Oppression, Dissolution, and Deadlock — these words read like a defensive strategy for a team making a deep March Madness run. They are also the buzzwords used by minority shareholders in claiming misconduct by a company’s managers or directors.
Companies can minimize the possibility of such costly claims by including in their governing documents a process for dissenting minority members or shareholders to exit the company pursuant to agreed upon terms.
Michigan’s minority oppression statutes apply to minority shareholders in corporations (M.C.L. § 450.1489) and limited liability companies (M.C.L. § 450.4515) to protect them against willfully unfair and oppressive conduct. Majority actions — including but not limited to terminating or disproportionately interfering with benefits relating to a minority shareholder’s rights to distributions, information, voting, or employment — can constitute oppression. Oppression often involves the majority interfering with the rights of the minority in order to convince the minority to exit the company. These are commonly called “squeeze-out” or “freeze-out” schemes, and have involved wrongful withholding of dividends, stock redemption plans that benefit only the majority shareholders, and improper capital calls. Oppression can consist of a single act or a pattern of conduct. Importantly, however, conduct expressly permitted by a shareholder agreement, the articles of incorporation or organization, the bylaws, or an operating agreement does not constitute oppression.
In the event a minority shareholder establishes oppressive conduct, the shareholder will often seek judicial dissolution and liquidation of the company as a form of relief. While judicial dissolution is one of the statutory remedies for minority oppression, courts have wide latitude to grant relief as they consider appropriate. Indeed, even where oppression is established, a court may refuse to grant the relief requested by the plaintiff if the equities warrant such refusal. Courts may determine to appoint receivers, enter injunctions against oppressive conduct, or force a buyout or redemption of the minority shareholder at “fair value.” Judicial dissolution is usually a remedy of last resort, and plaintiffs in oppression cases request the relief to inject the threat of dissolution into the judicial proceedings.
If oppression exists and the court decides to force a buyout or redemption at fair value, then the parties must hire experts and spend money to determine “fair value,” as the company’s shares are usually not readily marketable.
Often, a minority shareholder brings an oppression claim because the shareholder disagrees with the management of an investment and has determined there is no reasonable means of exiting that investment other than through judicial intervention.
A company and its shareholders can take steps to avoid such a mess by incorporating certain provisions in its operating or shareholder agreement. These provisions (e.g., deadlock and forced buyout provisions), if crafted properly, clarify and streamline the conditions under which dissatisfied shareholders or members can exit.
At the beginning of the relationship, the shareholders or members should define events that constitute a “deadlock.” Often these events include disagreements on matters such as dissolution, additional capital calls, or incurring indebtedness over certain thresholds, which may require unanimous or supermajority approval. The operating agreement or shareholder agreement should require multiple attempts by the shareholders or members to resolve the “deadlock” internally. If those attempts fail, then the company or its shareholders or members can force a buyout of party or parties creating the deadlock.
The governing documents may set the price for such a buyout by providing an agreed upon valuation (which may be adjusted on an annual basis) or by providing that one or more accounting professionals will perform a financial analysis and reach valuation binding on the parties at which the minority party or parties must sell their interest. This is usually the preferred method for arriving at a price in the context of a forced buyout.
Alternatively, the parties can incorporate provisions allowing them to submit to each other the prices at which they are willing to buy or be bought out. These provisions include the “Texas Shoot-Out” approach, whereby the party triggering the buyout names a price and the other partners may choose to either buy that party out at that price or force that party to buy the other members out at the same price. This approach is most often reserved for companies with two members or shareholders. Parties may also choose the Dutch Auction method, whereby all parties submit the lowest price at which they will sell their shares, and the bidder (or group of bidders) with the highest price gets the right to buy out the bidder (or group of bidders) with the lowest price at the lowest price.
Of course, these provisions do not protect directors, managers, or majority owners from liability for actual fraud or breaches of fiduciary duty. Companies can, however, minimize the possibility of dealing with costly shareholder oppression actions where claims arise out of conduct alleged to interfere with a minority shareholder’s voting, information, or financial rights by including in the company’s governing documents the conditions and procedures by which a minority investor exit the investment.
If you have not recently reviewed your operating or shareholder agreements, now is the time. Thoughtful planning on the front end can prevent costly disputes, preserve relationships, and ensure stability when disagreements arise. Contact Kerr Russell to discuss how we can support your business.
