Minority Oppression

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Selling Minority Equity Interests for What They’re Really Worth - The Lessons of Pappas v. Tzolis

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At first glance it might appear as if the New York Court of Appeals struck a major blow to LLC minority member rights in their November 2012 ruling Pappas v. Tzolis. After all, the New York high court held that a majority member owed no duty to disclose to his fellow members that upon buying out their equity interests, he planned to immediately flip for $17.5 million the interests he had acquired from them for $1.5 million. 

However, implicit in the opinion is the recognition that if business partners have a relationship based on mutual trust, a partner may not be free to cheat his partner out of financial gains by failing to disclose material facts.

            Pappas v. Tzolis involved a Limited Liability Corporation (“LLC”) formed by three parties in January 2006 to acquire a long-term leasehold interest in a Lower Manhattan building. Steve Pappas and Steve Tzolis each contributed $50,000 to this project with Constantine Ifantopoulos contributing another $25,000. Trouble plagued this LLC from the start. Tzolis sought to sublease the property to another company he owned, and according to Pappas and Ifantopoulos, they had to go along with this because Tzolis had blocked efforts to sublease to other entities. Further, Tzolis would not cooperate in the development of the property and his company neglected to pay the $20,000 monthly rent on the sublease.

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Expansion of Shareholder Oppression Doctrine in Texas

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Reasonable Expectation that Management will Meet with Prospective Purchasers of Shareholder’s Stock

In Ritchie v. Rupe, 339 S.W.3d 275 (Tex.App.-Dallas 2011, pet. filed), the Texas Fifth Court of Appeals held that a minority shareholder in a closely held corporation can have a reasonable expectation that management will meet with prospective purchasers of her stock.  Significantly, the Supreme Court of Texas has since granted petition for rehearing and review.  If the petition for review is granted, it will be the first shareholder oppression case heard by the Court.

In Ritchie, there was no shareholders’ agreement in place restricting the minority shareholder’s right to sell.  Initially, the shareholder, in an effort to sell, offered the stock to the corporation, but rejected the amount that the corporation was willing to pay as substantially below market.  The shareholder then began to seek third-party purchasers through a broker, but the broker was informed that company management would not meet with any prospective purchasers.  This made the stock virtually unmarketable, since it was unlikely that anyone would buy stock in a closely held corporation without first evaluating and obtaining information from management.

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Economic Duress and Minority Shareholder Oppression

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If a majority shareholder terminates a minority shareholder’s employment or forces him to sell his shares in the company at a below-market price, the majority shareholder could be vulnerable to a claim of oppression.  But, what happens if the majority shareholder is able to obtain a signed agreement from the minority shareholder in which the minority surrenders its rights in return for some – but far less than fair market – consideration?  Typically, an agreement giving the minority shareholder some severance rights or compensation for his shares will contain a general release provision, which would provide that the minority shareholder releases all claims he may have against the majority shareholder.

Often the minority shareholder – having lost his job and means of support or being compelled to sell his interest in his business – will be under significant pressure to accept an offer that provides him some continuing income or compensation – even if it is much less than what he might legally be entitled to or could negotiate for is he were not under duress.

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Limitations on Majority Rule in the Management of Business Entities

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The general rule in the corporate governance of business entities -- including corporations, limited liability companies and partnerships -- is that absent an agreement or statutory requirement to the contrary, majority rule governs.  Indeed, majority equity owners often assume that they can do pretty much anything they want with regard to the business entity. 

However, this is an erroneous assumption.  Over the years, many legal principles have evolved which limit the freedom of the majority  to do as they wish.