This case involved a claim of shareholder oppression in a closely-held construction company. At the time the lawsuit was filed, plaintiff and defendant both worked in the business; defendant held 50 shares, and the plaintiff held 10. At earlier times, there had been other minority shareholders, but at all relevant times the defendant had been the majority owner, president and sole director. The consistent practice over the years had been to distribute all profits as bonuses rather than dividends; however, the amounts of the bonuses had reflected relative contributions as employees in addition to a return on equity. The amounts had not followed any consistent formula and had been somewhat arbitrarily set by the defendant. In the year preceding the lawsuit, defendant had given himself a bonus 26 times that of plaintiff. Plaintiff sued for shareholder oppression, based on the bonus practices, as well as claims that his access to financial statements had been restricted and that he had been excluded from any role in management. Plaintiff also contended that defendant had usurped a corporate opportunity. The corporation had received the opportunity to develop and lease a manufacturing facility. The defendant declined the opportunity to own and lease the facility, but located another company to be the developer and facilitated the acquisition of the real estate in return for obtaining the construction project for the corporation. Subsequently, defendant personally invested in the LLC created by the developer. The case was tried to the court, which entered judgment for the defendant. Plaintiff appealed, and the court of appeals affirmed the judgment.
The court of appeals held: "Minority shareholder oppression is not defined by statute, and the case law indicates that the concept is rather nebulous, such that a definitive definition may not be possible." 174 P.3d at 614. "In closely held corporations, a breach of fiduciary duty by majority shareholders normally constitutes oppression." Id. However, "the existence of one or more badges of oppression in isolation does not necessarily justify relief. Instead, we examine the pattern of conduct of those in control and the effect of that conduct on the minority to determine whether, in sum, they show oppression." Id. (quoting Hays v. Olmsted & Assoc., Inc., 7 P.3d 178 (Or. App. 2001)).
With respect to the bonuses, the court relied on Zidell v. Zidell, Inc., 560 P.2d 1086 (Or. 1977), in which the Oregon Supreme Court applied a rather lenient standard to an oppression claim based on complaints that the return received by minority shareholders not working in the business through dividends was disproportionately small when compared to the dividends plus increases in compensation of the shareholders working in and controlling the corporation. The Court had required only that that the defendants demonstrate a legitimate business purpose, noting that the dividends were modest but not unreasonable in light of the corporation's finances. The court of appeals in Davis held that the past practices of bonus distibutions did reflect legitimate business purposes and did not find that the plaintiff had proved that the setting of bonuses was "entirely subjective or arbitrary." Id. at 616. The court rejected the plaintiff's argument that "the law is concerned not with intentional wrongdoing by the majority but with insufficient benefit to the minority." Id. at 617.
The court acknowledge that "denial of access to financial statements could constitute a breach of the fiduciary duty of full disclosure," but held that the evidence was conflicting, and plaintiff had not demonstrated any real denial of access. Id.
The court also rejected the plaintiff's claim of exclusion from any meaningful role in management. The court held that all of the decisions about which plaintiff complained were properly within the authority of the director and president. "Unless a corporation's articles of incorporation or bylaws (or some other agreement) specifically give minority shareholders the right to participate in such decisions-which they did not in this case-that right does not exist." Id. at 618
The court agreed that "when a corporate opportunity is usurped by the majority shareholder of a closely held corporation, that breach may constitute minority shareholder oppression." Id. However, the court did not find that the plaintiff had proven usurpation of a corporate opportunity. Leasing property was not in the corporation's line of business, and the corporation's participation in making the deal happen (locating a developer, assisting in securing the property, even advancing the earnest money) were all done to secure construction work that ultimately benefited the corporation. Defendant did have a conflict of interest by virtue of his personal investment, but the court did not find that defendant benefited in any way that was unfair to the corporation. Id. at 619.
ANALYSIS: Probably the most significant claim that the plaintiff had was the attack on the bonus policy. The legal analysis of this sort of claim is always complex because different duties and presumptions apply to different aspects of the same transaction. First, there is the decision to pay out all profits as bonuses, rather than dividends. This is a common practice in closely-held corporations so as to avoid double taxation. The decision to declare dividends and to determine the amount of those dividends are usually protected by the business judgment rule. Moreover, so long as all the shareholders consent to the policy of paying bonuses in lieu of dividends, then there is no basis for complaint. Second, given the decision to pay all profits as bonuses, the court must address the fairness of the bonus distributions. This is a complex task because ordinarily the amount of the bonus will reflect both stock ownership and performance as an employee or contribution to the success of business operations. Unless the shareholders have agreed, explicitly or implicitly to the contrary, such as by always paying out bonuses roughly in proportion to stock ownership, appraisal of employee performance and contribution is purely a management function protected by the business judgment rule and should not even involve considerations of share ownership. In short, management does not owe any particular duties to employees (as employees) in setting their bonuses. There are two wrinkles, however. In this case, the past practice seemed to have been that a portion of the bonus expressly reflected an agreement to provide a return on investment. That policy was observed every year except one. The court only held the defendant to establishing that the bonus practices as a whole served a legitimate business purpose. The court also held that the plaintiff had received a reasonable return on his investment overall. However, from the court's description of the evidence, it seems that the plaintiff could have established that his reasonable expectation or the implied agreement was that bonuses would be distributed every year in such a way as to provide a minimum return on investment relative to the profits earned. It seems that plaintiff could have made a claim for damages for at least the one year where that policy was violated. The second wrinkle is that attention must also be focused on the defendant's decision to raise his own compensation. The defendant's management decision as to setting plaintiff's employment compensation is entitled to deference. The defendant's decision as to setting his own compensation is not. On the contrary, that decision is presumed to be unfair to the corporation unless the defendant can prove the contrary. In a situation where a minority shareholder believes that the majority shareholder has improperly split the corporate profits by the setting bonuses, the attack should probably always be made from the position of challenging the amount of compensation that the defendant decided to give himself. This decision, however, involves only duties to the corporation and must be brought derivatively. The minority shareholder must bring both a derivative claim and an oppression claim. The minority shareholder's position is that the decision made by the majority shareholder to take profits out of the corporation and pay them to himself was a breach of the duty of loyalty to the corporation and that, because the effect of that breach was to harm the minority shareholders in order to benefit the majority, it was also oppression. The minority shareholder then argues that the majority shareholder must disgorge all or some of the compensation and that the court should then use its equitable powers to order a fair distribution of these reclaimed profits to the shareholders.
See also the www.shareholderoppression.com and www.fryarlawfirm.com.
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