Minority Shareholder Rights

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

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.

Shareholder Oppression in Delaware

Delaware does not have a cause of action for oppression per se, but it does offer relief for minority shareholder oppression-like claims applying other legal principles.  Thus, oppression-like claims must be carefully pleaded in Delaware.  

Since court’s in other states are likely to apply Delaware law to oppression-like claims to companies organized in Delaware, vigilance must also be exercised in pleading claims relating to Delaware corporations in non-Delaware courts.  Some courts outside of Delaware, such as the Southern District of New York and the Northern District of Illinois, have upheld causes of action for shareholder oppression under Delaware law, while others, such as the District of New Jersey, have dismissed oppression claims for failure to state a claim under Delaware law.

Nixon v. Blackwell, 626 A.2d 1366 (Del. 1993), is a Delaware case that often cited for the proposition that Delaware does have a shareholder oppression remedy, and also for the proposition that it does not.  The case states that “[t]he entire fairness test, correctly applied and articulated, is the proper judicial approach” to deciding claims brought by minority shareholders against those in control of the corporation.  Thus, some conclude that oppression claims may be pursued under the entire fairness doctrine.   

However, Nixon v. Blackwell also, contains language that seems to indicate otherwise:  

What is Shareholder Oppression?

The “shareholder oppression” doctrine is a set of legal principles that protect minority shareholders from abuse by the majority.  As such, these principles stand in direct contradiction to the central rule of corporate decision making that the will of the majority governs.  The doctrine also runs contrary to and can prevail over several other well established legal principles, including the business judgment rule, the employment at will doctrine and derivative claims distinction.  More on these later.

The principles protecting the rights of minority equity owners are articulated and implemented differently from state to state, and their implementation often involves a balancing of the rights of the majority to control the business entity’s destiny and the rights of the minority to receive the often unarticulated benefits they anticipated when they joined the enterprise.  The rules may vary within a state depending on the type of entity, as well. 

Limitations on Majority Rule in the Management of Business Entities

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.