Rights of an Ohio Employee who is a Minority Shareholder

posted by Neil Klingshirn  |  Jul 14, 2009 5:18 PM [EST]  |  applies to Ohio

A special exception to employment at-will doctrine applies to employees who are minority shareholders of close corporations. In their case, majority shareholders cannot terminate their employment without a legitimate business purpose. Crosby v. Beam, 47 Ohio St. 3d 105 (Ohio 1989).  The majority shareholders owe a fiduciary duty to the minority shareholders. The majority shareholder will breach that duty by terminating the employment of a minority shareholder, without a legitimate business purpose. 

Close corporations

A close corporation “is a corporation with a few shareholders and whose corporate shares are not generally traded on a securities market.” Crosby at 107-108.  Close corporations:

bear a striking resemblance to a partnership. In essence, the ownership of a close corporation is limited to a small number of people who are dependent on each other for the enterprise to succeed. Just like a partnership, the relationship between the shareholders must be one of trust, confidence and loyalty if the close corporation is to thrive. While a close corporation provides the same benefits as do other corporations, such as limited liability and perpetuity, the close corporation structure also gives majority or controlling shareholders opportunities to oppress minority shareholders.

Id. Ohio courts use the terms “close corporation” and “closely held corporation” interchangeably. The Ohio Supreme Court has held that a closely held corporation with a large number of minority shareholders was not a "close corporation," such that the breach of fiduciary duty claim was not available to a minority shareholder. (citation needed).

Controlling Shareholder

Controlling shareholders include those who own a majority of shares, as well as those who control employment decisions. For example, minority shareholders who vote together collectively have control. Thomas v. Fletcher, 2006 Ohio 6685, P16 (Ohio Ct. App., Shelby County Dec. 18, 2006) (two minority owners collectively owning sixty percent of the corporation owed the minority shareholder a heightened fiduciary duty).

The Duty: Utmost Good Faith and Loyalty

The Crosby v. Beam court held that controlling shareholders owe minority shareholders a duty of the”utmost good faith and loyalty.” Controlling shareholders breach this duty when they “utilize control of the close corporation to prevent the minority from having an equal opportunity in the corporation.”

Control of the stock in a close corporation cannot be used to give the majority benefits which are not shared by the minority. As an example, in Wilkes v. Springside Nursing Home, Inc. (1976), 370 Mass. 842, 353 N.E. 2d 657, cited by the Crosby court, majority shareholders breached their fiduciary duty to the minority by removing a minority shareholder from the payroll of a close corporation, which had never paid a dividend, and there was no legitimate business purpose for the removal.

An Exception to the At-will Doctrine

Ohio courts analyze the heightened fiduciary duty for the minority shareholder as an exception to the at-will doctrine.  In Gigax v. Repka, the appellate court rejected the controlling shareholder’s argument that it could terminate the minority shareholder, who was otherwise an employee at will, for no reason.  The Gigax court noted that the facts and circumstances surrounding the at-will agreement of a minority shareholder, including the course of dealing between the parties, altered the at-will relationship:

In determining whether Gigax was an at-will employee, we must take into account that MVC is a close corporation, that the parties are all directors, shareholders, and employees of MVC, and that until Gigax's termination, all the parties worked for MVC without an employment agreement, in order to determine whether Gigax was an at-will employee terminable at any time by the majority shareholders.

Gigax v. Repka, 83 Ohio App. 3d 615 (Ohio Ct. App., Montgomery County 1992).  Consequently, the Gigax court implied a term requiring a legitimate business reason for discharge. Id. 

Limits on the Breach of Fiduciary Duty Claim

Since the minority shareholder’s protection against arbitrary termination arises as an exception to the employment at-will doctrine, Haynes precludes a public policy Greeley claim.  Haynes v. Zoological Soc'y, 73 Ohio St. 3d 254 (Ohio 1995); Tablack v. Wellman, 2006 Ohio 4688, P122 (Ohio Ct. App., Mahoning County Sept. 8, 2006) (“Although Tablack was not a union member like Haynes, he was nonetheless not an employee at will.”)

In addition, a minority shareholder employee can waive his or her right to heightened protection. Hicks v. Bryan Med. Group, Inc., 287 F. Supp. 2d 795 (N.D. Ohio 2003) (Hicks waived his fiduciary duty claim in an employment agreement allowing for termination without cause); Mulchin v. ZZZ Anesthesia, Inc., 2006 Ohio 5773, P27 (Ohio Ct. App., Erie County Nov. 3, 2006) (when Cruz agreed that the corporation could terminate him without specification of cause, he relieved the corporation and the other shareholders of any duty they owed him to exercise their power of termination only for good cause.”)

Similarly, since the fiduciary duty obligation runs to at-will employees, a minority shareholder employee who accepts employment for a specific term will probably fall outside of the fiduciary protection afforded minority employees, since she is no longer an at-will employee once she agrees to employment for a specific term.

Contrasted to a Shareholders’ Derivative Action

A shareholder's derivative action is brought by a shareholder in the name of the corporation to enforce a corporate claim. Weston v. Weston Paper & Mfg. Co., 74 Ohio St. 3d 377 (Ohio 1996) Derivative actions are governed by Civil Procedure Rule 23.1. A derivative action allows a shareholder to circumvent a board's refusal to bring a suit on a claim. If the CEO spent corporate funds for her child’s college tuition without authorization, the corporation would have a claim for conversion against the CEO. If the CEO refused to bring that claim, a shareholder could do so through a derivative action.

If the complaining shareholder is injured in a way that is separate and distinct from an injury to the corporation, however, the complaining shareholder has a direct action. Cf Weston, supra. If that minority shareholder had to pursue a derivative action, then the corporation would recover the remedy, which would remain under the control of the very parties who are defendants in the litigation. Thus, a derivative remedy is not an effective remedy because the wrongdoers would be the principal beneficiaries. Consequently, the minority shareholder who suffers a harm as a result of the controlling shareholder’s breach of their fiduciary duty, which harm is not shared by the controlling shareholders, may bring a direct action against the corporation.

posted by Neil Klingshirn  |  Jul 14, 2009 5:18 PM [EST]  |  applies to Ohio

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