Employee-shareholders of closely held corporations may reasonably expect continued employment but corporations need to manage their business, including the ability to make management changes. Careful drafting of employment and shareholder agreements to balance these expectations can mitigate difficulty if conflicts arise.
A company’s vice-president takes bribes and kickbacks from customers. One of the managers gets into a heated argument with a customer and damages the customer’s vehicle. The inventor of the company’s technology is no longer productive or supportive of the leadership team. Most Minnesota employers would have little hesitation in terminating employment under any of these circumstances. After all, Minnesota employment law continues to follow the rule of at-will employment: employment may be ended at any time for any lawful reason.
Change the facts slightly. The employer is a closely held Minnesota corporation and the dishonest, argumentative, or unproductive employee is also a minority shareholder of the company. A relatively easy termination decision becomes much more complicated. Minnesota shareholder law recognizes that the reasonable expectations of an employee-shareholder may include continued employment and a significant role within the company until retirement or voluntary departure. Terminating the employment of an employee-shareholder may frustrate reasonable expectations and trigger rights to broad equitable relief.
This article identifies the tension between Minnesota employment and shareholder law, describes some of the key concepts concerning the employment expectations of employee-shareholders, and suggests steps that employers and employee-shareholders may take to prevent or resolve disputes concerning employment expectations.
Employment as an Expectation
Minn. Stat. §302A.751 gives a Minnesota district court significant discretion to fashion a remedy when minority shareholders are treated in an unfairly prejudicial manner:
A court may grant any equitable relief it deems just and reasonable in the circumstances or may dissolve a corporation and liquidate its assets and business:
In an action by a shareholder when it is established that: …
The directors or those in control of the corporation have acted in a manner unfairly prejudicial toward one or more shareholders in their capacities as … officers or employees of a closely held corporation.1
A closely held corporation has no more than 35 shareholders.
The initial Minnesota case recognizing that employee-shareholders may have a reasonable expectation of lifelong employment involved extraordinary service as the basis for the expectation.2 Pedro v. Pedro was a case brought by Alfred Pedro, an equal 33 percent owner of a family business along with his two brothers. Alfred had worked in the company for 45 years. His brothers had worked in the business for most of their adult lives and their father was active in the business until his death. Upon discovering a discrepancy between the company’s internal accounting records and its checking account, Alfred demanded an outside investigation. Alfred’s brothers told Alfred that if he did not forget about the discrepancy he would be fired. They placed him on a leave of absence and then terminated his employment. They falsely told employees that Alfred had suffered a nervous breakdown and left the company.
Based on these compelling facts, the Minnesota Court of Appeals issued a ground-breaking decision that an employee-shareholder may have a reasonable expectation of continuing lifetime employment. The court explained that an employee-shareholder has two separate interests in the company. First, as an owner, the shareholder has an interest in the value of the shares. Second, as an employee, “the reasonable expectations of such a shareholder are a job, salary, a significant place in management, and economic security for his family.”3 Alfred’s brothers frustrated his reasonable expectations by terminating his employment. The court ordered a buy-out of Alfred’s shares at fair value, and awarded Alfred lost wages through anticipated retirement at age 72, damages for breach of fiduciary duty, and attorney fees.
More recent cases suggest that continued employment may be a reasonable expectation of employee-shareholders even without a lifetime of service to the company. One of the leading cases is Gunderson v. Alliance of Computer Professionals, Inc.4 Gunderson joined a computer-consulting firm as a shareholder, director, officer, and employee shortly after it was founded. He guaranteed some of the company’s financial obligations and drafted a business plan. He worked on the financial and administrative side of the business for four years until the founder asked Gunderson to leave based on allegations that Gunderson was dishonest, worked short and unpredictable hours, and failed to perform assigned tasks.
The Minnesota Court of Appeals explained that Gunderson could not sue his employer under a common-law breach-of-contract theory because he was an at-will employee and there were no clear and unequivocal statements of job security. Nevertheless, Gunderson had a viable minority shareholder claim under Minn. Stat. §302A.751. “Typical close-corporation shareholders commonly have an expectation of continuing employment with the corporation,”5 said the court. Employment is “often a vital component of a close corporation shareholder’s return on investment and a principal source of income.”6 As a result, the termination of Gunderson’s employment could be grounds for equitable relief even though his employment was relatively brief and there were some issues concerning his behavior and performance.
The trend in recent cases is that continued employment is a reasonable expectation of most employee-shareholders. In fact, one district court opinion referred to employment until voluntary retirement as a “property right of a shareholder in a close corporation.”7 Employment expectations may be particularly high for founders who regard the company as an extension of themselves.8
Expectations Perhaps Unreasonable
Balanced against an employee-shareholder’s expectation to remain a significant player within a closely held business is the employer’s need to run the business productively and to make management changes when employees are no longer positively contributing to the organization. Courts have found that certain expectations of continuing employment are unreasonable and unenforceable for a variety of reasons.
First, the employee-shareholder may have entered into agreements with the company inconsistent with notions of lifelong employment. “Shareholders who sign buy-out agreements permitting termination of employment for any reason and obligating shareholders to sell their shares to the corporation upon termination of employment would not likely have a reasonable expectation of continuing employment.”9 Likewise, employment agreements establishing a term of employment, defining good cause for termination of employment, or acknowledging at-will employment status may be inconsistent with an employee-shareholder’s allegations concerning lifetime employment.
Second, reasonable expectations must be communicated to and shared by the employer.10 Absent agreement among the parties, an employee-shareholder’s subjective belief concerning continued employment may not be reasonable.
Third, expectations of continuing employment (even if reasonable at the outset of the employment relationship) may no longer be reasonable if the employee becomes dishonest or incompetent.11 Minnesota courts have refused to grant equitable relief to discharged employee-shareholders who engaged in various forms of misconduct, such as taking large amounts of money out of the company when it was struggling, wrongfully using company property, or disrupting the company’s operations.12 One often-cited case from outside Minnesota states that the only reasonable expectations of an employee-shareholder who engaged in egregious misconduct by stealing from the company were “ostracism and prosecution.”13
However, even if the employee-shareholder’s misconduct destroys reasonable expectations of continuing employment, it does not necessarily lead to a forfeiture of shares or discount on the fair value of shares.14 Because employment expectations are separate from ownership interests, the company may still be required to repurchase a terminated employee-shareholder’s stock. This requires determination of the fair value of a pro rata share of the corporation as a going concern without discount for lack of marketability.15 The need to pay a terminated employee-shareholder the fair value of shares, especially when the termination is based on dishonesty or other misconduct, can be one of the most frustrating experiences in the life of a closely held company.
It is in the best interests of both employee-shareholders and employers to enter into employment, stock, and other written agreements addressing the circumstances under which an employee-shareholder’s employment may be ended and the company’s repurchase or redemption obligations in such a situation. “Any written agreements, including employment agreements and buy-sell agreements, between or among shareholders … and the corporation are presumed to reflect the parties’ reasonable expectations concerning matters dealt with in the agreements.”16 There are many examples of Minnesota courts defining the parties’ expectations concerning employment by looking to the provisions in their contracts and governing documents.17
Addressing employment expectations at the beginning of the employment relationship can greatly assist in avoiding or resolving disputes when the employment relationship breaks down. Consider issues such as the following:
- Is there a term of employment? Does it renew automatically?
- Who decides whether employment will continue?
- What, if any, are the grounds for dismissal?
- In the event of discharge, what is the procedure for valuing shares: Agreed upon price? Formula? Appraisal?
- What are the terms and conditions of payment for shares?
Revisit the agreements periodically and make sure they continue to reflect the wishes and expectations of the company and its owners. By addressing these issues regularly, employers and employee-shareholders may better manage their expectations and continue mutually beneficial business and working relationships.
1 Minn. Stat. §322B.833 provides virtually identical provisions for Minnesota limited liability companies.
2 Pedro v. Pedro, 463 N.W. 2d 285 (Minn. App. 1990), 489 N.W. 2d 798 (Minn. App. 1992).
3 Pedro, 489 N.W.2d at 802.
4 Gunderson v. Alliance of Computer Professionals, Inc., 628 N.W. 2d 173 (Minn. App. 2001).
5 Id. at 189.
7 Compassionate Nursing Services, Inc. v. Masese, 2005 WL 1953906, *9 (Minn. Dist. Ct. 02/14/05).
8 Haley v. Forcelle, 669 N.W.2d 48, 60 (Minn. App. 2003) (fact that terminated employee-shareholder was also a cofounder “distinguishes it from typical employment-termination cases”); Sawyer v. Curt & Company, Inc., 1991 WL 65320, *2 (Minn. App. 1991) (“There is no doubt the reasonable expectations of respondent, who is a shareholder-employee-founder of appellant corporation, included a job, a salary, and a significant place in management.”)
9 Gunderson, 628 N.W.2d at 190.
10 Gunderson, 628 N.W.2d at 191.
11 Gunderson, 628 N.W.2d at 192.
12 Bolander v. Bolander, 703 N.W.2d 529, 548-549 (Minn. App. 2005); Rachel v. Veit, 2007 WL 1257445 (Minn. Dist. Ct. 01/22/07); Mohamed v. Jama, 2008 WL 5520067 (Minn. Dist. Ct. 11/18/08).
13 Gimpel v. Bolstein, 125 Misc.2d 445, 477 N.Y.S.2d 1014, 1017, 1019-1020 (N.Y. Sup. Ct. 1984).
14 See, e.g., Pooley v. Mankato Iron & Metal, Inc., 513 N.W.2d 834, 838 (Minn. App. 1994).
15 Advanced Communication Design, Inc. v. Follett, 615 N.W.2d 285, 292 (Minn. 2000).
16 Minn. Stat. §302A.751, subd. 3a.
17 See, e.g., Keogh v. John Henry Foster Minnesota Inc., 2008 WL 1747936, *7 (Minn. App. 04/15/08); Regan v. Natural Resources Group, 345 F. Supp. 2d 1000, 1012 (D. Minn. 2004).