The closely held nature of a family business means there is often a single controlling shareholder or a controlling shareholding group, making it important for shareholders in family businesses to be aware of the legal requirements and prohibitions created by shareholder oppression laws. In Washington, that means complying with RCW 23B.14.300(2)(b), which limits the ability of a controlling shareholder or controlling shareholder group to take certain actions which may harm, or be perceived as harming, minority shareholders.
This article discusses the rules governing Washington corporations—the same rules do not apply to family businesses organized as limited liability companies or limited partnerships.
Washington's shareholder oppression law stipulates that "The superior courts may dissolve a corporation . . . [i]n a proceeding by a shareholder if it is established that . . . [t]he directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent." In other words, minority shareholders may sue majority shareholders if they believe they are being oppressed by the majority shareholder, and the consequences for majority shareholders and a company to losing such a suit can be incredibly damaging.
So, what does it mean for a shareholder to be oppressed? In Washington there are two tests for oppression: (1) the reasonable expectations test, and (2) the fair dealing test.
The Reasonable Expectations Test
The reasonable expectations test states that oppression occurs when there is ". . . a violation by the majority of the reasonable expectations of the minority." Courts have held that "reasonable expectations" are "spoken and unspoken understandings on which the founders of a venture rely when commencing the venture." In plain English, this means that if a majority shareholder acts in a way that is contrary to how the minority shareholder reasonably would have expected the majority shareholder to act based on their prior actions or agreements, a minority shareholder has a case for minority oppression.
While this may sound broad, it is actually a rather narrow test, that, in order to be applied, requires there to be specific evidence that led to the creation of the expectations in the minority. So long as a majority shareholder does not act contrary to what they have said or implied to the minority, this test is not likely to be met.
The Fair Dealing Test
The fair dealing test is much broader and relies on the general reasonability of the conduct of the majority shareholder, not on specific expectations set between the parties. The fair dealing test defines oppression as "burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or a visible departure from the standards of dealing, and a violation of fair play on which every shareholder who entrusts [their] money to a company is entitled to rely." The imprecision of this test affords a judge a large amount of discretion when deciding whether an action constitutes oppression.
The Supreme Court of Washington has stated that "[t]hese two tests are not mutually exclusive and one or both may be used in the same case, depending on the facts." This means that cautious shareholders should always assume that their actions will be judged under the less forgiving fair dealing test.
It is important to note that while Washington's shareholder oppression statute only identifies one remedy—dissolution of the corporation—the courts have granted themselves the power to impose less severe equitable remedies such as an injunction or a mandated buy-out of the minority for the fair value of their shares.
Case Law Example
The following case provides an example of one kind of behavior that Washington courts have found to be oppressive.
In Real Carriage Door Company, Inc. ex. Rel. Rees v. Rees, the case's titular company had five shareholders. The family's husband owned 51 percent of the shares of the company, his wife owned 37 percent, their son owned 6 percent, their daughter 3.1 percent, and their son-in-law owned 2.9 percent.
All five shareholders were employees of the company, and the company consistently paid out pro-rated dividends to each shareholder. When the husband and wife divorced, the husband bought his wife's shares, which gave him ownership of 88 percent of all outstanding shares. The son, daughter, and son-in-law all quit their positions at the company, but maintained their equity positions.
Once the husband was the only family member still working at the company, he used his majority stake to cause the company to redirect all the profits being paid out in dividends to be put into his salary—causing a five-fold increase in his pay and leaving the other shareholders with nothing. The minority shareholders filed suit claiming shareholder oppression, and court ruled in their favor.
Just because a majority shareholder has the voting power necessary to take some corporate action does not mean that it is legal under Washington law for them to do so. Majority shareholders should always keep the interests of the minority in mind, and should consult qualified legal counsel if they are considering taking any actions which might be perceived as in their interests at the expense of the minority.