minority shareholders

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.

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.

Oppression Plaintiff Obtains Injunctive Relief

Recent New York Decision Grants Injunction Pending Litigation of Oppression Claims

In a recently issued opinion in Feinberg v. Silverberg, 2011 NY Slip Op 32299 (Nassau Co. 2011), Nassau County Supreme Court granted injunctive relief preventing Defendant from continuing oppressive acts. The case strongly supports the proposition that when an oppressed shareholder stands to lose his stake in control and management of a corporation, money damages are not sufficient compensation and an injunction provides greater equity as relief.

L&E is a closely held corporation founded by Feinberg, Plaintiff, and Silverberg, Defendant, who are both 50% shareholders. Feinberg is the President and Treasurer; Silverberg is the Vice President and Secretary. Victor Hecht, another named Defendant, is the Chief Financial Officer of L&E, and Brian Barney is an employee with responsibilities involving the business of L&E in Asia.

Economic Duress and Minority Shareholder Oppression

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.

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.