For Sellers of Minority Interests, the Rule is "Caveat Vendor" – Let the Seller Beware

  • New York Court of Appeals rules that seller of minority interest has no remedy when purchasing majority owner immediately flips the interest for twenty times what he paid

Owners of minority interests in companies often have very little say on the most important issues that determine the value of their interests. These issues include:

  •          whether equity owners will receive distributions and if so, in what amounts; and
  •          whether the business will be sold and when.

Because of these reasons and others, the only buyers of their interests are typically the majority equity owners and often, because of this, the majority owners can dictate the price.

What happens when the minority owner, who has been waiting for years to realize on the value of his interest finally gets an offer from the majority owner to buy his interest?  As several recent New York Court of Appeals decisions illustrate, the offer is often precipitated by the fact  that the majority owner has received – or is about to receive - an offer for the entire company that he is ready to accept. He realizes that he can increase his own profit on the sale by buying  out the minority owner at less than the pro-rata share of the value for the company that he is entitled to. So, he makes an offer, but neglects to tell the minority owner about the potential transaction or the value that this indicates for the company as a whole.  The minority owner accepts the buyout offer, contracts are drawn and the minority interest is sold to the majority owner. 

A few weeks later, the minority owner learns that the majority owner has sold the entire company at a value that reflects that the minority position was worth twenty times what he just sold it for.  Rightfully indignant, the minority owner sues to collect the amount he believes he was cheated out of. He claims a breach of the majority owner’s fiduciary duties by failing to disclose the offer at the much higher price.

Avoiding Shareholder Oppression Claims

The Threat:

Being a defendant in a shareholder oppression case can pose a significant threat to a closed corporation and its majority shareholders. Not only can the majority or the corporation be forced to buy out the shares of the minority at what the court determines to be “fair value,” the litigation itself can be a significant distraction and drain on company finances and managerial resources.

“Fair value” often involves an appraisal process, expert reports and expert testimony at a trial – and great uncertainty as to what the court will ultimately decide.  “Fair value” is a technical legal terms that is a legislative and judicial creation; it is not the same as “fair market value” and it can often be substantially different from what the minority’s shares can fetch in the open market or the amount of financing a company can obtain to buy these shares.