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Shareholder oppression in Delaware

Delaware does not have a cause of action for oppression per se, but it does offer relief for similar claims of oppression of minority shareholders by applying other legal principles. Therefore, claims similar to oppression must be carefully defended in Delaware.

Since courts in other states are likely to apply Delaware law to similar claims of oppression by organized businesses in Delaware, vigilance should also be exercised when bringing claims involving Delaware corporations in courts outside of Delaware. Some courts outside of Delaware, such as the Southern District of New York and the Northern District of Illinois, have upheld causes of action for shareholder oppression under Delaware law, while others, such as the District of New Jersey, have dismissed oppression claims for failure to file a claim under Delaware law.

Nixonv. Blackwell, 626 A.2d 1366 (Del. 1993), is a Delaware case often cited for the proposition that Delaware has a remedy against shareholder oppression, and also for the proposition that it does not. The case says that “[t]The full fairness test, properly applied and articulated, is the appropriate judicial approach for deciding claims brought by minority shareholders against those who control the corporation. Therefore, some conclude that oppression claims can be prosecuted under the doctrine of full equity.

However, Nixon v. Blackwell also contains language that seems to indicate otherwise:

A shareholder trading shares in a closely held corporation and paying for those shares…can make a business decision about whether to purchase a minority position, and if so, on what terms. One could negotiate final self-ordering provisions allowed to a Delaware corporation through the certificate of incorporation or bylaws under the provisions in [Delaware law, and] In addition to such mechanisms… [such as] prepare proofs of earnings, purchase provisions, voting trusts or other voting agreements. The good corporate practice tools are designed to give a buying minority shareholder the opportunity to negotiate for protection before considering sharing.

This lack of sympathy for minority shareholders who have not negotiated written protection of their rights fails to recognize that minority shareholders often find themselves in the minority due to factors they could not anticipate at the company’s inception, and that even the best and most extensive shareholder agreements cannot address all of the varied and creative ways that the majority can use its power to unfairly harm the minority.

However, many of the claims that fall within the general category of shareholder oppression may be brought under Delaware law using other accepted legal principles in that State.

The entire doctrine of equity, mentioned above, is one of them. It is an exception to the commercial judgment rule, which would normally protect directors’ actions from judicial scrutiny, and creates a framework for granting relief to minority shareholders when directors act in their own best interest. Therefore, when a minority shareholder demonstrates that the directors are on both sides of a transaction or that they will obtain a special benefit from the transaction, that is, there is a conflict of interest that produces a benefit that the other shareholders generally do not share, then the directors or those in control must demonstrate both fair dealing and fair pricing, a demanding standard. All equity analysis essentially requires judicial scrutiny of a transaction or action.

Delaware recognizes that controlling shareholders have fiduciary duties to their fellow shareholders. “[W]When a shareholder presumes to exercise control over a corporation, in order to direct its actions, that shareholder assumes a fiduciary duty of the same kind as that of a director.” Sterling v. Mayflower Hotel Corp 93 A.2d 107, 109-10 (Del. 1952). Thus, many types of conduct that would give rise to oppression claims in other jurisdictions would also support breach of fiduciary duty claims in Delaware.

Majority shareholders may be held liable in Delaware when:

  • cause the corporation to issue additional shares to the majority shareholder at an inappropriate price;
  • reduce the economic value of minority shares disproportionately or affect their voting rights;
  • participate in a course of trading designed to force a minority to exit below the fair market value of its shares; gold
  • Selling your majority stake to a buyer without adequate due diligence to ensure they are not a looter or corporate scammer.

In Delaware, it is very important to determine whether the claims being brought against those in control are direct claims, in which minority shareholders were directly harmed by breaches of fiduciary duties; or derivative claims – in which the corporation is injured. The distinction between direct and derivative claims in Delaware can often determine whether a claim can proceed and what steps must be taken before it can be filed. The rules for distinguishing direct from derivative claims can often be complex and appear to be constantly evolving under Delaware law, which we will address in a later post.

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