Minority Shareholders and Their Fiduciary Duties: Other Jurisdictions
In states that follow the majority approach, such as New York, Michigan, and Indiana, minority shareholders of closely held corporations owe fiduciary duties as shareholders.
In contrast, minority shareholders of closely held Delaware corporations rarely owe fiduciary duties because they typically do not exercise actual control over the company.
In some states, regular corporations that resemble close corporations but are not formally incorporated under the state’s Close Corporations Act should nonetheless be treated as close corporations.
Consider this scenario: Shareholder owns a minority stake in a Corporation that provides shipping and distribution services. Shareholder is not a director or officer of Corporation. Shareholder learns of an opportunity to contract with a trucking company at a discount on what Corporation currently pays for its trucking contract. Shareholder is interested in pursuing the discounted contract for Shareholder’s personal ventures, and there are no contractual prohibitions on Shareholder’s ability to do so. Can Shareholder pursue the trucking opportunity?
If Shareholder owes fiduciary duties to Corporation and the other shareholders, then the corporate opportunity doctrine likely prohibits Shareholder from pursuing the trucking opportunity for personal gain, unless Shareholder receives informed consent from Corporation. Specifically, Shareholder should report the trucking opportunity to Corporation so that Corporation has the option to pursue or forego that opportunity. But if Shareholder does not owe fiduciary duties by virtue of Shareholder’s status as a minority shareholder, then Shareholder is free to pursue the discounted trucking contract without advising Corporation before doing so.
Those with ownership stakes in privately held businesses, partnerships, or family offices need to closely collaborate with and trust others. When disagreements and disputes over rights and responsibilities arise, individual emotions and personalities can complicate matters. This ongoing series will help owners anticipate potential problems when structuring their businesses and find solutions to issues that commonly arise among owners of privately held businesses, both before and during litigation.
Previously, we explained that minority shareholders of closely held corporations owe fiduciary duties under Illinois law by virtue of their status as shareholders. So in this scenario, Shareholder cannot exploit the discounted trucking contract without breaching Shareholder’s fiduciary duties to Corporation if it is a closely held Illinois corporation.
Further, Illinois courts may treat a regular corporation that operates like a close corporation (similar to a partnership) as a close corporation even if that corporation was not incorporated under the Illinois Close Corporations Act. Therefore, if Corporation is a regular Illinois corporation that looks and operates like a partnership or close corporation, then Shareholder may owe fiduciary duties and could not pursue the discounted trucking contract without informed consent.
This post looks at whether, under the laws of other states, such as Delaware, New York, California, Indiana and Michigan, Shareholder can pursue the discounted trucking contract without breaching fiduciary duties. (Our prior posts explain common areas of disagreement between equal owners and rights that minority owners should seek.)
The Majority Approach: Shareholders of Closely Held Corporations Owe Fiduciary Duties
In states like Illinois that follow the majority approach, shareholders of closely held corporations typically owe each other fiduciary duties by virtue of their status as shareholders. But there are state to state variations.
Indiana: Indiana courts closely follow Illinois’s approach, where shareholders of closely held corporations owe fiduciary duties even if they are not directors or officers of the corporation. If Corporation is an Indiana closely held corporation, then Shareholder likely cannot pursue the discounted trucking contract for personal use without first disclosing the opportunity to Corporation and giving Corporation an opportunity to pursue it.
New York: Minority shareholders of New York closely held corporations owe each other the duty of good faith and a high degree of fidelity. This is a heightened standard that more closely resembles the duties that partners owe each other. If Corporation is a New York closely held corporation, then it is unlikely that Shareholder can pursue the discounted trucking contract absent disclosure of the opportunity to and approval by Corporation.
Michigan: Under Michigan law, minority shareholders of close corporations owe fiduciary duties only in certain circumstances, such as when those shareholders also participate in company management. Whether minority shareholders of close corporations in Michigan owe fiduciary duties is a context-dependent analysis and will vary depending on the relationship of the shareholders to the company. It is possible that, under Michigan law, Shareholder could safely pursue the discounted trucking contract without disclosure to and approval from Corporation, because Shareholder may not owe fiduciary duties to Corporation.
The Minority Approach: Shareholder Does Not Owe Fiduciary Duties, Unless Shareholder Has Actual Control
Delaware: Under Delaware law, minority shareholders do not owe fiduciary duties by virtue of owning shares unless they have actual control over the corporation. The “actual control” test is difficult to satisfy. The test requires a showing that minority shareholders have outsized voting and managerial power to the point that the minority shareholders effectively have majority voting control. In practice, it is rare that minority shareholders will have actual control over the company, triggering fiduciary duties. Under Delaware law, Shareholder would likely not owe fiduciary duties and therefore likely could exploit the discounted trucking contract without disclosure to and approval from Corporation.
States Are Split on Treating Regular Corporations as Close Corporations
Finally, states take varying approaches on how to treat regular corporations that look and act as close corporations. We previously explained that Illinois courts take a substance-over-form approach, which treats a regular corporation as a close corporation if the company’s shares are held in only a few hands and the company shares other features of a close corporation – even when that corporation was not incorporated under the Illinois Close Corporations Act.
Michigan: Taking the substance-over-form approach, Michigan courts look at the reality of how the company functions, rather than the law under which the company was incorporated, to determine whether to treat the company like a regular or a close corporation. If one person owns the majority of a company’s stock, or if family members control the majority of the stock, Michigan courts are likely to treat that company as a close corporation. Under Michigan law, if Corporation is a regular corporation that resembles a close corporation, Shareholder likely cannot pursue the discounted trucking contract without disclosure to and approval from Corporation.
Delaware and California: In contrast, Delaware and California courts do not treat regular corporations as close corporations, even if the company in question resembles a close corporation. Instead, Delaware and California courts take a more formalistic approach, treating a company as a close corporation only if it is incorporated under the state’s Close Corporations Act. Therefore, if Corporation is a Delaware or California regular corporation, then Shareholder likely will not owe fiduciary duties and likely will be able to pursue the discounted trucking contract without disclosure to and approval from Corporation.