Interview with Law Professor Douglas Moll, Leading Authority on Shareholder Oppression
Douglas K. Moll is Professor of Law at the University of Houston Law Center, where he teaches corporate and commercial law, and is one of the nation's leading authorities on shareholder oppression in the closely held business entity. His scholarly writings on the subject have been cited in numerous cases including, in New York, Horning v. Horning Construction LLC, 12 Misc 3d 402 (Sup Ct Monroe County 2006), in which the court relied on Professor Moll's analysis of the impact of the 1999 amendments to the LLC Law on relations between minority and majority members of LLCs.
I've had an occasional correspondence with Professor Moll for a number of years, so when I heard that he and co-author Robert Ragazzo had published a new treatise called The Law of Closely Held Corporations (Aspen Publishing 2009), I figured it would be a great opportunity to pose some questions about his views on shareholder oppression and about his new book. I think you'll find his answers interesting.
Mahler: Professor, how did you get interested in problems of the close corporation and shareholder oppression?
Moll: I practiced at Fulbright & Jaworski in Houston before becoming a law professor. While I was at Fulbright, I worked on several close corporation disputes, including the appeal of a shareholder oppression judgment. I read the briefs and the allegations of “shareholder oppression” and I couldn’t understand the operation of such a doctrine. What happened to the business judgment rule? What happened to employment at will? The area fascinated me and I read every court decision and secondary source that I could get my hands on. That has basically continued for the past fifteen years. I have now written multiple articles on the closely held corporation and the shareholder oppression doctrine; a casebook on closely held businesses, including close corporations; a second casebook on business organizations generally; and a just-published treatise on the law of closely held corporations.
Mahler: Some argue that courts shouldn't give minority shareholders protection they didn't see fit to bargain for when they became shareholders. Your reaction?
Moll: Well, first of all, there are a host of minority shareholders who have no opportunity to bargain before they become shareholders (e.g., shareholders who receive their stock via gift, inheritance, or in a divorce settlement). So denying these shareholders protection for their lack of bargaining doesn’t make sense to me. Second, there are many impediments to effective contracting that make such a position untenable in my mind. A few examples: (1) Because close corporation owners are frequently linked by family or other personal relationships, there is often an initial atmosphere of mutual trust that diminishes the sense that contractual protection is needed. (2) Even if an investor did recognize that planning for dissension was useful, barriers to effective contracting would still exist. In light of the countless ways in which oppressive conduct can occur, it is quite difficult to foresee all (if not most) of the situations that may require contractual protection. This inability to appreciate the universe of potential problems may result in incomplete contracting or, possibly, in no contracting at all. (3) Ex ante contracting is expensive, as it often requires the assistance of an attorney. In fact, effective ex ante contracting may require the services of multiple attorneys -- one (or more) representing the majority's interests, and one (or more) representing the minority's interests. This level of expense may be prohibitive for many small businesses, especially at their inception. I discuss these and other arguments in the treatise referenced above, as well as in an article that I wrote in the Wake Forest Law Review.
Mahler: In Delaware, unless the corporation elects to file as a statutory close corporation, there seems to be little or no remedy for the oppressed minority shareholder. Do you think it's a case of neglect or deliberate policy choice by the Delaware legislature, and do you see it ever changing?
Moll: Even if one elects to file as a statutory close corporation, what is the ex post judicial remedy? There isn’t one. Subchapter XIV of the Delaware General Corporation Law allows parties to contract for protection in advance, but if the parties do not, there is no provision providing for court-ordered dissolution for example. I do think this is a deliberate policy choice by the Delaware legislature, but I don’t think it is due to a hostility toward minority shareholders. I believe the Delaware legislature simply believes that their existing fiduciary duty doctrines and other provisions allowing for contractual protections are sufficient. In a sense, they are right. For example, many oppression lawsuits involve disguised dividend payments to the controlling shareholder or other violations of traditional shareholder rights. Those claims, in my view, are all actionable under Delaware law. They won’t be called “oppression” claims, but they will work as fiduciary duty, illegal dividend, conversion, or similar claims. What may be different about Delaware law is that they do not seem to offer protection to “non-traditional” shareholder rights – such as a right to employment or an active management role in a close corporation – absent a contractual right providing for such. In other states with oppression doctrines, those non-traditional shareholder rights can be protected even in the absence of a contract. It is also not clear whether Delaware would allow for a buyout as a remedy. It is hard to know if this will ever change. It would be interesting to see what Delaware would do with a classic freeze-out dispute in a close corporation, a la Wilkes v. Springside Nursing Home out of Massachusetts. A case like that would really test whether Delaware is serious about not providing special common-law protections for close corporation shareholders.
Mahler: Over the last decade LLCs have become the preferred form of new business entity filings in most states. Are minority members of LLC any more or less prone to majority abuse than minority shareholders of close corporations, and does LLC legislation adequately deal with the issue?
Moll: In my opinion, minority members of LLCs are just as prone to majority abuse as their close corporation brethren. The lack of a market exit and the same principles of majority rule set the stage for possible abuse. Several states provide a dissolution-for-oppression statute in the LLC setting, but such statutes are not as prevalent as they are in the corporation context. Some argue that LLC owners will be more likely to contract for protection because LLC statutes contain far fewer default rules than comparable corporate statutes. The fact that owners may need to contract for governance rules, however, does not mean that they will also contract for protections from abusive majority conduct – a problem that they may not even foresee. I have written somewhat extensively on this LLC and oppression issue in a 2005 Wake Forest Law Review article.
Mahler: You also published an article in the Duke Law Journal weighing the arguments for and against marketability and minority discounts in fair value proceedings tiriggered by oppression lawsuits. Where do you come out on the question?
Moll: This is a hard one to answer succinctly. (In fact, it took me on the order of 80-90 pages in the Duke article that you mention). I’ll just jump to the conclusion: I do not believe that discounts are appropriate in an oppression buyout. Discounts are discussed in great detail in the treatise referred to above as well as in the Duke Law Journal article that you mention.
Mahler: You and your co-author, Robert Ragazzo, have just completed a new treatise called The Law of Closely Held Corporations. Why did you write it, and who did you write it for?
Moll: We wrote the treatise because we have been researching, writing, and teaching about close corporations for years, and we have both served frequently as consulting and testifying experts in close corporation disputes (and disputes involving business organizations generally). Although there are some helpful resources out there, we found that a number of recurring and difficult issues are not adequately addressed by existing treatises, and some of those publications have become dated. We decided, therefore, to write a comprehensive and up-to-date treatise for practicing lawyers that would deal with the recurring problems that arise in close corporations and, more importantly, would provide answers and guidance for many of those problems. Plus, we thought it would be fun. After all, what could be more fun than spending two years writing a treatise? Hmmm.
Mahler: Lawyers who form private entities involving multiple owners don't always appreciate the problems that can occur down the road. How does your book help them?
Moll: I am obviously biased, but I believe that the treatise covers all of the major litigation and transactional issues related to the closely held corporation. The treatise discusses the common (and not-so-common) problems that can and often do occur down the road. Perhaps more importantly, the treatise discusses ways to avoid or mitigate those problems. Different jurisdictional approaches to major issues are covered (some in 50-state chart form), and a set of forms is also provided. We attempted to make the materials comprehensive and up-to-date, and it is our hope that practicing lawyers will find them to be useful.
Mahler: Does the book have a section on oppression and other bases for dissolution?
Moll: Yes. One of the largest chapters in the treatise is on oppression. There is another chapter on remedies for oppression and other forms of dissension. There is also a section on deadlock.
Mahler: How about variations in state laws governing closely held business entities -- does your book address them?
Moll: It does. As I mentioned above, we have several 50-state charts on some major issues. Even where there is not a chart, our goal was to provide authority for all of the major jurisdictional approaches to a problem or issue. To this end, the footnotes are extensive and there are references to multiple jurisdictions. The treatise, simply put, is intended to be national in scope.
Mahler: Thanks for taking the time Professor, and I look forward to reading the treatise.
Professor Moll's articles on shareholder oppression are available on the Social Science Research Network (click here for his author page). Click here for more information about the new treatise.
Fired Minority Shareholder's Oppression Claim Not Barred by At-Will Employment Provisions in Shareholders' Agreement
Some months ago, in a post about the intersection of the at-will employment doctrine and fiduciary duty among shareholders in close corporations, I wrote:
The most common allegation of oppression by minority shareholders involves termination of employment by the controlling shareholders. The Court of Appeals in Matter of Kemp & Beatley noted that obtaining employment is often the main reason for becoming a shareholder in a closely held company that typically pays no shareholder dividends. As I've pointed out before, case law holds that the majority's termination of the minority's at-will employment does not give rise to a wrongful termination remedy under either a contract or tort theory, but it may be oppressive for purposes of seeking judicial dissolution where the shareholder joined the venture with the reasonable expectation of getting and keeping a job.
This principle is vividly on display in a recently decided case called Ambar v. Devington Technologies, Ltd., 2009 NY Slip Op 32373(U) (Sup Ct NY County Oct. 13, 2009), where the court refused to dismiss a petition for involuntary corporate dissolution brought by a minority shareholder whose employment was terminated by the controlling shareholders, notwithstanding at-will employment provisions in their shareholders' agreement.
Devington Technologies Ltd. is a closely held New York corporation in the business of providing financial management computer software and programming to offices of medical providers. In 2002, founder Paul Ambar as 30% shareholder and Gershon and Tibor Klein, as combined 70% shareholders, executed a shareholders' agreement containing fairly typical provisions for election of the shareholders as directors and officers, spending authorization limits, and a right of first refusal ("RFR") fixing stock value at $8,335 per share unless otherwise agreed unanimously.
After five years, due to their dissatisfaction with his job performance, the Kleins attempted to buy out Ambar. They proffered an amendment to the shareholders' agreement reducing the board to two directors and replacing the existing RFR with a provision requiring Ambar to sell his 12 shares to the Kleins for a small fraction of the RFR share value. After Ambar refused to sign the amendment, the Kleins scheduled a special meeting of the stockholders and directors at which Gershon was elected president, Tibor was elected secretary, and Ambar was removed from Devington's board of directors and his employment terminated.
Ambar then filed a petition to dissolve Devington under Section 1104-a of the Business Corporation Law, primarily alleging oppressive conduct based on the Kleins' termination of his employment and their refusal to redeem his shares under the RFR at $8,335 per share. The Kleins opposed dissolution and moved to dismiss the petition, arguing that Ambar had no reasonable expectation of continued employment and a board position due to his at-will status under the terms of the shareholders' agreement. The Kleins also contended they were justified in firing Ambar for poor job performance and for causing Devington to incur major business losses.
The court's decision, by New York County Supreme Court Justice Marilyn Shafer, framed the issue as follows:
In opposition to the dismissal motion, Ambar details a different set of facts as to how and why Devington declined . . .. However, for purpose of the motions, it is not necessary for the court to evaluate or decide who or what triggered the corporate failures. It is sufficient to say that petitioner and respondents present diverse interpretations as to the factors that led the business to lose money, and submit dueling affidavits blaming each other for poor business decisions and incompetent day-to-day management. What is relevant to the court at this juncture is whether the petition sufficiently alleges that respondents, as the directors in control of Devington, engaged in conduct toward Ambar which entitles him to seek a judicial dissolution of the corporation.
Majority conduct is oppressive, Justice Shafer observed, when it "substantially defeats the reasonable expectations of minority shareholders," including the expectation to be actively involved in the company's management and operation. "When majority and minority shareholders can no longer work together in their day-to-day decision-making and management, judicial dissolution becomes an option."
Justice Shafer concluded that Ambar's petition (read here), while "not artfully drafted," sufficiently alleged grounds for dissolution based on the Kleins' termination of his employment. In addition, the Kleins' attempt to buy out Ambar's shares "at a severely discounted price ($125.00 rather than $8,335.00 per share) supports his claim of mistreatment by the majority shareholders and states a ground for involuntary judicial dissolution."
Cases like Devington are an important reminder to owners of closely held businesses of the need to include fair and workable shareholder exit mechanisms in the shareholders' agreement. The type of RFR used in Devington rarely succeeds, for at least two reasons. First, in the probable absence of any outside buyers for the minority interest, neither the minority nor majority can compel a buyout at any price. Second, the share price fixed at the outset almost always is doomed to obsolescence, either on the upside or downside. The shareholder agreements' unanimity requirement for any change in the share price effectively deters any later adjustments as the value of the business grows -- in which event the majority will resist adjustment -- or, as in Devington, shrinks -- in which event the minority will resist adjustment.
There are a number of techniques for overcoming the pricing problem, which in turn can ease mutual acceptance of a compulsory buyout trigger. One of the more popular ones is the use either of a single, independent business appraiser whose valuation is binding on the parties, or each side hiring their own appraiser. In the latter design, the agreement usually will provide for averaging the two appraisals if they fall within a specified range of each other or, if not, the appointment by those two of a third, independent appraiser whose valuation will either be determinative alone or is averaged with the first two, or is averaged with the closer of the first two.
None of the buyout mechanisms is perfect, but all are preferable to the uncertainty, expense and angst of dissolution litigation.
