Duties Owed by Controlling Shareholders

Controlling shareholders sometimes owe fiduciary duties to the corporation and the other shareholders. But not always.

It depends on what they are doing. For example, shareholders are allowed to vote in their own self interest. This makes sense. Fiduciary duties require you to act in the best interest of the principal. You wouldn't expect that a shareholder that owns 49% of the stock can vote in her own self interest but a shareholder that owns 51% would have to vote in everyone's interests. So what activities should trigger these fiduciary duties?

Controlling shareholder fiduciary duties arise when a controlling shareholder is doing more than acting as a shareholder. Specifically, when controlling shareholders use the "corporate machinery" to get their way. Corporate machinery could mean they are manipulating the board or things within the board's purview.

This makes sense if you think about it through the lens of agency. Remember that agency law creates fiduciary duties, and a key piece of agency is the ability to control. If a shareholder is controlling the board, then that shareholder will owe the fiduciary duties of that board. That's just the intuition, though. The actual tests are more detailed. We'll get into the specific tests as we read the cases.

Where this comes up most frequently is in squeeze out mergers (also called a "freeze-out merger", or depending on the payment, "a cash-out merger"). Recall that if the majority of shares vote for a merger, the merger happens whether the other shareholders like it or not. The objecting shareholders are forced to sell at the price in the merger agreement. A squeeze-out merger is where a large shareholder acquires the remaining shares, squeezing the other shareholders out of the company.

You can see why this would be a problem. A large shareholder with 51% of the voting power could vote for a merger agreement that paid almost nothing for the other 49% of the shares. The 51% voting power is enough to do it. Fiduciary duties can step in to stop that, and typically require entire fairness review.

But not every squeeze out merger is bad. Maybe the whole reason the shareholder holds such a large share of the company is because the two companies work well together. Suppose a hot dog manufacturer owns shares of a bun manufacturer. There might be value in combining the two. If we prevented every transaction with controlling shareholders, we may miss some deals that help everyone.

Because not every controlling shareholder transaction is a scam, the court has set up proceedures that lower the judicial review. These largely revolve around the controlling shareholder giving up control for the purposes of the transaction. If the majority shareholer doesn't exercise control, it doesn't make sense to treat them as controlling shareholders.

This is the intuition. We'll drill down more in the following cases.