Recent Amendment to Business Corporation Act Impacts Estate Planning

Section 489 of the Business Corporation Act was recently amended with an effective date of March 20, 2006.  It appears that this amendment was a response to the decision in the case of Franchino v. Franchino, 263 Mich.App. 172 (2004).  In Franchino, the Michigan Court of Appeals held that a minority shareholder in a closely held corporation was not oppressed by being terminated from employment with the corporation. The Court ruled that Section 489 protected only rights of the shareholder as a shareholder, which did not include employment or board membership.

By way of background, Section 489 allows a minority shareholder of a closely held corporation to bring an action against the corporation alleging that the acts of the directors or those in control of the corporation are willfully unfair and oppressive to the shareholder.  If the shareholder establishes grounds for relief, the court may grant relief as it considers appropriate. (Section 489 does not apply to a shareholder whose shares are listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national or affiliated securities association.)

The recent amendment added a single sentence regarding the definition of “willfully unfair and oppressive conduct.” The following sentence was added: “Willfully unfair and oppressive conduct may include the termination of employment or limitations on employment benefits to the extent that the actions interfere with distributions or other shareholder interests disproportionately as to the affected shareholder.” The key words are “termination of employment.”

Before gifting stock to a family member as part of his or her estate plan, an owner needs to consider the potential consequences if the family member is employed by the corporation.  Here is a common scenario: Mr. and Mrs. Smith own 100 percent of the shares of Smith Development, Inc.  In order to reduce their federal gross estate for estate planning purposes, they decide to gift shares to their daughter and her husband.  Both the daughter and son-in-law are employees of the corporation. The parents want to maintain control, so they gift less than 50 percent. In our scenario, shares are gifted to the daughter and son-in-law, and as a result each owns 15 percent of the outstanding shares. What happens if the parents later have a falling out with the daughter and decide to terminate the employment of the daughter and son-in-law?  What happens if the daughter gets divorced and the parents decide to terminate the employment of the son-in-law?  Under the Franchino ruling, the daughter and son-in-law would not have a cause of action against the corporation for willfully unfair or oppressive conduct due to the termination of their employment.  However, the recent amendment to Section 489 may change that result for the future cases.

A majority owner can respond to the recent amendment by a written agreement with the minority shareholders.  Section 489 specifically states that “willfully unfair or oppressive conduct” does not include conduct or actions that are permitted by agreement.  So, if shares have already been gifted, one approach is to enter into an agreement among the shareholders (before there are any problems or disagreements) that permits the termination of employment of shareholders by the president or a majority vote of the board of directors or shareholders.  The agreement could also state that an employee’s status as a shareholder does not guarantee continued employment.  Legal counsel for each party is recommended.

Another approach is to amend the articles of incorporation or bylaws to permit the termination of employment of any shareholder by the president or a majority vote of the board of directors or shareholders. Under the amended Section 489, “willfully unfair or oppressive conduct” does not include conduct or actions that are permitted by the articles of incorporation, the bylaws, or a consistently applied written corporate policy or procedure. Of course, any amendment would need to follow the proper procedures and legal advice is recommended.

What do you do if a person still owns 100 percent of the shares and has not made any gifts to family members? Is there anything that can be done to prevent a lawsuit for oppressive conduct due to termination of employment?  Yes. The owner could consider amending the articles of incorporation or bylaws as spelled out above.  Alternatively, the owner may want to consider forming a limited liability company and transfer certain assets or business to the limited liability company. The limited liability company could be the entity that actually employs the family member. The owner could also gift membership interests in the limited liability in order to reduce his or her federal gross estate. However, there may be some important tax consequences to the transfer of assets to the limited liability company.  So, before this strategy is adopted, legal and tax analyses would be required. The owner could also gift shares of stock in a corporation but not employ the family member through the corporation.

If you are in the preliminary estate planning stage and a decision needs to be made as to the type of entity to form, the use of a limited liability may be preferred over a corporation in order to avoid the threat of a lawsuit by a family member whose employment is terminated.  At this point, Section 515 of the Michigan Limited Liability Act has not been amended to include termination of employment as “willfully unfair and oppressive conduct.”  However, the Michigan Legislature may amend this act to add the same sentence that was recently added to the Business Corporation Act.

Therefore, the safest approach is to amend the articles of incorporation or bylaws in the case of a corporation and to amend the articles of organization or operating agreement in the case of a limited liability company. A written agreement among the affected shareholders or members would address this situation for those signing the agreement but would not be helpful if changes were made to ownership.

Ryan M. Wilson is an attorney with the law firm of Fraser, Trebilcock, Davis & Dunlap, PC, Lansing. Mr. Wilson is chair of the estate planning department and  practices in the areas of estate planning, probate, trust and business succession planning.  This article is intended as a source of general information. If you have questions regarding this article, please contact Mr. Wilson at 517- 377-0897 or rwilson@fraserlawfirm.com.

© 2006 Fraser, Trebilcock Davis & Dunlap, PC. 

 

 

 

 

 

 

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