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How to Take Control From Minority Shareholders

Originally published: 11.01.09 by Mike Coyne

How to Take Control From Minority Shareholders

Several options focus on shares and voting.

The simplest agreement for transferring voting rights from a minority shareholder is an irrevocable proxy. This is an agreement by a shareholder to permit another individual to vote his or her shares. Unfortunately, some states do not permit irrevocable proxies. Additionally, like any other agreement, alleged misuse of the proxy can lead to litigation. Since proxies typically provide very little detail regarding voting authority, litigation associated with proxies often is messier than that associated with other agreements.

For many years, the most common agreement among shareholders was a voting trust agreement, under which shares are transferred to a named trustee and registered in the name of the trustee. Typically, the voting trust agreement provides specific instructions to the trustee with regard to how shares are to be voted. For example, the agreement might require a specified list of individuals to be elected as Directors. The trustee has both a contractual obligation and a fiduciary duty to vote shares in accordance with the terms of the agreement.

Voting trust agreements have limitations. First, the agreement can address only matters with respect to which the shareholders have voting rights. Under most state statutes, management authority of the Corporation is vested in the Board of Directors. Consequently, the voting trust agreement is not terribly effective in addressing management issues. Additionally, most states limit the duration of a voting trust agreement to 10 years. Thus, it is not a

permanent solution.

Many states now permit simple shareholder voting agreements. These are simply written agreements among shareholders that do not require a trust. Ownership of the shares remains with the individual shareholders. As with voting trusts, courts will typically honor these agreements as long as they relate to issues upon which shareholders can vote.

Many states authorize the creation of a special type of shareholder agreement known as a “close corporation agreement.” This type of agreement is undeniably the most effective way of dealing with minority shareholders. The typical close corporation statute permits a close corporation agreement to supersede state corporation law in many, if not all, respects. For example, many close corporation statutes permit close corporation agreements to eliminate the annual meeting, eliminate the Board of Directors, vest complete management authority in one or more corporate officers, and so on. The close corporation agreement can specifically limit the rights of minority shareholders, including a right of employment.

Many close corporation agreements also include provisions regarding the transfer of shares, including mandatory redemption provisions, rights of first refusal, and so on. The agreement may include a formula or other method for determining the value of a shareholder’s shares.

Whenever a client contemplates selling a minority interest in his business, we recommend the adoption of a close corporation agreement prior to the sale of shares. The close corporation agreement then can be presented to the prospective shareholder so that there are no misunderstandings regarding the rights associated with the shares being sold.

As we have written before, a minority interest in the business is often not the best way of rewarding a key employee. If your only purpose in selling shares is to compensate a key individual, you should consider other options first.

Michael P. Coyne is a founding partner of the law firm, Waldheger Coyne, located in Cleveland, Ohio. For more information on the firm, visit: www.healthlaw.com or call 440-835-0600.

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