Corporate shareholders with voting shares have the right to elect a corporation’s directors. Elections typically occur at an annual shareholder meeting. If the company does not schedule an annual meeting, a shareholder may have the right under the applicable state corporation statute to ask a court to order that such a meeting be scheduled. In Ielmini v. Patterson Frozen Foods, Inc. (Court of Appeals of California, Fifth District, September 12, 2018), a California Court recently ordered that an annual meeting be held in the context of a family-owned business where certain directors and controlling shareholders had previously refused to hold a meeting.
John and Angelo Ielmini each held 50 percent of the shares in several agricultural companies which were involved in the farming and processing of produce. They were cousins and second-generation owners of the enterprise which had initially started with one business founded by John and Angelo’s fathers in the 1940s. John was 14 years older than Angelo and, as he aged, he delegated more management responsibility for the companies to Angelo. When John died in 2010, his half of the shares of the companies passed equally to his four children. However, as noted in the court’s ruling, “Angelo retained and perpetuated his control of the board of the directors of [the companies] by refusing to hold any annual shareholders’ meetings after John’s death.” John’s children thus were unable to elect any corporate directors to represent their interests. Angelo also appointed his own daughters as officers and directors of the companies even though there were no meetings at which the daughters were elected to those positions.
In 2012, John’s children sued Angelo and his daughters for breach of fiduciary duty and misappropriation of corporate assets. They also sought the removal of Angelo and his daughters as directors and requested dissolution of the companies. They further claimed that Angelo withheld company information and prevented their inspection of records in order to conceal the misuse of company funds. In response to the dissolution request, the companies attempted to invoke a statutory right to purchase John’s children’s shares. The court stayed the dissolution proceeding while the parties performed a valuation of the shares in connection with the possible buy-out.
In 2015, while the dissolution action was still pending, John’s children demanded that the companies hold annual shareholder meetings, since there had not been any such meetings in the five years since John died. The companies rejected the request for a meeting, claiming that John’s children had no legitimate interest in the management of the companies since there was a pending action through which they would be bought out of the companies. John’s children then filed a complaint with a California superior court seeking an order that the companies hold annual shareholder meetings.
In ruling on the request for an annual meeting, the superior court acknowledged there were empty seats on the board but nonetheless dismissed John’s children’s complaint, based on the pending dissolution and buy-out action. The court also noted the “potential futility of an election of the shareholders that would end in deadlock.” In that regard, the court rejected the children’s argument that annual meetings were required, not discretionary, under California law, regardless of any pending dissolution action, and that by not holding meetings, the children were “effectively disenfranchised” as shareholders since they were unable to exercise their right to vote for directors.
John’s children appealed to the California Court of Appeals. The Appeals Court reversed the superior court’s denial of the request for a shareholder meeting. It determined that the pending dissolution proceeding did not affect the requirement to hold a meeting. Indeed, the buy-out process had been ongoing for several years and, the Court noted, may never actually result in a purchase of the shares. In the meantime, the children remained shareholders of the entities and, as such, had rights they were entitled to enforce. Without a mechanism to enforce those rights, under the applicable statute, the children remained subject to the claimed misconduct of Angelo and his daughters. According to the Court: “A shareholder without a shareholder’s rights is at best an anomaly, and at worst a shadowy figure in corporate limbo who would be voiceless in the conduct of the business of which he is part owner and largely defenseless against neglect or overreaching by management.” The Court concluded that the corporation statute required the entities to elect officers and directors and to continue the ordinary conduct of the business despite the initiation of dissolution proceedings.
The Appeals Court also rejected the superior court’s determination of the potential futility of any elections due to the expected deadlock of the ensuing directors. To that point, the Appeals Court noted that the corporate statute provides a remedy through which a shareholder can petition a court to resolve director deadlock through the appointment of one or more neutral provisional directors. Such an appointment, if made, would “ensure that the governance of a corporation is equitable,” even in the face of otherwise deadlocked ownership factions. Where the superior court instead anticipated deadlock and denied the request for an annual meeting, John’s children “were left powerless to stop the perpetuation of control of the board by the Angelo faction or seek judicial relief to appoint neutral directors.” The Appeals Court thus remanded the matter to the superior court to order that all the entities hold shareholder meetings as required under the California statute.
The Ielmini case serves as a reminder of the importance of following required formalities in family-owned businesses.
In particular, both corporate directors and shareholders should be aware of their rights and obligations, under the applicable state corporation statute, in connection with holding annual meetings and available remedies if no meetings are held.
Parties further should understand their options for avoiding shareholder and director deadlock and available judicial remedies for breaking the deadlock, including appointment of provisional directors, appointment of a receiver or (in extreme cases) dissolution of the company. Finally, while a statutory buy-out remedy may not be available in every state, parties usually would be well served to consider whether a purchase or sale of shares is the best way to resolve intractable – and often generational – disputes between family-owned business shareholders.