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Understanding Minority Shareholders’ Rights

On Behalf of | Oct 18, 2023 | Business Law

Our clients often approach us about whether they should take on a minority shareholder. Failure to understand and confer the rights owed to minority shareholders can have dire consequences for companies and corporations of all sizes. Minority shareholders may initiate derivative lawsuits on behalf of the company or direct actions in which a minority shareholder asserts rights through legal proceedings. Majority shareholders should be aware of the obligations owed to and the rights of minority shareholders to avoid liability resulting from a breach of a duty owed to a minority shareholder.

Fair Dealing.  This duty requires the majority shareholders to exercise good faith, honesty, and loyalty in their dealings with the corporation and minority shareholders. Plainly stated, majority shareholders must deal fairly with minority shareholders. The majority shareholders may not take advantage of their position to gain personal benefits or engage in self-dealing transactions that harm the minority shareholders. As a rule, majority shareholders must act in the best interests of all shareholders, treat all shareholders equally, and avoid actions that discriminate against minority shareholders. Majority shareholders may not favor themselves or other majority shareholders at the expense of minority shareholders. Trouble can arise if majority shareholders take action that is interpreted by a court to benefit them but is understood to be detrimental to the minority shareholders. Said otherwise, if a majority shareholder in a company decided to take some action that would benefit the majority shareholder but adversely affected the value of the minority shareholder’s interest in the company, a court might construe this as a breach of the majority shareholder’s fiduciary duty. For example, if the majority shareholder decided it had excess manufacturing capacity and closed a plant operated by a minority shareholder instead of a majority shareholder’s plant, a minority shareholder might initiate a claim for breach of fiduciary duty.

Non-Oppression.  Majority shareholders are prohibited from oppressing or unfairly prejudicing the rights of minority shareholders. Typically, shareholder oppression occurs in closely held small businesses or corporations due to the absence of a public market to sell minority shares. Oppression occurs when majority shareholders exercise their power and position in the company to take action that appears to unfairly prejudice minority shareholders and harm the minority shareholder’s interest in the business. A common type of shareholder oppression is the “squeeze-out” of a minority shareholder. A squeeze-out is when the majority shareholders force an involuntary-compulsory acquisition of the minority shareholder’s interest in the business by utilizing a formulaic buy-out procedure and forcing the minority shareholder to accept a cash payout for their shares.

Continued Employment.  In Ohio, minority shareholders have successfully argued that they could not be fired because their minority ownership gave rise to an expectation of continued employment.  An employment agreement can negate this expectation; however, courts tend to closely scrutinize such agreements when the employee is also an owner. Additionally, employers should be wary about terminating an employee’s health insurance while an employee is on leave attempting to recover from a serious injury that occurred while working at the Employer’s facility, especially if the employee is a minority owner of the company. Employers should make reasonable accommodations for employees so injured employees may resume employment following the employee’s recovery. If an employer cancels an injured employee’s health insurance while the employee is recovering, the employer may be liable for the resulting damages.

Dissenter and Appraisal Rights.  In the event of a sale of a company, minority shareholders may have dissenter and appraisal rights. In these instances, a shareholder who votes against the action or sale may demand and receive the appraised fair market value for her shares rather than being bound to receive her portion of whatever would be distributed in the sale or merger.  This could be a problem if majority shareholders want to sell their company or merge with another established business. Typically, a sale by the majority shareholders includes the interest held by the minority shareholders. Minority shareholders will likely seek to increase the value of their ownership interest, while majority shareholders might have the right to acquire the minority’s shares at a formula price.  If there is a significant enough disparity between the formula price and the minority shareholders’ perception of the value of such ownership, minority shareholders might sue to invalidate the agreement.  Although the chance of success is remote for minority shareholders in the contemplated lawsuit, any claims plead could delay a sale and result in costly attorney’s fees and litigation expenses.

Dealing with Shareholders.  Companies tend to be affected by things that affect shareholders. For example, suppose a minority shareholder gets divorced or needs money. In that case, the minority shareholder may want the other shareholders to bail them out by purchasing all or part of their shares. Even if there is no legal obligation to do so, the minority shareholder may become disgruntled if the other shareholders do not comply or agree. In a divorce, the spouse may want to review books and records, or a judge may order the stock sold or grant the spouse a right to the shares. A restriction can be placed upon the shares in an attempt to avoid these results, but because a court is involved, majority shareholders are likely to lose some control.  Additionally, as a result, the company may become embroiled in the shareholder’s ongoing litigation because of the rights that the company seeks to assert and protect.

Disclosure and Transparency: Majority shareholders should provide accurate and timely information to minority shareholders regarding the corporation’s affairs. Companies and majority shareholders may not withhold material information that could impact the minority shareholders’ interests. Companies must provide financial records upon demand by minority shareholders or their agents.

General Shareholder Rights.  Under Ohio law, shareholders have basic general rights (i.e., rights to call meetings, rights to vote on amendments to a corporation’s articles or code of regulations, pre-emptive rights to purchase shares, right to receive fair and equal dividends or distributions, rights to review books, rights to bring derivative actions, rights to vote for directors, etc.).  While none of these rights alone is that troubling, they represent housekeeping items that must be addressed.  Most of these rights can be avoided by entering into a shareholder agreement; however, the more the company alters these rights, the less the interests look like typical shareholder interests.  This might negate the point of giving stock because they will not have a say in management, only appreciation rights.

Shareholder Litigation.  If litigation is a possibility, parties must take steps to preserve all potentially relevant documents and electronically stored information. These steps include, but are not limited to, suspending routine document retention and destruction policies and putting a “litigation hold” in place to ensure the preservation of relevant documents. The electronic information that must be preserved includes, but is not limited to, e-mails, texts, word processing documents and files, spreadsheets, databases, calendars, telephone logs, internet usage files, network access files, and all forms of social media.

Whether you are the majority shareholder seeking to avoid liability or a minority shareholder attempting to assert rights, retaining attentive and experienced legal counsel will ensure optimal results are achieved efficiently. Further, there are several ways to give an employee the economic benefits of ownership without burdening the company with minority shareholders.

For more information or legal assistance, please contact Harold O. Maxfield, Jr., or Matthew Mullins at (216) 621-7860.

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