How Is Shareholder Oppression Connected to Closely Held Corporations?
If you are a business owner in Texas, what do you need to know about shareholder oppression in relation to closely held corporations? First, shareholder oppression typically happens in closely held corporations, and we will say more about why this is true. Many individuals in Texas decide to form businesses together. Often, these individuals will form what is known as a “closely held corporation.”
According to an article in The Balance, a closely held corporation is also known sometimes as a “close corporation,” simply is a term that is used to describe a “corporation in which more than half of the shares are held by just a few individuals.” In the United States, approximately 90 percent of businesses are closely held corporations. Typically a closely held corporation is either a C corporation or an S corporation.
More specifically, the U.S. Internal Revenue Service (IRS) defines a closely held corporation as one that “has more than 50 percent of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals at any time during the last half of the tax year.”
In order to be a closely held corporation, the business cannot be a personal service corporation, which is a business owned by service professionals such as attorneys, physicians, or engineers. Now that you know more about closely held corporations, it is important to learn more about how shareholder oppression occurs.
In a closely held corporation, it is possible for majority shareholder to oppress minority shareholders. How does this happen? Since the number of shareholders is limited by Texas law and shares cannot be sold to the public (they are owned only by the business owners), a minority shareholder cannot simply sell his or her shares to the public in order to get out of the business. Instead, that minority shareholder can become vulnerable to harmful actions taken by the majority shareholders that can attempt to prejudice the minority shareholders.
Learning More About Minority Shareholder Oppression
When there is usually a situation in which a closely held corporation has majority shareholder(s) and minority shareholder(s), minority shareholder oppression can happen. The majority shareholders are the ones who end up running the company, and thus they have more control of the company than the minority shareholders.
In such a situation, the majority shareholders might engage in actions or behaviors that oppress the minority shareholders. In particular, shareholder oppression can happen when there is no shareholders’ agreement that takes into account the possibility of problems and inequalities with regard to the business.
In the Texas Supreme Court case of Ritchie v. Rupe (2014), the court emphasized that when “there is no shareholders’ agreement, minority shareholders who lack both contractual rights and voting power may have no control over how those disputes are resolved.” The court when onto observe the following about minority shareholders:
“[M]inority shareholders in closely held corporations have no statutory right to exit the venture and receive a return of capital like partners in a partnership do, and usually have no ability to sell their shares like shareholders in a publicly held corporation do; thus, if they fail to contract for shareholder rights, they will be uniquely subject to potential abuse by a majority or controlling shareholder or group.”
Indeed, when minority shareholders are “unhappy with the situation and unable to change it, they are often unable to extract themselves from the business relationship, at least without financial loss.” What are some examples of minority shareholder oppression?
- “Squeeze out” of the minority shareholder, which involves the majority shareholder employing tactics to force the minority shareholder to sell all of his or her shares to the majority shareholders for less than they are worth;
- “Freeze out” of the minority shareholder, which typically means running the business without the minority shareholder in any capacity (such as holding meetings, making important business decisions, and providing other benefits without paying any attention to the minority shareholder’s role in the business); and
- Conversion, or the attempt by majority shareholders to claim shares that belong to minority shareholders.
Remedies for Minority Shareholder Oppression in Texas
If there is no shareholder agreement, what remedies are available to a minority shareholder who has faced shareholder oppression? Prior to the Texas Supreme Court’s decision in Ritchie v. Rupe, minority shareholders did have a clear remedy for shareholder oppression. More precisely, majority shareholders would have to provide a fair price for shares to minority shareholders in order to buy them out.
However, as an article in the Yale Law Journal explains, the “astonishing” decision in Ritchie v. Rupe was one that “gutted the cause of action for shareholder oppression in Texas. As the article highlights, the Ritchie decision substantially limits available remedies for shareholder oppression.
As such, minority shareholders are ever more likely to face abusive conduct from majority shareholders, while also being unable to hold those majority shareholders accountable for their oppressive conduct. In other words, the “squeeze out” and “freeze out” of a minority shareholder looks to be entirely lawful.
In addition to Ritchie suggesting that remedies are limited or nonexistent for shareholder oppression, the article also intimates that the court’s decision is likely to have other harmful effects. For example, fewer Texans may be likely to invest in closely held corporations knowing that they could ultimately face a “squeeze out” or a “freeze out” without a clear remedy. In addition, the “economic health of many close corporations” is also likely to falter.
Seek Advice from an Experienced Business Law Attorney in Texas
Facing issues of shareholder oppression can be frustrating, angering, confusing, and often financially devastating. When you start a business with colleagues or associates, you expect that the business will run smoothly and will succeed, and that the shareholders in the business will thrive. However, when allegations of minority shareholder oppression arise, situations can become extremely contentious and complex.
If you are a minority shareholder in a closely held corporation and need assistance, you should seek advice from an experienced business law attorney in Texas as soon as possible. Contact Lindquist Wood Edwards LLP to discuss your situation with our team and to learn more about the services we provide to individuals and corporations in Texas.