Minority Shareholder Oppression – an Equitable Remedy for a Wrongfully Terminated Owner in a Closely Held Company – C. Clayton Gill
Terminating the employment of a minority shareholder without just cause may result in unintended and significant cash flow consequences for majority shareholders. This article will address a new equitable cause of action, minority shareholder oppression, and how to avoid claims for minority shareholder oppression through carefully drafted agreements.
A. A Common Factual Scenario for Minority Shareholder Oppression.
Consider the following factual scenario.
Acme Corporation has two shareholders, Snake and Slick. Snake and Slick each own 50% of the company, with the same distribution and voting rights. Snake and Slick approach Gullible and offer to make Gullible an equal one-third owner and manager for a capital investment of $5 million.
At the time Snake and Slick make their offer to Gullible, Acme’s earnings before interest, taxes, depreciation and amortization (EBITDA) are $3 million. Other comparable companies in Acme’s industry sell for a 5 times EBITDA multiple.
Gullible accepts the offer and Snake, Slick and Gullible sign written contracts that provide as follows: (1) Gullible pays $5 million to Snake and Slick; (2) Snake, Slick and Gullible become equal one-third owners with the same voting and distribution rights; (3) each is employed as a manager with equal management rights, which employment can only be terminated for cause after Acme gives notice and an opportunity to cure any performance deficiencies; and (4) upon termination of their employment, they must sell their shares to Acme and Acme must purchase their shares for fair market value after applying contractually-required discounts for lack of marketability and lack of control.
Three years after the agreements are signed, Acme’s EBITDA has doubled to $6 million, giving Acme an enterprise value of $30 million (using 5 times EBITDA multiple). Acme’s book value (assets minus liabilities) is $9 million at the same time.
In year three, Gullible is out of the office for considerable periods of time attending to her sick and dying mother. Neither Snake nor Slick complain about Gullible’s absences. At the end of year three, Gullible’s mother dies and Gullible apologizes to Snake and Slick for not carrying her weight, promising to rededicate herself to work in the coming year.
One week later, Snake and Slick terminate Gullible’s employment and demand that Gullible sell her shares to Acme for $4 million. Snake and Slick’s demand is based on a business valuation report that concludes that the fair market value of Gullible’s ownership interest, after applying lack of control and marketability discounts, is $4 million.
Three months after Gullible is terminated, Acme doubles Snake and Slick’s salaries.
This factual scenario raises numerous issues, including: (1) did Acme breach Gullible’s employment contract (i.e., did it have cause to terminate Gullible’s employment); (2) if Gullible was not terminated for cause, did Gullible’s termination without cause trigger the buy-back provision of the shareholder agreement; (3) if the buy-back provision of the shareholder agreement was not triggered, can Gullible require Acme, Snake or Slick to purchase her ownership interest and, if so, at what price?
B. The Idaho Supreme Court Recently Recognized the Equitable Claim of Minority Shareholder Oppression.
Recent decisions from the Idaho Supreme Court suggest that Gullible can require Acme, Snake or Slick to purchase her shares for one-third of Acme’s enterprise value without applying marketability or lack of control discounts (“Fair Value”), i.e. for $10 million (assuming the enterprise value is determined by using a 5 times EBITDA multiple). The difference between Fair Value (no discounts applied) and fair market value (discounts applied) can create a significant difference in the value of Gullible’s one-third interest. While the ultimate discounts are fact specific to the company being valued, it is not uncommon for marketability and lack of control discounts to result in a fair market value determination that is less than one-half of the Fair Value determination. For example, applying an assumed 30% lack of control discount and a 43% lack of marketability discount would reduce Gullible’s $10 million Fair Value determination to a $4 million fair market value determination.
When adopting the common law claim of minority shareholder oppression, the Idaho Supreme Court noted that this is an equitable claim that (a) requires a breach of fiduciary duty, and (b) is only available if there is no adequate alternative legal remedy, e.g., money damages for breach of contract or a statutory remedy. Thus, only if the employment agreement, shareholder agreement and the provisions of the applicable corporate code do not address this factual scenario or otherwise provide an adequate remedy can the Court fashion an equitable remedy that is appropriate in the circumstances.
Idaho’s adoption of the equitable claim for minority shareholder oppression is consistent with the trend in other states, some of which have gone so far as to incorporate a mandatory repurchase obligation for Fair Value into their corporate code.
1. The IBCA allows an oppressed shareholder to sue for dissolution, which may not provide an adequate remedy if the dissolution value is significantly lower than the going concern value.
The dissolution provisions of the Idaho Business Corporation Act (“IBCA”) provide that: “The Idaho district court . . . may dissolve a corporation . . . [i]n a proceeding by a shareholder if it is established that . . . [t]he directors or those in control of the corporation have acted or are acting in a manner that is illegal, oppressive or fraudulent, and irreparable injury to the corporation is threatened or being suffered by reason thereof.” Further, the IBCA provides that “[i]n a proceeding . . . to dissolve a corporation . . . the corporation may elect or, if it fails to elect, one (1) or more shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares.”
Applying the IBCA, Gullible could file a complaint in district court to dissolve Acme based on the oppressive conduct of Snake and Slick. But in any such proceeding, she cannot force Acme, Snake or Slick to purchase her ownership interest. Rather, the IBCA gives Acme, Snake and Slick the option, but not the obligation, to purchase Gullible’s shares for fair value.
Complicating matters further, the dissolution section of the IBCA does not define “fair value.” However, the appraisal rights section of the IBCA does. “‘Fair value’ means the value of the corporation’s shares determined: (a) Immediately before the effectuation of the corporate act to which the shareholder objects; (b) Using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal; and (c) Without discounting for lack of marketability or minority status . . . .”  Whether the definition of “fair value” in the appraisal section of the IBCA means the same thing as “fair value” as used in the dissolution section of the IBCA is uncertain.
In McCann v. McCann, the Idaho Supreme Court held that the IBCA does not preclude an equitable claim for minority shareholder oppression if (a) the “district court finds a breach of fiduciary duty”; and (b) “[dissolution] is not an adequate or available remedy.” In so holding, the Idaho Supreme Court noted that “[d]issolution of a corporation is a drastic remedy that should be invoked with extreme caution and only when justice requires it” and “[i]n some circumstances, dissolution may be a disproportionate and inadequate remedy.” Additionally, the McCann court held that “[i]f a district court finds a breach of fiduciary duty, and [dissolution] is not an adequate or available remedy, any alternative remedy—including those used in Steelman [v. Mallory, 110 Idaho 510, 716 P.2d 1282 (1986)]—not found in the above referenced [dissolution] statutory framework can be utilized.” While, McCann did not specifically hold that the repurchase of the minority owner’s interest for Fair Value is the appropriate remedy for minority shareholder oppression, it did cite with approval a North Dakota Supreme Court decision that remanded that case “for the entry of an order requiring [the majority shareholders] to purchase [the minority shareholder’s] stock at a price determined by the court to be the fair value thereof.”
Applying McCann, if Gullible can prove that Snake and Slick breached a fiduciary duty owed to Gullible and that the dissolution value of her shareholder interest is significantly less than the going concern Fair Value of her one-third interest, she can bring an equitable claim for minority shareholder oppression. Applying the facts set forth above, Gullible would argue that Snake and Slick breached their fiduciary duties by (1) manufacturing the termination of Gullible’s employment so that Snake and Slick could purchase her shares for $4 million, at a time when the shares had a Fair Value of $10 million (using a five times EBITDA multiple), and (2) doubling their salaries without any business justification. Additionally, Gullible would argue that the dissolution value of her shareholder interest is not an adequate remedy because the liquidation value of her one-third interest is $3 million or less (one-third of Acme’s book value), while the Fair Value of her interest is $10 million (using a 5 times EBITDA multiple).
Thus, if Gullible is successful on her claim for minority shareholder oppression, she might recover $10 million for her ownership interest (i.e., the Fair Value of her interest), whereas if her employment was terminated for cause, she might only recover $4 million (i.e., the fair market value of her interest after applying the contractually-required discounts for lack of control and lack of marketability) .
2. Minority shareholder oppression claims can be avoided through carefully drafted agreements.
In this case, the shareholder agreement requires Gullible to sell her shares to Acme for fair market value upon the termination of her employment. The shareholder agreement does not specify whether the buyout is triggered for all terminations or just a termination for cause. The employment agreement, on the other hand, requires cause for termination of Gullible’s employment. If the shareholder agreement applies to all terminations, Snake and Slick could terminate Gullible’s employment for no cause and, by doing so, acquire Gullible’s shares for a considerably reduced price after marketability and lack of control discounts are applied. Alternatively, a court could: (1) determine that the shareholder agreement is ambiguous and let the factfinder decide whether the compulsory buy-back provision is triggered by a termination without cause; (2) allow Gullible to pursue a claim for breach of the implied covenant of good faith and fair dealing because Snake and Slick wrongfully deprived Gullible of her contractual rights to employment and ownership in Acme; or (3) allow Gullible to pursue a claim for minority shareholder oppression.
Applying the Idaho Supreme Court’s holding in McCann v. McCann, Acme presumably could have avoided all of these issues by carefully drafting the shareholder agreement so that it clearly defined the purchase price in the event of a termination without cause.
In the end, without a carefully drafted shareholder agreement or buy-sell agreement, majority owners in a closely held company may expose themselves to the mandatory repurchase of a minority owner’s interest for Fair Value when they terminate the minority owner’s employment in an illegal, oppressive or fraudulent manner.
C. Clayton (“Clay”) Gill is a business and employment lawyer with the Idaho law firm, Moffatt Thomas. He has litigated a number of cases involving minority shareholder oppression and business valuations under compulsory buy-sell arrangements. He can be reached at Moffatt Thomas via phone 208.345.2000, or email: firstname.lastname@example.org. More information is available online by visiting http://www.moffatt.com
DOWNLOAD THE ARTICLE HERE: Minority Shareholder Oppression, by C. Clayton Gill
 McCann v. McCann, 152 Idaho 809, 815-19, 275 P.3d 824, 830-34 (2012); Wagner v. Wagner, 160 Idaho 294, 300-01, 371 P.3d 807, 813-14 (2016).
 Douglas K. Moll, Shareholder Oppression and “Fair Value”: Of Discounts, Dates, and Dastardly Deeds in the Close Corporation, 54 Duke L.J. 293, 315-18 & n.97 (2004).
 Id. at n.97.
 McCann, 152 Idaho at 818-19, 275 P.3d at 833-34.
 Id. at 819, 275 P.3d at 834.
 Robert C. Art, Shareholder Rights and Remedies in Close Corporations: Oppression, Fiduciary Duties, and Reasonable Expectations, 28 J. Corp. L. 371 (2003); Or. Rev. Stat. § 60.952; N.D. Cent. Code § 10‑19.1-115; Minn. Stat. § 302A.751.
 Idaho Code § 30-29-1430(2)(b).
 Idaho Code § 30-29-1434(1).
 Idaho Code § 30‑29‑1301(4).
 McCann, 152 Idaho at 819, 275 P.3d at 834.
 McCann, 152 Idaho at 816, 275 P.3d at 831; Balvik v. Sylvester, 411 N.W.2d 383, 389 (N.D. 1987)
 The Idaho Supreme Court recited the following examples of a breach of a fiduciary duty: “The squeezers may cut off the flow of income to the minority by refusing to declare dividends or they may deprive minority shareholders of corporate offices and of employment by the company. At the same time, the squeezers can protect their own income stream from the business by exorbitant salaries and bonuses to the majority shareholder-officers and perhaps to their relatives, by high rental payments for property the corporation leases from majority shareholders, or by unreasonable payments under contracts between the corporation and majority shareholders.” McCann, 152 Idaho at 816, 275 P.3d at 831 (quoting F. Hodge O’Neal & Robert B. Thompson, Oppression of Minority Shareholders and LLC Members § 3.2 (rev. 2d ed. 2004)).
 See, e.g., Hayes v. Olmsted & Assocs., Inc., 21 P.3d 178, 173 Or. App. 259 (Ct. App. 2001) (the Oregon Court of Appeals did not apply the valuation agreed to by the shareholders because it was not applicable in those circumstances).