Client Q&A: I’m a shareholder in a small company and the other shareholders are not being fair to me. What can I do?
I'm a shareholder in a small company and the other shareholders are not being fair to me. What can I do?
It is a familiar scenario: Three friends start a small business, each contributing capital and/or sweat equity to get the enterprise off the ground. They organize themselves as a corporation, but for the most part they operate informally. At first, everyone gets along, and the venture is a success. But with time, disputes arise. Maybe there are disagreements about the direction of the business. Or maybe personal or family conflicts spill over into the business relationship. The informal consensus that originally governed the business gives way to factions. Two of the original business partners align against the other – and because they hold a majority of the corporation's shares, the two can impose their will on third, minority shareholder. As tensions worsen, the majority owners might start to abuse their control over corporate decision making to harm the minority owner – e.g., firing him as an employee or officer of the business, refusing to declare dividends to him, or even denying him access to information about the business. Although the beleaguered minority shareholder lacks the power on his own to stop these abuses, there may be a legal remedy.
Minority Shareholder Oppression
Minority shareholder oppression can take many forms. As commonly defined by the New York courts, shareholder oppression encompasses actions by those in control of a corporation that "substantially defeat shareholder expectations that, objectively viewed, were both reasonable under the circumstances and were central to the [shareholder's] decision to join the venture." Specific examples of oppressive conduct might include:
- Firing the minority shareholder as an officer or employee of the company.
- Removing the minority shareholder from the board of directors.
- Refusing to declare dividends to the minority shareholder when the company is profitable.
- Siphoning earnings to the majority shareholders – e.g., through excessive compensation, or entering into self-interested contracts with affiliates or family members.
- Mergers or other transactions designed to dilute the minority shareholder's ownership interest.
- Cutting off the minority shareholder's access to information about the business.
A pattern of conduct including any of the above (or similar unfair treatment) can be referred to as a "freeze out" (i.e., denying the minority owner the benefits of share ownership) or a "squeeze out" (i.e., attempting to force the minority owner out of the business altogether).
In a minority shareholder oppression case, the court has broad power to fashion a remedy. By statute in New York, a minority owner who holds at least 20% of the voting stock of a non-public corporation can seek a court order dissolving the corporation, and distributing its assets to its creditors and owners. To obtain such a statutory dissolution, the minority shareholder must show either (1) that the controlling owners "have been guilty of illegal, fraudulent or oppressive actions" or (2) that "[t]he property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes." If the majority owners willfully or recklessly dissipated the corporation's assets, the court can remedy any prejudice to the minority by adjusting the owners' stock valuations or imposing a "surcharge" on the wrongdoers. The court can also issue an injunction to stop the looting or dissipation of assets.
Holders of smaller interests, or of non-voting stock, who cannot bring a dissolution proceeding under the statute, may be able to seek dissolution under a judge-made (or, common law) rule. This common law dissolution claim, which is less well-defined, requires "egregious conduct" by the majority that "disqualifies" them from exercising control over the corporation and its shareholders.
Dissolution is considered a drastic remedy, and often the courts will order other relief short of dissolving the company. Most commonly, the majority owners can be directed to buy-out the minority shareholder's interest at a fair value determined by the Court. In fact, in a statutory dissolution proceeding, the majority owners have the right, within 90-days of the filing of the proceeding, to elect to buy out the minority shareholder’s interest for the fair value (as determined by the Court) as of the day before the proceeding was commenced.
Different rules govern other business entities, such as limited liability companies and partnerships, which will be the subject of a separate post.
We have significant experience handling minority shareholder oppression claims and other disputes of all kinds among the owners of closely-held business entities. If you are an owner of a company that appears headed for a "business divorce," we would be happy to advise you on a cost-effective strategy to preserve your rights.