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Minority Shareholders Might Just Owe Fellow Shareholders A Fiduciary Duty

Where a minority shareholder exercised domination and control over the company’s sole director and its majority shareholder, it owed a fiduciary duty to the other minority shareholder.  Button v. Level Four Orthotics & Prosthetics, Inc., 2020 NCBC 18 (J.Robinson).  As a result, the other minority shareholder could maintain its breach of fiduciary duty claim.

In 2017, Plaintiff was negotiating with Defendant Irish, the managing partner of Defendant Penta Mezzanine SBIC Fund I, L.P. (“Penta Fund”), to become CEO of Level Four, Inc. (“Level Four”), a North Carolina corporation.  At that time, Irish was Level Four’s sole director. Penta Fund was both a minority shareholder in Level Four and the manager and majority interest owner in Level Four SBIC Holdings, LLC (“Level Four Holdings”), which itself was the majority shareholder of Level Four. During the negotiations, the parties agreed that Penta Fund would reduce its 18% interest rate on a loan it had previously made to Level Four (“Penta Loan”) down to just 2.5%, and that this new rate would also apply to any future loans Penta Fund made to Level Four. The agreement to the rate reduction was included as a term in Plaintiff’s employment agreement which he signed in July 2017, thereby becoming CEO of and a minority shareholder in Level Four (“Employment Agreement”).  Per the Employment Agreement, Plaintiff could be terminated with or without cause which, depending on the manner of his termination, either prevented or triggered Plaintiff’s ability to exercise certain rights (e.g., the right to purchase certain stock warrants in Level Four, a right of first refusal to buy Level Four, the price point for any buy-back of his shares in Level Four, etc.).  In November 2018, Plaintiff recommended Penta Fund loan additional funds to Level Four to implement certain business plans, but Penta Fund agreed to make the loan only if Level Four agreed to an 8% interest rate. Plaintiff refused but Penta Fund sent the money anyway. Penta Fund later presented a promissory note in connection with the loan containing an 8% interest rate. Plaintiff refused to sign the note because the 8% rate violated the Employment Agreement’s 2.5% rate for any loan. Defendant Irish then terminated Plaintiff “for cause,” noting that such decision was the unanimous decision of Penta Fund’s investment committee.  Defendant Irish then became Level Four’s CEO and agreed to change the interest rate on both the recent loan and the Penta Fund loan to 8%. Plaintiff thereafter filed suit, asserting multiple claims against Penta Fund, inter alia, a claim for breach of fiduciary duty.  Penta Fund moved to dismiss, contending that as a minority shareholder it owed Plaintiff no fiduciary duty.

The Business Court disagreed.  Although the general rule is that shareholders do not owe fiduciary duties to each other, the Business Court nonetheless recognized: a) the long-standing rule that a majority shareholder (like Level Four Holdings) owes a duty to protect the interest of minority shareholders (Opinion, ¶102); and b) the Supreme Court’s recent refusal to prohibit a similar duty between minority shareholders, especially where a minority shareholder exercises domination and control over the company’s directors and/or majority shareholder, as expressed in Corwin v. British Am. Tobacco PLC, 371 N.C. 605, 821 S.E.2d 729 (2018). Relying on Corwin and Delaware law, the Business Court held Plaintiff’s factual allegations evidencing Penta Fund’s control over Irish and Level Four Holdings were sufficient to create a fiduciary duty that ran from Penta Fund to Plaintiff. (Id., ¶¶106-111).

Based upon this decision, before taking significant action, a business should closely evaluate whether any of its shareholders (majority or minority) exercise such domination and control over the corporation that other minority shareholders might claim they are owed fiduciary duties.

            Additional legal points from this decision:

  • A shareholder’s loss of employment resulting from a third-party’s injuries to a company is a sufficiently separate and distinct injury to allow her to maintain a claim against the third-party. (Opinion, ¶99).

  • General allegations of malice are insufficient to show that a non-outsider forfeits a privilege of immunity against a claim of tortious interference with contract. (Opinion, ¶¶86-89, 91).

  • Where the interpretation or enforcement of a contract are not directly at issue in a case, any forum selection clause and consent to jurisdiction provisions contained therein do not automatically permit a court to exercise personal jurisdiction over the parties to the contract. (Opinion, ¶68).

  • Where a party to a contract neither attempts to assert his rights nor alleges that he plans to assert such rights under the contract, then no actual controversy related to the contract exists and a declaratory judgment related to the contract is improper.  (Opinion, ¶52).

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About this Author

Phil Mohr Bankruptcy and Litigation Attorney Womble Bond Dickinson
Partner

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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