This post is part of a series of posts related to Minnesota minority shareholder rights. The following posts cover specific issues related to minority shareholder rights:
- Introduction to minority shareholder rights
- Employment issues
- Accessing Corporate records
- Corporate Governance
An aggrieved shareholder of a corporation has an opportunity to seek relief in at least two distinct ways: through a derivative action or through a direct action. A shareholder derivative action is initiated to correct a wrong against the corporation, “[a] derivative action actually belongs to the corporation, but the shareholders…bring the action where corporation has failed to take action for itself.” In re UnitedHealth Group Inc. Shareholder Derivative Litigation, 745 N.W.2d 544, 550 (Minn. 2006) (quotation omitted). “Where the injury is to the corporation, and only indirectly harms the shareholder, the claim must be pursued as a derivative claim.” Blohm, 765 N.W.2d at 153. Meanwhile, a direct action is available to a shareholder where the shareholder suffered a “separate and distinct [injury] from the injury to other persons in a similar situation.” Northwest Racquet Swim and Health Clubs, Inc. v. Deloitte & Touche, 535 N.W. 2d 612, 617 (Minn. 1995). To summarize, “[i]n determining whether a claim is direct or derivative, the central inquiry is “whether the complained-of injury was an injury to the shareholder directly, or to the corporation.” Blohm, 765 N.W.2d at 153 (quotation omitted).
If it is determined that a claim is derivative, and hence belongs to the corporation, the shareholder “must first demand that the board [of directors] itself pursue the action.” UnitedHealth Group, Inc., 745 N.W.2d 544, 551 n.5. Pursuant to Minn.Stat. § 302A.241 subd. 1, the board may create a Special Litigation Committee (SLC), which can be charged with determining whether or not the claim is worth pursuing, on behalf of the corporation. SLCs are often used by boards to avoid a conflict of interest as the lack of independence from the events that brought on the claim can mean continuation of the derivative claim, despite board’s decisions to dismiss it. See UnitedHealth Group, Inc., 745 N.W.2d at 551 (“a board’s refusal to sue does not necessarily prevent the continuation of a derivative suit if the board members suffer from a conflict of interest.”). “When an [SLC] decides not to bring an action on behalf of the corporation, [SLC is not] authorizing or condoning the alleged wrongful acts but [is] merely saying that given the fact that the events did occur, it is not in the best interest of the corporation to pursue a legal remedy.” Id. at 557. And, in the majority of cases, the SLC will decide not to pursue a claim. However, the Minnesota courts may disregard the decision of an SLC, if there is a lack of independence among its members, and the investigative procedures used are inadequate. Id. at 559.
For example, in UnitedHealth, despite lacking necessary authority to challenge the independence of the SLC because of the posture of the case, the Court did specifically bring into focus the presence of a provision in the SLC’s charter that authorized the board to expand “the number of members of the Special Litigation Committee…if the board deems appropriate.” Id. at 560. This provision “could influence SLC members to alter their recommendations so as to avoid having their votes rendered meaningless;” a fairly clear indication of possible lack of independence among the members of the SLC. Id. at 561.
If however, the actions taken by the party in control of the corporation cause unique damages to a shareholder, a direct claim against the corporation can be brought. Despite being recognized an “entity” by the law, a corporation cannot act on its own. Thus, any actions of which a shareholder may complain were most likely caused to occur by another shareholder of the corporation, or an appointed officer. Due to this distinction, the actions that can be brought are often couched in terms of a breach of reasonable expectations, and/or fiduciary duties. See Minn. State. § 302A. 751.
A shareholder’s reasonable expectations should always be memorialized in writing upon formation of the corporation. See Minn. Stat. § 302A.751, subd. 3a (“written agreements…are presumed to reflect the parties’ reasonable expectations”). However, where writing is incomplete or nonexistent, the courts generally recognize that in a “closed corporation, a shareholder may have an expectation of a job, a share of corporate earnings, and a place in management.” Berreman, 615 N.W.2d at 374-75. Beyond this, the “reasonable expectations may be determined by reference to the understandings that would normally be expected to result from associative bargaining.” Gunderson, 628 N.W.2d at 185 (internal quotations and citation omitted).
Alternatively, a minority shareholder may seek redress for actions of controlling shareholders that breach the fiduciary duties they are charged to adhere to. Fiduciary duty that “majority shareholders have” towards minority is “a duty to deal ‘openly, honestly and fairly with other shareholders.’” U.S. Bank N.A., 802 N.W.2d at 381. To emphasize the breadth of the fiduciary duties, Minnesota Supreme Court expressly avoided drafting a specific definition; instead, it referenced three standards used in other jurisdictions when discussing it: “(1) the business purpose test; (2) the entire fairness test; and (3) the reasonable expectations test.” Id. (internal citation omitted). Ability to reference extra jurisdictional sources for identifying specific fiduciary duties gives minority shareholders a significant degree of protection. A few examples of possible breaches of fiduciary duties could include: “use of corporate funds for personal use;…use of corporate surplus to buy back majority stock while denying liquidity to minority;…fraud, illegality or bad faith and no compelling business purpose;…withholding material information related to reverse stock split;…paying price to minority for stock that is demonstrably lower than fair value;…asset sale depriving minority shareholders of all returns on investment.” Id. at 382 (internal citations omitted). This list however, is by no means exhaustive.
Another source of protection available for corporate shareholders is the right of dissent. When a shareholder does not agree with certain decisions of the board or controlling shareholders with respect to matters outlined in Minn. State. § 302A. 471, the shareholder may dissent, pursuant to the applicable provisions. Upon choosing to dissent, a “‘shareholder[ gains a right] to liquidate their equity investment in the corporation for its fair cash value’ in the event of certain fundamental corporate changes.” U.S. Bank NA, 802 N.W.2d at 374-75 (internal quotations and citation omitted). “To determine fair value, the…court may rely on proof of value by any technique that is generally accepted in the relevant financial community and should consider all relevant factors, but the value must be fair and equitable to all parties.” Advanced Communication Design, Inc., 615 N.W.2d at 290. The “fair value” should represent the “pro rata share of the value of the corporation as a going concern.” Id. Where the “fair value” evaluation will lead to “an unfair wealth transfer from the remaining shareholders to the dissenting shareholder,” the court may apply a marketability discount to the value of the shares. Id. at 292. When considering the existence of “unfair” wealth transfer, the fairness of the actions that cause the wealth transfer must also be considered. Some variables to consider “includ[e] whether the buying or selling shareholder has acted in a manner that is unfairly oppressive to the other or has reduced the value of the corporation, whether the oppressed shareholder has additional remedies such as those available pursuant to Minn.Stat. § 302A.467 (1998), or whether any condition of the buy-out, including price, would be unfair to the remaining shareholders because it would be unduly burdensome on the corporation.” Advanced Communication Design, Inc., 615 N.W.2d at 291-92. The important takeaway from this is that even if there is no agreement as to how the shares will be valued, or the method adopted appears unreasonable, the dissenting shareholder has other avenues to pursue.
Overall, the minority shareholders have a number of options to consider when evaluating the possible remedies for actions taken by those in control that they disagree with. Despite the availability of these options, pursuing legal remedy should not be taken lightly. As discussed in the opening section, because of the necessary indefiniteness infusing majority of avenues of legal recovery, the risk associated with choose this path suggests pursuing other options initially. To ensure that you choose the method that will lead to the outcome that will benefit you financially and otherwise, you should always consult an attorney. And, to minimize the need to resort to even considering such options, services of legal counsel should be retained at the onset of your business venture.