A “freeze-out,” also known as a “squeeze-out,” is a classic problem in the world of close corporations in which a minority shareholder is ousted by the majority. Depending on the state in which you reside, there are remedies currently available to minority shareholders in this situation. However, this issue is currently unsettled under Oklahoma law. This article explores how the issue may be decided under Oklahoma law in the future and provides options lawyers may consider to protect their clients in the interim.

WHAT IS A FREEZE-OUT?

To understand the issues involved in a freeze-out, one must first have a basic understanding of close corporations. A close corporation (also commonly referred to as a “closely held corporation”) is a privately held corporation whose shares are owned by a small group of investors and are not available to the public.[1] This is also known as a privately held corporation. Within a close corporation, there may be minority shareholders and majority shareholders. However, the expectations of a minority shareholder are generally similar to those of the majority shareholder: 1) an active participating role in management, 2) an employment or consulting role for compensation and 3) a return on investment. A minority shareholder holds less than 50% of the shares, while a majority shareholder holds more than 50% of the shares. By holding less than 50% of the shares, minority shareholders are subject to situations like a freeze-out by the majority shareholders. A freeze-out can be explained by the following example:

Steve, Jon and Audra start their own manufacturing business by incorporating under Oklahoma law using the standard form of certificate of incorporation available from the secretary of state’s office. Each founder contributes $5,000 for one-third of the authorized stock and begins working full time for the company as an officer and employee. The bylaws provide that the board will consist of three directors elected annually by majority vote of the shareholders, all officers and employees will serve at the pleasure of the board, and the bylaws may be amended by majority vote of the board or shareholders. The founders do not enter into a shareholders’ agreement or any employment agreements.

It is now 10 years later, and the business has flourished. The company has never paid a dividend. Any amounts not paid out to the shareholders in the form of salaries have been retained to grow the business. Steve and Audra suddenly have a serious falling out with Jon regarding a matter unrelated to Jon’s performance. At the next annual meeting of the shareholders, after giving proper notice and following all corporate procedures correctly, Steve and Audra amend the bylaws to reduce the number of directors to two and elect only themselves as directors. They fire Jon as an officer and employee, change the locks to the plant and issue orders to the company’s security guards to refuse Jon admittance to the premises. They also give themselves substantial raises. The aggregate increase in their salaries is equal to the salary formerly paid to Jon. They comply with all of Jon’s requests for inspection of the books and records of the corporation; however, they refuse his demands for declaration of dividends, saying the company needs to retain earnings for future capital needs. They also decline Jon’s request that either they or the company purchase his stock. Jon attempts to find other buyers for his one-third interest but can find no one interested in purchasing a minority interest in a closely held corporation.[2]

What protections or remedies are available for Jon, who was a victim of the classic freeze-out? Is it possible to protect Jon from such treatment before it happens? What can lawyers do to ensure their clients’ interests are protected in such situations? These questions are further examined in this article.

DEFINING OPPRESSIVE CONDUCT

States have defined “oppression” in different ways, but it generally includes a violation of the standards of fair dealing and fair play, a violation of a fiduciary duty owed to the minority shareholder or conduct that results in frustration of the minority shareholder’s reasonable expectations.[3] For example, the Colorado courts have defined oppression as “burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the affairs of the company to the prejudice of some of its members; or a … 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.”[4] Other courts have expanded that definition to also include conduct that substantially defeats the minority shareholder’s reasonable expectations.[5]

These definitions leave the court with the task of subjectively determining whether shareholders’ actions are oppressive. Terms such as “burdensome,” “harsh,” “wrongful” and “fair” in these definitions all lend themselves to any number of subjective interpretations and applications. What could be “wrongful” to one court may be completely tolerable to another. Courts appear reluctant to suggest a list of elements or even a “bright line” test for determining the presence of such behavior, preferring instead to consider factors, as applied to each case in the context of the applicable jurisdictional law. As a result, the broad term can be used to cover a multitude of cases in which improper conduct occurred. In acknowledgment of this fact, the New Mexico Supreme Court has stated, “The absence of a rigidly defined standard for determining what constitutes oppressive behavior enables courts to determine, on a case-by-case basis, whether the acts complained of serve to frustrate the legitimate expectations of minority shareholders, or whether the acts are of such severity as to warrant the requested relief.”[6] Although these broad, subjective and expansive definitions allow courts to conduct a case-by-case analysis of wrongful behavior, they provide very little guidance as to what the court will likely include as oppressive conduct. Courts continue to refine their jurisprudence on the subject, but shareholder “oppression” will likely never be distinctly defined.

PROTECTIONS AND REMEDIES PROVIDED IN OTHER STATES

Oklahoma currently has no statutory protection for minority shareholders absent “mismanagement, collusion, or fraud.”[7] However, 60% of states now provide some form of statutory relief for minority shareholders of closely held corporations in the form of a petition to the court for dissolution of the corporation on the grounds of “oppression” or similar conduct by the majority shareholders.[8]

The states that have not enacted oppression into their corporation statutes seek out a remedy that may be less severe than dissolution. One ambitious state Supreme Court listed no less than 10 potentially available remedies for the disenfranchised minority shareholder.[9] The draconian remedy of dissolution can certainly affect much more than simply the shareholders, who were acting in bad faith or in violation of their fiduciary duties. In pursuit of a less extreme remedy, Massachusetts developed a judicial remedy that may be a middle ground to the harsh statutory schemes of the majority of states.[10]

In Wilkes v. Springside Nursing Home, Inc., the Massachusetts Supreme Judicial Court was trying to determine whether a close corporation can fire one of four shareholders for the sole purpose of denying him income from the corporation.[11] The court determined the majority shareholders failed to advance a legitimate business reason for firing the shareholder and frustrated the minority stockholders’ purposes.[12] The fired shareholder, therefore, could recover from the other three shareholders the salary he would have received had he not been fired.[13] Under this scheme, a more moderate form of relief replaces the extreme measures enacted by statutory dissolution schemes. The Massachusetts court, rather than dissolving the corporation, provided a judicial remedy to the minority shareholder to recover damages due to the wrongful conduct or “oppression” by the majority shareholders.

However, other jurisdictions have rejected the idea of both statutory and judicial relief for minority shareholders in a freeze-out. The Delaware courts have affirmed that minority shareholders in close corporations have two protections available to them, which will not be distracted by judicial relief.[14] First, Delaware maintains a close corporation statute that contains certain protections to minority shareholders.[15] If a closely held corporation wishes to be protected by the close corporation statute, it must incorporate under such statute or forfeit those protections.[16] Second, minority shareholders have the chance to contract for protections prior to purchasing shares in a close corporation.[17] The court declared, “The tools of good corporate practice are designed to give a purchasing minority stockholder the opportunity to bargain for protection before parting with consideration.”[18] Since the close corporation statute and contract law preempt the field in their respective areas, the court determined it would be inappropriate to fashion a special judicial remedy when plaintiffs fall outside the provided statutes.[19]

The Supreme Court of Texas has followed Delaware’s lead and denied judicial relief outside of the close corporation statute and other statutory schemes that already exist in its law.[20] The Texas court further noted that other causes of action exist for minority shareholders, including breach of fiduciary duties, breach of contract, fraud, conversion, etc., which warrant a further judicial remedy for “shareholder oppression” unnecessary.[21]

WILL OKLAHOMA COURTS ACCEPT JUDICIAL RELIEF?

To date, Oklahoma has no statutory grounds to seek involuntary dissolution of a corporation for shareholder oppression of minority shareholders. Oklahoma has also chosen not to implement a close corporation chapter in its corporation laws. Since Oklahoma has not dealt with the issue of shareholder oppression, at least within its body of reported case law, minority shareholders are provided essentially no protection or remedy for oppression outside of contractual schemes. Under such circumstances, is it likely Oklahoma will accept judicial relief against oppression? Previous Oklahoma decisions may provide a clue as to how Oklahoma will decide this issue.

In general, Oklahoma’s corporate law is derived from the corporate law of Delaware.[22] Therefore, it seems Oklahoma would likely follow Delaware’s law on the issue. Much like Delaware, Oklahoma does not have a statutory provision to petition for dissolution in cases of oppression. However, unlike Delaware, Oklahoma elected to exclude the statutory close corporation chapter of corporate law. The Delaware case law denying a judicial remedy for oppression specifically relied upon the fact that statutory schemes for close corporations already existed and preempted the field on this issue. Thus, if Oklahoma were to follow Delaware’s lead, it would have to rely on separate reasoning. One potential resource upon which Oklahoma could rely would be the American Law Institute’s Principles of Corporate Governance, which seems to provide a remedy for a freeze-out of minority shareholders.[23] Section 7.21 states that a shareholder is entitled to a fair value of their shares in the event of any “corporate act or transaction that has the effect of involuntarily eliminating the eligible holder’s equity interest” or an amendment of the charter documents whose effect is to exclude or limit the voting rights of shares.[24] Oklahoma courts could use this provision for authority to provide a judicial remedy in freeze-out situations should the Legislature continue to decline to do so. However, in as much as the above principles are not specifically codified in Oklahoma statutory law, Oklahoma’s jurisprudence may veer away from the corporate laws of Delaware and perhaps accept a judicial remedy for minority shareholders experiencing a freeze-out.[25]

Another indication that Oklahoma may choose to implement a judicial remedy for minority shareholders stems from reasoning similar to that in Renberg v. Zarrow.[26] Although this decision does not discuss a freeze-out situation, it does provide insight into the Oklahoma Supreme Court’s stance on minority shareholder rights. In Renberg, the court determined that mandatory buy-sell provisions in a stock agreement may be unenforceable under the following circumstances: 1) where there is bad faith, 2) where there is a failure to disclose an enhancement in stock value or 3) where there is a misuse of power to promote personal interests at the expense of the corporation.[27] In making such determination, the court stated, “A court of equity will not enforce stock transfer restrictions adopted under circumstances which indicate bad faith and inequitable treatment of stock purchasers. … [Further], a majority shareholder has a fiduciary duty not to misuse his power by promoting his personal interests at the expense of the corporation, and the majority shareholder has the duty to protect the interests of the minority.”[28] The court makes it clear that Oklahoma seeks to protect minority shareholders from oppression. However, it is less clear if that protection extends to a judicial remedy for such oppression.

Other points of Oklahoma law seem to suggest that no such judicial remedy will be enacted in Oklahoma. For instance, minority shareholders of farming and ranching corporations may petition the court for dissolution of the corporation “for good cause shown” if the shareholder owns 25% or more of the shares in the corporation.[29] Neither the Legislature nor the judiciary have explained what is considered “good cause” under this statute. Oklahoma courts have noted that, in general, dissolution may occur if the minority shareholder proves fraudulent mismanagement or misappropriation of funds by the officers.[30] Although mismanagement and misappropriation are not the same as oppression, it does correspond to the majority shareholders’ fiduciary duties.[31] The existence of this statute for a specific type of corporation may be evidence that Oklahoma will enact further statutory protections for minority shareholders in close corporations rather than implementing judicial relief for the issue.

A LAWYER’S RESPONSE

No matter how Oklahoma ultimately decides, lawyers should utilize what they know to best protect the interests of their clients incorporating under Oklahoma law. If a client is seeking to set up a close corporation or purchase shares of a close corporation, a lawyer should discuss the possibility of oppression with their client. The client should know the risks of freeze-out in such circumstances and be able to make an informed decision on whether to enter into this kind of business venture. If the client desires to move forward, providing provisions to protect the client in a subscription and/or shareholder agreement, corporation bylaw or another governing document may evidence the parties’ intent to guard against oppressive conduct and minimize the prospect of litigating an unsettled issue in the future.

However, a client can also end up as a majority shareholder on some issues. In these instances, the protection of minority rights could hinder the majority’s aims. Be sure to discuss with your client which assets and issues need the highest levels of protection. Instead of doing a general or overall protection of minority rights, it may be best to simply protect the interests and assets most important to them and accept the business risk with the people whom the client has chosen to do business with respect to other minor issues.

If a lawyer represents a minority shareholder who did not negotiate contractual provisions to protect the client’s interests, it may be possible to utilize an argument for a judicial remedy in case of a freeze-out. Since Oklahoma provides essentially no protection for minority shareholders in either statutory or case law, a fair argument could be made for the implementation of a judicial remedy to the freeze-out, not unlike the authorities discussed within this article.[32]

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ABOUT THE AUTHORS

Benham Kirk is an experienced transactional attorney for Doerner, Saunders, Daniel & Anderson LLP and is an active member of the firm’s Executive Committee. Mr. Kirk focuses his practice on a broad range of acquisitions, divestitures, mergers, restructures, reorganizations, secured financing and commercial real estate, including extensive work in lease negotiation and drafting. Most recently, he has been nationally recognized by reputable organizations and publications for his outstanding achievements in real estate law, along with bankruptcy and creditor debtor rights/insolvency and reorganization law.

 

 

 

Alexandra J. Gage is a skilled attorney for Doerner, Saunders, Daniel & Anderson LLP. Her practice includes a variety of transactional matters involving employment law, corporate law and contract disputes. When she’s not helping clients fulfill their business objectives, Ms. Gage applies her leadership skills as an active board director of the OBA Young Lawyers Division for District 6. She also attends educational leadership development seminars for the YLD Leadership Academy of the Tulsa County Bar Association.

 

 

 

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ENDNOTES

[1] “Close Corporation,” Black’s Law Dictionary, (11th Ed. 2019).

[2] M. Thomas Arnold and H. Wayne Cooper, “Protection of Employment Rights of Minority Shareholders of Close Corporations,” Vernon’s Okla. Forms 2d, p. 2 (November 2021).

[3] Id.

[4] Polk v. Hergert Land & Cattle Co., 5 P.3d 402, 404-05 (Colo. App. 2000).

[5] Argo Data Resource Corp. v. Shagrithaya, 380 S.W.3d 249, 265 (Tex. App. Ct. 2012); Litle v. Waters, 18 Del. J. Corp. L. 315, 328 (Del. Ch. 1992); Gee v. Blue Stone Heights Hunting Club Inc., 604 A.2d 1141, 1145 (Penn. 1992); Brenner v. Berkowitz, 634 A.2d 1019, 1029 (N.J. 1993).

[6] McCauley v. Tom McCauley & Son, Inc., 724 P.2d 232, 236 (N.M. 1986).

[7] Western v. Acme Tool, Inc., 441 P.2d 959, 962 (Okla. 1968).

[8] See M. Thomas Arnold and H. Wayne Cooper, “Protection of Employment Rights of Minority Shareholders of Close Corporations,” Vernon’s Okla. Forms 2d, p. 2 (November 2021); See generally Ala. Code §10-2A-195 (1987); Alaska Stat. §10.06.628 (1989); Ark. Code Ann. §4-27-1430 (1989); Cal. Corp. Code §1800 (1990); Conn. Gen. Stat. §34-267(5) (2017) Ga. Code Ann. §14-2-940 (1989); Idaho Code §30-1-97(A)(2) (1980); Ill. Ann. Stat. Ch. 32, Para. 12.50 (1992); Iowa Code Ann. §490.1430 (1991); Md. Code Ann., Corps. & Ass'ns §3-413 (1993); Mich. Comp. Laws Ann. §450.1489 (1990); Miss. Code Ann. §79-4-14.30 (1992); Minn. Stat. Ann. §302a.751 (1992); Mo. Ann. Stat. §351.494 (1991); N.H. Rev. Stat. Ann. §293-A:98 (1987); N.D. Cent. Code §10-19.1-115 (1985); N.J. Stat. Ann. §14a:12-7; N.M. Stat. Ann. §53-16-16 (1983); N.Y. Bus. Corp. Law §1104-A(A)(1) (1986); Or. Rev. Stat. §60.661 (1992); Pa. Stat. Ann. Tit. 15, §1981 (1992); S.C. Code Ann. §33-14-300 (1990); S.D. Codified Laws Ann. §47-7-34 (1983); Tenn. Code Ann. §48-24-301 (1992); Utah Code Ann. §16-10a-1430(2) (1992); Vt. Stat. Ann. Tit. 11, §2067 (1984); Va. Code Ann. §13.1-747 (1989); Wash. Rev. Code Ann. §23b.14.300 (1992); Wis. Stat. Ann. §180.1430 (1992); Wyo. Stat. §17-16-1430 (1989).

[9] Baker v. Commercial Body Builders, Inc., 507 P.2d 387, 395 (Or. 1973). The Supreme Court of Oregon’s list of potential remedies included appointing a receiver to continue the operation of the corporation for the benefit of all shareholders until the oppressive conduct ceases, issuance of an injunction to prohibit continuing acts of oppressive conduct, an order for affirmative relief of a distribution of capital, an order requiring majority stockholders to purchase the minority shares at a price deemed fair and reasonable and an award of damages to minority shareholders for the oppressive conduct.

[10] Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842, 353 N.E.2d 657 (1976).

[11] Id.

[12] Id. at 662-63.

[13] Id.

[14] See generally Nixon v. Blackwell, 626 A.2d 1366 (Del. 1993).

[15] Id. at 1380.

[16] Id.

[17] Id.

[18] Id.

[19] Id. at 1381.

[20] Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014).

[21] Id. at 882.

[22] Watkins v. Hamm, 419 P.3d 353, 356 (OK Civ App 2017); Woolf v. Universal Fidelity Life Ins. Co., 849 P.2d 1093 (OK Civ App 1992).

[23] Principles of Corporation Governance §7.21 (Am. L. Inst. 1994) (further codification of these principles are anticipated due to the ALI’s ongoing work regarding the Restatement of the Law, Corporate Governance, Tentative Draft No. 1, 2022).

[24] Id.

[25] Oklahoma Supreme Court frequently relies on the ALI doctrinal restatements of law for guidance in applying Oklahoma law. See e.g., Schovanec v. Archdiocese of Oklahoma City, 188 P.3d 158, 2008 OK 70; Panama Processes, S.A. v. Cities Service Co., 796 P.2d 276, 1990 OK 66.

[26] 667 P.2d 465 (Okla. 1983).

[27] Id.

[28] Id. at 471-72.

[29] 18 O.S. §953(D).

[30] Sutter v. Sutter Ranching Corp., 14 P.3d 58, 62, n.18 (Okla. 2000).

[31] Whether acts of oppression equate to a breach of fiduciary duty would necessarily require a subjective case-by-case analysis given applicable law on fiduciary duty. See Lowrance v. Patton, 710 P.2d 108, 111 (Okla. 1985).

[32] For a more in-depth understanding of the issues related to a “freeze out,” one may wish to consult the following additional sources: M. Thomas Arnold and H. Wayne Cooper, “Protection of Employment Rights of Minority Shareholders of Close Corporations,” Vernon’s Okla. Forms 2d, p. 2 (November 2021); F. Hodge O'Neal and Robert B. Thompson, O'Neal and Thompson's Oppression of Minority Shareholders and LLC Members §1:2 (Rev. 2d ed. 2005); Douglas K. Moll, “Shareholder Oppression in Texas Close Corporations: Majority Rule (Still) Isn’t What it Used to Be,” 9 Hous. Bus. Tax L.J. 33 (2004); Daniel S. Leinberger and Douglas K. Moll, Oppression in LLCs, 2020 LLC Institute.