Fiduciary duties of shareholders in closely held corporation

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Reference no: EM13763933

Techno-Corp. was authorized by its' Articles to issue 200,000 shares of stock. Mallory bought 60,000 shares. Six of his associates bought 10,000 shares each. Forty investors who were not well known to Mallory bought 2000 shares each. Mallory thought of himself as an entrepreneur and considered the corporation to be "his business". He served as both President and Chairman of the Board. He and the six shareholders who owned 10,000 shares each made up the board of directors. Formal directors meetings were never held. Mallory believed that since he and the other directors owned a majority of the shares, there was no need to invite the other shareholders to the annual shareholders meetings which were held at Club Margarita --Mallory's favorite bar -- following an informal meeting of the directors.

Mallory lived in an expensive beach estate in Montecito. Since he was having financial problems, he ordered the corporate treasurer to cover his mortgage payments from the corporation's account. His mortgage payments were $20,000 per month. Knowing that Techno-Corp's finances were also shaky, Mallory borrowed $1 million from Milhouse, a wealthy investor. The loan was in the corporation's name and was unsecured. Mallory did not inform Milhouse of Techno-Corp's financial problems. Mallory had express authority to borrow money for the corporation. Milhouse has been unable to obtain repayment of his loan from Techno-Corp. Will he be able to obtain repayment from anyone else? Explain.

FIDUCIARY DUTIES OF SHAREHOLDERS

Under most circumstances shareholders are not fiduciaries - they do not owe any fiduciary duties to the corporation. For example, no duties are violated if a shareholder of General Motors purchases shares in one of that corporation's competitors such as Ford.

However under some special circumstances shareholders do owe fiduciary duties. Several of these circumstances involve fiduciary duties that are imposed only on controlling shareholders. A controlling shareholder is a shareholder who has the power to determine the policies of the corporation in the ordinary course of the corporation's business.

Persons who own a majority of the shares are of course controlling shareholders. (A person who owns a majority of the shares can always determine the election of a majority of the directors and therefore such a shareholder can determine the policies of the corporation.)

Under some circumstances a shareholder who owns less than a majority of the shares may still be a controlling shareholder.

Listed below are the situations under which shareholders are subject to fiduciary duties to the corporation or to the other shareholders.

1. Duty of controlling shareholders not to sell control of the corporation to a looter.

Controlling shareholders have a duty not to sell their controlling interest in the corporation to a looter. A looter is a person that the controlling person knows or has reason to know is likely to loot the corporation. A corporation is looted if its assets are stolen by fraud, embezzlement or any other illegal method.

2. Duty of controlling shareholders to act fairly towards the corporation and towards the other shareholders in connection with any transaction to which control of the corporation is relevant.

3. Fiduciary Duties of shareholders in closely held corporations.

A closely held corporation is one for which there is no regular market for the shares - the shares are not regularly traded. Shareholders in closely held corporations are subject to the same fiduciary duties as are partners. This means that they are subject to the full set of fiduciary duties: loyalty, care and skill, obedience and the duty to account. The duties are owed both to the corporation and to the other shareholders. (These duties are imposed because in closely held corporations the shareholders often participate directly in management in ways similar to partnership management.)

Reference no: EM13763933

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