In August 2012, Judge Jane Marum Roush, sitting by designation in the Circuit Court of Buckingham County, issued a comprehensive letter opinion in Colgate et al. v. The Disthene Group, Inc. The opinion reassessed a substantial portion of the body of law governing the duties of majority shareholders in closely held corporations.
For many years, Gene Dixon Jr. and his son Guy (Gene and Guy) owned all of the voting stock of The Disthene Group, Inc., a successful and diversified business operating in Buckingham County, Virginia. Among other enterprises, Disthene owned the Cavalier Hotel Corporation in Virginia Beach and Kyanite Mining Corporation, the world’s largest producer of the minerals kyanite and mullite. Gene and Guy consistently elected themselves and their allies as officers and directors of Disthene and its subsidiaries. Most of the non-voting shares not owned by Gene and Guy were owned by descendants of the company’s founder, Gene Dixon Sr., who were relatives of Gene and Guy.
Minority shareholders owning 42 percent of the outstanding shares brought suit, alleging that Gene and Guy had engaged in a pattern of oppressive and fraudulent conduct designed to disadvantage the minority shareholders and had misapplied and wasted corporate assets. Gene and Guy generally denied the allegations and relied on the business judgment rule to justify their actions. The business judgment rule insulates directors of a corporation who “discharge their duties in accordance with good faith business judgment of the best interests of the corporation.”
In their lawsuit, the plaintiffs sought the extraordinary remedy of corporate dissolution as provided by section 13.1-747 of the Virginia code. A circuit court is empowered to dissolve a non-public Virginia corporation if it finds, among other things, that the directors have acted in a manner that is illegal, oppressive or fraudulent, or if it finds that corporate assets have been wasted or misapplied. The Supreme Court of Virginia has held that, in this context, “oppressive” means “a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.”
Judge Roush summarized the business judgment rule as providing a safe harbor that shields a director from liability for actions taken or not taken. She further stated that application of the rule presumes that the director acted in absence of personal interest, made an informed decision based on a reasonable effort to become familiar with the facts, acted on a reasonable belief that the decision served the interest of the company, and acted in good faith. Because the rule does not apply unless the director has exercised his or her independent, good faith business judgment, the rule does not offer protection when the director fails to engage in informed decision making or when the decision is made in the best interests of the director as an individual, rather than of the corporation.
While the rule protects the director, the business judgment doctrine generally protects the decision itself. A director’s decision may be invalidated if reached in violation of the business judgment rule, such as through bad faith or gross mismanagement. The judge also noted that the business judgment rule applies to the discharge of duties by directors and not officers but that both corporate officers and directors have a fiduciary duty to exercise good faith in their dealings with shareholders. For example, both officers and directors owe a duty of fair dealing to shareholders seeking to sell their stock back to the company.
Judge Roush found that the plaintiffs had engaged in a long-standing practice of oppression of the minority, had wasted and misapplied corporate assets, and had engaged in misrepresentations and half-truths with respect to the efforts of some minority shareholder to redeem their shares. As a result, Judge Roush agreed to provide the remedy mandated by section 13.1-747; she ordered judicial dissolution of Disthene.
Gene and Guy appealed, but the case settled in August 2013 before the Virginia Supreme Court could review the matter. As a result, Judge Roush’s opinion stands as a valuable recitation of Supreme Court precedent and a compendium legal theory. While it is not necessarily the law of the Commonwealth of Virginia, it provides one judge’s thought provoking conclusions in this area of corporate law.
A significant portion of Judge Roush’s letter opinion was devoted to setting out and analyzing common techniques of the oppression of minority shareholder. These “squeeze-out” techniques include withholding dividends or keeping dividend payments artificially low in order to force minority shareholders to sell the shares at considerably less than actual value and awarding unreasonable jobs, salaries, pay-raises and bonuses to the majority shareholders or their family members.
While courts rarely scrutinize salaries set for directors by a disinterested board, the same deference does not apply when directors set their own salaries. Similarly, when a director has a personal interest in a corporate transaction, the burden is on the director to prove it was reasonable to the corporation. Factors to be considered in judging reasonableness include:
the qualifications of the employee;
the nature, extent and scope of the employee’s work;
the type of services rendered;
the difficulties involved in discharging the responsibilities;
the success of the business;
comparison between salary paid to the corporation’s net income; and
comparison of compensation paid to comparable officers in other companies.
In concluding her opinion, Judge Roush noted that “non-voting shareholders… have the right to be treated fairly by the corporate officers and directors.” This may be true, but corporate officers and directors often fall short of that standard and the breadth of Judge Roush’s ruling is open to question. In different circumstances, the Virginia Supreme Court in Glass v. Glass (1984) held that while majority directors owe a fiduciary duty to the stockholders as a class, they could leverage their controlling interest without violating their duty. Controlling shareholders have driven hard bargains ever since.