Negotiated Protections
Minority shareholders have only a few rights bestowed upon them by default contract law. But, the minority shareholders have the money to invest. As leverage, they will use the money to negotiate for protections that are otherwise unavailable.
Cumulative Voting and other Board Provisions
DGCL § 214 allows for cumulative voting. We have already discussed cumulative voting, the procedure where you can combine all of your shares to vote on one board member instead of spreading them out evenly for each (straight voting). Cumulative voting often gives a minority shareholder power to elect at lease one director. However, this power can be limited by staggering the election by making fewer directors available to elect.
Instead, a simpler way to achieve the same result with more protection is if shareholders enter into a voting agreement as authorized by DGCL § 218(c) and MBCA § 7.31. A voting agreement is where the majority shareholder agrees to utilize some of their votes to elect a director of the minority shareholder’s choosing. This protects against staggered elections and simplifies calculations.
Preemptive Rights
May be authorized by MBCA § 6.30(b); DGCL § 102(b)(3) through a charter provision but the default rule is that there are no preemptive rights. Preemptive rights are where the minority shareholder is offered an opportunity to purchase shares that are expected to be issued, proportionate to the percentage interest they already own. The purpose? Prevent ownership dilution.
These rights can also be contractually provided, a route commonly followed because it selects who can get the rights and involves less formalities.
Veto Rights
Veto rights are either explicit or implicit. Explicit veto rights are provisions that prevent a majority shareholder from taking actions without the approval of the minority shareholder. Implicit veto rights come from increasing the required number of shares outstanding to constitute a quorum. By not having a quorum, a majority shareholder cannot vote. Implicit veto rights also require preemptions or veto rights over additional issuances of shares so as to prevent the dilution of a minority interest sufficient to obtain the requisite quorum.
Employment Rights
An investor could contractual agree to become an employee for the corporation before investing.
Buyout Obligations
A corporation is unlikely to agree to broad buyout obligations, but without any, a minority shareholder would be stuck (unable to transfer shares or sell them in a public market). As such, these provisions may allow a minority shareholder to sell their shares to the corporation if certain events occur (such as death of the shareholder).
Dividend Policy
Determine when and how much of a dividend should be issued.
Documenting Protections
Documentation can occur in one of three ways: the charter, the bylaws, or through a separate shareholder agreement. Corporations enjoy opting for a shareholder agreement because they are easy to create and amend compared to the charter and bylaws. Additionally, they tend to be more private. These agreements are nice, but should fall in accordance with MBCA § 7.32(b)(1) or DGCL § 350.
Immutable Statutory Protections
Inspection Rights
Shareholders are free to inspect the corporations books and records for a proper purpose. See MBCA § 16.02; DGCL § 229. Shareholders are also entitled to receive annual copies of financial statements under the MBCA.
Judicial Dissolution for Oppression
MCBA § 14.30(a)(2) allows the court to dissolve the corporation if directors or those with control are engaged in illegal, oppressive, or fraudulent activities. Oppression occurs when the majority is engaging in activities that when a reasonable person sees those activities limits the minority holder’s ability to participate in the business. MCBA § 14.34 allows shareholders to purchase the shares of a shareholder wishing judicial dissolution. Nothing like this exists in the DGCL.
Judicial Dissolution for Deadlock
MCBA § 14.30(a)(2) also allows for judicial dissolution for deadlock. Deadlock occurs when there are an equal number of directors who differ in a decision that is necessary for the continued function of the corporation. Additionally, it requires that the corporation has failed to remove or replace directors for at least two annual meeting requirements. To avoid judicial dissolution, the bylaws may contain a “shotgun” provision, designed to remove one of the parties at odds and compensate them well for that removal.
The DGCL also allows for dissolution in accordance with § 273 where there are only two directors who are split 50/50. According to 226, a custodian could be appointed to handle the corporations assets and other business affairs.
Heightened Fiduciary Duties
If the corporation is a close corporation, they may also be subject to higher fiduciary standards such as “utmost” goof faith and loyalty.
Buy-Sell Agreements
When shareholders are part of a closely held corporation, buy-sell agreements are common. They restrict the ability to transfer shares and specify how many shares can be transferred following death or disability. These agreements are often drafted at the beginning of the business and as such are fair to both buyers and sellers (because the parties don’t know which one they may end up being).
Blanket Prohibition on Transfers
“Can’t transfer shares unless allowed under the agreement.”
Right of First Refusal or First Offer
A right of first refusal requires a shareholder who found a third party to sell to offer the shares to the corporation or other shareholders first. If they decide not to, then the shareholder can sell to the third party.
A first offer is where the selling shareholder sets the terms of the sale first, offers it to the corporation or shareholders, then (if denied) can make an offer to a third party for no better terms.
Obligations to Sell and Buy
If a shareholder hits a triggering event, it obligates the shareholder to sell and obligates the corporation or other shareholders to buy. The price of this sale is outlined in the agreement which could either be appraised, stipulated, or based on a formula.
Disclaimer
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.
