New Jersey Lawyer & Attorney : Stark & Stark Law Firm : New Jersey Law Blog

Minority shareholders in closely held corporations often find themselves on the outside looking in when it comes to managing the daily affairs and making important corporate decisions regarding the corporation in which they have invested. The reason for this circumstance is that, generally, the majority shareholders of a closely held corporation constitute the management of the corporation and, therefore, maintain control. With this division of power, it is not uncommon for minority shareholders of a closely held business to feel as though decisions are being made which favor the majority over the minority and that as minority shareholders they are being “oppressed.” Allegations of oppression often arise when management’s decisions result in the majority shareholders being awarded excessive compensation; when management furnishes what are deemed by the minority to be inadequate dividends; when management is accused of misapplying corporate assets; when shareholders in closely held corporations consist of family members or friends and the personal relationships deteriorate; or when minority shareholders become dissatisfied with the management of the corporation.

The New Jersey legislature has responded to the concerns of New Jersey minority shareholders by enacting the “Oppressed Minority Shareholder Statute” (N.J.S.A.14A:12-7). The Oppressed Minority Shareholder Statute was enacted to protect minority shareholders against 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 New Jersey courts over the course of the past twenty-five years interpreting the “Oppressed Minority Shareholder” statute, have afforded minority shareholders in closely held corporations, with twenty-five or fewer shareholders, substantial protection against oppressive conduct. Interestingly enough, the percentage of stock that a shareholder owns does not necessarily determine whether or not a shareholder is considered a minority shareholder. In one decision, the court found that the plaintiff (a 98% shareholder of the subject corporation) was an oppressed minority shareholder. In that case, the stock was held in a voting trust which was controlled by the owner’s father and the shareholder had no control over the stock. Since that decision, courts  have interpreted the meaning of “minority shareholder” loosely, 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 over the affairs of the corporation and is being oppressed by those shareholders in control.

If a minority shareholder has concerns of oppression, said shareholder has recourse by commencing litigation against the majority shareholders under N.J.S.A.14A:12-7. In the event that litigation is initiated, a court will fashion a remedy that it deems most appropriate, given 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 disputes are resolved, ordering a sale of the corporation’s stock, or entering judgment to dissolve the corporation. A judgment dissolving a corporation is a very drastic remedy and will only be ordered by the court if the court finds that the corporation has been irreparably harmed. Another common remedy that a court will utilize in resolving shareholder oppression claims is to order a buy out of the stock of one or more of the shareholders involved. The usual scenario is for the court to order the majority shareholders to buy out the minority shareholder’s stock interest in the corporation. However, in special circumstances, courts have ordered the minority shareholder to buy out the majority shareholders’ stock interest.

In the instance of a buy out, a critical element of the court’s decision will be the value of the selling shareholder’s interest.  In such cases, a shareholder agreement may establish the value or a court may determine the value of the interest. It is important to understand that there are various ways of valuing an interest in a corporation. In some instances the court may apply a “fair value” standard. “Fair value” is intended to fairly compensate the shareholder and may differ from a stock’s “fair market value,” as 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 also apply “marketability” and/or “minority interest” discounts to the valuation of the stock. Marketability discounts are applied to reflect the fact that there is only a small pool of potential buyers, if any, for the stock held by the minority shareholder and finding a market for the sale of the stock to an outside buyer would be difficult. Minority interest discounts may be applied when it is determined that any outside purchaser will also lack control over the corporation, so the “minority interest discount” will reflect a downward adjustment to the value of the minority shares.

A shareholder in a closely held corporation would be wise to remember that if “frozen out” of corporate decisions, shareholders may have significant rights under New Jersey law. A shareholder should continuously document the acts of the majority shareholders that he/she disapproves of, because acquiescence in inappropriate corporate acts can be used as a defense by the majority shareholders should litigation ensue. 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 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 and a resulting loss of stock value, he/she should seek legal counsel and protection under the “Oppressed Minority Shareholder” statute.

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Another form of minority oppression involves the majority shareholders awarding excessive compensation to themselves and/or members of their family.  This often occurs to the detriment to the minority shareholder and the corporation itself. Examples of excessive compensation have been found in the form of bonuses, salaries, pensions, profit sharing plans, and overly generous expense accounts and perks.
 

A minority shareholder who is the target of this commonly used squeeze-out technique may seek redress in the form of direct and derivative causes of action. An oppressed minority shareholder may assert a derivative claim on behalf of the injured corporation based upon the theory that the excessive compensation is a breach of fiduciary duty or constitutes corporate waste. Moreover, the oppressed minority shareholder may assert a direct claim under New Jersey’s minority oppression statute.
 

Of course, there are problems associated with proving that the majority has awarded themselves or others close to them excessive compensation. Because of the large number of objective factors involved in setting an employee’s compensation package, Courts have not set forth an exact formula or rules in determining what is and what is not excessive. In general, Courts have considered some of the following factors when arriving at the conclusion what is reasonable compensation:

1. the employee’s qualifications and abilities;
2. the qualities and quantity of services rendered for the benefit of the corporation;
3. the amount of time the employee devotes to the corporation;
4. the difficulties involved and responsibilities assumed;
5. the successes achieved by the individual;
6. the profits resulting to the corporation from the employee’s direct and indirect contributions;
7. the size and complexity of the business;
8. the number of people the employee is charged with training, mentoring and/or supervising;
9. the corporation’s financial conditions;
10. the prevailing economic conditions;
11. the compensation over the past few years (also considering factors which could have effected previous year’s compensation);
12. a comparison the compensation of other company employees; and
13. a comparison to others who work in similar companies.

 There are a number of remedies available to the Court if it were find that the compensation is excessive. One available remedy is requiring the repayment of what the Court determines to be excessive. Another remedy is the issuance of an injunction preventing future siphoning off of corporate funds and resources. A third available remedy is the appointment of a receiver or corporate director charged with running the day to day affairs of the company. The most often employed Court remedy is a Court Ordered buy-out of the minority interests. Of course, Court will often factor the additional value of the corporation had the majority shareholder taken reasonable compensation.

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The termination of a minority shareholder’s employment; the reduction of their salary; and/or the termination of their spouses’ and/or children’s employment frequently have devastating consequences. It is common that the terminated minority shareholder’s only source of income was the closely-held business in which they hold an ownership interest. Without their salary, the minority’s interest is, at least temporarily, worthless.

   
The majority’s decision to terminate their employment, or sharply cut the minority shareholder’s salary, frequently results in an immediate and significant economic crisis. It does not take much to imagine the financial strains associated with the loss of employment. Sometimes to make the squeeze-out more effective the majority shareholder may cancel the minority shareholder’s insurance policies and deprive them of the financial benefits of being an owner/employee of the closely held company. During the course of my representation of oppressed minority shareholders, I have seen majority shareholders try to take away the minority shareholder’s use of a company car and the suspension of their country club membership.

   
The termination of the minority shareholder’s employment is often coupled with the use of other squeeze-out techniques such as: withholding shareholder distribution; changing the company’s office’s locks; escorting the minority shareholder out of the building; making inappropriate comments to other employees, vendors, customers or clients about the minority shareholder or their termination; changing the computer’s passwords; denying access to the company’s books and other financial records; and sometimes threatening or engaging in physical violence.

   
Generally, the goal of the majority shareholder who terminates the employment of the minority (and/or their family members) is to acquire their interest at a below market price. Frequently, a terminated minority shareholder is pressed for money. Like most people, they still have the same financial obligations they had the day before their employment was terminated. Often, minority shareholders confronted with this dilemma will accept a below-market price for their interest in the company so that they can meet their current financial obligations.  That is unfortunate.

   
Fortunately, the law may provide redress for minority shareholders who find themselves in the afore-described situation. The oppressed minority shareholder may seek remedy in the Courts. Many times, New Jersey Courts will grant an injunction either reinstating the minority member’s employment, or ordering the majority to pay the minority shareholder as if they were still employed. Unlike regular “at will” employees who are severally limited as to the ways they can challenge an employer’s decision to terminate them; a terminated minority shareholder has the oppressed minority shareholder statute along with enhanced fiduciary duty claims within their arsenal. 
 

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Michael J. Fekete, member of Stark & Stark’s Business & Corporate group, served as Co-Panelist on the Camden County Bar Foundation's weekly television show, Legally Speaking. The show featured a discussion on alternative dispute resolution. More specifically, Mr. Fekete discussed mediation and arbitration as an alternative to litigation, and addressed the many benefits of alternative dispute resolution in place of traditional litigation.

The show is scheduled to appear on Comcast Cable channel 190 on March 15, 2009 at 11:30 AM and March 18, 2009 at 5:00 PM. 

 

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The majority’s decision to withhold the distribution of dividends is simply to apply and exhort great financial pressure on the minority. The majority’s use of this simple squeeze-out technique is often used to try and buy the minority’s interest in the corporation for a below-market price. It is most effective and potentially devastating in cases where the minority is highly dependent upon receiving their income from dividends. During the course of my representation of oppressed minority shareholders, I have seen majority shareholders attempt to withhold distributions to: a widower of a former employee; a handicapped person who can no longer work; and an employee who recently lost his job.


The oppressor often couples the withholding of dividends with other squeeze-out techniques. Often, the key to the success of the use of the withholding of distributions squeeze-out technique is tied to the financial wherewithal of the minority to live without the income stream.  If the minority does not need the distributions then the failure to pay dividends is probably going to be less effective. That is why I often see the dividend squeeze-out technique to be coupled with the termination of the minority’s employment or a major reduction of the minority’s salary.


Sadly, majority shareholders will often fabricate legitimate reasons why dividends are not being distributed. Examples of excuses often used are: the recession; the loss of a client or customer; and the need for the corporation to upgrade its equipment. It becomes the burden of the minority shareholder or their attorney to prove that the stated reason is not the real reason for the decision to withhold the distribution.  That is because Courts recognize that there are many plausible reasons why funds available for distribution as dividends should be retained by the corporation.  A minority shareholder challenging the majority’s failure to issue dividends often encounters many legal and factual obstacles in obtaining relief from a Court of law.


One obstacle is the Court’s adherence to the “business judgment rule.”  It embodies a broad judicial deference to the corporation’s board of directors. The Court’s deference to the “business judgment rule” is less of a concern when it considers the actions of a board in the case of a closely held company.  That is because in the case of a close corporation the decisions often made by the board directly affect their own interests. In other words, Courts are less inclined to strictly adhere to the “business judgment rule” where the voting shareholder has a conflict of interest.   


Another possible legal obstacle a minority shareholder confronts when seeking to challenge the decision of the majority is the principle of majority control or governance of the corporation.  Fortunately, New Jersey’s minority oppression statute does provide an exception to the general rule if the oppressed minority shareholder can demonstrate that the majority’s decision frustrates their reasonable expectations as a shareholder. Brenner v. Berkowitz, 134 N.J. 488, 506 (1993). Hence, if the minority can show that the pro-offered reason to withhold distributions is false or overstated they may seek redress.


Courts have examined a number of factors when considering whether or not the decision to withhold dividends is justified or oppressive. First and foremost, the Court will consider the corporation’s present and prospective financial needs. In doing so, Courts will often study the testimony of experts who provide it with testimony related to the amount of surplus cash the corporation is holding; the amount of retained working capital in previous years; the company’s business prospects; the need (if any) for expansion and the cost of any proposed expansion; along with the corporation’s liabilities. Courts will also consider whether or not other possible squeeze-out techniques are being employed by the majority. The Court is far more inclined to find the failure to pay dividends is oppressive if other factors are present. 


A Court who finds that the decision to withhold distributions was “oppressive” can employ a number of legal and equitable remedies. They include, but are not limited to: forcing the majority shareholder to pay the distributions which should have been made; ordering that the majority purchase the minority’s shares for “fair value”; and/or awarding reasonable counsel fees and costs the minority spend in cases where the majority has acted in bad faith.
 

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The purpose of this blog entry is to provide a brief list of the squeeze-out techniques often used by majority shareholders in their effort to oppress minority shareholders. The list which follows is merely illustrates of some of the techniques I often encounter with regard to my representation of oppressed minority shareholders. Of course, this list is not exclusive. 
 

Generally, “oppression has been defined as frustrating a shareholder’s reasonable expectations.”  Brenner v. Berkowitz, 134 N.J. 488, 506 (1993) (citing, 2 O’Neil’s Close Corporations § 9.29 at 132 (Callaghan & Co., 3rd ed. 1988)).  The following situations could constitute actionable unlawful “oppression” where the majority:

1. has cut off the flow of income to the minority owner by refusing to declare dividends;
2. terminated the employment of the minority or their family members;
3. removed the minority from the board of directors;
4. decided to award themselves (or their family members) exorbitant salaries and/or bonuses;
5. diverted corporate assets to other corporations which are owned by the majority and not the minority;
6. siphoned off corporate assets by entering into leases or loans with terms favorable to the majority while at the same time detrimental to the minority;
7. refused to enforce contracts that are beneficial to the corporation because the enforcement of those contracts would be personally detrimental to the majority;
8. withheld company information;
9. embezzled company assets; and/or
10. acted fraudulently towards the corporation, which, in turn affects the minority shareholder.

   
In blog articles to follow, I will go into greater detail as to the majority’s use of the afore-described squeeze-out techniques along with how a minority shareholder may employ the law to fight back.

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Scott I. Unger, Shareholder in Stark & Stark's Litigation and Shareholder & Partner Dispute groups, will present a Continuing Legal Education (CLE) seminar in conjunction with the Bucks County Bar Association discussing Business Break-ups. The seminar will address representing squeezed-out or oppressed minority shareholders in Pennsylvania and New Jersey. The seminar will compare and contrast the available causes of action and remedies under New Jersey and Pennsylvania law. It will also address the causes and general forms of oppression.  The seminar will take place April 7, 2009 from 4:00 - 6:00 PM. You can access a registration form online here, or for additional information, please contact the Bucks County Bar Association at 215.348.9413.

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A minority shareholder can suffer catastrophic damages in a squeeze-out or oppressive situation.  In such a dilemma, the minority shareholder may be deprived of any effective voice in the making of business decisions. Moreover, they could be locked out of the company’s premises, lose their job and be denied access to important information. Without the aid of competent counsel the oppressed minority shareholder could find that their investment in the enterprise is at least temporarily worthless.
 

Fortunately, New Jersey, unlike other states, provides protections for oppressed minority shareholders.  N.J.S.A. 14A:12-7(c).  When the New Jersey Legislature enacted those protections, it recognized that the size and nature of closely held companies, coupled with the fact the relationships tend to be more intimate and intense than in a larger corporate environment could lead to oppression.
 

The purpose of this brief article is to discuss some of the causes of oppressive conduct  and to make recommendations which will hopefully prevent them. Another purpose is to provide those who have been oppressed, or the subject of an unlawful squeeze-out, with the understanding that you are not alone.  Under New Jersey law, you have recourse if you are the victim of oppressive conduct.
 

I. Greed

As might be expected, many squeeze-outs are caused largely to avarice of individuals who see and seize opportunities to enlarge their power and influence and increase their wealth.  Frequently, an unchecked greedy shareholder will seek power and wealth at the expense of others. Because closely held corporations are generally run by “majority rule,” the majority shareholder could take advantage of their majority position.
 

In addition, a shareholder who holds a position of power within a corporation and runs the business like a one-person autocratic manner may cause unrest amongst the shareholders. Obviously, it is inappropriate for an individual to run a business as a one-person show where others are owners.  The autocratic leader may ignore or simply disregard the input or opinions of the other shareholders leading to conflict.

Obviously, the commencement of litigation could aid the minority shareholder in fighting back the oppressive conduct of a greedy or autocratic shareholder. So as to avoid costly litigation, it is always prudent to create corporate rules at the time the corporation is created. This will protect the shareholders from a “greedy” or autocratic party.  It is also prudent for the shareholders to take necessary steps to maintain their relationships during the course of their association with the corporation and the other owners.
 

II. Personality Clashes & Family Quarrels.

Many times conflicts between the shareholders are caused by changes in personal relationships amongst them. Oppression often occurs as a result of a change that disrupts a relationship or triggers a family dispute.
 

1.  Divorce. Divorce frequently causes minority oppression. Because of the size and nature of closely held companies,  business and family relationships often overlap. Family dysfunction can manifest itself in oppressive conduct.  For example, the spouse of a family member who was taken into a family owned closely-held company may get squeezed out once the marriage fails. Moreover, where ownership in a business is one of the assets that has been divided in a divorce setting, a former spouse who as received a minority interest may face oppressive conduct by the former spouse or the business associates of the former spouse who do not welcome the new owner in their midst. Obviously, you should discuss these issues with your matrimonial attorney at the inception of that relationship.  Those important discussions need to continue with your matrimonial attorney throughout the course of the representation. In addition, it is important to carefully chose a matrimonial attorney or law firm who has experience with these delicate and important issues.  My firm, Stark & Stark has professionals who possess the experience necessary to aid you if you are confronted with these issues.
2. Personal Clashes. Personal clashes often cause minority oppression. Changes in personal relationships caused by misunderstandings, “growing apart,” differences in work ethics and opinions have lead to strife amongst the shareholders. Like marriage, the relationships amongst shareholders require  “work.”  It is unrealistic to expect that shareholders will agree on every decision. The key to avoiding major discord amongst the shareholders which may lead to litigation is to work with one another and to listen to the other’s point of view.  The same strategies employed by a good marriage may help avoid shareholder disputes.

III. The Aging or Ill Shareholder.

An aging or ill shareholder may produce other circumstances conducive to dissension.  For example, a shareholder with diminished mental capacities caused by disease or advanced age may be taken advantage of by one of the other shareholders. Moreover, the diminished owner’s weakness and gullibility may be seized upon and utilized to squeeze-out a third-party.

In addition, oppressive conduct may be caused by an aging shareholder who refuses to relinquish control. Like the “greedy” shareholder, an aging founder who is accustomed to running the company the way they wish may regard the corporation as their own property. Sometimes as that person ages they may become more tyrannical.  That, of course, could lead to discontent.

   

To avoid problems caused by the aging or ill shareholder, I recommend that the shareholders discuss and create clear-cut retirement rules, disability and deferred compensation arrangements, which are put into place when the founder and all shareholders are healthy. I also recommend to avoid litigation with the aging or ill shareholder’s family that they know and understand the established rules well before their relative is confronted with diminished capacities.  If there are any questions related to the capacity of the aging shareholder at the time these plans are put into place, it is probably prudent to seek a qualified health care professional who could provide an opinion as to the competency of the elderly or sick shareholder if it is ever questioned.
 

IV. Death Of A Shareholder.

The death of a founder of a business or of a principal shareholder may produce problems which may lead to oppression.  Sometimes, the successor shareholder may want to actively participate while the others may not be willing for  him to join. As discussed above, personality clashes may present the new shareholder and the other participants from working together harmoniously.

   

Whenever a shareholder dies, the decedent’s block of shares may be divided amongst several people, which enhances the chances of an incompatible shareholder acquiring an interest in the company.  The unequal division of a majority shareholder’s stock between the testator’s children may serve as a catalyst for dissension, especially where the terms where unknown prior to the decedent’s death.  

   

To prevent dissension caused by the death of a shareholder it is wise to consider and implement a succession plan.  Often with the aid of a competent attorney like my partners, Rachel Stark, Esquire, Allen M. Silk, Esquire and Henry Van Blunk, Esquire who posses the training and experience in secession planning and may devise tax-friendly plans which can avoid turmoil in the event a shareholder passes.

   

Even if the shares are not divided, the death of a corporate leader could lead to oppression. A new person making decisions in place of the decedent could change the dynamic amongst the other shareholders.  In other words, the death of a shareholder could lead to a “greedy” leader taking control or personal clashes which could effect the dynamics amongst the surviving shareholders. Thus, I recommend that the shareholders discuss who and how the company should be lead if a shareholder were to die.
 

V. Financial Reversals, Personal Vices & Tough Economic Times.
 

Financial reversals and tough economic times often exacerbate problems that otherwise might not have arisen to provoking a squeeze-out.  Tough economic times, like the current recession often lead to discontent amongst the shareholders. Sometimes financial reversals and tough economic times result in a “greedy” shareholder taking more (either openly or by embezzling) than they should to support the lifestyle they established during better economic times. 

   

In addition, personal problems such as gambling, drug and alcohol addiction could lead to corporate dissension.  Addiction often causes problems within the workplace. Reduced effort generally results in decreased profits along with increased tensions amongst the shareholders.  Like tough financial times, addiction problems could result in embezzlement of corporate funds.
 
   

To avoid litigation and conflict, shareholders must be realistic and fair with one another. In addition, companies should establish protocols for addressing personal vices that if left untreated or unchecked could negatively affect the company and its shareholders.
 

VI. Undercapitalization of The Business.
 

In many instances, the undercapitalization of the corporate enterprise produce circumstances conducive to dissension.  Like financial reversals and tough economic times, the undercapitalization of a business could lead to tremendous problems. At the inception of the corporation, the shareholders need to consider how they intend on dealing with the possible need for additional capital and memorialize those agreements in writing.

   

In addition, shareholders sometimes try to characterize capital contributions as “shareholder loans” and seek re-payment of those “loans” during difficult times. The shareholders need to discuss and memorialize agreements when loans may and may not be repaid. Since undercapitalization could lead to discontent amongst the shareholders and other associated problems it is not wise to allow repayment unless the corporation is in a place financially when it may do so.
 

CONCLUSION
   
Minority oppression causes catastrophic damages to the squeezed-out shareholder and the corporation itself. Understanding and discussing the causes of oppression is important at the inception of the corporation and during the course of the shareholders’ relationships, so as to enact strategies to avoid it.

   

New Jersey law affords oppressed minority shareholder of a closely held corporation with a plethora of rights.  If you are an oppressed minority shareholder, you should speak with an attorney who is experienced representing those who were similarly situated.

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Governor Corzine and the New Jersey Legislature have recently enacted several laws aimed at easing corporate tax burdens.  One of the most widely heralded of such laws extends the net operating loss carryforward (“NOL”). 

NOL allows taxpayers to offset the profits that they may earn in future years with the losses that they are likely incurring now.  The new law extends the NOL deduction from its current seven tax periods to twenty tax periods.  Accordingly, New Jersey corporations may benefit from their current economic woes by spreading out their NOL deductions over twenty tax periods to offset their anticipated profits during that time.

The change not only provides welcome relief for existing New Jersey corporations, but it should also serve to attract more corporations to the state now that its NOL regulations are on par with those of Pennsylvania, New York and Delaware.

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Michael J. Fekete, member of Stark & Stark's Business & Corporate group, was a featured guest on the Camden County Bar Foundation's weekly television talk show Legally Speaking on Sunday November 9, 2009. Mr. Fekete discussed the New Jersey Home Improvement Law,  the Consumer Fraud Act and the Contractor's Registration Act. You can watch the full episode online here.

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