CORPORATE OPPRESSION AND DEADLOCK
By: John Newman, Spring, 2003
Most businesses are owned by small groups of people and are, therefore, “closely-held.” If the business is a corporation, they own stock and are stockholders. The percentages of ownership vary widely from equal ownership to skewed percentages.
Usually the owners of the majority of the shares can elect the board of directors, which in turn elects the officers and thereby controls the operation of the corporation. Absent a stockholders agreement providing specified rights, a minority stockholder cannot elect directors, cannot participate in management, cannot compel the payment of dividends and cannot demand employment. The only rights of a minority stockholder are to share in any dividends, to share upon liquidation of the corporation, if ever, and, perhaps, to vote on certain major corporate decisions such as sale of the company.
This imbalance of power between majority stockholders and minority stockholders has lead to many cases of corporate oppression, where the majority uses its position unfairly against the minority. Examples of such oppression are firing a minority stockholder who is employed by the corporation for no reason related to that person’s employment performance; making changes in corporate operations to hurt the minority stockholder’s status, power or financial standing; refusing to distribute profits although substantial cash is available; and refusing to hold meetings of stockholders or the board of directors. Any material, unjust disparate treatment of the minority stockholder may qualify as oppression. Corporate oppression is often used to “squeeze-out” a minority stockholder - to force him to sell his stock on a distressed basis.
Because of the fundamental unfairness of these acts, the New Jersey Legislature passed the Corporate Oppression Act 25 years ago, which has also been applied to limited liability companies and partnerships. It gives minority stockholders who are victims of corporate oppression and can prove it a number of invaluable rights.
First, a court may appoint a custodian selected by the court to run the corporation without actually declaring a receivership.
Second, the court may appoint a provisional director to serve on the board of directors and to vote on matters of importance coming before the board. This most often occurs when there is split voting power and the corporation is unable to function.
Third, the court can enter an order dissolving the corporation.
Fourth, and most significantly, the court may order the sale of all shares of the corporation’s stock held by either the majority stockholder or the minority stockholder to the corporation or to the other stockholder. In such case, the court will determine the stock’s “fair value” which will be the purchase price. After determining fair value, the court will set the terms of payment. If the court determines that any party to the suit acted “arbitrarily vexatiously or otherwise not in good faith,” it may also award reasonable expenses, including counsel fees, to the other parties.
The Corporate Oppression Act also applies in cases of corporate deadlock when either (a) there is such a division in voting power that the stockholders have not been able to elect directors at the last two scheduled annual meetings or (b) the directors or officers are unable to act on important corporate issues regarding management of the corporation due to deadlock.
The court may often appoint a custodian or provisional director before discovery and before there has been any final determination of either corporate oppression or deadlock. The goal is to maintain the company's operational status quo pending the litigation and to prevent wrongful acts during the litigation. While such appointments are burdensome, since they include the expense of the appointee and the potential unwieldiness of dealing with an outsider, they often bring dramatic protection for the minority stockholders.
The Corporate Oppression Act applies to every closely-held corporation in New Jersey. Therefore, good planning should try to strike a proper balance in the governing documents between the rights of the majority and the minority. Similarly, where voting power is equal, good planning should anticipate deadlock because people will always disagree. The alternative of a compulsory buyout in court is long and expensive. Often there is no other way out if problems have not been anticipated and provided for in corporate documents.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.
Most businesses are owned by small groups of people and are, therefore, “closely-held.” If the business is a corporation, they own stock and are stockholders. The percentages of ownership vary widely from equal ownership to skewed percentages.
Usually the owners of the majority of the shares can elect the board of directors, which in turn elects the officers and thereby controls the operation of the corporation. Absent a stockholders agreement providing specified rights, a minority stockholder cannot elect directors, cannot participate in management, cannot compel the payment of dividends and cannot demand employment. The only rights of a minority stockholder are to share in any dividends, to share upon liquidation of the corporation, if ever, and, perhaps, to vote on certain major corporate decisions such as sale of the company.
This imbalance of power between majority stockholders and minority stockholders has lead to many cases of corporate oppression, where the majority uses its position unfairly against the minority. Examples of such oppression are firing a minority stockholder who is employed by the corporation for no reason related to that person’s employment performance; making changes in corporate operations to hurt the minority stockholder’s status, power or financial standing; refusing to distribute profits although substantial cash is available; and refusing to hold meetings of stockholders or the board of directors. Any material, unjust disparate treatment of the minority stockholder may qualify as oppression. Corporate oppression is often used to “squeeze-out” a minority stockholder - to force him to sell his stock on a distressed basis.
Because of the fundamental unfairness of these acts, the New Jersey Legislature passed the Corporate Oppression Act 25 years ago, which has also been applied to limited liability companies and partnerships. It gives minority stockholders who are victims of corporate oppression and can prove it a number of invaluable rights.
First, a court may appoint a custodian selected by the court to run the corporation without actually declaring a receivership.
Second, the court may appoint a provisional director to serve on the board of directors and to vote on matters of importance coming before the board. This most often occurs when there is split voting power and the corporation is unable to function.
Third, the court can enter an order dissolving the corporation.
Fourth, and most significantly, the court may order the sale of all shares of the corporation’s stock held by either the majority stockholder or the minority stockholder to the corporation or to the other stockholder. In such case, the court will determine the stock’s “fair value” which will be the purchase price. After determining fair value, the court will set the terms of payment. If the court determines that any party to the suit acted “arbitrarily vexatiously or otherwise not in good faith,” it may also award reasonable expenses, including counsel fees, to the other parties.
The Corporate Oppression Act also applies in cases of corporate deadlock when either (a) there is such a division in voting power that the stockholders have not been able to elect directors at the last two scheduled annual meetings or (b) the directors or officers are unable to act on important corporate issues regarding management of the corporation due to deadlock.
The court may often appoint a custodian or provisional director before discovery and before there has been any final determination of either corporate oppression or deadlock. The goal is to maintain the company's operational status quo pending the litigation and to prevent wrongful acts during the litigation. While such appointments are burdensome, since they include the expense of the appointee and the potential unwieldiness of dealing with an outsider, they often bring dramatic protection for the minority stockholders.
The Corporate Oppression Act applies to every closely-held corporation in New Jersey. Therefore, good planning should try to strike a proper balance in the governing documents between the rights of the majority and the minority. Similarly, where voting power is equal, good planning should anticipate deadlock because people will always disagree. The alternative of a compulsory buyout in court is long and expensive. Often there is no other way out if problems have not been anticipated and provided for in corporate documents.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.
