Compensation is the baseline shareholder value of many, if not most, small businesses. The initial challenge of any small business is to achieve cash flow sufficient to pay its owner anything. The baseline value of many small businesses is employment, and often - times nothing more. As a practitioner whose practice is focused on business valuation, this reality is borne out again and again.

As companies grow in value, shareholder compensation can become, and often is, com - plex. Base compensation is often augmented by bonuses, which are in reality corporate profits, as well as a wide array of insurance, benefits, and other perks, together with—and this is often a big deal—personal and discre - tionary expenses that are expensed through the business, sometimes in jaw-dropping measure. In the end, the goal of small busi - ness is not to maximize bottom line net in - come, but rather, to maximize the cash flow to its owners while minimizing income taxes.

Many small businesses are founded by friends or family members. Those close re - lationships often seed both the concept of the business and partnership as owners. But once-close relationships sometimes sour. Anger and resentment can take root in ways akin to a toxic marriage, whether over the direction of the business, the level of effort exerted, frustrated succession planning/ expectations, family issues, or other dynam - ics. Things can get ugly. When emotions boil over, the majority owner(s), motivated by an - ger and resentment and not the company's best interest, may terminate the employment of a minority owner. Does Michigan share - holder oppression 1 law adequately protect minority owners whose shareholder benefits come in the form of compensation and relat - ed perks? It is this author's view that while unpublished cases have unnecessarily mud - died the waters on this issue, the oppression statutes 2 effectively provide the needed legal foothold and that we, the practitioners, need to do a better job identifying and advocating vast shareholder value that is channeled in the form of compensation and related ben - efits and perks in oppression cases.

Framing the Issue—Franchino v Franchino

The Michigan case that framed the issue regarding shareholder employment benefits versus legally established shareholder rights (e.g., the right to vote, the right to inspect records, and the right to dividends) is the 2004 decision in Franchino v Franchino .3 The Franchino case is fairly typical of oppression cases in that it involved a battle between family members, specifically a son and 31% shareholder against his father and major - ity shareholder owning the remaining 69% interest. The relationship between father and son deteriorated and the father ultimately terminated the son's employment while also seeking to merge the company into a new entity to avoid certain obligations to the son under a buy-sell agreement. The son sued for shareholder oppression.

As is often the case, compensation was a key component through which the Franchino shareholders received value for their respec - tive interests in the company, with the son and father each receiving compensation of $500,000 per year in 2001 dollars (adjusted for inflation, roughly $725,000 as of 2020). While being paid such robust compensation, they were only paid a modest $3,100 a year in dividends, thus demonstrating the level of shareholder value channeled in the form of compensation rather than dividends.

The facts in Franchino, where corporate profits are paid out to the shareholders in the form of compensation rather than dividends, is typical for many small, privately-owned companies. It is near certain that the compen - sation paid to the Franchinos far exceeded market-based compensation, i.e., what the company would have to pay in order to at - tract a comparably-skilled non-owner em - ployee to perform the tasks handled by the shareholder-employee owners. The situation in Franchino, where corporate profits are paid out in compensation, is commonplace.

The oppression statute (before being amended in 2006), however, only protected "the interests of a shareholder as a share - holder." The Court in Franchino wrestled with whether the statute protected shareholderrelated benefits channeled through compensation:

It is generally acknowledged that, in close corporations, shareholders often work for the corporation, and the corporate dividends are often paid in the form of a salary. Likewise shareholders in close corporations are often members of the corporation's management. However, employment and board membership are not generally listed among rights that automatically accrue to shareholders. Shareholder's rights are typically considered to include voting at shareholder's meetings, electing directors, adopting bylaws, amending charters, examining the corporate books, and receiving corporate dividends.4

Because the oppression statute did not at that time reference employment, both the trial court and the Michigan Court of Appeals—despite expressly recognizing that corporate profits are often paid out in the form of compensation to shareholder-employees—felt constrained to limit oppression claims to the rights that automatically accrue to shareholders as a matter of law (e.g., the right to vote, right to inspect records, and the right to dividends), and not employment.

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Footnotes

1. The oppression statutes are effectively the same for corporations, MCL 450.1489, and limited liability companies, MCL 450.4515. For each of reference, this article simply references "shareholder oppression" as a generic alternative.

2. MCL 450.1498; MCL 450.4515.

3. Franchino v Franchino, 263 Mich App 172, 687 NW2d 620 (2004).

4. Franchino v Franchino, 263 Mich App 172, 184, 687 NW2d 620 (2004) (citations omitted) (emphasis added). 5. MCL 450.1489(3); MCL 450.4515(2).

Originally published by State Bar Of Michigan Business Law Section

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