Corporations often undertake a unique characteristic as a business entity - perpetual duration. Unlike joint ventures or partnerships that evaporate once the desired goal is achieved, or when a partner departs from the partnership, a corporation has the potential to outlive all of it’s creators, which presents its own set of benefits and challenges.
While it may be desirable to create a corporation at the outset with an indefinite duration, in closely held corporations where the entirety of the outstanding shares are held by a handful of shareholders, minor disputes amongst family or friends can cripple the viability of a business and ultimately dissipate the benefit one would receive from owning a portion of a corporation. In some cases of corporate abuse by majority shareholders, or a coalition which together make a majority, it is better to attempt a dissolution of the corporation rather than try to make amends.
Corporate dissolution occurs in two ways: voluntary and involuntary. Voluntary dissolution can take place if a majority of the board of directors, or a majority of the shareholders wish to dissolve the corporation. Involuntary dissolution, which is very difficult to achieve, occurs for two reasons: oppression by the majority, or deadlock.
Consider the following example. Bobby and Sue own a combined 20% in Corporation, Inc. The Shareholder Agreement and Articles of Incorporation directed that they be compensated as officers of this closely held corporation with a salary, and dividends or bonuses of the profits of the company in proportion to their ownership stake. After a dispute with the CEO and majority shareholder, Bobby and Sue are fired from their positions as officers of Corporation, Inc. and are told that they will no longer receive dividends or bonuses. Bobby and Sue are having a difficult time re-selling their shares on the market because it is a closely held corporation, and there is typically not a ready market for those shares.
The above scenario is what is called a “Freeze Out,” or, simply defined as the oppression of minority shareholders by the majority shareholders such that the minority loses its ability to gain from shares, or must sell them and lose voice in the corporation. Typically, the only way out of the corporation is to sell the shares at a low price to the majority because of the lack of a ready market for the shares of a closely held corporation.
The following are the traditional factors to consider in determining whether a minority shareholder has been frozen out:
- Majority offering a low price for minorities’ shares;
- Refusal to pay dividends;
- High salaries/pensions for the majority shareholders;
- Majority denies minority employment/salaries/pensions;
- Majority selling corporate assets at a low price; and
- Majority paying exceptionally high rent.
To avoid liability for a freeze out, corporate majority shareholders should:
- Ensure that salary and pension are within “reasonable” range;
- Do not offer minority shareholders anything for their shares - let them keep them so they do not have a low offer as an argument against you (and if minority shareholders ask majority to purchase their shares, say no!);
- Then, the Business Judgment Rule of Deference will protect the majority shareholder’s decisions.
The second situation that leads to an involuntary dissolution is deadlock. Deadlock occurs when a corporation has a n even number of directors who are equally divided with respect to the management of the affairs, or if the votes of the shareholders are so divided that they cannot elect a board, the holders of one half of the stock may petition the Court of dissolution. If there is a stalemate such that efficient management is prevented and the object of the corporation’s existence cannot be achieved, involuntary dissolution is appropriate.
If there is a dissolution, first there will be a period of time during which the two sides can attempt to work out their differences, then the corporation has the opportunity to purchase the shares from the complaining shareholders at a fair price. If the corporation declines, the Court appoints receivers to wind down the corporation, deal with contracts, creditors, and shareholders.
There are a number of remedies that the talented Business & Corporate Law team at Antonoplos & Associates are well-trained in utilizing to alleviate the corporate oppression of a minority shareholder by the majority, avoid inadvertent freeze outs by the majority, and resolve deadlock disputes. Contact our office at (202) 802-5676 to learn more!
About the Authors:
Peter D. Antonoplos, Esq. is a partner in the Law Firm of Antonoplos & Associates. Mr. Antonoplos’ practice focuses on estate planning, real estate, probate, and business & corporate law matters. Mr. Antonoplos is admitted to practice in the District of Columbia, the State of New York, and the State of Maryland. Mr. Antonoplos routinely lectures on real estate, estate planning, probate and business & corporate law issues in Washington, DC and New York. Mr. Antonoplos is a graduate of Catholic University Columbus School of Law (JD), Georgetown University Law Center (LLM in Taxation), and Yale University School of Management (MBA). He lives in Washington, DC with his wife and children. He is an avid chess player and motorcycle enthusiast. He may be reached at (202) 803-5676 or Peter@AntonLegal.com .