What are the rights of a minority owner in a closely held company?
Most businesses in the United States operate as “closely held” companies. This means the stock or ownership interest of the company is not publicly traded, but is instead held by a small group of private owners. Closely held companies include corporations, limited liability companies, and many other types of business entities. They can range in size from small family-owned businesses to large multi-national corporations.
Our firm frequently represents the owners of closely held companies in break-up or “business divorce” cases. This article briefly explores some of the common problems facing such owners, with special emphasis on one of the most common problems of all: the plight of the minority owner who believes he or she is not being treated fairly by the majority owner.
Sources of Trouble in Closely Held Companies
The owners of closely held companies usually get along well. When trouble arises, however, it frequently stems from one of the following sources.
No Written Agreement: During the infancy stages of many new businesses, the owners begin “on a handshake.” Everybody trusts everybody, and nobody sees the need to reduce anything to writing or hire a lawyer to draft an Operating Agreement. These owners do a great job of predicting the success of their new product, idea, or business plan, but they do a lousy job of predicting the problems that success can bring. Years later, these owners often find themselves in disputes, usually over money or control of the business. There are no written agreements to give direction, and each owner has a different memory of the past.
Multiple Hats: Moreover, the owners of closely held companies can be required to wear many different hats: majority owner, minority owner, president, manager, managing-member, boss, employee. These are each different roles with different (and sometimes conflicting) duties and responsibilities. What happens, for example, when the 51% owner, who is also the manager of the business, decides to fire the 49% owner, who is also an employee? Does the 49% owner have a right to a job at the company? What about salary? Can the 51% owner set everybody’s salary, including his own, regardless of what the 49% owner thinks?
Family & Friendship Bonds: The owners of closely held companies are frequently family members or long-time friends. When disputes arise, these relationships can complicate ordinary business judgment. Dollars and cents gives way to jealousy, resentment, anger and other emotions.
Stock Can’t Be Sold: The owners of stock in a closely held company cannot simply call their brokers and “sell.” There is no public market for the stock. Moreover, the written agreements that govern closely held companies usually place severe restrictions on the ability to sell the stock to anyone, public or private. Thus, minority owners frequently find themselves in the position of being part-owner of a multi-million dollar business that provides them with zero income or benefits.
Who’s Really in Charge?
Most closely held companies govern themselves based on a written agreement, called a Shareholders’ Agreement or Operating Agreement. This agreement spells out the rights and responsibilities of the owners.
If the company does not have a written agreement, the owners’ rights and responsibilities “default” to the state statutes that govern the type of entity at issue. For example, Florida’s corporate code (Ch. 607, Fla. Statutes) governs corporations. Florida’s LLC statute (Ch. 608, Fla. Statutes) governs LLC’s. Florida’s partnership statute (Ch. 609, Fla. Statutes) governs partnerships. And so on.
These statutes set up the basic outline for company governance, portions of which owners are free to modify with written agreements.
As a general rule, control starts with the owners. The owners elect a board of directors to run the company. The board then hires executive officers, such as a president, to run the day-to-day affairs of the company. The executive officers, in turn, hire and fire employees, make business decisions, and run the company on a day-to-day basis.
In a closely held company this entire command structure may be collapsed into a single 51% owner. With 51% of the vote, this person may control the board of directors, the executive officers, the distribution of profits, and all day-to-day decisions of the company.
What are the Rights of the Minority Owner?
As a general rule, unless the written agreements state otherwise, a minority owner has only three basic rights in a closely held company:
- the right to vote for the board of directors (in the case of a corporation), or the manager (in the case of an LLC);
- the right to review the books and records of the company upon request; and
- the right to receive dividends or profit distributions from the company IF they are
This lack of authority often comes as a surprise to long-time minority-owners who have also served as employees of the company. Despite years of effort and service, these minority owners find they may have no right to continued employment or to participate in the daily decisions in the company. If the majority owner decides to cease profit distributions (as is often the case in a business dispute), the minority owner may find himself starved of any financial benefit from his stock ownership.
What is “Oppression of Minority Rights”?
For minority owners, a saving grace frequently comes from the fiduciary duties owed by the majority owners. As a general rule, majority owners owe a fiduciary duty to run the affairs of the company in the best interest of the company and not in a manner that favors their own interest over the interests of minority owners.
This doctrine, frequently called “minority oppression,” prohibits majority owners from using their power to deny minority owners the right to participate in, or enjoy financial returns from, the closely held company. Examples of oppressive conduct can include:
- refusing to declare dividends or distributions when the company is profitable;
- diverting earnings to the majority owners through excessive compensation;
- removing the minority owners from the board or other management position; and
- entering into favorable contracts with affiliates of the majority owner.
Although a minority owner cannot force the majority owner to act fairly, he or she does have a remedy for improper, oppressive conduct – a lawsuit for minority oppression. The minority owner can seek money damages or, at times, a court-ordered buy-out of the minority owner for the fair market value of his or her shares.
Please Note: Rabin Kammerer Johnson provides these FAQ’s for informational purposes only, and you should not interpret this information as legal advice. If you want advice as to how the law might apply to the specific facts and circumstances of your case, please contact one of our attorneys.