Minority Shareholders: Understand Your Fiduciary Duties and How to Eliminate Them

When acquiring shares in a corporation, minority shareholders often evaluate the profitability of the corporation, the value of their shares, and what protections are in place to shield them from wrongdoing at the hands of the controlling shareholders. Most minority shareholders likely believe that they do not owe any obligations to their fellow shareholders or to the corporation. But under Illinois law, minority shareholders of certain types of corporations may actually owe fiduciary duties even if they are not directors or officers of those corporations.

Those with ownership stakes in privately held businesses, partnerships, or family offices need to closely collaborate with and trust others. When disagreements and disputes over rights and responsibilities arise, individual emotions and personalities can complicate matters. This ongoing series will help owners anticipate potential problems when structuring their businesses and find solutions to issues that commonly arise among owners of privately held businesses, both before and during litigation.

This post explains the circumstances in which minority shareholders may owe fiduciary duties and steps that shareholders may take to eliminate any fiduciary duties they might owe. (Our prior posts explain common areas of disagreement between equal owners and rights that minority owners should seek.)

Fiduciary Duties that Minority Shareholders May Owe and Under What Circumstances

Fiduciary duties – the duties of care, loyalty, and good faith – are obligations to act in the best interest of another party. In the context of corporations, fiduciary duties typically protect minority shareholders from wrongdoing at the hands of directors, officers, and controlling shareholders. These fiduciary duties generally prohibit directors, officers, and controlling shareholders from competing with the corporation and using corporate resources or relationships for personal gain, among other things.

Depending on the type of corporation, however, minority shareholders may owe fiduciary duties. These unanticipated obligations can alter a minority shareholder’s rights and responsibilities toward the corporation and other shareholders, making ownership more costly. For example, fiduciary duties may prevent a shareholder from competing with or entering into deals with that corporation.[1] Shareholders who find themselves unexpectedly owing fiduciary duties to their corporations probably did not consider the opportunity cost of these prohibitions when they acquired shares.

Under Illinois law, all shareholders of a close corporation – which is a corporation that looks and acts like a partnership – owe fiduciary duties to the corporation and their other shareholders.[2] Moreover, minority shareholders of a regular corporation may owe fiduciary duties where the corporation operates like a close corporation, even if the corporation is incorporated under the Illinois Business Corporations Act rather than the Close Corporations Act.[3]

To determine whether the corporation looks like a common law close corporation, courts consider factors such as whether the corporation’s stock is held in few hands, how frequently the stock is sold, whether the stock is publicly traded, and whether all of the shareholders are officers or directors or otherwise participate in the day-to-day business of the corporation. Courts justify the imposition of fiduciary duties in these circumstances by comparing shareholders of regular corporations that operate as close corporations to partners in a partnership or joint enterprise.

Minority Shareholders May Be Able to Avoid Owing Fiduciary Duties

There are a few actions that minority shareholders can take to attempt to avoid owing fiduciary duties by virtue of owning shares.

The Illinois Close Corporations Act allows shareholders of close corporations to waive any fiduciary duties that they may owe.[4] To do that, the statute requires that shareholders also broadly waive their rights to control or influence the corporation, including their rights to vote their shares and to serve as a director or officer of the corporation. Waiver of fiduciary duties protects shareholders only if the waiver is made before those shareholders have breached those fiduciary duties. In many instances, minority shareholders of close corporations may seek to maintain their rights to control or influence the corporation even though those rights also come with fiduciary duties.

Another way that minority shareholders may be able to avoid owing fiduciary duties is by entering into a shareholder agreement that explicitly states that shareholders do not owe fiduciary duties and do not have the ability to control the corporation solely by virtue of their status as shareholders. This may help to persuade a court not to treat the corporation as a close corporation. In addition, if minority shareholders face breach of fiduciary duty allegations in litigation, those shareholders may be able to argue that they did not owe fiduciary duties if they do not have the ability to hinder, influence, or control the corporation.[5]