A recent Michigan appellate court issued a lengthy, scholarly opinion about shareholder oppression and the business judgment rule. The decision will have significant implications for future disputes between owners and shareholders of closely-held businesses in the state.
The Michigan Court of Appeals decision in Franks v. Franks makes clear that:
- Those claiming shareholder oppression must demonstrate that the acts in question were done with intent to interfere with their interests, not just that the conduct had the effect of interfering with their interests.
- The business judgment rule does not preclude courts from evaluating business decisions to determine whether such decisions or other policies were made in bad faith or part of a plan to oppress shareholders in violation of MCL 450.1489(1).
Michigan’s Shareholder Oppression Statute
Michigan law robustly protects shareholders of closely held corporations whose shares are not readily marketable because of actions by directors or others in control of a corporation that are “illegal, fraudulent, or willfully unfair and oppressive.” The law defines “willfully unfair and oppressive” conduct as “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.”
Buyback and Dividend Policy at Issue
At issue in Franks v. Franks were stock buybacks and dividend policies. The defendants owned Class A voting shares of Burr Oak Tool and Die, Inc (“Burr Oak”), a machine tool company. The plaintiffs each owned non-voting Class B or C shares in the company. While Class B shares did not get dividends, those shares could be converted into Class C shares, which do get dividends.
One of the defendants asked for a valuation of the company in anticipation of a stock buyback. The appraisal concluded that Burr Oak’s stock was worth approximately $598 per share for the 77,043 shares of outstanding stock. After the valuation, the defendants had Burr Oak offer to purchase the defendants’ shares for $62 per share.
The plaintiffs then sued, alleging that the defendants used their voting power and control of Burr Oak to benefit themselves and wrongfully oppress the minority shareholders. In response, the defendants asserted that failing to purchase stock was not by itself oppressive, nor was their offer to buy the stock at a certain price. Additionally, the defendants argued that their decision not to issue dividends was due to legitimate business reasons and thus permissible under the business judgment rule.
The trial court granted the plaintiffs’ motion for partial summary disposition on their claim of shareholder oppression. It determined that the appropriate remedy was to compel the company to buy the nonvoting members’ shares at a price to be determined after an evidentiary hearing.
The Court of Appeals reversed the trial court and found that the plaintiffs failed to establish shareholder oppression. However, it also held that the business judgment rule did not prohibit the court from evaluating the defendants’ business decisions, including their dividend policy, to determine whether the evidence showed that their policy was made in bad faith and was part of a plan to commit acts amounting to shareholder oppression.
Intent, Not Effect
The court noted that the definition of oppression focuses on “the majority’s conduct rather than the effect of that conduct on the minority” and that “the Legislature required proof of an intent to act in a manner that was unfair and oppressive to the shareholder” to establish a claim for shareholder oppression.
As such, “the complaining shareholder must prove that the directors or persons in control of the corporation engaged in a ‘continuing course of conduct’ or took ‘a significant action or series of actions’ that substantially interfered with the interests of the shareholder as a shareholder, and that they did so with the intent to substantially interfere with the ‘interests of the shareholder as a shareholder.’”
Consequently, “a defendant can avoid liability by showing that he or she did not have the requisite intent when he or she took the acts that interfered with the shareholder’s interests.” Since the defendants could establish a question of fact on this issue by providing evidence that their conduct was motivated by legitimate business reasons and not intending to harm the shareholder’s interests, the court vacated summary disposition.
Business Judgment Rule Is Not an Impenetrable Shield
The defendants also argued that the business judgment rule precluded the court from reviewing its decision-making regarding its dividend policy. Under that rule, courts generally will not substitute their judgment for that of directors concerning dividend policies absent evidence that the policy was fraudulent or done in bad faith.
However, “a shareholder necessarily overcomes the business judgment rule by presenting evidence to establish the elements of a claim under the shareholder-oppression statute because that statute identifies wrongful conduct and provides a remedy for it.”
“Accordingly, the business judgment rule does not prohibit a court from evaluating defendants’ business decisions—including their dividend policy—in light of the totality of the evidence to determine whether the evidence showed that defendants formulated their policy in bad faith and as part of a plan to commit acts amounting to shareholder oppression under MCL 450.1489(1).”
While shareholders of closely held Michigan corporations can certainly have viable claims and remedies for oppressive conduct, they need to show more than just oppressive effects. They also need to show oppressive intent. Conversely, directors or others in control of companies need to remain cognizant that the business judgment rule will not necessarily shield them from a court’s scrutiny.