How can a shareholder in an LLC or Corporation protect themselves from being taken advantage of by other shareholders or officers of the company.

Generally, a stockholder may not maintain an action on his own behalf for a wrong done by a third person to the corporation on the theory that such wrong devalued his stock and the stock of the other shareholders, because these types of actions would authorize multitudinous litigation and ignore the corporate entity.  Under proper circumstances a stockholder may bring a representative action or derivative action on behalf of the corporation.  But if the injury is one to the plaintiff as a stockholder and to him individually, and not to the corporation, as where the action is based on a contract to which he is a party, or on a right belonging severally to him, or on a fraud affecting him directly, it is an individual action.

 

Lets look at these two situations and we’ll discuss examples to understand them more fully.  Lets say that Jane and Mike are business partners, and they are running a large softball park, under the name of Jane’s Softball Park, LLC.  They make money off teams renting their fields as well as on concessions.  Jane runs the facilities and fields, while Mike takes care of the business end, pays the bills, and does all of the paperwork their business requires.   If Mike makes bad decisions in purchasing supplies and food for the concessions, or fails to pay their credit card bills, thereby incurring fines and late fees to the company, Jane might decide one day to make a claim against Mike for the lousy job he is doing.  But, in this scenario, Mike has not only injured Jane, but has also injured himself.  Jane can’t distinguish any specific harm she has incurred that is any different from harm that Mike incurs through his own actions.  This type of claim would be a derivative action on behalf of their LLC, and therefore the members of the LLC would decide if they want to pursue the action or not.  Most likely in this situation, Jane would only have 50% of the vote, and Mike would have the other 50%.  Because common sense says that Mike would not vote to sue himself, Jane won’t have a majority vote in order to pursue the action.

 

Changing the above scenario just a bit, we’ll discuss a situation in which Jane could pursue a direct action against Mike.  Lets say that because they are both in business together, they each have a right to 50% of the profits made by Jane’s Softball Park, LLC.  But instead of paying Jane her fair share of the profits, Mike has been cooking the books, and only pays her 30% of the profits, and keeps 70% for himself.   Once Jane finds out about it, she sues Mike for his actions.  In this situation, Mike can no longer claim that the Corporation has been injured.  The corporation doesn’t care who gets the profits, or how much each shareholder gets, as long as the profits are paid.  Jane does care how much she gets paid, and Jane can prove that Mike’s actions cause a specific injury to her because she didn’t receive all of the money that she was owed.  It doesn’t matter if they follow every other part of the Operating Agreement or state guidlines, Jane will have a direct cause of action against Mike for injures he caused her under the contract they had with one another to form the business.  She can sue him for breach of contract, and doesn’t have to worry about the LLC taking control of the lawsuit.

Check with you local counsel to see how your State statute differs from the scenario above, and what options are available to you to protect yourself in business.

 

Photo By: Moyan Brenn

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