AN OVERVIEW You are co-owner of a successful business, but your business partner and good friend has run into hard times. His life is upside down and he is in the middle of a nasty divorce and desperate for money. Because his personal distractions have kept him away from the business, he has taken advances against future earnings without consulting you, and you believe he has misused his position in the company for his personal gain. A legal battle could cost you and/or the company hundreds of thousands of dollars if not more. What do you do?
At Hance Law Firm, Ltd., from time to time, we encounter this and other variations of business ownership disputes, and we know that your reaction could determine survival of your business, or result in protracted, expensive and destructive litigation.
One thing you must do to minimize cost and impact of this potential conflict is to recognize the need to act in the best interests of the company, and consistent with your duty to treat co-owners in an honest, fair and reasonable manner.
UNDERSTANDING YOUR DUTIES The starting point is understanding your role and duties (and those of your rogue partner) in the company. Business ownership is reflected in shares of stock (known as “membership units” for llcs). Officers (also known as “managers” for llcs) are responsible for the day-to-day affairs of running the company and the Board of Directors (or Board of Governors for llcs) is responsible for overseeing operation of such businesses.
State laws establish some rights and restrictions regarding company officers, directors and shareholders. For example, shareholders are entitled to: (i) vote on issues that affect the corporation as a whole; (ii) their pro-rata share of dividends; (iii) access to books and records, and; (iv) they have rights relative to their pro-rata ownership interests in other stock. Officers, directors and shareholders are required to be loyal to the company and avoid self-dealing, among other things.
Beyond basic statutory requirements though, the scope of duties and specific roles of owners, officers and directors is spelled out, if at all, in company articles, bylaws or shareholder/member control agreements. For small businesses, however, the formalities of ownership, control and management are often ignored and undocumented. In this informal structure of ownership and control, significant challenging disputes occasionally develop.
CLOSE CORPORATIONS Court decisions and state laws recognize a distinction between public companies and the so-called “close corporation.” Close corporations have three common attributes: (1) a small number of shareholders; (2) no ready market for corporate stock; and (3) active shareholder participation in the business. Berreman v. West Publishing Co., 615 N.W.2d 362 (Minn. Ct. App. 2000); (citing Donahue v. Rodd Electrotype Co., 328 N.W.2d 505, 512 (Mass. 1975)).
Courts generally recognize that close corporations are really more like partnerships in corporate guise, and that the relationship among shareholders in closely held corporations is analogous to that of partners. As such, shareholders or members of such businesses have a duty to the company and each other to act in an “honest, fair, and reasonable manner.” Minn. Stat. §302A.751, subd. 3a. This is known as a “fiduciary duty” and alternatively described as a duty to act in the “utmost good faith and loyalty” toward the company and other owners.
Additionally, courts have authority to grant equitable relief to a shareholder or member of a close corporation when the officers or directors have “acted in a manner unfairly prejudicial” toward that shareholder in his capacity as shareholder or director. Minn. Stat. §302A.751, subd. 1(b)(3). “A court may grant any equitable relief it deems just and reasonable…” including dissolving the company or ordering a buyout of one or more shareholders. Courts have found that unfairly prejudicial conduct is conduct that frustrates the reasonable expectations of the affected shareholder.
REASONABLE EXPECTATIONS In the absence of specific written agreements, reasonable expectations are determined by reference to the understandings “that would normally be expected to result from associative bargaining.” Berreman, 615 N.W.2d at 374. Courts make assumptions about the understandings objectively reasonable close-corporation shareholders would have reached if, at the venture's inception, they had bargained over how their investments should be protected. Gunderson v. Alliance of Computer Professionals, 628 N.W.2d 173 (Minn. Ct. App. 2001). One example of such a reasonable expectation would be a founding shareholder's expectation of continued employment with the company.
What this summary tells you is that in litigation, these general concepts of fairness and reasonableness often dictate the outcome and should always dictate the parties' position in negotiations. Moreover, what amounts to reasonable and fair often depends on the facts of each particular case.
OTHER TYPICAL SCENARIOS Shareholders and members often run afoul of these general principles in a couple of common ways: (i) by taking company assets or opportunities for personal use; or, (ii) by excluding co-owners from having a voice in management or reasonable benefits in the company. Taking corporate opportunities is referred to legally as “usurpation of corporate opportunity.” Excluding co-owners from the company is sometimes referred to as a minority shareholder “squeeze-out.”
Even if company shareholders or members breach their duties though, it is imperative that the company and/or other owners respond based on these principles of fairness and reasonableness. To do otherwise may well backfire.
One example is a 2005 Minnesota Supreme Court decision involving the well known fourth generation Minnesota construction company Carl Bolander & Sons, Inc. The former COO, Bruce Bolander, whose father David was the Board Chair, was terminated allegedly for taking unauthorized advances to cover his personal expenses even though the company had been suffering substantial financial losses. Although the case involved a number of complex issues, a jury awarded Bruce Bolander $1.3 million in unpaid compensation plus over $500,000 in attorney's fees after deciding that his employment agreement had been orally extended by the company, and despite his alleged misconduct. It was an expensive mistake for the company to decide it could disregard existing agreements in reaction to Bruce Bolander's misconduct. Bolander v. Bolander, 703 N.W.2d 529 (Minn. 2005).
It is important to get advice early in disputes involving co-owners of close companies to minimize the damages and preserve the chance of resolving the conflict without litigation. Communicating with other owners either informally or through formal shareholder or director meetings can often bring about a resolution.
In the absence of resolution, owners or the company can pursue injunctive relief, money damages or equitable relief from a judge or jury. Minnesota Courts have wide latitude in granting relief ranging from granting a money judgment for damages, dissolving the company or ordering a buy-out of one or more owners.
Disputes over business ownership and/or control can be very time consuming and expensive. Often the owners have had a long history, the issues are emotional, and a trial involves many witnesses and exhibits. If conflict arises, it is essential for the parties to have experienced, competent and level-headed counsel. Hance Law Firm welcomes inquiries from businesses, shareholders or officers, and our first consultation is always free of charge.