Typically, freeze out scenarios involve majority equity holder(s) of a close corporation leveraging their position to force minority equity holder(s) into acting or refraining from acting in a certain way. The New Jersey Oppressed Shareholder Statute provides a cause of action for any shareholder of a corporation with 25 or fewer shareholders; in which officers, directors or members have acted fraudulently, illegally, mismanaged the business, abused their authority or acted oppressively or unfairly toward the minority, resulting in harm or detriment to the minority shareholder. Depending on the exact nature of this wrongful behavior and its harmful effects, actions can be maintained on behalf of both the shareholder and the corporation.
New Jersey court’s define shareholder oppression as, “frustrating a shareholder’s reasonable expectations” with respect to their business investment. Factors that are considered by the court include, “the circumstances, arrangements and personal relationships that frequently underlie the formation of close corporations [which] generate certain expectations among the shareholders concerning their respective roles in corporate affairs, including management and earnings.” Often in freeze-out scenarios the minority shareholder has several causes of action to effect legal recourse against the majority.
Majority vs. Minority
Under New Jersey state law, to bring an action as an oppressed or frozen-out minority shareholder you do not necessarily need to hold a minority position. The exception to the rule was applied in Bonavita v. Corbo, a 1996 New Jersey case in which the Court held the owner of 50% of a closely held corporation’s stock can be considered a “minority shareholder” within the meaning of the oppressed shareholder statute authorizing the court to take remedial action.
LLC’s: Operating Agreement vs. Default Provisions
In the absence of a signed operating or shareholder agreement, the New Jersey Revised Uniform Limited Liability Company Act provides default provisions that define the relationship between owners of closely held corporations. Specific default provisions of the Act have been highlighted below to give a sense of what rights and obligations are guaranteed to shareholders of a New Jersey LLC.
- An LLC is “member-managed” unless the operating agreement expressly provides it will be “manager-managed” or “managed by managers.” N.J. Stat. Ann. §42:2C-2.
- Effect: Absent a contrary provision in your operating or shareholder agreement, every member of the LLC has pro rata management authority.
- Contributions Are Not Limited to Cash
- Contributions include any tangible or intangible benefit provided by an individual to a limited liability company in exchange for equity and may include “money, services performed, promissory notes, other agreements to contribute money or property, and contracts for services to be performed.” J. Stat. Ann. § 42:2C-32.
- Effect: Absent any other agreement, contributing any of the above can have an equal effect on your receipt of equity in the corporation and thus your entitlement to its earnings/profits.
- Who Is Entitled to Profits?
- Distributions from the company’s profits prior to dissolution must be made in pro rata shares to all members and often dissociated members as well. J. Stat. Ann. § 42:2C-34., N.J.S.A. 14A: 12-7(1)c).
- Effect: Absent any contrary agreements (i.e. priority return of capital) all members of an LLC are entitled to share in distributions and under the Act members can be personally liable to the company for the amount of any improper distributions.
LLC Members Owe Fiduciary Duties
Under New Jersey state law, members of a member-managed company owe to the company and to the other members, the fiduciary duties of Loyalty and Care. Furthermore, N.J. courts have held shareholders of a close corporation to a higher standard of duty which can be compared to that between partners of joint venturers (i.e. that of the utmost good faith and finest of loyalty). The New Jersey Oppressed Shareholder Statute provides a cause of action for any shareholder of a corporation with 25 of fewer shareholders, in which a member has engaged in oppressive, harmful and unfair conduct thereby breaching their underlying fiduciary duties. It is important to note that in some instances, operating and other member agreements may attempt to limit or even remove these fiduciary duties, which is something to pay close attention to during the negotiation process.
What Constitutes Actionable Oppression?
Typically when a shareholder or member of a close corporation has been denied their “reasonable expectation or return” in investing time, money or other capital there will exist an actionable claim based on shareholder oppression. While every case involves unique facts some examples involve the minority shareholder:
- prevented from meaningful participation in the business,
- denied a reasonable return on their investment,
- prevented from receiving pro rata distributions from earnings/profits, or
- being pressured into selling their minority stake for an inadequate price.
More often than not, members who have made significant cash contributions will use this as leverage over members who have made property or service contributions in an attempt to unfairly profit from the business.
Whether you are in the process of starting a small business, investing in an established close corporation or are currently in a dispute with other shareholders or members, the Business Law Attorneys at Rowe Law Group can provide insightful guidance with tailored solutions to meet each client’s unique needs while ensuring the protection of your guaranteed rights.