“Self-dealing” is a legal concept which is applied to a transaction in which a fiduciary (such as a trustee, general partner, controlling shareholder, director, or officer) derives a personal benefit from a transaction with or involving the entity to which he owes the fiduciary duty. In re Nat'l Auto Credit S'Holders Litig., 2003 Del. Ch. LEXIS 5, 30 (Del. Ch. Jan. 10, 2003), (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).
The “Equitable Accounting” Remedy
The right to an accounting has its basis both in common law and in statute.
The law related to common law “equitable accountings” has evolved and changed over the years, and this evolution affords courts much flexibility to achieve just results. But, the law is still subject to conflicting opinions and inconsistent rules of law. As New York Supreme Court Justice Judith J. Gische stated after analyzing the law relating to equitable accountings:
“The body of law on equitable accountings is conflicting and muddled.” - Evans v. Perl, 2009 N.Y. Slip. Op. 31413, 2009 WL 1905169 (N.Y. Sup. Ct. June 23, 2009).
Rights of Limited Partners in the Face of a General Partner’s Self-Dealing
Limited partnerships have in large measure been replaced by limited liability companies as the passive investment vehicles of choice. But, they are still relevant because they are still sometimes used and there are many legacy limited partnerships that are still in existence.
On the surface, it appears limited partners have very few rights and protections. They are not allowed to participate in management or to second guess the general partner’s actions. However, while the law requires that they stay passive insofar as management is concerned, it does afford them a number of protections to assure that their financial interests are not abused.
"A limited partner is not in the hopeless position where he must only suffer in silence when an alleged wrong occurs. He has a right of full and free access to information contained in the partnership books, and of all things affecting the partnership, as well as a right to formal accounting." Millard v Newmark & Co., 24 AD2d 333, 336 (lst Dep' t, 1966).
DO DISCOUNT BROKERS OWE THEIR CLIENTS FIDUCIARY DUTIES?
THAT DEPENDS - TO SOME THEY DO AND TO SOME THEY DON’T
Full service securities brokerage firms owe their clients certain fiduciary duties. They have an obligation to clients to whom they offer investment advice or recommendations, to make reasonable efforts to assure that their investments are “suitable.” They also have a duty to monitor the client’s investments on an ongoing basis and warn the clients of any undue risks.
Discount brokers, on the other hand, make no recommendations and therefore, take the position that they owe their clients no duties other than to execute trades in accordance with the clients’ instructions. Thus, when a discount broker permits a client to commit “economic suicide” by making wholly unsuitable or extremely risky investments or over-trading the account, the broker can avoid liability by claiming it had no duty to monitor the client’s investments or warn him of their unsuitability or riskiness.
Fiduciary Duties in LLCs and Limited Partnerships
It has long been a truism that partners in joint endeavors owe each other certain responsibilities to look out for one another. Justice Benjamin N. Cardozo stated the proposition as follows:
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.
Meinhard v Salmon, 249 NY 458 (1928). Although Justice Cardozo elucidated this rule over 90 years ago, it still rings true today. In Birnbaum v Birnbaum, the court reaffirmed this strong duty stating:
This is a sensitive and ‘inflexible’ rule of fidelity, barring not only blatant self-dealing, but also requiring avoidance of situations in which a fiduciary's personal interest possibly conflicts with the interest of those owed a fiduciary duty (Matter of Ryan, 291 N.Y. 376, 407). Included within this rule's broad scope is every situation in which a fiduciary, who is bound to single-mindedly pursue the interests of those to whom a duty of loyalty is owed, deals with a person "in such close relation [to the fiduciary] * * * that possible advantage to such other person might * * * consciously or unconsciously" influence the fiduciary's judgment.
Protection of Minority Shareholder Rights and Shareholder Oppression Doctrine in Texas
What can minority shareholders do in under Texas law to protect themselves against unfair treatment, including “squeeze-outs”, “freeze-outs” and the taking of disproportionate benefits by the majority?
Texas recognizes both the shareholder oppression doctrine and “breach of fiduciary duty” theories in close corporations to protect the rights of minority shareholders.
The Dissolution Statute:
The Texas corporate dissolution statute, Article 7.05 of the Texas Business Corporation Act, provides for the appointment of a receiver and the possibility of dissolution when an aggrieved shareholder establishes “illegal, oppressive, or fraudulent” conduct by directors or those in control.
Of significance, Texas Courts have used this statute as a basis to fashion a broad range of remedies less harsh than dissolution, where they find that minority shareholder rights have been abused.
What is Oppressive Conduct?
Though illegal and fraudulent conduct is fairly easy to identify, oppressive conduct is less readily definable. One of the leading cases in Texas, Davis v. Sheerin, adopts the language of New York’s Matter of Kemp for oppression, and defines “oppressive conduct” as follows:
Shareholder Oppression in Delaware
Delaware does not have a cause of action for oppression per se, but it does offer relief for minority shareholder oppression-like claims applying other legal principles. Thus, oppression-like claims must be carefully pleaded in Delaware.
Since court’s in other states are likely to apply Delaware law to oppression-like claims to companies organized in Delaware, vigilance must also be exercised in pleading claims relating to Delaware corporations in non-Delaware courts. Some courts outside of Delaware, such as the Southern District of New York and the Northern District of Illinois, have upheld causes of action for shareholder oppression under Delaware law, while others, such as the District of New Jersey, have dismissed oppression claims for failure to state a claim under Delaware law.
Nixon v. Blackwell, 626 A.2d 1366 (Del. 1993), is a Delaware case that often cited for the proposition that Delaware does have a shareholder oppression remedy, and also for the proposition that it does not. The case states that “[t]he entire fairness test, correctly applied and articulated, is the proper judicial approach” to deciding claims brought by minority shareholders against those in control of the corporation. Thus, some conclude that oppression claims may be pursued under the entire fairness doctrine.
However, Nixon v. Blackwell also, contains language that seems to indicate otherwise:
Shareholder Oppression in New Jersey
Applicable Statue:
The New Jersey Shareholder Oppression Statute, N.J.S.A. § 14A:12-7, provides that when those in control of a corporation having 25 or fewer shareholders “have acted fraudulently or illegally, mismanaged the corporation, or abused their authority as officers or directors or have acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees,” the Court can impose a wide variety of equitable remedies, including ordering a buy-out at “fair value.” (emphasis supplied).
The buyout that the Court can order does not necessarily have to be of the minority shareholders’ interest. It can order a buyout of the majority’s interest. The purchaser can be the corporation or the other shareholders.
What is Oppressive Conduct?
Oppressive conduct is defined in New Jersey as conduct that frustrates the “reasonable expectations” of the minority as of when they joined the enterprise.
In Brenner v. Berkovitz (1993), the New Jersey Supreme Court stated that the special circumstances, arrangements and personal relationships that frequently underlie the formation of close corporations generate certain expectations among the shareholders concerning their respective roles in corporate affairs, including management and earnings. A court, then, must determine initially the understanding of the parties in this regard. Generally, the court noted that any increase in benefits to the majority shareholders without corresponding benefit to minority may provide a claim of oppression.
Case Law Update: What are Acts of Shareholder Oppression?
In Stephanie (Younger) Waters v. G&B Feeds, Inc. and Wiliam Younger, No. SD29745, March 4, 2010, the Missouri Court of Appeals upheld the trial court's finding of shareholder oppression, showing that a pattern of oppressive acts is key to the cause of action. The trial court recited a medley of actions taken by Appellant-Defendant which the trial court considered to be acts of shareholder oppression:
[h]e assumed control of the corporation and the operation of its business without lawful authority and in complete disregard for the rights of [Respondent]. He borrowed money and refinanced debts on his own without consultation with [Respondent]. He testified that throughout the term of the business he purchased livestock feed at cost for [his] herd of 500-600 head of livestock, a substantial savings over a period of six years. However, the court has no evidence, other than [Bill’s] testimony, as to any such amounts paid for feed. He declined the opportunity to pay [Respondent] $70,000[.00] for her stock, the amount she had paid for it, and thus be in a position to have complete ownership of the corporation and the lawful right to operate the corporation business as he was doing without lawful right. He refused to cooperate in the sale of the business property to the ultimate financial detriment of both shareholders. He retained all rental receipts from the storage units and gave no accounting therefore. He has totally failed to give a proper accounting of his stewardship of the business affairs.
The Court of Appeals went on to hold that there was "sufficent evidence supporting the trial court's determination that [Appellant-Defendant] breached his fiduciary duty to Respondent in his dealings with her and in his operation of the affairs of [the company]" and upheld the trial court's finding of minority shareholder oppression.
For the entire decision, click here.
Shareholder Oppression in New York
Applicable Statute
New York State’s corporate dissolution statute, NY Business Corporations 1104-a, provides for the involuntary dissolution of a corporation when the “directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders” in a company that is not publicly traded.
New York courts have held that oppressive conduct is distinct from illegal or fraudulent conduct, and thus also a reason for corporate dissolution.
What is Oppressive Conduct?
In an “oppression” case, the first inquiry of a New York court will be to determine whether the complained of acts are actually “oppressive.” Though the dissolution statute does not define what oppressive acts are, one of the leading cases on the subject, Matter of Kemp & Beatley, Inc., interprets them as actions which “substantially defeat shareholder expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner’s decisions to join the venture.” This standard is widely followed.
Oppressive conduct is most often found when there are a number of actions that, when taken together, have the effect of denying the minority shareholder benefits from the company that he or she had the reasonable expectation of. Often the Court will look at what is motivating the majority’s actions and whether there is an effort to “freeze out” or “squeeze out” the minority.
What is Shareholder Oppression?
The “shareholder oppression” doctrine is a set of legal principles that protect minority shareholders from abuse by the majority. As such, these principles stand in direct contradiction to the central rule of corporate decision making that the will of the majority governs. The doctrine also runs contrary to and can prevail over several other well established legal principles, including the business judgment rule, the employment at will doctrine and derivative claims distinction. More on these later.
The principles protecting the rights of minority equity owners are articulated and implemented differently from state to state, and their implementation often involves a balancing of the rights of the majority to control the business entity’s destiny and the rights of the minority to receive the often unarticulated benefits they anticipated when they joined the enterprise. The rules may vary within a state depending on the type of entity, as well.
Limitations on Majority Rule in the Management of Business Entities
The general rule in the corporate governance of business entities -- including corporations, limited liability companies and partnerships -- is that absent an agreement or statutory requirement to the contrary, majority rule governs. Indeed, majority equity owners often assume that they can do pretty much anything they want with regard to the business entity.
However, this is an erroneous assumption. Over the years, many legal principles have evolved which limit the freedom of the majority to do as they wish.