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The Special Situation of “Passive” Shareholders

As the economy keeps getting worse, many family-run businesses are finding that conflicts between shareholders that had been brewing beneath the surface for years are finally coming to a head, and business partner disputes are becoming more common in such businesses.  The humming economy helped to mask those problems, since there was less of a reason to act on them while everyone was making money.

Passive shareholders are those who own an interest in the company, but who are not involved in management or as an employee.  Often the existence of passive shareholders in a family owned business means that the “next generation” has inherited from the one before it, and that some family members have chosen, for whatever reason, not to work the family business.  Those that do the work often feel that they “deserve” more money than their salary alone provides them, and that those that provide no “sweat equity” are entitled to nothing.  This is a litigation just waiting to be filed.

One situation that could exacerbate such feelings is when dividends suddenly cease after a history of being paid.  Many family-owned businesses are feeling the pinch of the economic downturn, and several that previously paid dividends with regularity have stopped doing so.  Of course, this hurts passive shareholders the most – those who do not actually work at the company for a salary, and who depend on dividend payments as the only financial benefit they receive from the company.

The failure to pay dividends is not necessarily “wrong.”  There is law in New Jersey indicating that the failure to pay any dividends could constitute “oppression” entitling the minority shareholder to, among other remedies, a potential buy-out of their shares.  The theory is that a company cannot keep someone’s investment “hostage” and refuse to pay a return on that capital.  However, that has not yet been put to the test in a situation where a company that is losing money stops paying dividends temporarily because it cannot afford to pay them any longer.  After all, companies that are losing money arguably have no business paying dividends to shareholders.

But when interpersonal problems between the shareholders already existed, the fact that some shareholders no longer receive anything from the company often serves to make those issues worse.  For example, when a minority shareholder who has stopped working in the company believes that those family members who run the company are not doing a very good job, the lack of trust of your business partner only gets worse when business is bad and the money stops flowing.

What can be done to prevent such a situation?  For starters, all minority shareholders, including passive shareholders, should be provided full access to the company’s books and records – as much financial information as possible.  If a minority shareholder sees that there is transparency in the company’s record keeping, it may do much to ameliorate concerns about what has been happening.  However, when a discontinuation of dividends is followed by what is perceived, at least, as secrecy, suspicions often persist about what is “really” going on within the company.  All too often the mere lack of access to company records has led to a suit between business partners that could easily have been avoided.