Involuntary Dissolution of a California Corporation: The Nuclear Option for Mistreatment of Minority Shareholders

By Gerald P. Burleson, Member of the California Bar, and

Emily Bishop, 3rd year law student, University of San Diego Law School,

and a candidate for the July, 2017 California Bar Exam

© 2017 by Gerald P. Burleson, all rights reserved

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Unlike a partner in a partnership, a minority shareholder has no right to dissolve a corporation merely by withdrawing her interest. Absent judicial intervention, corporate dissolution occurs only at the consent of all shareholders. Although a disgruntled shareholder in a public corporation can always withdraw her investment by selling her shares in the market, such an exit strategy is rarely available to a minority shareholder in a private company. Nonetheless, oppressed minority shareholders are not without a remedy in California. Subsecs. (b)(4) and (b)(5) of Corporations Code section 1800, which is California’s involuntary dissolution statute, offer protection to minority shareholders in certain situations from the prejudicial acts of those in control. “Involuntary dissolution” refers to the court ordered termination of corporate existence and liquidation of corporate assets. Despite being characterized as “the nuclear option” by many commentators, involuntary dissolution may be the only option for minority shareholders to cash out their investments when they find themselves oppressed by the corporation’s majority shareholders. This article explores the most common situations in which the remedy of involuntary dissolution of the corporation may be available for the protection of minority shareholders in California.

The California Corporations Code permits certain minority shareholders to initiate proceedings for the involuntary dissolution of a corporation. Generally, a verified complaint for involuntary dissolution may be filed by a shareholder or group of shareholders holding at least one-third of any of the following alternative ownership interests: (a) the total number of shares outstanding, (b) the outstanding common shares, or (c) the equity of the corporation. [1]  But, where the involuntary dissolution is sought under subsec. (b)(4) of the statute, the calculation of such one-third for purposes of bringing the dissolution complaint will exclude the shares owned by persons who have personally participated in the persistent and pervasive fraud, mismanagement, abuse of authority, or persistent unfairness toward any shareholders, which are the separate grounds for involuntary dissolution under (b)(4).  Accordingly, in certain circumstances, even minority shareholders owning less than one-third of the shares of the corporation can file for involuntary dissolution where it is sought under subsec. (b)(4). For example, if shareholders who control the corporation through their collective ownership of 80% of the outstanding common shares participated in acts constituting “persistent unfairness” toward another shareholder who owns 10% of the outstanding common shares, the 10% shareholder would still be entitled to file a complaint for involuntary dissolution of the corporation since, for purposes of gauging the sufficiency of the oppressed shareholder’s percentage ownership to bring a complaint for dissolution under subsec. (b)(4), the shares held by those who participated in the acts constituting the persistent unfairness are excluded and not considered as outstanding.

The California courts first interpreted the terms “persistent mismanagement,” “persistent abuse of authority,” and “persistent unfairness” in subsec. (b)(4) of the involuntary dissolution statute in Buss v. J.O. Martin Co. (1966) 241 Cal.App.2d 123. The appellate court upheld a trial court’s finding of “persistent mismanagement” on the basis of factual circumstances in which the majority shareholder lost the company’s accumulated goodwill and market position, alienated customers, lost or fired nearly all of the competent employees, and essentially managed and directed the corporation “as his private affair,” to the financial detriment of minority shareholders. The Buss appellate court noted that these allegations also established “persistent abuse of authority” and “persistent unfairness,” particularly when combined with the fact that the controlling shareholder deprived minority shareholders of access to corporate books and records and paid himself excessive salaries using corporate funds.

In reliance on Buss, the California appellate court in Bauer v. Bauer (1996) 46 Cal.App.4th 1106, interpreted “persistent unfairness” under subsec. (b)(4) in what the court referred to as “the context of the statute’s general focus on the dominant stockholder’s ‘persistent mismanagement.’”[2]  Bauer concerned two minority shareholders and officers of West Coast, a small family owned corporation, whose employment was terminated after they set up a competing business and actively solicited away West Coast’s customers. Those two minority shareholders sought involuntary dissolution, alleging “persistent unfairness.”

The appellate court affirmed the trial courts judgment, finding that plaintiffs had not established “persistent unfairness” within the meaning of the statute. The court held that an action under subsection (b)(4) is aimed at the misconduct of the controlling shareholders, rather than the “reasonable expectations” of the minority shareholders, and, unlike in Buss, the plaintiffs had failed to show any misconduct by those in control. Equating “persistent unfairness” with “persistent mismanagement,” the court observed that West Coast performed relatively well when controlled by the majority shareholder, and there was no evidence the majority shareholder paid himself excessive compensation, nor that he had barred the minority shareholders from membership on the board of directors or denied them access to corporate books or records.

The plaintiffs also alleged “persistent unfairness” on the theory that they were “squeezed out” of the corporation because they were denied all economic benefits from their stock ownership and excluded from participating in the business. In support of their allegations, the plaintiffs cited the majority shareholder’s termination of their employment and his failure to pay dividends. The appellate court concluded that although failure to pay dividends and termination of employment are typical indicia of a corporate “squeeze out,” the plaintiffs failed to show they were improperly “squeezed out” of the company. Neither they nor the majority shareholder had ever received any corporate dividends, and the plaintiffs had never objected to this practice. Further, the controlling shareholder had a legitimate reason for terminating the minority shareholders—they were stealing the company’s customers and trade secrets! As the court observed, “it makes a great deal of difference whether dividends had at one time been paid on a regular basis, but were stopped; whether the minority shareholder had a job with the corporation, from which he was fired; and whether the controlling majority shareholders increased their own officers’ salaries after the rift appeared and the dividends were terminated.”

The Bauer court also held that dissolution was not “reasonably necessary” under the more liberal provisions of subsection (b)(5), which protects the rights, interests, and expectations of minority shareholders in corporations with 35 or fewer shareholders. [3]  After considering the relative misconduct of the parties, the court found no basis for dissolution, reasoning that the plaintiffs could not have had a reasonable expectation of dividends or salaries from the company in light of the evidence that they were engaged in establishing a competing company and soliciting away the corporation’s customers. The court concluded that to permit minority shareholders acting in bad faith to use subdivision (b)(5) as a “coercive tool to force an involuntary dissolution” would be “tantamount to sanctioning abuse.”

In Stumpf v. C.E. Stumpf & Sons, Inc. (1975) 47 Cal.App.3d 230, 234, an early California decision applying the predecessor statute to Section 1800, the appellate court affirmed the trial court’s order of dissolution where a shareholder in a close corporation was ousted from participation in management and profits. On appeal, the corporation argued dissolution was inappropriate absent some finding of deadlock, mismanagement, or unfairness toward the complaining shareholder. The court rejected this contention, concluding that the ground for involuntary dissolution stated in what is now subdivision (b)(5) was distinct from, and therefore not limited to, those specifically enumerated statutory grounds in other subdivisions (i.e., shareholder deadlock, corporate mismanagement, and persistent unfairness). In Stumpf, the plaintiff Donald Stumpf, his brother, and their father all owned equal shares in a corporation. Extreme hostility between Donald and his brother forced Donald to sever contact with his family. Based on evidence that Donald had no say in the operation of the business and that he received no salary, dividends, or other revenue from his investment in the corporation after he withdrew from the business, the appellate court affirmed the trial courts order of dissolution.

In the most recent California decision applying subsection (b)(5), the appellate court in Stuparich v. Harbor Furniture Mfg., Inc. (2000) 83 Cal.App.4th 1268, 1274, found dissolution unnecessary after comparing the facts and circumstances to Bauer and Stumpf.

The court in Stuparich noted that here there was no evidence of bad faith conduct by the majority shareholder rising to the level demonstrated in Bauer. In distinguishing the case from Stumpf, the court in Stuparich noted that the plaintiffs continued to receive dividends from the corporation, and, although there was extreme family hostility as there was in Stumpf, here the plaintiffs voluntarily removed themselves from participation in board meetings. On these facts, the court affirmed the trial judges grant of summary judgment in favor of the corporation.

Although involuntary dissolution is a remedy for oppressed minority shareholders in California, is it too radical? No. Even if a seemingly radical remedy, in many cases involuntary dissolution may be the only viable option for minority shareholders who have been victimized by those in control. Further, involuntary dissolution is a less drastic remedy than it appears on the surface since the corporation may halt an involuntary proceeding and thereby avoid dissolution simply by purchasing the shares of the initiating shareholder at fair cash value. [4]

[1] Cal. Corp. Code § 1800(a)(2). The court of appeals has interpreted this provision to allow preferred shareholders to file for involuntary dissolution if their preferred shares represent one-third of the corporation’s equity. Kline Hawkes California v. Superior Court (2004) 117 Cal. App. 4th 183, 196.

[2] II This interpretation is hard to reconcile with the legislature’s intent to state separate grounds, as evidenced by the fact that it included both the terms “mismanagement” and “unfairness” in subsection (b)(4).

[3] Subsection (b)(5) permits involuntary liquidation of a corporation whenever “reasonably necessary” for the protection of the rights or interests of the complaining shareholders.

[4] Cal. Corp. Code § 2000.

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