Minority Business Owners Are Not Always Bound by an Operating or Shareholder Agreement

A newly-decided case in New Jersey dictates that the court follow an operating agreement (LLC) or shareholder agreement (corporation) that has a specific provision on valuing shares when an owner is retiring or otherwise voluntarily leaving.

Introduction

The point of that case is that the operating agreement can only be amended expressly; it can’t be amended by conduct. However, a minority owner is not necessarily bound by the written agreement in the event of member or shareholder oppression.

In the recent case referred to, the court expressly found that no member oppression had occurred. But if there had been member oppression, the court likely would have reached a different conclusion.

Takeaways

What this means for business owners is that the valuation methodology set forth in one’s shareholder agreement may apply, or it may not. If the very reason you want to leave the company in the first place is because of improper action by the majority shareholders (or even a 50/50 shareholder), the operating agreement may not govern your departure. Take, for example, a situation where you believe that the majority owners are dramatically overpaying themselves in relation to what they actually do for the company. If you don’t know what the law is, you may not be aware that such conduct may violate your minority shareholder rights. Consequently, you might simply start negotiating a buyout on your own behalf, and conclude that you are stuck with the provision in the Operating Agreement that says a departing member gets paid according to some predetermined formula that is far below market value.

However, if you educate yourself about the law, you will learn that – at least in New Jersey – paying oneself far above market value for the job can constitute shareholder or member oppression under the right circumstances. (The “wrong circumstances” could entail your being involved in setting the objectionable salaries, or knowing about the issue for a long time and never complaining.) If the court considers you an oppressed member or shareholder, there is a solid chance that it will not apply the formula set forth in your agreement. Such a clause is supposed to govern voluntary, arms-length transactions. If you get bought out as a remedy because of the other side’s wrongful action, it would be unfair not to provide a remedy that gives you the full value of your interest.

Conclusion

So, while this recent case makes it clear that the court will not rewrite an operating agreement to give you a better value than what you agreed to, the law still recognizes that your agreement may not apply if you are a victim of oppression.