A squeeze out is a corporate dispute that coerces an initially unwilling minority shareholder to sell his or her shares to the majority. This can be accomplished through a variety of tactics and most squeeze outs in practice employ several to achieve their goal. The following techniques seek to persuade or push the shareholder to sell. I have chosen the metaphor of the siege to represent how these kinds of squeeze play generally involve attempts to cut the shareholder off from many of the benefits of their shares.
One of the most obvious squeeze plays is to terminate the minority shareholder’s employment. This has the dual benefit of cutting off their salary and removing them from the directorate of the company. In the absence of compensation, the shareholder will increasingly become more likely to agree to a buyout of their shares.
Another option is to withhold dividends from the shareholder. C corporations typically compensate their employees in salary since dividends incur double taxation, but in S corporations dividends are a very common form of compensation and dividend withholding can be a potent component of a squeeze out. Again, just like with denying salary, the idea is simply to cut the minority shareholder off from the benefits of their shares, thus encouraging them to sell.
Rather than directly oppressing the minority, the majority can indirectly apply pressure by increasing their own compensation. This is accomplished by siphoning an increased share of revenue to themselves in the form of salary, benefits, bonuses and other compensation. Aside from creating a situation which the minority is likely to regard as unfair, more importantly this practice can impair the company’s perceived earning power. Earning power is often determined by looking at a company’s recapitalization of its assets, and if those assets are instead being funneled to a few shareholders the whole company’s value will be reduced, lowering the value of the minority’s shares and applying pressure for them to sell.
Finally, the majority can squeeze the minority by denying access to information. Withholding information is a powerful addition to other squeeze out techniques, and it is usually a part of any squeeze. The actions of the majority to restructure the company or to deny dividends, are more effective if the minority does not know they are coming. Information blackout can also squeeze on its own. The squeezee, for example, may not know that they are a shareholder. Perhaps they inherited shares in a relative’s will, but they never learned this fact. Other shareholders could manipulate this ignorance to perform a variety of actions to squeeze the minority.
In any of the above cases the actions of the majority are not without risk. As a general principle, state and federal courts have held that a shareholder is part owner of a company and as such is entitled to information about that company’s operation. The majority must always be wary of placing themselves in a situation where they may be accused of breaking their fiduciary duty or of being wasteful. An elected director of officer of a company is expected to act in the interests of that company. A director is more likely to run afoul of the court’s judgment for overcompensating themselves rather than terminating the employment of or withholding dividends from the minority since courts have typically held that the sound judgment of the directors is sufficient basis upon which to make decisions on dividends and employment. Much like Congress, rule of the majority is the guiding line in corporate governance, but unlike in the Senate, few rules exist in the corporate sector to protect the rights of an oppressed minority.
For information contact the Chicago corporate dispute attorneys at Horowitz and Weinstein.
Next installment: Restructuring