Mergers and acquisitions (M&A) and other turbulent events such as takeovers can generate significant concerns among minority shareholders. Can a majority shareholder force you to accept unfavorable terms? Can a company force you to sell your stock? If yes, then why, when and how?
Minority shareholders can often find themselves in problematic situations. However, it’s possible to defend yourself against prejudice, including unfair forced sales. This article explores your key shareholder rights, examines examples of shareholder disputes, and explores the legal options to help you oppose unfair forced sales.
Overview of seven fundamental shareholder rights
Model articles of association don’t contain provisions allowing one party to compel another party to dispose of their shares. So, how could a shareholder be forced to sell their shares? The law does allow this in certain circumstances.
However, shareholders can still oppose it when they believe companies are violating their rights. Shareholder rights are regulated under federal securities laws and state laws, like Delaware, New Jersey, and Illinois. Knowing your shareholder rights will help you raise valid claims against unfair forced sales and squeeze-out tactics under applicable laws.
1. The right to be informed
Shareholders can access corporate books and records, including bylaws, financial statements, tax returns, ledgers, lists of shareholders, and financial reports.
The Securities and Exchange Commission (SEC) also requires companies to disclose executive compensation, proxy statements, and M&A deals as part of investor protections. You can access these statements in the company’s public records or by sending an official request.
2. The right to vote on company decisions
Holders of common shares have voting rights and can influence significant company decisions, such as the election of board directors, CEO turnover, dividend approvals, and M&A deals.
3. The right to receive dividends
Holders of common shares receive dividends. Companies typically pay bondholders and preferred shareholders first. Any remaining profits may be distributed to common shareholders.
However, the board may decide to among a number of options, including reinvesting the profit, refinancing debt or initiating an M&A instead of paying dividends.
4. The right to participate in annual meetings
Regulators require companies to hold annual shareholder meetings where shareholders vote on corporate decisions. Shareholder votes may be in-person or remote. Usually, you can check the dates and locations of shareholder meetings in the company’s bylaws.
5. The right to buy newly issued shares
The preemptive or “first option to buy” rights mean existing shareholders can purchase newly issued shares before the company sells them to third-party buyers.
It helps shareholders, especially minority ones, to hedge against power dilution when an external investor attempts to acquire a significant percentage of interest. However, this right is only available if a company states so in its corporate charter. Otherwise, it’s not mandatory.
6. The right to divest shares
A minority shareholder has tag along rights. This contractual obligation allows small stockholders to sell their shares along with large shareholders for the same price.
It provides liquidity and fair value to minority shareholders in private companies, closely held corporations, and startups. That is because private shares are much easier to sell on secondary markets for major stockholders, like venture capital firms, and not so much for individuals.
7. The right to take legal action
…a controller owes a duty of good faith to not harm the corporation or its minority stockholders intentionally.
Albert J. Caroll, Partner, and Bryan Townsend, Counsel
Morris James LLP
Shareholders can sue the company’s executives and directors for violating fiduciary duties. Shareholders can file a lawsuit in representation of the company or a direct lawsuit against it. This crucial right protects minority shareholders from denial of dividends, squeeze-out tactics, coercive share sales, and other violations of shareholder rights.
The role of majority shareholders
A majority shareholder owns at least 51% of company shares (a controlling interest). Majority shareholders have significant control over the strategic priorities of companies and may determine voting outcomes discarding the opinions and interests of minority shareholders.
So, can a company force shareholders to sell their stock under the influence of majority shareholders? Yes, it can do so through several squeeze-out practices:
- Reduce dividend payments
Majority shareholders may vote to terminate dividend payments, oppressing minority shareholders financially and forcing them to exit. That may happen when a former director refuses to transfer shares.
- Remove from the company
Majority shareholders may manipulate company decisions to remove minority shareholders from corporate roles. It may force minority shareholders to sell their shares and leave the business.
- Limit access to information
Majority shareholders may restrict the amount of company information shared with minority stockholders to weaken their decision-making power.
- Conduct freezeout mergers
A freezeout merger occurs when a majority shareholder sells the company to a new company it owns, forcing minority shareholders to sell their shares.
- Pass a special resolution
A major shareholder with over 75% of corporate interest may amend the articles of incorporation through a resolution and initiate a compulsory transfer or share sale.
You can file a lawsuit against most of these oppressive tactics. However, there may be exceptions. Let’s explore a few cases.
Bone v. Coyle Mech. Supply, Inc.
The Bone vs. Coyle Mechanical Supply case illustrates that minority shareholders can effectively oppose squeeze-out tactics. The majority shareholders of Coyle Mechanical Supply deprived minority shareholders of dividends, denied access to company information, and improperly removed them from the board of directors.
In turn, minority shareholders filed and won a direct lawsuit against Coyle Mechanical Supply. The court ruled that Coyle Mechanical Supply Inc. “acted in an oppressive manner toward the minority shareholders.” The judges ordered the corporation to pay $250,000 to each plaintiff.
Small v. Sussman
The Small vs Sussman case illustrates that minority shareholders may have limited protection against freezeout mergers under specific circumstances. Paul Sussman, the majority shareholder of Day Surgicenters, Inc. (DSI), was accused of excessive corporate control, waste of corporate assets, and a freezeout merger that terminated Richart Small’s (minority shareholder) stock position.
However, the court dismissed Small’s claims, referring to the Illinois Business Corporation Act and the legal status of freezeout mergers:
The type of freezeout executed by DSI (a reverse stock split and elimination of fractional shares) is authorized by the Illinois Business Corporation Act (“IBCA”)
Circuit Court of Cook County
Legal grounds for forcing a minority shareholder to sell shares
The majority shareholder can force the minority shareholder to sell their shares under applicable corporate law. Let’s explore some of the legal grounds for forced sale of minority stocks.
Drag-along provisions
How can a minority shareholder be forced to sell shares? Majority shareholders may exercise forced selling through drag-along rights. State laws permit drag-along provisions in shareholders’ agreements, bylaws, or company’s articles of incorporation.
Under the drag-along provision, minority shareholders must sell 100% of their stock when the majority shareholder decides to sell the company. Still, drag-along provisions may benefit minority shareholders when they get the same price terms as majority shareholders.
Forced buyout of a shareholder
Majority shareholders can compel minority shareholders to sell through shareholder buyouts. It’s possible through a buy-sell agreement, cross-option agreement, share buyback, or other valid contract. These provisions trigger in certain circumstances, such as when a shareholder dies, files for bankruptcy or divorces. Mergers and acquisitions can also be triggers.
What happens to employees when a company is acquired, if employees are also minority shareholders? They may no longer profit from the newly formed company because shareholder-employees may be forced to sell their shares under buyout provisions if their employment is terminated.
It is possible when shareholder agreements require continued employment in the company. As a consequence, a leaving stockholder employee must sell their shares to the company or its shareholders for a predetermined buyout price.
A shareholder’s agreement may also have a buyout outcome written in favor of majority shareholders. When that’s the case, majority shareholders may unfairly remove shareholder-employees and forcefully buy out their stock at a “discount” price. This happens when the real worth of stock exceeds the nominal value following the company’s success.
Corporate bankruptcy
Shareholders may also be forced to sell under unfavorable business conditions, like the insolvency of the company.
When a company files for bankruptcy protection, chances are its shares will lose most—if not all—of their value, and that the company will be delisted from its exchange. That’s bad news for shareholders.
Finra.org
When a company can’t comply with the statutory demand, the court may order it to liquidate its assets to pay off its debt. This process significantly devalues the company’s stock, and shareholders may have no option but to sell devalued shares to a stockbroker.
Shareholder dispute remedy
The court may order the sale of all shares when resolving shareholder issues and disputes based on fraud, corporate misconduct, or shareholder oppression. The court may do this as the last resort when other remedies appear insufficient.
In this instance, the court orders to shareholders to sell their minority shares at a fair price. Rarely, the court may order the majority shareholders to sell to the minority shareholders, depending on the business dynamics.
Muellenberg v. Bikon Corporation
The Muellenberg v. Bikon Corporation case demonstrates that a majority shareholder can be forced to sell shares to a minority shareholder as a remedy. Kurt Burg, a minority shareholder at Bikon Corporation, was systematically oppressed by Muellenberg and Passeri, the majority shareholders. Muellenberg and Passeri also attempted to forcefully buy Burg’s stock and remove him from the company.
The court ordered Muellenberg and Passeri to sell their shares to Burg, referring to the corporate laws of New Jersey, where Bikon Corporation was founded. Specifically, the New Jersey Corporation Business Act authorizes oppressed minority shareholders to buy out stock from majority shareholders as a remedy.
Corporate takeovers and mergers
Majority shareholders typically force minority shareholders to sell all their shares during business transactions. That may happen in a stock-for-stock acquisition, corporate takeover (hostile or friendly), or merger. Corporate acquirers typically aim for full ownership and consider it undesirable when former shareholders retain minority shares and receive future profits.
Most companies favor that with buyout and drag-along provisions in articles of incorporation, bylaws, and shareholder agreements. Such policies simplify the share transfer procedure by eliminating interventions from minority shareholders.
However, corporate takeovers and mergers may not be inherently detrimental to minority shareholders. The reason is that acquirers buy companies above the market value that benefits shareholders.
How can minority shareholders prevent unfair forced sales?
Minority shareholders, including individual investors and co-owners, have several tools to protect themselves against unfair forced sales.
Carefully consider shareholder agreements
Awareness is the best tool for preventing unfair treatment and forced sales. With new investments, request a shareholder agreement. Carefully review the existing provisions and pay attention to the following red flags:
- Lack of preemptive and tag-along rights
- Lack of fair price guarantee in drag-along provisions
- Lack of independent appraisal guarantee in buyout provisions
- Lack of supermajority (75%–90% of outstanding shares) voting requirements for decision approvals
- Majority shareholder consent requirements in stock transfer provisions
What if you have already signed an unfavorable shareholder agreement? You could negotiate more favorable terms and modify appropriate provisions.
If you see the risks of imminent oppression, you may consider an exit strategy before it’s too late. Engaging a legal counsel and analyzing liquidity options before leaving the company would be preferable.
Explore the pros and cons of IPO vs acquisition exit strategy.
Enter a new shareholder agreement
Drafting a new mutual agreement may be effective if the existing one contains oppressive provisions. It helps alleviate potential disputes and may deter majority shareholders from oppressive tactics in an attempt to minimize liability and avoid litigation.
Probably the only way is to enter into a written agreement – possibly an entirely new shareholders agreement or operating agreement – that guarantees certain things to the minority owner going forward.
David C. Roberts
Chair at Norris McLaughlin P.A
File a class action lawsuit
Litigation may work when other measures fail. Consider that any damages will be recovered to the corporation in a derivative lawsuit, and you may have indirect benefits.
In a direct lawsuit against the company and other shareholders, however, damages will be recovered to you personally. It’s advisable to seek expert advice from a dispute attorney to choose which one is preferable in your situation.
Final words
- Minority shareholders have the right to receive corporate information, vote on decisions, receive dividends, participate in annual meetings, be the first to buy newly issued shares, and sue the company if oppressed.
- Majority shareholders in closely held corporations or private companies have been known to employ semi-legal or illegal squeeze-out tactics, forcing a shareholder to sell his/her shares of stock.
- Majority shareholders can legally force minority shareholders to sell stock under drag-along clauses, buyout provisions, and court orders. Minority shareholders are often compelled to sell shares in corporate takeovers and mergers when acquirers anticipate 100% equity ownership.
