A Simple Statutory Solution to Minority Oppression in the Closely-Held Business

Abstract

Disputes involving closely held businesses come in primarily two varieties. When, as is often the case, the business fails, creditors bring lawsuits seeking to pierce the corporate veil in an attempt to reach the assets of the business owners. When the business does well, on the other hand, minority owners often accuse those in control of seeking ways to keep a bigger slice of the profit pie and of squeezing or freezing out minority owners. These latter disputes are often categorized under the rubric of minority shareholder oppression; and attempts to deal with them by statute and judicial decision are as old as corporate law. Moreover, they are not unique to business in the United States; rather, they are part of the fabric of modern business organization law on a global scale.

The source of this oppression, majority rule in corporate governance, arose in response to the problem of oppression by a minority: Early corporation statutes required unanimity for major decisions, permitting a holdout minority owner to extract a windfall for consent to a mutually beneficial proposed action. Legislatures responded by permitting corporations to make fundamental decisions with less than unanimity. Further legal refinements, like the business judgment rule and the doctrine of independent legal significance, permitted corporations to act more decisively even in the face of shareholder dissent. The unhappy shareholder has two main options: sell the shares on the market or, when provided by statute, petition for dissent and appraisal rights. But when a majority shareholder in a closely held corporation uses these same powers to "freeze out" the minority by, inter alia, (lawfully) voting him off the board and by (lawfully) eliminating dividends, the minority shareholder has no effective remedy. No one will buy the shares, and statutory appraisal rights are not triggered.

Virtually every state recognizes, at least in some way, that the individual who becomes an owner by joining an entrepreneurial or development-stage enterprise finds herself in a position profoundly different from the investor who buys shares of Microsoft through a broker. The closely held corporation, by definition, has relatively few shareholders, meaning that everyone knows everyone. These business relationships often begin with little or no pre-planning for an eventual (if not inevitable) breakup. Adding to the potential for conflict, the majority and minority shareholders frequently participate in the corporation's management. Finally, there is no ready market for the shares. So when disagreements reach a boil, they cannot be resolved by placing a sell order with a broker.

Yet even if most courts and commentators can agree that closely held corporations are different, they have struggled to articulate how these differences should alter the rules of engagement in disputes between minority and majority shareholders. Those who argue that the permissive rules governing large corporations should also apply to closely held corporations often contend, in essence, that the oppression "cure" is worse than the disease. Those in favor of greater judicial intervention contend that shareholders in closely held corporations are, in essence, partners in an ongoing economic and social relationship, and that the unique nature of the closely held corporation requires special remedies when one owner acts inconsistently with the interests or expectations of another.

A true legislative and judicial patchwork has emerged. Each state has a unique regime for addressing minority shareholder oppression in closely held businesses - a surprising state of affairs for such an important area of corporate law. This phenomenon is exacerbated by the development and use of the limited liability company - that is, the problem of oppression is one involving the closely held businesses, not just closely held corporations. Any resolution of the conundrum should be applicable across business entity types.

We contend that the development of this area of law involves a desire by courts and legislatures to provide an exit strategy for minority owners in closely held businesses. While most states have concluded that a buyout of the minority owner's interest by the company (or the majority owner) is the preferred solution, there is discordance as to the bases for granting that desired remedy. That is, there is evolution and divergence over the factual and legal predicates to providing liquidity to the minority owner.

The Appendix highlights these conclusions. We undertook a completely independent and exhaustive state-by-state analysis of the statutes and case law of minority oppression to determine the underlying circumstances and the nature of the relief granted by courts and legislatures. The Appendix, labeled "Shareholder Oppression Standards and Remedies," includes the most important aspects of our fifty-state survey. For each jurisdiction, the Appendix reports the type of statute, the standard of liability, whether a buyout is permitted, and the context for the buyout remedy.

We conclude that states have been grappling uneasily with establishing a way to provide relief in the form of a buyout exit for the minority business owner. Constrained by the traditional common law concept that a remedy should only follow where a wrong has been committed, the states have been haplessly mired in the task of determining the proper bases upon which to grant this separation remedy. One solution to this morass is a model statute that provides liquidity to the disgruntled minority owner without the wasteful and acrimonious litigation attendant to resolution of such disputes today. The goal of this Article is to develop and defend this solution.

Part I discusses the state of the law of closely held corporation disputes. Importantly, the law has both evolved and converged. Evolution has taken place in an attempt to define the bases for relief for the minority business owner. Convergence has occurred in lawmakers' attempts to provide a liquidity-based remedy. The flailing tail of potential predicates for relief has been wagging the dog of desired remedial results. Part II examines why the current resolutions are inadequate and proposes a statutory reform model. Part II also addresses some possible concerns about the proposed statutory solution and provides the context for states to move forward to adopt the model statute as part of their business organization law.