July 22, 2013

Shareholder Oppression: What is it and Why Care?

Holland & Knight Shareholder Rights Blog
Michael J. Zdeb

Modern corporations have as a fundamental concept that the majority controls the election of the board fundamental decisions and therefore the activities and enjoyment of the benefits of the corporation. While LLCs may manage in a way that varies this notion of a majority controlling the enterprise, generally the same is true: a majority of the vote controls all decisions.

A participant, whether shareholder or member, who holds less votes than a controlling position or a contractual right to control, effectively has a limited or no voice in decisions. As a result, the enjoyment of the economic benefits of the enterprise and participation in the management for a minority participant is at the discretion of those in control.

When this lack of a voice is combined with the fact that closely-held and family- owned enterprises rarely have a ready market for the sale of interests, a minority participant is susceptible to having his or her rights ignored or worse, abused, without a market in which to sell out. When the majority uses the mechanism of control to act in a manner that is fundamentally unfair to the minority’s interest, several theories of liability have developed to provide a remedy.

Was the Minority Share Exploited?

The idea is that those in control should not be able to exploit the minority  through the use of their authority and control.  The theories have been stated in a variety of ways:  

  • the use of the duties of partners as an analog;
  • treating the corporation or LLC as if a partnership;
  • finding direct intra-shareholder duties, and 
  • with statutory provisions using the word “oppression.”

Frequently, all of the theories get discussed under the general term "shareholder oppression." For purposes of this discussion, the term will refer to the specific provision in the model business corporation acts and the business corporation and LLC acts of a number of jurisdictions. In these acts, oppression has been defined in a number of ways:  unfairly prejudicial conduct toward the minority; persistent unfairness; unduly burdensome and unfair conduct; and what is becoming a majority position, the frustration of the reasonable expectations of the minority.

If a court finds that the majority has oppressed the interests of the minority under these acts, the court can order a variety of actions: from appointing a receiver or independent directors or managers to operate the business, expressly reversing decisions of the majority, and directing distributions to ordering an appraisal and buyout of the value of the minority’s interest. Most frequently, the value of the interest is determined under the term "fair value" (and not fair market value).

Results of Shareholder Oppression

Any dispute among shareholders or members that involves acts of oppression can result in an expensive and time-consuming process of litigation or dispute resolution.  Parties end up disputing their conduct and the "fair value" of their interests. As a result, the expense is not only the prospect of a buyout order at fair value (which can represent substantially more than fair market value), but also the expense of experts, auditors and attorneys.  In addition, the toll on the human capital of the business, customer relations, employees and operations, as well as reputations can be devastating. In the family business context, the prospect of family relationships being destroyed is also a reality.

In short, it matters how the majority exercises their authority, not only from the perspective of the minority, but from the point of view of the potential impact on themselves and their own interests. The very survival of an enterprise can be threaten by these disputes.

Related Insights