A Classic Squeeze-Out: Minority Member Oppression in Wilson v Gandis
In the previous blog, we looked at one of the risks of being in an LLC, minority member oppression. This happens when a member or members of the LLC act to reduce a minority member’s involvement in the company against their will. The majority member(s) may try to “squeeze out” or “freeze out” the minority member from the company altogether. Or they may engage in conduct like withholding distributions and reducing the minority member’s involvement in the company while essentially trapping their investment in the LLC with no way for the minority member to get it back out.
This was the central issue in a case heard by the South Carolina Supreme Court in June 2019, Wilson v Gandis, in which the oppression was described as a “classic squeeze-out.” It’s rather convoluted, with multiple lawsuits and issues, but we’ll focus on the issue of minority oppression and exactly what constitutes it in the eyes of South Carolina courts.
The Background
In 2007, David Wilson and John Gandis formed Carolina Custom Converting (CCC), a company selling film, resin, and other materials. It was a manager-managed LLC, with each owning 50% membership interest. Importantly, Wilson and Gandis never executed a formal operating agreement and had no employee, noncompete, nondisclosure, or nonsolicitation agreements. Many of their oral conversations and agreements were memorialized through email, however.
CCC’s business was intricately linked to other businesses owned by Wilson and Gandis. When CCC was formed, Wilson owned Eastern Film Solutions (EFS) and Gandis owned DecoTex and M-Tech. Wilson agreed to wind down EFS and bring that business over to CCC, for which he was compensated $8,000 per month, later raised to $12,000 per month. Gandis agreed to extend a line of credit to CCC from DecoTex and M-Tech. Plus, CCC operated out of a building owned by M-Tech, so Gandis received the benefit of the rent money paid by CCC.
Gandis brought on Andrea Comeau-Shirley, a CPA, to help with accounting and advice. In 2009, Gandis and Wilson each transferred 5% of their interest to Shirley. She didn’t have a formal voting interest but was actively involved in managing CCC.
Not long after, things started to go south for Wilson. Shirley and Gandis grew closer and began excluding Wilson from discussions about the company’s operations. Over the course of years, they exchanged many emails, which later the trial court said “provide[d] evidence of their oppressive conduct against Wilson.”
The Lawsuits: Wilson v Gandis
After a long period of behavior unfavorable to Wilson, lawsuits followed. The main issue we’ll be looking at is Wilson’s claim against Gandis and Shirley for minority member oppression. (Other issues not relevant here include Gandis’s and Shirley’s counterclaim against Wilson for breach of fiduciary duty, which they lost, and CCC’s claim against Wilson and companies he worked with after CCC for misappropriation of trade secrets, which they also lost.)
In a 5-day bench trial in 2014, a trial court found Gandis and Shirley had engaged in oppressive conduct against Wilson, saying “This is a classic squeeze-out,” and that the body of emails between Gandis and Shirley “abounds with evidence of calculated oppression” and “could serve as a script” for minority member oppression. The court found in favor of Wilson and ordered Gandis and Shirley to buy out Wilson’s interest in CCC as individuals, rather than having CCC buy him out.
Gandis and Shirley appealed, and in an unpublished decision, the appeals court agreed with the trial court and adopted the order in its entirety. They appealed again, and the South Carolina Supreme Court heard the case in June 2019.
Examples of Oppressive Conduct
In its opinion, the supreme court states that it’s not necessary for the plaintiff to prove illegal or fraudulent conduct in order to prove minority oppression. The minority investor instead needs to show that their investment is “trapped” and that they’re facing exclusion from participation in business returns for an indefinite period of time. What constitutes oppressive behavior must be determined on a case-by-case basis.
In this case, the supreme court agrees with the trial court’s conclusions about oppressive conduct on the part of Gandis and Shirley. Here are many of the acts Gandis and Shirley engaged in that the courts found oppressive:
Conspiring together to “get Wilson out.” Many emails exchanged between Gandis and Shirley blatantly and boldly discussed their plans to get Wilson out by different means, including making him an employee with a 5-year noncompete agreement and firing him on the smallest of pretexts.
Withholding distributions. From 2007 to 2010, CCC set aside funds to cover members’ individual tax liabilities, which were proportional to their membership interests. In 2011, this changed. Shirley emailed Gandis and encouraged him to use the funds that would have gone to members to help pay their tax liabilities to instead pay back what was owed on CCC’s line of credit from Gandis’s other business, which would directly benefit Gandis and leave Wilson without money to pay his tax liability. Shirley let Wilson know that there would be no distributions that year to members to cover tax liabilities.
Secretly monitoring Wilson’s emails. Gandis and Shirley began reading Wilson’s emails and referenced them in their own email exchanges. In 2011, they read an email to Wilson from his wife in which she expressed frustration over how Shirley and Gandis were managing CCC. From then on, Gandis’s and Shirley’s efforts to exclude Wilson from the LLC increased.
Gandis and Shirley later said in court that they were simply archiving all of CCC’s incoming emails in order to keep customer quotes and so forth available, but the trial court said this testimony was not credible, and the supreme court agreed. They also said that the employee handbook makes it clear that company email should not have an expectation of privacy – but the handbook was never issued.
Withholding income from Wilson. Not long after reading the email to Wilson from his wife, Gandis and Shirley stopped paying Wilson the monthly $12,000 they had agreed upon to compensate him for bringing his previous company’s business over to CCC.
Plus, they began classifying Wilson’s distributions as loans. When the situation came to a head in October 2011, Gandis (on Shirley’s advice) gave Wilson two options. 1. Surrender his membership interest in order to satisfy his loan balance of $123,000, which began accruing once they recategorized his distributions as loans. Or 2. Become an at-will employee of CCC (with the aim of firing him for the smallest of reasons, according to an email from Shirley).
From there, Wilson and Gandis entered into back-and-forth negotiations. Wilson was trying to find a way to either stay involved fairly or leave with his rightful share of what he was owed, while Gandis was trying to find a way to get Wilson out paying as little as possible.
Revoking financial authority. Around this time, Shirley removed Wilson as signatory on CCC’s bank account, leaving Gandis as the only signatory on the account, and revoked Wilson’s authority to make wire transfers. Wilson’s ability to access CCC’s financial information was also limited.
Misrepresenting the company’s finances. Gandis and Shirley made it look as if CCC had less cash than it had and later manipulated the December 2011 pro forma balance sheet to make it look like Wilson’s interest in the company was less than it really was.
Locking Wilson out of the building. In January 2012, after Wilson and Gandis were unable to come to an agreement about what should happen, Wilson arrived at the office to find Gandis there with a police officer and a locksmith. Since Wilson was a co-owner, the officer didn’t make him leave, and Wilson was able to enter the building and take two laptops, a Blackberry, and a number of files with him before he left and the locks were changed.
Emails between Gandis and Shirley showed that this was their plan. They discussed the legality of it and what to use as a cover story – first that Wilson had resigned (which he protested he didn’t), then that they did it because Wilson was competing with CCC.
Terminating Wilson’s health insurance coverage and cell phone services. These benefits were cut off for Wilson – but not for other members of the LLC – after he was locked out. Plus, from here Gandis and Shirley increased CCC’s monthly rent, which, remember, directly benefited Gandis since CCC rented a building from Gandis’s company M-Tech. They also raised the rate on the line of credit, which again directly benefited Gandis.
Starting up a competing company. In July 2012, Gandis and Shirley started up another LLC, ZOi Films, without telling Wilson. They said they founded it in an attempt to rebrand CCC and it was to be a wholly-owned subsidiary of CCC, but the trial court characterized it as an attempt to “siphon off” business from CCC.
Minority oppression must be determined on a case-by-case basis, says the supreme court, and in this instance it was not ambiguous – the trial court, court of appeals, and supreme court all agreed that Gandis and Shirley engaged in oppressive acts that were “brazen” and “unconscionable” (in the words of the trial court).
A Point of Disagreement
There was one point on which the supreme court disagreed with the trial court, and that’s the issue of who should be responsible for buying Wilson out. Gandis and Shirley argued against the trial court’s order that they must buy out Wilson’s share with their own money, as they argue that the LLC should protect them. They cited subsection 33-44-303(c) of South Carolina Code which protects LLC members from personal liability when acting in the course of ordinary business. But engaging in acts of calculated oppression is not in the course of ordinary business, the court determined.
Still, the supreme court did reverse the trial court’s order for Gandis and Shirley to personally buy Wilson out and remanded the case back to the trial court. CCC is ordered to buy out Wilson’s share, and if it doesn’t do that in a timely manner, then Gandis and Shirley will have to do so personally in a way that’s proportional to their interest in the business.
Protect Your Interests with LLC Governing Documents
The supreme court’s opinion called out that Wilson and Gandis did not have an operating agreement, employee handbook, or other optional but important documents to help them run their business. While having governance documents can’t entirely prevent minority oppression, they can help protect minority members’ interests and give recourse should the issue go to court. Not all instances of minority oppression are as blatant (and numerous) as in the case above.
If you are planning to start up an LLC with other people, or even if you already run one but don’t have anything beyond Articles of Incorporation, get your governance documents drafted and done. Call business attorney Gem at the Gem McDowell Law Group in Mount Pleasant, SC. He and his associates can draft documents that are tailored to your business that are fair to members and will help as you run the business and run into questions. Call today to schedule a free consultation at 843-284-1021.
Your Risks as a Minority Member in an LLC: Oppression and Squeeze-Out
A limited liability company (LLC) is a great thing for many entrepreneurs. Among other things, it provides liability protection while requiring fewer formalities than a corporation. But it’s not risk-free. One of the potential risks is minority oppression of members who own less than 50% of the LLC.
Today we’re going to look at what minority member oppression is, what your rights are as a minority member of an LLC, and what you can do to protect yourself.
Risk of Oppression for Minority Members in an LLC
Minority member oppression occurs when a member or members of an LLC act to reduce a minority member’s involvement in the LLC against their will.
When minority shareholder oppression occurs in a corporation, the shareholder can simply sell their shares (albeit at an unfairly low price in many cases) and walk away. However, in an LLC and close corporations, it’s often not so easy. The minority member may find that their investment is essentially being held hostage, and they don’t have a legal avenue to get it out of the company. Walking away means losing their investment.
The oppression often entails reducing the minority member’s income from the business, keeping them out of the loop regarding company business, and excluding them from important management decisions. Another tactic is for the majority member(s) to create a new, separate business entity and merge that with the existing business without giving the minority member any ownership in the new merged business, instead exchanging their interests for cash or eliminating it altogether.
When the end goal of this oppression is to force the minority member to give up their ownership in the LLC altogether, that’s commonly referred to as a squeeze-out or freeze-out.
LLC Minority Members’ Rights Under South Carolina Law
If your LLC does business without important governance documents (covered in the section below) and a dispute arises and goes to court, then South Carolina laws regarding LLCs apply. These vary somewhat depending on what kind of LLC it is (member-managed or manager-managed), but under SC law, minority members can expect certain rights, including:
- The right to a share of distributed profits
- The right to a share of proceeds of a sale if the LLC is sold or dissolved in proportion to their ownership
- The right to see the company’s books and financial records
- The right to sue another member or members for breach of fiduciary duty if they engage in misconduct
These protections sound great but they may not play out the way you want in real life. For example, majority members may take an income as an employee (rather than a distribution as an owner) or spend the company’s money in another way to avoid making distributions to minority members. Or they could structure a sale of the LLC in such a way as to legally cut out a minority member from the proceeds.
In short, don’t rely on default South Carolina laws to protect your interests as a minority member in an LLC. It’s best to have governance documents including an operating agreement with terms that are favorable to minority members and for you as a minority member to know, understand, and agree to those terms.
How Minority Members Can Protect Themselves: The Operating Agreement
In South Carolina, the Articles of Incorporation is the only document your LLC is legally required to have to be in business. Other governing documents are optional but extremely important for multi-member LLCs, the most important of which is the operating agreement.
An operating agreement details the ways in which the LLC will operate, covering such topics as ownership, members’ and managers’ duties, voting rights, how decisions are made, how profits and losses are handled, and more. Terms regarding buying and selling ownership or the LLC may be included or can be handled in a separate buy-sell agreement. Same with raising capital, which may be included in the operating agreement or detailed in a separate capital call agreement.
It’s important to understand that an operating agreement is not bulletproof. Majority members may still try to squeeze out or freeze out a minority member. However, when drafted in a way that protects a minority member’s interests, an operating agreement can help. If an issue arises and goes to court, then the court will look at the terms of the operating agreement rather than defaulting to SC law, which will be better for you (assuming the agreement is drafted well).
Work with a Business Attorney to Draft Your LLC’s Governing Documents
Each LLC is different and the members within each LLC are different, so no two operating agreements are alike. If you’re planning on joining or starting up an LLC with other people, or if you’re already in one but don’t have governing documents, talk to a business attorney. They can not only draft an operating agreement (and other documents) tailored to you and your business, they can also advise you on potential pitfalls and situations you may not have considered. Because what you don’t know can hurt you.
Gem McDowell is a business attorney in Mount Pleasant, SC, serving clients in the Charleston area and across the state. He and his associates at the Gem McDowell Law Group help people start, grow, and protect their businesses and business interests. Gem is a problem solver who has seen a lot in over 30 years of experience, and he can advise you on your situation and help you protect your interests. To schedule a free consultation, call 843-284-1021 today.
5 Ways A Business Lawyer Helps Grow And Protect Your Business
Business law, or corporate law, is the application of law to the business world. The two are completely intertwined at all times. For that reason, as a business owner you should plan to work closely with a business attorney throughout the life of your company, right from the very start. Here are 5 common ways a business lawyer can help you and your business.
1. A business lawyer will help you create your business.
This is called “choice of entity” and it’s a crucial step every business owner must take. Should you be an LLC? A corporation? If so, what kind? Both provide shelter from creditors to your personal assets, but the two entities are very different from one another. Furthermore, there are four ways to structure limited liability companies in South Carolina, and numerous ways to structure corporations.
An experienced business attorney can advise you on which entity is right for you and can tell you the potential pitfalls that you won’t read about on LegalZoom or other DIY sites.
2. A business lawyer can draft your corporate governance documents.
Corporate governance documents describe, govern and constrain activity of the business owners. They “set the rules” and tell everyone involved how things should go and what should happen when a particular occasion arises. They are unique to each business.
You absolutely should have these documents if your company has two or more owners/shareholders/partners (these terms will be used interchangeably through the rest of this article, though they are technically different). Here are some you might consider having:
Bylaws detail how the business is structured and give information on the board of directors, the responsibilities of the owners and more.
An Operating Agreement details how much each member owns in the company, how profits and losses will be allocated, what each member’s responsibilities are, how the company should be managed and more.
A Buy-Sell Agreement is essentially a “pre-nup” for the company. This document lays out what will happen in the event that one of the owners or shareholders dies, becomes ill, simply stops working, etc.
A Capital Call Agreement spells out what happens when the company needs to raise money and what happens when one of the partners can’t come up with their part. A partner who can’t contribute equally may lose voting rights, give up shares, or forego distributions, for example.
Non disclosure agreements (NDAs) and covenants not to compete are intended to protect your company against a former owner or employee running off with your trade secrets and your best customers, thereby hurting your business.
Question: Can you DIY? Should you?
Google these documents and you’ll find plenty of examples and templates you can download and fill in yourself – but don’t do it! Those documents might have been created in a different state, or before a significant change in the law, and they may not be valid. They were certainly drafted for a different business, for different people with different needs from yours. No two businesses are alike, and no two sets of governance documents should be alike.
Question: When is the best time to get these documents?
The best time to draft these documents is at the birth of your new company, when it’s likely that you’ll come up with documents that are fair to all parties. Imagine three years down the road, when one of your partners can’t come up with the money for a capital call – do you think they will want to sign a capital call agreement penalizing non-payment with a high rate of interest? Probably not. To avoid situations like that, it’s best to do it as early as possible, when all the owners feel goodwill towards each other. However, if you’re years into your business and still don’t have them, get something drafted now. Every single company faces issues that these documents address, so it’s not a matter of if but of when something will happen.
3. A business lawyer advises you on the best course of action and helps protect you from potential problems.
A lawyer is often referred to as “attorney and counselor-at-law.” A lawyer both applies the law and provides counsel on it. During a company’s growth, a business lawyer will be most helpful providing counsel on various issues that pertain to the law in order to deal with problems as they arise or, better yet, prevent them in the first place.
Contracts are the area in which you’ll probably need the most regular help from an attorney. As a business owner, you should have a lawyer familiar with your business draft your contracts and look over contracts given to you before signing. Other issues attorneys can help with may include long-range planning (see #4 on succession planning below), drafting terms & conditions for a website, advising on letters received, and, in the case of an attorney experienced in real estate law like Gem McDowell, rezoning or buying and selling land, to name just a few.
4. A business lawyer helps you with succession planning.
Succession planning allows all partners to come to an agreement about what will happen when one of the partners retires and leaves the company. Succession planning usually happens when one partner starts thinking about retirement.
5. A business lawyer represents you in litigation.
Working with a lawyer in the four situations above should hopefully reduce the likelihood that you’ll ever be involved in a lawsuit – and that’s really the point. Litigation is costly, lengthy and stressful for all parties. By being proactive and working with a business attorney from Day 1, you can sidestep the landmines that could otherwise destroy your business.
Learn more about how a business lawyer can help your business
Contact South Carolina attorney Gem McDowell and his associatess at their Charleston office at 843-284-1021 to discuss your company and its legal needs. Whether you’re thinking of starting a new entity or you’ve been running a thriving business for decades, it’s never too late to get legal advice from lawyers with experience in corporate law.
