There are several new legal issues facing LLCs and corporations, and these naturally affect CUSOs as well. CUSO board members should be aware of these issues and ensure appropriate expertise is engaged so the directors are informed before making decisions.
Actions specifically authorized by the articles of incorporation, bylaws, and/or operating agreement, as well as consistently applied written policies or agreements, will usually exempt the organization from liability. These corporate documents are the first line of defense for both companies and shareholders.
Shareholder oppression
Minority shareholders in closely held corporations have rights even if these shareholders do not have voting power. One such right is the ability to challenge the acts of the company’s directors and those in control of the company if those directors are abusing their power, taking illegal or fraudulent actions, or running the business in ways that are usually referred to as “willfully unfair and oppressive conduct.”
Willfully unfair and oppressive conduct may include, but is not limited to, such things as:
- Terminating the shareholder’s employment with the company
- Refusing to pay dividends
- Preventing a shareholder from exercising their rights as a shareholder
- Reducing a shareholder’s interest in the company (dilution)
- Engaging in self-dealing that harms the company
The business judgment rule may not be a defense because these acts are considered “bad faith.” In theory, courts have far-reaching powers to fashion remedies for oppression. For example, and without limitation, courts can dissolve a company, appoint a receiver to take it over, order a buyout at what the court considers a fair price, which may or may not include minority discounts, undo or prohibit unfair acts, order or cancel special dividends or distributions, and award damages and attorney’s fees.
Shareholder dilution
Shareholder dilution occurs when the majority shareholders issue additional shares or options, reducing the ownership percentage of the minority shareholders. By diluting the shares, the majority can effectively diminish the voting power and influence of the minority shareholders, making it even more difficult for them to protect their interests.
Note that shareholder dilution does not by itself cause liability for directors, especially if the value of the business is increased. The right to purchase additional equity can protect a company, as well as when a bona fide business purpose indicates that the best interests of the organization would be served.
Related-party transactions
A related-party transaction is an arrangement between two parties that have a preexisting business relationship. Related-party transactions carry the potential for conflicts of interest, so aggressive attorneys will look for transactions that affect shareholders’ value or the corporation’s profits negatively.
To force settlements, plaintiffs’ attorneys sometimes bundle numerous minor allegations of “wrongdoing” and retain hired gun “experts” to testify about the unfairness of related party transactions. The proofs as to the “fairness” of these transactions to the company can be complex and subjective.
Merger and acquisition
Recent litigation has held directors liable for mergers if shareholder value is not maximized through the highest value share price available at the time of the merger. This can happen if the board is shown to neglect other bidders, fail to adequately pursue higher offers, act in self-interest, and receive personal financial benefits as a result of the merger, or breach their duty of candor when issuing a materially incomplete and misleading proxy statement that omitted information necessary to enable the shareholders to cast an informed vote.
CUSOs, keep informed
Directors and managers have a fiduciary duty to remain informed and to oppose wrongful conduct. Failing to oppose wrongful acts as a director/manager could expose one to potential liability. Directors should retain experts as needed to help navigate these issues when they arise.
