Waiting for the Omelet to Set: Match Specific Assets and Minority Oppression in the Close Corporation

Abstract

We argue that the close corporation form is uniquely suited to enterprises with a high density of match specific assets, particularly where the assets are not yet fully developed, as in an omelet factory. The corporate law limitations on exit, combined with the corporate law rules against non pro rata distributions, largely prevent opportunistic behavior by the majority shareholder towards the minority. By locking both into the enterprise, the majority shareholder, in maximizing its own wealth, also maximizes the wealth of the minority. The projects are given the opportunity to develop without concern that parties could threaten to remove their capital in order to secure a greater share of the profits. Indeed, as we show, many of the persistent features of the stylized close corporation can best be understood as self-enforcing mechanisms to protect the participants from opportunistic behavior by fellow participants. Starting from this view of close corporations, we analyze the classic problem(s) of minority oppression in the close corporation. We argue that minority oppression can best be understood as a combination of two separate and separable dimensions, with two distinct legal responses. The first dimension is a version of precisely the same problem that, in employment law, arises under the heading of "employment at will," and is best handled with the same judicial passivity, absent explicit agreements to the contrary. To do otherwise is unnecessary and threatens to undermine the self-enforcing structure in place. The second dimension of the problem is fundamentally different from employment at will, and involves attempts by the controlling shareholder to make non pro rata distributions of firm assets. Here, we show that vigorous judicial enforcement of a prohibition on such distributions, including the vigorous protection of ancillary rights to information, is necessary to enforce norms of non-opportunism. We further show that courts are much better at sorting out issues of this sort than employment at will type issues because doing so does not require either relying on unverifiable factors, nor valuing assets that the courts cannot value. Out of our appreciation of the beauty of the close corporation form comes the implication that courts further the purposes of the close corporation when they hold narrowly within the corporate form and avoid ad hoc adjudication of substance. In this model of the close corporation, courts remain passive in the face of the employment issues that animate many bitter close corporation cases. By contrast, courts take an active role in blocking the attempts by majority shareholders to enter into self-dealing transactions with the corporation as a way around the sacred prohibitions on non pro-rata distributions.