Because Delaware is known for its corporate-friendly legal policies, it is the preferred jurisdiction for many corporations due to its business-friendly laws and a court system with a great deal of experience in corporate law matters. This also means Delaware’s corporate laws are regularly referenced other states’ deals and cases. In Delaware, the law places a heavy emphasis on the fiduciary duties of directors, officers, and sometimes even the shareholders of corporations.
This article will discuss the fiduciary duties owed by both majority and minority shareholders, as well as the implications for directors who are also majority shareholders. It is important to note that these duties refer to shareholders of corporations. These same duties may not apply to members or governors of limited liability companies in which those rights may be modified or even eliminated by the terms of an operating agreement.
What Makes Up Fiduciary Duties
Fiduciary duties include the duty of care and duty of loyalty. They are usually discussed in terms of corporate directors and officers but can also apply to any person or entity that has the ability to direct the affairs of the company, such as a majority shareholder.
Most of the time, when talking about fiduciary duty to the company, it means what is in the best interests of the shareholders and usually that means the majority shareholder, if there is one. In a privately held company with only a few shareholders, it may be easier to identify the majority shareholder and act accordingly. Many companies only have one owner, so there is no distinction between the company and the shareholder. However, in other companies, including those with outside investors or a lot of smaller investors, there is no clear majority owner. For the purposes of this article, we assume that there is at least one majority shareholder and at least one minority owner.
Fiduciary Duties of Majority Shareholders
Majority shareholders in a corporation are those who own more than 50% of the shares in the corporation. Because of their voting power, they have significant control over the corporation’s operations and policies. Delaware law recognizes that majority shareholders have a fiduciary duty to the corporation and the minority shareholders. Sometimes the fiduciary duty is expanded to creditors if the company is in financial trouble. Those issues are examined in more detail in this article.
This duty requires that majority shareholders act in the best interests of the corporation and consider the interests of minority shareholders, though this does not mean that they cannot act in their own best interests. This includes refraining from engaging in self-dealing or using their position to unfairly advantage themselves. Majority shareholders should also be careful about taking any action that would harm the corporation, such as making decisions that would reduce the value of the shares held by the minority shareholders compared to the value of the majority shareholder.
One common situation where the duty of loyalty is implicated is in transactions between the corporation and a controlling shareholder. In Delaware, such transactions are subject to heightened scrutiny by the courts. The controlling shareholder must show that the transaction was entirely fair to the corporation and its minority shareholders, and that the terms of the transaction were negotiated in good faith. Majority shareholders may be able to avoid this issue by having independent board members or the minority shareholders approve the related party transaction.
Another common situation is when the majority shareholder wants to sell the business and the minority shareholders may disagree. Putting aside issues such as dissenter’s rights or blocking rights, the majority shareholder should be able to sell the business and may even be able to force the minority owner to sell as well. What the majority shareholder should avoid is having the minority shareholders treated differently from themselves in the sale.
Fiduciary Duties of Minority Shareholders
Minority shareholders, by contrast, own less than 50% of the shares in a corporation. They have less control over the corporation’s operations and policies, but they still have a voice in certain decisions. In general, minority shareholders owe no duty to the corporation or the majority shareholder when making their decisions.
Fiduciary Duties of Directors who are Majority Shareholders
In many corporations, the majority shareholder is also a member of the board of directors and may also be an officer, such as the CEO. This can create conflicts of interest, as the director may be tempted to use their position to benefit themselves at the expense of the corporation and the minority shareholders.
Delaware law recognizes the potential for conflicts of interest in such situations and has strict standards for how directors who are also majority shareholders must act. In addition to the duty of loyalty, directors have a duty of care and must exercise the same level of care that a reasonably prudent person would under similar circumstances.
Directors who are also majority shareholders must be careful to avoid any self-dealing or other conflicts of interest. They must act in good faith, with the best interests of the corporation and its shareholders in mind, and must disclose any potential conflicts of interest. If a conflict of interest arises, they must recuse themselves from any decision-making process that would be affected by the conflict.
Even if a director isn’t the majority owner (or representing one), any director who has an interest in a matter before the board should consider whether they can be independent to exercise their duty of loyalty to the company. Often, boards will have independent directors who can act when other directors have conflicts.
Fiduciary duties for shareholders, directors, and officers can be complicated to navigate. There rarely are black and white issues or redlines where something is right or wrong. Consider consulting a qualified attorney if the way forward looks difficult.
