Majority and Minority Shareholders Relationships: Duties to the Business and Each Other By Michael J. Zdeb The relationship of shareholders in private, closely held companies to each other as well as the business involve important implications not only in the establishment of the business but as well in its operations. The general rule in most states is that the holder of the majority of the voting shares controls the corporation. The majority being the holder of more than 50 percent of the voting power. This is equally true with the limited liability companies. The members holding a majority of interests can effectively control the business (Majority Rule). The majority therefor can, absent cumulative voting, elect the board of directors or board of managers and control the affairs of the business. The holders who are in the minority effectively can be left without a voice in the affairs of the business. The exceptions to this general position include corporations with cumulative voting; in some states certain fundamental decisions (sale, merger, dissolution; known as Fundamental Decisions) require two-thirds votes and, businesses where the holders have entered into agreements then control voting. It is worth noting that cumulative voting may enable a minority of shares to elect a minority of the board of directors, with the number of directors being the result of a formula on the voting. For example, if a shareholder holds one-third of the voting shares, in an election of three or more directors, the shareholder would be able to elect one director. Shareholder agreements can address the election of the board and not infrequently, minority investors negotiate the ability to nominate and elect a director as a representative. Fundamental Decisions include those that amend the formation documents filed with the state; the sale of all or substantially all of the assets of the business; the merger of the business or, the dissolution of the corporation. Fundamental Decisions requiring a special vote also provide a minority with the ability to dissent and force a buyout of the shares. It effectively gives the minority an ability to exit the business and have the interest valued in an appraisal proceeding with the court. It is important to note that the standard of value employed by a court in an appraisal proceeding is not the commonly known standard of "fair market value." Instead the standard of value applied is "fair value." Generally, "fair value" as a standard will produce a valuation significantly greater than "fair market value." With closely held, private companies, there is rarely a market for the shares or interests of the minority position holders. The minority then may be in a position of having no effective voting rights and no market in which to sell the shares. Unlike shareholders in a publicly traded company who can disagree and sell their shares, the minorities' capital remains locked in the closely held business. As a result, the minority can be in a vulnerable position if the majority chooses a course of action that is adverse to the interests or opinion of the minority. This vulnerability has led many state courts to treat the relationships in closely held, private companies differently than how the duties and relationships in publicly traded companies are viewed. Some jurisdictions, however, will treat the relationships among the shareholders similar to the approach with publicly traded corporations. In particular, this is the approach in Delaware and states that follow its corporate law and decisions. Consequently, the law of the jurisdiction in which the business is incorporated or formed is an important consideration, as that is the law that will govern the relationships of the shareholders to the business as well as each other.
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