Where You Incorporate Your LLC Matters

By Adam Schwartz, Esq.
aschwartz@pashmanstein.com

Popular convention is to incorporate in Delaware, even if a company conducts no business there.  Due to its business-friendly regulatory environment and large body of case law regarding corporate management issues, over 900,000 business entities have incorporated in Delaware.  However, if you are minority owner of a closely-held company with its principal place of business in New Jersey, you may not want to follow popular convention.

New Jersey has enacted a Minority Oppression Statute, N.J.S.A. 14A:12-7(c), which provides a range of remedies for minority owners in closely held corporations when the majority has acted to defeat the “reasonable expectations” of the minority owner or has otherwise acted fraudulently, illegally or oppressively toward the minority.  The potential remedies include the appointment of a custodian or provisional director to manage the company, ordering the corporation to purchase the minority shareholder’s interest, or dissolving the corporation.

Delaware, however, does not have a corollary to the Oppressed Shareholder Statute, and its courts have not recognized any common law remedy for minority shareholder oppression.  Under Delaware law, a minority stockholder must protect him or herself by bargaining for any such protection.  If there is no contractual provision for a buyout or the appointment of a custodian or director, a Delaware court will not imply one.  In short, New Jersey law is for more favorable for a minority shareholder.

This difference is important because, when a lawsuit involves the internal affairs of a corporation, New Jersey courts will apply the law of the state of incorporation.  Therefore, even if a company’s business is conducted solely within New Jersey, if it is incorporated in Delaware, Delaware law ordinarily governs shareholder and management disputes.  This results in a distinct disadvantage for the minority shareholder.

In 2008, the New Jersey Appellate Division found an exception to this general rule. Kraszteck v. Global Resource Industrial & Power, Inc., 2008 N.J. Super. Unpub Lexis 1360 (App. Div. 2008).  In that case, the Court recognized that “the location of incorporation is not always dispositive” and that New Jersey courts may apply the law of the state with the greatest interest in resolving the dispute.  Specifically, the Kraszteck Court noted that, for claims of minority oppression, when the company is headquartered in New Jersey and has no other connection to the state of incorporation, New Jersey the greater interest and its law applies.

However, in 2012, another Appellate Division matter, Hopkins v. Duckett, 2012 N.J. Unpub Lexis 93 (App. Div. 2012), arguably reached a different conclusion than the Kraszteck court.  In Hopkins, Appellate Division held that, even though the company had no connection with Delaware other than the fact that it was incorporated there, Delaware law applied the plaintiff’s minority oppression claims because “the [shareholders] freely entered into an operating agreement that they explicitly provided was to be governed by Delaware law” and the disputes at issue arose out of that agreement.  Consequently, the minority shareholder was not entitled to the protection of New Jersey’s Oppressed Shareholder Act.

In light of these seemingly divergent decisions, the question still remains — will New Jersey’s Oppressed Shareholder Act apply to business entities incorporated in Delaware with their principal offices in New Jersey?  Although subsequent cases may eventually follow Kraszteck, until there is a decision from New Jersey Supreme Court reconciling Kraszteck and Hopkins, the safer course of action for a minority shareholder concerned about majority management of a closely-held company would be to incorporate in New Jersey, instead of Delaware.

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