April 29, 2009 - An alleged scheme to freeze out a minority shareholder is divisible into portions that primarily injure that shareholder and those that principally damage the corporation, according to a majority of the Wisconsin Supreme Court.

But the majority’s distinctions lack coherence and give little guidance to either a shareholder asserting a claim or a party defending against it, dissenting justices argued. The distinctions matter because shareholders cannot sue in their own right to recover for injuries that are deemed to be chiefly those of the corporation. Such relief would only be available by way of a “derivative suit” on behalf of the corporation.

In Notz v. Everett Smith Group, Ltd., 2009 WI 30, Edward Notz was the minority shareholder of Albert Trostel & Sons (ATS), a plastic manufacturer, bringing a direct action against the Everett Smith Group. The Smith Group was the ATS majority shareholder and controlled the ATS board of directors.

Notz rejected the Smith Group’s efforts to buy out his shares. Notz alleged that this led the Smith Group to hatch a plan to freeze minority shareholders out of a potentially profitable expansion in violation of the majority shareholder’s fiduciary duty to treat the minority fairly.

First, Notz alleged, the Smith Group exercised its control over ATS to prevent ATS from acquiring Dickten & Masch, a rival plastics manufacturer, but not before ATS paid for a study of the synergy savings created by such a takeover. With that study in hand, the Smith Group itself bought Dickten & Masch shortly thereafter. According to Notz, the Smith Group then had its newly acquired plastics company purchase the plastics manufacturing assets of ATS, thereby achieving the expansion objectives without Notz.

Loss of a corporate opportunity is a corporate injury

Lower courts had determined that Notz’s version of events failed to state a direct claim for breach of fiduciary duty because, as alleged, striping ATS of its most important assets and diverting to the Smith Group the corporate opportunity to buy a rival was principally an injury to ATS.  In the majority opinion authored by Justice N. Patrick Cooks, the supreme court agreed, citing Rose v. Schantz, 56 Wis. 2d 222 (1972).

To determine when the shareholder is primarily injured, the court looked to Jorgensen v. Water Works, Inc., 2001 WI App. 135 , which held such harm “affects a shareholder’s rights in a manner, distinct from the effect upon other shareholders.” The majority said that all of the ATS shareholders were affected equally by the loss of the corporate opportunity and the sale of its plastics division that left the company incapable of continuing in that business.

But the majority then found that Notz was injured unlike the other shareholders by the expense of the due diligence report ATS conducted in anticipation of taking over its rival. “[A]s ATS majority shareholder, the Smith Group made the decision to let ATS pick up the tab for the due diligence, the benefits of which expense accrued only to the Smith Group, not to ATS’s minority shareholders, when the Smith Group made the decision to acquire Dickten & Masch on its own,” the majority stated.

The majority said the money spent by ATS for the due diligence analysis was a “constructive dividend” unfairly given to the Smith Group, the true beneficiary of the report. Other instances of “constructive dividends” include excessive compensation, bargain purchases of corporate property, and shareholder use of corporate property, the court explained.

Justice Ann Walsh Bradley, in dissent with Chief Justice Shirley S. Abrahamson, criticized the majority for applying an inconsistent standard to measure injury to shareholders. She wrote that when the majority analyzed the Smith Group’s usurpation of a corporate opportunity, it minimized issues of how this came to benefit the Smith Group. “If this analysis is correct, then the injury caused by the Smith Group’s decision to use ATS’s funds to conduct due diligence was an injury primarily to the corporation as well, because extrinsic benefit is irrelevant and ‘all shareholders were affected equally’ by the funds paid for due diligence,” Bradley wrote.

“Unlike the majority shareholders, Notz was denied continued participation in a thriving growth industry,” Bradley wrote of the lost corporate opportunity, concluding that this injury was unique to him and accordingly he could bring a direct claim for breach of fiduciary duty.

In rebuttal, the majority said that Bradley’s approach “would create the possibility of direct actions whenever there are shareholders in common between a parent corporation selling a subsidiary and the purchasing corporation ... Such an unworkable approach would impose unnecessary costs and uncertainty on routine corporate transactions.”

Dissolution

In the lower court, Smith Group forced dismissal of Notz’s claim for judicial dissolution on account of shareholder oppression by initiating a cash-out merger while the claim remained pending. The Smith Group argued that following the merger, Notz was no longer a shareholder and he lacked standing to bring the action.

But the supreme court reinstated the claim, citing Wis. Stat. § 180.1106 (1) (d). This statute provides that a civil proceeding pending by or against any business entity that is a party to the merger may be continued as if the merger did not occur. The court said this prevents fraudulent mergers that aim to deny plaintiffs the opportunity to pursue previously filed claims.