Business Organization FAQs
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Do shareholders of closely held corporations have any responsibilities to each other?
Shareholders of closely held corporations owe each other a fiduciary duty, similar to the duty owed in a partnership, due to the vulnerability of minority shareholders in a closely held corporation. Incidentally, directors of a closely held corporation also owe shareholders a fiduciary duty in addition to their duty to the organization.
Although some courts have disagreed on the scope, in closely held corporations shareholders are generally owed a duty of loyalty. Shareholders must act in the best interests of all shareholders, and cannot act in such a way that only their own interests are served. Shareholders are also owed a duty of good faith, requiring fairness in corporate actions. These duties prohibit self-dealing by shareholders and require the highest candor and honesty from them.
The fiduciary duties owed to other shareholders are usually codified in statute, but they spring from duties developed in the common law.
What facets of a closely held corporation trigger fiduciary duties?
Courts have viewed closely held corporations as distinct from other types of corporations because of the nature of their corporate structure. First, closely held corporations generally have a much smaller number of shareholders than other corporations. Second, minority shareholders generally do not have liquidity because there is no market for the shares they own. Third, majority shareholders in closely held corporations may be directors, officers or otherwise have control over the corporation.
As Robert Keatinge and Ann Conaway note in their treatise on entity selection for closely held businesses, other courts have rejected an approach that triggers fiduciary duties based on corporate structure; rather, those courts have found that as long as the corporation treats minority shareholders fairly, although not necessarily equally, it has fulfilled its obligations to the shareholders.
In what circumstances can the fiduciary duty arise?
In close corporations, shareholders are likely to be close business partners, friends and even family. Despite personal ties, shareholders may wish to promote their personal interests to the detriment of the corporation. For instance, a shareholder may wish to award himself or herself a contract for the corporation’s business although it may not be on favorable terms for the corporation. This is referred to as self-dealing, and it may violate the shareholder’s duty of loyalty to the close corporation.
In another example, an employee owns shares in the corporation as a minority shareholder. Other shareholders may wish to redeem the employee’s shares by discharging him or her from employment. Shareholders owe a fiduciary duty to other shareholders, but not to employees. Courts may judge this circumstance on a case-by-case basis to determine whether a fiduciary duty is owed to the employee shareholder.
How is a fiduciary duty established in court?
In litigation over fiduciary duties, a minority shareholder (or a majority shareholder, for that matter) may accuse other shareholders of violating their duties of loyalty and good faith. If accused of violating a fiduciary duty, a shareholder must show that the action was taken for a legitimate purpose. The accusing shareholder must then respond with evidence that an action that would have better served the corporation was available.