MAY 2014 NEWSLETTER

The Rights of a Minority Shareholder Against Oppression

Minority shareholders are by definition outnumbered by majority shareholders and, as such, they are targets for shareholder oppression by the majority. However, there are various equitable remedies available to minority shareholders who are subjected to such oppression.

I. What is Shareholder Oppression?

Typically, shareholder oppression occurs in closely held corporations, or other small businesses, because there is a lack of a public market to sell minority shares. Oppression occurs when the majority shareholders exert their majority power or authority to take actions that unfairly prejudice minority shareholders and jeopardize their interest in the business.

One of the most common types of shareholder oppression is a “squeeze-out” of a minority shareholder. This occurs when the majority shareholders force an involuntary compulsory acquisition of the minority shareholder’s interest in the business by forcing the minority shareholder to accept a cash payout for his or her shares. This may arise when majority shareholders take actions to freeze out the minority shareholder in an attempt to force them to sell his or her shares. Often times this will happen by the majority shareholders refusing to issue dividends, or even physically barring the minority shareholder from entering the business’ premise or reviewing the corporate books and records. By blocking the minority shareholder’s access, the majority is able to limit the minority’s knowledge and information relating to the operation of the business, which could cause significant harm to his interest in the business.

Shareholder oppression can take many forms, but always results in harm or prejudice to the minority shareholders by the majority shareholders.

II. Remedies to Shareholder Oppression

Each state has separate corporate laws which govern that state’s responses and remedies to shareholder oppression. Accordingly, a minority shareholder must look to the law of the state where the business was formed or incorporated to determine what relief is available to him or her in the case of shareholder oppression.

A. Pennsylvania Remedies to Shareholder Oppression

Pennsylvania has various statutes and safeguards in place to offer protections to minority shareholders.

1. Inspection

15 Pa.C.S. § 1508, offers one such protection by granting a right of inspection to shareholders. The statute requires every business corporation to keep complete and accurate books and records of its accounts, minutes of proceedings, and a register of the shareholders and directors. Every shareholder of the business corporation has the right to examine the corporate books and records during business hours for any proper purpose, upon his or her written demand. A “proper purpose” under Pennsylvania law is any purpose which is reasonably related to the interest of the shareholder. Additionally, if the corporation refuses a minority shareholder this right of inspection or does not allow inspection within five (5) days of the written demand, the statute allows for the shareholder to apply to the Pennsylvania Courts for an order compelling inspection.

2. Dissenters’ Rights and Other Remedies in a Squeeze-Out

Pennsylvania corporate, 15 Pa.C.S. § 1571, et seq., law allows for dissenter’s rights or appraisal rights for shareholders who object to a merger. This can provide relief for minority shareholder during a squeeze-out situation. Under the Dissenters’ Rights law, 15 Pa.C.S. § 1571, a shareholder “shall have the right to dissent from, and to obtain payment of the fair value of his shares in the event of any corporate action” covered under the law. This allows a minority shareholder to dissent to proposed mergers of a corporation and give notice of their intent to demand payment of the fair value of their shares if the proposed merger is approved.

If the proposed merger is approved by the majority over the dissent of the minority, then the dissenting minority can demand payment of the fair value of his shares. The corporation may then give notice of the fair value of the shares, and the minority shareholder has an opportunity to provide his or her own estimate of the fair values of his or her shares to the corporation. If the amount cannot be agreed upon and the demand of payment is unsettled then, pursuant to 15 Pa.C.S. § 1579, the business corporation may initiate valuation proceedings to have the Court determine the fair value of the shares in question.

In addition, in Mitchell Partners, L.P. v. Irex Corp. et al., 617 Pa. 423 (Pa. 2012) the Supreme Court of Pennsylvania interpreted Pennsylvania’s Dissenters’ Law and determined what remedies are available to a minority shareholder in a squeeze-out situation. The Court found that appraisal was the exclusive remedy in merger situations, unless fraud or fundamental unfairness is present. In instances of fraud or fundamental unfairness, a minority shareholder may seek remedies under other equitable and legal claims such as breach of fiduciary duty and unjust enrichment and he or she is not limited to appraisal as his or her exclusive remedy. However, the Court in Mitchell Partners, L.P., expressly stated that appraisal is the usual remedy and other remedies would only be considered in exceptional circumstance with fraud or fundamental unfairness to the minority shareholder.

3. Dissolution

In other instances of shareholder oppression, the minority shareholder can apply for an involuntary dissolution of the corporation pursuant to 15 Pa.C.S. § 1981. This statute allows a shareholder to apply to the Court to dissolve and wind up the corporation when “the acts of the directors, or those in control of the corporation, are illegal, oppressive or fraudulent and that it is beneficial to the interest of the shareholders that the corporation be wound up and dissolved.” This provides a catch-all remedy for minority shareholders to any actions of the majority shareholders which are found to be illegal, oppressive and/or fraudulent.

B. New Jersey Remedies to Shareholder Oppression

Similar to Pennsylvania, New Jersey statutes also provide protections for minority shareholder subjected to oppressive tactics by majority shareholders.

Pursuant to N.J.S.A. § 14A:12-7, if a corporation has twenty-five (25) or less shareholders, a shareholder may bring an action if the “directors or those in control of the corporation 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 capacity as shareholders, directors, officers or employees.” This allows minority shareholders to have a remedy even if they are prejudiced or harm in their capacity as an employee and not just as a shareholder with a business interest. Often times with closely-held corporations, shareholders are employees and majority shareholders will terminate the minority shareholder’s employment in an attempt to oppress the minority shareholder’s interest and freeze them out from the corporation.

Furthermore, the statute provides a minority shareholder with multiple remedies to choose from including, seeking a order to: (1) to dissolve the corporation, (2) appoint a provisional director, (3) appoint a custodian, or (4) order a sale of the corporation’s stock. If either a provisional director or custodian is appointed that person must be a disinterested party who is not a shareholder, creditor or affiliate of the corporation, who will report on the status of the situation to the Court and will participate in making decisions relating to the business of the corporation.

If the Court orders the sale of the corporation’s shares, the purchase price will be the fair value of the shares on the date of the action was commenced, or any other date the Court deems equitable. If the parties cannot agree on the fair value of the shares then the Court may determine the fair purchase price of the shares. If the minority shareholder is seeking dissolution of the corporation, the Court will consider whether the corporation is operating profitably and in the shareholder’s best interest and any other relevant factors.

Furthermore, N.J.S.A. § 14A:12-7 provides for attorney’s fees and cost to the injured party if a determination is made that the other party acted “arbitrarily, vexatious, or otherwise not in good faith.”

In addition to closely-held corporation, New Jersey statutes also provide remedies for members of Limited Liability Companies and Partnerships who are the victim of oppressive behavior by majority members.

III. Conclusion

If you are a minority shareholder or member and think you are the victim of oppression which is jeopardizing your business interest, please contact this office to further discuss what remedies are available with one of our experienced attorneys.