“A resolute minority has usually prevailed over an easygoing or wobbly majority whose prime purpose was to be left alone.”
—James Reston, Sketches in the Sand (1967)
In a democracy, the majority rules, but the minority has rights, too.
This principle applies in corporate governance as well. The rights of minority shareholders in business corporations often transcend the magnitude of their corporate holdings.
A trio of recent rulings of the Minnesota Supreme Court and Court of Appeals reflect this reality. Three cases decided by those tribunals during the same week this summer address various facets of minority rights in corporate law.
Two views of minority shareholder rights in connection with the valuation of their interests in corporations were addressed by the Minnesota Supreme Court in Advanced Communication Design, Inc. v. Follett, 2000 WL 1060503 (Minn. Aug. 3, 2000). An employee who owned one-third of the shares of the company, all nonvoting stock, was being sued for breach of fiduciary duty. He counterclaimed and sought a court-ordered buyout of his interests under the Minnesota Business Corporations Act, Minn. Stat. sec 302A.751, which permits the court to compel purchase of a minority shareholder’s interest in a corporation which has 35 or fewer shareholders if those who control the corporation have acted in an “unfairly prejudicial” manner to a minority shareholder. Minn. Stat. sec 302A.751, subd. 1(b)(3).
Both the trial court and the Court of Appeals held that a series of actions by the majority shareholder constituted “bad faith,” but that valuation of the minority shareholder’s interests should not include any discount for the restricted marketability of the shares. The Court of Appeals also ruled that the minority shareholder did not owe a “fiduciary duty” to the company. 601 N.W.2d 707 (Minn. Ct. App. 1999).
Noting that the trial court has “broad discretion both in the process and ultimate determination” in deciding the “fair value” of minority shareholders’ interest in a court-ordered buyout, the Supreme Court stated that the determination should be based on “all relevant factors [and]… must be fair and equitable to all parties.” A marketability discount, which is an adjustment because of the “lack of liquidity” in a corporation is predicated on the difficulty of selling an interest in a closely held company without an established market value, which leads investors to “pay less, and sometimes significantly less, for such shares.” The propriety of a marketability discount is a matter of “first impression” in Minnesota law in court-imposed buyouts. Reference to caselaw in other jurisdictions was a sparse aid because of the disagreement on this issue.
The court retreated from establishing a “bright-line test,” which it felt would clash with the policy of “flexibility and fairness to all parties.” Under this criterion, the court held that, “absent extraordinary circumstances,” a minority shareholder’s interests should be valued in a court-ordered buyout under the statute “as a growing concern without discount for lack of marketability.” In this case, however, the court found that “extraordinary circumstances exist,” which warranted discounting the value of the minority interest. A marketability discount is appropriate because valuing the shares without discount would be “clearly unfair” to the controlling shareholders and the owners of the business, since without a discount, the minority shareholder would receive more than five times the total net worth of the company, nearly seven times its annual operating cash flow, and more than eight times its average net income over the past five years. The company had followed a policy of reinvesting cash flow to finance its growth, and paying one-third of the value of the company, without discount, to the minority shareholder would represent “an unfair wealth transfer for the remaining stockholders … because it places unrealistic financial demands on the corporation … and in all probability strips [the company] of necessary cash-flow and earnings for future growth.”
Therefore, the case was remanded to the trial court to determine the appropriate marketability discount, somewhere between 35 percent and 55 percent, which were the figures presented to the trial court by the parties during the litigation.
Upon remand, the trial court will not need to consider whether the minority shareholder breached his fiduciary duty to the corporation. Although shareholders generally have fiduciary duties to a closely held corporation, in this case, the minority shareholder only had nonvoting stock and was not a director, which precluded him from having “any significant ability to control corporate decision-making.” Since the majority shareholder had control of the voting stock, the relationship between the majority shareholder and the minority shareholder was “not comparable to that of partners,” which forms the predicate for any fiduciary duty.
The absence of a fiduciary duty by a minority stockholder differs from the obligation of majority stockholders to the minority, as reflected in a pair of decisions of the Court of Appeals, which reached divergent results in breach of fiduciary duty claims.
In Berreman v. West Publishing Company, 2000 WL 1051894 (Minn. Ct. App. Aug 1, 2000), a veteran employee who had acquired a small amount of stock in the giant law publications company retired in mid-1995, which triggered redemption of his shares at current book value, yielding approximately $2.8 million.
A couple of weeks before his retirement, the company began looking into the possibility of being acquired or entering into a joint venture. It announced that possibility to other employees a few months later. The company was ultimately sold a year later, at about five times its book value, which would have netted more than $10 million to the retired employee had he kept his stock until the acquisition.
He sued for fraud, breach of common law fiduciary duty, and “unfairly prejudicial” conduct under the Business Corporations Act. His lawsuit was predicated upon the contention that the company failed to disclose the prospective transaction to him at the time he retired and had his stock redeemed.
The Dakota County District Court dismissed the case, and the Court of Appeals affirmed. Although the company had some 200 shareholders, its stock was “concentrated” in only a few individuals, which gave it the characteristics of a closed corporation. While shareholders in a closed corporation owe “a fiduciary duty to one another,” the court noted that the scope of the duty “has never been well defined.”
The court concluded, based on caselaw in other jurisdictions, that fiduciary duty in this case included the obligation “to disclose material facts.” Whether the type of “preliminary merger discussions” involved in this case are sufficiently material to warrant disclosure depends on the “probability magnitude” test. This requires balancing the “indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.”
Applying that standard to this case led to the conclusion that facts known to the company at the time of the employee’s retirement ̶
0;were immaterial as a matter of law.” The company had only had “tentative, speculative discussions” about prospective opportunities and had not yet “initiated discussion with any potential buyers” at that time. Since there was only a “low probability” that a merger or other acquisition would occur at the time of the employee resigning, the early intimations to “explore” the company’s financial options were “not material,” thereby negating any breach of fiduciary duty.
The court also held that the “unfairly prejudicial” standard under the Business Corporations Act was not satisfied in this case. The court applied the “reasonable expectations” doctrine, which turns on whether the actions by the company of those in control of it “frustrated a minority shareholder’s reasonable expectations.” That standard was not satisfied here because the claimant, who was an at-will employee, did not have any “reasonable expectation that he would be informed of any speculative discussions” about the financial future of the company. Similarly, a fraud claim was rejected because there was no “affirmative duty” to disclose to the employee at the time of his retirement the initial merger discussions that had been undertaken at that time. Accordingly, the employee could not proceed under any of the common-law or statutory claims.
But a skewed distribution schedule yielding minimal amounts to a pair of doctors who were part of a 23-physician practice group that was part of a medical merger yielded nearly $2 million to the two physicians for breach of fiduciary duty in Butwinick v. Minnesota Oncology Hematology, P.A., 2000 WL 1051983 (Minn. Ct. App. Aug. 1, 2000). The two plaintiffs were internists, who worked with 21 oncologists. When their practice was merged, the oncologists received sizeable payments ranging from nearly $800,000 to $1.5 million each. The two internists, however, were to receive minimal amounts, less than $20,000 to one, while one actually would have to pay the company a small amount because of debt owed by him.
A Hennepin County District Court jury awarded the two claimants nearly $1 million each, and the Court of Appeals affirmed, while slightly reducing the damages. It concluded that the oncologist shareholders owed a “fiduciary duty” to the two internists, which included the obligation “to deal openly, honestly, and fairly” with them in distributing the merger payments. That duty was breached by excluding the internists from a shareholder meeting until after the proposed distributions had been completed, which deprived them of payments they were entitled to receive “as a matter of fairness.”
As President Franklin Delano Roosevelt told the nation: “No democracy can long survive which does not accept as fundamental to its very existence, the recognition of the rights of minorities.”
These cases reflect that, as in a democracy, minority rights must be honored in corporate governance, too.
Marshall H. Tanick is an attorney with the Twin Cities law firm of Mansfield, Tanick & Cohen, P.A. He is certified as a civil trial specialist by the Minnesota State Bar Association and represents employers and employees in a variety of workplace-related matters.