Whether you are a shareholder in a closely held corporation, a partner in a partnership, or a member of a limited liability company, you and your business partners owe each other a lot. You are supposed to put the business’s interests before your own. You are supposed to be loyal. You are supposed to be honest. You are supposed to act in good faith. Likewise, your fellow shareholders, partners, and members owe you the same. Just as importantly, or perhaps more so, all of you as owners of a Minnesota business owe your S-Corp, C-Corp, LLC, or partnership fidelity, loyalty and good faith. After all, your business is your baby.
In the eyes of the law, your business is a legal entity that can own and sell property, earn income, and pay taxes; it can be sued and sue others, and is treated almost equal to a person (albeit a fictional person). Seems like a great deal for you to be responsible for. Even if you only own the smallest sliver of a business, you may have these responsibilities.
Baseline Obligations for Business Partners
The law imposes the same burden on everyone who owns a business with others—whether you own 15%, 49%, 51%, or 95% of the company.
The baseline obligations remain the same but, in some cases, may increase in direct proportion to your ownership stake. This is especially true if you are part of the controlling, majority owners. But, even as a non-controlling minority owner with fewer shares, not as many ownership units or with less of a percentage, you still owe your partners duties of loyalty, honesty and fidelity. Likewise they owe the same to you. And all of you owe the same to your business.
As an owner of 15% percent of the stock, you have the same rights as the person who owns 75%, just not as much voting power (if voting is based on ownership percentages). Neither of you can start up a directly competing business across the street. Neither of you can help yourself to the company’s bank account so you can spend the weekend as a high roller in Vegas. Neither of you can pay your kid’s private school tuition with the company checkbook. Neither of you can take a kickback on the new contract that’s coming in next week and keep it for yourself. These are easy and extreme examples. But they make the point that you both owe one another an obligation to treat each other fairly, openly, and honestly. When one of you stops doing this, that is when trouble begins.
In Minnesota, the benefits and obligations the law promises and imposes on you are significant. No matter how your privately owned business is organized, the basics stay the same. That means it includes closely held corporations, limited liability companies, and partnerships. As co-owners of your business, you are all fiduciaries of one another and of your business. Stay with me here and don’t let the legalese turn you off. This is actually a very intuitive concept that you already know; the only thing unfamiliar is likely the term fiduciary. This is nothing new and you already act this way daily.
A fiduciary is “[a] person who is required to act for the benefit of another person on all matters within the scope of their relationship.” Fiduciary, Black's Law Dictionary (8th ed. 2004). Think parent/child, priest/parishioner, agent/client, trustee/beneficiary. (Trust in Latin is fiducia--alright no more Latin). The duty imposed on fiduciaries is the highest standard inferred by the law. So, what does that mean for you as a business owner just trying to make a buck? Essentially, there are two components to the standard of conduct required by Minnesota law that apply to businesses. One: the duty of loyalty; and Two: the duty of care.
Over 100 years ago, there was a case where the directors of an almost bankrupt corporation borrowed money to the corporation secured by a mortgage on the corporation’s main asset: a piece of real estate. When the corporation could not pay the money back, the directors foreclosed on the mortgage, took title to the real estate away from the corporation and then left all the other creditors out to dry. In that case, the Minnesota Supreme Court described the duties owed as follows: “Upon the plainest principles of right, fair dealing, and common honesty, such a transaction ought, in equity, to be held to be fraudulent as to other creditors.” Taylor v. Mitchell, 80 Minn. 492, 496, 83 N.W. 418, 420 (1900).
The relation of directors to their corporation is essentially a fiduciary one, and upon sound principles of public policy they are, as a general rule, prohibited from dealing with the property of the corporation for their own benefit. This is very much like a trustee is disqualified from purchasing, for their own advantage, the property of their cestui que trust [that was French, not Latin and just means “beneficiary”]. In other words, don’t be a cheat, a liar, or a thief. Or, quite simply, apply the Golden Rule: Treat your business partners as you want them to treat you and expect your partners to treat your business as you treat it yourself.
When dealing with your business partners, comply with (and demand the same in return) the fiduciary duties the law imposes: be loyal, be honest, act in good faith, and exercise due care. Acting like this will benefit all of you will help you to ensure a profitable business that’s run wisely and fairly. If you suspect you are not being treated accordingly, contact MKT Law today! We accept cases involving shareholder and partner disputes for small businesses in Minnesota.