Minority Shareholder Oppression: Minority Owners Have Rights Too
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In a closely held business in which one person or a small group of people have control over the company’s voting majority, life can be made difficult for a minority owner. Often times when there is a disagreement about the business the majority owner(s) will use their majority interest in an attempt to impose their will upon the minority owner. Common actions taken by the majority owner(s) are to lock the minority owner out of access to bank or other accounts, issue cash calls, stop distributions and reinvest profit back into the company, terminate the employment of the minority owner if they are an employee or increase the pay and benefits of the majority owner(s) so that there is no profit to distribute. If the company is an S-Corporation then stopping distributions and reinvesting the profits may cause the minority owner to receive a 1099 that reflects his/her share of the profit of the company when no money was actually received. This is sometimes referred to as phantom income and taxes generally must be paid on the share of the profit that was reinvested in the business. Sometimes, the majority owner(s) takes all of the above actions at once in an effort to force the minority owner to sell out.
What can a minority owner do when they are being oppressed by the majority owner(s)? The first place to look to answer this question is in the governing documents of the company. If the company is a corporation then there should be Articles of Incorporation and a Shareholder Agreement. If the company is a Limited Liability Company there should be Articles of Organization and an Operating Agreement. In addition to these documents there may be additional agreements that govern the rights of the shareholders/members. If there are no agreements other than the Articles of Incorporation or the Articles of Organization then most of the rights of the shareholders/members are going to be dictated by Florida Statutes. There is a Chapter in the Florida Statutes that govern Limited Liability Companies and there is a Chapter in the Florida Statutes that govern Corporations.
First and foremost, minority owners have a statutory right to inspect company records. If company records are being withheld from the minority owner a written demand to inspect records that complies with Florida Statutes should be made. Next, a minority owner should analyze their strongest claims and whether those claims are direct or derivative. For instance, if the minority owner had been a long term employee of the company but was suddenly terminated by the majority owner(s) then absent an employment agreement the termination of employment may not be a strong claim. However, if the majority owner(s) expend company funds on personal expenditures that may subject the majority owner(s) to significant liability. Once a minority owner analyzes their strongest claims they need to analyze whether the harm caused by the majority owner(s) was direct and specific to the minority owner or if the harm was caused equally to all owners. If the harm was caused equally to all owners then the harm was really caused to the company. If the minority owner wants to bring a claim predicated upon action by the majority owner(s) that equally harmed all owners then they would technically bring a claim on behalf of the company against the majority owner(s). This is called a derivative action and is governed by Florida Statutes. The Florida Statutes have a notice provision which requires the minority owner to give notice to the majority owner(s) of the harm they are causing the company and requesting that the majority owner(s) take action to rectify that harm. Sometimes, particularly in companies with a small number of owners, the analysis of whether a claim is direct or derivative can be complicated. Majority owner(s) generally have a fiduciary duty to the minority owner(s) and often, in a closely held company, claims of breach of fiduciary duty could be brought either directly or derivatively.
As is true in most areas of business, the best defense against minority shareholder oppression are well drafted agreements. Often when a person is given opportunity to become a minority owner they are so happy for the opportunity that they don’t put much thought into the agreements. Additionally, people that are offered an opportunity for minority ownership often underestimate their negotiating power. The minority owner should realize that control of the company is something the majority owner(s) wishes to protect. However, if the minority owner is going to be a key employee that employment relationship can be protected by a written employment agreement. If the company is a closely held company than an addendum to the shareholder/operating agreement may also be negotiated to help protect the soon to be minority owner from some of the more common methods of oppressing a minority owner. When joining a company as a minority owner you should always make your deal up front and have a well drafted agreement that fully set forth the entirety of the deal. Remember, hope for the best but plan for the worst.