Often majority shareholders will reduce the minority shareholder’s proportionate voting rights, distributions and voting rights by causing the issuance of additional stock and controlling who receives the newly issued shares. Typically, the oppressor will issue the new stock at less than its fair value.
The issuance of new shares is frequently done to maintain control over the closely held company. Those in control may wish to issue the new shares in order to maintain control after the end of a voting trust; to head off creation of a new majority amongst the shareholders; or to obtain the necessary votes for approval of a fundamental corporate change such as a merger.
Sometimes shareholders in closely held companies hold certain “preemptive rights.” A preemptive right gives each shareholder an option to subscribe to a new allotment of shares in proportion to their existing shares before new shares are offered. Typically, preemptive rights do not attach to nonvoting stock. At one time most states provided for preemptive rights, either as mandatory or the default rule. That has changed over the course of time. For example, in New Jersey, any corporation organized after January 1, 1969, does not have preemptive rights unless the certificate of incorporation provides otherwise. N.J.S.A. 14A:5-29. Any New Jersey corporation formed before January 1, 1969, may alter or abolish preemptive rights by amendment to its certification of incorporation. N.J.S.A. 14A:5-29.
Even if preemptive rights are not provided, the specific issuance of additional shares as a means of oppressing the minority shareholder could be challenged by the assertion of litigation alleging breach of fiduciary duty. If a minority shareholder was to assert the same, the Court would ultimately have to decide whether or not the issuance of additional shares is within the sound discretion of the majority (i.e. the “business judgment rule”) or “self-dealing.” See, Maul v. Kirkman, 270 N.J. Super. 596, 614 (App. Div. 1994) (the business judgment rule “is rebuttable presumption , and the burden shifts to the defendant to show the intrinsic fairness of the transaction in question upon the showing of ‘self-dealing’ or ‘other disabling factor’”).
Often, New Jersey Chancery Courts asked to adjudicate this issue will need to determine whether or not the majority shareholder issued the new shares in an effort to interfere with the reasonable expectations of the minority. If the new shares are offered for grossly inadequate consideration; or the primary purpose of the issuance was to squeeze-out the minority, there is a greater chance that the Court could rule that the issuance of said shares was oppressive as opposed for a legitimate business purpose. Of course, rarely does a defendant admit that they issued shares to themselves or those close to them for less than they are worth or to oppress the minority. As such, when I am asked to represent a minority shareholder confronted with this form of oppression it is important that I rely upon my along with the experiences of well-trained experts to present evidence to the Court which demonstrates that the issuance of new shares was to oppress rather than for a legitimate business purpose.
