Those in charge of running a business have countless decisions to make every day. Those decisions are generally protected under Michigan law by the so-called “business-judgment rule.” But as numerous recent decisions make clear, the business-judgment rule is not an absolute defense to claims of oppression by minority shareholders, and the business decisions of the majority shareholders and those in control of the corporation remain subject to scrutiny.
In general, courts will not substitute their judgment for that of officers and directors. The reason is obvious: courts are not in the business of interfering in the affairs of corporations and recognize that those in control must have latitude to make decisions they believe are in the corporation’s best interest. As a result, under the business-judgment rule, courts refrain from interfering in matters of business judgment and discretion, unless the directors or officers are guilty of willful abuse of their discretionary powers or act in bad faith. But what happens when a minority shareholder claims that those in control engaged in willfully unfair and oppressive conduct as a result of their business decisions? Does the business-judgment rule provide an easy defense for those in control? Recent cases establish that it’s not so simple.
For example, in Franks v Franks,1 the plaintiffs sued the defendant corporation and its managers, arguing that the defendants’ decision to retain cash and not pay dividends constituted shareholder oppression. The defendants responded that their decision to not pay dividends was protected by the business-judgment rule, such that the plaintiffs’ oppression claim should be dismissed. In looking at the evidence and the nature of the plaintiffs’ claim, the Court of Appeals noted that the plaintiffs were not asking the court to review the soundness of the defendants’ business decisions but, rather, presented evidence that defendants’ decisions, including their decision to not pay dividends, were not for legitimate business reasons but instead were to oppress plaintiffs as shareholders. The Court held that a shareholder necessarily overcomes the business-judgment rule by presenting evidence in support of their oppression claim, and therefore “the business-judgment rule does not prohibit a court from reviewing the totality of the evidence when evaluating defendants’ business decisions – including their dividend policy – to determine whether the evidence showed that defendants formulated their policy in bad faith and as part of a plan to commit acts amounting to shareholder oppression.”
Similarly, in Smith v Smith,2 the minority shareholder sued the majority shareholders, claiming oppression based on defendants’ decision to not issue dividends. Defendants argued that their decision was protected by the business-judgment rule and that they had legitimate business reasons for not issuing dividends, including that the company’s long-standing policy was to not issue dividends and instead use profits to grow the business and that an agreement with their bank did not permit dividends. The plaintiff, however, presented conflicting evidence showing that the corporation was profitable and that the majority owners paid themselves excessive salaries and transferred funds for their benefit, while plaintiff received no benefit from his ownership interest. Given the conflicting evidence, the court denied summary judgment, finding there were factual questions as to whether defendants’ decisions were motivated by legitimate business reasons or, rather, by an intent to interfere with the plaintiff’s interest.
The business-judgment rule provides significant protection to those in control of a company and grants officers and directors latitude to make decisions they believe are in the company’s best interests. But, as the above cases illustrate, evidence that those decisions were made for the purpose of negatively impacting a minority shareholder’s interest can overcome the business-judgment rule and expose the corporation and its officers and directors to liability for shareholder oppression.
1 330 Mich App 69; 944 NW2d 388 (2019).
2 Unpublished opinion of the United States District Court for the Eastern District of Michigan, Case No. 19-10330, May 8, 2020.More Publications