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Commercial & Business Litigation

The Tyranny of the Minority

By Daniel D. Quick and Erin M. Pawlowski – February 5, 2014


Twenty-five years after the Michigan legislature revised and relocated the minority shareholder oppression statute, Mich. Comp. Laws § 450.1489 (section 489) within the Michigan Business Corporations Act (MBCA) and added a universal demand rule for all shareholder derivative actions, Mich. Comp. Laws § 450.1493a, Michigan courts and lawyers continue to struggle with the ramifications of these changes. The result has been a small library of literature, a multitude of court opinions (not all reconcilable), as well as three revisions to the oppression statute itself.


What has begun to crystallize is the vitality of the minority shareholder oppression claim. Nationwide, courts and legislatures have attempted to balance shareholder and corporate rights by upholding the line between direct and derivative shareholder actions, and when Michigan revised its oppression statute in 1989, it simultaneously adopted substantial changes to the provisions governing derivative litigation. What has transpired, however, is not balance but rather the dominance of the oppression cause of action. 


Now able to avoid the procedural and substantive hurdles of derivative actions and take advantage of ill-defined standards for what constitutes oppression, a single shareholder can now sue the company and all of its executives and likely force them through invasive and expensive litigation. Early efforts to rein in shareholder litigation by strict construction of the Michigan statute—exemplified by the Michigan Supreme Court’s Franchino ruling—were hobbled by both legislative action and decreased judicial rigor. The result is that a shareholder pleading oppression under Michigan law stands little risk of dismissal on the basis of an initial motion and can thus engage in broad, expansive discovery with its attendant distractions to management before a post-discovery motion for summary disposition can be heard. Even then, courts construing the statute have most often found murkiness in the statutory definitions to create disputes of fact requiring a trial. 


What has been lost in the evolution of the oppression claim is the balance that has always existed in corporate law and, indeed, within the MBCA itself. It has long been recognized that “derivative actions brought by minority shareholders could, if unrestrained, undermine the basic principle of corporate governance that the decisions of a corporation . . . should be made by the board of directors. . . .” Daily Income Fund, Inc v. Fox, 464 U.S. 523, 531 (1984).  Moreover, shareholder claims are often brought for harassment purposes and/or “more with a view to obtaining a settlement resulting in fees to the plaintiff’s attorney than to righting a wrong to the corporation (the so-called “strike suit”).” Model Business Corp. Act § 7.4, Introductory Comment (1994).  It was for these reasons that the derivative demand structure was adopted, with Michigan requiring demand in every case.  But why go through all of that if you can just file a minority shareholder oppression claim?


The Michigan legislature did not intend to create this sort of imbalance nor to condone the free rein of minority shareholder litigation. Courts must start strictly applying the language of the shareholder oppression statute in order to bring back into equilibrium the (limited) rights of the shareholder with the rights of the corporation.  The tools exist, and some courts have utilized them, but opinions remain inconsistent.   


Context Matters
The MBCA grants the officers and directors of a corporation authority to carry out the corporation’s most important functions and imposes on them fundamental duties of good faith, care, and loyalty to the corporation. See, e.g., Mich. Comp. Laws § 450.1501–450.1571; Estes v. Idea Eng’g & Fabricating, 649 N.W.2d 84 (Mich. Ct. App. 2002) (explaining that duties created by section 450.1541a are owed to the corporation, as distinct from its shareholders). The MBCA also provides certain statutory procedures and causes of action to redress perceived violations of those duties. For example, a shareholder seeking relief from the violation of the duties owed to the corporation under section 541a may bring a derivative action in the name of the corporation after filing a written demand upon the corporation and allowing the corporation 90 days to investigate and respond.
See Mich. Comp. Laws § 450.1493a; Estes, 649 N.W.2d at 93 (“[A] plaintiff in a §541a action is a corporation suing for breach of a duty to the corporation or a shareholder suing derivatively on behalf of the corporation.”).


This pre-suit demand requirement is designed to respect the decisions of the corporation and limit judicial interference because “[w]hether to sue or not to sue is ordinarily a matter for the business judgment of directors, just as is a decision that the corporation will make bricks instead of bottles.” In re Consumers Power Co., 132 F.R.D 455, 465 (E.D. Mich. 1990) (internal quotation omitted). If displeased with the result of that investigation, under certain circumstances, the disgruntled shareholder may then initiate a derivative shareholder action under section 541a, “to enforce corporate rights or to redress or prevent injury to the corporation, whether arising out of contract or tort.” Mich. Nat'l Bank v. Mudgett, 444 N.W.2d 534, 536 (Mich. Ct. App. 1989).


Shareholders traditionally also had the right to bring “direct” actions. The definition of an action that is direct and not derivative has not always been crystal clear, but there was a good body of case law on the topic both in Michigan and elsewhere. Direct actions relate to injuries that have happened to the shareholder not because he or she is a shareholder but as a result of a distinct, independent duty “owed directly to him [or her].” Id. (emphasis omitted).


Section 489, added in 1989, was the Michigan legislature’s response to a trend in other jurisdictions of expanding the remedies available to oppressed shareholders in closely held corporations. Although the remedies for shareholder oppression were expanded by section 489, “[t]he standard of oppression” was not changed. Revised Michigan Business Corporation Act: Reporter’s Commentary (Aug. 1989). Contemporaneously, the legislature also overhauled the MBCA’s provisions concerning derivative actions, including by mandating written demand, providing mechanisms for determining whether an action is in the corporation’s best interests, and allowing the court to stay or dismiss a derivative proceeding. Thus, in enacting section 489, the legislature did not except closely held corporations from the stringent derivative procedures that were enacted in the same bill. The framework of the statute upheld the principle that corporations are distinct from their owners:  “where the injury to the individual results only from injury to the corporation, the injury is merely derivative and the individual does not have a right of action.” Mich. Nat’l Bank, 444 N.W.2d at 536.


The Fuzzy Evolution of “Oppression”
The scope of the oppression statute was an issue from the first day. The standard for “oppression”—conduct that is “illegal, fraudulent, or willfully unfair and oppressive to the corporation or its shareholder”—presented a host of potential interpretive issues. But not much litigation ensued, in part due to the 1998 opinion in Baks v. Moroun, 576 N.W.2d 413 (Mich. Ct. App. 1998), which held that the statute did not provide a direct cause of action.


In 2001, the legislature amended section 489 to define “willfully unfair and oppressive conduct” as follows:


a continuing course of conduct or a significant action or series of actions that substantially interferes with the interests of the shareholder as a shareholder. The term does not include conduct or actions that are permitted by an agreement, the articles of incorporation, the bylaws, or a consistently applied written corporate policy or procedure.

Mich. Comp. Laws § 450.1489(3).


A year later, the court of appeals decided Estes v. Idea Eng’g & Fabricating, 649 N.W.2d 84 (Mich. Cit. App. 2002), effectively reversing Baks and holding that the statute did provide a direct cause of action.  The new definition was accompanied by multiple new defenses, based on “a continuing course of conduct,” a “significant action or series of actions,” interference with “the interests of a shareholder as a shareholder,” and exemption for conduct or actions permitted by specified written agreements. Each of these provided new hurdles for a complaining shareholder. 


In Franchino v. Franchino, the court of appeals held that the phrase “the interests of the shareholder as a shareholder” limited the shareholder rights protected:  “Shareholder’s rights are typically considered to include voting at shareholder’s meetings, electing directors, adopting bylaws, amending charters, examining the corporate books, and receiving corporate dividends.” 687 N.W.2d 620, 628 (Mich. Ct. App. 2004). The minority shareholder’s oppression claim was dismissed because he failed to allege that the defendant interfered with or oppressed rights central to being a shareholder.


After Franchino, the Michigan legislature amended section 489 to add protection for the “termination of employment or limitations on employment benefits to the extent that the actions interfere with distributions or other shareholder interests disproportionately as to the affected shareholder.” Pub. Act No. 68 (2006). While the amendment is a rebuke in some sense to the Franchino ruling, it still preserved the key language that the actions interfere with “shareholder interests.”


Michigan courts soon were confronted with cases in which minority shareholders sought redress under section 489 for a broad array of alleged wrongdoing, and the judicial response was inconsistent. On the one hand, the Michigan Court of Appeals (albeit in unpublished cases) rejected attempts to expand the scope of section 489. See, e.g., Haarer v. Vreba-Hoff Dairy Dev., LLC, No. 260001 (Mich. Ct. App. Aug. 17, 2006) (per curiam) (affirming summary disposition for claims arising from the financial decline and bankruptcy of a corporation); Wojcik v. William J. McNish & McNish's Sporting Goods & Trophies Inc.,No. 267005 (Mich. Ct. App. July 25, 2006)(per curiam) (holding claims arising from breach of employment contract and stock purchase agreement unprotected by section 489). On the other hand, in Bromley v. Bromley, No. 05-71798, 2006 U.S. Dist. LEXIS 37022 (E.D. Mich. Oct. 4, 2006), the U.S. District Court for the Eastern District of Michigan held that shareholders pursing what would normally be considered derivative founded on allegations of inappropriate corporate spending, self-dealing, and general mismanagement harming the corporation and not its shareholders could proceed under section 489. While the court applied clear statutory language making section 489 applicable to improper acts “to the corporation or to the shareholder, it has been questioned whether the opinion went too far and whether there is a middle ground wherein traditional derivative actions are preserved but conduct over a higher threshold (“willfully unfair and oppressive”) opens the door to an oppression action.


After these and other decisions, the core question of what constitutes “willfully unfair and oppressive” conduct remained unclear and largely unanswered by courts. But one thing became increasingly clear. Litigants were embracing oppression claims under section 489 as the easy end-run around the direct versus derivative distinction. Since Estes was decided in 2002, not one opinion had been issued by the Court of Appeals dealing with this issue, but during the same period there have been 31 decisions addressing the oppression statute. 


While there certainly is a “trend” of increased use of the statute, whether there is a “trend” in judicial treatment is not as clear.  On the one hand, in Arevelo v. Arevelo, Nos. 285548, 286742 (Mich. Ct. App. Apr. 6, 2010) (per curiam), the appeals court duly dismissed a section 489 claim in which the plaintiff had alleged such “wrongful acts” as misappropriating business property and intangibles, including laptop computers, business records, and customer lists; inducing key employees to leave their employment and key customers to do business with third parties; usurping business opportunities; and using the corporate credit line. It explained that none of the alleged tortious activity affected the plaintiff’s rights as a shareholder:


She does not explain how Raymond’s alleged act of “[i]nducing key employees to leave their employment” or his alleged act of “charging personal expenses to the business” affected her rights to vote at shareholder meetings, to elect directors, to adopt bylaws, to amend charters, to examine corporate books, or to receive corporate dividends.


Id.


While “[s]ome of the alleged wrongful acts, such as ‘[i]nducing key customers to do business with third-parties’ and ‘[u]surping business opportunities which belong to the business’ could possibly effect the amount of corporate dividends that [the plaintiff] received,” they did not impair her “right to receive dividends” and thus failed to state a section 489 claim. In short, in Arevelo, the appeals court confirmed that to be actionable under section 489, there must be a “connection between [a defendant’s] alleged wrongful acts and the oppression of [] shareholder rights.” Id. (emphasis added). 


Other court of appeals decisions, on the other hand, continue to create more questions than answers. For example, the line between direct and derivative claims, blurred in the Bromley decision, was further grayed in Berger v. Katz, Nos. 291663, 293880 (Mich. Ct. App. July 28, 2011) (per curiam), when the court of appeals affirmed a judgment that the defendants engaged in willfully unfair and oppressive conduct by (1) eliminating the plaintiff’s salary and giving themselves raises, (2) terminating rental payments to the plaintiff that normally were made to all three directors, (3) issuing a capital call when the corporation was doing fairly well, which diluted the plaintiff’s stock and shares and forced the plaintiff to put his own money into the corporation, and (4) engaging in other actions with the intent to squeeze the plaintiff out of the company. While some of these actions could arguably implicate rights flowing to the plaintiff by virtue of his status as a shareholder, others—such as the capital call—do not. Berger appears to cast a much broader net than the statutory language allows, including general corporate mismanagement rather than injuries to rights unique to shareholders.


The court of appeals grappled with identifying shareholder interests in another recent opinion, one that might bring some clarity in the Supreme Court. In Madugula v. Taub, No. 298425 (Mich. Ct. App. Oct. 25, 2012) (per curiam), the trial court found a number of violations of basic shareholder rights, including the right to vote and access to books and records. When the defendant protested on appeal that the trial court had turned a breach of a stockholder agreement into minority shareholder oppression, the court of appeals ruled that while this was not the case on the facts of the case, such breaches, together with other misconduct, could constitute oppression.


The Michigan Supreme Court has granted leave to appeal and specifically ordered that the parties brief the following issues: (1) whether claims brought under section 489 are equitable claims to be decided by a court of equity; (2) whether the provisions of a stockholder’s agreement can create shareholder interests protected by section 489; and (3) whether the plaintiff’s interests as a shareholder were interfered with disproportionately by the defendant’s actions. This is the first time the Michigan Supreme Court has agreed to hear a case involving the issue of shareholder rights under section 489 and promises to bring at least some clarity to the interpretation of the statute, although the limited questions accepted for review suggest that holistic treatment might not be in the cards.


Where Do We Go from Here?
Application of the statute which preserves its textual integrity as well as its intended role within the MBCA requires two considerations.


1. The words of the statute must be applied. While many key terms are undefined, the statute sets out several requirements that a plaintiff must satisfy in order to state a claim.  Even under generally applicable rules of notice pleading, a plaintiff should be required to plead facts that support, at least on a threshold basis, the basic statutory elements. As minority oppression is arguably in the same genus as fraud—as evidenced by fraud within the definition as well as the “willful” requirement—a heightened pleading standard arguably applies.


In any event, the distinct elements of the claim—which can be easily laid out in flow chart form —require independent treatment and analysis. Undefined statutory terms need to be given meaning, not viewed as mere surplusage. Other torts—for example, tortious interference—have developed a body of law addressing the unique issue presented by words and concepts (such as tortious, interference, relationship/expectancy). The same is true of section 489. For example, the statute requires not only interference with a shareholder right but “substantial” interference.  The courts must give meaning to that word in order to eliminate claims that clearly do not meet the standard before forcing the parties to engage in expensive discovery.


2. The remedy provided by section 489 must be evaluated relative to other provisions of the MBCA. Issues such as those raised in Bromley need careful consideration so as not to cause the oppression statute to subsume the coequal derivative litigation statutes. Similarly, the courts must recognize that public policy values a corporation’s right to govern itself free from vexatious litigation as much as the protection of minority shareholders against “oppression.”


In interpreting words like “unfair,” this context is meaningful and appropriate. Lack of guidance from the courts creates a free-for-all, where shareholders generically plead oppression and defendants are left without any threshold means to sort out cases that do not meet the statutory standard. That standard is intended to be high, not merely out of consideration of competing policy goals but to make sure that the minority—which in the first instance is entering into a corporate environment with known limited rights—does not wield disproportionate power.  Courts have already rejected expansive notions such as the “reasonable expectations” rubric.  See, e.g., In re Kemp & Beatley, Inc., 473 N.E.2d 1173 (N.Y. 1984) (“Majority conduct should not be deemed oppressive simply because the petitioner’s subjective hopes and desires in joining the venture are not fulfilled. Disappointment alone should not necessarily be equated with oppression.”) The absence of any other cohesive paradigm means that trial courts simply let cases proceed, and this inaction is equivalent to taking sides given the time, burden, and expense of shareholder litigation. The statutory scheme deserves more.


Keywords: litigation, commercial, business, shareholder oppression, derivative suits, Madugula, shareholder rights


Daniel D. Quick is a member and department manager and Erin M. Pawlowski is an associate of Dickinson Wright PLLC in Troy, Michigan.


 
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