I.

Minority shareholders typically play an active role in closely held corporations, but, if serious differences arise, majority shareholders have the power to call the shots, including whether to employ minority shareholders and whether to declare dividends.  Absent additional bargained-for rights, minority shareholders may find themselves unemployed and frozen out of any return on their investment.  Unlike shareholders in public corporations, minority shareholders cannot protect themselves by selling their stock and exiting the corporation.  There is no public market for close corporation stock, by definition, and who would be willing to buy a minority interest in a business after the shareholders have had a falling out?

In order to salvage their investment, minority shareholders may seek judicial intervention.  However, because claims of minority shareholder oppression involve the standard features of a close corporation—majority control and locked investment—courts face a dilemma.  If they revise central terms of the relationship after the fact to avoid perceived unfairness to minority shareholders, courts diminish the viability of the close corporation as a distinct form of business organization.  For that reason, some courts refuse to recognize any doctrine of shareholder oppression, observing that corporate law permits minority shareholders to bargain for desired protections before investing.¹ In a majority of jurisdictions, though, courts either borrow the heightened fiduciary obligations of partnership law, holding controlling shareholders to a higher standard than would be required under corporate law, or provide relief to the extent a minority shareholder’s “reasonable expectations” have not been met.²

Taken at face value, each of these standard approaches is flawed—either too quick to dismiss the specific challenges faced by the minority in a close corporation or else too willing to impose vague obligations on the majority.  But there is also a procedural aspect to the evaluation of claims of oppression.  Often, controlling shareholders can assert a plausible business justification for conduct that disadvantages the minority and the underlying facts will be hard to ascertain.

In close cases, as a practical matter, the outcome may depend more on the level of scrutiny applied by the court in deciding whether the minority’s claim of oppression has merit than on any divergence in the substantive standard for oppression.  Thus, whether the core obligations of controlling shareholders are understood primarily in contractual or fiduciary terms, it independently matters how hard the court will look to see if the obligations have been met.  Unless a court places some burden on the majority to substantiate its proffered justification, the minority shareholders will almost certainly lose.

II.

Despite its importance, the procedural dimension of minority shareholder litigation has received little notice.³ The level of scrutiny instead seems to correlate with the substantive standard in a particular jurisdiction, reflecting either a relatively permissive or strict attitude toward the majority’s right to enjoy the benefits of control.  The procedural and substantive questions can be disaggregated, however.  I argue that courts should embrace this flexibility and should use minority “voice” to set the appropriate level of scrutiny.

Flexible judicial scrutiny based on voice would improve existing approaches to shareholder oppression, allocating pleading or production burdens to the party best able to meet them.  If the minority lacks a voice in the business—in other words, a meaningful opportunity to review information relevant to important corporate governance decisions and to participate in the decisionmaking process—courts should apply enhanced scrutiny, accepting general pleadings and requiring controlling shareholders to establish a legitimate business purpose for challenged conduct. When adjudicating claims of shareholder oppression in close corporations with substantial minority participation—paradigmatically, representation on the board of directors—courts should apply more relaxed scrutiny, giving substantial deference to the majority’s business judgment absent evidence of self-dealing or bad faith.⁴

Although it might seem odd to focus on voice when the more pressing issue for minority shareholders, in the event of a freeze out, is lack of exit, the two problems are connected.  The foundation of my argument is Albert Hirschman’s classic insight that exit and voice are interrelated mechanisms and that economic and political responses to a firm’s decline may be complementary.⁵ For example, regular customers at a restaurant may complain of bad service, if they think that will help; if service does not improve, they can shift from voice to exit and take their business elsewhere.  Given the restrictions on exit in a close corporation, minority shareholders must rely on voice to protect their interests when potential conflicts arise.  The proposed voice-based framework would offer close corporations an incentive to include substantial minority input in corporate governance decision making, and it would guide judicial analysis when litigation cannot be avoided.

III.

In the article, I identify three major objections to the proposed voice-based framework.  First, why not attack the problem of oppression directly by creating an enhanced right of exit for minority shareholders? Second, and related, why worry about minority shareholder voice when, at the end of the day, the majority still has the power to make the decisions? Third, since shareholders have the ability to bargain for desired protections, or to choose a different form of business organization, why give minority shareholders a voice option they did not bargain for?

Admittedly, an automatic right of exit would seem to simplify matters by eliminating the need for complex liability determinations.  Professors Matheson and Maler, for example, have proposed a statutory right of exit akin to a no-fault divorce.⁶ My principal concern is that creating a right of exit would undermine the significance of the close corporation form and the shareholders’ interest in having a locked investment.  If corporate law rules can be circumvented without even a showing of fault, the distinction between a partnership and a close corporation will be lost.  To the extent choice of form has value, the loss of a meaningful choice is a cost to consider.

It also seems unclear whether an automatic exit right would actually reduce the cost of litigation.  Given the lack of an established market for shares, creating liquidity for close corporations involves considerable valuation difficulties.  Under existing doctrine, there must be a showing of harm before any remedy is available, which limits litigation and focuses those lawsuits that do go forward on liability issues that courts are better suited to address.  Even if no-fault exit promises some efficiency benefits, those savings may not amount to much because litigating valuation will also be expensive.

Moreover, minority shareholders could gain too much power in the governance of the close corporation.  While some boost in exit could enhance voice by backing it with a credible threat, the possibility of shareholder litigation may already serve that function.  If the threat of exit becomes too strong, given the need for locked investment, then minority shareholder demands may overwhelm sensible decision making.  (For similar reasons, the problem of oppression cannot be solved via mandatory voice-enhancing mechanisms like veto power or super-majority voting because those mechanisms, too, would shift power to the minority, creating a risk of deadlock or the extraction of rents to avoid holdout problems.)

However, my modest insistence that minority shareholder voice is important to the health of close corporations and should guide the intensity of judicial scrutiny leaves me open to a different kind of objection—that voice, as I define it, has no practical value.  Allowing a minority shareholder to have her say and then outvoting her is, for all practical purposes, the same thing as just outvoting her.  The problem with the objection is that it conflates voice with voting.

Although majority shareholders ultimately decide all contested questions, voice is a political mechanism and need not be synonymous with control.  A person’s ability to participate and to be heard on issues important to a shared enterprise, whether family, business organization, or nation-state, does not turn on the final tally of votes.  Voice is not as crude a mechanism as exit; its value lies in its nuance, as a means of shaping the goals of a close corporation to better accommodate the interests of all shareholders.  Corporate decisions based on transparent, open discussion will more often serve the interests of all shareholders and the minority will more likely accept the results of an inclusive, deliberative process as fair.

Finally, some scholars may object that voice-based scrutiny would disregard the choice of business form made by the parties, altering the bargain they thought they had.  The objection is misplaced.  The proposed framework does not change substantive doctrine or impose a new fiduciary obligation; rather, to the extent controlling shareholders are already prohibited from appropriating the value of the minority’s investment, I contend that courts should place the burden on the party best able to meet it.  A more flexible, voice-centered model of judicial scrutiny would better serve the interests of minority shareholders and the close corporations to which they belong.

Even if the proposal could be understood to restrict the ability of parties to customize control arrangements, because minority voice determines the level of judicial review, the choice-of-form objection would remain unconvincing.  One of the distinguishing features of corporate law is the mandatory fiduciary duty of loyalty owed by controlling shareholders to the corporation—directly or by dint of their control of the board of directors.  If investors want to sharply limit fiduciary duties, perhaps in favor of enhanced, contractual exit rights, the choice-of-form theory indicates that they should pick a partnership or limited liability company form more amenable to contractual modification.

Acknowledgments:

Copyright © 2009 Georgetown Law Journal.

Benjamin Means is Assistant Professor of Law at University of South Carolina School of Law.

This Editorial is based on the following full-length Article:  Benjamin Means, A Voice-Based Framework for Evaluating Claims of Minority Shareholder Oppression in the Close Corporation, 97 GEO. L.J. 1207 (2009).

My article addresses how risk governance thinking shapes both treatment protocols and judicial review of coverage decisions. In this summary, I focus on a third set of questions covered in the article: the political and normative argument for an approach to health care allocation decisions that fosters deliberative democracy.

Virtually everyone experiences the health care system, but the public’s knowledge about health-related policy involves far more breadth than depth. The system’s underlying structures of financial risk allocation are complex and not well known or understood. The result is that despite an intense media focus on the politics of reform, policy decisions are effectively hidden from the public, even if they are hidden in plain sight.

The public’s relation to health care policy also lacks, in large part, a participatory dimension. Limits on public understanding and knowledge are exacerbated by limits on mechanisms by which members of the public can participate effectively in health-related policymaking. Although individuals are increasingly empowered as patients, the idea that serious public engagement with health care system governance is a viable concept seldom surfaces in public consciousness.

In this article, I seek to offer both a normative argument for enhancing democratic engagement in health care system governance and a proposal for doing so grounded in the pragmatic spirit of democratic experimentalism. I argue that beyond the identities of patient and consumer, individuals should occupy the role of citizen in the health care system. Because governance encompasses more than just actions by the state, a meaningful concept of citizenship in the health care system must be applied to private sector institutions as well as to government.

 
I.
Building New Publics for Health Policy

One way to begin addressing the problem of Americans’ shallow engagement with health policy issues is to conceptualize such debates as occurring within a particular “public,” using the analytic structure developed by Jürgen Habermas.¹ In Habermas’s work, the concept of a public denotes a cultural and social space for dialogue about shared concerns; there can be many publics. Habermas claims that the quality of society depends on the quality of our dialogic engagement on important issues. The quality of that engagement, in turn, depends on whether the procedures for engagement reflect core ethical concerns, such as equality of participation.

Because democracy is not possible without meaningful participation, we advance democratic norms in the governance of any system when we enhance the capacity of citizens to debate and discuss substantive issues and to participate in their resolution. Once one sees the health care system as centered on risk managerialism, the central issue for enriching the democratic characteristics of such a system becomes how to empower citizens to participate more effectively in the politics of risk allocation and distribution.

My suggestion is that we consider using risk pools as a venue for building publics in the Habermasian sense. A risk pool is the organizational and governance unit of any insurance plan. However, it is seldom thought of in terms of self-governance. Risk pools are actuarial constructs. They exist as clusters of individuals whose characteristics cause them to fall within some category of risk relevant to the form of insurance being sold (for example, the risk pool of teenage drivers or of beachfront property owners). They usually lack any social meaning for their members.

But the risk pools that compose almost all group health insurance are different in important ways. Employer-sponsored insurance (ESI) creates risk pools consisting of individuals who share a common employer, many of whom know each other, some quite well. Because membership in the plan is determined by reasons other than the goal of securing insurance, and because a large workplace plan invariably includes persons in a broad range of health status categories, ESI plans are “natural risk pools.” The link to employment creates a material reason for individuals not to exit the risk pool lightly, which diminishes the likelihood of high transaction costs for the insurer.

These same factors also make the ESI risk pool attractive as a site of governance for its participants. The link to employment that creates a material reason for individuals not to exit the risk pool also provides an incentive for employees to join a participatory risk governance process for the plan, were one to be offered. Many employees might welcome the opportunity to negotiate collectively with employers about health insurance benefits and other collective goods, without committing to full-scale union representation on all issues.²

Most importantly, a workplace health insurance group maps precisely onto a set of rich, dense, and strong social relationships. Using the work of Robert Putnam and other social scientists, employment law scholar Cynthia Estlund has built a powerful argument that democratic theory has underestimated the importance of workplaces in advancing democratic ends.³ Three of Estlund’s assertions stand out as relevant to the project of workplace-based risk pool governance. First, people often build their civic skills in the workplace, through discussions of political and other issues of public importance conducted in relatively public spaces. Second, outside of family or close friends, social ties at the workplace provide people with a stronger sense of belonging than any other institution in their lives. Third, greater racial diversity exists in the American workplace than in most other civic settings, including neighborhoods and schools.

The network of social connections at work also provides a useful foundation for effective governance of health risk. In the best case scenario, the social connections in work settings could facilitate the development of norms of reciprocity and trustworthiness, which in turn reinforce patterns of cooperation. This social capital helps to overcome problems of collective action, such as the resistance to engaging with difficult allocation decisions (the tragic choices problem) or the inclination to reject certain risks for oneself to achieve the gain that would result from someone else assuming them (the prisoner’s dilemma problem). The decision-making group grounded in a risk pool would operate without necessarily knowing what serious illnesses they or their families might suffer.

For these reasons, at least some workplace insurance plans have the potential to function also as publics. In ideal form, they would create space for political participation, debate, and opinion formation within the economic sector and as part of the system of risk managerialism. Their deliberations would require participants to engage with the arguments, concerns, and beliefs of others in the same risk pool, thus creating the potential for understandings that transcend self-interest.

Harnessing the economic power of risk pools to democratic governance structures could have a powerful effect on the quality of American political culture as it engages with health policy issues. Providing mechanisms for citizens to participate in shaping the parameters of their own health insurance could open up the discourse of risk allocation, which is currently dominated by management.

Finally, an important contribution of self-governance structures at the level of risk pools would be to make it easier for citizens to infuse risk allocation discourse with ethical values. As Deborah Stone has argued, insurance is a technology of governance that invites contemplation about issues of social responsibility because it requires resolution of questions about compassion and collective responses to suffering. In a world of individualism and competition, the very presence of insurance “legitimates social obligation and mutual aid.”⁴ More widespread citizen engagement with such issues would, in effect, democratize the norm setting implicit in the process of health insurance risk allocation.

 
II.
Concerns and Shortcomings

In contrast to my approach, many health policy experts argue for a complete de-linking of health insurance from the workplace. Their argument is that the economic distortions from an ESI system outweigh any benefits that come from administrative convenience. The most powerful argument against ESI is that it is doubly destructive: it fragments the overall population, thus undercutting social insurance principles, and it subsidizes individual health care consumption, thus creating moral hazard. Path dependency, not logical reasoning, has kept us locked into the workplace system for health insurance. I find these critiques of ESI to be compelling as rationales for a national, universal system of health care delivery, which I support. But given the enduring popularity of ESI, I offer a counter-perspective: infusing ESI risk pools with worker governance mechanisms could advance both democracy and justice.

I do, however, recognize that many shortcomings of an ESI system would carry over into attempts to foster greater employee control. Perhaps the bottom-line issue is how much power such democratized structures would have and how much discretion and authority employers would retain. It is naïve to imagine that such institutions could function outside of the power relations around them. Given those inequalities, the question is whether participants would be able to deliberate under conditions of egalitarian reciprocity and universal respect. If the aspiration of deliberative democracy is to create institutions that “tie[] the exercise of power to free reasoning among equals,” the very thickness of background social relations in a workplace may make it difficult to achieve that result among co-workers.⁵

Workplace power relations would inevitably produce problems in such an arrangement. Cooptation of workers by employer interests, the possible capture of the process by those most motivated to further their self-interest, or the simple failure of group members to fairly represent other workers all come to mind as possibilities. The history of gender and racial inequities within unions provides merely one example of the fact that more democratic norms in workplace relations are hardly a panacea for injustice.

Although these issues illustrate the ambitiousness and difficulty of using risk pool governance structures, the problems are not insurmountable. Ground rules would be necessary to prevent such groups from exacerbating, rather that moderating, inequities in health insurance. One protection would be to limit risk pool governance to the largest workplace groups, those with a significant degree of built-in diversity of interests. Additionally, legal restrictions to require justification for limitations on coverage would be necessary to counteract tendencies to exclude those with stigmatized diseases, such as HIV/AIDS. If we do achieve an expansion of insurance through health reform proposals currently under discussion, other ground rules would presumably include coverage of all (including part-time) employees and a minimum basic benefits package.

It is not practical to require every employer-sponsored plan to have a democratized risk pool governance structure. But it seems realistic to imagine that policies might be put in place to enable risk pool governance structures in workplaces with a large enough number of employees to constitute a robust risk pool and a meaningful degree of diversity. My goal here is not to set forth a full blueprint of a workplace-based risk pool governance structure. Rather, it is to encourage the idea of embarking on an experimentalist project through which these complexities can be explored.

 
III.
Toward Justice

The proposal that I have outlined speaks to how the concept, identity, and role of citizen can become a viable component of health care system governance. But it also offers the potential for advancing norms of distributional justice. Ideally, it could initiate a discourse of interdependency that could ultimately lead to greater equity.

Risk governance in health care represents a powerful compound of economic policy and moral normativity. The practices of risk allocation identify certain risks to be collective, others to be assumed by individuals; they mark certain actors as eligible for protection, others as not; and they incentivize certain conduct, but not all conduct, as socially beneficial because of its tendency to diminish risk. Allocating financial risk structures choices about who will receive what forms of care, who will pay for what kinds of illness, and how quality or negligence will be defined.

Our traditional constructs for addressing justice issues have not effectively engaged these health equity problems. Liberal rights discourse has never proven adequate or even fully relevant as a basis for confronting the gaping health care hole in the quality of American life. Negative liberty principles offer no purchase for contesting private actions, and even equality mandates that extend into the private sector seem insufficient for a problem that does not fit the minoritizing discourse of civil rights issues. Moreover, the individual fairness focus of a civil rights mandate can cut against an argument for community sharing of risk.

Debates on the ethical dimensions of health care have thus been dominated by the conflict between the insurance industry’s principle of “fair discrimination” in allocating risk and the solidarity norms of social insurance. For those who wish to advance equity in health care while still acknowledging the risk structure that governs the health system, it has been difficult to find a framework that engages both risk and equity in an effective manner.

Addressing issues of equity within a risk allocation paradigm offers a new and, I would argue, better way to capture and articulate the stakes at issue in the debate. It allows us (indeed, it forces us) to identify who gets included and excluded in the pooling process; how allocation decisions are made; and whether there are systems of accountability built in to produce a risk allocation scheme that is equitable, efficient, and flexible in determining how and to whom various kinds of risk are apportioned. Calling the system for what it is, and how it actually operates, is the most honest way to address the underlying values.

Simply establishing a risk-centered normative frame will not, of course, resolve the tensions. Risk talk can cut both ways. It is highly elastic, capable of framing normative issues around invocations of both solidarity and short-term self-interest. But governance structures based in risk pools would provide a framework through which advocates of greater equity could make their claims.

 
IV.
Conclusion

Mechanisms governing and distributing financial risk are what drive the health care system today.  The system’s viability is contingent on efficient risk allocation, but the inherent tensions and trade-offs between equity and efficiency in health care could be negotiated in a more open and democratic process. Such a venue is missing in the contemporary American health care system, both in the status quo and in proposals for reform. Regardless of whether health care financing mechanisms change in the future, increasing citizen engagement in the health care system will remain important. For something as central to our lives and our economy as the health system, we should interrogate much more vigorously than we have so far our conventional understanding of whether and how democratic norms and structures could provide mediating processes for risk-centered decision-making.

Acknowledgments:

Copyright © 2009 Georgetown Law Journal.

Nan. D. Hunter is Professor of Law at Brooklyn Law School.

This Editorial is based on the following full-length Article:   Nan D. Hunter, Risk Governance and Deliberative Democracy in Health Care, 97 GEO. L.J. 1 (2009). Click Here for the Full Version