Who is Owed a Fiduciary Duty, and Why Does it Matter?
Who is owed a fiduciary duty? We previously wrote a post involving a lawsuit for breach of fiduciary duty, and gave the definition of that term as being “a duty owed by one person to act in the best interests of another.” The fiduciary duty has a number of aspects, including the following: (1) a duty of good faith and fair dealing, (2) a duty of loyalty, (3) a duty of impartiality, (4) a duty to delegate, (5) a duty to inform, and (6) a duty to keep adequate records.
These obligations cover a lot of territory, and an informed entrepreneur (who may have multiple businesses going on at the same time) needs to be sure that he or she is in compliance with any applicable legal requirements. Thus, the existence of a fiduciary raises the following question: To whom is the duty owed?
It is important to know who the duty is owed to because there are many players in most business situations – the business entity itself, and the people who have an interest in it, such as shareholders, officers, managers, interest owners members of an LLC, and so forth.
First, officers, managers, and directors owe a fiduciary duty to the company itself, i.e., the corporation or LLC. They do not owe a duty to the individual shareholders or members, though. This is self-explanatory, and it makes sense that the people running a company have a fiduciary duty to the company first and foremost.
On the other hand, owners of a minority interest, such as minority shareholders or members, do not owe a fiduciary duty to the company. Think of it this way: the fact that you own stock in Coca-Cola doesn’t prevent you from sipping a Pepsi – or even selling it at your store. Minority interest owners can and do invest in multiple and even competing businesses without breaching any fiduciary duty.
A case from the North Carolina Court of Appeals, Kaplan v. O.K. Techs., LLC., 196 N.C. App. 469 (2009), summarizes this rule:
The North Carolina Limited Liability Company Act, N.C. Gen. Stat. §§ 57C-1-01, et seq., does not create fiduciary duties among members. Members of a limited liability company are like shareholders in a corporation in that members do not owe a fiduciary duty to each other or to the company. …. [A]s a general rule, shareholders do not owe a fiduciary duty to each other or to the corporation[.] [See Robinson, North Carolina Corporation Law, § 11.4 (1990).]
Majority shareholders or majority interest owners, however, do owe a duty to minority owners. In Freese v. Smith, 110 N.C. App. 28 (2009), the North Carolina Supreme Court clearly held that “In North Carolina, it is well established that a controlling shareholder owes a fiduciary duty to minority shareholders.”
Why is this? Why do majority owners owe a fiduciary duty to minority owners, when minority owners do not owe a complementary duty to each other or to the majority? It is because of the vast power that the majority shareholder has – he or she has almost total control of the company, and the duty to the minority provides a necessary balance.
An 70-year-old case from the North Carolina Supreme Court, Gaines v. Long Manufacturing Co., Inc., 234 N.C. 340 (1951), explains the logical rationale for this rule. This case is still good law.
The holders of the majority of the stock of a corporation have the power, by the election of directors and by the vote of their stock, to do everything that the corporation can do. Their power to ... direct the action of the corporation places them in its shoes and constitutes them the actual, if not the technical, trustees for the holders of the minority of the stock. They draw to themselves and use all the powers of the corporation ....
The devolution of unlimited power imposes on holders of the majority of the stock a correlative duty, the duty of a fiduciary or agent, to the holders of the minority of the stock, who can act only through them – the duty to exercise good faith, care, and diligence to make the property of the corporation produce the largest possible amount, to protect the interests of the holders of the minority of the stock, and to secure and pay over to them their just proportion of the income and of the proceeds of the corporate property.
The controlling majority of the stockholders of a corporation, while not trustees in a technical sense, have a real duty to protect the interests of the minority in the management of the corporation, especially where they undertake to run the corporation without giving the minority a voice therein. This is so because the holders of a majority of the stock have a community of interest with the minority holders in the same property and because the latter can act and contract in relation to the corporate property only through the former. It is the fact of control of the common property held and exercised, and not the particular means by which or manner in which the control is exercised, that creates the fiduciary obligation on the part of the majority stockholders in a corporation for the minority holders.
This is a detailed explanation, but the short of it is that the majority and minority have a “community of interest” in the company, and that, as a practical matter, the minority is able to interact with the company through the majority. If there were no duty to the minority, the majority could run roughshod over the, in any way it wanted.
What is the lesson you should draw from all of this talk about fiduciary duties? The lesson is that if you are involved with a business entity, you should take a hard look at what your role is – and what rights and responsibilities go along with your role.
In our firm’s experience, we have seen companies in which widespread violations of fiduciary duties were occurring and minority owners were either unaware of it. It happens frequently, especially, though by no means exclusively, in closely held companies.
If an owner is violating their fiduciary duty, legal remedies are likely available to stop the violation and to obtain damages for any financial harm he or she caused.
If you have questions about corporate fiduciary duties, or about any other matter involving business law and litigation, give us a call at 980-999-3557 to see how we can help your business. We represent entrepreneurs, business owners, and franchisees in Charlotte and throughout North Carolina.