- Let’s discuss legal remedies for oppressive conduct against members of closely-held New Jersey companies.
- The shareholder oppression doctrine is a statutory and case law remedy developed to protect minority shareholders in New Jersey closely-held corporations from abuses of power by majority shareholders and by the officers and directors they select.
- The shareholder oppression doctrine has several elements: First, majority shareholders owe duties to minority shareholders not to “oppress” – meaning to frustrate and/or deprive the “reasonable expectations” of these minority members based on an express or implied agreement or implied by law, or to commit egregious acts of bad faith and unfair dealing. Second, the law provides equitable remedies for the violation of those duties, including a compulsory buy-out of the minority shareholder at a fair price determined by the court.
New Jersey courts developed a broad definition of “oppressive” which describes a range of wrongful conduct in closely-held corporations. In appropriate cases, the courts invoke their general equitable powers to fashion appropriate remedies, including the compulsory buy-out of the oppressed shareholder’s stock.
Oppressive Conduct in Closely-held Corporations
In a corporation, whoever votes the majority of the shares exercises control over all aspects of the company. These majority shareholders almost always vote themselves and friendly persons to the board of directors. In closely-held corporations, where the number of shares and shareholders is small, the majority ownership of shares by one person or a small group is the standard and minority shareholders have only that amount of control that the majority allows.
Things don’t always work out as planned: shareholders die, the business struggles, relationships change, and disputes arise. When there is no shareholders’ agreement, minority shareholders who lack both contractual rights and voting power may have no control over how those disputes are resolved.
Many times, shareholders in small companies work for the company. Many times, their personal wealth is also tied up in the company. They are dependent upon salary, distributions from the company, or both to make a living. When a dispute arises, the majority shareholder will often attempt to “squeeze out” the minority member. The squeeze out usually begins with firing the minority shareholder as an employee and/or refusing to declare dividends, so the minority shareholder gets no economic benefit from share ownership. In a subchapter-S corporation, the minority shareholder may continue to owe taxes on corporate earnings, even though he receives nothing. Then the majority shareholder(s) also vote the minority shareholder out as a director, cutting off access to information about the company, and refusing to hold shareholder meetings.
In such a case as I have described, the minority shareholder is trapped in an oppressive situation and will be forced to sell to the majority shareholder at a price dictated by the majority. If the minority does not sell, then he will be subject to a “freeze out,” in which his share ownership is simply ignored as irrelevant.”
[M]inority shareholders in closely-held corporations have ‘no statutory right to exit the venture and receive a return of capital’ like partners in a partnership do, and ‘usually have no ability to sell their shares’ like shareholders in a publicly-held corporation do. … Unhappy with the situation and unable to change it, minority shareholders are often unable to extract themselves from the business relationship, at least without financial loss.”
The frozen-out minority will receive no benefits, no information, and no opportunity to participate as a shareholder.
Oppressive conduct is effective in closely-held corporations because of majority rule and the absence of an exit.
A wielding of this power by any group controlling a corporation may serve to destroy a stockholder’s vital interests and expectations. As the stock of closely-held corporations generally are not readily salable, a minority shareholder at odds with management policies may be without either a voice in protecting his or her interests or any reasonable means of withdrawing his or her investment.”
Shareholders may protect themselves by drafting shareholder agreements “that contain buy-sell, first refusal, or redemption provisions that reflect their mutual expectations and agreements.” However, shareholder agreements that address future problems not anticipated at the founding of the company are exceedingly rate. From a relational standpoint, people enter closely-held businesses in the same manner as they enter marriage: optimistically and ill-prepared.” Owners of closely-held corporations usually trust each other, at least at the outset of the venture, and regard contractual protection as unnecessary.
Without legal protection, minority ownership in a closely-held corporation can become essentially a joke.
To discuss your NJ shareholder matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com. Please ask us about our video conferencing consultations if you are unable to come to our office.
By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Shareholder Law Attorney