Minority Shareholders in a Family Business
Many successful small to medium sized corporations begin as closely-held family businesses.
For example, a parent starts a business and then brings in their children. Or a group of relatives starts a business and then brings in the next generation.
Family-owned companies are often formally incorporated with each family member given an equal number of shares and with Director positions similarly divided among family members. This may work well at the outset. However, with the passage of time, family-based interactions can become acrimonious. This is especially the case in closely-held corporations where clashes of personality and undocumented expectations can lead to shareholder disputes.
In family-owned businesses, situations can arise where pressure is placed on a minority shareholder to sell his or her shares to majority stockholders who want to take control of the corporation — or minority shareholders can find themselves being forced out of a business by the majority.
Majority Shareholders May Try to Push Out Minority Shareholders
Some such strategies include:
- removal as a Director,
- denial of access to corporate financial information,
- unilateral reductions in dividends,
- termination of employment from a business they long considered to be “theirs,” or,
- other measures designed to force a sale at below market value.
In legal terms, this kind of conduct is described as “oppressive” or “unfairly prejudicial.” Shareholder oppression occurs when majority shareholders take action that unfairly prejudices minority shareholders. It occurs most often in closely-held companies, where a lack of any market for selling one’s shares leaves minority shareholders without a way to obtain fair value for their shares and to leave the corporation.
Majority shareholders may harm the economic interests of minority shareholders through any number of oppressive or unfairly prejudicial acts or omissions directed at the shareholders or the corporation itself A helpful approach is to consider whether the conduct of the majority shareholders and or Directors meets with the reasonable expectations of the minority.
Can the Law Help Protect Shareholders’ Rights?
Oppressive and unfairly prejudicial conduct is governed by section 227 of the Business Corporations Act of British Columbia. Under section 227, an aggrieved person may ask the court to make an order it considers appropriate to assist them. This could include an order for compensation, an order directing a shareholder to purchase the shares of another, or even an order directing the company to be liquidated and its assets distributed.
In addition, under s. 295 of the Act, the courts have also held that even where there is no oppressive conduct found, participants in a family-owned business may be entitled to have the company wound up or their interests bought out in accordance with reasonable expectations: Safarik v. Ocean Fisheries Ltd.,(1995) 12 B.C.L.R. (3d) 342 (C.A.).
In the Safarik case, the second-largest fish processing plant in BC, Ocean Fisheries, was operated by a father and his four sons. Over the years the father took less of an active role in the management of Ocean leaving one son in charge. This son, along with some brothers and the father, essentially excluded Gordon Safarik from the business. Gordon filed a Petition in BC Supreme Court seeking a number of potential remedies including an Order that his shares in Ocean be bought out. The Petition was later turned into a more formal lawsuit and a 64-day trial took place.
At trial, evidence was tendered regarding Gordon Safarik’s various complaints some of which included that:
- he had received smaller annual bonuses than his brothers,
- he had been prevented from receiving management statistics, reports and a strategic objective study,
- he had been excluded from major corporate decision making,
- he was not being permitted to attend management meetings, and
- one of the sons had caused funds to be transferred to a subsidiary, contrary to a bank financing arrangement, causing Ocean harm.
Gordon also asserted that the salary and bonuses he received were unfair when compared to those that his brothers received.
Ocean denied that the corporation or any of the other sons, or the father, had acted in an oppressive manner. Ocean argued that over the years Gordon’s behaviour had been irrational, unpredictable and incompetent. It argued that Gordon was not an active participant in the company, yet he had been paid a substantial annual salary. Finally, Ocean argued that any order to wind up the company and distribute the assets amongst the shareholders would be profoundly unfair and would bring a successful company to a premature end.
The trial judge found that Ocean did not deal honestly and fairly with Gordon and had improperly tried to remove him from management without due cause. Ocean was ordered to purchase Gordon’s shares for $2.25 million plus interest and 65% of his special costs.
Ocean appealed to the BC Court of Appeal (“BCCA”) arguing that the trial judge was wrong to find that it had acted in an oppressive or unfairly prejudicial manner.
The BCCA considered the trial judge’s decision and reviewed the evidence and law surrounding minority shareholder oppression and concluded:
100 Family companies are very different from non-family companies. They are different because, usually when a young man joins his father in the business, he does so trusting his father to do right by him and the father intends to do right. Thus no contracts are drawn up. It is not unusual for differences to arise as they did here, not because either father or son is dishonourable but because each sees the world through different eyes.
101 If this were not a family company, but a company in which the respondent had simply bought his common shares and in buying them had decided not to be a director for whatever reason, there would be no case for an order under s. 295(3).
102 But, in my opinion, it is not erroneous to take a more liberal approach to the words “just and equitable” in the case of a family company in which one of the family after many years of service is no longer permitted to participate in the business.
103 Taking such an approach, I am of the opinion that it is just and equitable to wind up this company. I do not found this conclusion on any of the learned judge’s findings which may be said to amount to findings of “wrongdoing”.
104 S. 296 gives the Court the discretion to make some order other than a winding-up order. It prescribes no criteria for the exercise of that discretion…
As a mechanism to achieve a fair buyout price, the Court of Appeal ordered a “shotgun” arrangement commonly found in Shareholders Agreements under which participants are motivated to make an offer at fair market value.
Shotgun clauses are generally inserted in shareholder agreements from the outset as a potential exit provision. They way they work is that one party offers to purchase the shares of the other shareholders at a certain price per share. Other shareholders then have the option to either sell their shares at that price or purchase shares at that same price. In Safarik,the Court-ordered shotgun arrangement forced the majority shareholders to set a fair price per share since if they set the price too low, they risked having all their shares purchased by Gordon (meaning they would no longer be involved in Ocean). Ultimately, Gordon accepted the offer and sold his shares to his family members.
Courts in British Columbia have since looked to the decision in Safarik as a guide for matters involving shareholder oppression and in particular, family run businesses. Courts recognize that family run businesses where decisions are made informally with sometimes less than ideal record keeping are different than other types of companies.
Based on the reasoning from cases like Safarik, courts now take a flexible approach when dealing with disputes between shareholders who are also family members. As a result, courts may be more willing to liquidate a company or order a buy-back of a family member’s shares where oppressive conduct can be shown.
If You are Being Forced Out of a Family Business
If you are a shareholder of a family run business who is experiencing things such as being:
- excluded from management decisions,
- denied financial information,
- denied physical access,
- denied fair salary or dividends, or even
- excluded from carrying out your normal work activities in whole or in part;
your first course of action should be to consult with a litigator experienced in minority shareholder disputes to discuss your options.
In certain situations, minority shareholders can launch legal action alleging that Directors and/or majority shareholders have acted in an oppressive manner and/or have breached their fiduciary and good faith duties. In some instances, the potential of a lawsuit alone can end up leading to a negotiated or mediated settlement.
If a trial is necessary, a Court can end up ordering that the shares owned by an oppressed minority shareholder be bought out or even that an accounting and winding up of the Corporation occur.
If you, or someone you know, is a minority shareholder who is being mistreated in a family-owned business, appropriate legal advice may assist in maximizing your potential recovery of fair value from your participation in the family business.