Shareholder Disputes and Shareholder Control Agreements
(Minnesota Shareholder Rights, Shareholder Disputes, Shareholder Derivative Lawsuits, Business Ownership Disputes)
Ownership, Member and Shareholder disputes are not limited to large corporations. They may occur at any time in any type of business entity. Disputes may range from breaches of fiduciary duty and loyalty to dilution of ownership interests and valuation issues.
According to the Small Business Administration (SBA), small businesses make up more than 99.7% of all employers. Moreover, they create more than 50 percent of the non-farm private gross domestic product (GDP). In fact, small businesses are located in virtually every state, city and neighborhood that you can find. Home-based businesses alone account for 53 percent of all small businesses.
One of the most important issues presented to a new business is their choice of a business entity. These choices include sole proprietorships, partnerships, limited liability companies and corporations. In most instances, business owners wisely choose the corporate form that limits their personal liability and allows them to save money in a variety of ways including taxes.
Many of these corporations are small, privately held companies. These are also known as "close" corporations or “Subchapter S corporations.” Unlike large corporations, such as 3M or General Mills, the ownership or stock of closely held corporations is not publicly traded. Instead, the stock ownership is maintained in the hands of a small number of people. These are often family members or friends who started the business together.
The make up of these small businesses also means that the stock owners have quite different expectations than those held by shareholders in publicly traded corporations. For example, shareholders of Microsoft stock have invested in that stock primarily as an investment. Since it is publicly traded they may very easily sell their stock and the going rate on the stock market on any given day. If such freedom to sell stock in closely held corporations were allowed, family member could find themselves sharing ownership and working side by side with strangers or new owners with a very different view of how the business should be run. This is a breeding ground for conflict.
For that reasons, a minority interest in a close corporation is effectively worthless unless the minority shareholder is employed by or allowed to share in the profits of the corporation, or some mechanism exists that allows the minority shareholder to exit the corporation and receive fair value for his interest in the corporation.
It is not difficult to imagine how a majority shareholder in a close corporation, or a combination of shareholders forming a majority, can unfairly take advantage of their majority position to the detriment of the minority. While the possibilities are endless, classic examples of majority "oppression" include firing minority shareholders without paying any value for their shares, unreasonably raising the majority shareholder's salary, and refusing to pay dividends in bad faith.
Because of the ease with which a majority shareholder can abuse its position, Minnesota law provides that majority shareholders owe minority shareholders the fiduciary duties of good faith, loyalty, fair dealing, and full disclosure. In essence, the majority shareholder must act for the benefit of all shareholders, not just the majority.
It is important to note that Minnesota law also gives any shareholder the right to examine the financial books, stock register, meeting minutes and other important corporate records, and provides a direct right of action, including an award of legal expenses, to enforce these rights.
In addition to these statutory rights, business owners may further define the rights and responsibilities of the shareholder members by contract. Sadly, in small corporations, all to often owners concentrate only on forming the business without any thought to what may occur in the future or how potential disputes may be resolved. When the business is formed, the owners may have a unified vision of what they hope to accomplish. Unfortunately, over time, circumstances have a way of changing what once were uniform expectations and goals. As a result, it is imperative for every corporation to have in place an enforceable agreement between the shareholders that will save legal wrangling if a situation arises.
Situations may be created over simple life changes such as the death of a stock owner, divorce, retirement or a desire to sell their business shares. In each case, it is important for the shareholders to have an agreement that covers each situation and how the corporation will be owned operated. Even a corporation that is running efficiently and smoothly can be thrown into chaos when such life and ownership changes occur and a power struggle ensues. Such agreements are called “Shareholder Control Agreements.”
In most case to prevent shareholder disputes, a Shareholder Control Agreement should address the following issues:
1. VALUING STOCK. One of the most important issues is how to value a shareholder’s stock interest. Businesses may be valued in many different ways, including fair market value, book value and based on a percentage of the business’ gross revenue. In some cases, Shareholder Control Agreements specify that business shareholders meet annually to establish a value to be applied until the next meeting. In other instances, specific appraisals and methods of appraisals may be specified in the event of death, divorce or retirement of a shareholder. Depending on the nature of the business one valuation method may be more appropriate than another.
2. RESTRICTIONS ON STOCK TRANSFER. Another extremely critical issue relates to how shareholders’ may restrict the sale or transfer of their shares. A Shareholder Control Agreement can address a myriad of possibilities and may limit the circumstances under which shares can be transferred and give shareholders the right to approve any purchaser. In most cases, the company generally has the first option to purchase the shares that are offered for sale. After the corporation, the remaining shareholders often have the next option. Restrictions on the transfer of stock may address issues related to death, retirement, bankruptcy, divorce and more
3. EVENTS THAT TRIGGER STOCK SALES. As stated previously, death, retirement, bankruptcy and/or divorce frequently trigger the sale of the stock of a shareholder. It is very important that Shareholder Control Agreements list these and any other events that, upon their happening, are treated as an immediate offer to sell the shares. Other events may include: termination of employment of a shareholder, conviction of a felony, or, where appropriate, the loss of a professional license. Where desired, the Shareholder Control Agreement may state that certain events trigger a reduction in the purchase price or less favorable method of valuation.
4. PROCEDURES ON TRANSFER. A Shareholder Control Agreement also encompasses the procedures by which shares are transferred and compensation for those shares paid.
5. COVENANTS NOT TO COMPETE AND PROPRIETARY INFORMATION. Shareholder Control Agreements often include terms that are most often seen in employment contracts such as: Covenants not to Compete, Confidentiality Agreements, Return of Proprietary Information and/or Client or Buyer lists.
If you would like more information about disputes among business owners and/or shareholder disputes, please contact us at 612-240-8005 or e-mail
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Minority shareholders may obtain relief from controlling shareholders in the following circumstances:
Breaches of fiduciary duty
Failure to declare proper dividends
Unlawful competition and non-compete issues