“Power tends to corrupt and absolute power corrupts absolutely.” Lord Acton
There is no guaranty that a business partner with a controlling interest will always act in the best interest of other non-controlling owners. Conversely, rest assured that someone at this very moment is suffering some level of “squeeze” from a majority owner of a business. A new law in Louisiana now provides much-needed protection for victims of oppression in a closely held business.
Take Goose Commander, Inc., a family business started by its patriarch, Johnny Robinson. Johnny got his start in the 1950s selling homemade goose calls that he dipped in a 5-gallon bucket of polyurethane. Three generations later, the Robinson family sells their goose calls worldwide and now star in a reality TV series: Goose Dynasty. Like most businesses that survive more than one generation, ownership has now become quite fragmented. While the reality TV series portrays a nice happy family, the “real reality” is that family dynamics within the business are tense. All four sons work for the company, but Johnny decided long ago that only one of his four sons, Jackie, would assume the helm, so he gave Jackie fifty-one (51%) of the company with the understanding that Jackie would treat his three brothers fairly. Without any meaningful “check,” Jackie has not kept his end of the bargain. With a controlling interest in the Company, Jackie raised his salary to Wall Street standards and cut his brothers’ salaries to below Main Street levels. Jackie hasn’t declared a dividend in three years because he pays himself a year-end “bonus” that depletes any extra cash that might be available for distribution to the other shareholders. Jackie employs his immediate family (spouse, children, and spouses of children), but refuses to employ any of his siblings’ family members. Jackie is completely unaccountable because at the end of the day he is the majority shareholder and has utter and complete control.
What’s the Problem?
Unlike the stock of a publicly traded corporation, a minority interest in a closely held business cannot be readily sold, which effectively traps the minority shareholders into an oppressive situation. In real terms, any minority interest owner lacks control, cannot affect decisions or compel distributions, and is otherwise subject to the whims of the self-interested majority. This abuse of power is often referred to as the “minority squeeze.” Neither the law nor the courts are naïve about the potential for abuse by controlling shareholders. Prior to a recent change in the law, the only remedy available to a minority shareholder was a claim for a “breach of fiduciary duty” owed by officers and directors to shareholders. Because of a legal concept known as the “business judgment rule, ” courts cannot second guess most business decisions, so it is difficult to win a breach of duty claim where there exist any potential business purposes for self-interested decisions of a majority shareholder.
What’s the Solution?
The Louisiana Business Corporation Act (“LBCA”) ushered in sweeping changes in 2015, one of which affords special protection to minority shareholders in closely held corporations. Under the new remedy, a minority shareholder can force the corporation to buy out his or her shares at “fair value” if it can be proved that the corporation, through the acts of the majority shareholder, engaged in acts of “oppression.”
The term “oppression” is defined as corporate practices which “considered as a whole over an appropriate period of time, are plainly incompatible with a genuine effort on the part of the corporation to deal fairly and in good faith with the shareholder.” La. R.S. 12:1-1435(B). In other words, if you put it all up on a chalkboard and it looks the majority shareholders are not treating the minority shareholders fairly, the minority shareholders can force a buy-out, which is a tremendous remedy and a complete turnabout from prior Louisiana law.
The LBCA further stacks the deck in favor of minority shareholders by defining “fair value” to be exclusive of any “minority interest” or “lack of marketability” discounts. A “minority interest discount” takes into account the fact that a minority shareholder cannot affect decisions or compel distributions, which makes the interest worthless. A “lack of marketability discount” accounts for the fact that a closely held business is either not readily marketable, or cannot be sold due to restrictions placed on transferability in the governing documents. If an owner cannot affect decisions, compel distributions or sell their interest, an investor will not pay full value in real terms, which is the basis for these discounts, which often approach forty (40%) percent. For example, if a shareholder owns a forty-nine (49%) percent interest in a closely held corporation worth One Million ($1,000,000.00) Dollars, a forty (40%) percent valuation discount for minority interest and lack of marketability would reduce the value from Four Hundred Ninety Thousand ($490,000.00) Dollars to Two Hundred Ninety-Four Thousand ($294,000.00) Dollars. This concept of valuation discounts has been “trumped” by the LBCA. As such, a minority shareholder must be paid full value for their interest exclusive of any discounts. Citing the example above, a minority owner would be paid Four Hundred Ninety Thousand ($490,000.00) Dollars – without any discounts – for their forty-nine (49%) interest if they can prove they have been “oppressed.” This is a complete turnabout and provides a much-needed check against the ruling class for acts of oppression of minority interests.
Duck, Duck, Goose.
Jackie and his siblings gather for the holiday feast to celebrate another great year in business. Jackie has loosened the reins a bit since being confronted by his siblings with Louisiana’s remedy for acts of oppression of minority owners. All the Robinson brothers now have a voice in the business and the dynamic has changed for the better now that Jackie is more accountable. Ratings for the reality TV series have jumped now that Jackie’s siblings are no longer afraid to challenge Jackie, which sparks heated but healthy banter. The show must go on.
Theus Law Offices provides a complete range of business services. If you are facing an issue with a small business and need a Louisiana business attorney in Alexandria, Lafayette, Lake Charles, Baton Rouge, New Orleans, Shreveport, Monroe, Central Louisiana, or elsewhere, let our business attorneys help you and your business.