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Buy-out Rights in Close Corporation Shareholder Litigation

Authors: Stanton Gallegos

In 2001, the Oregon legislature enacted ORS 60.952, which gives circuit courts discretion to award shareholders in close corporations who are facing litigation, a wide range of remedies if the shareholder is able to demonstrate that the corporation’s directors are deadlocked in managing the corporation; those in control of the corporation are acting in a manner that is illegal, oppressive, or fraudulent; or corporate assets are being misapplied or wasted.1 The same statute also provides close corporations and their shareholders the right to end shareholder litigation by purchasing the complaining shareholder’s shares for fair value.2 This “buy-out” option is available whenever a shareholder files a proceeding seeking relief on one of the grounds for relief set out in the statute.3

The close corporation’s buy-out option provides a powerful tool not only for avoiding the often enormous expense associated with shareholder litigation, but also for solving the underlying problem, i.e., dissension among shareholders. Although many businesses are organized as close corporations,4 this buy-out provision has received surprisingly little attention from the courts. That is changing with two recent appeals: Graydog Internet, Inc. v. Giller, decided by the Oregon Court of Appeals in July of this year, and Scallon v. Scott Henry’s Winery Corp.,5 which is currently being briefed in the Ninth Circuit. This article provides a brief summary of these cases and how they may impact the availability of this defense in future cases.

Graydog Internet, Inc. v. Giller

In Graydog, a close corporation filed suit against a minority shareholder seeking a declaratory judgment that the minority shareholder was an at-will employee and could be terminated.6 The minority shareholder asserted counterclaims and filed a third party complaint against the majority shareholder.7 The third-party complaint asserted, among other things, claims for breach of contract based on allegations that the majority shareholder violated the corporate bylaws and acted for his personal interests.8 The corporation responded by notifying the minority shareholder that it was exercising its option to buy out the minority shareholder and terminate the litigation. The minority shareholder argued that the buy-out defense did not apply because (i) the buy-out right only applies where a shareholder initiates a new action, not to counterclaims or third-party claims in an existing case; and (ii) he was only asserting contract claims not covered by the statute.9

The Court of Appeals rejected both arguments. Looking to the statutory definition of the word “proceeding” and Oregon Supreme Court case law, the Court held that the filing of counterclaims and third-party claims trigger the statutory buy-out option.10 The Court went on to explain that limiting the buy-out’s applicability to newly filed complaints would “allow feuding shareholders to strategically undermine the legislature’s desire to allow the early buy-out election as an alternative to protracted litigation.”11 The Court also concluded that the fact that the claims were alleged as contract claims did not preclude the corporation from exercising its buy-out rights because “nothing in the statutory language suggests that the legislature intended the availability of the buy-out election ... to depend on how the plaintiff labels the claims.”12

In sum, Graydog embraced a broad view of the buy-out provision, giving close corporations and their shareholders the ability to avoid costly litigation regard less of the labels used or procedural posture of the shareholder claims.

Scallon v. Scott Henry’s Winery Corp.

The second case that will impact the scope of the buy-out option is Scallon. There, minority shareholders in a close corporation asserted derivative claims against certain shareholders and officers of a close corporation, alleging, among other things, waste of corporate assets.13 As in Graydog, the corporation promptly sought to exercise its right to buy the plaintiffs’ shares in order to avoid the prospect of protracted litigation.14 The district court refused to allow the buy-out, concluding that the buy-out remedy did not apply in the context of derivative claims because derivative claims are not proceedings “by a shareholder.” At the request of the corporation, the district court certified an interlocutory appeal on whether the buy-out provision applies to derivative claims.15

In the Ninth Circuit briefing, the corporation made three primary arguments to support application of the buy-out option to derivative, as well as direct, claims. First, the corporation argued that the appropriate definition of the word “by” (as used in the phrase “proceeding by a shareholder”) indicates an agent performing an action, and in a derivative action the agent performing the action—i.e., initiating the proceeding—is a shareholder. The corporation also pointed to other instances where courts describe derivative cases as proceedings “by a shareholder” and to a prior decision of the Oregon Court of Appeals that applied ORS 60.952’s predecessor statute to a derivative claim.16

Second, the corporation argued that the legislative history indicates that the buy-out defense was intended to apply in all shareholder actions, including derivative actions. The brief pointed to statements by one of the bill’s primary drafters, Professor Robert Art, explaining that the statute was intended to allow close corporations to avoid the costly and otherwise destructive effects of shareholder litigation.17

Third and finally, the corporation argued that interpreting ORS 60.952 to exclude derivative claims would abro- gate the common law rule that actions for corporate waste—one of the types of actions explicitly listed in the statute—can only be pursued as a derivative claim. If courts can award relief for waste under ORS 60.952, then either the statute applies to derivative claims for waste or the rule that waste must be brought as a derivative claim is overruled by implication. Because statutes are presumed to be consistent with the common law absent clear legislative intent, the brief argued that ORS 60.952 (and the buy-out option) must be available in derivative actions.18

The shareholders’ opposing brief was due on October 11, 2016, and the case will be fully briefed later this fall.

Conclusion

The law in this area is developing, and could have significant impact on the ability of close corporations to avoid shareholder litigation. While Graydog gives close corporations broad buy-out rights that can be used to avoid litigation in a broad range of circumstances, the upcoming decision in Scallon could have a significant impact on the reach of that defense.

Originally published in the December 2016 issue of the Oregon Association of Defense Counsel's publication, The Verdict.

endnotes

1       ORS 60.952. The statute defines close corporations as all corporations that do not have shares that are traded in widely accessible markets, like national securities exchanges.

2          ORS 60.952(6).

3          ORS 60.952(1), (6).

4         Approximately 90 percent of corporations in the United States are not publicly traded. See Venky Nagar, Kathy Petroni, & Daniel Wolfenzon, Governance Problems in Close Corporations 1 (NYU Pollack Center for Law & Business Working Paper, 2008) (analyzing the number of corporation that file tax returns that are listed on major stock indexes and finding that the vast majority of all U.S. corporations are closely-held corporations), available at http:// pages.stern.nyu.edu/~dwolfenz/ CC.pdf.

5         The author’s firm represents the appellants in this case.

6         279 Or App 722, 381 P3d 903 (2016).

The minority’s status as an employee was of particular importance because a shareholder agreement provided that if a shareholder’s employment ended, that he would be deemed to have offered to sell all of his shares to the corporation and the other shareholder. Id.

7         Id.

8         Id.

9         Id. at *1-2.

10       Id. at *4.

11       Id. at *4.

12       Id. at *5-6.

13       See Scallon v. Scott Henry’s Winery Corp., No. 14-cv-1990-MC, 2015 WL 5772107, at *1 (D Or Sept. 30, 2015) (granting motion for certification of an interlocutory appeal).

14       Id.

15   Id. at *1-2.

16     Appellant’s Opening Brief, at 8-15, 17-21, Scallon v. Scott Henry’s Winery Corp., No. 15.35952 (9th Cir July 11, 2016)

17     Id. at 15-17.

18     Id. at 22-23.