Avoiding Family-Owned Business Pitfalls: Minority Shareholder Oppression Claims
It is often the case that many family-run businesses emphasize the “family” part of the business, providing jobs, money, and resources for members of the family. In fact this is often among the main reasons to start a family-run business – providing a source of income and employment for the family. At the same time, using corporation resources for the family members can run afoul of legal technicalities. Corporate decisions can be justified based on the “business judgment rule,” but not on the basis of a “family-benefit rule.” Using too many business resources for the family can put the officers and directors at risk of a piercing-the-corporate veil lawsuit if the corporation falls into financial difficulty with its creditors.
There is also the problem of minority shareholder oppression. In practice, this concern arises under several circumstances including:
- Minority shareholders are complaining — even if those shareholders are members of the family, they can still legally sue for minority shareholder oppression
- Granting stock to valued employees as compensation — once they become shareholders, then the “family-benefit” rule cannot apply
- Bringing in minority shareholders as investors
- And more
When running your San Diego family business, it is important to avoid these pitfalls. In this article, we discuss some of those principles. A good corporate attorney can provide some counsel and advice.
San Diego Corporate Law: What is Corporate Oppression?
In general, corporate officers and directors have fiduciary duties of due care and loyalty to the corporation and to all of its shareholders. Controlling shareholders have greater fiduciary duties; they must exercise their control and influence fairly for the benefit of the corporation and the other shareholders. In practice, this means no favoritism and no use of corporate assets for personal benefit and/or the family. Whatever benefit is derived from company assets/resources must benefit all shareholders proportionately and must not conflict with the proper conduct of the corporation’s business.
A good case example is Turner v. SCICON TECHNOLOGIES CORP. et al., an unpublished opinion from Los Angeles (Cal. App. 2nd Dist. December 21, 2016). In that case, the corporation, Scicon Technologies Corp., was started as a family-owned company. The business provided advanced 3D printing and stereolithography services for rapid prototyping and manufacturing applications. The father — Thomas Bulger — owned the majority of the company’s stock (eventually dropping to 70%) and his son — Bradley — had a minority stake (15%). The wife/mother — Marie Bulger — was not a shareholder, but was an officer and director of the company. In the early 1990s, the company hired Peter Turner as director of engineering. Part of his compensation was shares of stock. He eventually accumulated a 15% stake in the company.
Turner was fired in 2009 and sued for various claims including breach of fiduciary duty and minority shareholder oppression. Turner claimed that the Bulger family used the corporation for their own personal benefit, used corporate funds for personal expenses and paid themselves and other members of the family excessive salaries, bonuses, and benefits. Turner also claimed that Scicon fired quality employees and hired incompetent Bulger family members in their place. At the trial level, the trial court dismissed these claims at the pleading stage, substantially in advance of trial.
However, the Court of Appeals reversed. Based on the allegations in the case, the Court of Appeals held that Turner had alleged facts that could allow a jury to conclude that the Bulger family breached its fiduciary duties to Turner and committed minority shareholder oppression.
San Diego Corporate Law: What Steps to Take
Here are a few tips on how to avoid these types of pitfalls:
- Avoid unjustified nepotism (the hiring of family members) — hiring family members is very much allowed if they are qualified; they do not have to be the MOST qualified, but they have to have the basic qualifications for the job
- Avoid excessive salaries for the job and for the industry
- Carefully comply with corporate formalities and procedures
- Establish procedures that apply to everyone with respect to bonuses and benefits — in other words, no special bonus only for family members; all officers and employees should be eligible based on actual standards
- Establish procedures with respect to use of corporate credit cards and reimbursements that apply to all
- ENFORCE established procedures equally against all officers and employees — no favoritism in enforcement
Contact San Diego Corporate Law
For further information, contact Michael Leonard, Esq. of San Diego Corporate Law. To schedule a consultation, contact Mr. Leonard via email or call at (858) 483-9200. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters, and proudly serves business owners in San Diego and the surrounding communities.