Introduction to Minority Shareholder Rights Under the Oppressed Minority Shareholders Statute of NJ
First off, let’s be clear about one thing. Not every action and decision taken by a majority of shareholders that is opposed by less than a majority of shareholders qualifies as shareholder oppression.
Our courts will also consider whether the alleged misconduct by the majority places a minority shareholder’s investment at risk.
Then the court will consider whether the misconduct negatively affects the minority shareholder’s reasonable expectations of his or her role in the corporation or the reasonable economic benefits of being a member of the company. The key phrase is the “reasonable expectation(s)” of the minority shareholder.
One of the earliest cases in New Jersey that defined the reasonable expectations test for minority shareholders in a corporation was Exadaktilos v. Cinnaminson Realty Co., Inc., 167 NJ Super. 141 (Law Div. 1979). The Court in Exadaktilos determined that:
The special circumstances, arrangements, and personal relationships that frequently underlie the formation of close corporations generate certain expectations among the shareholders concerning their respective roles in corporate affairs…. These expectations preclude the drawing of any conclusions about the impact of a particular course of corporate conduct on a shareholder without taking into consideration the role he [or she] is expected to play.
The facts of the Exadaktilos case are similar to those that confront shareholders in their participation in corporate affairs, especially when the relationship(s) are not defined by a written agreement. In such cases, a Court must determine the parties’ relationship through a fact-intensive analysis of the evidence before it. In the Exadaktilos decision, however, the parties involved were original and founding shareholders at the time the corporation was formed. Consequently, the Court was able to determine the expectations, or understandings, of the parties at the time they created the company and established their individual and collective business relationship(s). If you are not an original family shareholder, then shareholder disputes become more challenging.
More Details About Oppressed Minority Shareholder Rights Law
Many New Jersey Corporations are considered “Closely-Held” Corporations, meaning these corporations consist of a small number of owners or shareholders, often family members, who work together to run the business. Usually, the corporation runs smoothly, but unfortunately, personality and other conflicts arise, leading to situations in which shareholders disagree on key issues. Because most corporations are run by a majority of shareholders who have the right to make final decisions about the business when disagreements arise, it’s the minority shareholders who must often accept the unfavorable outcome.
What many shareholders (both majority and minority) are not aware of is that a majority shareholder(s) may not make decisions that benefit just themselves to the detriment or exclusion of minority shareholders. This corporate doctrine is known as the “Fiduciary Duty of Loyalty”. This duty is imposed on all majority shareholders and requires them to act in the corporation’s best interests. A fiduciary duty of loyalty also applies to all shareholders, including majority and minority shareholders. All transactions entered into by the majority shareholder(s) on behalf of the corporation must meet a test of objective fairness. If a minority shareholder challenges a corporate decision, the court will assess the decision’s objective fairness to determine whether the majority shareholder was living up to their fiduciary duty of loyalty. If the majority shareholder breaches this duty to minority shareholders, courts may award minority shareholders relief or, if it’s not too late, and order the majority shareholder that they cannot act a certain way in a specific transaction.
IDENTIFYING WHAT MINORITY SHAREHOLDER RIGHTS CONSIST OF
Minority shareholders in small, closely held corporations often find themselves on the outside looking in when it comes to the day-to-day affairs and corporate decisions of the majority. Allegations of oppression often arise when shareholders are family members, friends, or long-time business associates, and the personal relationships between them deteriorate, or when minority shareholders become dissatisfied with the management of the corporation by the majority shareholder.
The New Jersey legislature has addressed the concerns of minority shareholders by enacting the “Oppressed Minority Shareholder Statute”. The Oppressed Minority Shareholder Statute was enacted to protect minority shareholders from majority shareholders, directors, and officers of closely held corporations that have (i) acted fraudulently or illegally, (ii) mismanaged the corporation, (iii) abused their authority as directors or officers, or (iv) acted oppressively or unfairly toward one or more minority shareholders. The statute, coupled with a series of cases decided by this state’s courts over the past twenty-five years, has afforded minority shareholders substantial protection against oppressive conduct. Interestingly, the percentage of stock a shareholder owns does not necessarily determine whether a shareholder is considered a minority shareholder. In one decision, the court found that the plaintiff (a 98% shareholder in a company) was an oppressed minority shareholder because the stock was held in a voting trust controlled by the owner’s father, and the shareholder had no control over the stock. Consistently, New Jersey courts have interpreted the term “minority shareholder” loosely, often allowing any shareholder to claim protection under the statute if the shareholder can prove, (irrespective of the percentage of stock he/she owns), that he/she lacks sufficient control and decision-making authority over the affairs of the corporation and is being oppressed by those shareholders in control.
The New Jersey Oppressed Minority Shareholder Act protects the rights and interests of minority shareholders in closely held corporations with 25 or fewer shareholders against oppressive conduct.
A shareholder in a closely held corporation will be wise to remember that if “frozen out” of corporate decisions, he or she may have significant legal rights under New Jersey law. If oppression is happening to you or, alternatively, you are a majority shareholder being accused of wrongful conduct towards a minority shareholder, then there are steps you should take. A shareholder should continuously document the acts of the majority or minority shareholder(s) that he/she disapproves of, because acquiescence in corporate acts and decisions can be used as a defense by the majority or minority shareholders should litigation be filed. Furthermore, if a shareholder feels that the majority shareholders are mismanaging the corporation, he/she should exercise his or her statutory right to access the records of the corporation to determine if, in fact, the majority shareholders are mismanaging the corporation and wasting corporate assets. In the event that a review of the corporate records proves that the majority shareholders have mismanaged the corporation, subjecting the minority shareholder to oppression resulting in a decline of stock value and/or other economic loss, he/she should seek legal protection under the “Oppressed Minority Shareholder” statute.
If a minority shareholder believes a case of oppression exists, the shareholder has the right to commence litigation against the majority shareholders. If litigation is initiated, a court will fashion a remedy appropriate to the facts of the case. If oppression is found to exist, one of the most common remedies is to appoint a custodian or provisional director to run the corporation’s daily affairs until the shareholder dispute is resolved. In the alternative, a judge can, under the appropriate circumstances, order a sale of the corporation’s stock or enter judgment to dissolve the corporation. A judgment dissolving a corporation is a very drastic remedy and will be ordered only if the court finds that the corporation has been irreparably harmed and is likely to go out of business, or has defrauded the public or creditors. Another common remedy a Court will use in resolving shareholder oppression claims is to order a buyout of the stock of one or more shareholders involved. The usual scenario is for the court to order the majority shareholders to buy out the minority shareholders’ stock interest. However, in special circumstances, courts have ordered the minority shareholder to buy out the majority shareholder’s stock interest. This is generally not the outcome, but there are several reported cases in which the judge has required the majority shareholders to sell their stock to the minority shareholders at fair value. If you are a minority shareholder who has been operating the corporation continuously for a period of time and is now being forced out by the majority, and you believe your rights as a shareholder are being violated, contact me immediately. Delaying your response can be detrimental to your case.
Can a Corporation Fire a Minority Shareholder Employee?
Losing Your Job in a Shareholder Buyout
Employment and the opportunity to earn a salary are judicially recognized as benefits of ownership in a small corporation. Will a Court include the fair value of lost wages and employment compensation as factors to be considered in determining the valuation of the shares being purchased by the majority shareholders?
Termination of a minority shareholder’s employment may constitute oppression under N.J.A.A. 14A:12-7(1)(c), because a person who acquires a minority share in a closely-held corporation often does so” for the assurance of employment in a managerial position.” Such a person can have a reasonable expectation that they will enjoy “the security of long-term employment and the prospect of financial return in the form of salary,” and will have “a voice in the operation and management of the business and the formulation of its plan for future development.” If these expectations are frustrated by the majority shareholders or directors, a court may find that oppression has occurred. I’ll discuss minority shareholders as being oppressed because of their employment status further down this page.
The Net Present Value of an Employment Interest Should Be Added to the Appraised Value of Stock to Arrive at the “Fair Value” of Those Stocks
Most minority shareholders who are also employees believe that their wages and compensation should be added to the overall value of their shares. Is this accurate?
N.J.S.A 14A:12-7 addresses this position and states in pertinent part:
(1) The Superior Court, in an action brought under this section, may appoint a custodian, appoint a provisional director, order a sale of the corporation’s stock as provided below, or enter a judgment dissolving the corporation, upon proof that…
(c) In the case of a corporation having 25 or fewer shareholders, the directors or those in control have acted fraudulently or illegally, mismanaged the corporation, or abused their authority as officers or directors, or have acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees
That section also provides:
(8) Upon motion of the corporation or any shareholder who is a party to the proceeding, the court may order the sale of all shares of the corporation’s stock held by any other shareholder who is a party to the proceeding to either the corporation or the moving shareholder or shareholders, whichever is specified in the motion, if the court determines in its discretion that such an order would be fair and equitable to all parties under all of the circumstances of the case.
(a) The purchase price of any shares so sold shall be their fair value as of the date of the commencement of the action or such earlier or later date deemed equitable by the court, plus or minus any adjustments deemed equitable by the court if the action was brought in whole or in part under paragraph 14A:12-7(1)(C).
In fashioning a buy-out, a court of equity must ensure that the minority shareholder(s) being bought out are fairly compensated overall, meaning fairly compensated for the “fair value” of their shares.
The New Jersey Supreme Court has held that, given the nature of close corporations, a minority shareholder’s “reasonable expectations” include reasonable employment and wages as a natural benefit of ownership. Most courts hold that a buyout should include “a fair price for [the transferor’s] stake in the corporation, including compensating [the transferor] for the loss of a contract of employment.”
Valuing the Economic Rights of a Minority Shareholder
When a minority shareholder feels their corporation is not operating in a manner they are satisfied with, they often seek to be bought out. When the majority shareholder refuses to buy them out and continues to operate the business in a manner that personally benefits themselves at the expense of the minority shareholders, this is a form of Minority Shareholder Oppression, a violation of New Jersey law.
New Jersey law provides that a shareholder is to be paid the “Fair Value” of his/her shares, determined by a valuation expert’s testimony. This is different from “Fair Market Value,” which is generally understood to mean (in simple language), the amount your shares are worth on the open market.
One key factor affecting the value of your shares is the valuation date. Under NJ law, this is the date of filing the litigation, or any earlier/later date the court deems equitable. The court has considerable discretion to decide the date and, within guidelines, determine the value of your shares. As one might imagine, this value can fluctuate depending on when your lawsuit is filed and when the court assigns a value to your shares.
In some instances, the court may apply a “fair value” standard to establish the company’s market value and thereby the valuation of a minority shareholder’s interest. “Fair value” is a valuation technique intended to fairly compensate a shareholder for the value of his or her stock ownership and may differ from a stock’s “fair market value.” In establishing fair value, consideration is given to the fact that an impartial buyer may not be willing to buy a small stake in a closely held corporation. In appropriate circumstances, a court may apply a “marketability” and/or “minority interest” discount to the valuation of the stock. Marketability discounts are applied to reflect the fact that there is only a small pool of potential buyers for the stock held by the minority shareholder, and finding an outside buyer is difficult. Minority interest discounts may be applied when it is determined that any outside purchaser will also lack voting control over the corporation, so the “minority interest discount” will reflect a downward adjustment to the value of the minority shares.
ATTORNEY’S FEES AND EXPENSES IN SHAREHOLDER RIGHTS LITIGATION
Fredrick P. Niemann Esq.
In a Shareholder Rights case, the Chancery Court has the authority to award to a winning shareholder reasonable attorney’s fees and costs (including costs of retaining experts) incurred in litigation with the company. In addition, if a court determines that a party acted “arbitrarily, or otherwise not in good faith”, it may award reasonable expenses to the injured party or parties, including counsel fees. Not every party that wins an oppressed shareholder suit, however, will be awarded fees. A court may award attorney’s fees to (a plaintiff or defendant) if the Court determines that the other party in the litigation acted arbitrarily or otherwise in bad faith. Often, the conduct of the losing side must be highly offensive or shocking to an impartial observer. Bonafide disputes and good-faith differences of opinion do not qualify for an award of fees and expenses.
Are you a majority shareholder or a minority shareholder in a new corporation having issues that can’t be settled? Contact me personally today to discuss your shareholder matter. I am easy to talk to, very approachable, and can offer you practical, legal ways to handle your concerns. You can reach me at (732) 863-9900 or e-mail me at fniemann@hnlawfirm.com.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, New Jersey Shareholder Rights Attorney