Jordan Ramis pc. Attorneys at law
Preventing Shareholder Disputes in Close Corporations
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This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.
Many of you reading this article, perhaps even a majority, work for a corporation. Many of these corporations are probably small, privately held companies, also known as "close" corporations. Unlike large corporations, such as Microsoft or General Motors, the stock of a close corporation is not publicly traded. This has ramifications in many areas, but probably most importantly in the relationship between those who hold the majority of the close corporation's stock, and those who have only a minority interest in the corporation.

Publicly held corporations
In a publicly held corporation, most stockholders have no connection or involvement with the operation of the company. Rather, they hold stock merely as an investment and may sell it literally on a moment's notice at the price the market will bear. Thus, regardless of what dissatisfaction they may have with the corporation or its leadership, and regardless of the corporation's treatment of them, these shareholders generally have an escape valve — the ability to sell their stock for fair market value on the open market.

Close corporations
In a close corporation, on the other hand, all shareholders are generally either employees of the company or have significant involvement in the company's operations. While stock in the company does constitute a form of investment, the primary benefit the shareholders of a close corporation receive from the corporation is compensation for their employment, and/or a share of the corporation's profit. Unlike shareholders in publicly traded corporations, these shareholders cannot simply sell their stock for fair market value on a moment's notice, as a close corporation's stock is not publicly traded. For these reasons, a minority interest in a close corporation is effectively worthless unless the minority shareholder is employed by or allowed to share in the profits of the corporation, or some mechanism exists that allows the minority shareholder to exit the corporation and receive fair value for his interest in the corporation.

It is not difficult to imagine how a majority shareholder in a close corporation, or a combination of shareholders forming a majority, can unfairly take advantage of their majority position to the detriment of the minority. While the possibilities are endless, classic examples of majority "oppression" include firing minority shareholders without paying any value for their shares, unreasonably raising the majority shareholder's salary, and refusing to pay dividends in bad faith.

Because of the ease with which a majority shareholder can abuse its position, Oregon law, as in all states, provides that majority shareholders owe minority shareholders the fiduciary duties of good faith, loyalty, fair dealing, and full disclosure. In essence, the majority shareholder must act for the benefit of all shareholders, not just the majority.

The possible remedies for "oppressive conduct" or breach of fiduciary duty are practically endless, depending on the facts, with the most drastic remedy being dissolution of the corporation. Because the specific standards of conduct in this area are far from black and white, and because these cases often involve significant personal relationships, they are often complex, difficult, and expensive to resolve.

It is therefore critical that persons entering into a majority/minority relationship in a close corporation develop agreements that will define shareholders' roles and responsibilities, as well as prescribing a method for separation of shareholders in the event of a dispute or other events. The same holds true for existing close corporations.

The specific type of provisions that will be necessary depend on the circumstances and are beyond the scope of this article. However, at bare minimum, the shareholders should have a buy/sell agreement, describing the events and circumstances, such as termination or retirement, under which a shareholder may be required or allowed to sell his shares back to the corporation. Important provisions that are typical in buy/sell agreements include provisions describing under what conditions a shareholder may sell his interest in the corporation to another, the method for valuing a shareholder's shares, and under what circumstances a departing shareholder can compete with his prior corporation.

The shareholders may also wish to have some type of agreement describing the responsibilities of all shareholders in operating the corporation, and specifics on how the corporation is to be run. For example, such an agreement might discuss compensation issues, including future raises, to avoid disputes and lessen the chance that the majority will act oppressively.

Finally, in some corporations, such as family corporations, it is desirable to have an agreement outlining how the corporation will be operated when the majority owner retires or dies. A corporation that is seemingly functioning efficiently and smoothly can be thrown into chaos when a majority owner dies and a power struggle ensues. Any agreement should have alternative dispute resolution language, requiring mediation and arbitration.

With proper planning, shareholders of a close corporation who encounter unexpected events and disputes stand a good chance of resolving these issues relatively quickly and continuing in their primary endeavor - growing the corporation and making profits. Without proper planning, these events can disrupt, even destroy, the goals shareholders work so hard to achieve.