Dan
Welcome to sound business insights. I’m Dan Watkins. This episode is an overview of shareholder rights and disputes. This podcast is not intended to provide legal advice.

Neil
So Dan, in this episode on shareholder rights and the inevitable disputes that come along with that, let’s start with the rights of a shareholder. What are some of those rights that every shareholder or investor has?

Dan

Well, first of all, let’s be clear. We’re talking about privately held companies. Yes. When you invest in a company down the street, that’s not on the New York stock exchange, you still become a shareholder and shareholders have rights. First thing you should think about when you become a shareholder is like shareholders should be treated in a like or similar fashion. When you join a corporation by investing and you find out that someone with a similar shares as you is getting paid more dividends than you are, you are not going to like that. And you shouldn’t because that’s why we have different classes of shares. We have, you know, B general share stocks.

Dan
That’s why we have those rules. Also. You have to look and find out if there’s a shareholder’s agreement, which could define who gets what and who gets paid. What, but generally speaking, if you want to pay people differently than what their ownership is, you should have a limited liability company. But if you’re selling shares, you’re still subject to shareholder laws in the state of California and other places. And those shareholders have a right to vote. They have a right to see certain disclosures. If you have over 5%, you get to see more financial documents of the company and you have a right to dividends. If people are, if other people are getting dividends, then you have a right to show up at this annual shareholders meeting.

Neil
So Dan, do all shareholders have voting rights most of the time.

Dan
Yes. Unless you’re told in advance, there’s going to be a non-voting share or there’s going to be some other agreement in place you’re supposed to have a right to vote and how are voting rights weighted.  Is it by the type of shares that you hold? Or is it the percentage? Well, that’s, that’s where it gets tricky.  When a corporation issues shares or authorizes shares, for example, they’ll authorize 10,000 shares and they’ll issue 1000. So when you buy half of the issued shares, you’re not getting half the company, you’re getting 5% because the other 10,000 are sitting back at the corporate offices and they can sell those too. So you’ve got to make sure that your pool of investors is not diluted or the stock is not diluted in ways that some companies tend to do to the disadvantage of their shareholders.

Neil
And you mentioned reporting and inspection rights. What are some of the typical reports that you would expect your clients as shareholders to receive and what are some of their inspection rights?

Dan
Well, like I said, depending on how much they own, how much, what percentage of the company they own, they have a general right, to see the, uh, financial disclosures the company gets, if they’re, uh, less than 5% shareholder. And if they’re more than 5% shareholder, they can go audit the company’s books and records. And sometimes they’ll be told they have to sign a non-disclosure agreement to do so, but they can literally give notice and appear in two weeks at the company offices and start making copies or investigating, uh, what’s going on with the company. Or if that doesn’t happen, they can literally file a motion in court and have a judge order. They’d be given access to the books and records of the company.

Neil
So are there protections from minority shareholders against wrongful actions, by the majority interest or officers and directors,

Dan
There’s laws in place that protect them. But unless they have some type of, uh, shareholder agreement or some type of assurances or representations and warranties, then they just have the right to, to grievance in court.

Neil
So Dan, why would this information be important to a shareholder in the first place?

Dan
For example, we’ve, we’ve had so many shareholder fights where, um, a company group of friends or a group of friends who know friends, maybe 30 people invest in a company and it’ll be doing well, but not great. And they investors, the shareholders won’t be receiving, uh, disclosures, or they will be receiving them, but they sort of don’t add up. And then they do an investigation and they come to some law firm like ours and they say, well, let’s, let’s get in there seeing the books and records and you get some pushback from the company. And that’s when all the hairs in your neck stand up and you come to the Watkins firm and we file a motion. And we discover through our due diligence that the company’s doing very good and that they also formed an offshore corporation of the same name. And they’ve taken all the assets and they’re all driving Rolls-Royces. So this has happened more times than I can say, because it just does happen. Nobody fights over anything unless there’s money involved. If it’s just doing okay, they would tell the truth and say, it’s all great. But if that big money offer comes in the door and they have a way of, of keeping it for themselves, it’s very tempting for human nature to turn that down.

Neil
Obviously not all shareholders need legal advice, but many of them do. When should a potential shareholder seek the advice of the Watkins Firm?

Dan
Well, if you’re investing $500, no, but if you’re making a substantial investment in a company, you are a buyer of that company. So all the same thought process that we go through when we acquire a company or we sell a company and we do our due diligence should come into play. And law firms have resources that average people don’t. We have computer databases, we can do background searches, we can pull up, uh, request disclosures. We can actually help you ask certain questions of the, uh, corporation. And if it adds up, we can all, we can literally even hire our CPA to review the financial documents to make sure it adds up. For example, there’s something called IBIDA. Now your average person doesn’t know what Ida is, but a business broker, a lawyer or a CPA will know that that’s what we judge the profitability of a company on.

Dan
And let’s say normally the company’s worth four times IBIDA. The company makes a hundred thousand dollars a year. It’s worth $400,000. You come along and you are going to buy 5% of the company and you offer $200,000. If you had gone to a lawyer, we would say, you’re, you’re overpaying just from the accounting point of view. And you might want to do some further due diligence to see why the price is set so high. And then you can have us discover how much does the, uh, president of the company make? How much does the vice president of the company make? What are they spending profits on? That’s a big one. You’ll invest in a company it’s doing great, but somehow it never says it’s making the money that it should because the people who control the corporation have the right to pay their key employees, whatever they want. And usually that’s a million dollars a year for the president. If the company makes that much money when they were making a hundred thousand dollars a year. So there’s all kinds of, uh, financial considerations, accounting considerations, and disclosures, you should consider. And so spending two or $3,000 on your lawyer before you spend 500,000 or 200,000 on an investment is a definitely a, a must thing to do.

Neil
So in this conversation, we really need to establish, what’s the difference between a minority shareholder and a majority shareholder?

Dan
Majority rules, 51% in these agreements, we have things called super majorities in our corporations. We can have shareholder agreements that require super majorities. For example, you’d want a 70% majority before you allow the company go out and take a big loan and use that money, giving it away to the majority. You’d want a super majority before the company go sell the company, terrible things have happened. You invest in a company, you got a hundred thousand in it. And the company says we’re going to sell the company for $200,000 and you get 10 cents on, on your, on your money. And they sell it to a related company. And then they take it public. That happens a lot. So I like to say, when you will become a shareholder, if you don’t plan ahead and do your homework, then you are planning to fight because you’re just making it too easy for people to take money from you if they technically can.

Neil
And if you are an active investor, you need help keeping an eye on your investment.

Dan
Yes.

Neil
So how do you balance the influence of shareholders with what the majority would see as the corporate mission?

Dan
Well, shareholders just want to be treated just like other shareholders. And so when you don’t have these safeguards in place, it’s very tempting for management to say, well, technically I going to pay me myself more. Technically I need a new car. And technically I, I, they should lease me, you know, a house to stay in. And technically this, when, if you would had a request that certain things be in place before you invest a substantial amount of money, they may have said, yes, I don’t want executive compensation to exceed so much of the IBIDA, simple things like that could be requested. If they say, no, you keep your money.

Neil
So what you’re describing is basically a balance of legal stipulations and responsibilities with a simple sense of fairness, correct?

Dan
Correct! Don’t let the term shareholder or investor make you think you don’t have any rights. They make an offer to sell shares at a certain price and you come along and just say, yes. I mean, that’s, that’s how my wife used to buy CARSs.

Neil
So in your experience, Dan, do shareholders ever get into disputes

Dan
Funny yes. All the time.

Neil
So Dan what are a couple of examples of common shareholder disputes

Dan
Breach of the shareholder agreement and most importantly, lack of access.

Neil
And what can you do as an attorney to help protect our clients contract in their shareholders agreement and their access to information?

Dan
Well, we like to say, if it’s off a penny, it’s off a million. So we look at the financial disclosures you’ve given, and if they don’t add up or doesn’t seem straightforward, we suggest you demand for documentation. And if they don’t give it, that’s sort of like, uh, them pleading the fifth, you know, something’s wrong when they’re not willing to give their investors, their owners full access, full transparency into what’s going on with the company.

Neil
So that sense that you have that something’s just not right. That should also be a sense that maybe I should get some help.

Dan
Yes. And you should do it right away. because, uh, when shareholder fraud or shareholder breach happens, it’s easy for a purpose. That is an opportunity for management. And it’s usually happening now.

Neil
And it’s probably a lot of money.

Dan
It, well, they, they usually won’t do it unless it’s worth something. And if, and what I mean is timing . If let’s say you don’t have a shareholder agreement, or you have a weak shareholder agreement and, uh, management has broad discretion to do a lot of things, and they’re getting ready to do some questionable things, to make a big profit. And you come along and say, wait a minute, I think something’s wrong here. And you pose an objection. Well, before you file a lawsuit, this opportunity that management has is still there. So if you are the squeaky wheel right away, before they go forward with whatever they’re doing, then you may profit from that. But if you’re not, then it’ll just happen. And you’ll, instead of being sharing in the profits, you’ll be fighting to claim you had rights to get some money back.

Neil
Dan you’re describing what I would consider to be a conflict of interest between their obligation to their shareholders and their own personal interests.

Dan
That’s true. Everybody hears the term conflict of interest and they think it’s something like special or amazing or complicated, but it’s really not. This is the oldest con game. There is example you are working somewhere and you get access to checks coming in. So you go form a company in another state. That sounds just like the name on the checks that are coming in. And you start taking those checks and putting them in your own bank account. Well, think about that. If you’re a corporation you’re in management and you have a uncle that forms a company and you start sending business that way, and before, you know it, you taking assets from one company and giving it to another company, which technically you don’t have anything in writing as an ownership of, but you have a conflict of interest and you’re breaching your fiduciary duty. And so if the shareholders aren’t watching this happens, and I would say 20% of our litigation every month is based on shareholder disputes fights between shareholders and the corporation and, uh, breach of fiduciary duty

Neil
And fiduciary duty is basically the obligation to act in the best interests of those that they have a charge due. Is that correct?

Dan
Because they have such an advantage. The term fiduciary duty comes in this definition when somebody has an advantage of knowledge of power of money over somebody else who’s invested in good faith. They have a duty not just to do what the contracts say, but they have a duty to be a fiduciary to take their position in favor the shareholder and against themselves, if there is a conflict. So they have the utmost duty to disclose and to act in good faith for the interest of the shareholder.

Neil
Dan, an example of what you’re talking about is the lack of a valid corporate purpose for a transaction or the action of an officer or a director or a shareholder. Right?

Dan
Very common happens all the time, usually because there’s no limits placed on the executive team or the management. But what happens is all of a sudden, you know, the new president needs a sailboat

Neil
(Laughs)

Dan
Or he needs his kids to go to school on the company dime, or he needs housekeeping services to be paid for by the company that happens all the time. And if you’re not looking at the financial disclosures, you won’t know about it, and you won’t be able to utilize the newer laws on breach of fiduciary duties to stop that type of activity.

Neil
And Dan, the law describes arm’s-length dealings. Can you basically tell our audience what it means to handle your business and an arm’s-length,

Dan
Arm’s-length, and good faith. This goes back to, um, two terms. One is an arm’s-length transaction, meaning that I’m over here and you’re over there and you have an obligation to do things for you. And I have an obligation to do things from me and buyer or beware caveat emptor. So it’s not a term of protection. So to speak what it is, is a term that says, this is an arms link transaction. We’re both on equal footing. And therefore I don’t have a real fiduciary duty to you. And you’ll see that in the boiler plane, in a lot of agreements, even though someone does have an advantage and it is not a arms link transaction, they’ll put it in there and say, yes, it is. And you agree that this is an arms link transaction, and that you’ve been told everything you need to know about this deal. And then you sign up and they turned out to be, uh, ready to steal from you all along.

Neil
Yep. And corporations are a great source of theft and fraud. Are they not?

Dan
Well, the greatest, the greatest source? I know

Neil
Wow. So Dan, in a layman’s world, there are two terms that we hear a lot: the “squeeze out” and the “freeze out.” What is the squeeze out from the perspective of a shareholder?

Dan
Well, let me give you an example. There’s 10 shareholders in a company and they’re not getting along and they’re fighting. So the majority says, okay, it’s not working. We’re going to sell the company for, uh, one 10th of what it’s worth. And then without you knowing about it, they, you know, find out two years later that four of the six majority members took jobs in employment with that new company, you’ve just been squeezed out of all your access by votes and by agreements and by people breaching their fiduciary duty.

Neil
And how is that different from the tactic known as a freeze out

Dan
A freeze out is just that, and it happens a lot. You got management thinking they have the right to do this and that, and you have this angry shareholder over here. And finally, they just say, don’t give them any more documents. Don’t let, them come to any more meetings and don’t pay them any dividends and just ignore them

Neil
And change the locks on the doors,

Dan
Change the locks, fire them, terminate their employment, do all these things and say, go ahead, Sue me.

Neil
So what’s the difference between when that shareholder is a squeaky wheel and when they show up with Dan Watkins from the Watkins firm,

Dan
Well, the first comes to the shareholder, says, what’s this and what’s that. And then, uh, they get locked out and then they come to us and we, if we, we don’t get cooperation, we’ll file a lawsuit immediately. Or if we do get cooperation, we’ll look at it and we’ll try to work out the differences between the parties. Sometimes that’s all it takes is, is somebody in the middle to, uh, explain things to our shareholder client or our corporate client, and to go back and forth and, and educate both sides on what’s wrong.

Neil
So from the perspective of a minority shareholder, having an attorney on your site’s going to balance some of that playing field, isn’t it?

Dan
Well, we get to file lawsuits in a public court that could report it on. So if you’re trying to buy a company and all of a sudden there’s a shareholder lawsuit that’s been filed and won’t be resolved for three years, that’s going to be important to the management of that company. And any decent and intelligent executive is going to take it seriously, get their lawyers on it and try to resolve it as soon as possible.

Neil
And likewise, we’re the general counsel and advisors for many corporate entities. So we, we also often have to get involved advising the corporate side of the equation. Do we not?

Dan
Oh yeah. That’s, that’s where we see over 60% is us trying to resolve or assist our, our clients in resolving, you know, disputes that go the other way. For example, when we talk about shareholders, we’re talking small company, not publicly traded. Yeah. When you see these shareholder derivative suits in the, in the news about, you know, at and T or other large corporations back in the, in the day, and currently you’ll see these large firms take them on contingency fee basis, just to put pressure on the company, to deal with them well, in a similar but smaller setting, if you’re a shareholder in a small company, you still need to take actions to, to protect your investment. And as the owner of the company or the majority, you have to take actions to stop shareholders from, uh, blackmail yet to pay and exorbitant sums. They’re not entitled to.

Neil
And the Watkins firm is able to help people on both sides of that equation. Are we not?

Dan
We do it every day.

Neil
You have any final thoughts Dan, on shareholder rights and disputes.

Dan
Yeah. Yeah. Like I said, before you, if you plan ahead, do your due diligence, then you won’t have to fight later bottom line. I’d rather see my clients come in and see my transaction team rather than my litigation team. So if you treat shareholder rights as if you are buying a company and you hire a lawyer to come in and take a close, look at it and come up with suggestions, do some, that’s a lot cheaper than having to come back and find out that your 100, $200,000 investment was taken from you by some, um, unscrupulous individuals

Neil
And the same thing holds true for a corporate owner that’s trying to attract some investors correct?

Dan
Absolutely. Yeah. Having everything disclosed and stated and clear stops people from frivolously or from

Neil
Trying to take control of your company

Dan
That happens too.

Neil
Thanks Dan

Dan
Yes.   You can learn more about the Watkins Firm by visiting our website at https://watkinsfirm.com or call our office at (858) 535-1511.