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Bad Contracts Between Shareholders - Unfavorable Loans and Lease Agreements

By Scott I. Unger

Often majority shareholders will enter into various kinds of unfavorable contracts between the closely held company and themself or a business owned by them in order to siphon off corporate earning or assets.  Generally, directors and majority shareholders are fiduciaries and owe to the minority shareholders along to the corporation itself certain duties of care, loyalty and good faith. Majority shareholders must place the interests of the corporation and its shareholders above their own. Moreover, the majority shareholder or directors must act to further the best interest of the corporation and may not utilize their powers to further a personal interest. Based upon those duties minority shareholder who are mistreated as a result of the majority entering into unfavorable contracts may have recourse.

 

Unfavorable loans and leases are two types of contractual arrangements commonly used by the oppressor to drain off corporate earnings.   Courts have found the following to be forms of unlawful oppression and/or breach of fiduciary duty:

1)    a majority shareholder in a closely held New Jersey corporation abused his power when he caused the company to rent his condominium in Puerto Rico, Street v. Vitti, 685 F.Supp. 379 (S.D.N.Y. 1988);
2)     renting corporate assets to another corporation for below market rents, Marian v. Mariani, 276 A.D. 205 (1st Dept. 1949); 
3)    failing to collect rental fees from another corporation due under the governing contract, Apicella v. PAF Corp., 479 N.E.2d. 315 (8th Dist. Cuyahoga County, 1984);
4)    a majority shareholder unlawfully caused the corporation to renew the shareholder's lease of corporate property without making a change in lease terms, thus permitting the majority shareholder to retain the property for a long period of time at the original rent though the rental value of the property greatly increased, Peri-Gil Corp v. Sutton, 84 Nev. 406, 442 P.2d 35 (1968);
5)    a majority shareholder borrowed large sums of money from a closely held New Jersey corporation without paying interest and providing little to no security for said loan, Street v. Vitti, 683 F. Supp. 379 (S.D.N.Y. 1988); see also, Xerox Corp. v. Genmoora Corp. 888 F.2d. 345, 351 (5th Cir. 1989);
6)    a corporation made large loans to some of its shareholders despite the fact it had to borrow substantial funds to meet it own operating expenses, Merritt v. Colonial Foods, Inc., 505 A.2d 757 (Del. Ch. 1986); and
7)    a majority shareholder used funds borrowed from the corporation to establish a business that competes with it, Bresnick v. Franklin Capital Corporation, 10 N.J. Super. 234 (App. Div. 1951); Kean v. Johnson, 9 N.J. Eq. 401 (Ch. 1853); New England Inv. Corp. v. Sandler, 329 Mass. 230 (1952); see also, Valle v. North Jersey Automobile Club, 141 N.J. Super. 568, 573-574 (App. Div. 1976), mod. on other grounds, 74 N.J. 109 (1977) (holding a director or officer may not take personal advantage of a business opportunity if the opportunity is within the corporation's scope of business; the corporation has the financial capability to take advantage of the opportunity; and the director/officer by taking the opportunity for themself will assume a position adverse to their duties to the corporation).
         

Minority shareholders who find themselves in a situation where the majority shareholder is taking funds from the business through loans or leases have recourse available.

Full post as published by New Jersey Law Blog on June 02, 2010 (boomark / email).