Any financing, buying, or selling of equipment has to fall within the business judgment rule. If it’s something that’s necessary for the company to operate and the purchase is proper in the ordinary course of business, that most probably is not going to be considered oppressive or harmful conduct.
However, if it improperly benefits the majority to the exclusion of the minority, then that may be oppressive conduct that violates the fiduciary duties each director owes to the corporation. For example, if the majority ownership goes and buys a piece of property, moves the company’s headquarters to that property, and then the company pays exorbitant lease payments, that may be oppressive conduct. These are lease payments that are higher than market rate and potentially improperly favor the majority.
Before investing in a company as a minority shareholder, it is advisable to examine the by-laws to see if you are offered protection from shareholder oppression. We see corporations that were formed with complete boiler plate by-laws and nobody ever pays attention to even keeping corporate minutes. That’s not uncommon in a small, closely-held business.
The state of Texas upholds shareholder agreements if they are properly drafted. These agreements are considered enforceable and binding. Fortunately, in Texas there are specific requirements that must be met to make them enforceable and binding on the corporation.
For example, in a shareholder agreement, you can spell out how shareholders who are also employees are going to be compensated. You can have provisions that specifically address compensation, or you can have buy-sell agreements if one side or a certain shareholder becomes unhappy or falls out of favor with the other shareholders. You can have a shareholder agreement that triggers some mechanism to let the parties have a business divorce so they’re not tied together for as long as that business exists.
Most people, when they first call us, are really just trying to figure out what their rights are. They reach a point they know they’re not being treated fairly. Often times, they have tried to negotiate or contact the other side in some way and have been rejected.
Due to the laws surrounding this area, it is always best to first consult with an experienced attorney. They’re able to walk you through options and provide you with the information they require. In some cases, they’re able to explain all the rights and options are available so that you can make a decision of whether or not it’s worth pursuing.
For example, sometimes after the initial call, we lay out steps and things to do and things to watch for and we can sit back. If we are called early and there is nothing to act on, we can help them write letters on their behalf. These letters can flush out what the majority’s plans may be.
If the majority then reveals their plans in a way that makes it clear that it’s their intent to deprive the minority shareholders of their rightful share of profits, then we know that we have a case and we could move forward.
There are certainly some rights that are the same for all Texas corporations. In most states, the laws are pretty similar and what the basic shareholder rights are which apply to all shareholders. We also have to look at the corporation’s by-laws, the company’s agreements, or any shareholder agreements because those can modify those rights. While there is a general process we follow, no two cases will be the exact same.
One of the actions that we always recommend is obtaining the books and records of the company. However, you have to be very careful about how you ask for them. In order to get those key documents, you’ve got to ask for them in a certain way under statute and the case law interpreting the statute. The request has to be in writing. It has to state the purpose of why you’re requesting the records and it has to be for a proper purpose. It has to specifically state which types of records you want. The written request also has to allow a reasonable time to respond and it has to be clear in the writing that the person requesting is entitled to them.
Oftentimes, when a request is made to look at the books and records of a corporation, the officers of that corporation think that only entitles you to see the monthly financial statements. In Texas law, the request can be much more detailed than that. The shareholder has a right to look at contracts and sometimes, underlying invoices and other records.
When we request these records, we are trying to get the detailed information that allows you to do a detailed analysis of what’s going on within the corporation. If the corporation refuses to give you the records that you’re entitled to, there’s a special form of action that you can file in Texas courts called, ‘a petition for writ of mandamus’ that will order the corporate officer to turn over the records to the shareholder. If the writ of mandamus contains the proper predicate, proper groundwork, and is successful, the corporation officer has to pay your attorney’s fees.
It is possible when a minority files a claim for them to get an injunction to preserve the company’s assets. We’ve actually had some cases involving injunctions. Injunctions, typically, are designed to stop assets from being stripped out of the company that we might not be able to recover. Nonetheless, it’s unusual to seek temporary injunction.
Once we’re filing litigation, the goal, is usually to force the purchase of the minority interests of their shares. It’s a good solution under Texas law because if you talk about the value of a minority shareholder’s stock, business evaluation experts will say, “If the company’s worth $10,000,000 and you own a 10% interest, your shares might not be worth $1,000,000 because there’s what’s called the ‘minority discount.” The fact that that 10% owner doesn’t control the corporation affects its value in the open market.
If they were going to go sell that stock to a third party, they’re going to find that that third party wouldn’t pay a full $1,000,000. They would take a minority discount of 25%, 40%, or even 50% off that value and so that’s what I’ll be willing to pay for a minority interest where I can’t control the operations of the company.
Many times the business partners in dispute know each other. Sometimes it’s friends who go into business together and other times it’s family businesses. Oftentimes, there will be one owner that is called “the operational owner.”
The operational owner is the person that has industry knowledge or operational knowledge of a certain industry but no capital or money. The other owner typically provides the funding. Many times, the ownership with the capital will be the ones that influence the ownership more and form the documents that exert control.
The operational owner is typically relegated to a partial ownership and also acts as an employee. If things don’t go as planned, that’s often when they feel as though they don’t have much power. They didn’t get the company formed and they’re simply an employee.
Is it more advantageous to have the expertise or the capital when starting a business?
It truly depends on the situation. We handled a situation where the corporation or the group of people, had a series of corporations that were set up to build surgery centers. The group would then find a doctors or surgeons who wanted to own the surgery center where they were performing surgeries.
The group formed a corporation to build each surgery center. Afterwards in operation, they had the health care company that wanted to buy the doctor’s interest and the corporation’s interest in those surgery centers.
After several clinics were built, the corporation was controlled by two individuals that had a finance and real estate background and had some employees. They had several employees who were also nurses. In one of these surgery centers, they decided to give the nurses a minority interest in the corporation.
After that surgery center was built, it wound up actually being one of the more valuable ones they had ever done. They thought they were giving these nurses a nice, small bonus for all their work. When they saw how profitable it was, they began to get greedy.
Can success hurt relations between majority and minority shareholders?
The two owners first came to the nurses and tried to negotiate with them and pressure them into giving up a portion of their stock for much less than it was worth. When one of the nurses refused, they just set out on a whole course of threats, telling her that she’ll never see any profits. They threatened that they would never sell that corporation so she would never be able to liquidate her ownership.
Often, a situation arises when the corporation becomes profitable, the majority gets a little greedy and they decide, “We were the ones primarily responsible for this. We were making the day-to-day decisions. We should get all those profits.” They’ll get greedy and try to deprive the minority shareholders of their rightful share of the profit.
If a corporation is equally owned by shareholders, can shareholder oppression still occur?
Even if there is no majority owner (for example each shareholder has an equal 20% stake), shareholder oppression can still occur. If the shareholders who controlled 60% were aligned in a different way than the two 40% owners and they vote together consistently, they could exert oppression.
Through their clear different economic motives or some kind of a voting block, the aligned shareholders establish that they’re going to take this course of action that benefits just the three shareholders controlling the 60%. In such circumstances, the shareholders who made up the remaining 40% may have a cause of action.
Once you accept a position as a minority shareholder in a corporation, you’re limited on your options. A majority interest holder who really is set on depriving you of the value of your investment has the ability to do it. The best way you can protect yourself is to make sure you monitor what’s going on in the corporation. Even though you’re a minority shareholder, you have the right to inspect books and records.
You have the right to information about it. You could raise issues at shareholder meetings to understand what’s going on. Sometimes having that documentation as you go along can help you to identify the fact that shareholder oppression is going on and then help prove your case when you have to bring some kind of legal action.
The sooner you act to retain an attorney, the better. It’s a lot easier to be proactive. In many instances, if you start to exercise those rights, to inspect the records or call a special shareholders’ meeting or request that there are certain things to be put on the corporate the agenda, it will alert the majority shareholders to the fact that they do have a duty. Not only do they have a duty to the corporation itself, but they have regulations that prevent them from stripping away the value of the company and keeping it all for themselves.
Many times closely-held businesses don’t have regular corporate counsels that they confer with. A minority shareholder raises the right kind of questions that might trigger the majority owner into seeking legal counsel. If they seek reputable counsel, they’ll be told they can’t do those kinds of things and informed of any upcoming statutes. It’s the most beneficial to take action as soon as you suspect it. There are statute of limitations that will prevent you from going back to recoup profits that you were deprived of in the past. Typically, the statute of limitations is four years. It can vary by state and there are some exceptions to it but four years is a good rule of thumb.
We take on shareholder oppression cases on a variety of fee agreements. Many of the cases we have pursued were on an hourly basis. If there’s clear value and our client has sufficient funds to pay our fees by the hour, sometimes that makes the most sense. They don’t want to give up a percentage of their total value of their investment to their lawyers.
In other cases, where perhaps our client has inherited stocks and they don’t really have assets, they don’t have any other option than a contingency fee. They can’t afford to pay us by the hour so we’ll consider those onto taking those on a contingency basis. Then, we’ve also done arrangements where it’s a little bit of both.
Unlike personal injury cases where you find there’s kind of a standard percentage, you really have to evaluate what the company is ultimately worth and what the minority shareholders’ interest is worth. We try to reasonably set fees based on what we think the chances of success are and what the ultimate recovery will be.
There are many different reasons a shareholder may decide to wait. A lot of times what we see is because the company is a family company or they were friends or business partners, people are reluctant to go the next step. They delay in taking some type of legal action against someone that they’ve known for a long time or a family member.
Or many times people believe that because they are a minority owner, they don’t have any rights. They often are under the impression that by giving up the majority ownership to the other owners, they’ve given up their rights to contest things and that’s simply not the case.
One of the dangers of shareholder oppression, is that it might start with some small issues. It might start with minor issues that do not have enough economic value to warrant hiring a lawyer. Those seemingly minor events can trigger the running of the statute of limitations. It’s important to be vigilant and protect your shareholder rights and get advice early on, even when it may not seem like that big of a deal.
Shareholder oppression is when a person owns less than a majority of the stock and the people that own a majority take steps to deprive them of the value of their interest in the company. Shareholder oppression typically occurs in privately held companies.
Public companies must follow the SEC regulations that protect all shareholders. Only in privately held companies do the majority owners have the ability to manipulate the results of the company and control it in an unregulated way. Typically shareholder oppression occurs in small, closely-held companies with only five or fewer shareholders. Many times, the people involved are business partners who have gone into business together, friends, acquaintances, or even family members.
These people collectively started or formed small companies that then grew. When a dispute arises between the owners of the company regarding how to run the company, they may be regarding the financial aspects of the company or disputes the strategies of the company moving forward.
When you talk about oppression cases, it typically involves the minority taking a loan from the company. There have been instances where the majority, in order to get cash out of the company without having to share it with the minority, might have the corporation make a loan to themselves.
There are instances where the majority takes money out and uses it for whatever they want. Because they control both sides of the corporation, they’re not required to put up any real security that protects the corporation’s interest. There might not even be any reasonable repayment terms. The majority member might just put it on the books as a loan and not have repayment terms or have the loan collect interest. This could allow the majority to pull cash out of the corporation, which could potentially constitute shareholder oppression.
It Is Possible for Minority Shareholders to Sue Majority Shareholders for Breach of Fiduciary Duty?
The majority shareholders have the responsibility to put het company’s interest before their own. This includes the duty of loyalty, or good faith to put the company’s interest above their own, and to not self-deal. If they completely mismanage the corporation, they could be held liable. Essentially, it’s like making an allegation that they were negligent in the way they carried out their duties as the officers or the directors of the company.
The lawsuit the minority shareholder would bring is brought on behalf of the corporation would sue one of its’ officers for failing to perform his job properly. In those cases, if you were awarded a judgment against the president, who is also a majority shareholder, the president is forced to pay damages into the company and therefore benefitting the minority shareholder.
Can the Majority Shareholder Discontinue Payment to a Minority If the Minority Is Bringing a Shareholder Oppression Suit against Them?
You can’t ensure anything. Once litigation is filed it would be a step in the wrong direction for the majority owner to take further action to harm the minority owner. It is not a common occurrence, but once a lawsuit is filed we ask for the books and records of the company and so the majority owner knows that there’s an attorney involved. When that happens, you typically don’t see the majority owner engaged in new conduct or taking new actions that harms the minority.
While it could always happen, hopefully they will talk to a lawyer at that point and company counsel will advise them of the rights and obligations of the different ownership classes.
There is always the option of trying to seek an injunction to prevent the majority from doing something harmful. We’ll often ask a court to require that the company continue to operate in the ordinary course of business and not incur any large debts or shut off funding or stop the operations of the company during the tenancy of a lawsuit. There are legal ways that we can ensure that no additional harm comes to our client.
The amount of shares owned does not make a difference in pursuing a shareholder claim. The only difficulty with owning a small percentage is justifying legal expenses needed for counsel. The problem with a very small interest in a closely-held company is that it’s very often an investment that’s not worth a lot of money.
It’s difficult to file a small claim because of the legal expense that’s required to protect your rights. If you own a one percent interest in a company that’s only worth $50,000, your investment’s really only worth $500. The economics of getting legal representation make it difficult to enforce your rights. A one percent owner in a $10,000,000 company is going to have the motive and the ability to enforce their rights just as if they own 49% of the company.
Even with a small shareholding, you are legally entitled to enforce your rights. I’ve handled cases where my client’s interest was worth as small as $10,000. Those are difficult cases and we really have to be efficient. It just takes a special understanding that it is not a case that can justify full-blown litigation.
I would say, typically, when you get into a minority interest that’s worth $50,000 to $ 100,000, it’s certainly worth the effort to make sure that your rights as a minority shareholder are protected.
The most basic right a shareholder has is the right to examine the books and records of the corporation. Books and records are not just a monthly financial statement; it includes basic accounting records and includes the minutes in formal actions. It can also include the governing documents of the corporation and it can even extend to significant contracts, so you can find out about how much money the other owners are paying themselves in salaries.
The second basic right is the right to receive your proportionate share of the profits when and if profits are distributed. Again, the issue in closely-held corporations is sometimes those profits are distributed in forms that disguise them as salaries or bonuses or other kinds of distributions.
There is a legitimate reason for doing that in corporations, it can help avoid double taxation. If the corporation is taxed on its profits and then distributes dividends then the dividends are taxed on the individual shareholder’s returns as well. There are legitimate reasons to call the money salaries, but once it reaches a point where it’s done disproportionately, that’s a problem. They’ve got to separate salaries from the distribution of dividends.
The third basic right is the right to attend and participate in the meetings of shareholders. Shareholders are entitled to their vote. They’re entitled to be able to question issues at meetings and that’s a basic requirement.
Shareholders are also entitled to require officers and the directors and the other owners to follow the company’s rules and regulations and by-laws. They’re also entitled to have the majority owners put the interest of the company in front of their own personal interest and to follow their fiduciary duties to the company. Those are just the part of the basic rights.
In a closely-held corporation, you wouldn’t think this comes up very often but it does. Shareholders have a right to demand that their shares, the actual share certificates actually be given to them. A lot of times, these corporations are formed without any legal counsel and they say that you’re a shareholder but nobody ever gives you a share of stock. You are entitled to that share because it’s evidence of your ownership. It’s something that you can use to secure a loan if you’re applying for some unrelated loan. Without those stock certificates, you might not be able to do that.
Shareholders also have a general right to participate in corporate expansion and the right to participate in corporate opportunities that are presented to the corporation. This applies if, for example, the president becomes aware of some new opportunity that came to the president because he was in his position at the corporation.
They can’t divert this opportunity to another company because shareholders have the right to participate in that expansion and in that new opportunity.
The majority can be a single person or a group of people who vote together and they control more than 50% of the voting interest in the corporation. The minority can be from one share of stock up to 49% of the outstanding stock of the company.
Typically shareholder issues arise when the owners disagree on the direction the company should take. The people that have voting control in those situations decide that they’re going to do it their way and punish the minority shareholders. They do that declaring by themselves some kind of bonus or raises instead of distributing dividends to the shareholders.
Another example is firing an employee or director. If the minority shareholder is also an employee, officer, or director, sometimes the majority ownership will fire that owner and disallow them from becoming involved in any of the operations of the company. It’s kind of a ‘freeze out or squeeze out’ situation.
The strongest claim is typically taking money, assets, or business that rightfully belongs to the company. For instance, declaring cash distributions or dividends to the majority shareholders without paying proportionate share to the minority is typically a very strong claim.
A more difficult type of claim arises when the majority owner awards himself a salary that may be excessive. Oppression is difficult to prove if the amount of their total compensation isn’t excessive and they’re earning similar salaries to other comparable people in the industry who have similar companies. It’s difficult to establish that those salaries rise to the level of oppression because they are not exorbitant. Even though the industry standard might be earning $100,000 if you’re running a company of this size, the fact that they’re pulling out $125,000, is a difficult oppression case to make.
If they get to the point where they’re taking a salary two or three times the industry average, it’s a lot easier to pursue because those business owners, in deciding what the right salary is, are protected by what’s called, ‘the business judgment rule’.
The courts aren’t going to second guess every decision. That case, in just a limited time frame, is going to be difficult to establish.
We’re able to resolve a lot of cases without litigation. Our approach begins with contacting the majority owners before we file a lawsuit in most cases.
We have found if you put them on notice through specific request for inspection and citing the statutes in the Texas business organization code it is very effective. If you show them code that calls out, “you’ve done this wrong” or “you’ve done that wrong,” often times the majority owners will kind of realize the error of their ways and be willing to negotiate.
In most cases of clear shareholder oppression, the parties have reached a point where they don’t like each other. They want to try to figure out a way to separate themselves. You can often resolve these things through negotiation instead of litigation. Often times what you’re looking for is a buy-out of the minority shareholders’ interest.