Pitfalls and Traps
When times are good, the economy is running smoothly, and businesses are profitable, business partners are inclined to “get along.” In other words, when there is enough money and benefits to “go around,” business partners are more likely to overlook minor grievances and treat each other with fairness – at least one hopes. However, when times get tough, the economy slows, and businesses become less profitable, business partners tend lose patience with one another. As a result, we tend to see an uptick in legal disputes between business partners during these less prosperous periods. Those business partners, however, have fiduciary duties which they to one another. When a fiduciary duty is breached, litigation can be difficult to avoid. And, when litigation is brought, the stakes can be very high. When it comes to fiduciary duty litigation, there are several pitfalls and traps to avoid.
Fiduciary duties are typically found amongst business partners, shareholders in a close corporation, members of a limited liability company, officers and directors of a corporation or limited liability company, and trustees of a trust to its beneficiaries. The elements of a breach of fiduciary duty claim, most recently upheld by the Ohio Court of Appeals for the Third District, Shelby County are (in re: Thomas v. Fletcher):
- The existence of a duty arising from a fiduciary relationship;
- A failure to observe those duties; and
- An injury resulting proximately therefrom.
For purposes of this discussion, the reader can simply substitute “majority members of a limited liability company,” or “partners of a partnership,” for majority shareholder of a closely held corporation. This is because, for purposes of applying fiduciary law, close corporations bear a striking resemblance to a partnership or a limited liability company. In essence, the ownership of a close corporation, like limited liability companies or partnerships, is limited to a small number of people who are dependent on each other for the enterprise to succeed. Just like a partnership, the relationship between the shareholders must be one of trust, confidence, and loyalty if the business is to thrive. Crosby v. Beam, 47 Ohio St.3d 105, 107 (1989); Gigax v. Repka, 83 Ohio App.3d 615, 620 (Montgomery Cty. 1992).
Majority shareholders owe a heightened fiduciary duty to minority shareholders. That duty is defined as the “utmost good faith and loyalty.” Crosby v. Beam, 47 Ohio St.3d 105, 108 (1989); Gigax v. Repka, 83 Ohio App.3d 615, 621 (Montgomery Cty. 1992); and Thomas v. Fletcher, 2000-Ohio-6685 (Shelby Cty. App.) at ¶15. It is a breach of fiduciary duty for a majority shareholder, to use their majority control of the corporation, for their own advantage, without providing the minority shareholders with an equal opportunity to share in the benefits of the corporation or to deprive minority shareholders of the benefits of their stock ownership in the corporation. Crosby v. Beam, 47 Ohio St.3d 105, 109 (1989); Gigax v. Repka, 83 Ohio App.3d 615, 621 (Montgomery Cty. 1992); Yackel v. Kay, 95 Ohio App.3d 472, 477 (Cuyahoga Cty. 1994).
There are many traps waiting for majority shareholders to fall into when dealing with minority shareholders. Examples of a majority shareholder’s misuse of their majority control of a corporation include:
- Removing a minority shareholder from the payroll of a close corporation which has never paid a dividend and where there is no legitimate business purpose for the removal. Crosby v. Beam, supra at 109;
- A majority shareholder who derives excessive personal financial benefit from the close corporation that deprives the minority shareholders of their just share of the corporation’s profits;
- Excessive personal financial benefit can include: excessive salary and bonuses, personal automobile and gasoline expenses, excessive medical insurance benefits, excessive use of credit card to pay personal expenses, which are reimbursed by the close corporation. Yackel v. Kay, 95 Ohio App. 3d 472, 475 (Cuyahoga Cty. 1994);
- A majority shareholder who induces a minority shareholder to extend loans or to post personal assets as collateral for loans to the close corporation at the same time that the majority shareholder is taking action against the interest of the minority shareholder constitutes a breach of fiduciary duty. Estate of Louise Morad v. Task, 1994, Ohio App. LEXIS 921 at 5. Both the Yackel case and the Morad case present analogous fact patterns that are instructive for our case.
A director and an officer of a close corporation owes a fiduciary duty of utmost good faith and loyalty to a minority shareholder as well. Cousins v. Brownfield, 83 Ohio App.3d 782, 791 (Franklin Cty. 1992). The failure of a director or officer of a close corporation to comply with the duties specified by Ohio statute constitute a breach of fiduciary duty owed to a minority shareholder. Id. For example, it is a breach of fiduciary duty for a director or officer to fail to provide a financial statement of the corporation to a minority shareholder who has properly requested one. Cousins v. Brownfield, supra at 785; Ohio Revised Code Section 1701.94(A)(4). The failure to send amended regulations to a minority shareholder violates a statutory obligation under Ohio law and amounts to a breach of fiduciary duty. Ohio Revised Code Section 1701.94(A)(2).
When litigation is filed, the stakes are high. That is because compensatory and punitive damages can be awarded for a breach of fiduciary duty that has caused actual damages to be suffered by the minority shareholder. For punitive damages to be awarded, there must be actual malice, which is evidenced by extremely reckless behavior revealing a conscious disregard of a great and obvious harm to another. Actual malice requires conscious, deliberate, or intentional wrongdoing, in the absence of which punitive damages cannot be awarded. Preston v. Murty, 32 Ohio St. 3d 334 (1987); Cousins v. Brownfield, 83 Ohio App.3d 782, 793 (Franklin Cty. 1992); Yackel v. Kay, 95 Ohio App. 3d 472, 481 (Cuyahoga Cty. 1994). Examples of actual malice can include wrongful termination, breach of majority shareholder fiduciary duty, and increasing personal compensation and maintaining family members on the payroll of the close corporation. Blake v. Faulkner, 1996 Ohio App. LEXIS 5288 (Shelby Cty.) at 17. In one case, Estate of Morad, punitive damages were awarded where the Court found that the majority shareholder, President, and Director of the close corporation fraudulently induced the minority shareholder to extend loans and to post collateral to the corporation and the majority shareholder.
If you have questions regarding your rights and responsibilities as an owner, officer, director, manager, or partner of a business entity, please reach out to request a consultation, visit David’s bio for his contact information to reach out to him directly, or give us a call at 216-696-1422.
