Are You Oppressed? Truth and Consequences for Minority Shareholders
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.
