It is a nightmare scenario for any small business owner: your partner in business falls through, and you’re stuck working with someone you never intended to. It could happen in a variety of scenarios. Maybe your partner decides they would rather vacation in the Bahamas eight months a year instead of showing up at the office; maybe your partner dies, and his loud-mouthed and obnoxious children suddenly inherit half of the business. Maybe your partner is your spouse, and after a divorce, you find yourself having to work side-by-side with your ex-spouse on a daily basis in order for them to keep bread on their table. It is a tough problem, and one with limited solutions. It is natural enough that resentment builds up, and the majority shareholder or president of the company may decide to freeze the minority or equal shareholder out of the corporation.
On the other hand, what if you are an heir or the “ex”? You’ve inherited or have been awarded stock in the company. What happens if your interest is a minority interest, and the other owner or owners vote (or worse, just take actions without a meeting and vote) to stop making distributions, if an S-Corporation, or paying dividends, if a C-Corporation, and your stock becomes essentially worthless? What rights do you have?
The Missouri courts recently dealt with a situation similar to this. A father, and separately his son and daughter-in-law, each owned 50 percent of a company. The son got a divorce, and the court in the divorce proceeding awarded the son’s shares to his ex-wife. The father, perhaps understandably frustrated at the development and the fact that he now had to share the company with his son’s former wife, decided to take steps on his own. He refused to hold shareholder meetings or elect directors or officers. Without consulting his former daughter-in-law, and contrary to the requirements of the corporation’s by-laws, he paid himself a salary, and conducted a series of financial transactions and loans between himself, the business and some related companies. The former daughter-in-law brought a lawsuit, and the court undid most of the transactions and liquidated the corporation. Though this case dealt with shareholder oppression, the lesson is applicable to limited liability companies as well.
Missouri law generally requires directors and officers to act in good faith and for the benefit of the corporation and all of its shareholders. Missouri requires those in control of a corporation to not act in a manner that is “burdensome, harsh, wrongful, prejudicial to some of its members, or which is a departure from the standards of fair dealing and fair play.” Because the potential for abuses are high, courts put additional scrutiny on small, privately held corporations and hold those in control to an even higher standard of fiduciary duty than in a publicly traded corporation. The case law is fact-specific, so it is difficult to generalize what constitutes minority oppression, but some specific actions have been considered factors:
1. If the corporation fails to distribute dividends when warranted or as it has done in the past;
2. If the corporation grants favorable or long-term employment contracts to its controlling shareholders;
3. If the corporation fails to hold shareholder meetings as required by law (which is at least an annual meeting) or the corporation’s by-laws;
4. If the corporation enters into transactions with the controlling shareholder’s related companies; or
5. If the corporation forces the sale of minority shares at less than market value.
In each of these situations, the action was prescribed or proscribed, and yet those in control of the corporation continued to act in total disregard of their and the corporation’s duties to the minority shareholders.
When a court finds that oppression has occurred, the court has wide discretion in taking action to remedy the situation. Courts have remedied such oppressive conduct by ordering the appointment of a receiver to operate the corporation, rescission of agreements, payment of dividends or other sums, awarding damages to the injured shareholder, and even liquidation of the corporation.
In short, if you find yourself in this situation, there are no easy solutions. Of course, you can plan ahead to address these issues before they arise. You should consider a buy-sell agreement to avoid having to run your company with your partner’s ex-spouse, children or a judgment creditor who gained the shares through execution on a judgment. If not, you will have to work out arrangements with them after the fact, which are often more costly, and certainly without the leverage of a buy-sell agreement. If you cannot work it out, your only “solution” may eventually include dissolving the business through the courts and starting over from scratch—hardly the ideal situation for any small business owner. What the case law indicates is that you cannot just ignore your fellow shareholders and run a company as though you were the sole owner.