There is a common misconception that ownership equals control. But in many businesses—especially those participating in the Small Business Administration’s (SBA) 8(a), Women-Owned Small Business (WOSB), or Service-Disabled Veteran-Owned Small Business (SDVOSB) programs—the reality is far more complex. As companies grow, take on investment, or bring in new members, questions of ownership rights, decision-making authority, and fiduciary duties become increasingly fraught. For minority stakeholders, the risk of being sidelined is real. And for majority owners, mismanaging that balance can trigger litigation or worse, including the loss of small business program eligibility. In this sixth installment of PilieroMazza’s blog series, “Managing Litigation Risk During the Business Lifecycle,” we examine how to manage risk associated with minority stakeholder interests, including claims of oppression, loss of control in SBA small business programs, and best practices for governing stakeholder relationships. Visit this link to access Parts 1-5 in this blog series.
What Is Minority Stakeholder Oppression?
Majority stakeholders generally have a much larger say in how a company is run when compared to minority stakeholders. Majority stakeholders are often entitled to elect the members of the board of directors, appoint officers of their choosing, and use their influence to sway company decisions. As a result, the company tends to follow the path laid out by the majority stakeholders. This disparity in control may not be an issue when majority and minority stakeholders are in alignment and receiving the expected returns on investment. But when the company’s actions unfairly prejudice its minority stakeholders, they may be able to sue for minority stakeholder oppression.
Typically, this occurs where there is wrongful conduct, a lack of honesty in carrying out duties, or purposeful conduct to harm a minority stakeholder’s interests. Examples of minority stakeholder oppression include:
- excessive salaries or bonuses to the controlling stakeholders;
- coordinated attempts to coerce minority stakeholders to sell their shares;
- attempts to divorce a minority stakeholder from their interests on unfavorable terms; and
- excluding minority stakeholders from participating in management decisions.
These actions, evaluated in the context of the type of business and how it is organized, can lead to significant liability on the part of the controlling stakeholders or even judicially ordered buyouts. Minority stakeholder oppression regularly overlaps with the issues arising in breaches of fiduciary duties as well, which are discussed in Part 5 of this blog series.
Common Sources of Minority Stakeholder Litigation
Closely held businesses are particularly vulnerable to disputes among owners arising from unfair treatment of minority stakeholders. Such businesses can lack the policies and oversight that larger organizations maintain to spot these issues and avoid them. In these circumstances, oppression may occur where minority stakeholders are excluded from management decisions, denied access to financial information, or when their economic benefits, such as distributions or employment, are restricted or withdrawn without clear justification. This type of conduct can lead to allegations of breaches of fiduciary duties, self-dealing, and oppression, each carrying significant legal risks.
The above-mentioned issues are particularly relevant for government contractors whose ownership structures and control mechanisms are scrutinized by the SBA for program eligibility. Control by the qualifying owner is a strict program requirement, which may naturally tend to place them at odds with minority stakeholders when making business decisions. Yet, when too much control is left to the minority stakeholders, the SBA may question the qualifying owner’s actual authority, leading to potential program termination or ineligibility determinations.
Legal Protections for Minority Stakeholders
Minority stakeholders have various legal protections derived from fiduciary obligations of majority stakeholders, statutory frameworks, and carefully drafted agreements. Fiduciary duties of majority stakeholders include the requirement that majority owners act with loyalty, care, and good faith toward minority stakeholders, especially in closely held entities. Statutory protections in many jurisdictions permit minority owners to pursue remedies for oppressive conduct, such as forced buyouts, equitable relief, or even judicial dissolution in extreme cases.
For businesses participating in SBA small business programs, additional care must be taken. Any governance documents must comply with SBA guidelines to avoid creating affiliation or control issues. Minority protections should be structured to meet both commercial fairness and regulatory compliance, too. Furthermore, business owners need to disclose these governance decisions to prospective minority stakeholders so that the limitations are understood.
Best Practices to Mitigate Oppression Risk
The best protection against minority stakeholder disputes is proactive and thoughtful governance planning. Both majority and minority stakeholders benefit from clearly defined rights, roles, and responsibilities outlined from the outset of their business relationship. Key steps for government contractors aiming to mitigate risk include:
- Draft Clear Operating and Stakeholder Agreements: Clearly define voting thresholds, decision-making rights, and the specific roles and responsibilities of all stakeholders. Detail distribution policies, decision approval processes, and conflict resolution mechanisms up front.
- Establish Transparent Financial and Operational Reporting: Share detailed financial statements and operational updates with all stakeholders on a regular cadence. Transparency prevents disputes that arise from information asymmetry and promotes trust and cooperation.
- Incorporate Well-Defined Exit and Valuation Mechanisms: Include precise buy-sell provisions and valuation methodologies to ensure a smooth transition if a stakeholder wishes to exit or if disputes necessitate separation.
- Define Dispute Resolution Pathways: Include mandatory mediation or arbitration clauses in governance documents, providing an efficient and less adversarial process for resolving internal disputes.
- Regularly Review and Update Governance Documents: Governance methods need to evolve with the business. Regularly review and amend documents to ensure they accurately reflect the current business reality and remain compliant with legal and regulatory requirements specific to the business.
- Tailor Minority Protections Within SBA Guidelines (for SBA-Regulated Businesses): Ensure that minority investor rights are carefully structured to comply with SBA requirements. Specifically, ensure any minority veto rights fall within SBA-approved exceptions to avoid unintended eligibility issues.
Conclusion: Planning for Partnership, Preparing for Conflict
Governance planning for closely held businesses, especially those in regulated environments like the SBA’s small business programs, must address the potential for stakeholder conflicts. Carefully designed agreements, proactive transparency, and compliance with regulatory frameworks are key strategies to reduce litigation risk and protect long-term business viability.
By understanding and addressing these risks, organizations can foster equitable governance, ensure compliance with SBA requirements, and build resilient stakeholder relationships. For questions about fiduciary duties or strategies to reduce litigation risk, please contact Todd Reinecker, Abby Baker, Mark Rosenow, Kirby Rousseau, or Nathan Jahnigen, members of PilieroMazza’s Litigation & Dispute Resolution and Corporate & Organizational Governance practice groups.
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If you’re seeking practical insights to gain a competitive edge by understanding the government’s compliance requirements, tune into PilieroMazza’s podcasts: GovCon Live!, Clocking in with PilieroMazza, and Ex Rel. Radio.
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