Share |

Small Interests, Big Problems: Addressing Minority Rights in Limited Liability Companies

Embedded Scribd iPaper - Requires Javascript and Flash Player

May 2014 Nevada Lawyer 19
Many states have developed a robust
body of law, both statutory and judicial,
to protect the interests of minority
owners and remedy what is often
referred to as “minority oppression.”
Closely-held businesses are particularly
susceptible to minority oppression
because, by definition, ownership
is concentrated in a relatively small
number of individuals and owners
substantially participate in the
management of the business. It is
not difficult to imagine the myriad
problems that can arise when financial
interests associated with ownership are
coupled with the power and discretion
of management.
This disparity in power can result in the oppression
and abuse of minority owners, such as the termination
of the minority’s employment, removal of the minority
from management and the exclusion of the minority from
receiving the business’ profts. While these big problems have
traditionally arisen in the context of closely-held corporations,
limited liability companies (LLCs), as the entity-of-choice
for many closely-held businesses, have become a hotbed for
minority oppression disputes.
Traditionally, courts developed a set of principles
commonly known as the “minority oppression doctrine” to
protect minority shareholders in close corporations against
potential abuses by controlling shareholders. Depending on the
jurisdiction, courts generally apply the doctrine by either:
1. Imposing a fduciary-like relationship between the
majority and minority shareholders;
1
or
2. Assessing whether the majority’s conduct “defeats
the reasonable expectations held by minority
shareholders in committing their capital to the
particular enterprise.”
2
SMALL INTERESTS,
BIG PROBLEMS:
ADDRESSING MINORITY RIGHTS IN
LIMITED LIABILITY COMPANIES BY BENJAMIN COMIN, ESQ.
continued on page 20
20 Nevada Lawyer May 2014
If the majority’s conduct does not survive this heightened
scrutiny, the court refuses to give the actions the ordinary
deference afforded under the “business judgment rule.”
Unlike many jurisdictions, Nevada has virtually no
substantive case law addressing the “minority oppression
doctrine” in the context of the close corporation, let alone
as it applies to LLCs. Nevada’s single case addressing this
issue, Hollis v. Hill, was rendered by the Fifth Circuit Court
of Appeals in an attempt to determine if and how the Nevada
Supreme Court would apply the doctrine to a
close corporation.
3
In Hollis, the court drew
on the Nevada Supreme Court’s decision in
Clark v. Lubritz,
4
in which the court imposed
fduciary duties between shareholders akin
to that of a partnership.It concluded that
close corporation jurisprudence provided a
“persuasive basis” for imposing a fduciary
duty between shareholders of a close
corporation.
While one might reasonably assume that fduciary
duties would likewise be imposed in cases of oppression
of minority members in the context of an LLC, Nevada’s
particular statutory scheme governing LLCs may prevent such
an application. While a number of states require fduciary
duties from the manager and among members of an LLC,
NRS Chapter 86 explicitly rejects any mandatory duties. In
fact, Nevada law is clear that “an operating agreement may...
[eliminate]... any and all liabilities for breach of contract and
breach of duties, if any, of a member, manager or other person
to a limited-liability company, to any of the members or
managers….”
5
In other words, protections commonly assumed
or expected, such as the duty of loyalty and duty of care, can be
eliminated entirely if the parties so desire. It is not unreasonable
then to conclude that a court might decline to apply the
“minority oppression doctrine” to achieve the statutory
aspiration of “giv[ing] the maximum effect to the principle of
freedom of contract….”
6
In the absence of judicial and statutory protections, the
burden of addressing minority protections is left almost entirely
to the contracting members. While many of the terms of a
relationship may be constrained by the realities of a given
transaction, and a potential owner
may have little choice but to accept
the risks of minority membership, the
more serious problems arise when
these risks are simply not addressed or
contemplated in the negotiations and
resulting documents of the parties. One
would expect that members, particularly
minority members, would negotiate
fercely for safeguards in the operating
agreement that would prevent the more
common big problems. In reality,
parties frequently forge ahead in the
bliss of their new venture without addressing these issues.
In light of the risks that minority membership in an
LLC carries, it is imperative for the conscientious practitioner
to raise these issues in the early stages of negotiation and
propose solutions that provide clarity and protect the minority’s
interests. The following list highlights some of the major issues
that should be discussed as members contemplate the terms of
an operating agreement where there is a possibility of minority/
majority disagreement and abuse.
7
Appointment of Managers
The right to appoint the manager[s] of an LLC is a
right that should not be lightly conceded. Many generic or
form operating agreements require only a simple majority to
remove or appoint a manager. A minority member may insist
on a supermajority or unanimous consent of the members to
remove or appoint a new manager. Alternatively, some LLC
arrangements provide for a “board of managers” to which the
minority member may elect one or more managers. In such
cases, the minority member should be mindful of the voting
power of such manager in relation to the board to ensure that
the minority member is meaningfully represented.
Powers of Managers
Operating agreements also frequently specify the
powers that can be exercised by the manager(s) without the
interference of the members. The minority member (with the
assistance of counsel) should anticipate issues that might
require member oversight and provide for the same. Such an
operating agreement might provide a list of transactions that
ADDRESSING MINORITY RIGHTS IN
LIMITED LIABILITY COMPANIES
continued from page 19
can be performed by the manager only upon a vote of the
members. While the minority member may have little voice
in many routine transactions, the minority member can still
retain some control over more signifcant transactions that
may have a more substantial and direct effect on the health of
the business and the minority’s interests.
Pre-emptive Rights
Pre-emptive rights give a minority member the right to
purchase a pro rata portion of any future membership interest
issued by the LLC. This right protects the minority member’s
interest from dilution. It is important to note that, by default,
members have no pre-emptive rights.
8
This can be changed, of
course, by agreement between the parties.
Rights of First Refusal
Another common mechanism to maintain control of who
the company can admit as a new member and to whom new
membership interests are issued is by including a right of frst
refusal. A right of frst refusal requires a member who intends to
sell her interest to frst offer the interest to the other members.
“Shotgun” Clause
A “shotgun” clause is a mechanism that may be included
in an operating agreement or buy/sell agreement to provide
an exit to a member in the event of an irreconcilable
disagreement between members. Member 1 may invoke
the clause by naming a buyout price for the member’s
interest. Member 2 then has a specifed period of time to
either sell his interest to Member 1 or buy Member 1’s
interest at the designated price.
“Piggyback” or “Tag-along” Rights
A “piggyback” or “tag-along” right gives a minority
member the right to “piggyback” on another member’s
negotiated sale of its interest. In other words, if Member 1
negotiates a sale of her interest, Member 2 has the right to sell
her interest to the buyer on the same terms that Member 1 sells
her interest. This protects a minority member from missing out
on a valuable exit opportunity and unwittingly becoming a
co-owner with an unintended or unwanted third party.
Non-Compete Clause
As in Hollis v. Hill, a common example of minority
oppression is the usurpation of corporate opportunities
by the majority, which the majority uses to compete with
the business. The paramount concern with any non-
compete clause is that the intentions of the parties should
be discussed and memorialized before problems arise. If
the parties want to retain the right to compete with the
business, they can agree to do so.
There are numerous other considerations that
might need to be addressed to protect a minority member
depending on the specifc facts of a given transaction.
Minority members may wish to include terms that prevent
the termination of their employment, prevent them from
being forced out in a “squeeze out,” or provide for a fair
valuation of their interest in the event of a buyout. The
process of raising these concerns and negotiating terms
that are mutually acceptable will do wonders to prevent
many of the big problems that frequently accompany
minority interests.
1. Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334,
1334 (Del. 1987)
2. In re Kemp & Beatley, Inc., 473 N.E.2d 1173, 1179 (N.Y. 1984)
3. Hollis v. Hill, 232 F.3d 460 (5th Cir. 2000)
4. Clark v. Lubritz, 113 Nev. 1089, 944 P.2d 861 (1997).
5. NRS 86.286(7)
6. Id.
7. See Hollis v. Hill, 232 F.3d 460, n. 21 (“It is not critical that
Hill and Hollis each owned 50 percent of [the company] and
therefore neither was a majority shareholder.”)
8. NRS 86.326(4)
BEN COMIN is an associate attorney at
Hutchison & Steffen and practices primarily
in the areas of corporate transactions
and fnance, real estate, and internet and
e-commerce law.
Font: Constantia (Illustrator)
Brown: Pantone 7517 C
Green: 370 C
May 2014 Nevada Lawyer 21

Published under a Creative Commons License By attribution, non-commercial
AttachmentSize
NevLawyer_May_2014_Small_Interest_Big_Problems.pdf688.29 KB