Majority Owners of closely held businesses may face claims that they engaged in minority oppression of shareholders, limited liability company members or partners.
Defending the minority oppression claim requires examination of written agreements and consideration of the reasonable expectations of the owners when the business was formed.
Claims of minority oppression are asserted in any number of disputes between the majority owners of a business and one or more of the minority interest holders. The oppressed minority lawsuit is disruptive, expensive and can threaten the investments and value of the majority owners.
Claims based on oppression by minority members are available in most states under statutes applicable to corporations, limited liability companies and partnerships. While there differences in the claims based on the type of business entities, many of the claims and defenses apply to all types of businesses.
Addressing the Minority’s ‘Reasonable Expectations’ Claims
The touchstone of minority oppression claims under New Jersey law is that the majority’s behavior was contrary to the “reasonable expectations” of the minority owner when the business was formed.
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The majority owners can mount a defense by demonstrating that the claimed reasonable expectations were not in fact reasonable, or that the majority was unaware of such expectations. Alternatively, they may argue that no reasonable expectations were violated at all.
The New Jersey Supreme Court has defined oppressive conduct as objectively unreasonable when it “substantially intereferes” with the minority’s interest as shareholders. That definition has been applied to limited liability companies.
The first consideration in dealing with the reasonable expectation claims will be the scope of any agreements between the parties. If there is a written operating or partnership agreement, a shareholder’s agreement or corporate by-laws that address what the owners should expect from thew business, that agreement often will govern.
In many cases, the parties’ have other agreements that govern such issues as employment and compensation, participation in management, access to information and distribution of profits or dividends. A viable defense is often based on the written provisions of these agreements.
The conduct that is reasonable is also a fact-specific inquiry. It is judged not from the subjective viewpoint of the parties, but from an objective assessment of the facts and circumstances. Building a case that the majority’s actions were objectively reasonable is a strong defense.
Breach of Fiduciary Duties
Those who control a business, whether as an officer, director or manager or as owners of a controlling majority will typically owe fiduciary duties to those who lack control.
These fiduciary duties include a duty of loyalty and care that precludes misappropriation or waste of corporate assets, competition or self-dealing. In order to protect themselves, it is possible for majority shareholders to provide evidence that they have fulfilled their obligations of care and loyalty.
Fairness of Transactions
One of the principal ways that a controlling majority will defend itself against claims of breach of fiduciary duty is to show that that all were treated equally. A second defense is to establish that the challenged activity was objectively fair to the minority.
The majority will need to demonstrate its activities were conducted in an equitable manner, taking into account the concerns of all stockholders, members and partners.
Expert testimony is often needed to establish that the conduct challenged by the minority was objectively fair. For example, the acquisition of an asset from a majority owner may be justified by showing that it was on fair terms. Similarly, the majority be defend claims challenging loans or investments by showing that the terms in the best interests of the company.
The Business Judgment Rule
The Business Judgment Rule provides those in control of a business — majority shareholders, directors or managers – with a presumption that the actions they take in good faith in the best interests of the businesses will not be second-guessed by a court.
Many of the claims brought my minority owners alleging mismanagement will be subject to a defenses that they were within the discretion of the majority as a result of the Business Judgment Ruse.
Maintaining corporate formalities is imperative in ensuring sound corporate governance. Adhering to proper procedures when making significant decisions, such as maintaining meticulous records of board and shareholder meetings, can also serve as a strong defense.
In cases where a conflict arises regarding the provision of ample information to minority shareholders, a defense argument may arise that all necessary disclosures were, in fact, provided.
In certain situations, majority shareholders may contend that actions which appear to be oppressive were carried out due to economic exigency or as a result of a genuine business objective.