Rescuing the Oppressed

The Equities of Business Dissolution and Oppressive Conduct in Closely Held Corporations

It is likely true that most small business owners intend, in good faith, to fulfill their fiduciary obligations to the entity and their co-owners. For that reason, the “business judgment rule” shields many decisions from a meddling court.[1] But in the event of financial distress, a controlling owner might simply reach for the nearest pot of money or take other unseemly actions to be sure the business survives. Even the most well-intentioned and informed majority or controlling owner could at some point be accused of oppressive conduct toward the minority owners. Most attorneys are familiar with the law school concept of oppressive conduct in a closely held corporation. Despite this, and perhaps because many such cases settle, there has been little case law to shed light on what conduct falls within the purview of “oppressive” or, to the extent it exists, what can be done.

Minority “oppression” usually arises under the statute authorizing corporate dissolution.[2] Because it is well settled that statutes in derogation of common law are to be strictly construed,[3] the laws creating and dissolving corporations have been viewed narrowly by courts.[4] While the term “oppression” existed in the dissolution statute prior to 2005, there was no case in Tennessee providing a precise definition or guidance as to what remedies might be available. Tennessee has joined other states and opened the doors to minority owners by broadly defining incidents of “oppressive” conduct and injecting concepts of equity into the remedy analysis.[5] Attractive options beyond corporate dissolution now exist for shareholders who believe they have been subjected to oppressive conduct.

What Is a “Close” Corporation?

The concept of “oppressive” conduct is often thought to apply primarily to closely held corporations. Close corporations often, but not always, have (1) few shareholders; (2) shareholders who know each other, live in the same area, and are familiar with each other’s skills; (3) shareholders who are active in the business; and (4) a limited market for the corporate stock.[6] In addition, shareholders of a close corporation frequently expect to be actively involved in corporate management and operations.[7] Perhaps because of the unique relationships in a close corporation, majority shareholders are in a heightened position to use oppressive tactics to “freeze out” or exclude minority shareholders[8] and deprive them of an opportunity to participate in the business or receive a fair return on investment.[9]

While majority shareholders in a closely held corporation may have an enhanced opportunity to harm minority shareholders, it is important to note that officers and directors of every corporation have a fiduciary duty to the corporation and its shareholders.[10] As an extension of that principle, the shareholders in a close corporation “share” a fiduciary relationship that imposes a duty to act in good faith and fairness with regard to their respective interests as shareholders.[11] It is out of this reciprocal relationship that equitable remedies beyond dissolution take shape.

What Is Oppressive Conduct?

Not always illegal or fraudulent, “oppressive conduct” is a broad term and can often be measured in terms of fiduciary duties: whether the majority owner has taken actions to benefit her, but to the detriment of the minority.[12] Such conduct can also be alternatively measured based on the minority shareholders’ “reasonable expectations.”[13]

Oppression can exist through conduct where the majority attempts to “freeze” or “squeeze” the minority shareholder out of the business. This type of “freeze out” technique deprives the minority holder of her right to participate in the management of the corporation or the right to benefit financially in the form of reasonable compensation, distributions or dividends.[14]

Oppression may also be found when a majority owner treats minority owners unfairly through conduct that lacks probity and fair dealing with the affairs of the company to the prejudice of some of its shareholders. Oppressive conduct may also include a visual departure from the standards of fair dealing, and a violation of fair play on which a shareholder who entrusts his money to a company is entitled to rely.[15]

A majority owner’s efforts to subvert a minority owner’s right to distributions or dividends through self compensation can constitute an oppressive act. This concept includes conduct where the controlling shareholders/directors do not declare dividends, but provide themselves with high compensation or other benefits. This behavior typically leaves minority shareholders who do not hold corporate office with the choice of getting little or no return on their investment for an indefinite period of time or selling out to the majority shareholders at whatever price they will offer.[16]

While some forms of oppression are more succinctly defined, oppression may include any inappropriate benefit to the majority owners. Broadly, an inappropriate benefit is any effort by the controlling shareholders to operate the business for their sole (or primary) benefit which is to the detriment of minority shareholders.[17] Despite the potentially broad scope, Tennessee courts have attempted to curtail the definition of “oppressive conduct” by stating that while “a finding of oppressive conduct does not require finding illegal or fraudulent acts, it does require finding more than merely poor business judgment on the part of the controlling shareholders.”[18] Rather, oppressive acts must thwart the expectations of the minority shareholders that are objectively reasonable.[19]

Remedies for Oppressive Conduct

Many minority shareholders, believing dissolution to be the sole remedy, may be reluctant to pursue any action for fear that dissolution is ultimately more detrimental than addressing the existing circumstance. Despite this reluctance, there are many remedies available where oppressive conduct is shown. While Tenn. Code Ann. §48-24-301(2)(B) still provides for the possibility of corporation dissolution, it is worth noting that the statute only says a court “may” enter a decree dissolving the corporation upon a finding of oppressive conduct — not that it must do so.[20] Even if dissolution is warranted, it could simply be ordered as a future event effective only if the shareholders fail to resolve their differences prior to that date.[21]

Regardless of circumstance, a minority shareholder’s expectations must still be balanced against the corporation’s need to exercise business judgment and to be efficient.[22] Because a court is not limited to dissolution upon such a finding, a court might consider options within its equitable discretion and provide alternative remedies. To the surprise of some, there are many equitable remedies available that allow a recovery without the sometimes draconian remedy of dissolution.

Without requiring dissolution, a court could retain the case and appoint a receiver — not for dissolution — but to continue operation of the corporation for the benefit of all the shareholders until differences are resolved or oppressive conduct ceases.[23] In circumstances where oppression is claimed, there is often uncertainty or skepticism by the complaining shareholder about corporate finances or even alleged misappropriation. In those situations, a Plaintiff may pursue an initial investigatory step and pray for an accounting by the majority in control of the corporation.[24] Depending on the nature of alleged misappropriations, a court could enter an injunction prohibiting continuing acts of oppressive conduct or order the reduction of salaries or bonus payments which are unjustified or excessive.[25]

Other forms of affirmative relief are also available, such as a required declaration of a dividend or a reduction in distribution of capital.[26] Like courts in other states,[27] it appears Tennessee courts could require the corporation (or a majority of its shareholders) to purchase the stock of the minority shareholder at a price to be determined by the court as fair or through some other established or determined formula. Casting the net of possible equitable remedies even further, and although perhaps questionable as to exactly how to enforce such a requirement, a court could order affirmative relief permitting minority shareholders to purchase additional stock under specified conditions. Perhaps most obvious, a court could simply make an award of damages to a minority shareholder as compensation for injuries suffered as the result of oppressive conduct.[28]

Equitable remedies may seem enticing in the abstract and could be quite helpful in some situations. However, one could question the ability to enforce them and may be wary of unintended consequences. While not technically dissolving the corporation, an order of dissolution at a future date or the appointment of a receiver to operate the business without dissolution, could impair its ability to conduct business. It is common for contracts and loan documents to identify dissolution and receivership (or similar language) as an event of default. Thus, while the corporation might legally be entitled to continue operations without dissolution in its future, it may be left trying to explain the situation to its vendors, clients and lenders. Moreover, because close corporations are similar to partnerships in many respects, most small businesses would have a difficult time explaining to its customers and clients why a receiver is now the primary contact.

The recognized remedies involving stock acquisitions seem even more problematic. Even assuming an order requiring the majority to purchase shares owned by the minority is facially “fair,” there are many complications. What evidence is required to determine a fair value of a close corporation, which inherently has no market for its stock?[29] Assuming a value is determined by some method, is the ability of the majority to actually consummate the deal a valid consideration or concern? Certainly, in a court’s effort to rescue the oppressed, it could work substantial prejudice to the majority.

Despite some of the potential problems, several equitable remedies may be patently reasonable. For example, entering an injunction to stop abusive conduct or requiring an accounting should, in most instances, improve the situation without immediately harming the corporation itself. A reduction in salaries or distributions to majority owners may, in many respects, be easily accomplished without significant unintended consequences. Notwithstanding all the creative remedy opportunities, perhaps the simplest option is a traditional award of damages.

Conclusion

Like any business arrangement, many problems can arise in a closely held corporation. More often than not, the “business judgment rule” should shield corporate decision makers from judicial interference. However, there are instances where minority “oppression” exits and can be proven. Through the years, most have understood the only (or at least primary) remedy in Tennessee is corporate dissolution. However, whether dissolution is helpful, even for the oppressed shareholder, is often called into question. Jurisprudence in Tennessee now allows for a wide range of possible remedies for the oppressed shareholder short of dissolution and may provide relief without destroying the business
entity itself.

Notes

  1. See Summers v. Cherokee Children & Family Services Inc., 112 S.W.3d 486, 527-28 (Tenn. Ct. App. 2002).
  2. Tenn. Code Ann. § 48-24-302.
  3. See Tradesman Pub. Co. v. Knoxville Car-Wheel Co., 32 S.W. 1097, 1103 (Tenn. 1895); Ezell v. Cockrell, 902 S.W.2d 394, 399 (Tenn. 1995).
  4. See Owens v. Bricks Inc., 703 S.W.2d 147,150 (Tenn. Ct. App. 1985).
  5. See Cochran v. L.V.R. & R.C. Inc., 2005 WL 2217067 (Tenn. Ct. App. 2005); Balvik v. Sylvester, 411 N.W.2d 383, 388-89 (N.D. 1987); Alaska Plastics Inc. v. Coppock, 621 P.2d 270, 274-75 (Alaska 1980); Sauer v. Moffitt, 363 N.W.2d 269, 274-75 (Iowa Ct. App. 1984).
  6. Cochran, 2005 WL 2217067 at *3 (citing Balvik v. Sylvester, 411 N.W.2d 383, 386 (N.D. 1987)).
  7. Id.
  8. Id. at *4; see Brooks v. Hill, 717 So.2d 759, 764-65 (Ala. 1998) (suggesting a close corporation is similar to a partnership).
  9. Cochran, 2005 WL 2217067 at *3. The Cochran court offered the example of where a minority owner who does not work in the business is effectively deprived of a return because money is paid out to the majority owners who work in the business as salaries, wages or bonuses. Id.
  10. See Cherokee Children and Family Servs. Inc., 112 S.W.3d at 504 (Tenn. Ct. App. 2002).
  11. Cochran, 2005 WL 2217067, at *4 (citing Hall v. Tenn. Dressed Beef Co., 957 S.W.2d 536, 541 (Tenn. 1997)). While Tennessee appears to favor an approach where majority owners may have some enhanced obligations to minority owners in a close corporation, not all jurisdictions hold such a view. See Blaustein v. Lord Baltimore Capital Corp., 2013 WL 1810956, at *14 (Del. Chancery 2013) (where the Delaware court said that Delaware law does not recognize that a majority stockholder has a special fiduciary duty to minority shareholder in a closely held corporation and that Delaware has declined such an approach).
  12. Id. at *5.
  13. Id.
  14. Id. at *4 (citing Balvik v. Sylvester, 411 N.W.2d 383, 386 (N.D. 1987)).
  15. Id. at *5 (citing Maschmeier v. Southside Press Ltd., 435 N.W.2d 377, 380 (Iowa App. 1988)); see Burt v. Burt Boiler Works Inc., 360 So.2d 327, 331 (Ala. 1978); see also Redmon v. Griffith, 202 S.W.3d 225 (Tx. Ct. App. 2006) (noting that wrongful conduct and unfair dealing may give rise to a breach of fiduciary duty).
  16. Id.
  17. Id.
  18. Id.
  19. Id.
  20. Id. at *6 (noting that while the statute does allow dissolution, it does not require it).
  21. Id.
  22. See Willis v. Bydaleck, 997 S.W.2d 798, 802 (Tx. Ct. App. 1999).
  23. Cochran, 2005 WL 2217067 at *6.
  24. Id.
  25. Id.
  26. See Gaines v. Long Mfg. Co., 67 S.E.2d 355 (N.C. 1951).
  27. Advance Marine Inc. v. Kelly, 1991 WL 114463 (Tx. Ct. App. 1991); see also Douglas K. Moll, “Shareholder Oppression in Texas Close Corporations: Majority Rule (Still) Isn’t What It Used to Be,” 9 Hous. Bus. & Tax L.J. 33 (2008) (providing a good discussion of the law in Texas).
  28. Cochran, 2005 WL 2217067 at *6.
  29. See G & G Fashion Design Inc. v. Garcia, 870 So.2d 870 (Fla. Ct. App. 2004) (where the  court discussed difficulties of valuing stock in a close corporation).

Josh McCreary JOSH A. MCCREARY is a member of Cope, Hudson, Reed & McCreary PLLC, a general practice firm in Murfreesboro. He has extensive experience representing businesses, individuals and governmental entities in a wide variety of complex and general legal matters, including business and civil litigation, general business matters, health care, estate planning and probate matters. He received his law degree magna cum laude from the University of Tennessee in 1998.