The recent demise of “shareholder oppression doctrine” at the hands of the Texas Supreme Court has led some to suppose that there are now few legal restrictions on how a closely-held corporation treats its minority shareholders. But such a conclusion is not warranted.
While questions remain about the proper interpretation of extant case law following the court’s recent decision, generally speaking, that decision returns the situation in Texas to what it was before the shareholder oppression doctrine first developed.
At that time there did not exist a specific claim labeled “minority shareholder oppression,” but minority shareholders still had certain rights, and had legal recourse if the corporation did not meet its obligations. The corporation’s responsibility was understood as essentially fiduciary, that is, a duty of good faith and trust. Lower courts will likely rely on this body of law to make sense of the situation now that “shareholder oppression” is no more.
How Corporations Resemble Trusts
In the pre-”shareholder oppression” framework, and likely also today, corporations have a quasi-fiduciary responsibility to all shareholders, including minority shareholders. This responsibility derives from the nature of stock ownership.
Owning stock is not the same as possessing the physical stock certificate, which provides evidence of ownership but is not the stock itself. Stock in a corporation is an abstract entity, a bundle of rights and interests. If you own stock you hold both direct ownership of a partial undivided interest in the corporation, and indirect ownership of the corporation’s assets and business operations.
This indirect ownership of the corporation’s assets is in fact what direct ownership of its stock amounts to. The shareholder holds beneficial ownership in the property to which the corporation holds legal title.
This form of beneficial ownership arises through the stockholder giving the corporation his or her investment for a specific purpose and in exchange for a claim on the corporation. The relationship between corporation and shareholder is thus, as many Texas courts have held, akin to that between a trustee and a beneficiary.
The point of the analogy is the quasi-fiduciary responsibility it entails. A trustee has an obligation to manage the trust for the benefit of the beneficiaries, and beneficiaries have legal recourse if they believe that the trust is not being managed in this way.
Similarly, according to many cases from the pre-”shareholder oppression” era, a corporation has certain responsibilities to its shareholders, responsibilities intended to ensure that shareholders receive the benefits of their investment.
Differences between Corporations and Trusts
Differences do, however, exist between the legal structures of corporations and the legal structures of trusts, differences which necessitate the “quasi” in quasi-fiduciary responsibility. The most important is this: the trust is not a legal person, but the corporation is.
Because a trust is not a legal person, all legal actions taken to protect the trust, such as suits in defense of the trust’s property, will be taken by someone else, usually the trustee. A corporation, on the other hand, because it is a legal person, can take legal action in its own defense. It is as if the corporation is both trust and trustee.
This difference means that the most common claim a beneficiary would make against a trustee, namely, that the trustee is acting in his own self-interest rather in the interest of the trust, does not apply in the case of a corporation.
The corporation has no interest other than those of its shareholders, and so by definition has no self-interest to place ahead of theirs. If the corporation is not being managed in the best interest of its shareholders, then it is not being managed in its own best interest.
This is the second major difference between trusts and corporations, a consequence of the first: unlike the trustee managing the trust, the corporation does not manage itself. Rather, it has officers and directors to whom it delegates its management.
If a corporation is mismanaged, then it has, meaning that its shareholders collectively have, a legal claim against its agents, but no individual shareholder will have a claim. Individual shareholders will only be able take action through what are called derivative claims, in which the shareholder takes action on behalf of the corporation against its agents, whose duties the corporation is for some reason unable to enforce.
The Responsibility of Management and the Responsibility of the Corporation
Given these differences, it might seem that there is no sense to talking about a corporation oweing a quasi-fiduciary responsibility to an individual shareholder. Indeed, some believe that the only responsibility in question is that of the management to the corporation. This conclusion would, however, be premature.
The management certainly has a fiduciary responsibility to the shareholders collectively, which it violates if it does not act in their collective interest. The corporation itself, however, has a responsibility to each individual shareholder, which it violates if it denies any shareholder his rights as shareholder, regardless of whether that denial was in the corporation’s best interest.
Shareholders do not have a right to be employed by or to do business with the corporation in which they own shares. But they do have certain rights just by virtue of being shareholders. These include the right to information about its corporate affairs, the right to a voice in those operations, the right to a proportionate share of any resulting profits, and the right to transfer their ownership share (and so to transfer these rights).
The corporation has a responsibility to act in accordance with these rights, and it owes this responsibility not to the shareholders collectively (which would just be to itself), but to each shareholder individually.
The corporation also has a responsibility to act impartially when its actions affect the interests of multiple shareholders, in their capacity as shareholders. This does not mean that a corporation needs always to act in the best interest of each individual shareholder.
For example, a corporation can refuse to employ one of its shareholders, and can even terminate a shareholder’s employment (so long as the termination does not violate any employment agreement or applicable employment law). But, if the majority shareholder is an employee of the corporation and the minority shareholder is not, the corporation cannot raise the majority shareholder’s salary so as to avoid paying out dividends to the other shareholders.
To do so would be to privilege the interest of one shareholder, the majority owner, over that of the minority shareholder, and so would be a breach of the duty of impartiality.