An earlier blog post described some of the ways a company’s majority shareholders or members attempt to “freeze out” a minority or non-controlling shareholder from the reasonable expectations and benefits of ownership in the company. These freeze-out efforts are often, though not always, geared toward forcing the non-controlling owner to sell his or her shares, usually at a discount. This post discusses one of the most common ways such freeze-outs occur, via termination of employment.
In Massachusetts, owners of a closely held corporation – a corporation that has a small number of shareholders, no ready market for the company’s shares, and substantial majority shareholder participation in the management direction and operations of the corporation – owe each other a fiduciary duty. When the majority shareholders of a closely held corporation terminate the employment of the minority shareholder(s), that can be a breach of that fiduciary duty.
As the Massachusetts Supreme Judicial Court has recognized, a minority shareholder often invests in a corporation as a minority expecting that continued employment – and the attendant salary, bonuses, and benefits – will constitute the substantial, if not full, return on his or her investment. In Wilkes v. Springside Nursing Home, the SJC found that a majority cannot terminate the employment of a minority shareholder unless the majority can establish two things.
First, the majority has to demonstrate that the termination of the minority shareholder was for a legitimate business purpose, i.e., not part of a scheme to freeze the minority shareholder out of the company. Massachusetts courts give a substantial amount of deference to corporate management in determining the internal affairs of the company, but some legitimate business purpose for the termination must be shown.
Second, even if the majority can establish a legitimate business purpose for the termination, the majority must also show that the legitimate business purpose in question cannot have been achieved through a course of action that is less harmful to the minority shareholder. Examples of less harmful alternatives to terminate might be include reassignment or relocation.
When considering whether a minority shareholder’s termination of employment constitutes a breach of fiduciary duty, courts emphasize in particular whether the benefits of employment constitute the majority – or all – of the benefit of ownership, such as when a corporation does not make distributions of profit.
Search Terms: Closely held, Fiduciary, Freeze out, Majority shareholder, Minority shareholder, Shareholder, Squeeze out