This article, written by attorney Ryan Lirette, was originally published on seacoastonline.com and can be found here.
The breakup of a business with multiple owners is often referred to as a “business divorce.” And that is for good reason. As many have recognized, these breakups, like their romantic counterparts, can often lead to hard feelings, resentment, and costly battles over assets. That is especially true when, as often happens, a dissatisfied shareholder wants to cash out the value of his or her ownership interest and leave the business.
Absent agreement from the other owners, a shareholder that seeks such a departure will encounter hurdles. Generally, shareholders of corporations or LLCs (the two most prominent forms of businesses) do not have an unfettered right to receive a buy-out of their ownership interest from the business or its owners. Instead, where an exit cannot be negotiated, the law provides certain legal tools that a dissatisfied shareholder can use to facilitate an exit from the business. Corporate and LLC shareholders should be aware of these tools to minimize the cost and disruption associated with a business breakup.
A party facing the possibility of a business divorce should first evaluate the agreements governing the business, whether that be bylaws, articles of incorporation, shareholder agreements, or LLC operating agreements. These agreements often contain provisions regulating how, and under what circumstances, a shareholder can transfer his or her shares or otherwise withdraw from the business. For example, such agreements often contain “buy-sell” provisions restricting an owner’s ability to transfer shares by granting the business or other owners a right of first refusal or a veto over contemplated transfers. Alternatively, an agreement can grant a shareholder the right, in certain circumstances, to require the business or its owners to buy his or her shares at a particular price. These are just some of the potentially relevant provisions that can be found in governance agreements. Simply put, shareholders thrust into a potential business split must become familiar with their business’s agreements.
If there are no contractual solutions, corporate and LLC shareholders will often find themselves in litigation. A dissatisfied shareholder may have a variety of claims against management or other shareholders, including claims for breach of contract or breach of fiduciary duty. The claim most likely to be raised in an attempted business departure, however, is a breach of fiduciary duty claim for a “freeze out” or oppression, which can entitle a dissatisfied shareholder to a court-ordered buyout or damages.
Although this claim has not been formally recognized by the New Hampshire Supreme Court, lower courts have assumed that a minority shareholder in a closely-held business will have a claim where controlling shareholders have acted oppressively. Oppression generally consists of conduct that subverts the minority owner’s reasonable expectations or is objectively unfair. Examples include, among other things, limiting minority shareholders’ access to the business’s profit, paying exorbitant salaries to the controlling shareholders, restricting a minority shareholder’s employment opportunities in the business, and withholding business information. Accordingly, businesses that have a dissatisfied shareholder would be well-advised, to the extent possible, to conform to the parties’ pre-existing expectations, be scrupulous about ensuring that all shareholders can access the business’s profit, and be transparent about the business’s governance.
Finally, a dissatisfied shareholder may also petition a court to dissolve the business, which could result in a court order requiring the business to wind up its accounts and liquidate its assets. Although the standards for dissolution differ slightly for corporations and LLCs, a shareholder of either entity may be entitled to relief when he or she can show, among other things, that management or the shareholders are stuck in deadlock that is permanently harming the business or preventing it from operating effectively. Dissolution is a drastic remedy, and courts are often hesitant to dissolve an otherwise productive business. Yet, dissolution is a viable remedy under appropriate circumstances. Given this, businesses must be ready to show the court that they can remain healthy and productive despite any internal strife.
In sum, a dissatisfied shareholder’s demand to cash out the value of his or her ownership interest presents problems that can implicate complex contractual and litigation issues. With a proper response, however, a business can minimize the detrimental effects associated with such a demand.