Shareholder Oppression: Minority Squeeze-Outs & Remedies Under California Law
When the majority wants to get rid of “pesky” minority shareholders but still keep control of the business, they may attempt a squeeze-out acquisition. First, the majority will form a second entity where they are the sole owners. Under their direction, this new company offers to acquire or merge with the target corporation. Using their majority vote in the target corporation, they approve a sale/merger that forces the minority to accept what the new company offers for the purchase of the corporation’s shares. Under this scheme, the minority get squeezed out and the majority now continues to operate the business as the sole owner(s).
Fortunately, California’s Corporations Code provides some remedies for the dissenting minority shareholders. These remedies can be effective if the tender offer undervalues the shares, or if it provides otherwise undesirable non-monetary compensation.
Thus, dissenting shareholders may “require the corporation in which the shareholder holds shares to purchase for cash at their fair market value the shares owned by the shareholder.” (Corp. Code, § 1300, subd. (a).) “The fair market value shall be determined as of the day of, and immediately prior to, the first announcement of the terms of the proposed [acquisition], excluding any appreciation or depreciation in consequence of the proposed reorganization or short-form merger, as adjusted for any stock split, reverse stock split, or share dividend that becomes effective thereafter.” (Corp. Code, § 1300, subd. (a).)
In order to avail themselves of this remedy, dissenting minority shareholders must “make written demand upon the corporation for the purchase of those shares and payment to the shareholder in cash of their fair market value… not later than the date of the shareholders’ meeting to vote upon the [acquisition]” of, if not approved by vote at a shareholders meeting, within 30 days after the date on which the notice of the approval by the outstanding shares is mailed to the shareholder. (Corp. Code, § 1301, subd. (b).) “The demand shall state the number and class of the shares held of record by the shareholder which the shareholder demands that the corporation purchase and shall contain a statement of what the shareholder claims to be the fair market value of those shares as determined pursuant to subdivision (a) of Section 1300. The statement of fair market value constitutes an offer by the shareholder to sell the shares at that price.” (Corp. Code, § 1301, subd. (c).)
At this point the corporation can choose to accept the offer, and pay the dissenting shareholder the amount stated in the demand. However, “[i]f the corporation denies that the shares are dissenting shares, or the corporation and the shareholder fail to agree upon the fair market value of the shares, then the shareholder demanding purchase of such shares as dissenting shares …, within six months after the date on which notice of the approval by the outstanding shares (Section 152) or notice pursuant to subdivision (h) of Section 1110 was mailed to the shareholder, but not thereafter, may file a complaint in the superior court of the proper county praying the court to determine whether the shares are dissenting shares or the fair market value of the dissenting shares or both or may intervene in any action pending on such a complaint.” (Corp. Code, § 1304, subd. (a).) In other words, if the corporation rejects the offer, the dissenting shareholder may file an action for an appraisal within six months after the vote, or (if no vote) the date notice of the approval was mailed to the shareholder.
On the trial of the action, the court shall first determine (if disputed) the status of the shares as dissenting shares. “If the fair market value of the dissenting shares is in issue, the court shall determine, or shall appoint one or more impartial appraisers to determine, the fair market value of the shares.” (Corp. Code, § 1304, subd. (c).) After deciding the fair market value, “judgment shall be rendered against the corporation for payment of an amount equal to the fair market value of each dissenting share… with interest thereon at the legal rate from the date on which judgment was entered.” (Corp. Code, § 1305, subd. (c).) “The costs of the action, including reasonable compensation to the appraisers to be fixed by the court, shall be assessed or apportioned as the court considers equitable, but, if the appraisal exceeds the price offered by the corporation, the corporation shall pay the costs (including in the discretion of the court attorneys’ fees, fees of expert witnesses and interest at the legal rate on judgments from the date of compliance with Sections 1300, 1301 and 1302 if the value awarded by the court for the shares is more than 125 percent of the price offered by the corporation under subdivision (a) of Section 1301).” (Corp. Code, § 1305, subd. (e).)
But what if the dissenting minority wants to still be involved in the business and does not want cash in exchange for their shares? If the majority and the new company have common ownership, the dissenting shareholder(s) may bring an action to have the acquisition “set aside or rescinded.” (Corp. Code, § 1312, subd. (b).) However, if they elect to pursue this remedy, “the shareholder shall not thereafter have any right to demand payment of cash for the shareholder’s shares.” (Corp. Code, § 1312, subd. (b).) The acquisition may then be set aside “upon 10 days’ prior notice to the corporation and upon a determination by the court that clearly no other remedy will adequately protect the complaining shareholder or the class of shareholders of which such shareholder is a member.” (Corp. Code, § 1312, subd. (b).) Importantly, when the majority owners of the target corporation also own part of the new company, they “shall have the burden of proving that the transaction is just and reasonable as to the shareholders of the [target corporation.” (Corp. Code, § 1312, subd. (c).)