Former shareholder cannot sue

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Third parties lack standing to sue an accountant unless it was reasonably foreseeable that they would rely on the accountant’s reports.

The June 10 opinion from the Wisconsin Supreme Court also clarifies when shareholders should bring derivative or direct actions.

Henry J. Krier and Michael Vilione were business partners whose operations were divided between three corporations — EOG Disposal; EOG Environmental; and Vil-Kri Invest-ments.

Michael’s brother, Donald Vilione, who works at Virchow Krause & Company, was the accountant for the three corporations.

Krier alleged that Michael Vilione misappropriated more than $1.2 million from EOG Environmental and $7,000 from EOG Disposal, and a settlement was reached in 2003.

Under the settlement, Krier became the sole owner of EOG Disposal and Vil-Kri, and Michael became the sole owner of EOG Environmental. However, they continued to do business together for the next two years.

In 2005, Krier brought suit against Donald Vilione, alleging a variety of theories, but claiming in short, that Vilione was either negligent in failing to discover the misappropriations, knew but failed to prevent them, or assisted in them.

The circuit court granted summary judgment in favor of Vilione, concluding that the suit could go forward only on the $7,000 allegedly embezzled from EOG Disposal, but the Court of Appeals reversed in a published opinion. Krier v. Vilione, 2007 WI App 235, 306 Wis.2d 147, 742 N.W.2d 537.

Separate Corporations

The Supreme Court reversed in an opinion by Justice Annette Kingsland Ziegler, concluding that permitting suit would be inconsistent with traditional corporate law principles.

The court rejected the argument that the three corporations were so closely intertwined that the corporate formalities could be ignored.

Ziegler wrote, “The plaintiffs cannot pick and choose when they would like to operate separately and when they would like to operate as one corporation. Their business’s interdependence does not blur the entities’ distinct corporate structures.”

Whatever damages Donald caused, the court concluded, those damages were to EOG Environmental, and only EOG Environmental or its shareholders could make a claim against him. Because Krier is no longer a shareholder, the court held he lacks standing.

The court also noted that, even if Krier were still a shareholder, his standing would be limited to the form of a derivative action, rather than a direct action.

Thus, if Krier could bring the suit, non-shareholders would stand in a better position than shareholders, when a corporation is defrauded.

The court further found that there would be no logical stopping point to liability if the suit could proceed: “If the plaintiffs’ claims were to survive, any business could sue another business’s advisor whenever that business advice negatively affects a plaintiff’s business.”

Foreseeability

The court then distinguished those Wisconsin cases that have permitted accountants to be sued by third parties on foreseeability grounds.

In both Citizens State Bank v. Timm, Schmidt & Co., S.C., 113 Wis.2d 376, 335 N.W.2d 361 (1983), and Chevron Chemical Co. v. Deloitte & Touche, 168 Wis.2d 323, 483 N.W.2d 314 (Ct.App.1992), the accountants prepared audits knowing that lenders would be relying on them to determine whether to loan money to the client. The lenders were therefore allowed to sue, despite their third-party status.

Here, however, the court found no similarly foreseeable reliance on Krier’s part. Justice Ann Walsh Bradley dissented, in an opinion joined by Chief Justice Shirley S. Abrahamson.

Direct Action

The dissenting justices concluded that Krier was the party injured by Donald Vilione’s actions, and therefore, he should be able to bring a direct action, rather than a derivative action in the name of the corporation.

The dissent compared the alleged fraud to that in Jorgensen v. Water Works, Inc., 2001 WI App 135, 246 Wis.2d 64, 630 N.W.2d 230, and Notz v. Everett Smith Group Ltd., 2009 WI 30.
In Jorgensen, the corporation stopped paying distributions to one group of shareholders while paying them to other shareholders. The court held that the unpaid shareholders could bring a direct claim.

In Notz, the controlling shareholders engaged in self-dealing, but paid no direct dividends to themselves. Nevertheless, the Supreme Court held that they had paid themselves “constructive dividends,” and the minority shareholders could bring a direct action against them.

The dissenters found no relevant distinction between Notz and the case at bar, finding that, in Notz, it was “as though” one shareholder put corporate money in its pocket, whereas in this case, Michael Vilione allegedly did put corporate money directly in his pocket.

Justice Bradley wrote, “[D]ue to this conflict with Notz, the majority here confuses the law, giving practitioners and judges no real guidance.”

In an interview, attorney Ward I. Richter, who represented Virchow Krause, stressed that Krier would have been able to sue, had he got an assignment from the corporation allowing him to.

When Krier and Donald Vilione split up the corporations, the settlement between them gave Krier the right to sue Vilione, Richter said, but it failed to assign the corporation’s right to him.

Richter said that in future cases, “Shareholders clearly have to position themselves to retain ownership of claims or some status as owner of the business to prosecute such an action.”

Also, given the paucity of cases nationally on this subject, Richter said he expects the case to be significant nationally, for the proposition that, “if shareholders want to wrap themselves in the cloak of incorporation, they can’t shed it whenever it suits them to do so.”