Most small businesses with more than a single owner typically opt to conduct their business as a corporation or as a limited liability company. When these businesses are properly established, the owners will enter into a shareholder’s agreement or a well-drafted operating agreement that provides a mechanism for the sale of a minority owner’s interest in the business should his interests diverge from the other owners, or should he no longer wish to participate in the business. However, when the parties fail to anticipate these issues, the minority owner may face problems unique to the small business. In the absence of a market for the sale of his interest, the minority shareholder at odds with the majority shareholders of a close corporation, may be without either a voice in protecting his interests or any reasonable means of recovering the value of his investment. Fortunately, for New York corporations at least, the state’s Business Corporation Law may provide a solution.
Section 1104-a of New York’s Business Corporation Law permits the holders of 20% or more of the outstanding shares of a closely held corporation to petition the courts to dissolve the corporation where the persons in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders.
The state’s highest court has interpreted “oppressive action” in light of the statute’s remedial purpose and the nature of close corporations. Unlike the shareholder in large, publicly held corporations, the shareholder in a closely held corporation typically expects to be actively involved in its management and operation. His employment by the corporation is his principal source of income and may have been the primary reason for the corporation’s organization. He looks to his salary as the return on his investment, because the earnings of the close corporation are distributed through salaries, bonuses and retirement benefits. Thus, a shareholder who reasonably expects his ownership in the corporation to entitle him to a job, a share in the corporate earnings, and a place in the corporate management “would be oppressed in a very real sense when others in the corporation seek to defeat those expectations and there exists no effective means of salvaging the investment.”
New York courts will find oppression of the minority shareholder when the majority conduct substantially defeats the minority shareholder’s reasonable expectations, which were central to that shareholder’s decision to join the venture. Where oppressive conduct is found, the court will then examine the totality of circumstances surrounding the current state of corporate affairs and relations, to determine whether dissolution is appropriate. When there has been a complete deterioration of relations between the parties, a court usually will not hesitate to order dissolution.
The statute also provides a mechanism for the majority shareholders to avoid dissolution by permitting those shareholders to file a petition electing to purchase the minority shareholder’s interest at their fair value. This effectively ends the dissolution proceeding and converts it to one addressed to the valuation of the company’s shares.
It is worth noting that a completely different standard applies where the business is a limited liability company. Because limited liability companies are governed by a different statutory scheme, the courts will look to the reasonable expectations of the parties as expressed in their agreements. If the parties fail to provide a mechanism for purchasing a dissatisfied or departing member’s interest, the courts will not look beyond those agreements to determine the parties’ intentions when establishing the business.
Frank J. Monteleone – Monteleone Law
Address: 11 Broadway, Suite 615 New York, NY 10004