The majority owner(s) or the owner(s) running the daily operations is(are):
- Withholding distributions of company profits and creating taxable “phantom” income by issuing K-1s with reportable “profits” but no corresponding distributions to offset the tax liability
- Majority is withholding salary from the minority or non-controlling owner
- Controlling party is issuing unnecessary or excessive capital calls (demand for cash or additional investment) to put unnecessary financial pressure on one or more owners, or conversely, an owner refuses to fund cash shortfalls leaving one or more other owners shouldering the burden
- Terminating, restricting, or precluding the employment in the company
- Taking excessive salaries, expenses, or fringe benefits and eliminating the profits
- Withholding information about the operation of the company
- Misappropriating company assets
- Failing or refusing to hold company/board/management meetings
- Preventing participation in the company decision-making
- Operating a competitive side business
- Setting up an exit plan and recruiting clients and key employees
There are a variety of strategies and legal rights to resolve a dispute among business owners. Some of the more common rights are listed below.
Breach of Contract – There should be a written contract that governs the relationship between the owners. It is important to understand the obligations under the written agreement. If there is no agreement, the owners’ conduct is governed by the default provisions in the relevant entity laws. Far too often, partners will go into business together without putting their agreements in writing. Family owned businesses are often inherited from a single parent who never foresaw the need to create an agreement with themselves thus causing multiple siblings to reinvent the relationship when that parent dies.
Breach of Fiduciary Duties – The duties of business owners to the company, and to each other if applicable, are complex. They are defined in the statutes that govern the type of entity (corporation, partnership, limited liability company, etc.). Those duties often can be and often are modified by the written agreement of the parties, particularly in the context of a limited liability company which enjoys broad contractual freedom. Justice Benjamin Cardozo is famous in part for his enunciation of the duties that business partners owe to one another:
Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. * * * Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.’
Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545 (1928) as quoted in Seaboard Industries, Inc. v. Monaco, 276 A.2d 305, 310 (Pa. 1971). However, in these more modern times, those fiduciary duties are much more nuanced than they once were and it is important to have legal representation that understands the different duties that apply in different entities, between differently responsible owners, and with different contractually defined rights.
Statutory Books and Records Inspection or information requests – All entity types provide the owners statutory rights to some level of access to the company information including financial information, if requested for a proper purpose. This information can often be compelled in an expedited judicial proceeding.
Disassociation – In some circumstances, the Court may have the power to disassociate, or expel, an owner from the business. This is particularly true in the case of a wrongdoer. But the Court has equitable powers that enable it to order a buyout of an owner who may not be a wrongdoer when fairness dictates such a result.
Accounting – A controlling owner can often be compelled to account to the non-controlling owners for the income and expenses of the business.
Dissolution – When all else fails, the Court usually has the power to order a judicial dissolution, or a sale of the business or winding up of the company affairs and sale of the assets.
It would be easy to think that the path to a judicial resolution is for one owner to sue the other. But that is very often not the correct procedural approach because an individual owner may not have standing to sue, in their individual name. Rather, if the relief belongs to the company – such as where one owner is misappropriating money from the company – then it is the company that has been “wronged” and the claims must be brought in the name of the company. However, there are very nuanced and very strict procedural requirements that govern Derivative Actions. If the procedural requirements are not properly followed, your claims can quickly be lost. Many a good lawyer has made critical mistakes in the filing or attempted filing of a derivative action and it is important to have a lawyer that is practiced and experienced in this specific type of law.
Courts will usually give deference to the controlling owners of a business in routine disagreements about the direction of the company but not if the controlling owner stands to gain, personally, from the disputed action.
Business Judgment Rule . . .
The “business judgment rule” insulates an officer or director of a corporation from liability for business decisions made: (1) in good faith; (2) where the director or officer is not interested in the subject of the business judgment; (3) is informed with respect to the subject of the business judgment to the extent he reasonably believes to be appropriate under the circumstances; and (4) rationally believes that the business judgment in question is in the best interests of the corporation.
Viener v. Jacobs, 834 A.2d 546, 557 (Pa. Super. 2003)
or “Intrinsic fairness”
Where a majority shareholder stands to benefit from his decisions as a controlling stockholder, the law requires that the majority’s action be “intrinsically fair” to the minority interest.
Most states, but not all, recognize a cause of action for “minority oppression” which allows a minority owner to assert a claim for actions by the majority that are peculiarly intended to harm the minority:
A policy of corporate governance which has as its objective the denial of benefits to the minority interest runs afoul of this fairness standard and calls into question the majority’s fulfillment of its fiduciary duty to the other shareholders.
Orchard v. Covelli, 590 F. Supp. 1548, 1556 (W.D. Pa. 1984)(Internal cite omitted). There is a fairly well-developed body of case law in Pennsylvania discussing when a majority is engaged in minority oppression and fashioning relief for the wrongdoing.
The Corporate Opportunity Doctrine precludes an officer or director “from appropriating to himself a business opportunity which in fairness should belong to the corporation, and subjects any property or profit he so acquires to a constructive trust in favor of the corporation.”
74 Harv. L. Rev. 765
In Pennsylvania, “if there is presented to [an officer or director] a business opportunity which is within the scope of its own activities and of present or potential advantage to it, the law will not permit him to seize the opportunity for himself; if he does so, the corporation may elect to claim all of the benefits of the transaction. Nor is it material that his dealings may not have caused a loss or been harmful to the corporation; the test of his liability is whether he has unjustly gained enrichment.”
Ciampa v. Conversion Sciences, Inc., 2015 WL 8196712, at *10 (Pa.Super.,2015) (quoting Lutherland, Inc. v. Dahlen, 53 A.2d 143, 147 (Pa.1947)).
- Money damages
- Lost profits
- Punitive damages
- Specific performance
- Injunctive relief
- Books and records inspection
- Appointment of a receiver
- Constructive trust
and, maybe anything the Court deems fair under its powers of equity.
