California stock corporations are owned by their shareholders who then elect directors. Directors, in turn, elect officers who handle a corporation’s day-to-day management. Accordingly, shareholders hold influential positions in a corporation through their voting power.
California requires corporations issuing more than one class of shares to designate the classes and/or series of stock in its articles of incorporation. A stock corporation’s capitalization, or “cap,” table is a type of ledger that designates shareholders’ percentage ownership and equity value.
Most early shareholders know the equity value of their ownership, but as companies add investors, assets, and shareholders, the shareholder ownership structure can shift. This may result in a dilution of shares, changing the structure of shareholder ownership. These changes can lead marginalized minority shareholders to file major shareholder litigation disputing changes to the corporate ownership structure. While dilution may not affect the financial value of shares, it can have a drastic impact on voting rights and ownership structure.
Minority Shareholder Dilution
Most growing corporations expect to add new classes or series of shares to entice investors or grant employees stock options. Majority shareholders often do this by creating additional shares. For example, a company that began with 100 shares may amend its articles of incorporation to add another 100 shares to sell to investors. This naturally dilutes the ownership percentage of certain stockholders by half. If Shareholder A owns 10 shares of the original 100, then she owns 10% of the corporation and has proportional voting rights. Adding an additional 100 shares means she owns 10 of 200 shares, diluting her voting rights and ownership value by 5%. This can result in “squeeze-outs” whereby the majority shareholders threaten to create so many new shares that the minority owners’ voting rights are effectively zero.
Disputing the Corporate Ownership Structure
Business litigation can stem from shareholder disputes relating to the rights of minority shareholders facing a decline in ownership value. These ultra vires actions seek to challenge changes in ownership structure when the minority shareholders claim the corporation acted outside the scope of the ownership agreements. Such business litigation relates to:
- Issuing new shares in violation of shareholders’ preemptive rights;
- Dilution of shares in violation of restrictions in the stock certificate;
- Changes in corporate structure in violation of state law, such as adding stock fraudulently and without consideration; and
- Shareholder breach of contract.
Shareholders challenging the corporate ownership structure may also make a derivative claim against the majority shareholders for breaching their fiduciary duties. The rights and limitations of shareholders challenging changes to the corporate ownership structure depend on the nature of the agreement between the parties and applicable state and federal law.
Speak with an Experienced San Jose Business Litigation Lawyer Today
The experienced shareholder litigation attorneys at Structure Law Group, LLP can review proposed changes to a corporate cap table to help prevent expensive shareholder litigation. To schedule your business litigation consultation, call Structure Law Group, LLP’s San Jose office today at 408-441-7500 or contact us online.