December 16, 2019

Shareholder Control and the Existence of Associated Duties

Holland & Knight Shareholder Rights Blog
Michael J. Zdeb
Shareholder Rights Blog

The use of a position of control to abuse the interests of a non-controlling shareholder has been and remains a serious issue in the governance of closely-held entities. Depending on the jurisdiction, the approach to such conduct is either addressed by judicially recognized fiduciary duties or statutory provisions, such as the “oppression” provisions in a number of states. In some jurisdictions, both approaches exist side by side.

Frequently, articles and judicial decisions addressing the duties among shareholders in closely held enterprises will state that the “majority” owe certain duties to the “minority” shareholders and members.

The use of the terms “majority” and “minority” has raised a couple of issues:

  1. What if the person whose conduct is challenged is not the “majority” but is a director, officer, manager, etc.? Can a group, where not one member of which has a greater than 50 percent interest, be considered the “majority?”
  2. Are there circumstances in which a non-majority holder can owe duties to other shareholders, including the “majority?”

Judicial Dissolution and Oppression Statutes

The Model Business Corporation Act (Act) language in the context of an oppression action does not use the words “majority” or “minority.” Instead, it uses the term “directors or those in control of the corporation.”

The Act focuses on the relationship of the parties and the ability to affect the rights of other shareholders. The existence of “control” and how it is manifested is not defined. As such, the determination of “control” is highly dependent on the circumstances and conduct of the parties.

For example, in one situation, the board was dominated by a non-board member who held a majority of the shares as trustee. Using the influence of the voting power, the trustee advocated and the board acquiesced in firing a shareholder. This led to the question of whether the trustee was “in control” and could be named along with the board in a statutory oppression action. The matter was resolved (a buyout occurred) before the court ruled. However, it certainly seemed likely that trustee effectively controlled the board and its decisions.

Case Law

Courts that have considered non-statutory duties among shareholders have frequently stated that the “majority or those in control” have duties to the other shareholders. Generally, control and a majority ownership go hand in hand. But at times, it may not.

At least once, we have faced the claim that certain shareholders, no one of which held more than 25 percent, were not the “majority” and therefore did not owe fiduciary duties directly to other shareholders. In that situation, the courts of the jurisdiction took the position that the real question to be faced is not the percentage of ownership, but the unfair exercise of control, which should not be limited to whether one person or a group has greater voting power.

If a person or group so dominates the corporation or limited liability company to the exclusion of a minority, and uses that domination to engage in self-dealing or oppressive conduct, the lack of greater than 50 percent of the vote should not matter to the question of fiduciary duties to the minority.

In effect, control and the existence of associated duties can arise in a variety of ways. A recent Delaware Chancery decision found that the entire fairness standard of review was applicable to the conduct of a minority stockholder. This entire fairness standard applies to the conduct of those in control of the actions of the corporation where self-dealing occurs or questions of breach of duty arise. The court determined that certain contractual rights of the minority contained in preferences (blocking) effectively controlled financing decisions and was exercised in an inequitable manner. This despite the fact that there was an unrelated majority. Basho Techs. Holdco B. LLC v. Georgetown Basho Inv., LLC 201 8 WL 332669 (July 2018).

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