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Litigating a Breach
LITIGATING A BREACH OF MAJORITY OWNER Wade H. Watson, III I. What Is The Problem? Georgia law recognizes a wide variety of legal entities in which people may conduct business: sole proprietorships, partnerships, corporations, S corporations, statutory close corporations, limited partnerships, limited liability partnerships, limited liability limited partnerships, and limited liability companies. Despite the proliferation of these different types of entities, each with its particular set of operating rules and tax characteristics, corporations remain the entity of choice for most businesses. It is easy and inexpensive to set up a corporation and can be done-and often is done-without advice of counsel. A corporation separates ownership from management. The owners are the shareholders. The shareholder's risk is limited to the capital he or she contributes to the enterprise. The shareholders elect directors to establish the objectives and policies of the corporation. The directors select the officers to carry out these objectives and policies and to handle day to day affairs. The governing principal for the decisions of shareholders and boards of directors is majority rule. "The control and management of corporations is always dictated by the majority." Comolli v. Comolli, 241 Ga. 471, 474, 246 S.E.2d 278, 280 (1978). This model works well for governing the huge amounts of capital that is invested in corporate America. The success of this business model, however, is based on the availability of regulated public markets where information in great quantity, detail and variety-if not always with perfect veracity-is readily available to the investing public. The markets reward corporations that manage their capital well and punish those who manage it poorly. The exchange of information and the ability to act on it by the investor happen almost instantaneously. The majority may rule the corporation, but every shareholder who disagrees with management, even the holder of a single share, is free to take his capital (or what's left of it) and go home. He may even be able to do so over the internet from the comfort of his living room. The Model Business Corporations Code, which Georgia largely adopted in 1988, is based upon this paradigm of management separate from ownership and public markets. See O.C.G.A 14-2-101 et seq. through 14-2-1703. But see, Article Nine (Statutory Close Corporations), O.C.G.A. 14-2-901 et seq. through 14-2-950. There is, however, another world of corporations where management and ownership are not separate, and where there are no public markets for trading shares. This is the world of the close corporation or the closely held corporation. In their treatise on close corporations, Professors O'Neal and Thompson define the close corporation as having the following features: (1) the shareholders are few in number, often only two or three; (2) they usually live in the same geographical area, know each other, and are well acquainted with each other's business skills; (3) all or most of the shareholders are active in the business, usually serving as directors or officers or as key participants in some managerial capacity; and (4) there is no established market for the corporate stock, the shares not being listed on a stock exchange or actively dealt in by brokers; little or no trading takes place in the shares. F. H. O'Neal & R. Thompson, O'Neal's Close Corporations, 1.08 (3rd Ed.). Because of these characteristics, the formalities of governance are frequently not observed or are observed only selectively. In Picket v. Paine, 230 Ga. 786, 791, 199 S.E.2d 223, 228 (1973), the Georgia Supreme Court commented that in a close corporation: [T]he participants very often fail to hold shareholder's and director's meetings and to distinguish between the two, they neglect to keep books and records or to keep them properly, they fail to maintain a separate bank account for the corporation, and they often do business by resolution and do not go through the procedure of authorizing expenditures such as salaries. The most important characteristic of the close corporation from a litigation standpoint, however, is the absence of a public market for the shares. When a dispute arises among the owners of a close corporation, those who own or control a majority of the shares will win the day under the Georgia Business Corporation Code (the "Code") because the majority rules. The owners in the minority cannot sell their shares for their fair value. Consequently, the minority shareholder has no way to protect himself from abusive policies, unfair practices, or the ubiquitous human failures of lying, cheating, and stealing. The Georgia Supreme Court has recognized this problem: In close corporations, minority stockholders may easily be reduced to relative insignificance and their investment rendered captive, because ordinarily there is no market for minority stock in a close corporation and a minority stockholder cannot easily liquidate his investment for its true value. We recognize that these circumstances may arise in close corporations at any time through combinations of stockholders, sales of stock between stockholders or to third parties, and are inherent in the organization of corporations. Comolli v. Comolli, 241 Ga. at 474. An exhaustive examination of the ways in which the majority can oppress minority shareholder is found in F. H. O'Neal & R. Thompson, O'Neal's Oppression of Minority Shareholders, 3.02 (2nd Ed.). These techniques include:
Id. It is not unusual to find that the majority may follow the appropriate corporate formalities to carry out the squeeze out technique. The willingness of majority owners to engage in these practices, or of the minority to accuse them of it, seems to be totally unaffected by the fact that the majority owners and minority owners are usually tied to each other by close bonds of family or long standing personal relationships. See e.g. Comolli, 241 Ga. 471 (dispute between brothers over control of family granite company); Thomas v. Dickson, 250 Ga. 772, 301 S.E.2d 49 (1983) (dispute between controlling shareholders and deceased shareholder's widow); Marshall v. W.E. Marshall Co., 189 Ga.App. 510, 376 S.E.2d 393 (1988) (dispute between father and son); Quinn v. Cardiovascular Physicians, P.C., 254 Ga. 216, 326 S.E.2d 460 (1985) (dispute among doctors over assets and income of their practice); West v. West, 825 F.Supp. 1033 (N.D.Ga. 1992) (dispute between father and son over son's rights in family business). Anyone familiar with family law practice or estate litigation will find little or nothing new in the fact patterns that spawn these suits. In summary, the problem is that the factual assumptions that govern most of the corporate code usually do not apply in the close corporation setting, leaving room for much mischief that is arguably authorized by the rules that vest control in the majority shareholders.
II. What Is The Legal Duty? In order to mitigate the excesses that could occur in the close corporation from unfettered majority control, Georgia law recognizes a fiduciary duty that those in control of the corporation owe to the minority shareholders. "It is settled law that corporate officers and directors occupy a fiduciary relationship to the corporation and its shareholders, and are held to the standard of utmost good faith and loyalty." Quinn v. Cardiovascular Physicians, P.C., 254 Ga. 216, 217, 326 S.E.2d 460, 463 (1985), citing King Mfg. Co. v. Clay, 216 Ga. 581, 118 S.E.2d 581 (1961). "Directors and officers in the management and use of corporate property in which they act as fiduciaries and are trustees [,] are charged with serving the interests of the corporation as well as those of all the stockholders." King Mfg. Co., 216 Ga. at 585; Pelletier v. Schultz, 157 Ga.App. 64, 276 S.E2d 118 (1981). "The demand of good faith is not limited to corporate profitability, but extends to the rightful interests of minority shareholders as well." Quinn, 254 Ga. at 217, citing Comolli v. Comolli, 241 Ga. at 475. "Directors may decide in good faith what is best for the corporation but this interest must be consistent with good faith to the minority stockholder." Comolli v. Comolli, 241 Ga. at 475; Quinn v. Cardiovascular Physicians, P.C., 254 Ga. at 217-218. This duty of utmost good faith and loyalty is not limited to the officers and directors. It applies to majority shareholders in closely held corporations as well. Marshall v. W. E. Marshall Co., 189 Ga.App. 510, 376 S.E.2d 393 (1988). In Marshall, the defendant father, who controlled a majority of the shares of the corporation, argued that he did not owe a fiduciary duty to his minority shareholder son. The Court of Appeals rejected this argument because of the special circumstances of the close corporation. "[I]t would be inconsistent with the realities of the business world to impose a fiduciary relationship upon the directors and officers of a close corporation to protect minority shareholders, but not upon the majority shareholder who really controls the corporation." Marshall, 189 Ga.App. at 512. This formulation of the duty is analogous to the duty of care owed by persons in confidential relationships. "Any relationship shall be deemed confidential, whether arising from nature, created by law, or resulting from contracts, where one party is so situated as to exercise a controlling influence over the will, conduct, and interest of another or where, from a similar relationship of mutual confidence, the law requires the utmost good faith, such as the relationship between partners, principal and agent, etc." O.C.G.A. 23-2-58. The power and flexibility of the concept of a fiduciary duty in a confidential relationship is illustrated in the case of Time Warner Entertainment Company, L.P. v. Six Flags Over Georgia, LLC, 245 Ga.App. 334, 537 S.E.2d 397 (2000), vacated and remanded, 122 Sup. Ct. 24 (2001), appeal after remand, 254 Ga.App. 598, 563 S.E.2d 178 (2002). There the Court held that the general partner breached its fiduciary duties by favoring its own financial interests over those of its limited partners based on its failure to invest sufficiently in new rides for the amusement park. The Georgia Court of Appeals ultimately affirmed the $454 million judgment, after finding that $257 million in punitive damages was not excessive. The fiduciary duty owed to the minority shareholder appears to be in addition to the general duties of care owed by officers and directors to the corporation as stated in the Code. Generally, an officer or director of a corporation shall discharge his duties in a manner he believes in good faith to be in the best interests of the corporation and with the care an ordinary prudent person in a like position would exercise under similar circumstances. O.C.G.A. 14-2-830 (Standards of conduct for directors); O.C.G.A. 14-2-842 (Standards of conduct for officers). Significantly, the codified standards for officers and directors make no mention of any duty owed specifically to the shareholders, nor does it describe the duty as a fiduciary duty. One can easily see a tension between the judicial and legislative definitions of these duties. This difference becomes important in formulating factual defenses to claims by minority shareholders. The majority shareholders will defend their actions using the Code's prudent person standard and argue that their conduct benefited the corporation. The minority shareholder, by contrast, will argue that the conduct in question breached the duty of utmost good faith and loyalty to the minority shareholder.
III. How Is The Duty Breached? It appears that any course of conduct by which those in control of the corporation favor their personal interests over the interests of the minority shareholder may constitute a breach of the fiduciary duty of utmost good faith and loyalty. The cases provide some examples, but are certainly not exhaustive of the conduct that may breach the duty. In Comolli v. Comolli, 241 Ga. 471, the Court held that the majority shareholder could not use corporate funds to buy out the shares of one minority shareholder if he did not offer to buy out the other minority shareholder on the same terms. The majority shareholder was thereby prohibited from using corporate funds to maintain his personal control over the corporation. In Quinn v. Cardiovascular Physicians, 254 Ga. 216, the Court held that the minority shareholder was entitled to a jury trial on her claim for breach of fiduciary duty where the controlling shareholders shut down the corporation and transferred its assets to a new corporation in which she was not a shareholder. In Thomas v. Dickson, 250 Ga. 772, 301 S.E.2d 49, 51 (1983), the widow of the minority shareholder was entitled to recover one-third of the profits of the corporation that were paid out in the form of additional compensation to the two majority shareholders. The widow successfully argued that the payments were essentially dividends and she was entitled to a pro rata share, which had been the practice before her husband died. In Caswell v. Jordan, 184 Ga.App. 755, 362 S.E.2d 769 (1987), the majority shareholders breached their fiduciary duties by using corporate assets to secure a personal loan. In Marshall v. W.E. Marshall Co., 189 Ga.App. 510, the minority shareholder was entitled to a jury trial on the issue of waste and mismanagement of corporate assets. In Dunaway v. Parker, 215 Ga.App. 841, 453 S.E.2d 43 (1995), the Court of Appeals affirmed a jury verdict for the minority shareholder where the majority shareholder was involved in self-dealing in connection with the sale of the family business. The defendant shareholder had obtained $300,000 and a company car in exchange for signing a covenant not to compete, benefits that would otherwise have gone to the corporation. Shortly before the sale, he changed the terms of certain leases held by the company in favor of himself, and the changes reduced the perceived value of the corporation to the buyer. Silence when there is a duty to speak can breach the fiduciary duty. In General Information Processing v. Sweeney, 176 Ga.App. 315, 335 S.E.2d 722 (1985), the corporate officer failed to disclose the terms of a settlement and how the settlement funds were used. The Court of Appeals observed that "[d]ue to the fiduciary relationship, 'the beneficiary . . . may rely implicitly not only on what is said, but also on the supposition that nothing important will be left unsaid by the officer.'" Id. For a virtual catalogue of the ways in which the income and assets of a corporation may be diverted to majority shareholders, see West v. West, 825 F.Supp. 1033 (N.D.Ga. 1992). Among other things, the minority shareholder in West complained of excessive compensation to majority shareholders, excessive benefits and perks such as the provision of maids, automobiles, airplanes, vacation homes, and yachts to favored shareholders, and the diversion of corporate capital through the transfer of improved real estate to individual shareholders using corporate credit, corporate development services, and favorable long term leases. IV. What Are The Remedies? A. Shareholder's Inspection Statute One of the first things that often happens when the shareholders in a closely held corporation have a dispute is that the majority or controlling shareholders withhold information about the corporation and its activities from the minority shareholders. The Code, however, provides a limited right by the shareholder to inspect records of the corporation. See O.C.G.A. 14-2-1601 through 14-2-1604. Among other things, the corporation is required to keep minutes of all shareholder and board of directors meetings, and unanimous consent resolutions made in lieu of meetings. The corporation is also required to keep "appropriate accounting records." O.C.G.A. 14-2-1601(b). It is required to maintain a record of its shareholders, including their addresses, and the number and type of shares held by each. O.C.G.A. 14-2-1601(c). Any shareholder may obtain the corporation's governing documents, records of actions taken by shareholders, and its correspondence with shareholders, including the annual financial statements the corporation is required to furnish to shareholders under O.C.G.A 14-2-1620. See O.C.G.A. 14-2-1601(a) and 14-2-1602(a). In order to obtain access to the corporation's board of directors minutes, accounting records and list of shareholders, the shareholder has to provide a statement to the corporation declaring that he is making the inspection in good faith and for a proper purpose. O.C.G.A. 14-2-1602(c)(d). He must also explain his purpose and how the records he seeks relate to that purpose. The corporation may limit this right to shareholders holding at least 2 percent of the outstanding shares. O.C.G.A. 14-2-1602(e). These inspection rights are cumulative of the rights the shareholder may have to discovery of information in litigation and of the independent power of a court to compel production of corporate records for examination. O.C.G.A. 14-2-1602(f). This inspection right may be enforced by the superior court, and if inspection is ordered, the court may award the shareholder his litigation expenses and attorneys fees. O.C.G.A. 14-2-1604. Inspection may be ordered "summarily" by the superior court upon application by the shareholder. Id. Attorneys representing shareholders may find that exercise of the inspection rights is helpful before filing suit. The corporation's records may not be in order, may be missing, or may simply not exist. The corporation may also improperly resist the inspection. A corporation that is unprepared or improperly resists inspection can be cast in a bad light before the jury. It creates an inference that records were either destroyed or altered before the production was made. In a similar vein, attorneys representing the corporation should have the corporation prepared to respond quickly and appropriately to the inspection demand to avoid an appearance of impropriety. B. Derivative Action For Damages The general rule is that a shareholder that is injured as the result of a breach of fiduciary duty by an officer or director of a corporation may not sue the officer or director directly. O.C.G.A. 14-2-740 et seq.; Grace Bros., Ltd. v. Farley Indus., Inc., 264 Ga. 817, 819, 450 S.E.2d 814 (1994); Thomas v. Dickson, supra. Instead, he or she is required to bring what is known as a derivative action, that is, an action in the name and right of the corporation. Id. The Code requires the shareholder to jump through a series of hoops in order to bring the action. Id. The most important feature of the derivative action, however, is that any recovery that is obtained by way of judgment belongs to the corporation, not to the shareholder who prosecutes the suit. Id. In order to have standing to bring a derivative action, the plaintiff must have been a shareholder at the time of the act or omission that forms the subject of the claim (or must have received the stock by operation of law from such a shareholder). O.C.G.A. 14-2-741. He must also fairly and adequately represent the interests of the corporation. Id. Before filing the action, the shareholder must first make a written demand on the corporation, usually addressed to the board of directors, to take suitable action. O.C.G.A. 14-2-742. He or she must then wait 90 days from the date of the demand before filing suit. Id. The corporation is an indispensable party to the derivative action. Kilburn v. Young (I), 244 Ga.App. 743, 536 S.E.2d 769 (2000). Once suit is filed the corporation may ask the court to stay the action while it investigates the claim stated in the demand. O.C.G.A. 14-2-743. Thereafter the corporation may appoint a committee of independent directors or ask the court to appoint two or more independent persons to determine in good faith whether prosecuting the claim is in the best interests of the corporation. O.C.G.A 14-2-744. If the committee determines in good faith that the derivative suit is not in the best interests of the corporation, it may move to dismiss the action. Id. If the derivative action survives these hurdles, it proceeds as any other action. At the conclusion of the suit, the plaintiff may seek recovery of his reasonable expenses (including attorneys fees) from the corporation provided that he can show that the litigation "resulted in a substantial benefit to the corporation." O.C.G.A. 14-2-746. On the other hand, if the suit is unsuccessful, the defendant may seek recovery of his reasonable expenses if he can show that the suit was prosecuted "without reasonable cause or for an improper purpose." Id. The Georgia Supreme Court has identified four reasons for requiring the suit to be brought derivatively in the name of the corporation. Thomas v. Dickson, 250 Ga. at 774, 301 S.E.2d at 51. First, the derivative action prevents a multiplicity of lawsuits by the various shareholders seeking recovery for the same breach of fiduciary duty. Second, the derivative action protects corporate creditors by putting the proceeds of the recovery back in the corporation where they can be used to satisfy debts. Third, the derivative action protects the interests of all shareholders by increasing the value of the corporation and thus the value of their shares. Otherwise the recovery to one shareholder would prejudice the rights of other shareholders who are not parties to the suit. Fourth, the injured shareholder is adequately compensated by increasing the value of his shares. Id. One can readily see that this rationale is based on the paradigm of corporate ownership that is separate from management, and the availability of public markets that will perfectly reflect the benefit of the corporate recovery in the price of the stock. This paradigm has little or no relationship to the facts of most disputes in closely held corporations where management and ownership are the same small group of people, and where there is no public market, or market price, for the shares. The derivative action has been roundly criticized in the context of closely held corporations because in many instances the corporate recovery benefits the parties who were guilty of the acts or omissions that formed the basis of the complaint. See Thomas v. Dickson, 162 Ga.App. 569, 571, 291 S.E.2d 747, 749 (1982), aff'd, 250 Ga. 772, 301 S.E.2d 49 (1983). In the case of an officer or director who misappropriates assets or income, the derivative action simply returns the money to the corporation where the persons who took it remain in charge. Despite its limitations, a shareholder in a closely held corporation should usually set up and plead a derivative claim as part of his complaint for breach of fiduciary duty. It may be the only claim that the court will allow to survive summary judgment. See West v. West, 825 F.Supp. 1033. Although Georgia recognizes a direct action in certain circumstances, it may be difficult for the shareholder to fit his case into those limited circumstances, and to convince the court that the general rule requiring derivative actions does not apply. A word of caution should be added for cases where the corporation was incorporated in another state. With a few exceptions noted in the Code, the law of the state of incorporation will govern the substance of the dispute. O.C.G.A. 14-2-747. This choice of law provision may govern the outcome. In Phoenix Airline Services, Inc. v. Metro Airlines, Inc., 260 Ga. 584, 397 S.E.2d 699 (1990), the plaintiff contended that the defendants usurped a business opportunity and the jury awarded $30 million in damages. The plaintiff corporation, however, was itself a shareholder of the corporation that suffered the alleged injury. The plaintiff had presented his case as a direct action. Because both plaintiff and defendant were Delaware corporations, the Court applied the law of Delaware. See Phoenix Airline Services, Inc. v. Metro Airlines, Inc., 194 Ga.App. 120, 390 S.E.2d 219 (1989). Delaware does not recognize direct actions except in cases of "special injury" to the shareholder and the plaintiff had not alleged a " special injury." Accordingly, the verdict was overturned. A different result might have been possible under Georgia law because the plaintiff was the only injured shareholder. Thomas v. Dickson, supra. The Phoenix Airlines decision is sometimes erroneously cited as stating Georgia law. See, e.g., Matthews v. Tele-Systems, Inc., 240 Ga.App. 871, 525 S.E.2d 413 (2000) at f.n. 5 and 6, and Holland v. Holland Heating & Air Conditioning, 208 Ga.App. 794, 797(3), 432 S.E.2d 238 (1993). The Court of Appeals' opinion in Phoenix Airlines, however, makes it clear that Delaware law was at issue. Phoenix Airlines, 194 Ga.App. at 123; Grace Bros., Ltd. v. Farley Indus., Inc., 264 Ga. at 819. Choice of law can also become an issue if the shareholder sues in federal court using diversity jurisdiction. A discussion of this issue is found in West v. West, supra. C. The Direct Action For Damages Unlike a derivative action, a direct action is one that is brought by the shareholder directly against the controlling shareholders, officers, and directors who are accused of breaching their fiduciary duties to the minority. The direct action has the advantage of bypassing all the procedural hurdles of the derivative action, and it provides a recovery directly to the injured shareholder. The problem of course is that it is a judicially created remedy not found in the Code, and can only be used in those cases where the facts can be molded into the exceptions set up by the case law. For a discussion of the history of the direct action in Georgia, see the author's article, The Development of the Shareholder's Direct Action Damage Remedy, 28 Georgia State Bar Journal 195 (1992), cited in Dunaway v. Parker, 215 Ga.App. at 846-847. The seminal case defining the direct action in Georgia is Thomas v. Dickson, 250 Ga. 772, 301 S.E.2d 49 (1983). In that case, Messrs. Dickson, Thomas, and Akin owned and operated a closely held corporation. Each shareholder owned one-third of the stock and each received $1000 per month in salary plus one-third of any profits of the corporation as additional compensation. Thomas v. Dickson, 250 Ga. at 774. When Dickson died, Thomas and Akin attempted to acquire his stock from his estate by paying his widow a $5000 death benefit. When she refused to sell, the other shareholders continued to pay the corporate profits to themselves in the form of compensation and denied Mrs. Dickson the right to participate in any of these distributions. Mrs. Dickson brought a direct action against the other shareholders to recover one-third of the profits which they had paid to themselves as compensation. The defendants responded by contending that she was required to bring a derivative action. The trial court permitted the direct action to proceed and the jury awarded damages to Mrs. Dickson equal to what they found to be her husband's share of the profits which had been paid to the controlling shareholders. Thomas, 162 Ga.App. 569, 570, 291 S.E.2d 747, 749 (1982), aff'd, 250 Ga. 772, 301 S.E.2d 49. The jury also awarded punitive damages and attorneys' fees. The Court of Appeals approved the direct action because it found it unfair to allow the corporation to retain the proceeds of the judgment when this result would actually benefit the parties who were guilty of the misconduct which gave rise to the action. Id. at 571, 291 S.E.2d at 749, citing Davis v. Ben O'Callaghan Co., 238 Ga. 218, 222, 232 S.E.2d 53, 56 (1977); Pelletier v. Schultz, 157 Ga.App. 64, 67, 276 S.E.2d 118, 121 (1981). On certiorari, the Georgia Supreme Court affirmed the ruling of the Court of Appeals. The Supreme Court declared that "[a]lthough Georgia follows the general rule [requiring derivative actions], we believe that in exceptional situations this Court and our other state courts should look at the 'realistic objectives' of a given case to determine if a direct action is proper." Thomas, 250 Ga. at 774, 301 S.E.2d at 51. The Supreme Court cited with approval authorities which supported the Court of Appeals' rationale. Id. See generally Jerome L. Kaplan, Nadler's Georgia Corporation Law 11-16 (1971); Comment, Corporations - Shareholders' Derivative and Direct Actions - Individual Recovery, 35 N.C.L. Rev. 279 (1957). See also, Watson v. Button, 235 F.2d 235 (9th Cir. 1956). However, the Supreme Court rejected what it described as the "blanket rule" for permitting direct actions adopted by the Court of Appeals because that rule focused solely on the benefit to the alleged wrongdoer and failed to consider the "possibility of prejudice" to other interested parties, such as creditors and other shareholders. Thomas, 250 Ga. at 775, 301 S.E.2d at 51. Instead the Supreme Court found that the availability of the direct action depends upon the realistic objectives of the suit and a four part analysis of whether the reasons for requiring derivative actions apply. This analysis poses the following questions, the responses to which should be based upon the realistic objectives of the particular suit: (1) Will the direct action result in a multiplicity of actions? (2) Are there creditors in need of protection? (3) Will the rights of other shareholders be prejudiced by a direct recovery by the minority shareholder? and (4) Would the plaintiff be adequately compensated by a corporate recovery? Id. The Court then looked at the facts of the Thomas case to determine if the reasons for the derivative action applied. Looking to the "realistic objectives" of the suit, the Court found that these reasons did not exist. Since the other shareholders had assented to and participated in the misappropriation of corporate profits, Mrs. Dickson was the only injured shareholder. Thus, there was no concern about the possibility of a multiplicity of suits (factor no. 1) or prejudice to the rights of other shareholders (factor no. 3). The defendants also presented no evidence of any creditor "in need of protection" (factor no. 2). Id. at 775, 301 S.E.2d at 51. Perhaps most importantly, the Court found that a corporate recovery would not adequately compensate Mrs. Dickson (factor no. 4). The Court determined that since the corporation was closely held, there was no ready market for her shares. Consequently, Mrs. Dickson had no ability to sell her shares and thereby benefit from the theoretical increase in the value of her shares which might result from a corporate recovery. The direct action as defined in the Thomas decision has been applied or discussed in Medlin v. Carpenter, 174 Ga.App. 50, 359 S.E.2d 159 (1985); Caswell v. Jordan, 184 Ga.App. 755, 362 S.E.2d 769 (1987); Marshall v. W.E. Marshall Co., 189 Ga.App. 510, 376 S.E.2d 393 (1988); Dunaway v. Parker, 215 Ga.App. 841, 453 S.E.2d 43 (1994); and Matthews v. Tele-Systems, Inc., 240 Ga.App. 871, 525 S.E.2d 413 (2000) at f.n. 5, 6. See also, Kilburn v. Young (II), Georgia Court of Appeals Nos. A02A0184, A02A0185 (July 11, 2002) 2002 WL 1477492 (minority shareholder recovers directly against majority shareholder for breach of fiduciary duty). As with many legal propositions, however, there is another line of authority. In Holland v. Holland Heating & Air Conditioning, 208 Ga.App. 794, 797(3), 432 S.E.2d 238 (1993), the Court of Appeals rejected a direct action claim on the grounds that no "special injury" was alleged as explained in Phoenix Airlines, a case decided under Delaware law. Perhaps the same result would have been reached in Holland if the Thomas analysis was applied, but the Court did not cite Thomas or explain why it was not applicable. Nor does it mention any of its own opinions that follow Thomas. In a radical and dubious departure from Thomas, the Court of Appeals recently opined that a direct action may only be brought in cases where the corporation is a statutory close corporation under O.C.G.A. 14-2-901 et seq. through 14-2-950. See Carter v. Murphy, Georgia Court of Appeals No. A02A0021 (6/14/02) 2 FCDR 1816, 2002 WL 1301516. The Carter opinion cites Matthews v. Tele-Systems, Inc., supra, Grace Bros. Ltd. v. Farley Indus, Inc., 264 Ga. 817, 819 (2), 450 S.E.2d 814 (1994), and Jamal v. Pirani, 227 Ga.App. 7213, 714 (2), 490 S.E.2d 140 (1997), as support. None of these cases, however, stands for the proposition that direct actions may only be brought in a statutory close corporation. The Carter opinion does not even cite the Thomas case or explain why the Thomas analysis does not apply. In Grace Bros. Ltd., the minority shareholders complained of the price they received for their shares in a corporate merger. Because they had sold their shares, they lacked standing to bring a derivative action. Id. 264 Ga. at 818. They sought to sue the defendants directly. The court discussed the Thomas v. Dickson exception to the derivative action requirement, but found that it did not apply because the exceptional circumstances were not present. It then answered a question left unanswered in Thomas, i.e., under what circumstances may the shareholder sue for a direct injury. The court looked back to its decision in Phoenix Airlines, and adopted the "special injury" test from Delaware law. The court held that "outside the context of a close corporation, a shareholder must be injured in a way which is different from the other shareholders or independently of the corporation to have standing to a assert a direct action." Id. at 819 (emphasis supplied). The Carter v. Murphy opinion erroneously treats the exception for "close corporations" in Grace Bros., which obviously referred to closely held corporations, as being limited to "statutory close corporations." This conclusion cannot be reconciled with the Grace Bros. court's discussion of Thomas v. Dickson. The Georgia Supreme Court's opinion in Thomas does not limit the direct action to statutory close corporations for a very good reason. The Code that enacted statutory close corporations was not adopted until 1988 (effective July 1, 1989), five years after Thomas was decided, and the statutory close corporation did not exist in the old Code. O.C.G.A. 14-2-901 et seq. through 14-2-950. Furthermore, the new Code was not intended to change the Thomas analysis. To the contrary, O.C.G.A. 14-2-901 provides that the statutory close corporation article "does not repeal or modify any statute or rule of law that is or would apply to a corporation that is organized under this chapter" (referring to Chapter 2, the Georgia Business Corporations Code). The drafting committee's comments are even more pointed: "[e]nactment of this article does not affect the law applicable to corporations, including closely held corporations, that are not statutory close corporations." O.C.G.A. 14-2-901 (emphasis added). See also O.C.G.A. 14-2-940(e) (which states that the remedies for a shareholder under the statutory close corporation article are "in addition to any other right or remedy he may have"). Accordingly, the Carter v. Murphy opinion appears to be an aberration. D. Dissolution In addition to an action for damages, the Code provides that a superior court may dissolve the corporation under certain circumstances, including some that may apply in a breach of fiduciary duty case against the majority or controlling shareholder. O.C.G.A. 14-2-1430. The text of the dissolution statute is as follows: The superior court may dissolve a corporation:
The subsections that are most likely to apply in a shareholder dispute are 1430(2)(B) and 1430(2)(D). Subsection 1430(2)(B) provides for dissolution in the case of conduct that is "illegal or fraudulent," but that ground can only be asserted by shareholders with at least 20 percent of the outstanding shares. Subsection 1430(2)(D) provides grounds for dissolution where "corporate assets are being misapplied or wasted." Most of the typical behaviors that lead a shareholder to file a claim for breach of fiduciary duty can be characterized as a misapplication or waste of corporate assets. The Code also provides that in lieu of dissolution, the superior court may order the appointment of a receiver to wind up the affairs of the corporation or a custodian to manage the business and affairs of the corporation. O.C.G.A. 14-2-1432. Except for corporations choosing the statutory close corporation status, it is an open question under Georgia law whether the superior court could order the corporation or those who control it to purchase the complaining shareholder's shares for their fair value. Logically, if the superior court has the power to dissolve the corporation-the corporate death penalty-it should also have the inherent equitable power to order a lesser remedy of a buy-out. In other states, the buy-out remedy has been recognized for some time as an equitable remedy alternative to dissolution. F. H. O'Neal & R. Thompson, O'Neal's Oppression of Minority Shareholders, 7.12, 7.13 (2nd Ed.). The claim for dissolution is essential in a breach of fiduciary duty case because it provides a way for the minority shareholder to get his capital out of the closely held corporation. If the court does not accept a direct action claim, it may be the only remedy that would provide meaningful relief. E. Remedies In The Statutory Close Corporation The 1988 Code created a new creature called the statutory close corporation. In order to become a statutory close corporation, the shareholders must make such an election in the corporation's articles of incorporation. O.C.G.A. 14-2-901 et seq. through 14-2-950. There is not a single case annotated under this section of the Code. In my practice, I have come across only two corporations that had elected statutory close corporation status, and both involved the same controlling shareholder. My client now has a $2 million judgment against that individual, who is questioning the wisdom of choosing the statutory close corporation form of business. The Code allows a shareholder in a statutory close corporation to petition the superior court for relief if, inter alia, "[t]he directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, fraudulent, or unfairly prejudicial." O.C.G.A. 14-2-940. The Court may provide relief in the form of damages to any aggrieved party, it can order the payment of dividends, it can order the corporation to purchase the shares of the aggrieved shareholder for their fair value, or it can order dissolution. O.C.G.A. 14-2-941, 942, 943. Compare this statute to the judicial dissolution statute for other corporations. O.C.G.A. 14-2-1430. In addition, two new grounds for relief have been added for conduct that is "oppressive" or conduct that is "unfairly prejudicial." No cases have been reported construing these terms, however. What do these terms mean? Some states use these terms in their dissolution statutes for regular corporations. See, e.g., Meiselman v. Meiselman, 307 S.E.2d 551 (N.C. 1983). In those states, the definition of oppression or unfair prejudice has focused on the "reasonable expectations" of the shareholder when he invested in the corporation. Id. Professor Thompson, the co-author of O'Neal's Oppression of Minority Shareholders, once explained to me the idea behind the statutory close corporation. He said that the legislation was intended to create an entity that provided every conceivable remedy for oppression of minority shareholders and to limit those remedies to corporations that elected the statutory close corporation status. He suspected that corporate lawyers who helped get this model statute enacted all over the country were looking for a way to derail the growing body of case law expanding remedies for oppression of minority shareholders. Their argument would be that oppressed shareholders are not entitled to the expansive remedies codified for statutory close corporations if their corporation did not elect statutory close corporation status. The idea is one of caveat emptor for investors in all other corporations. Our Court of Appeals appears to have accepted this argument in Carter v. Murphy by ruling that direct actions are only available in statutory close corporations. F. Dissenter's Rights The Code provides a remedy for shareholders to obtain an appraisal and buyout of their shares for their "fair value" where there is a transaction that requires shareholder approval for merger, share exchange, or sale of substantially all of the corporation's assets. O.C.G.A. 14-2-1301, et seq. The procedures provided in this section of the Code are specific and time sensitive. Fair value is the shareholder's proportional interest after valuing the enterprise as a whole. Blitch v. Peoples Bank, 246 Ga.App. 453, 540 S.E.2d 667 (2000) (rejecting use of minority and marketability discounts). The remedy should be adequate for a shareholder that is lucky enough to qualify because he will at least get his capital out of the corporation. He may even get a windfall if the appraised value turns out to be higher than the true economic value of the enterprise. I know of one case where the appraised value was so high that the corporation became bankrupt upon entry of the judgment for the dissenting shareholders. There is authority, however, that where it applies, the appraisal remedy is the exclusive remedy. Grace Bros. v. Farley Indus., Inc., 264 Ga. 817, 450 S.E.2d 814 (1994); Columbus Mills v. Kahn, 259 Ga. 80, 377 S.E.2d 153 (1989); but see Croxton v. MSC Holding, Inc., 227 Ga. 179, 489 S.E.2d 77 (1998) (recognizing exception for shareholder with employment contract requiring buy-out). The shareholder cannot obtain payment for his shares under the merger transaction and then bring an action complaining of the inadequacy of the price. Id. G. Securities Law Remedies In many situations, the dispute that leads to the assertion of a breach of fiduciary duty claim involves the purchase or sale of a security. Both state and federal law prohibit fraud in the sale of securities. See O.C.G.A. 10-5-12; Rule 106-5, 17 USC 78j, 17 CFR 240.106-5. The scope and application of these securities laws are beyond the scope of this paper. For a discussion of the use of securities laws as a remedy in shareholder oppression cases, see F. H. O'Neal & R. Thompson, O'Neal's Oppression of Minority Shareholders, 7.29, 8.01 et seq. (2nd Ed.). The point here is that the possible application of securities laws should be considered and it may be useful to consult a securities law specialist. Be aware that the statutes of limitations for securities law violations may be as short as one year. Id. V. What Are The Defenses? A. Estoppel And Ratification "It is a general rule of law that shareholders in a corporation who participate in the performance of an act, or who acquiesce and ratify the same are estopped to complain thereof in equity." Picket v. Paine, 230 Ga. 786, 199 S.E.2d 223 (1973), quoting Bloodworth v. Bloodworth, 225 Ga. 379, 169 S.E.2d 150 (1969). This rule applies in derivative shareholder claims as well as direct actions against corporations. Id. I believe the reference to direct actions here is to the corporate dissolution statute. For example, in Claire v. Rue de Paris, Inc., 239 Ga. 191, 236 S.E.2d 272 (1977), the Court cited this doctrine in rejecting a dissolution action brought by a shareholder who had been ousted as manager of the restaurant business run by the corporation. The shareholder complained of illegal actions of the new principals for such things as watering down drinks, taking food and drinks for personal consumption without paying, giving away liquor to the bartender and to personal friends, and taking cash out of the register. The deposition of the plaintiff revealed, however, that he had done the same things when he was in charge. The trial court granted summary judgment and the Supreme Court affirmed. Id. The estoppel defense can be applied creatively to a wide variety of circumstances. In the environment of the closely held corporation, particularly one involving family members, the minority shareholder has often received at least some kind of benefit from the corporation that might not have been entirely proper. The minority shareholder's acceptance of the benefit, even if he did not ask for it or particularly want it, may provide a basis for defeating his claims. B. Unclean Hands The unclean hands doctrine is a first cousin of estoppel. "Whenever a party, who, as actor, seeks to set the judicial machinery in motion and obtain some remedy, has violated conscience, or good faith, or other equitable principle, in his prior conduct, then the door of the court will be shut against him in limine; the court will refuse to interfere on his behalf, to acknowledge his right, or to award him any remedy." Claire v. Rue de Paris, Inc., 239 Ga. 191, 236 S.E.2d 272 (1977), citing Smith v. Nix, 206 Ga. 403, 57 S.E.2d 275 (1950). The Supreme Court in Claire also found that the shareholder seeking dissolution was guilty of unclean hands. Not every bad act, however, falls within the unclean hands defense. "The unclean-hands doctrine does not bar a litigant from seeking equitable relief unless the misconduct relates directly to the transaction concerning which relief is sought. See, e.g., Sparks v. Sparks, 256 Ga. 788, 508 S.E.2d 508 (1987). In Sparks, a husband who had fraudulently transferred the marital residence to his wife to avoid the claims of creditors, was permitted to seek equitable division of the house in his divorce with the wife because the Court did not find that his claim for equitable division was directly related to the fraudulent transfer. The marriage gave each party an equitable interest in the house regardless of how it was titled. Id. In West v. West, 825 F.Supp. 1033 (N.D.Ga. 1992), the plaintiff very nearly lost his entire case due to the court's application of the unclean hands doctrine. The plaintiff in that case was one of five children of Charles West who controlled the West Lumber Company building supply business. At the time he filed suit, the plaintiff had been estranged from his father for over five years. During that time he had not received any benefits from the corporations although he owned approximately 10 percent of the family business. Plaintiff's evidence was that during the four years prior to the suit, the father and plaintiff's siblings had withdrawn approximately $18 million in capital and benefits from the West Family Corporations, but plaintiff had not received anything. The plaintiff brought direct and derivative claims, as well as a claim for dissolution. He asserted that the transfers were really dividends in which he should have participated according to his stock ownership. The father responded by pointing out all the many times he had allegedly come to the plaintiff's aid over the course of his life by paying his debts or lending him money and that the source of this help was the family business. The father added that he had helped the plaintiff by allowing him to use his secretary to type his school papers in high school and that the typing was done on company time. The plaintiff argued that the father's assertions were largely untrue or exaggerated. The plaintiff admitted that he did owe the father some money and offered to pay that back. He argued vehemently that the father's allegations were not directly related to his shareholder claims, particularly since they related to events which occurred when the plaintiff was in high school, and in any event the equitable doctrine of unclean hands had no application to an action at law for damages. The district court reached a decision that pleased neither side and ultimately led to settlement of the case. The court ruled that unclean hands barred the direct action, but not the derivative claims. Id. at 1051. The court ruled that by offering to repay the debts he acknowledged the plaintiff had purged himself of the unclean hands and should be allowed to sue derivatively on behalf of the corporations. Id. The ruling was a pyrrhic victory for the defense because neither the father, the siblings, nor the corporations had paid income taxes on the $18 million they had allegedly taken out of the companies over the previous four years. Therefore, even though a judgment on the derivative claim would not provide any meaningful relief for the plaintiff, the trial could lead to a disastrous tax result for the rest of the family. VI. Conclusion The representation of shareholders in a closely held corporation presents many challenges but it also presents many opportunities for creative advocacy. The key to representation of the minority shareholder is to understand his fundamental economic problem-he has no market in which to sell his stock. The advocate has to educate the court to understand the difference between the closely held and public corporation so that the court can fashion an effective remedy where the facts of the case justify it. |
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