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In Determining Legal Duties Owed, The Nature Of The Entity–And Not What You Call It–Controls

Where a business was organized as a corporation rather than an LLC, the duties and obligations owed to and among the owners will be governed by statutes dealing with corporations.  Panzino v. 5Church, Inc., 2020 NCBC 13 (J. Conrad).  Thus, notwithstanding the fact that the owners referred to the business and purportedly ran the business similar to an LLC, the Business Court would apply the statutes governing corporations in deciding duties owed among and to shareholders.

Plaintiff was a 20% shareholder in Defendant 5Church, Inc. (“Company”).  The Company’s majority shareholder, MAP Management of Charlotte, LLC (“MAP”), was purportedly controlled by Defendant Whalen. Although formed as a North Carolina corporation, Plaintiff and the other shareholders treated and referred to aspects of the Company as if it were an LLC, entering into an operating agreement (rather than corporate bylaws), vesting management authority in a manager (rather than a corporate board of directors), and referring to owners as members (not shareholders). The Company appointed Whalen as its “manager.” The Company opened and operated a restaurant in Charlotte, North Carolina and soon sought to open other restaurants in other locations (organizing each subsequent restaurant under a separate LLC).  Plaintiff declined the Company’s offer to invest in its second restaurant.  Thereafter, Whalen did not offer Plaintiff the option to invest in further opportunities.   In 2017, Whalen and others—through a separate company—opened a restaurant next door to the Company’s original restaurant. Plaintiff filed suit, asserting numerous claims against Whalen including, inter alia, breach of fiduciary duty and constructive fraud.  After the close of discovery, Whalen moved for summary judgment, contending he did not owe Plaintiff any fiduciary duty.

The Business Court agreed. Although Plaintiff contended that Whalen owed him a fiduciary duty as the manager of the Company, the Business Court held that the Company was actually a corporation—notwithstanding how it might have been governed or what its owners were called—and thus Whalen (who acted essentially as a single-director board for the Company) owed a fiduciary duty only to the Company pursuant to North Carolina’s corporate law. (Opinion, ¶¶16-17). The Business Court also rejected Plaintiff’s argument that Whalen owed him a fiduciary duty based upon their relationship as shareholders. While a majority shareholders owes a fiduciary duty to minority shareholders, the Business Court found this exception did not apply because MAP—and not Whalen—was the majority shareholder. The mere fact that Whalen was a controlling shareholder in MAP was insufficient to transfer any fiduciary duty MAP might have owed Plaintiff to Whalen, especially where no claim against MAP existed in the lawsuit. (Id; ¶20).

Based upon this decision, a business should review and ensure that its organizational documents are consistent with the way in which the business is being operated, as the nature of the business will control any legal obligations that are owed among and to the owners.

Additional legal points from this decision:

  • The legislature’s amendment to the statutes governing corporations eliminated the provision that a director’s duty runs to both the shareholders and the corporation, notwithstanding the old saying that directors have a “general duty” to act for the benefit of all shareholders. (Opinion, ¶16).

  • While members of an LLC can depart from a statute’s default rules by the terms of the LLC’s Operating Agreement, such flexibility likely does not exist within the framework of a corporation.  (Opinion, ¶17).

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Phil Mohr Bankruptcy and Litigation Attorney Womble Bond Dickinson
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Phil is a trial lawyer. Although he will search for creative legal and business solutions for his clients, his more than two decades of trial experience for both publicly traded and privately held companies in state and federal courts throughout the country have taught him that some cases simply have to be tried to verdict. Representing companies that have both been wronged and accused of wrongdoing, Phil has honed his trial skills in cases involving complex business litigation (including fraudulent transfer and equitable subordination cases in federal bankruptcy court)...

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