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Squeezes, freezes and the rights of minority shareholders in closely-held businesses

Let’s start with a hypothetical scenario in which A offers his friend B a job in his newly founded tech company if B is willing to invest in the business. Trusting his friend, B agrees to become a minority shareholder. For a while things are going great. A’s company is growing fast and adding new employees every month, and B likes his work. But after a couple of years B starts noticing alarming changes: A’s close relatives have obtained positions on the board of directors while B himself has been passed by, and he is increasingly feeling excluded from the decision making process. B is frustrated. The question is: What, if anything, can he do?

In California, aggrieved minority shareholders who believe that they have become victims of majority shareholder oppression or of a squeeze-out or a freeze-out can use a couple of legal tools to protect their investment. These instruments begin with voting rights and go as far as the right to force the involuntary dissolution of the company. More specifically, a minority shareholder can try to align himself with other minority shareholders in the company to create a voting majority. This new alliance can call a special meeting of the board of directors, elect a new board and gain control of the corporation. Or, if the aggrieved minority shareholder is a director in the company, he or she can demand to inspect and copy corporate documents. Such an inspection can lead to revelations that make the enforcement of other rights or remedies appropriate.

In cases where minority shareholders are able to show oppression by the majority, the courts will consider remedies ranging from damages to the redemption or purchase of shares to the involuntary dissolution of the corporation. Dissolution is considered a drastic option; a court will only order it if those in control of the corporation have engaged in what the law calls “persistent and pervasive fraud, mismanagement or abuse of authority or persistent unfairness toward any shareholders, or [the corporation’s] property is being misapplied or wasted by its directors or officers.”

Shareholder conflicts in closely held businesses, meaning corporations with less than 35 owners, are actually rather common. In some cases they arise because one individual or a handful of people turn greedy. But more often business owners simply lack the experience to run a corporation, or they don’t have the resources to handle financial difficulties or clashes between personalities. Whatever the reason for the problems may be — minority shareholders can and should protect their investments.

By Kevin J. Moore