The Power of the Courts to Govern a Corporation During Controversy and/or a Shareholder
Lawsuit(s)by the Appointment of a Receiver, Fiscal Agent, and Professional Director(s)
Oftentimes, shareholders are conflicted about bringing a lawsuit when things within the corporation start going badly, often debating if the uncertainty and cost of litigation is worth the potential benefit(s). It is important that BEFORE you go to court, you have made an informed decision. I encourage you to consult a knowledgeable Shareholder Law attorney to help you navigate your options.
New Jersey has strong Minority Shareholder laws that protect the rights of minority shareholders in a closely held corporation. The laws apply to corporations with 25 or fewer shareholders. These laws state that any oppressed minority shareholder has the right to file a lawsuit against the majority shareholder(s) for oppression and other causes of action. Depending on the claims against management, a court may order interim remedies to govern the corporation pending a final judgment if it finds that the majority shareholder(s) have engaged in misconduct. That’s what I will discuss now: judicial remedies during corporate litigation over claimed majority shareholder misconduct.
Shareholders’ Rights: The Power of the Courts to Govern Corporations When in Turmoil
There are numerous remedies that the Courts can fashion in shareholder rights cases. Some of the most common remedies are the appointment of a receiver, a provisional director, or a custodian to run the corporation’s daily affairs while the dispute is settled. Sometimes, the court will order that one or more shareholders’ stock be sold to resolve the dispute. One of the more significant remedies is dissolving the corporation. Courts will typically only order this remedy if the corporation has been irreparably harmed, is likely to go out of business, or has committed fraud against shareholders, creditors, or the public.
Another common remedy available to the Court is ordering a buyout of a shareholder’s interest in the company by another shareholder. Here, the Court will order the majority shareholder to buy out the minority shareholder, requiring the minority shareholder to pay “fair value” for the shares. The term “fair value” means establishing the economic worth of stock shares in a forced buyout. Fair value is used when it appears that the “fair market value” of the shares is not a fair and reasonable price. It is important to note the difference between these two similar-sounding terms. In establishing fair value as the proper value, courts will examine what a neutral buyer would be willing to pay for a minority interest in the shares of a closely held corporation.
Under special circumstances, the Courts may order a minority shareholder to buy out the majority shareholder, though this is extremely uncommon.
Depending on the circumstances, courts may elect to apply a “marketability” or “minority interest” discount to the stock valuation. A marketability discount assumes that there is a small pool of potential purchasers for these shares and that finding a neutral outside buyer is often difficult. A minority interest discount is sometimes disregarded because the Court determines that the value of the minority(s) shares should not be adjusted because outsider buyers are less inclined to buy a minority stake in the corporation and this unfairly produces the value of the minority shareholders interest.
NJ COURTS: PROTECTORS OF SHAREHOLDERS DURING TIMES OF CONTROVERSY
New Jersey law gives its chancery courts the power to protect the best interests of a corporation and its shareholders (both minority and majority) during periods of controversy and conflict. The range of remedies available to the chancery court is extensive. The following discussion will explain some of these remedies and powers.
The Appointment of a Receiver to Manage the Company During Litigation
One of the broadest powers of the court is the power to appoint a receiver for a corporation when there is evidence of gross or fraudulent mismanagement by corporate officers or directors, gross abuse of trust, or a provable dereliction of duty by those with decision-making authority. Our courts have the authority to appoint one of two types of receivers, a statutory receiver or a custodial receiver. A statutory receiver can be appointed when a corporation: 1) has become insolvent; 2) has suspended its business operations because of a lack of cash flow; or 3) is operating at a loss, which generally is fraudulent and prejudicial to the interests of prospective or actual creditors. Upon appointment by the court, a receiver is vested with title to the corporation’s property and has the power to: 1) take possession and control over corporate property, assets and cash; 2) institute and defend legal actions on behalf of the corporation; 3) sell, assign, convey or dispose of the company’s property; 4) negotiate and settle claims involving the corporation and any debtor or creditor.
A Custodial receiver is appointed for the limited purpose of preserving the corporation’s assets for a predetermined period, for example, during litigation between fighting shareholders. Custodial receivers do not acquire legal title to corporate Assets and property and are without the power to liquidate and dissolve the corporation.
THE APPOINTMENT OF A FISCAL AGENT IN LIEU OF A RECEIVER
The appointment of a receiver can be avoided if the shareholders can persuade a court that the corporation’s interests can be served by a less intrusive means. As an alternative remedy to protect the corporation, a court may appoint a fiscal agent with limited but specified powers. A fiscal agent is an interim solution, a temporary appointment intended to avoid the more expansive powers of a receiver. Generally, the fiscal agent’s responsibilities will be limited to the financial safeguarding of a corporation’s resources, such as when claims of fraudulent or excessive expenditures, officer compensation, or the diversion of corporate resources are denied.
THE APPOINTMENT OF A PROVISIONAL DIRECTOR
A court of equity also has the authority to appoint one or more provisional directors to manage the corporation’s affairs during controversies. Provisional directors are appointed by the Chancery Judge if it is determined that their placement in the company is in the best interests of the corporation and its shareholders. A court can appoint a provisional director(s) even when the corporation’s bylaws, certificate of incorporation, or governing resolutions adopted by the Board of Directors or shareholders prohibit anyone but certain individuals from serving on the Board of Directors. Provisional directors have the same rights and powers as elected directors until they are removed by the court, or by the vote or written consent of all or a majority of shareholders entitled to vote for a director, unless a court decides otherwise. But remember, a provisional director is just that, a director and nothing more. In and of itself, the provisional director does not have control over the corporation beyond his or her director’s title.
THE APPOINTMENT OF A CUSTODIAN IN LIEU OF A RECEIVER
In addition to or in the alternative of appointing a provisional director(s), a court may also appoint a custodian for the corporation, if such an appointment is in the best interests of the corporation and its shareholders. A corporate custodian has the same powers as the board of directors and officers to the extent necessary to manage the affairs of the corporation. The custodian’s appointment will remain in effect until removed by an order of the court, or by the vote or written consent of a majority of the shareholders entitled to elect directors.
Provisional directors and custodians may be appointed, for example, when the shareholders are so divided that they fail to elect successors to the Board of Directors as their terms expire. They may also be appointed when the directors of the corporation, or the person or persons having management authority on the board, are unable, for a multitude of reasons, to act on one or more important matters respecting the corporation’s affairs. A provisional director or custodian can be appointed when the Board of Directors or those in control of a corporation have mismanaged the corporation, abused their authority, or otherwise acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees.
Fredrick P. Niemann Esq.
Provisional directors or custodians cannot be shareholders or creditors of the corporation. They are obligated to report to the court from time to time on the corporation’s operations and the status of its business. Custodians or provisional directors can, in addition, file their recommendations to the court as to the appropriate decision to be made on whatever corporate matter is at issue that necessitated the appointment of the provisional director or custodian.
Not sure what remedies are the best for you and/or the corporation during a time of turmoil and dispute? Then contact me personally today to discuss your shareholder corporate 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 email me at fniemann@hnalwfirm.com.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, New Jersey Shareholder Rights Attorney