Legal issues arise in a variety of situations for shareholders in a business. Unfortunately, for many small incorporated businesses, issues arise where owners have irreconcilable disputes, reach deadlock or impasse, cannot work with their fellow shareholders any longer, or wish to terminate the business relationship for some other reason.
In some cases, attorneys can help facilitate this relationship before such issues arise. An attorney might draft a buy-sell agreement, partnership agreement, or shareholder agreement. These types of agreements govern the rights and obligations of the shareholders, capital contributions, loans to the business, or dissolution or termination of the corporation.
In other cases, however, where shareholders do not have clearly worded contractual agreements governing their rights and responsibilities, the shareholders may have conflicting views about their legal rights. In different cases, shareholders may be acting in good faith but simply disagree about the direction the company should take. In situations where this type of disagreement arises, a shareholder may want to sell out or dissolve the business.
In either case, it’s necessary that shareholders understand their legal rights and responsibilities before such issues arise. It’s even more important that shareholders understand the legal nature of their relationship with other shareholders when confronting significant situations during the life of the corporation.
Some shareholder claims involve distinct injuries to individual shareholders. These claims are typically brought as direct claims to benefit the shareholder. That is to say, the shareholder is the plaintiff representing only his or her interests. Under Minnesota law, there is a direct claim where “the injury to the individual plaintiff is separate and distinct from the injury to other persons in a similar situation as the plaintiff.”
Shareholder Derivative Suits
Sometimes, minority shareholders can be harmed by actions that injure the financial health of the corporation in general, as opposed to actions directed specifically at the minority shareholder. For example, the individuals controlling a Minnesota corporation (e.g., corporate officers, directors, or majority shareholders) may engage in self-dealing by misusing corporate funds, usurping corporate opportunities for their own personal gain, or entering into “sweet heart” deals involving the use of corporate funds to pay family members or other related entities under their control. Such actions may violate fiduciary duties owed to the corporation and have the effect of harming the corporation itself (and, indirectly, its shareholders).
If the controlling officers, directors, or shareholders have misused corporate funds for personal purposes, the other shareholders have the right under Minnesota law to start a shareholder’s derivative suit. In such a shareholder derivative action, the shareholder objecting to the self-dealing or misuse of corporate funds sues the controlling officers, directors, and/or shareholder for the injury suffered by the corporation.
Once the Minnesota shareholder’s derivative suit has been started, the Minnesota corporation has certain defenses which include the creation of an independent special litigation committee to investigate the merits of the minority shareholder’s derivative claims. While shareholder derivative suits are similar to individual claims brought by minority shareholders, the procedures for asserting a derivative action are different. Failure to differentiate between individual claims versus derivative claims can be fatal to the lawsuit unless the proper procedures are followed.
Minnesota shareholder’s derivative lawsuits are complex. Whether you are a majority shareholder or minority shareholder, if shareholder derivative claims have been threatened or asserted, it is important that you hire a Minnesota attorney experienced in handling Minnesota shareholder’s derivative suits. A Minnesota shareholder’s derivative suit attorney can help shareholders and corporations alike in battles over corporate funds and control.
What is a closely held corporation under Minnesota law?
A closely held corporation under Minnesota law is defined as a corporation with 35 or fewer shareholders, but a court may also find a larger corporation to be closely held under common law. The Minnesota Supreme Court has identified three characteristics indicating a common law close corporation: (1) the shareholders are active in the business; (2) there is no market for a minority interest in the stock; and (3) dividends are not usually distributed. U.S. Bank N.A. v. Cold Spring Granite Co., 802 N.W.2d 363, 380 (Minn. 2011).
What duties do shareholders owe each other?
Controlling shareholders in closely held corporations owe other shareholders a fiduciary duty. Minn. Stat. § 302A.751, subd. 3a. Specifically, the duty to “act in an honest, fair and reasonable manner in the operation of the corporation.” The fiduciary duty requires controlling shareholders to exercise “the highest standard of integrity and good faith in their dealings with each other.” Noncontrolling shareholders’ duties are less, at least where the minority shareholder lacks any “significant ability to control the corporate decision-making …” Advanced Commc’n Design, Inc. v. Follett, 615 N.W.2d 285, 293-94 (Minn. 2000).
All close corporation shareholders have an obligation not to engage in oppressive or unfair negotiating tactics that may otherwise conform to the rough morals of the marketplace. They also owe each other a duty to “refrain from arbitrarily exercising discretion or veto power,” and a “duty of loyalty, which encompasses an obligation to act with complete candor in their negotiations with each other.” Gunderson v. Alliance of Computer Professionals, Inc., 628 N.W.2d 173, 185 (Minn. Ct. App. 2001).
What duties do shareholders owe the corporation itself?
Shareholders who serve as officers and directors of a corporation also have a fiduciary duty to the corporation to act in its best interest. Minn. Stat. § 302A.251, subd. 1; Minn. Stat. § 302A.361. This duty generally requires the officers and directors to stay informed of important matters affecting the corporation, avoid self-dealing and conflicts of interest, avoid usurping corporate opportunities or engaging in competition against the corporation, and not allow the dissipation or wasting of corporate assets. Sometimes, minority shareholders assert derivative claims against the officers, directors and those in control of the corporation alleging that they have not acted in the corporation’s best interest. Most often, this occurs when those in control are accused of taking unreasonably high salaries, paying themselves extraordinary bonuses, incurring extravagant personal expenses paid by the corporation, spending corporate money to pay family members unreasonable compensation, creating conflicts of interest by doing business with companies owned by the officer or director or his/her family members, or competing against the corporation through a side business or individually.
While the law does not automatically prohibit those in control from increasing their compensation, hiring relatives, or doing business with companies owned by family and friends, these transactions should be transparent, commercially reasonable, and entered into in good faith. Under the “business judgment” rule, many of these decisions may be shielded from second-guessing by the minority shareholders provided that they are made in good faith for a valid business purpose. See In re UnitedHealth Group Inc. S’holder Derivative Litig., 754 N.W.2d 544, 551 (Minn. 2008).
What information and records are minority shareholders entitled to?
You have an affirmative duty to share material (important) information to your fellow shareholders. Further, when requested, you have a duty to provide minority shareholders with access to certain corporate records such as financial statements, tax returns, business plans, and other sensitive documents. If a shareholder submits a written demand, you must make the requested records available to them within 10 days of receipt of the written demand. The Minnesota Business Corporation Act defines what records a minority shareholder has a right to access. If a minority shareholder does request corporate documents that are required to be furnished, they must be furnished at the expense of the corporation.
What is unfairly prejudicial conduct and shareholder oppression?
In closely held Minnesota corporations, majority shareholders have a fiduciary duty to act in good faith, and with honesty, candor and loyalty when dealing with minority shareholders. Further, they cannot act in a manner that is “unfairly prejudicial” to the “reasonable expectations” of fellow shareholders. Disgruntled minority shareholders can bring claims of “shareholder oppression” when they believe these duties have been violated.
Examples of unfairly prejudicial conduct include: (1) being denied access to corporate records; (2) being denied access to financial records; (3) having responsibilities unjustly stripped away; (4) being excluded from important corporate decisions; (5) being “squeezed out” or “frozen out” of the corporation; (6) refusal by the majority shareholder to declare profit distributions; (7) being unjustly terminated from employment without cause; and (8) any other actions involving dishonesty, misrepresentation or fraud.
What is considered a “reasonable expectation” can be very subjective, and depends on the reasonable expectations of all shareholders as they exist at the inception and develop during the course of the shareholders’ relationship with the corporation and with each other. Such a determination depends on the unique facts and circumstances of each case, but courts may consider: a shareholder’s ownership interest, their job, salary, place in management and economic security when determining whether these expectations were reasonable.
To schedule a consultation to discuss your rights and options, whether as a controlling or minority shareholder, feel free to contact Bryan Battina at 612-455-0505 or by email at firstname.lastname@example.org.