Shareholder Oppression and Reasonable Expectations: Of Change, Gifts, and Inheritances in Close Corporation Disputes

Abstract

By identifying and protecting the "reasonable expectations" of close corporation stockholders, the doctrine of shareholder oppression attempts to safeguard the close corporation minority investor from the improper exercise of majority control. The leading formulation of the reasonable expectations inquiry focuses on the shareholder's expectations at the time he decided to invest in the business. For the disputes that characterize most of the published oppression decisions, this "time of investment" focus is suitable, as the aggrieved shareholder is usually complaining about expectations that were established around the time of the shareholder's actual commitment of capital to the business. In certain significant contexts, however, a time of investment focus is problematic. First, a strict time of investment standard seems to ignore the possibility that post-investment expectations may arise. Focusing on one point in time - the time of investment - to measure the shareholder's expectations fails to capture potentially valid and reasonable expectations that may develop well after a shareholder commits capital to the venture. Second, a strict time of investment framework fails to account for close corporation shareholders who have made no investment at all in the company. This group of "non-investing shareholders" includes, among others, stockholders who receive their shares as gifts or inheritances. Because these shareholders have committed no capital themselves, there is, literally-speaking, no "time of investment" peculiar to them. For this group, therefore, an assessment of reasonable expectations at the time of investment may lead to a conclusion that no specific reasonable expectations exist at all. This Article analyzes whether and how the reasonable expectations inquiry could be applied to these changing expectations and non-investing shareholder cases. By conceiving of oppression as a doctrine that protects the fair value of the shareholder's investment, this Article provides a context for thinking about the purpose of the shareholder oppression doctrine and its accompanying reasonable expectations inquiry. Using this "investment model" of oppression as a guide, the Article argues that the law should view a reasonable expectation as a bargain struck between majority and minority shareholders over a specific entitlement the minority is to receive in return for its investment in the company. Because majority and minority shareholders may strike these "investment bargains" throughout their participation in a close corporation, the Article contends that the oppression doctrine should look for evidence of such bargains during the entirety of the shareholders' relationship, rather than merely at the narrower time of investment. The reasonable expectations inquiry, therefore, should reflect this broader perspective. Moreover, although non-investing stockholders do not, by definition, commit any of their own capital to the company, they too may reach mutual understandings with the majority that, if proven, should be protected as investment bargains. Part I of this Article discusses the nature of the close corporation and explains the development of the doctrine of shareholder oppression. Part II describes the investment model of oppression and the special nature of the close corporation shareholder's investment. While a time of investment focus for measuring reasonable expectations is not well-suited to disputes involving changing expectations or non-investing shareholders, this Part explains that a time of investment inquiry is nevertheless consistent with the theory of the investment model. Building on this analysis, Part III discusses the problems presented by shareholder expectations that change over time. Because corporate law seeks to prevent freeze-out conduct, this Part argues that the law should protect post-investment expectations. Moreover, by drawing from relational contract theory, this Part provides an additional basis for validating and enforcing post-investment expectations, even when the minority has provided no additional consideration. Part IV explores the puzzle of the non-investing shareholder and the various positions that the oppression doctrine could take towards these parties. After discussing whether non-investing shareholders should have (1) no specific reasonable expectations at all, (2) only the specific reasonable expectations of their investing transferors, or (3) any specific reasonable expectations that can be proven, this Part concludes that the third alternative promotes fairness and provides consistency with the investment model of oppression. Finally, Part V considers the role of the transferor's intent in single-founder cases. Rather than serving to bind successor shareholders, this Part suggests that the founder's intent should serve merely as an evidentiary factor in the reasonable expectations analysis.