A proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of a company.
INTRODUCTION
An individual or institution (including a corporation) that owns one or more shares of stock legally in a Public or Private Corporation is a shareholder.
DEFINITIONS
A majority shareholder is a single shareholder that dominates more than 50% of a corporation’s outstanding shares or sometimes a small group of shareholders who collectively control more than half of a corporation’s outstanding shares.
A minority shareholder is a one that owns less than 50% of the shares of a specific company and so the shareholder holding the minority is often less important when it comes to taking major decisions of the company.
MAIN BODY
OPPRESSION TOWARDS MINORITY SHAREHOLDERS
In order to achieve success for companies, the relationship between shareholders must be a very smooth one and should be based on loyalty, equality & honesty.
However, shareholder oppression is a situation which occurs when actions taken by majority shareholders of a corporation is responsible for oppressing the minority shareholders of a company. Since minority shareholders are particularly vulnerable as they cannot escape mistreatment by selling their stock and exiting the corporation, oppression by the majority shareholders to them is perhaps inevitable. The economic interests of a minority shareholder may be harmed by the majority if it refuses to declare dividends or attempts a squeeze out or diversion of contracts from the company to the directors personally. Minority may be locked by the majority out of the corporate premises and even the minority may be denied the right to inspect corporate records and books, making it necessary for the minority to sue every time it wants to look at them.
Majority shareholders are often charged with the complaints of squeeze out[1] or freeze out[2] . A very common claim occurs when company redeems shares but fails to provide same opportunity to minority shareholders. If a company decides to redeem shares & if it asks the majority shareholders to sell their shares it should also offer the same to minority shareholders to sell their shares at an identical price.
Majority shareholders often flout the decisions taken by the board of directors & make it almost absurd for companies to function smoothly. The majority shareholders often get the company involved in risky objects against the opinion of minority. Shareholders holding majority of shares often decide to terminate employment, or sharply cut the minority shareholder’s salary, which frequently results in an immediate and significant economic crisis. It does not take much to imagine the financial strains associated with the loss of employment. Sometimes, majority shareholder may cancel the minority shareholder’s insurance policies and deprive them of the financial benefits of being an owner/employee of the closely held company to make the squeeze-out more effective.
CASES: EXAMPLES OF OPPRESSIONS
LAWRENCE VS THEODORE.
One such case of a disagreement or a conflict between a majority shareholder and a minority shareholder is the famous case between two brothers Lawrence Lerner & Theodore Lerner. Since 1965 Theodore and Lawrence have been Lerner Corp.’s only stockholders. Theodore owned 70 shares, from 1965 to late 1995. Lawrence owned 25 shares or 26.4% of the?73.6% of the common stock. Theodore was the Corporation’s president and a majority shareholder. Prior to 1983, Lawrence was the secretary and a director. While Theodore was away for treatment the company was run by Lawrence, and after Theodore returned he found out that the Lawrence took some major decisions for the company without Theodore’s consent.
The relationship between both the brothers began to get soured. In 1985, Lawrence sued Theodore & alleged a breach of fiduciary duties[3] and attempted to?sought dissolution of the Corporation. Theodore taking advantage of being the majority shareholder attempted to freeze-out Lawrence by way of reverse stock split[4] which meant buying out the shares of Lawrence by the Lerner corporation.
Under a settlement between the parties which was reached on October 16, 1987 Theodore would continue with his then current activities while Lawrence would remain only as a minority stockholder. For development opportunities Theodore was permitted to use Lerner Corp.’s personnel and resources?and Lerner Corp without first offering Lawrence the right to purchase his proportionate share at the same price and terms offered to any other party, was not to issue additional shares of common stock.
However, the settlement did not resolve the conflicts. Lawrence filed yet another suit against Theodore, Lerner Corp and some other entities controlled by Theodore.
ALEX VS JOHN
A further example of exploitation of a minority shareholder by a majority shareholder is the case of KIRIAKIDES v. ATLAS FOOD SYSTEMS SERVICES INC John A. KIRIAKIDES and Louise Kiriakides, Respondents, v. ATLAS FOOD SYSTEMS.
In this case the allegations of the minority shareholders against the majority shareholders are that the majority shareholders have adopted means which are fraudulent, oppressive and unfairly prejudicial. They seek a buyout of their shares under judicial dissolution statutes.
Respondents are John & his sister Lousie who are the minority shareholders and the petitioners are Alex & Marica and the case is about their family business, Atlas food systems. Atlas is a food vending service which provides refreshments to factories and other businesses.
Alex has been in charge of the financial and corporate issues of the family business and has had the most control and is also the Chairman of the board of directors. In 1986, John became President of Atlas, after years of operating client relations and field operations.
Atlas, for so many years was operated as a close knit prototypical family. Problems aroused when in 1995 a rift started in the corporation between Alex & John. The initial conflict arose when Alex convinced John to transfer the property they owned in Greenville to Alex’s son Alex III. John signed the deed prepared by Alex believing he was conveying only a small portion of his interest in the property to Alex III but later discovered that the entire interest had been transferred. John became very distrustful of Alex & started requesting documents and records concerning the family business.
In December 1995, the shareholders decided to convert from the corporation from one form to another. Alex did not even care to inform John about the conversion. Later, Alex decided for sale of a piece of commercial property which John had opposed without even consulting John. As a result, John even expressed his anger & allegedly advised Alex III he was quitting his job as President.
The following Monday, when John went to work as usual he was informed that Alex had decided that John would no longer remain as president.
In September 1996, Atlas offered to purchase John’s interest for one million dollars and cancellation of 800,000 obligations owned by John. This offer was rejected by John as he presumed it to be too low. John, decided to take legal action.
After a five day hearing, the referee found Alex was engaged in fraud in numerous respects, and found Atlas had engaged in conduct which was fraudulent, oppressive and unfairly prejudicial toward John and Louise. The referee found that, at the bifurcated damages hearing, it would be determined whether John and Louise had suffered any damages from the fraud in this regard. The Court of Appeals affirmed in result. The judgment was in favor of John.
ANALYSIS
From the case of Lawrence & Theodore Lerner, we can see that the disputes between the majority and minority shareholders were very severe. In such cases, the reputations of such companies get tarnished very easily. These companies become the prime victims of yellow journalism which rapidly spoils the image of companies. As a result, the contracts or business deals that are on the way to the companies go to other companies because clients do not want to give deals to companies involved in litigations[5]. To expel minority shareholders, majority shareholders should have a valid reason such as fraud, treachery, dishonesty etc. By taking advantage of fiduciary relationships, if companies want to terminate minority shareholders, minority shareholders have all the rights to seek help of law. In the Lerner case, Theodore took advantage of fiduciary relationship to terminate Lawrence. Even in the case of John & Alex, Alex followed suit. He adopted unfair means and utilized fiduciary relationship to eliminate John. When clients of such companies get to know that minority shareholders are being mistreated, they do not want to buy shares of the company. As a result, prices of the shares of such companies decrease drastically. These conflicts of majority and minority shareholders affect a company’s performance in a very negative way by decreasing the profits it could otherwise attain. These conflicts discourage clients and prospective shareholders to work with companies involved in litigations and mistreatment of minority shareholders. If no conflicts exist, company share values increase and they continue to make profits. A good reputation can be easily attained if a company’s minority and majority shareholders are in harmony.
RIGHTS OF MINORITY SHAREHOLDERS
Minority shareholders have to work harder to preserve their shareholder rights, in comparison to majority shareholders. Shares held by minority shareholders are termed as illiquid since there is a lack of market for shares held closely. Often, for financial benefit of majority shareholders, lack of corporate control of minority shareholders is exploited.
The basic rights of minority shareholders are listed below:
• They must have the right to vote on the election of directors;
• They must have the right to amend corporate bylaws;
• They must have the right to amend articles of incorporation;
• They must have the right to vote on major corporate events such as mergers, liquidation, or the sale of substantially all the corporation’s assets;
• They must have the right to take action through a written consent;
• They must have the right to attend annual stockholder meetings;
• They must have the right to call special stockholder meetings
They must have the right to inspect books and records and the list of shareholders.
REMEDY FOR OPPRESSION
There are however, remedies for oppression which include taking the aid of law.
Shareholders are the owners of a corporation under the US law. They are entitled to elect those directors who act on behalf of the shareholders. After election of directors, they are legally required to act on behalf of the corporation and all of the shareholders. In many cases, the board delegates its management powers to the officers who are appointed by the corporation, who are legally the agents of the corporation. Controlling of the board both through the certificate of incorporation and a board seat, and the careful drafting of corporate bylaws are the best ways of maintaining corporate and corporate officer responsibility to minority shareholders. The management of the business and regulation of corporate affairs are provided by corporate by laws. The duties of officers are usually addressed by the bylaws such as, procedures governing shareholder and board meetings, access to corporate information, and similar matters. Bylaws of closely held corporations, generally corporate bylaws for two or more shareholders should take care about how each provision affects minority shareholder rights. To amend the bylaws the articles of incorporation should require that a supermajority shareholder vote is needed. During major corporate decisions such as sale of the company, the board consisting of the two shareholders should have some mechanism for tie-breaking or the input of an uninvolved third-party. Through contractual agreements minority shareholders can get and keep some measure of control. The typical three areas of focus on shareholders agreements are:
• Voting – Shareholder voting agreements; irrevocable proxies; Voting trusts
• Employment and Executive Control – executive Employment agreements
• Management and Governance – comprehensive Shareholder agreement
In maintaining the value of a minority investment and reducing minority shareholder oppression, certificate of incorporation and bylaw amendments, along with shareholder agreements, become very essential. Minority shareholder litigation typically focuses either on the majority shareholder’s breach of a fiduciary duty or minority shareholder oppression. To reduce the pain of investment illiquidity[6] and the burden of exploitation, a minority shareholder may turn to litigation. Minority shareholder litigation typically concentrates on either on the majority shareholder’s breach of a fiduciary duty or minority shareholder oppression. The court may rule that the closely held corporation is similar to a partnership and therefore shareholders owe each other a fiduciary duty similar to that owed by partners in a partnership in a minority shareholder lawsuit. Proving the exploitation in a lawsuit is immensely essential in a litigation. Exploitation generally takes the form of salaries, bonuses, “perks,” and fringe benefits going to the benefit of majority shareholders while the minority shareholder gets less or none.
A judge can find a remedy to oppression of a minority shareholder by
1) the payment of money
2) by directing the majority to buy the aggrieved shareholder’s shares for a reasonable price
3) by reinstating the aggrieved shareholder to his or her former position in the business
4) by holding an auction at which all of the shareholders have the right to purchase shares of the corporation.
There are also income tax considerations. The value of shares is affected how shares are sold. If the corporation redeems the shares for cancellation, the shareholder will receive a taxable dividend. If the shares are purchased by another shareholder, the selling shareholder may be able to claim an exemption from capital gains taxes. There are also other tax issues. Advice from a tax accountant or lawyer is required to identify the most efficient way to dispose of the shares.
Since it may take a long time for the litigations to begin, the court also has the power to grant temporary relief to ensure that the interests of the minority shareholders are preserved until the trial or hearing. The Court’s motive is to preserve the current situation without pre-judgment of the case.
Since parties, minority & majority shareholders do not want to drag the company conflicts to court, an out of court settlement is perhaps the best option. Both parties should try their best to sort out the matter amicably.
CASE: SMOOTH FUNCTIONING COMPANY
MR. MUSA ZAKARIA VS MRS. MAYA ZAKARIA.
Mr. Zakir Zakaria, in 1978 , along with his younger brother Mr. Musa Zakaria started a factory named “ZAKARIA SHIP MANUFACTURING COMPANY.”. From the very beginning, Mr Zakir was the majority shareholder & the president holding 70% of the stock and Mr. Musa was the minority shareholder holding 30% of the stock. Although Mr Musa was a minority shareholder, Mr. Zakir always made sure that he was never oppressed and all his rights were met by the company. Mr. Musa always expressed his opinions regarding the major decisions of the company.
However, Mr. Zakir, after running the business successfully for 25 years fell ill. As a result, the doctor advised him to take rest and he decided to retire from his company. After Mr. Zakir took a decision to retire from the company, Mr. Musa was confident that he would be crowned the president and would get a majority of the shares owned by Zakir. However, Mr. Musa was highly disappointed when the Mr. Zakir’s wife Mrs Maya was crowned the president & the majority of the shares were transferred to her name.
Mrs Maya, unlike her husband, was a very conniving and cunning woman who did not follow her husbands footsteps. Instead of ensuring that Musa received all his rights properly, she took all the measures to reap her own benefits at the cost of Musas rights. She declared dividends unfairly in her name and also formed agreements with different suppliers without even consulting Musa and tried to gain undue advantage from those dealings also. She also did not bother to inform Musa to attend annual meetings. All these things alienated Musa and he started to confront Maya. Then Maya also tried to freeze him out buy offering to buy his shares at a very low price as she felt his shares were illiquid and he stood no other options. These confrontations were costing the company dearly and Musa also opted for taking legal assistance to secure his rights.
However, Mr Zakir, the elder brother, came to know about his brothers intentions and decided to personally sort out the matter. He arranged a meeting among his wife and his brother and also kept lawyer present. To avoid litigations and to avoid tarnishing the goodwill established for so many years, Mr Zakir explained to his wife with the help of the lawyer what drastic consequences her exploitation of fiduciary relationship can bring. So, he decided that from then onwards a good balance between the rights of the majority and minority should be maintained. By the help of the lawyer, he tried to ensure that such exploitations on the part of Maya do not come up in the future. This out of court settlement helped to strike a proper balance between the two shareholders. As a result, the their reputation was preserved and share prices were going high, more clients wanted to work with the company and the annual financial reports showed a noteworthy increment in the profits of the company.
ANALYSIS:
Above was the example of a company, which resolved internal conflicts within the family enterprise without dragging the matter to court. They solved all their differences by themselves ensuring preservation of their reputation & good share prices. Because of the smooth functioning of the company, more people were encouraged to buy shares of the company and give them contracts.
CONCLUSION: From the first two cases above, we can deduce how adversely conflicts between majority & minority shareholders can affect a company’s performance and progress and from the last case we can see, that the company opted for out of court settlement and continued to earn high profits. Therefore, majority shareholders should ensure that the minority are getting all the rights that they truly deserve. Therefore, in order to maximize profits and establishment of good reputation, a healthy relationship between majority & minority shareholders is extremely vital.
BIBLIOGRAPHY
1.(n.d.). Retrieved March 10, 2011, from Accaglobal: http://www.accaglobal.com/archive/inpractice/62/1047930
2.(n.d.). Retrieved March 11, 2011, from Shareholder rights: http://www.shareholderrights.co.uk/disputes_nf.htm
3.(n.d.). Retrieved March 10, 2011, from Lawyers club India: http://www.lawyersclubindia.com/articles/MINORITY-SHAREHOLDER-RIGHTS-NECESSITIES-LIMITATIONS-1464.asp
4.(n.d.). Retrieved march 14, 2011, from CWSlaw: http://www.cwslaw.com/CmsData/Site/ModuleNews/DJB%20scoop%20reprint%2010.27.06.pdf
5.(2005, may 27). Retrieved march 10, 2011, from CWS LAW: http://www.cwslaw.com/CmsData/Site/ModuleNews/DJB%20scoop%20reprint%2010.27.06.pdf
6.(2007, june 23). Retrieved march 7, 2011, from http://www.hbtlj.org/v08p3/v08p3dalleyar.pdf
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8.business law. (2006, february). Retrieved march 8, 2011, from the business law blog: http://thebusinesslawblog.blogspot.com/2007/04/think-before-you-invest-as-minority.html
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[1] Squeeze out: Squeeze out occurs when majority shareholders use the power of corporate control to deny the minorities the opportunities they deserve and even eliminate them.
[2] Freeze out: Freeze out is a situation when majority shareholders frustrate minority shareholders by keeping them unaware of decisions made and by concealing company information.
[3] Fiduciary relationship is often used as a weapon for majority shareholders against minority shareholders. A legal or ethical relationship of confidence or trust regarding the management of money or property between two or more parties, most commonly a fiduciary and a principal is a fiduciary relationship. When a majority shareholder uses his control to distribute a disproportionate share of corporate profits (whether in the form of a dividend of excessive executive compensation), depriving the minority of its fair share of corporate profits, a majority shareholder breaches his fiduciary duties to the minority.
[4] Reverse stock split: It is a process by which a company issues to the shareholder a smaller no. of new shares proportionally to the original shareholding that was cancelled.
[5] Litigation (n.) is the process of taking a case through court. In litigation, there is a plaintiff (one who brings the charge) and a defendant (one against whom the charge is brought).
[6] Illiquidity: An illiquid asset is an asset which is not readily saleable due to uncertainty about its value or the lack of a market in which it is regularly traded
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