Breaches of fiduciary duties are some of the most frequently litigated issues in shareholder disputes. It is important to understand the fiduciary duties owed to minority shareholders by majority shareholders and those officers and directors in control of Minnesota closely held corporations. Violating the rights of minority shareholders can lead to strained relationships and potential litigation. This page outlines some of the more important obligations a corporation has to its minority shareholders as provided by the Minnesota Business Corporation Act.
FIDUCIARY DUTIES TO THE CORPORATION ITSELF: The officers and directors of a corporation have a fiduciary duty to the corporation to act in its best interest. This duty generally requires the officers and directors to stay informed of important matters affecting the corporation, avoid self-dealing and conflicts of interest, avoid usurping corporate opportunities or engaging in competition against the corporation, and not allow the dissipation or wasting of corporate assets. Sometimes, minority shareholders assert derivative claims against the officers, directors, and those in control of the corporation alleging that they have not acted in the corporation’s best interest. Most often, this occurs when those in control are accused of taking unreasonably high salaries, paying themselves extraordinary bonuses, incurring extravagant personal expenses paid by the corporation, spending corporate money to pay family members unreasonable compensation, creating conflicts of interest by doing business with companies owned by the officer or director or his/her family members, or competing against the corporation through a side-business or individually.
While the law does not automatically prohibit those in control from increasing their compensation, hiring relatives, or doing business with companies owned by family and friends, these transactions should be transparent, commercially reasonable, and entered into in good faith. Under the “business judgment” rule, many of these decisions will be shielded from second-guessing by the minority shareholders provided that they are made in good faith for a valid business purpose. In order to avoid such claims:
Decisions involving compensation of officers, directors, and shareholders should be discussed by the board of directors and voted on.
Decisions to do business with related parties and companies should be discussed by the board of directors and voted on. Any conflicts of interest should be disclosed and reflected in official minutes.
Ideally, decisions to increase the majority owner’s compensation should be backed up by market research showing the prevailing salaries for the work being done. Sudden or dramatic increases in compensation or bonuses for those in control should be avoided unless justified by extraordinary business circumstances (such as a dramatic increase in profits). If those in control increase their own salaries, they should strongly consider increasing the salaries of minority shareholders proportionately.
Business contracts with related parties should be commercially reasonable and ideally entered into after seeking competitive bids from several vendors before a final decision is made. Those in control should negotiate with the third party and keep records of the negotiations, to help demonstrate that the key terms were negotiated at arms-length and do not represent a “sweetheart deal.”
Those in control should not take advantage of business opportunities available to the corporation (e.g., a customer’s desire to place an order or expand its business with the corporation into a related area) without disclosing the opportunity to the corporation, receiving a decision by the corporation’s board of directors to decline the opportunity, and obtaining the corporation’s consent to take advantage of the opportunity directly.
All profit distributions to shareholders should be approved by the board of directors at a duly called board meeting or in a unanimous resolution signed by all members of the board. If possible, profit distributions should be made consistently at periodic intervals provided that the profits are available to be distributed. Absent business reasons, the board of directors should avoid sudden increases, decreases, changes in amount or frequency, or discontinuation of profit distributions. Such changes should be justified by business circumstances. For example, it would be appropriate to stop customary profit distributions if the corporation needs the capital to purchase an important piece of machinery or real estate or for another legitimate investment.
PROVIDING MINORITY SHAREHOLDERS ACCESS TO INFORMATION:
The corporation, through its officers and directors, has an affirmative duty to share material (meaning important) information to shareholders. Further, when requested, officers have a duty to provide minority shareholders with access to certain corporate records such as financial statements, tax returns, business plans, and other sensitive documents. If a shareholder submits a written demand, the requested records must be made available to them within ten (10) days of receipt of the written demand.
Under the Minnesota Business Corporation Act, minority shareholders have a right to access the following corporate records:
The share register;
Records of all proceedings of shareholders for the last three (3) years;
Records of all proceedings of the board for the last three (3) years;
Corporate articles of incorporation and all amendments currently in effect;
Corporate bylaws and all amendments currently in effect;
Financial statements required by law and the financial statement for the most recent interim period prepared in the course of the operation of the corporation for distribution to the shareholders or to a governmental agency as a matter of public record;
Reports made to shareholders generally within the last three years;
A statement of the names and the usual business addresses of all directors and principal officers;
Voting trust agreements;
A copy of agreements, contracts, or other arrangements or portions of them incorporated by reference in the articles of incorporation; and
Other corporate records if the shareholder demonstrates a proper purpose.
If a minority shareholder does request corporate documents that are required to be furnished, they must be furnished at the expense of the corporation.
AVOIDING CLAIMS OF MINORITY SHAREHOLDER OPPRESSION:
In closely-held Minnesota corporations, majority shareholders have a fiduciary duty to act in good faith, with honesty, candor, and loyalty when dealing with minority shareholders. Further, they cannot act in a manner that is “unfairly prejudicial” to the “reasonable expectations” of fellow shareholders. Disgruntled minority shareholders can bring claims of “shareholder oppression” when they believe these duties have been violated. As you can imagine, determining when the reasonable expectations of a shareholder have been violated can be very subjective. The source of “expectations” includes official corporate records (e.g., articles, bylaws, and shareholder control agreements) and contracts between the shareholders. But it also includes the parties’ course of dealings with each other and whatever mutual expectations have been discussed between the shareholders over time. Therefore, it is important to set clear expectations regarding roles, responsibilities, and the flow of information. Examples of minority shareholder oppression may include:
dishonesty, misrepresentation, or fraud;
failure to disclose material information to the minority shareholder;
denying the minority shareholder access to corporate and financial records;
stripping away the minority shareholder’s duties and responsibilities;
excluding the minority shareholder from helping to make important corporate decisions;
kicking the minority shareholder off the board of directors;
removing the minority shareholder from an officer-level position;
refusal by the majority shareholder to declare profit distributions in order to force the minority shareholder to sell his/her shares at a depressed price (in a business entity such as S-Corporation or LLC with flow-through taxation);
unjustly terminating the minority shareholder’s employment without cause; and
any other actions involving violation of the minority shareholder’s reasonable expectations.
STRATEGIES FOR AVOIDING MINORITY SHAREHOLDER CLAIMS:
The following suggestions for maintaining transparency and dealing with minority shareholders should reduce the risk of litigation:
1. Update the corporation’s articles and bylaws.
2. Ensure that the board of directors and officers have been duly elected and appointed. If not, call a shareholder and board meeting for this purpose.
3. Enter into a Shareholder Control and Buy-Sell Agreement that addresses the roles and responsibilities of the shareholders and addresses what happens to the shareholder’s stock upon death, disability, termination of employment, resignation of employment, involuntary transfer (e.g., divorce or bankruptcy), or when a third party offers to buy their stock. Typically, the corporation should have the option to buy-out the shareholder under such scenarios.
4. If the minority shareholder is providing personal services to the corporation and is involved in its day-to-day affairs, enter into an employment agreement with the shareholder stating clearly that the shareholder has no expectation of continued employment and can be terminated “at will.” Alternatively, if appropriate, enter into an employment agreement stating that the shareholder can be terminated only for “cause.”
5. Throughout the year, provide written notice to shareholders of any major events or changes.
6. Call a year-end board meeting and prepare minutes of the meeting.
7. Call a year-end shareholder meeting and prepare minutes of the meeting.
8. In connection with the annual shareholder meeting, provide the minority shareholders with a year-end packet (marked “confidential”) containing a summary of the company’s dealings throughout the year, including a summary of:
* Major events;
* Significant contracts signed;
* Significant customers gained or lost;
* Positive or negative changes to revenue streams;
* Positive or negative changes to expenses;
* Significant personnel matters (e.g., hiring and firing);
* Compensation of the majority shareholders, officers, and directors;
* Profit distributions (if any) made during the year;
* Year-end financial statement / profit and loss statement; and
* Anticipated changes to the company’s business model (if any).
9. Circulate annual federal and state tax returns once prepared.
By following these general tips, you will minimize the risk of legal claims from minority shareholders. By treating minority shareholders openly, honestly, and fairly and keeping them informed of important decisions, most claims can be avoided.
DUTIES OF MINORITY SHAREHOLDERS
Whereas majority and controlling shareholders have fiduciary duties, minority shareholders generally do not owe a fiduciary duty to other shareholders. The Minnesota Supreme Court held that only majority or controlling shareholders generally owe a fiduciary duty to the corporation or its other shareholders. The rationale is obvious: it is difficult for a minority shareholder to owe the highest duties to other shareholders when the minority shareholder has effectively no control of the business.
Still, minority shareholders must recognize that certain factors may affect their rights and obligations to the corporation. These factors include their relationship with other shareholders, their role in the management and control of the corporation, their status as employees, or heightened authority given to them in the bylaws or shareholder agreement. In carefully considering their conduct, minority shareholders should consult with a shareholder attorney to fully understand factors that may affect their rights and obligations.