Minority Oppression in Limited Liability Companies: The Birth of a New Claim or a Hole in the Law?, 0116 ALBJ, 77 The Alabama Lawyer 36 (2016)

Author:Douglas B. Hargett and G. Bartley Loftin, III.
Position:Vol. 77 1 Pg. 36
 
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Minority Oppression in Limited Liability Companies: The Birth of a New Claim or a Hole in the Law?

Vol. 77 No. 1 Pg. 36

Alabama Bar Lawyer

January, 2016

Douglas B. Hargett and G. Bartley Loftin, III.

“I don’t like to think of laws as rules you have to follow, but more as suggestions.”

George Carlin’s clever one-liner about his approach to everyday life is not only followed by free-spirited comedians, but it is also the mantra of some business owners. Take a business that begins with a brilliant idea, a cutting-edge product or a unique service developed by two business partners who decide to form a company. For different reasons, ownership of the company is split 60/40, creating majority and minority owners. The majority owner assumes the roles of company president and chair of the board of directors. Everything is going great, until one day the owners disagree on a big decision, and then later, several smaller decisions. Things snowball, and the majority owner begins to unilaterally run the company, terminates the minority’s employment, stops sharing the company’s profits and cuts off the minority’s access to credit cards and bank accounts. The minority owner has no control, needs a paycheck and has no way to sell his minority interest to anyone other than the majority owner, who is happy to buy the same at a deep discount. This is a clear-cut example of how a majority owner can use his or her control to oppress and squeeze out a minority owner. It happens every day, regardless of laws designed to prevent it. Those laws are many times considered, in George Carlin’s words, mere suggestions to majority owners.

Minority shareholders in closely-held corporations can file a claim for corporate oppression and squeeze-out against abusive majority shareholders to remedy these actions. In Alabama, however, no clear legal precedent can be found, neither statutory nor common law, authorizing minority members of a limited liability company (LLC) to pursue an oppression claim under Alabama law. Alabama caselaw discussing oppression in LLCs is non-existent, which the Alabama Supreme Court alluded to in DGB, LLC v. Hinds.1 Caselaw addressing LLC member disputes where oppression might have been raised is scarce. Alabama trial courts are left considering competing arguments in different cases involving oppression in LLCs, which has and will continue to lead to inconsistent rulings throughout the state at the trial level. This article discusses many of the arguments for and against the recognition of an oppression claim in the LLC context, taking into consideration standing precedent in closely-held corporation oppression cases.

What is Minority Oppression And Squeeze-Out?

The genesis of corporate oppression or squeeze-out can be found in the 1978 decision of the Alabama Supreme Court in Burt v. Burt Boiler Works, Inc.2 The claim has evolved over the last 37 years, but the basic tenets of a corporate oppression claim set out in Burt remain intact: “Majority shareholders owe a duty to at least act fairly to the minority interests, and the majority cannot avoid that duty merely because the action taken was legally authorized.”3 Majority shareholders cannot “deprive the minority shareholders of their just share of the corporate gains.”4 Oppression typically occurs when majority shareholders assume the multiple roles of owners, directors and officers, creating the perfect environment for majority dominance over the minority. The only thing needed is a catalyst (e.g., disagreement, greed or something else) to trigger the majority to abuse their power. This scenario leads to minority shareholders being denied a “voice in the operation of the business,” deprived of “income from their interest in the business” and “holding stock which pays no dividends and which cannot, as a practical matter, be sold.”5 As the terms suggest, majority shareholders can use their control to “oppress” (i.e., unfairly or unjustly use authority or power to prevent others from enjoying their rights) or “squeeze out” (i.e., actions taken in an attempt to eliminate or reduce an interest) minority shareholders.6

Because closely-held companies are owned or controlled by a few individuals, unlike public or widely-held corporations, oppression in closely-held corporations was established in “recognition that a close corporation enterprise often ‘acquires many of the attributes of a partnership or sole proprietorship and ceases to fit neatly into the classical corporate scheme.’”7 Shareholders in closely-held corporations view themselves as business partners who will share in the company’s gains; however, majority shareholders and members can systematically discriminate against the minority by refusing to pay distributions, bonuses and salaries, excluding the minority from positions and eliminating other privileges and benefits.8 Oppression claims are often evaluated by comparing the benefits received by the majority to the benefits distributed to the minority to determine whether the company’s gains have been proportionately shared.9

Oppression’s Growing Pains: More Questions than Answers

There has been much debate about the nature of a shareholder oppression claim, leading to more questions than answers. Oppression is now almost four decades old in Alabama. By legal standards, oppression is still in its infancy when compared to other claims that have developed since the formation of Alabama’s judiciary system two centuries ago. Oppression has had its fair share of growing pains since Burt. Considerable time has been spent by practicing attorneys, legal scholars and Alabama courts attempting to develop a workable, consistent body of law by reviewing and, in many instances, adopting oppression precedent from other jurisdictions, and comparing and contrasting oppression with similar causes of action in Alabama. Some early questions concerned whether oppression was a contract or tort claim, whether oppression was a derivative claim that must be brought on behalf of the company or a direct claim that can be asserted by and against an individual shareholder and whether a separate claim for oppression was necessary because the claim arguably falls under the umbrella of established breach of fiduciary duty law.10 Even with decades of legal precedent, there are still conflicting answers to these questions. The side of the case an attorney represents (plaintiff or defendant, minority or majority, company or shareholder) will likely determine the answers he or she gives when arguing these issues before trial and appellate courts, and there is legal authority to support most positions taken.

This is not the case in the LLC context. To the contrary, there is no direct legal authority in Alabama that can be used to analyze a claim for oppression of a minority member of an LLC because this claim has not yet been formally recognized by Alabama appellate courts. Common sense and general principles of fairness and equity lead to the conclusion that the tactics used by majority shareholders in closely-held corporations can also be used by majority or controlling members of LLCs to oppress and squeeze out minority members. If a claim for minority oppression of LLC members is authorized in Alabama, existing corporate oppression law can be borrowed and tweaked by courts to resolve future cases and ease the growing pains associated with this new claim. However, the statutory framework governing LLCs, which does not contain an express duty owed by the majority to the minority, combined with the overtly contractual nature of the LLC entity, may lead courts to altogether dismiss this claim.

DGB, LLC v. Hinds: A Hole in The Law and Need for Clarity

Both proponents and opponents of a cause of action for minority oppression of LLC members frequently cite Hinds, a June 30, 2010 decision of the Alabama Supreme Court. In Hinds, three individual investors owned a 100 percent interest in DGB, LLC. DGB, LLC, in turn, owed a 40 percent minority member interest in Bon Harbor, LLC. The controlling 60 percent majority ownership interest of Bon Harbor, LLC was owned by other members. DGB, LLC and its three members asserted a cause of action for what they called "shareholder oppression" related to oppressive actions allegedly taken by the majority members of Bon Harbor, LLC that harmed the minority's interest in a multi-million dollar real estate development.[11] In support of their oppression claim, DGB, LLC and its three members relied on § 10-12-21(h), the predecessor to § 10A-5-3.03(h), arguing that '"[a] member shall discharge the duties to a member-managed company and its other members under this chapter or under the operating agreement and exercise any rights consistently with the obligation of good faith and fair dealing.'" Refusing this argument and...

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