Why Private Company Minority Investors Need a Buy-Sell Agreement
Majority shareholders tend to have greater influence when it comes to making financial decisions for a company because they have more at stake, but this leaves minority shareholders vulnerable to oppression and mistreatment by the majority shareholders. Until a few years ago, minority shareholders could sue majority shareholders for misconduct and ask the court to order the majority shareholders to buy back shares from the minority investors. But a Texas Supreme Court decision in 2014, Ritchie v. Rupe, removed court-ordered buyouts as an available remedy for minority shareholders.
Technically, the Texas Supreme Court left court-ordered buyouts as an available remedy in cases of breach of fiduciary duty, but it remanded all fiduciary issues back to the Dallas Court of Appeals to be decided there. Although the jury in the initial trial had found the majority shareholders guilty of breaching their fiduciary duty to the minority shareholders, on appeal, the court decided the majority shareholders did not owe the minority shareholders any fiduciary duty. The issue of whether the minority shareholders were owed a buyout therefore became a moot point.
Although the decision did not ban court-ordered buyouts as an option, it set a precedent, because no Texas appellate court has ordered majority shareholders to buy out minority shareholders in the six years since the decision was made, and they don’t seem likely to start now.
The Ritchie decision did give minority shareholders the ability to appoint a “rehabilitative receiver”, although the language of the Texas Supreme Court’s decision failed to clarify whether the receiver would have the ability to require a majority shareholder to buy back a minority shareholder’s interest in a company. But the rehabilitative receiver needs to be appointed by the court, and so far, there have been no cases in which a minority shareholder has succeeded in gaining such an appointment.
Since the Ritchie decision, a minority shareholder’s best chance at bringing legal action against majority shareholders who have breached their fiduciary duty is a derivative action, but there’s a catch. In order to bring a derivative action against majority shareholders, the plaintiffs need to prove the defendants breached their fiduciary duty to the company, not necessarily to the minority shareholders. In cases where dividends or distributions were withheld from minority shareholders and kept in the company’s bank account (or invested back into the company), it’s sometimes difficult to prove the best interests of the company were at risk but failing to pay for taxes incurred by shareholders often is a good basis to challenge failure to pay dividends.
Because of all these restrictions on how and when minority shareholders can sue majority shareholders to reclaim the cost of their shares, it’s important to have a buy-sell agreement in place before buying any shares of a company. The problem is, friends and family members often come together to form and invest in private companies, and they usually don’t know, or don’t bother, to put their agreement into writing.
Even when working with those you love and trust (arguably, especially when working with those close to you), it’s important to put everything in writing so everyone has a clear exit strategy if things don’t turn out the way they expect.
If you have claims regarding a business, LLC or shareholder dispute contact one of our Chicago partnership dispute attorneys at our toll-free number 630-333-0333 or contact us online here.