June 30, 2020

Termination of Employment Versus Breach of Duty

Current Issues in Closely Held Businesses Series: Part 2
Holland & Knight Shareholder Rights Blog
Michael J. Zdeb
Shareholder Rights Blog

Was the removal of an shareholder-employee as an officer an employment claim or a breach of duty and shareholder oppression?

When disputes develop and interests among owners diverge, a shareholder-employee may have his employment terminated. It can occur with "cause" that may be a pretext or without

When the discharge occurs, the majority will argue that as an "at-will" employee, the discharge is within the authority of the board and is done in the best interests of the corporation.

This is an argument that arises frequently in closely held and family-owned businesses. Written employment agreements and policy statements generally will not exist with provisions for a term of employment, provisions for termination, severance, etc., and frequently, the jurisdiction has "employment at will" as a legal doctrine.

Under the "at-will" doctrine, an employee can be terminated without notice or cause. In these shareholder cases, the argument becomes that the shareholder-employee does not have a right to employment as a consequence of being a shareholder. Without a right to continued employment, the shareholder employee can be discharged without notice or cause.

The decisions demonstrate that when the interests of the shareholders diverge, the circumstances around a termination of an "at-will" shareholder-employee can become important.

Terminated shareholder-employees will argue that the termination was in bad faith. The actions of those in control will be examined. Were there meetings in secret to discuss the elimination of the shareholder's interest? Was there a the lack of notice or discussion of any employment issues with the shareholder? Did the termination result in the effective exclusion of the shareholder from the financial benefits of being a shareholder? Was participation in management and participation in decision-making directed at eliminating the voice of the shareholder? Was there an associated attempt to buy out the shareholder-employee at an unfair or heavily discounted value?

Note: It does not help if the police were called to enforce a removal from the premises. In a case a number of years ago, a client was honored at a ceremony of the business on a Friday, only to have their way into the business blocked by police on Monday without notice or cause. The motivations and manner of termination became important in that case.

The majority will assert that status as shareholder did not create a right of continued employment. Instead, the approach will be that the claim of oppression was really just a claim for wrongful termination and the business judgment of the board under the by-laws applied. And, under the particular facts, this can be an effective argument.

But when the termination is surrounded by motives to eliminate any participation, such as the denial of role as officer, exclusion from management and participation rights, and elimination of financial benefits (salary, vehicle, cell phone, insurance, etc.), without a real business-related cause, the assertion of a breach can be convincing. Claims that go beyond lost wages and an exclusion from continued participation in management and decision-making, as well as the loss of financial benefits, can be seen as an attack on all attributes of the position as a shareholder.

When a shareholder-employee is discharged, there are a number of elements to consider as to whether it is more than an employment claim. What was the background of how the employment came about, the manner of compensation and the use of it as a shareholder benefit? How have the parties participated in management and decision-making, and had access to records and financial benefits and the absence of returns on equity (compensation in lieu of dividends)? What was the association with the business in the community? What was the manner of the termination and surrounding evidence of ill will and lack of fair dealing in the discharge?

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