A minority shareholder may petition the Court to dissolve a corporation on grounds that a majority shareholder has engaged in fraudulent, oppressive, or illegal conduct. If judicial dissolution is ordered, the company can be liquidated or even sold. Although dissolution is a drastic remedy, the consequences are severe enough that a majority shareholder should be mindful to avoid any conduct that may provide a basis for judicial dissolution. This is especially true in family-owned or closely-held corporations, which are most at risk for judicial dissolution.
So how can a majority shareholder reduce the likelihood of judicial dissolution? “Fraudulent” and “illegal” conduct are self-explanatory and therefore easier to avoid. But what is “oppressive” conduct? Moreover, what conduct is considered sufficiently “oppressive” to justify judicial dissolution? Courts have grappled with this issue for decades, particularly since many statutes that authorize judicial dissolution fail to define what “oppressive” means. Over the years, courts have developed at least two approaches for evaluating “oppressive” conduct: the “fair dealing” test and the “reasonable expectations” test.
Under the “fair dealing” test, oppression is defined as:
[B]urdensome, 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 visual 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.
Robblee v. Robblee, 841 P.2d 1289, 1293 (Wash. Ct. App. 1992) (citation omitted); Edenbaum v. Schwarcz–Osztreicherne, 885 A.2d 365, 378 (Md. Ct. Spec. App. 2005) (citation omitted); see also Pankratz Farms, Inc. v. Pankratz, 2004 MT 180, ¶ 76, 95 P.3d 67 (applying similar definition); Stickley v. Stickley, 43 Va. Cir. 123, *19 (Vir. Cir. Ct. 1997) (same).
Under the “reasonable expectations” test, oppression is defined as a “violation by the majority of the ‘reasonable expectations’ of the minority.” Robblee at 1293 (quoting Gimpel v. Bolstein, 477 N.Y.S.2d 1014, 1019 (N.Y. Sup. Ct. 1984). “‘Reasonable expectations’ are those spoken and unspoken understandings on which the founders of a venture rely when commencing the venture.” Id.
Although the analysis varies depending on the test, decades of jurisprudence have fleshed out several activities that are often deemed “oppressive” regardless of the definition. These activities include:
- Paying excessive or unreasonable compensation to the majority shareholder;
- Engaging in improper related party transactions or self-dealing;
- Failing to pay adequate dividends to stockholders;
- Refusing to provide appropriate financials and/or other corporate records;
- Failing to observe corporate formalities, such as holding regular meetings;
- Unilaterally changing the terms of agreements with the minority shareholder;
- Stacking the board of directors with friends and family members of the majority shareholder;
- Denying a minority shareholder a voice in the decision-making process or only pretending to discuss and dialogue;
- “Freezing out” or “squeezing out” a minority shareholder from deriving any benefit from his investment; and
- Terminating the minority shareholder from employment with the company on pretextual grounds.
By avoiding these and other “oppressive” activities, a majority shareholder may reduce the likelihood that a disgruntled minority shareholder will successfully prevail in a petition for judicial dissolution.