 1968; Illinois; State Appellate Court

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Charles Urnest, as a minority shareholder of The Forged Tooth Gear Company (FTG), filed a derivative lawsuit against FTG and its principal shareholder, The Cornell Forge Company, along with its primary shareholders A. Nelson Cornell, Alverin M. Cornell, and Arthur M. Cornell. The Cornell Company, established for over 35 years, manufactures small steel drop forgings and began producing forged tooth gears around 1938, outsourcing final machining to Western Metal Products Company, which the individual defendants also partially controlled. In 1952, the defendants formed FTG with an initial capital of $1,000, but it remained inactive until 1958, ostensibly to secure the corporate name for future gear production. In 1957, facing production issues with Western Metal, the defendants sought Urnest's expertise in gear manufacturing. He was hired in July 1957 on a temporary basis at a salary of $200 per week to address technical challenges, assist in gear design and production, and promote sales. There was no formal employment contract or specified duration for his role, which continued until April 1958.

Plaintiff expressed interest in acquiring a stake in the inactive corporation FTG to achieve capital gains and tax advantages rather than ordinary income. After discussions with individual defendants, it was agreed to activate FTG for this purpose. In 1958, FTG's articles of incorporation were amended to allow the issuance of 100,000 shares. On June 10, 1958, 19,000 shares were issued to The Cornell Company, raising its total ownership to 20,000 shares, while the plaintiff received 10,000 shares at $1 each, totaling $10,000. On the same day, the plaintiff was elected as a director and president of FTG, with an annual salary of $13,000 plus bonuses.

Post-activation, FTG had no operational role in the production and sale of forged tooth gears, which continued to be handled by The Cornell Company and Western Metal Products. FTG received a portion of the sales receipts from Cornell, with no fixed percentage established for its share. FTG maintained its own bank account for these receipts, from which the plaintiff's salary was paid. It lacked any physical assets, office space, or independent customer base, relying entirely on Cornell for operations and resources. All activities were conducted through Cornell, with no formal employment contracts or agreements between the plaintiff and either Cornell or FTG regarding employment terms or business operations.

In March 1959, the activated Forged Tooth Gear Company (FTG) had grown its net worth to $63,704.04 from an initial capital of $30,000, due to payments from Cornell Company. A. Nelson Cornell informed the plaintiff of the decision to discontinue the arrangement and terminate the plaintiff’s employment, offering to return the original $10,000 investment plus an additional $1,000 or $2,000. Following this, a special meeting removed the plaintiff as president, replacing him with A. Nelson Cornell, despite the plaintiff's dissent. The official reason for the discharge involved alleged conflicts with personnel at Western Metals, although the court found this reason to be immaterial. After the plaintiff's removal, the Cornell Company continued operations without hiring a replacement for the plaintiff, and payments to FTG ceased. The plaintiff objected to his discharge and the cessation of payments. 

At the 1959 annual shareholders' meeting, Alverin M. Cornell and A. Nelson Cornell were re-elected as directors, while the plaintiff voted against the dissolution of FTG in 1960. The Cornells voted for dissolution, which the plaintiff opposed. The plaintiff is seeking to prevent the dissolution and to obtain an accounting of unpaid funds. The defendants counterclaimed for a judicial declaration supporting the dissolution. A Master’s findings favored the defendants, which were upheld by the trial court, allowing the dissolution and denying the plaintiff's requests while reserving jurisdiction to ensure legal compliance and protection of the plaintiff’s minority shareholder rights. The plaintiff argues that Cornell Company and the individual Cornells breached their fiduciary duties to FTG and him as a minority shareholder, while the defendants assert that there was no contractual obligation for Cornell Company to maintain the relationship with FTG.

Defendants' brief lacks citation of any legal authority, claiming their position is "Hornbook Law." The plaintiff's request for an accounting faces challenges due to the absence of a contract specifying payments to FTG, with past payments appearing arbitrary. The plaintiff's argument for basing the amount on historical patterns is deemed insufficient. The duration of any obligation from The Cornell Company is also indeterminate. The Master's report noted that FTG lacks legal or equitable rights to maintain its business relationship with Cornell Company, suggesting directors' fiduciary duties do not extend to preserving this arrangement.

The court posits that the actual dispute lies between The Cornell Company and the plaintiff, not between the corporate entities. It contends that the plaintiff functioned as an employee of Cornell, with the corporate structure serving merely as a mechanism to provide tax benefits. Given that the defendants could terminate the plaintiff's employment at will, they also have the right to dissolve the entire arrangement without liability.

The court can disregard the corporate entity in cases where creditor and third-party interests are irrelevant, allowing for equitable considerations of the substance of the transaction. In this case, FTG holds no legitimate stake in the controversy, as no creditors or third parties are involved. The corporate form was used primarily for tax advantages. The court concludes that FTG is essentially an extension of The Cornell Company, allowing it to disregard its corporate existence. Ultimately, The Cornell Company had the right to terminate the plaintiff's employment, which was at will, leading to the affirmation of the lower court's decree.