My wife is a therapist. As such, she often refers to her “wise-woman instincts” and how clients often ignore the red flags in their lives. Rather, they see these red flags as fuchsia. In my decades of handling partnership disputes and shareholder oppression cases, I can say that this is definitely a recurring problem in the business world. Partners, shareholders or co-members often stifle or fail to act on fears of wrongdoing. They often fail to investigate their suspicions until things have unraveled.
A recurring theme in cases involving minority LLC member or shareholder oppression is a lack of disclosure by the majority to the minority regarding the financial condition of the business. Such a disclosure would have supported a claim for mismanagement or concealment. It is often the case that a majority shareholder will refuse to voluntarily provide the minority shareholder with financial records or other important information about the company where those financial records reveal fraud, embezzlement, or other wrongdoing committed by the majority shareholder. The financial records might also reveal the information necessary for determining the fair value of the minority shareholder’s interest. Clearly, this information would prove essential in any negotiation over a buyout.
Often, a client will come to us with very little in the way of financial records. Controlling shareholders in these situations will withhold information evidencing their fraud or the artificial deflation of the value of the minority shareholder’s interest. Therefore, litigation is required to compel the majority shareholder to provide the business’s complete financial records. We often work closely with forensic accountants in these cases to get to the heart of the matter.
Financial Records Can Tell a Story
Frequently, when the minority shareholder is able to obtain the business’s complete financial records, the documents may reveal that the majority shareholder has been taking a disproportionate share of benefits to the detriment of the minority. For example, the financials may demonstrate that the majority shareholder is:
- diverting business assets to another entity solely owned by the majority shareholder;
- paying him or herself an unreasonably high salary or is taking disproportionate distributions;
- paying him or herself additional compensation in some form, such as ambiguous or vague “management fees”;
- using the company credit card or company funds to pay for his or her personal expenses; and/or
- has taken “loans” from the company with no intent to pay the loan back, sometimes failing to even designate the loan on the company’s books as an asset.
Actions like these may form the basis for a minority member or shareholder oppression case. It is important to timely expose fraud and other misdeeds by a business partner, co-shareholder or co-member. Please call me if you have any questions about this blog or other related issues.