It’s Hard to Fire the President . . .

by Lee Gesmer on November 20, 2005

Minority Shareholder/Fiduciary Duty.

. . . of your company, that is.

OK, here the facts, minus the legal jargon.

You’re a businessman with a successful company. You meet someone that wants to go into business with you in a related area. You start a new company, making sure that you hold a majority interest (52.5%). Your new “partner” gets 37.5%, and the rest of the stock goes to a couple of employees. Although your partner is a minority shareholder he’s running the business, so you make him president of the company.

Almost ten years go by, and although the company is making money you’re unhappy with your partner. He’s bad at finances, and tensions arise over bookkeeping and other business issues.

Eventually you reach your boiling point, and one morning you fire your minority partner.

Simple enough you think. After all, you own a majority of the company, what’s stopping you from doing this?

In O’Connor v. U. S. Art Co., a recent case decided by Judge Allen Van Gestel in the Suffolk County Business Law Session, the minority shareholder was awarded $218,000 in damages based on these facts. The judgment was against the other three shareholders, personally.

Here’s the rub: in Massachusetts, shareholders in “close” corporations (nonpublic companies with a small number of shareholders) owe each other a fiduciary duty. You can’t fire a minority shareholder unless you have a “legitimate business purpose,” and there is no “less harmful alternative.” Harmful to the minority shareholder, that is.

In the U.S. Art case Judge Van Gestel found that the majority shareholders could have hired a bookkeeper, among other possible solutions. In other words, even assuming there was a problem, they could have solved the problem without firing the guy.

What’s interesting about this case? Nowhere in the 11 page decision did Judge Van Gestel indicate that the minority shareholder had invested any money when U.S. Art was formed. Usually, the rationale behind cases like this is that the minority shareholder invested in the company, expecting to earn a living from the company, only to find him or herself fired, and out both the investment and the job. That appears not to have been the case here.

What could the majority shareholder have done to avoid this outcome? Easy: enter into an agreement when the business was formed, permitting termination, either at will or for cause. If that wasn’t feasible, take proper steps before terminating the minority shareholder. In the U.S. Art case the Judge described the majority’s actions as “ham- handed.” It doesn’t take a Supreme Court Justice to see that the Judge thought the majority shareholders behaved offensively, and that this contributed to the result.

If you’re interested in further details on this case you can read the full decision here.

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