Disputes Among Shareholders in Closely Held Organizations
Closely held business are often owned by a small group of people, typically families or close friends. The experienced business attorneys at Thompson Legal know that it is crucial to understand the rights associated with business ownership, especially with closely held organizations. Additionally, recent case law developments have shed light on the fiduciary duties owed by directors to shareholders, providing shareholders with clearer avenues for legal recourse. This article by the business lawyers of Thompson Legal explores the common legal claims of business owners in shareholder disputes, as well as highlight key insights and strategies for navigating such business conflicts.
What is Shareholder Oppression?
The State of Michigan has codified a shareholder right to file a circuit court action in they are faced with illegal, fraudulent, willfully unfair, or oppressive conduct. While actions that are illegal and fraudulent are clear and easy to prove, conduct that is “unfair” or “oppressive” is not. There is no one clear definition of unfair or oppressive conduct, but courts generally equate it to a breach of fiduciary duty or conduct that is so burdensome, harsh, or wrongful that it violates fair play standards.
Common Legal Claims of Business Shareholders:
There are many legal causes of action that shareholders may have against the company or each other. Some of the most common claims of shareholders include:
Breach of Fiduciary Duty: Directors in closely held organizations owe shareholders the common law fiduciary duties of loyalty, care, and good faith in managing the affairs of the business.
Shareholder Oppression: When majority shareholders act unfairly or prejudice minority shareholders. Majority shareholders may attempt to force minority shareholders out of the company through freeze-out tactics. Oppressive conduct may include exclusion from decision-making, unequal distribution of profits, or dilution of shares.
Breach of Contract: Shareholder agreements, bylaws, or other contracts may define the rights and obligations of shareholders. Breaching these contractual terms can lead to legal claims among shareholders.
Derivative Actions: Shareholders also have the ability to bring a derivative action on behalf of a company if the directors fail to enforce their fiduciary duties. Common allegations in these cases include business asset mismanagement, self-dealing, or fraud by the board of directors.
Shareholder Disputes over Valuation: Disagreements may arise regarding the valuation of shares during buyouts, mergers, or other transactions. Valuation disputes often involve multiple complex financial assessments and can be a source of contention.
Non-Disclosure or Misrepresentation: If shareholders do not provide accurate and complete information about the company's affairs, claims of non-disclosure or misrepresentation may arise. Material omissions or false statements can lead to legal action.
Unfair Competition: Shareholders may bring claims against each other for engaging in activities that harm the business, such as stealing clients, intellectual property, or employees.
Recent Legal Developments
In Murphy v. Inman, a pivotal 2022 Michigan Supreme Court case, the court addressed the foundational issue of the common law fiduciary duties owed by directors to shareholders in closely held organizations. The case brought clarity by explicitly stating that directors indeed owe common law fiduciary duties to shareholders. The significance of Murphy v. Inman can be distilled into two primary points:
Fiduciary Duties Affirmed: The court unequivocally affirmed the existence of common law fiduciary duties, emphasizing that directors owe these duties to shareholders. This recognition is crucial for shareholders seeking legal recourse in situations where directors may have breached their fiduciary obligations.
Individual Lawsuits Allowed: Importantly, Murphy v. Inman established that individual shareholders have the standing to sue directors individually in circuit court if the shareholders breach their fiduciary duties. The lower courts in this case had dismissed the claims considering them to be derivative actions, but this ruling enforced the avenues available for shareholders to seek remedies.
Insights and Strategies:
Documented Agreements: Clearly defined and documented written shareholder agreements, bylaws, and operating agreements can prevent disputes by preventatively establishing the rights, responsibilities, and requirements of each shareholder.
Alternative Dispute Resolution (ADR): Consider utilizing alternative dispute resolution mechanisms such as mediation or arbitration to resolve disputes more efficiently and cost-effectively than traditional litigation. Some of these dispute resolution techniques have the benefit of keeping records confidential as well.
Fiduciary Duty Awareness: Directors should be aware of what their fiduciary duties are and act in the best interests of the company. Shareholders, in turn, should be vigilant in holding directors accountable for any breaches. It is recommended directors swear and sign to these duties upon appointment.
Regular Communication: Open and transparent communication between shareholders and directors can help prevent misunderstandings that might lead to disputes. When necessary, document communication in writing (such as an email or text) so there is a clear record.
Legal Counsel Involvement: Engage legal counsel early in the process to assess the merits of a potential claim, explore alternative dispute resolution options, and provide strategic guidance.
Conclusion:
Understanding the fiduciaries duties and potential legal claims among shareholders in closely held organizations is important for effective business management. Recent Michigan Supreme Court decisions affirm that director owe fiduciary duties to shareholders, and shareholders are free to seek remedy from oppressive conduct in the circuit court. The business law attorneys of Thompson Legal are experienced in navigating these complex disputes and protecting the rights and interests of shareholders in closely held organizations. If you are faced with illegal, fraudulent, or oppressive conduct, contact Thompson Legal to speak with counsel about the specifics of your case.
This blog is for informational purposes only and is not intended as legal advice. In the event you would like to speak with a business attorney about your case Contact Us at (734) 743-1646 to schedule a consultation.
