We are frequently approached by shareholders or members of small businesses struggling to figure out what duties they have to the company or whether others involved with the company have run afoul of such duties. Typical issues include:
- Mismanagement that has resulted in serious liability;
- Management has taken business opportunities that belonged to the company;
- There has been self-dealing or company funds or assets have been taken by a controlling person;
- Controlling people have excluded minority owners from the business or its revenues;
- A fiduciary has hired away employees of the company.
Often times the businesses do not have formal written agreements that govern and formalize the rights, duties and interests of the owners, officers and directors. Business operations and planning are often conducted orally and without documentation. In these circumstances, the principals should be particularly cognizant of the fiduciary duties they owe to the company and each other to avoid liability and maintain the integrity of the business.
When a person is a fiduciary, they are duty-bound to be open, honest and act in good faith. Fiduciaries cannot merely act in their own self interests but rather must inform and protect the interests of others. There are two areas where fiduciary duties commonly become an issue in North Dakota businesses. The first relates to the fiduciary duties the officers (or managers in the LLC context) and directors (or governors in the LLC context) owe to the company. The second relates to the fiduciary duties shareholders (or members in the LLC context) owe each other in the closely held business context.
FIDUCIARY DUTIES OF OFFICERS AND DIRECTORS Officers and directors of a company are fiduciaries to the company. They are required to protect the interests of the company and act in the best interests of the shareholders (including members or partners in the LLC or partnership context). Their fiduciary duties to the company fall into two categories: (i) the duty of care, and; (ii) the duty of loyalty.
Generally, the duty of care requires directors and officers to “inform themselves, prior to making a business decision, of all material information reasonably available” and to “act with requisite care” in discharging their duties. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). In North Dakota, the duty of care requires that managerial duties of a company be performed with the care an ordinarily prudent person in a like position would exercise under similar circumstances.
The duty of loyalty encompasses discharging one's duties in good faith and in the best interests of the company based on reasonable belief. Generally, the duty of loyalty prohibits directors and officers from assuming positions in conflict with interests of the company and/or from engaging in self-dealing by taking personal advantage of (“usurping”) company opportunities.
Although businesses are often established, in part, to insulate operators from liability, failure to act consistent with these duties may expose directors and officers to personal liability. Similarly, if you are a shareholder where the company directors or officers have breached these duties, you (or the company as the case may be) may have recourse for any resultant damages to the company.
FIDUCIARY DUTIES OF SHAREHOLDERS Shareholders of “closely held” companies typically have the same fiduciary duties of an officer or director although the scope of these duties is likely more limited where they are not actively employed by the company. Moreover, in North Dakota, shareholders (or members in the LLC context) in closely held companies owe fiduciary duties to other shareholders because their relationship is considered tantamount to that of partners in a partnership. Shareholders in closely held companies have no ready market to sell or transfer their ownership interests in the company. As such, they are often subject to unfair treatment by controlling shareholder(s). One common scenario is the shareholder “squeeze out” where the controlling shareholder(s) exclude the non-controlling shareholder from working at the company or from having a voice in management in the company.
North Dakota courts have held that in closely held companies shareholders owe each other a duty of “utmost loyalty and good faith” and require each shareholder to deal openly, honestly and fairly with other shareholders. N.D.C.C.§10-19.1-115(4); and see Kortum v. Johnson, Ltd., 755 N.W.2d 154 (N.D. 2008). Finally, although not specifically deemed a fiduciary duty, those in control of closely held companies must not act in a manner that is “unfairly prejudicial” to minority shareholders. See N.D.C.C. §10-19.1-115(2)(b)(3). If they do, the prejudiced shareholder may be entitled to equitable relief such as a court ordered buy-out or the corporation may face dissolution.
These concepts are broad, subjective and somewhat dependent on the facts of each case. As a result, there is always uncertainty. It is always better to resolve disputes through negotiation and reasonable compromise. Mutual fairness is always a key to resolution. However, where parties have acted with fraud and deception, or where dialogue has completely broken down, litigation may be the only option. Cases involving shareholder fiduciary duties are complex and costly. Good representation is imperative in such cases.
At Hance Law Firm, we welcome inquiries and always provide a free initial consultation to help you ascertain your rights, duties and options.