Legal Definitions - freeze-out

A freeze-out describes a situation where the majority or controlling shareholders in a company, particularly a privately owned one (known as a "closely held corporation"), use their power to unfairly disadvantage, oppress, or eliminate minority shareholders. The primary goal is often to force the minority shareholders to sell their shares, typically at a price favorable to the majority, or to significantly diminish their influence, ownership stake, or access to company benefits and opportunities. This practice is considered an abuse of corporate control and can violate the legal duties owed by controlling shareholders to others within the company.

Here are some examples illustrating how a freeze-out can occur:

• Example 1: Dilution of Ownership and Voting Power

  Imagine a small, privately owned technology startup where three founders collectively own 75% of the shares, and an early angel investor owns the remaining 25%. The founders, acting as the majority, decide the company needs a significant capital infusion. Instead of seeking external investment or allowing all shareholders to participate proportionally, they approve a new issuance of a large number of shares at a very low price and purchase all of these new shares themselves. This action drastically reduces the angel investor's 25% ownership stake to perhaps 5% or 10%, and their voting power is similarly diminished, without giving them a fair opportunity to maintain their original percentage. This is a freeze-out because the majority shareholders used their control to dilute the minority shareholder's ownership and influence, effectively marginalizing their investment.

• Example 2: Unfair Merger or Buyout Terms

  Consider a successful regional manufacturing company owned by a family. Two siblings own 60% of the shares, and their cousin, who inherited shares from a parent, owns the remaining 40%. The siblings decide to merge the manufacturing company with a new, less successful distribution business they recently started. They structure the merger so that the manufacturing company's assets are valued very low, and the cousin's 40% stake is bought out for a minimal cash payment. Meanwhile, the siblings retain significant ownership and control in the newly combined, larger entity, effectively forcing the cousin out of the profitable manufacturing business at an unfair price while consolidating their own control over the valuable assets. This illustrates a freeze-out where the minority shareholder is compelled to sell their shares on unfavorable terms during a corporate transaction.

• Example 3: Withholding Benefits and Opportunities

  In a small, profitable consulting firm, the two founding partners hold 85% of the shares, and a long-time senior consultant who invested early holds 15%. The firm has historically paid out substantial annual dividends to its shareholders. Suddenly, the founding partners, as the majority, decide to stop paying dividends entirely, claiming the funds are needed for reinvestment. However, they simultaneously approve large salaries, bonuses, and perks for themselves as executives, and start a new, related subsidiary company that takes over the most profitable client contracts, excluding the minority shareholder from any ownership or participation in this new venture. This is a freeze-out because the majority is using its control to deprive the minority shareholder of the financial benefits and opportunities they were entitled to, making their investment less valuable and potentially pressuring them to sell their shares.