Waiting for the Omelet to Set: Match-Specific Assets and Minority Oppression
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Description
Closely held corporations (or “close corporations”) form an important subset of corporations with concentrated ownership.’ The category includes an interesting variety of enterprises, including the traditional “mom- and-pop’’ businesses, high-tech start-ups, and mature publicly held corporations post-leveraged buyout. More generally, close corporations are important because of their number and because even the largest publicly held corporations often started out as closely held corporations. As such, close corporations are incubators for tomorrow’s publicly held corporations. Two sets of problems have arisen repeatedly in closely held corporations but only rarely in publicly held firms. The first, now resolved, revolved around the enforceability of attempts by participants to tailor the terms set by the general corporation law. Because states historically have provided one corporation law for all corporations, participants in closely held corporations have often tried to modify the statutory structure by contract to serve their needs. These variations raised the question of the extent to which parties can contract out of the rules provided by the statute. The evolution toward greater flexibility was long and, at times, difficult, but flexibility is no longer a central issue. Today, participants in the close corporation can largely tailor its terms to their purposes. The second set of problems, and the focus of this paper, goes under the caption protection of minority shareholders. To what extent should the law protect minority shareholders from “oppression” by majority shareholders, beyond what the parties have contracted for? This set of questions, unlike the first set, remains alive and controversial. It has been the subject of an enormous amount of judicial and legislative effort, much of which has been devoted to expanding the rights of minority shareholders. The questions raised, however, go to the very core of what corporations are about. There are several repeated scenarios that raise the issue of minority oppression. Consider the following: Case A . There is a falling out between the majority shareholder, Major, and the minority shareholder, Minor, both of whom work in the business. Major fires Minor, who then can either hold on to his shares, which pay no dividends (all distributions are through excessive salaries), or sell them back to the firm for whatever the majority shareholder is willing to offer. A variant arises when there are three equal shareholders, A, B, and C . After a falling out, A and B gang up on C and fire him, at which point he is left with shares that pay no dividends and that only the firm is willing to buy. Case B. The majority shareholder or a group of shareholders enters into a transaction with the firm in which, for example, the firm buys back a portion of the majority shareholders’ shares, without making the opportunity available to the minority shareholders. Easier variants of this scenario include the full range of transactions between controlling shareholders and the firm, including compensation, selling/buying property, and diversion of corporate opportunities. More difficult variants include the situation in which the majority shareholder takes advantage of opportunities that are not clearly corporate opportunities, such as developing a more liquid market for shares, in which the minority shareholders would like to participate but are not offered the opportunity. Case C. The majority shareholder sells its majority (controlling) stake to a third party without giving the minority shareholder an opportunity to participate. This paper addresses the question of what, if anything, the courts should do for the minority shareholders in such cases when the parties have not provided for the problem by contract. Our basic answer is that the courts should not do anything except enforce the participants’ con- tracts and vigorously prevent non pro rata distributions to shareholders. This second principle provides a guide to the expansion of minority-shareholder protection against oppression. We proceed as follows. First, we make a fundamental break with the traditional legal treatment of the problem of minority oppression by rejecting the analogy between close corporations and partnerships and the intuitions and implications that flow from it. We also show that the alternative argument that emphasizes the low agency costs of close corporations needs to be expanded to explain the Silicon Valley start-up-type close corporation. Second, we show that the close corporation form is best suited to companies that require extensive investments in match assets. In such cases, the close corporation acts as an incubator, and the lock-in is a benefit, not a cost. Low agency costs are more likely a result of the choice of form, not the reason that the form is adopted in the first instance. Third, we argue that the problem of minority oppression combines two fundamentally separate problems: the issue that, in the employment context, is raised by the doctrine of “employment at will” and the quite separate problem of controlling shareholder attempts to make non pro rata distributions of firm assets. Building on an earlier analysis of employment at will, we then show that the same norm of judicial nonintervention that governs the employment relationship solves closely similar problems in the close corporation context. This norm, combined with vigorous judicial enforcement of the rule of no non pro rata distributions, including ancillary enforcement of minority-shareholder information rights, and limitations on the ability of control shareholders to sell shares to the firm, allows the close corporation to maximize the value of its match assets. We close by drawing the implications of the analysis for a larger theory of close corporations.
Source Publication
Concentrated Corporate Ownership
Source Editors/Authors
Randall Morck
Publication Date
2000
Recommended Citation
Rock, Edward B. and Wachter, Michael L., "Waiting for the Omelet to Set: Match-Specific Assets and Minority Oppression" (2000). Faculty Chapters. 1909.
https://gretchen.law.nyu.edu/fac-chapt/1909
