On May 11, 2021, Division II of the Washington Court of Appeals issued an opinion arising out of a corporation owned by the Rees family. The case is interesting for a host of reasons, but the focus of this article is minority oppression.
The Family v. Don Rees
Don Rees owned 51% and his wife, Beth, owned 49% of the stock in Real Carriage Door Company (RCDC), an S corporation. Between 2010 and 2013, the two gifted shares to their son (Scott Rees), daughter (Mardie Broderick), and son-in-law (Jeremy Broderick). In January 2015, Don and Beth divorced. Don purchased Beth’s remaining shares in the divorce and owned 88% of RCDC shares.
Scott, Mardie, and Jeremy sided with Beth throughout the divorce, and all three terminated their employment at RCDC. As a result, RCDC – at Don’s direction – stopped distributing dividends to shareholders and instead dramatically increased Don’s salary instead.
Scott, Mardie, and Jeremy filed suit against Don for minority shareholder oppression. The appellate court concluded Rees’s conduct constituted minority shareholder oppression, breach of fiduciary duty and fraud.
The Duty to Minority Shareholders
The court pointed out majority shareholders have an obligation to “exercise good faith” toward minority shareholders and recited two tests for determining oppressive conduct toward minority shareholders under RCW 23B.14.300(2)(b). To prevail on a minority oppression claim, a minority shareholder must prove oppressive conduct without a legitimate business justification.
Two Tests for Oppressive Conduct
The first test, the “reasonable expectations” test, defines oppressive conduct as an act taken by the majority in violation of the minority’s reasonable expectations – “those spoken and unspoken understandings on which the founders of a venture rely when commencing the venture.”.
The second test defines oppressive conduct as “‘burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.’” The court essentially asks whether the operation of the business exists for the sole benefit of the majority stockholders, to the detriment of the minority stockholders.
After identifying the two tests, the court went on to discuss burden shifting and the implications of the business judgment rule. The court quickly held as a matter of law that ending dividends and converting those dividends to increased salary was “wrongful and oppressive”.
Considerations
In closely held entities, often with family involved, one generation often rules over another. However, the rules of corporations still apply, even to family held entities. There are ways to eliminate minority shareholders and owners (see, for example, my post on Sound Infiniti here). The Rees case shows one way NOT to do it. Something tells me that we have not seen the last of this case, so stay tuned.