Litigation Insights

Because of the fiduciary duties owed by business owners to each other, whether they are shareholders in a closely held corporation, members in a limited company, or partners in a general or limited partnership, a business owner generally is prohibited from competing with the company. This general prohibition can be modified by an agreement among the owners, but in the absence of such an agreement the prohibition stands.

Failure to do so is referred to as the diversion of corporate opportunities. An owner of a closely held business has a duty to bring to the company any business opportunity that the company would normally expect to seek to pursue. The opportunity must be presented to the company and cannot be pursued individually unless the company decides not to pursue that opportunity.

As with the prohibition on competition, the requirement to present all opportunities to the company can be altered by contract. Pursuant to N.J.S.A. 14A:3-1, a corporation can renounce its interest in, or expectancy of the opportunity to pursue, specific opportunities. One manner in which corporate opportunities can be relinquished is to insert the pertinent language in the Certificate of Incorporation. When starting a new business, if there is any thought that one or more owners might want the right to pursue competing opportunities, you want to include language in the Certificate of Incorporation, or a separate shareholder agreement, that specifies what competing businesses the shareholder may appropriate.

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The April 13, 2017, decision of the appellate division in Mill Pointe Condominium Association v. Rizvi, sought to address a condominium association’s efforts to obtain rental income, during the pendency of a foreclosure lawsuit involving an empty condominium unit. By way of background, the association had obtained a judgment against the unit owner who had failed to pay both his residential loan mortgage payments and common expense assessments, and then filed a motion before the Law Division seeking the appointment of a rent receiver, during the pendency of the mortgage lender’s foreclosure lawsuit. The association’s proposed remedy would apply the rent payments to the outstanding judgment in its favor leading up to the foreclosure. The Law Division judge denied the association’s motion, which was opposed by the mortgage lender on the basis that the commencement of a leasehold with a third-party tenant would interfere with the completion of the foreclosure suit, and that it would force the lender to become a landlord. Unfortunately, the Appellate Division was unable to rule on this issue, which became moot because the foreclosure judgment was granted before the court could address the issues. It’s important to note, however, that the court found that the association had “raised interesting and novel legal issues that could have widespread importance.” The court went so far as to recommend that future appellants file a motion to accelerate the appeal, advising the court of the time factors involved.

While the guidance from the Appellate Division in Mill Pointe Condominium Association is certainly no guaranty that another appellate panel will favorably view an association’s request for the appointment of a rent receiver in order to obtain rental income from an otherwise vacant condominium unit, it certainly presents an indication that the court is interested in investigating the possibility of a remedy for similarly situated associations facing lengthy foreclosures.

There are positive and negative considerations involved in the appointment of a rent receiver, even without the potential for contested litigation with a mortgage lender, as was the case in Mill Pointe. Generally speaking, the appointment of a rent receiver by a condominium association is more typical in the context of a foreclosure action commenced on the association’s behalf. On the positive side, rent receivers are able to collect income and apply it to monthly assessments, fees, and arrears owed on a condominium unit as set forth in the order of appointment, and they have a responsibility to avoid waste and disrepair. On the negative side, rent receivers are court-appointed professionals who are answerable only to the court, and do not take direction from the association, once appointed. Furthermore, a rent receiver is only permitted to remain in place for a limited amount of time, from the date of appointment, to the conclusion of the foreclosure case. In order to gain the most benefit, smart associations will consider moving for the appointment of a rent receiver in conjunction with initiating foreclosure proceedings.

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The New Jersey Appellate Division’s decision in Matejek v. Watson, issued on March 3, 2017, compelled the owners of condominium units to share in the cost of environmental investigation under the New Jersey Spill Compensation and Control Act (the Spill Act), without proving liability. This remedy, not previously available to private parties, will likely give rise to an increase in Spill Act litigation due to this advantage over the Comprehensive Environmental Response, Cleanup and Liability Act (CERCLA), which is the federal counterpoint to the Spill Act.

The environmental contamination in Matejek v. Watson dates from 2006, when oil was discovered on the surface of a tributary to Royce Brook in Hillsborough. In response, New Jersey Department of Environmental Protection (NJDEP) removed underground storage tanks from each of five adjoining condominium units that were near the location of the tributary. Other than visiting the site a few months after the removal of the underground tanks in order to confirm the absence of oil in the tributary, the NJDEP took no further action and its file remained open, leaving, as the trial judge later found, a cloud on the title to all five units, given that the presence of the oil would have to be disclosed if any of the properties were to be sold.

Seven years after the removal of the tanks, the owners of one of the impacted condominium units sued the owners of the other four units under the Spill Act, in order to require the owners of the impacted units to participate in and equally share in an investigation, and if necessary, remediation of the property. The Association was joined to the lawsuit in order to compel access to any portions of the common elements required for investigation, testing or remediation.

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Have you ever heard a story among your friends about a company where two partners got along great, but then one suffered an untimely death and then his widow or children caused the company to breakup? That is a common scenario, although one might not be able to place the blame on the surviving spouse or the children. This is one of the ultimate worst case scenarios that proper planning can help avoid.

As shareholders in a small company each shareholder may have a reasonable expectation of continuing employment and participation in management of the company. When one shareholder dies, unless an agreement among the shareholders is in place providing a right for the company or remaining shareholder to purchase the deceased shareholder’s stock, that stock will be transferred to that deceased shareholder’s heirs, whether by will or by intestacy. As a result, most often the deceased shareholder’s stock ends up in the hands of a surviving spouse or children. In some cases the heir of the deceased shareholder will be able to step into his or her shoes and be able to participate meaningfully in the operation of the business. There may be personality conflicts and other difficulties in operating the business with a new partner, but hopefully, those can be worked out.

More often, however, the deceased shareholder’s stock is inherited by someone who does not have any clue about the business and cannot be expected to participate in or contribute to the operation of the business in any realistic sense. Sometimes this leads the remaining original shareholder to think that he will not pay them a salary since they are not working in the business and he can retain the earnings to reinvest in the business since he is not required to pay dividends. This is a recipe for disaster and some really unfortunate consequences.

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Statutory remedies are made available to shareholders in a small, closely held corporation should harmful actions be undertaken by other shareholder or directors of the corporation. Importantly, these statutory remedies are available only to owners of a corporation with 25 or fewer shareholders.

Pursuant to N.J.S.A. 14A:12-7(1)(c), a shareholder in a closely held corporation may seek judicial remedies if the directors or other persons in control of a corporation have:

  • Acted fraudulently;
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Does your business partner owe you anything? We’re not talking about money, although that may be an ultimate outcome, we’re talking about how they treat you. Do they owe you any duty to be fair or to bring business opportunities to your company? Whether you are a shareholder in a small, closely held corporation or a member in a limited liability company, the answer to this question is yes, with some exceptions.

Every small business owner, again, whether be it a corporation or limited liability company, has a fiduciary relationship with the other business owners. What is a fiduciary relationship? A person who is a fiduciary is someone charged with a legal and/or ethical relationship of trust with one or more other persons. A fiduciary duty, in turn, is the highest standard of care that can be imposed on someone. A fiduciary is required to be loyal to the beneficiaries of that duty and there must be no conflict of interest between the fiduciary and beneficiaries. The fiduciary cannot profit personally from his position as a fiduciary.

Since each shareholder or limited liability company member owes each other a fiduciary duty the responsibility is reciprocal. Therefore, as a small business owner, you owe a fiduciary duty to your other partners whether you own 60% of the company or 5% of the company and they also owe you a reciprocal fiduciary duty.

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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.

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Recently, the New Jersey Appellate Division, in the case of Scannavino v. Walsh (Docket No. A-0033-14T1), issued a fourteen page Opinion (Approved for Publication on April 14, 2016), setting forth the law on the liability of property owners whose trees/vegetation encroaches on the neighbor’s property.  In that case, plaintiff alleged that defendants improperly allowed the roots of trees on their property to cause damage to a retaining wall between the parties’ properties.  Because the defendants did not plant or preserve the trees, they were deemed a natural condition for which the defendants were not liable.  The Opinion is very helpful in dealing with many situations involving encroaching trees/vegetation between neighbors.

There was a three day bench trial which gave the Appellate Division many facts from which to analyze the law on the subject, and most particularly the law on nuisance.  The Appellate Division noted that when analyzing nuisance claims, involving vegetation and trees, New Jersey courts are guided by the principles set forth in the Restatement (Second) of Torts.  The court recognized that the Restatement (Second) of Torts “draws a distinction between nuisances resulting from artificial and natural conditions.  The former are actionable; the latter are not.”  Thus, New Jersey courts have held that injury to an adjoining property caused by roots of a planted tree are actionable as nuisance.  Similarly, a property owner will be liable for dangerous conditions caused by hanging branches or matter dropping from trees which are not deemed “natural”, when specifically planted for the purposes of the defendant land owner.

There are fine lines of liability, which require an analysis of the specific facts of each case. There is no liability for the natural growth of tree roots; instead it is the positive acts – the affirmative acts – of the property owner in the actual planting of the tree or vegetation, which imposes liability. For example, as set forth in the Restatement (Second) of Torts §840 and noted in the Walsh case, where a possessor of land or his predecessor has planted a number of eucalyptus trees near the boundary line of B’s land and the roots of the eucalyptus trees grow onto B’s land causing damage, the landowner is subject to the rule of liability for artificial conditions, since the eucalyptus trees are not a natural condition. In contrast, there is no strict liability in nuisance where a branch of the defendant’s tree falls onto the neighbor’s garage. Burke v. Briggs, 239 N.J. Super. 269, 275 (App. Div. 1990). But then, there are gray areas under the Restatement (Second) of Torts at §363 – which may permit liability for damages caused by a tree not planted by the possessor of land where the possessor has “preserved” the tree. Liability may be imposed because the preservation is some sort of affirmative act (e.g. fertilizing or maintenance to keep the tree alive) on the part of the defendant, and not simply its failure to act.

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.

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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.

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