Many of our previous posts delve into the benefits of resolution of a commercial or shareholder dispute without litigation. Cost, uncertainty and business distraction are factors which often weigh in favor of settlement even at a price which seems unfair. But making a deal necessitates a desire to do so from both sides. As they say, it takes two to tango. If one party is simply not so inclined or the final best offer is simply unacceptable, litigation may be inevitable, and the only mechanism available to bring about resolution.
In a corporate setting, that litigation may take several forms. Choosing the right path is fact intensive and dependent on the relative positions of the parties. Of course, the terms of agreement between business owners may either provide mechanisms for resolution or limit potential alternatives. Regardless, every course of action comes with significant consequences which must be carefully considered prior to embarking on what can be both emotionally taxing and expensive.
Minority Shareholder Strategies
A minority shareholder who is not actively involved in the business has limited options. Unless a shareholders’ agreement provide a mechanism for redemption or transfer, it may be difficult for a minority shareholder to compel a purchase. That minority shareholder would be left to argue that he or she has been “frozen out” from the business, i.e. excluded from information relating to management, oppressed or treated inequitably in terms of distributions of profits so as to trigger an obligation that the company redeem their shares at “fair value”. An action for the appointment of a custodian or receiver is the minority shareholders weapon of choice in that instance. Majority and controlling shareholders are loathe to lose control of what is often their economic life blood.
Majority Shareholder Strategies
A majority shareholder desirous of consolidation of ownership faced with a minority owner not interested in selling also has limited options to compel a sale. In the absence of an agreement which provides for same, there is no provision at law relating to corporations to simply expel a shareholder. With regard to llc’s, the Pennsylvania Limited Liability Company Act provides a limited number of circumstances where the right of expulsion may apply. In either case, involuntary expulsion of a minority interest is no easy task.
The Nuclear Option
The above being said, the nuclear option available to a controlling interest is dissolution. Blow it up, resign all positions which impose fiduciary obligations at law, liquidate the assets and start something new. While the process may be incredibly disruptive to the continuity of business and the personal finances of all the parties, if the separation of the minority interest holder is imperative dissolution may be the only option. The minority may scream breach of fiduciary duty, but in the absence of an agreement among shareholders that the shareholders would not move to dissolve, the success of such a claim at law is speculative at best.
In the end, the decision of whether to engage in such explosive tactics involves a financial analysis but also other factors such as whether the long term interests of the parties require same. In some cases, such as in professional settings, potential irreparable damage to reputation may demand action regardless of the short term pain such action may cause.
Pennsylvania has adopted specific provisions relating to a shareholder’s right to inspect the books and records of a corporation duly organized under the laws of the Commonwealth. The Business & Corporations Law clearly provides for a shareholder’s inspection of corporate records, including the share registry, books of account and records of proceedings upon written notice stating a proper purpose. However, when the legislature adopted the Limited Liability Company Law of 1994 (the “LLC law”) no similar provision was made relating to a member’s right to review company books and records, and no reference was made to the right of inspection applicable to corporations.
The absence of a specific reference in the LLC law does not mean that a member in a Limited Liability Company does not have the right to inspect business records. The statute approaches that right from a different direction through the application and incorporation of partnership law. Section 8904 of the LLC law incorporates by reference provisions relating to general partnerships in the case of a member managed LLC and additional provisions related to limited partnerships in the case of a manager managed LLC. In either case, the provisions of Chapter 83 relating to general partnerships are rendered applicable.
Section 8332 provides that “the partnership books shall be kept, subject to agreement between the partners, at the principal place of business of the partnership, and every partner shall at all times have access to and may inspect and copy any of them”. While partnership law does not define the types of records which are to be maintained in the same manner as the provisions relating to corporations, the statutory intent appears to be the same and thus the types of records subject to inspection are arguably similar in scope.
There are material differences between the right applicable to corporations and partnerships/ LLC’s. One major difference is that the partnership/LLC provision does not reference a requirement that the partner seeking an inspection state a “proper purpose” for the inspection. The right as stated appears to be absolute as to partnerships/LLCs whereas in a corporate setting the shareholder must identify and communicate the purpose. In addition, the provisions relating to corporations specifically provide for a cause of action for review of corporate records and for the recovery of attorney fees associated with the enforcement of that right. No provision in the partnership law applicable to LLCs provides a specific similar right, nor the recovery of attorney fees. A practitioner is left to argue the applicability of the provisions relating to corporations and the similarity of purposes served by the two statutory provisions.