Corporate and M&A Insights

What is a shareholder dispute or, in other words, shareholder oppression? The terms “shareholder dispute” and “shareholder oppression” are short hand references to business disputes between two or more owners of closely held businesses. Although the phrases both refer to “shareholders” they are used interchangeably by most people to refer to disputes between owners of not only corporations, but between owners of partnerships and limited liability companies. There are important distinctions between the various business entities that can be used, but those are beyond the scope of this introduction.

In a closely held business there are often several shareholders/partners who decided to go into business together. They can be relatives, close friends or even just business acquaintances who realized that they could combine their efforts and make a go of a new business. In many cases there is an inside partner and an outside partner. The inside partner typically is responsible for the production and fulfillment operations of the business while the outside partner is responsible for promoting the business and securing orders for the businesses goods and/or services. Sometimes a business is started by one person with a vision, but they want to share their success with others who have helped them out, when the business founder decides that he or she wants to give those individuals a chance to share in the growth and prosperity of the company, they do so by giving them stock in the company. Other times the founder opens up the ownership of the business to others in an effort to raise capital to help take the business to the next level. Whichever scenario, or even any other scenario that hasn’t been mentioned, there is the very real potential for disputes to develop over, among other things, the management of the business, the direction of the business, the level of effort being expended by owners, the compensation being paid or lack of profits to distribute.

Any of these disputes can blossom into full-fledged, to the death litigation contests, pitting partners, and their respective wills, against each other. Often times the dispute erupts over perceived slights or resentment that has festered beneath the surface for months or even years. These disputes can, and do, usually lead to the breakup of the business relationship. One owner may be compelled to sell his or her interest to the other owner at a price determined through a valuation process. In rare cases the sale of the business to a third party may be forced.

New Jersey’s General Corporations law establishes an important statutory remedy for oppressed minority shareholders in a closely held corporation.  It is critical to understanding your rights as a shareholder, however, to understand who is considered under the statute to be a minority shareholder.  You may well think, I own 50% of the stock in my company so, I can’t possibly be a minority shareholder. Well, if that is what you think, then you are potentially shortchanging yourself.

An owner of 50% of closely held corporation’s stock can be considered a “minority shareholder” within the meaning of N.J.S.A. 14A:12-7(1)(c).  Bonavita v. Corbo, 300 N.J.Super. 179, 188 (N.J.Super.Ch. 1996).  Thus, even where a corporation is owned equally by two shareholders, a court may order an equitable remedy to a shareholder dispute upon proof that the “minority” shareholder has been oppressed, or the majority shareholder has acted fraudulently or illegally, mismanaged the corporation, or abused their authority. Depending upon the particular circumstances of the case, one court has even indicated that in appropriate circumstances the owner of 98% of stock in closely-held corporation could be considered a “minority” shareholder.  The existence of voting agreements and other control restrictions may tilt the playing field in your favor.

New Jersey’s General Corporations law provides a statutory remedy for oppressed shareholders in a closely held corporation.  N.J.S.A.  14A:12-7 that so long as a corporation has 25 or fewer shareholders, then any shareholder can bring an action in New Jersey Superior Court seeking dissolution of the corporation when “the directors or those in control have acted fraudulently or illegally, mismanaged the corporation or abused their authority as officers or directors or have acted oppressively or unfairly toward one or more shareholders in their capacities as shareholders, directors, officer or employees.”

Shareholder oppression is not the only circumstance under which such a lawsuit can be commenced, but the other bases for such a lawsuit are relatively straight forward.  Thus, the definition of “shareholder oppression” requires some explanation as that term is interpreted by the courts.

As defined by New Jersey’s courts, shareholder oppression means conduct which “frustrates a minority shareholder’s reasonable expectations.” Brenner v. Berkowitz, 134 N.J. at 506.   In determining whether a particular course of conduct has oppressed a minority shareholder, courts will examine the understanding of the parties concerning their roles in corporate affairs. Muellenberg v. Bikon Corporation, 143 N.J. 168, 178-9 (1996).   When reviewing an oppression claim, the courts will consider even non-monetary expectations of the shareholder when determining whether a shareholder’s expectations are reasonable and whether the corporation or controlling shareholders or directors unreasonably thwarted them.  One of the most common expectations of a shareholder in a closely held corporation is continuing employment by the corporation and the termination of a shareholder’s position as an employee frequently leads to shareholder oppression litigation.

The New Jersey Appellate Division recently issued a ruling in a minority shareholder oppression case which reinforces the concept that the best way to resolve a minority shareholder oppression case is through settlement. The decision, Wisniewski v. Walsh, et al. (A-2650-13T3), is an unreported case but reaffirms that the finder of fact, whether it be jury or judge, is not bound by, or required to accept, the testimony of any expert and may, in fact, make its own determination of value, as long as it is based upon facts in the record.

Wisniewski v. Walsh is a case that has been in the courts for 20 years on a variety of legal issues. The issues in this particular ruling concerned whether a marketability or illiquidity discount had been imbedded in the valuation experts’ determination of the value of the company and, if not, what discount should be applied. On a prior appeal the Appellate Division had ruled that Norbert Walsh, the oppressing shareholder, was to be bought out and that a marketability discount should be applied to the value of his shares to reduce the purchase price and ensure that he, as the oppressing shareholder, did not receive a windfall by having the purchasing shareholders bear the full burden of the company’s illiquidity.

In this case the dueling experts had used different methods of valuation, one had used a discounted cash flow method of valuation while the other had used a market approach, and the trial court during the valuation aspect of the case had found the discounted cash flow approach more reliable and sound and adopted the first expert’s approach for valuation. The discounted cash flow approach involves estimating the company’s revenues over a period of time, normalizing its expenses and then discounting the resulting income stream to a present value at an appropriate rate. When determining the valuation, the trial judge accepted the first expert’s estimation of future revenues, but rejected his analysis of the company’s expenses, adopting instead the second expert’s approach to normalizing adjustments. The valuation trial judge then accepted the first expert’s discount rate of 12% for purposes of determining the present value of the resulting income stream.