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. Continue Reading Watch Out For Minority Shareholder Oppression Claims After Admitting Non-Family Shareholders To The Family-Owned Business
All too often, family businesses are run in an “informal” fashion, with insufficient attention being paid to corporate formalities, including requirements set forth in a corporation’s bylaws. The Delaware Chancery Court recently ruled in Rainbow Mountain, Inc. vs. Begeman (March 23, 2017), that even in a family-owned business where all of the parties to a dispute are family members, the bylaws will control corporate actions.
In Rainbow Mountain, the defendant Terry Begeman was a member of the family that had founded the corporation. After a falling out among the family members, the group that held a controlling interest sought to remove Terry from the board of directors of the corporation, and in 2008 voted him off of the board of directors. Terry refused to accept this removal, and in 2014 the corporation filed an action for declaratory judgment seeking to confirm that Terry had been removed from the board.
In a recent decision, the United States Bankruptcy Court for the Eastern District of Massachusetts sent a reminder to practitioners and family business owners that it is critical to maintain corporate formalities in order to avoid unintended liabilities. In the case of In re Cameron Construction & Roofing Co., Adv. P. No. 15-1121, 2016 WL 7241337 (Bankr. D. Mass. December 14, 2016), the Bankruptcy Court applied the concept of substantive consolidation and made the assets of a non-bankrupt related entity available to creditors in the bankruptcy proceeding.
Directors of all corporations – including family owned businesses – owe a fiduciary duty of loyalty to the company. This duty requires a director to put the interests of the company ahead of his or her personal interest and not to divert corporate opportunities or assets for his or her own benefit. Many state statutes further address potential conflicts of interest and allow for such conflicting interest transactions as long as the director makes prior disclosure and obtains the approval of all non-interested directors or shareholders before embarking on the transaction. This statutory process protects the corporation from the potential damage of a self-interested deal by one or more directors. It also provides cover for the director when acting for his or her own benefit as long as the director makes the proper prior disclosures and receives the needed approval.
Family owned corporations are subject to the same statutory requirements regarding entity governance as non-family owned businesses. Thus, in order to fully comply with the applicable statute for the state where the business is incorporated, a family business should pay attention to all provisions that require annual or other ongoing action by the company. These include:
- Holding annual shareholder meetings
- Holding formal elections of directors at shareholder meetings,
- Documenting actions taken by the unanimous consent of the directors without a meeting
- Maintaining complete records of the company’s operations and finances
Many companies also have detailed provisions in their by-laws that spell out additional duties of directors and officers, along with shareholders’ rights and responsibilities.