Resolving shareholder disputes: when to call in an attorney

Shareholder disputes can arise for a number of reasons, including alleged breaches of fiduciary duties, disagreements between majority and minority shareholders, or violations of operating guidelines. When a dispute comes up, it may seem like a small problem that can be resolved without bringing in an attorney, but minor disagreements can also escalate into much larger disputes if all parties do not understand their obligations and rights, as well as how to properly follow and enforce them.

The Importance of Getting Good Advice Early

Getting early advice from a business attorney can help deescalate a problem before it becomes more expensive and relationships become even more strained. First, you should get legal advice on precisely what your obligations and rights are under your shareholder agreement, or if there is no agreement, on how laws apply to your situation. Failure to comply with your shareholder agreement can lead to even more problems and potential claims of misconduct, so it is best to refrain from acting until you clearly understand your legal duties.

Many shareholder agreements will include specific dispute resolution procedures.  This can include requirements to mediate or arbitrate disputes, and sometimes procedures a forced or mandatory buyout. More often than not, a business solution can be agreed to once the parties are all forced to address the issues. A business attorney with experience specific to shareholder disputes can often identify creative solutions to solve disputes without resorting to litigation, saving you time and money.

How to Hire a Business Attorney for Shareholder Litigation

“The best time to find an attorney is before you need one,” says Inc. magazine. The earlier an attorney is involved, the sooner they can help you develop decisions and strategies with an eye to the end game and a permanent solution.  Usually, early counsel will save on litigation time and expense.

In seeking a business attorney, keep the following tips in mind:

* Be sure to hire an attorney with the right background and experience. “I once bought a company that had as its counsel an insurance litigation firm,” Barry Schwimmer of the Stamford Innovation Center told Inc.   “It had no expertise in that business. Result? Bad advice.”

* Choose an attorney that understands your priorities. There is a time to fight, but if you would rather resolve your issue by mutual agreement, pick an attorney that has come up with creative solutions to shareholder disagreements before.

* Be sure you understand the attorney’s fees. Most firms charge by the hour.  You should ask the rate, how the firm controls hours, and what steps they take to have simpler work done at lower rates.  Some law firms are offering unique fee structures that do not necessarily run on minutes and hours.  Such structures may work to your advantage, but probably will not in all circumstances.  You should be sure you understand what advantage the firm receives by entering into such an agreement, so you will know the potential down side of such an arrangement.  In all cases, you should ask and how firms handle different types of expenses (postage, photo-copies, service of process, court reporters).   

Derivative and Direct Litigation

If a business solution cannot be reached, litigation is your last resort for resolving your shareholder dispute. Often, particularly in companies with many shareholders, the shareholders are required to defer to the corporation’s board of directors in business actions.  They only way they can file a lawsuit may be through something called a derivative action, which is a shareholder suing on behalf of the corporation to enforce the corporation’s rights.  However, when there are fewer shareholders there are often means for direct litigation between shareholders, such as claims for breach of shareholder agreements or breach of fiduciary duties.

Despite the costs and long duration of the litigation process, it can have advantages.  For example, litigation forces parties to resolve an issue.  Litigation can force production of documents, records email, and other evidence.  Ultimately, it forces the matter to some resolution.  This can be necessary when other efforts at resolving the dispute have been unproductive.

For example, consider Allen v. Devon Energy Holdings LLC.  There, a minority shareholder redeemed his shares to the LLC based on a $138.5 million valuation of the company. The LLC was sold two years later for $2.6 billion – almost twenty times the valuation used in Allen’s redemption. Allen sued claiming the LLC made misrepresentations and failed to disclose material facts about the company that affected its valuation.  The trust was low and stakes were high, making it unlikely that an agreed resolution could ever be reached, but economically reasonable to incur the expense of litigation. 

In Allen, an appellate court determined that the majority shareholder owed a fiduciary duty to the minority shareholder.  The cost of litigation made sense for the plaintiff to seek redress and for the defendant to defend.  However, even in cases with lower stakes, a skilled attorney can often use the threat of litigation to effectively convince the parties to compromise.

Chernoff Law prides itself on creativity in shareholder disputes. While our priority is a business solution for our clients, but we are prepared to use our extensive litigation experience when necessary. If you have questions about shareholder disputes or other legal matters, please reach out to us HERE.

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