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.
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.
- 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.
- 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.
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.