NYS law protects minority shareholders of corporations from potential abuses by majority shareholders, particularly in the context of closely held corporations (private entities where shares of equity are not publicly traded). Corporate officers (i.e., those managing the day-to-day operation of the business) and directors (i.e., those overseeing/directing management of the corporation and responsible for major corporate decisions) are fiduciaries of the corporation. As such, officers and directors owe a fiduciary duty to both the corporation and its owners (i.e., shareholders), encompassing the duty of care and duty of loyalty. Generally, shareholders owe no duties to one another. However, controlling shareholders (i.e., those who own/control at least 51% of voting shares) do have fiduciary duties to minority shareholders in certain situations. Where there are clear disparities in financial compensation or treatment between majority and minority shareholders, NYS law provides clear and robust methods of remedy to protect the interests of the minority shareholders.
What is the Duty of Loyalty?
The governing principle of duty to loyalty to the corporation is that directors and majority shareholders must place the interests of the corporation itself first. They cannot act in their own self-interest, particularly in ways that either “self-deal” or cause harm by a “freeze-out” of minority shareholders. This means they cannot exclude minority shareholders from forms of financial compensation that they themselves receive or allow disparities in such compensation that do not have legitimate business justifications. For example, majority shareholders cannot pay themselves salaries and bonuses without paying similar dividends to minority shareholders. Nor can majority shareholders consistently exclude minority shareholders from decision making processes that impact the corporation as a whole. Transparency, disclosure and the prevention of self-dealing are key components of the duty of loyalty.
What is the Duty of Care?
The governing principle of duty of care to the corporation is that directors and majority shareholders must apply due diligence and informed thought to managing the affairs and business of the corporation. Practically speaking, this means that they have an obligation to reasonably inform themselves before making decisions that impact the corporation as a whole. Directors or officers of the corporation who act recklessly or that don’t apply minimal levels of diligence and care to their decisions can be found to be negligent in their duties and personally responsible for any harm they cause to minority shareholders as a result of those decisions.
The Business Judgement Rule
The business judgment rule protects corporate directors and officers from personal liability for business decisions made in good faith. It applies to both the duty of care and duty of loyalty, creating a rebuttable presumption that a director reasonably believed their actions served the corporation’s best interests. Courts will not disturb those decisions unless there is fraud, illegality, or self-dealing. This protection can be lost, however, if a director consciously disregards their duties—for example, by willfully ignoring risks or failing to maintain adequate reporting and oversight systems. It can also be overcome when a director unreasonably fails to gather or investigate critical information before acting on a significant corporate matter.
The Impact on Closely-Held Corporations
Closely-held corporations are typically small businesses, often family-owned, that don’t have many shareholders. Minority shareholders of closely-held corporations do not have much if any control over operational decisions nor liquid markets where they can sell their shares of the corporation. As such, to protect their rights and interests, New York State and the courts maintain heightened levels of scrutiny to these types of corporations, particularly when it comes to the actions and decisions of directors and majority shareholders.
Relevant Case Law:
In the Matter of Kemp & Beatley, Inc (64 N.Y.2d 63, 1984) the court found that the majority shareholders violated their duties of loyalty and care to the corporation when they withheld dividends from minority shareholders and intentionally excluded and isolated them from executive decision making and management of the corporation. This case law provides a core pillar of protection for minority shareholders of closely-held corporations in New York State.
In Auerbach v. Bennett (47 N.Y.2d 619, 1979), the court found that, under the business judgement doctrine, unfavorable outcomes that result from business decisions made by officers or majority shareholders in good faith and judgement are not sufficient in and of themselves to violate the duty of care to a corporation. To overcome the presumption implied by the doctrine, minority shareholders must clearly demonstrate that the decisions were made in bad-faith or personal self-interest or through fraudulence.
Business Corporation Law (BCL) § 1104-a is a statute in NYS law that provides minority shareholders of closely-held corporations a specific remedy when majority shareholders violate their duties of loyalty and care to the corporation by self-dealing or freezing-out minority shareholders. If shareholders controlling at least 20% of a corporation’s voting shares believe they have standing, they may petition the courts to dissolve the corporation. The grounds for dissolution include “oppressive actions” by the directors or majority shareholders of the corporation, or the “waste, misapplication or diversion” of corporate assets and resources that are without legitimate business justifications. When petitions are made under this statute, majority shareholders are provided opportunities to buyout the petitioning parties, at a fair market value.
Finally, in Alpert v. 28 Williams St. Corp, (63 N.Y.2d 557, 1984), the court held that majority shareholders must show “entire fairness” in transactions that impact minority shareholders, including mergers and buyouts. In the case of a “freeze-out” merger[1], for example, the Alpert court set forth two principal components of a “fair” transaction: (i) the majority shareholders followed a course of fair dealing toward minority shareholders, and (ii) they must have offered a fair price for the minority’s stock. When majority shareholders fail to meet this fairness standard, an aggrieved shareholder can challenge the transaction as unlawful and may be entitled to equitable relief.
Common Examples of Breach:
Some common types of breach that violate the duties of loyalty and care to the corporation described above include:
- Payment of excessive salaries or bonuses to majority shareholders while withholding similar compensation to minority shareholders
- Freezing minority shareholders out of the general decision-making, operation and management of the corporation
- Forcing minority shareholders out through buyouts or dilution of equity/shares
- Using company assets for personal benefit with no legitimate business justification
- Transferring or liquidating company assets to other entities without disclosure or approval of minority shareholders
Recommendations and Remedies for Minority Shareholders:
If you are a minority shareholder in a closely-held corporation and you believe that the officers or majority shareholders have violated either of their duties of loyalty and care, you have a few different courses of action and remedies available to you. These include:
- Requesting an audit of financial and accounting records
- Petitioning a dissolution of the corporation for oppressive conduct, under BCL § 1104-a
- Seeking financial damages for back pay or owed dividends or an equitable remedy such as a fair-market buyout.
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[1] A “freeze-out” merger (also called a “squeeze-out” merger) is a transaction in which a majority shareholder or parent company forces minority shareholders to sell their shares, typically by merging the corporation with another entity the majority controls. The goal is to “freeze out” the minority’s ownership and gain 100% control of the company. Minority shareholders usually receive cash or other consideration instead of shares in the new entity.