The Innovator’s Counsel: What Are Fiduciary Duties In a Closely Held Corporation?

Jeremy Weltman Uncategorized

Shareholders in a closely held corporation  (e.g. a corporation whose stock is not freely traded and is held by only a few shareholders) owe fiduciary obligations to one another. The extent and parameters of these obligations is the subject of great tension between what the courts say should happen and what actually happens in practice.

Case law and model jury instructions speak of “utmost good faith and loyalty” where each shareholder puts every other shareholder’s interests above his/her own. Of course, when the rubber hits the road, many times the individuals who run a closely held corporation develop the view that they can and should manage the corporation to maximize their individual return. It is not unusual to see situations where a majority shareholder sees and treats other shareholders as a mere nuisance to be tolerated, but entitled to little or no “say” in corporate affairs, and are unfairly restricted access to the belly of the business. Given this disconnect between the law and what is happening on a day-to-day basis in closely held businesses across the Commonwealth, breach of fiduciary duty cases will continue to be brought in abundance, and often with considerable success.

Duty Owed to the Corporation

According to Massachusetts case law and statute, corporate officers and directors owe the corporation a duty of good faith, prudence and loyalty, the breach of which is ground for a shareholder’s derivative action brought by a shareholder on behalf of a corporation. See Mass. Gen. Laws c. 156B, §65; Demoulas v. Demoulas Super Markets, Inc., 424 Mass. 501, 528-530 (1997).

Duty Owed to Other Shareholders

The seminal case in Massachusetts on the duty owed to other shareholders is Donahue v. Rodd Electrotype Co. of New England, 367 Mass. 578 (1975). A breach of the Donahue established fiduciary duty of “utmost good faith and loyalty” can provide the grounds for a direct suit by the wronged shareholder against the offending shareholder(s), individually. Although direct actions among shareholders typically arise when a minority shareholder is “frozen out” from participation in the corporation’s activities or decision-making, the same fiduciary duty doctrine applies equally to majority and minority shareholders.

Choice of Law Considerations

An interesting wrinkle to the fiduciary duty discussion is added when closely held corporations are choosing place of incorporation  –  as the Donahue fiduciary duty is not recognized in all jurisdictions. Of particular interest is that it is not recognized in Delaware, where many corporations seek incorporation for a variety of reasons.  Although Delaware does not impose the heightened fiduciary duty of utmost good faith and loyalty on shareholders in a close corporation generally, minority shareholders can be protected in Delaware by contract. Here in Massachusetts, the Donahue fiduciary duty owed by and between shareholders is inherent in every closely held corporation.