Failure to Pay Distributions May Be Shareholder Oppression, but Not Always
One of the most common claims of shareholder oppression in New Jersey, often leading to business divorce litigation, is the failure to pay distributions to shareholders. Obviously, there can be many reasons for not paying distributions, including, simply, an inability to do so. But when a company has the funds available but always finds a reason not to pay distributions, it could be seen as unfair or oppressive.
Quite often, distributions are not made because the shareholders running the company have set their own compensation so unfairly high that no money is left over for a dividend. If their compensation is significantly above market-rate, a court could determine that the overcompensation is a deliberate means to avoid making any payment ever to minority shareholders. A minority owner’s capital is effectively held hostage and rendered of no value unless the company is sold, which is fundamentally unfair.
Even when this happens, though, the circumstances of a given case are important. For example, in one trial that just concluded (successfully for my client), my own clients did exactly that – paid themselves high salaries and bonuses and made no distribution to the minority shareholder. However, the circumstances were extenuating, as the share ownership among the brothers involved was part of an intra-family agreement. Son #1 received a significant amount of money from their parents, and son #2 received the business. There was an unwritten – yet very real – agreement that all the monies from the business would go to son #2, regardless of the fact that son #1 was a ten percent owner, because substantial other monies had been paid to son #1. As a result, we were able to defend against the claim of oppression for failing to make shareholder distributions.
It is very unlikely, of course, that anyone reading this article has the same or similar circumstances in their case. The point is, though, that the facts do matter. Had the attorney representing the losing brother in the above scenario had more experience in these types of cases, he could have avoided wasting the time and money to bring an unsuccessful litigation. From the point of view of a majority shareholder, seeking legal advice in advance about whether their actions (failure to make distributions or otherwise) could result in shareholder oppression litigation might save countless legal fees and avoid a court order to buy out a minority shareholder. In more than one case, clients have been counseled to make at least some distribution to shareholders to avoid litigation, under the theory that some payment will look better to the court than zero payment.
Whether you are the majority shareholder or a ten percent minority owner, don’t take any action until you have consulted with an attorney experienced in business divorce litigation.