- the right to notice and voting at shareholder meetings;
- the right to inspect a company’s books and records;
- the right to dissent and receive payment for shares in certain instances;
- the right to maintain a derivative action;
- remedies for breach of fiduciary duty; and
- statutory remedies for shareholder oppression (aka “membership oppression”).
CARES Act Paycheck Protection Program Civil Fraud Investigations ResourceWhat are some Common Scenarios Giving Rise to Membership Oppression? What are some Examples of Membership Oppression? Right to Notice and Voting at Shareholder Meetings Right to Inspect the Company’s Books and Records Right to Dissent and Receive Fair Market Value for Shares Right to Maintain a Derivative Action What are some Remedies for Breach of Fiduciary Duty? Why Hire Crane Law?
What are some Common Scenarios Giving Rise to Membership Oppression?Even though the facts giving rise to membership oppression are not one size fits all, the most common scenarios involve disagreements about control and money. A minority shareholder or member has a right to know how the company is being managed and how its finances are being handled. Even minor inquires by the minority shareholder may result in the majority stakeholder or managing member acting in a way that leads to minority membership oppression. Often, the controlling majority stakeholder retaliates against the minority owners by denying them their right to notice, inspection, receive payment of dividends, etc. Oppression of minority rights can also occur in a family-run business. Conflicts between siblings or other family members that begin outside the company can end up plaguing the family business. In other cases, minority shareholder oppression occurs because the company’s directors, managers, or majority shareholders truly have something to hide. The resulting efforts to cover up the embarrassing information can involve the violation of the minority owner’s rights.
Examples of Membership OppressionThe most common examples of membership oppression include:
A. Denial of Access to Corporate Books and RecordsCorporate shareholders, LLC members, and limited partners have as a matter of law reasonable access to financial records, such as profit and loss statements and balance sheets. Denying a minority owner access to such books and records can constitute minority oppression. The Legislature has statutorily protected a corporate shareholder’s right to examine corporate records, provided penalties for a violation of those rights, and identified applicable defenses in an action to enforce those rights.
B. Withholding or Refusing to Declare DividendsMembership oppression arises when failure to declare dividends, the failure to declare higher dividends, and the withholding of dividend payments after a dividend has been declared. Minority owners have a right to receive payment of a declared dividend in accordance with the terms of the corporation’s certificate of formation, bylaws, and operating agreement. These owners may be able to enforce that right as a debt against the corporation.
C. Termination of EmploymentA minority shareholder’s loss of employment with a closely held corporation can be particularly harmful because a job and its salary are often the sole means by which shareholders receive a return on their investment in the corporation. Although at-will employment is the default, employers and employees have the freedom to contract for a different employment relationship. Corporate shareholders may memorialize the terms of employment for a director, officer, or other employees in a shareholders’ agreement. Despite the absence of an employment agreement, termination of a key employee can still be determined improper, for no legitimate business purpose, intended to benefit the directors or individual shareholders at the expense of the minority shareholder, and harmful to the corporation. The ultimate determination will depend on the facts of a given case; such a decision could violate the directors’ fiduciary duties to exercise business judgment for the sole benefit of the corporation.
D. Misapplication of Corporate Funds and Diversion of Corporate OpportunitiesThe directors of a corporation, general partners and the LLC managing member stand in a fiduciary relationship to the corporation and its stockholders, and they are without authority to act as such in a matter in which a director’s interest is averse to that of the corporation. The directors are not permitted to appropriate the property of the corporation to their benefit, nor should they permit others to do so. Shareholder oppression arises with the misapplication of corporate funds and diversion of corporate opportunities. As a matter of law, officers and directors owe a duty of loyalty to the corporation which specifically prohibits them from misapplying corporate assets for their personal gain or wrongfully diverting corporate opportunities to themselves.
E. Manipulation of Stock ValuesShareholder oppression may arise when directors manipulate the value of the corporation’s stock. In other words, in a closely held corporation, it is oppressive conduct where the controlling shareholders or directors of seek to artificially deflate the shares’ value, perhaps to allow the company or its shareholders to purchase a minority shareholder’s shares for less than their true market value, or to hinder a minority shareholder’s sale of shares to third parties.
F. Withholding Dividend PaymentsCompanies may refuse to declare or pay dividends to a minority shareholder. The controlling owners instead divert the company’s income to themselves. This is oppressive conduct. Misuse of company funds, mismanagement, and the violation of company bylaws and operating agreements can all fall within a pattern of oppression. There are as many ways to abuse the rights of minority owners as there are greedy controlling owners.
G. Dilution of Voting Rights or OwnershipThe owners who control a company sometimes try to dilute the ownership of minority members or shareholders. This can take several forms. Sometimes it happens through a change in the governing documents, such as the bylaws or operating agreement. These changes might involve the issuance of new shares or altered voting rules. Sometimes companies will allocate profits and losses in ways that are most beneficial to those in control. These changes might show up on tax returns sent to minority owners, such as Form K-1s – and they sometimes result in unfair tax implications for the minority owners.
H. Unreasonable Transfer RestrictionsShares of stock in closely held businesses are usually illiquid, and they are hardly ever traded on the open market. With few exceptions, they have no established market value. As a result, a minority owner usually cannot escape a bad situation by selling their shares for a fair value. Even when there is a market for shares, companies may restrain minority owners from selling their interest. Companies may impose reasonable restrictions on the sale or transfer of stock or membership interests. However, some restrictions may be unreasonable to the point that they constitute oppression.
I. Restrictive Determination of Share ValueIn some cases, the company or its controlling ownership might require a minority owner to provide them a right of first refusal before selling. Often, this transfer value is fixed at an amount far less than the actual value. This can be cause for an oppression action.
Right to Notice and Voting at Shareholder Meetings
Shareholders with voting rights have a right to advance notice of shareholder meetings and also the right to have an “inspector” appointed. An inspector ensures that the proceedings and all voting are conducted fairly, properly, and impartially. If the majority shareholders refuse to hold an annual meeting, a minority shareholder can petition the court to require the company to hold one.