When forming a small business, whether a corporation or an LLC, you should know your rights and responsibilities vis-a-vis other shareholders or members of your business. Many of the rights and duties of partners, shareholders or members are governed by the company’s formal written bylaws or operating agreement, or other contract between those who form a legal business entity.
But a fact little known to many of our business clients, whether they’re forming a business or trying to efficiently operate one they formed long ago, is that there are a whole host of additional duties that owners owe each other that aren’t found in any corporate documents. These rights and responsibilities of those operating a business are derived from the common law and have nothing to do with any written document or contract.
One of the most important of those duties is found in the law of shareholder oppression. Shareholders in a closely held corporation or members of an LLC owe each other fiduciary duties, including the duty of good faith and fair dealing.
Shareholder oppression is a heavily litigated, oftentimes factually confusing and always fact-specific area of the law. It would take many, many blog entries to fully detail, but a general overview of the duties owed by owners of companies is essential for all business owners.
Oregon courts have described the standard for determining whether a business owner has been oppressed as “nebulous” and “lacking in definition.” See Weiner Investment Co. v. Weiner (1991). In summarizing the common law authorities, the Oregon Supreme court stated that what constitutes oppression of another shareholder is:
“burdensome, harsh and wrongful conduct; a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or a visual departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.” Baker v. Commercial Body Builders (1973).
While that standard may appear clear as mud, what is clear is that those in control of closely held corporations owe duties of good faith, fair dealing and full disclosure toward minority shareholders. Ultimately, oppression occurs when “the majority shareholders of a closely held corporation use their control over the corporation to their own advantage and exclude the minority from the benefits of participating in the corporation.” Cooke v. Fresh Express Foods Corporation, Inc. (2000).
This means that employment decisions, when they involve the employment of one of the owners, must be made fairly and for business, not personal reasons.
Dividend decisions must also be made in good faith and reflect “legitimate business purposes rather than the private interests of those in control.”
Because a shareholder in a small, closely held business cannot simply sell his shares on the New York Stock Exchange and get out of a bad business relationship, courts are particularly quick to protect minority shareholders in small private companies. Hayes v. Olmstead & Associates, Inc, (2001). This is called the marketability problem.
If the court determines that oppression has occurred, it has a number of remedies at its disposal, from ordering a modification of dividends or bonuses, a forced buyout of the minority shares or even dissolution or liquidation of the company.
When relations break down between co-owners, sharp elbowed conduct, or worse, is common. I always advise my clients that being very careful in the hard times is the only way to avoid liability for treatment of other shareholders.
What I’m trying to say is, no matter how big of a jerk your partner might have become, business owners have to be careful not to run afoul of the law of shareholder oppression.
See our Ten Point To-Do list in starting a small business.