Watch Out For Minority Shareholder Oppression Claims After Admitting Non-Family Shareholders To The Family-Owned Business

by Murtha Cullina

Controlling shareholders and managers of family-owned businesses often direct the use of company funds and other resources to provide employment and other benefits to non-shareholder family members. In a business that is wholly-owned by close family members, there may be little concern that other family member shareholders will complain about the use of such resources, as long as there is disclosure and perceived fairness concerning the use of company funds and access to employment opportunities. The risk of a potential claim for breach of fiduciary duty or minority shareholder oppression may increase, however, when non-family members are admitted into the ownership structure. At that point, historic and perhaps informal practices concerning family member involvement in, and benefits from, the company may not be acceptable to a new owner.  The controlling family member owners must therefore be careful to follow good corporate governance practices when making decisions on the company’s behalf.
A recent case from the Appellate Division of the Superior Court of New Jersey – Kieffer v. Budd – serves as a reminder that controlling owners of family businesses need to take steps to avoid potentially oppressive conduct toward minority, non-family shareholders and to ensure that decisions regarding the use of corporate resources are made in the best interest of the corporation. In the Kieffer case, a non-family minority shareholder sued the majority owner for oppressive conduct in violation of the New Jersey corporation statute.

That statute, like similar statutes or common law causes of action in many other states, provides a court with the power to fashion appropriate remedies to protect minority shareholders if corporate directors or controlling shareholders have mismanaged the corporation, abused their authority or acted oppressively or unfairly toward the minority shareholders.

Charles Budd was the president, founder and sole shareholder of Digital Production, Inc. (DPI), a closely held family business that provided graphic solutions to retailers and manufacturers. DPI, Budd and Michael Kieffer entered an agreement through which DPI employed Kieffer as vice president and through which Budd sold Kieffer twelve of Budd’s one hundred shares of common stock. Kieffer was to be paid an annual salary of $100,000. However, five months after Kieffer acquired his shares in DPI and began working as vice president, Budd informed him that the company needed to reduce both Kieffer and Budd’s salaries to $1,000 biweekly.  Budd told Kieffer that the salary reduction was temporary but necessary to induce DPI’s bank to purchase the company’s receivables. Budd also told Kieffer that DPI’s sales were poor and that the company needed to lay off two employees, Budd’s son and Budd’s girlfriend, in response to the company’s cash flow problems.

Budd eventually told Kieffer that the bank was not going to purchase DPI’s receivables and that the company lacked funds to reinstate his full salary. During the following several months when DPI was paying Kieffer a reduced salary, however, Kieffer learned that Budd had been using company funds to finance a separate graphics business managed by Budd’s son, pay for trips to Cancun, Las Vegas, and Boca Raton and pay for Budd’s girlfriend’s gym membership fees and automobile insurance. Budd also used DPI funds to pay for his grandchild’s child care costs, carpeting in his home, Broadway theater tickets, and various retail purchases. Budd produced no documents to demonstrate a business purpose for any of these expenditures.  Kieffer also learned that Budd’s son’s girlfriend was on DPI’s payroll.

Kieffer resigned as an employee as a result of his disagreement with Budd over the continuing reduced salary.  He was then replaced by Budd’s son at a higher salary.  Kieffer, as a DPI shareholder, then demanded copies of DPI’s financial records. Budd refused to produce any records and instead demanded that Kieffer sell his shares of stock back to the company for approximately one-third the price Kieffer initially paid. Kieffer rejected the share redemption offer and filed a complaint alleging minority shareholder oppression and other claims.

After trial, the judge determined that during the time of Kieffer’s salary reduction, Budd improperly used large amounts of DPI’s funds without informing Kieffer of the payments.  The judge found that the payments deprived DPI of funds that otherwise would have been available to finance activities to increase DPI’s sales and productivity.  The judge further found that Kieffer was damaged by the diversion of money from DPI to Budd’s family since the payments negatively impacted the company’s ability to pay Kieffer’s salary. The judge concluded that the lack of transparency by Budd in the payments made by DPI to and on behalf of Budd’s son, his family and company, the total amount of money diverted from DPI and the simultaneous reduction of Kieffer’s salary all constituted oppressive conduct in violation of the New Jersey minority shareholder oppression statute. The judge therefore entered an award for Kieffer in the full amount of his unpaid salary. The judge also entered an order compelling DPI to purchase Kieffer’s shares for the full amount of the initial purchase price.

On appeal, Budd argued that the record did not support the trial judge’s finding that Kieffer was an oppressed shareholder within the meaning of the New Jersey minority shareholder oppression statute. On the record before it, the Appellate Division of the Superior Court concluded that Budd’s arguments were “without sufficient merit to warrant discussion in a written opinion.”  The Court then affirmed the underlying decision “substantially for the reasons the judge expressed in her written opinion.”  In so doing, the Court flatly rejected Budd’s arguments that his conduct was in any way justified as being in the best interest of the corporation.

No two minority shareholder oppression cases are the same.  However, certain conduct appears to be common in many of these cases, including lack of transparency in decision-making, restriction of access to corporate information, use of corporate funds for non-business purposes and reduction of the minority shareholder’s salary or termination of employment.  In the case of some family-owned businesses, customs and processes may develop that are acceptable to all stakeholders even if not consistent with best corporate governance practices. When family businesses admit non-family members to the shareholder ranks, however, controlling directors or shareholders of such companies may need to reconsider their decisions and practices to ensure that they are in the best interest of the corporation and all of its shareholders. Otherwise, the continuation of past practices that were acceptable when the company was entirely family-owned may lead to claims of minority shareholder oppression and the entry of judgment against the company and its directors or controlling shareholders.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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