When a shareholder claims that a director or officer has harmed a corporation through his or her improper conduct, these claims typically must be brought through a derivative action, in which the shareholder sues on behalf of the corporation. Ordinarily, however, a corporation’s board of directors has the authority to bring lawsuits on the company’s behalf, for the benefit of all of the shareholders. Thus, a shareholder who wants the company to pursue claims must first make a demand upon the board to file a lawsuit, unless such a demand would be futile. As courts in Delaware and elsewhere have determined, so-called “demand futility” may be found where there is a “reasonable doubt that, as of the time the complaint is filed, a majority of the board could have properly exercised [their] independent and disinterested business judgment in responding to a demand.” In these situations, a demand would be futile because “a shareholder would be effectively asking a majority of the board of directors to cause the corporation to sue themselves.” If a shareholder attempts to bring a derivative suit without first making a demand or without showing futility, that suit may be dismissed on a motion by the defendants.
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Should an Estate or Trust Operate a Decedent’s Family-Owned Business?
When a business owner dies, his or her ownership interests often become part of a probate estate or are transferred to one or more trusts in order to continue the operations of the business. But sometimes the decedent’s business is distressed at the time of death and of questionable value to the estate or to the trust beneficiaries. In that case, executors or trustees, along with their beneficiaries, should understand what fiduciary standards apply to the use of estate or trust resources in connection with the continued management, operation and ownership of the business.
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Beware of Successor Liability Claims in Connection with Family-Owned Businesses
A corporation ordinarily is not liable for the debts of other entities or for the debts of its owners in the absence of an express agreement, such as a guarantee. However, a creditor of one company may try to impose liability on one or more non-debtor entities under “alter ego” or “successor liability” theories in certain circumstances. In these circumstances, a creditor often alleges that there has been a transaction between a predecessor debtor entity and successor non-debtor entity through which: (1) the successor expressly or impliedly has assumed the liabilities of the predecessor; (2) the transaction has resulted in a de facto merger between the entities; (3) the successor is a mere continuation of the predecessor; or (4) the transaction is a fraudulent effort to avoid liabilities of the predecessor. If the creditor is successful, a non-debtor entity may then become liable for debts that it did not incur in its own name and that non-debtor entity’s assets also may be reachable to satisfy the debts.
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Watch the Calendar When Considering Claims in Connection With a Family-Owned Business
Shareholders of family-owned businesses sometimes assert claims of misconduct against their co-owner relatives. These claims can take the form of oral complaints or written claim letters. However, actual lawsuits based on such claims must be timely filed in court or else they may be barred by the applicable statute of limitations, leaving the shareholder with no ability to pursue the claims. A United States District Court in Ohio recently dismissed certain claims by a sister against her brother in connection with a family-owned business because, the court ruled, the sister waited too long before filing suit.
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Court Ruling Highlights The “Perils Of Going Into Business With Family Members”
An Indiana Court of Appeals recently ruled upon a dispute between a mother and her daughter and son-in-law (and their business) concerning the lease of commercial property and the repayment of loans the mother made on the business’ behalf. The Court began its decision in Wayt v. Maschino (December 29, 2017), by noting: “This case can be added to an unfortunately long list of cautionary tales concerning the perils of going into business with family members.”
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Is A Non-Compete Agreement In Connection With The Purchase And Sale Of A Family-Owned Business Enforceable?
In connection with the purchase of a family-owned business, the buyer may seek a non-compete agreement from the selling owners and certain family member employees. Such agreements are intended to protect the buyer from a seller’s competition with the business post-sale and from diversion of the customer relationships and goodwill that typically are part of the purchased assets. Courts will generally enforce a non-compete agreement negotiated as part of a business sale as long as it is reasonable in geographic scope and duration. What is reasonable will depend on factors such as the type of business being purchased, the pre-sale geographic reach of the business, and the consideration paid for the restriction on the seller’s future competition. Parties to a non-compete should therefore carefully consider these factors when drafting the agreement. The parties also should carefully define what type of “competitive” conduct will be restricted.
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Watch Out For Minority Shareholder Oppression Claims After Admitting Non-Family Shareholders To The Family-Owned Business
Controlling shareholders and managers of family-owned businesses often direct the use of company funds and other resources to provide employment and other benefits to non-shareholder family members. In a business that is wholly-owned by close family members, there may be little concern that other family member shareholders will complain about the use of such resources, as long as there is disclosure and perceived fairness concerning the use of company funds and access to employment opportunities. The risk of a potential claim for breach of fiduciary duty or minority shareholder oppression may increase, however, when non-family members are admitted into the ownership structure. At that point, historic and perhaps informal practices concerning family member involvement in, and benefits from, the company may not be acceptable to a new owner. The controlling family member owners must therefore be careful to follow good corporate governance practices when making decisions on the company’s behalf.
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Should You Mediate Your Family-Owned Business Dispute?
Disputes between and among owners of family-owned businesses are sometimes unavoidable. When such disputes progress to litigation, they can be extremely costly, time-consuming, and disruptive for the business and its owners. However, most civil lawsuits still settle before reaching a trial before a judge or jury. More specifically, many of those suits settle through mediation. Indeed, judges routinely encourage parties to attempt to settle their disputes, through mediation or otherwise, before setting a trial date.
Mediation is a process through which parties to a dispute select a neutral third-party – often a retired judge or an attorney with subject-matter experience – to attempt to broker a deal between the opposing sides. Mediation sessions are confidential and provide an opportunity for parties to explore a variety of options for resolving their dispute that otherwise may become unavailable once the case is put in a judge or jury’s hands. If done early in the life of a case, mediation can also allow the parties to avoid substantial litigation costs and business disruption.
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Definitions in Shareholder Agreements Matter When Transferring Family-Owned Business Stock
Owners of family-owned corporations often enter into shareholder agreements that spell out whether and to whom corporate shares can be transferred. Frequently, these agreements provide for rights of first refusal by the other stockholders or a stock repurchase by the company if a shareholder wishes to transfer shares during his or her lifetime. These agreements also typically address whether shares may be transferred to any heirs upon a shareholder’s death. Unless the language regarding permitted transfers is clear, claims may arise between generations of owners concerning the proper ownership of shares upon a shareholder’s death.
A recent California Court of Appeal decision – Saccani v. Saccani – is illustrative of the type of dispute that can arise between family members over a deceased owner’s shares. Albert Saccani started Saccani Distributing Company in 1933. According to the Court, Albert’s “desire was that the company would always be kept in the family.” When he died, each of his sons – Donald, Roland, and Gary – received one-third of the company’s shares.
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Do You Have a Reasonable Expectation of Receiving Dividends if You Acquired Your Shares in a Family-Owned Corporation Through Gift or Inheritance?
Corporate shareholders often expect to receive dividends in connection with their ownership of corporate shares. This is particularly true when owners invest capital in or provide other services to the company in exchange for their ownership interests. But do shareholders’ rights to or expectations of dividends change when shares are acquired through gift or inheritance? This issue frequently arises in family-owned businesses where shares are transferred from one generation of owners, who may have built the business through their investment of capital and labor, to the next generation, who themselves may never have worked in, or invested in, the business.
In Jones v. McDonald Farms, Inc., a Court of Appeals in Nebraska recently was presented with a claim by Diane Jones against her two brothers, seeking a decree of judicial dissolution of the company based on the brothers’ alleged “corporate oppression” through their failure to pay dividends to Diane in proportion to her share ownership. Charles and Betty McDonald had incorporated McDonald Farms, Inc. in 1976. Their two sons, Donald and Randall, began farming with Charles in the mid-1970s and they became officers of the company in 1989, while continuing to perform all farming duties. From 1976 through 2010, Charles and Betty were majority shareholders and Donald and Randall were minority shareholders. In 2010, Betty died and her shares were devised equally to her four children, including Donald, Randall, Diane and another sister, Rosemary. In 2012, Charles gifted his stock equally to Donald and Randall. Charles died in 2014. As a result of these transfers, Donald and Randall each held 42.875% of the company’s stock, while Diane and Rosemary each owned 7.125% of the stock.