Corporate Governance for the Entrepreneur

By Cohen, Brian S | St. John's Law Review, Winter 1997 | Go to article overview

Corporate Governance for the Entrepreneur


Cohen, Brian S, St. John's Law Review


INTRODUCTION

Over the years, divergent schools of corporate scholarship have produced a litany of commentary on the topic of corporate governance, specifically in the context of public corporations.1 On the right are those who advocate the shareholder2 model. This model, a long-standing doctrine in corporate law, asserts that the responsibility of corporate directors is to foster the profit motive of the residual owners, or shareholders.3 On the left are those who advocate the stakeholder model.4 Stakeholder model proponents argue that directors and officers owe a fiduciary duty to all corporate constituents, or stakeholders. The term "stakeholders" is defined to include not only shareholders, but also "suppliers, customers, employees, stockholders, and local community, as well as management in its role as agent for these groups."5 In the middle is an amalgamation of the shareholder and stakeholder models which considers the best interests of the corporation.6 Proponents of this view insist that directors should not afford primacy to any particular stakeholder, but rather to the corporation as a whole.7

In the wake of the takeover boom of the 1980s, many states enacted statutes specifically granting corporate directors the power to consider nonshareholder interests when making decisions involving the corporation.8 These nonshareholder constituency statutes codified the directors' right to consider the best interests of the corporation as a whole.9 In many states, this standard arguably has become the accepted model of corporate governance for public corporations.10

It is unclear whether this broad authorization to consider the interests of the corporation as a whole was extended to directors of closely-held corporations. Unlike their publicly-held counterparts, in many states directors of close corporations are subject to remedial legislation intended to protect noncontrolling shareholders.11 Legislatures have provided a statutory remedy granting the relief of dissolution for illegal, oppressive or fraudulent conduct by the controlling shareholders because noncontrolling shareholders are particularly at risk when disagreements develop in a close corporation.12

Application of the remedy of dissolution in accordance with the remedial legislation has proved somewhat difficult.13 In attempting to determine whether specific conduct is sufficiently oppressive to merit involuntary dissolution, a number of jurisdictions adopted the reasonable expectations test14 which requires that the controlling shareholders of a close corporation act so as not to defeat objectively reasonable expectations of the noncontrolling shareholders.15

In the majority of circumstances involving close corporations, application of the reasonable expectations test is compatible with the best interests of the corporation model of corporate governance. Decisions by the controlling shareholders that are made in good faith to benefit the corporation as a whole will generally meet the reasonable expectations of the noncontrolling shareholders. Illegal or fraudulent conduct by the controlling shareholders, however, would neither meet the reasonable expectations of the minority shareholders nor be in the best interest of the corporation.

Difficulty arises when the conduct ascribed to the controlling shareholders under the reasonable expectations test is described as "oppressive." Unlike fraudulent or illegal conduct, "oppressive conduct" is not easily defined.16 Since the term "oppressive conduct" is somewhat vague, controlling shareholders of a close corporation must effectively make their "best guess" as to whether a good faith decision in the corporation's best interest defeats the reasonable expectations of the noncontrolling shareholders.17 If the majority guesses wrong, the decision could result in corporate dissolution.18

This Note asserts that the application of the reasonable expectations test to good faith decisions made in the best interest of a close corporation by controlling shareholders is untenable.

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