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When An Owner is Fired

Dear Advisor:

I’ve recently fired my brother (who owns 20% of the business). He’s been relieved of all responsibilities and received six months at full pay. He is now threatening a lawsuit. He says his attorney says there’s a difference between terminating a non-owner and an owner. Any merit to that view?


Because this question called for legal advice, we asked our friend Henry Krasnow of the Chicago law firm Krasnow, Sanberg, Cornblath & Hobbs for his input. His answer: “When a business fires an employee, it finds itself with an angry ex-employee with the normal rights regarding discrimination. But when a business fires an employee-shareholder, it finds itself with an angry shareholder – and an angry shareholder can usually cause serious problems (especially one who, like many family members, has been on the “inside” of the business’ financial dealings).

Of course, there are a few very large family businesses where angry family shareholders rarely cause problems. A family shareholder in Johnson’s Wax, for example, has no business motive to cause problems since he or she can sell stock at a fair market value. Similarly, a terminated employee-shareholder in a third or fourth generation family business whose stock pays regular dividends and is widely owned by both employed and non-employed family members, or in a business that has a well established liquidity program that purchases stock at a fair market value, will probably do not more than sell the stock and avoid family functions.

But in a company where the major advantage of stock ownership is the chance to go to work each morning, even though the president may have the perfect right to fire a shareholder, the likely cost of that firing (once the ex-employee finds a clever enough lawyer) will be the purchase of his or her minority interest at a price higher than is comfortable.

In other words, firing a family shareholder in such a company will typically start a negotiation to buy his or her stock. And, since his or her ability to cause trouble greatly exceeds the value of the stock in the marketplace (a minority interest in a small company that pays no dividends and is controlled by the chief employee usually has no market value), the controlling shareholder should be prepared to pay far more than he or she thinks the fired employee’s stock is worth.

Most states have a legal framework that allows a minority shareholder both to question the fairness of the salaries of the officers or to cause the sale of a company that is ‘abusing’ the shareholders or breaking laws. ‘Abuse’ is rarely clearly defined, thus giving judges broad discretion to correct perceived unfairness. My experience is that judges often think there is a premium on resolving disputes among family members and rarely think there is a premium on control of a small family business. Thus, when a judge who has very broad discretion hints that ‘abuse’ is not providing any cash benefits for the non-employed minority shareholders, a purchase of the stock at more than its ‘market value’ becomes an appealing compromise.

The other common problem is that some small businesses cut corners, particularly in relation to taxes. When the person being fired knows every skeleton in every closet, and if there is a refusal to purchase that shareholder’s stock and silence, all these skeletons may soon be marching across a court room.

As long as reasons for termination are performance-based and well documented, there is no significant difference between firing an owner or firing a non-family employee. Your case is further bolstered if you’ve had input from an independent board. The difference is that a shareholder enjoys the legal standing and insider knowledge to mount an attack on another front. Be prepared by dealing fairly on the matter of buying back stock and by having strong defenses.

The Advisor

 

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