Bernstern v. Lutkowski

A-4929-97T5 (N.J. Super. App. Div. 1999) (Unpublished)
  • Opinion Date: April 12, 1999

CORPORATIONS; SHAREHOLDERS—In a close corporation, although a shareholder’s expectation of employment is to be honored, that expectation must be balanced against the corporation’s ability to run a business efficiently.

A sales representative business was set up as a corporation with three shareholders. One of the shareholders held a majority interest and in essence ran the company. No formal shareholder meetings or director’s meetings were held. Instead, all required corporate action was by written consent. All three shareholders worked for the company as salespersons and received a salary which was, in effect, an allocation of the company’s profits. After the payment of salary and other expenses, the company never showed a profit. When the company was organized, each of the shareholders paid $100 per share. At that time, there were four shareholders, but when the fourth shareholder’s employment was terminated because of what the other three shareholders considered to be poor performance, his shares of stock were bought back by the two remaining minority shareholders, equally, at the same $100 per share. A time then came when one of the two remaining minority shareholders consented to a reduction in his salary. That reduction was a result of the other shareholders reached the conclusion that the third shareholder’s job performance was deficient. The third shareholder actually consented to the reduction of his compensation. A year later, his salary was again reduced, and, again, he consented to the reduction. Each time his salary was reduced, he reduced the amount of days he worked in direct proportion to that reduction. Finally, after his job performance did not improve, the other two shareholders decided to terminate his employment because of his continued poor performance and the poor financial status of the company. The discharged shareholder then filed an action asserting that the remaining shareholders acted oppressively or unfairly toward him, as a minority shareholder, in his capacity as an employee.

N.J.S. 14A:12-7 recognizes “the fact that in a closely-held corporation oppressive conduct often takes the form of freezing-out a minority shareholder by removing him from his various offices or by substantially diminishing his power or compensation.” After taking testimony, the lower court ruled (with the Appellate Division’s subsequent approval) that there was no oppressive action by the other two shareholders. This was because the discharged shareholder’s expectation of employment was honored, and the resulting loss of his employment was through no fault of the remaining shareholders. Instead, the loss of his expectation to participate as an employee was a result of his own failure to perform the duties of his employment. His “expectation of employment must be balanced against the corporation’s ability to run a business efficiently.” The thrust of the statute is to protect the shareholder from the abusive exercise of power. The Court rejected the discharged shareholder’s contention that his initial monetary investment in the corporation gave him a reasonable expectation of indefinite employment. In the words of the lower court, “[w]ell we know if you don’t do the work you get fired.” In addition, there was no finding that the remaining shareholders acted in bad faith or violated any fiduciary duty to the corporation or their duty of good faith or loyalty because the decision was based upon what was best for the corporation as opposed to what was best for an individual shareholder. In addition, the lower court, having found that the discharged shareholder was not an oppressed minority shareholder, did not direct a buy-out. It did, however, value his shares in the event he chose to divest himself of them. The valuation was set at the original price of $100. When reaching this conclusion, the lower court found that the “corporation has not retained any earnings, has no major assets. ... This is not an asset rich corporation. This corporation’s value is based upon the work performed by the three shareholders who really operate as partners. So therefore it would be reasonable to expect that if the corporate value comes from the work of the salesmen who happened to be shareholders, then the only value to a shareholder that is leaving, the only reasonable value would be that shareholder’s investment… .” In addition, the lower court found that when the shareholder was fired, he asked to be reimbursed for his shares at the original $100 per share price and when he was asked about the $100 per share price paid to the earlier shareholder, he told the lower court that it was a fair price because “that’s the amount he invested originally.”