duty of fair dealing and impartiality

Basic Duty of Fair Dealing = Impartiality Among Shareholders

Nothing can be more unjustifiable and dishonorable than an attempt on the part of those holding a majority of the shares in a corporation to place their nominees in control of the company, and then to use their control for the purpose of obtaining advantage to themselves at the expense of the minority. It would be a conspiracy to commit a breach of trust. The directors of a corporation are bound to administer its affairs with strict impartiality, in the interest of all the shareholders alike; and the inability of the minority to protect themselves against unauthorized acts, performed with the connivance of the majority, renders their right to the protection of the courts the clearer.

Memphis & C. R. Co. v. Wood, 88 Ala. 630, 641-42, 7 So. 108, 112 (1889).

Duties Flowing From Trust Relationship

The Texas Supreme Court held in Yeaman v. Galveston City Co., “[T]he trusteeship of a corporation for its stockholders is that of an acknowledged and continuing trust. It cannot be regarded of a different character. It arises out of the contractual relation whereby the corporation acquires and holds the stockholder’s investment under express recognition of his right and for a specific purpose. It has all the nature of a direct trust.” Texas law recognizes that a corporate entity is a sort of trust in which the corporation holds legal title to property for the benefit of the equitable owners, the shareholders. That trust relationship imposes certain quasi-fiduciary duties upon the corporation toward every shareholder and results in certain constraints on permissible corporate actions.

Trustee's Duty of Impartiality

When there are two or more beneficiaries of a trust, the trustee is under a strict duty to deal impartially with them.  Texas courts have held: “Where there are several beneficiaries, the trustee owes the same fiduciary duty to all of them to protect their respective interests, without partiality or favor to some beneficiaries at the expense of the others.” This common-law principal is codified at Tex. Prop. Code § 117.008 (“If a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries.”). For example, if an income-producing property were held in trust for the benefit of the settlor's widow (primary beneficiary) during her lifetime and then for his children (secondary beneficiaries), the trustee would not be permitted to sell the property during the lifetime of the widow, even if on exceptionally good terms, and thus extinguish the interest of the children in the trust.

According to the Restatement (Third) of Trusts: 

(1) A trustee has a duty to administer the trust in a manner that is impartial with respect to the various beneficiaries of the trust, requiring that: (a) in investing, protecting, and distributing the trust estate, and in other administrative functions, the trustee must act impartially and with due regard for the diverse beneficial interests created by the terms of the trust; and (b) in consulting and otherwise communicating with beneficiaries, the trustee must proceed in a manner that fairly reflects the diversity of their concerns and beneficial interests.

Impartiality is not “equality” of treatment but "does mean that a trustee's treatment of beneficiaries or conduct in administering a trust is not to be influenced by the trustee's personal favoritism or animosity toward individual beneficiaries, even if the latter results from antagonism that sometimes arises in the course of administration. Nor is it permissible for a trustee to ignore the interests of some beneficiaries merely as a result of oversight or neglect, or because a particular beneficiary has more access to the trustee or is more aggressive." "Therefore, in short, it is the trustee's duty, reasonably and without personal bias, to seek to ascertain and to give effect to the rights and priorities of the various beneficiaries or purposes as expressed or implied by the terms of the trust."

Translation to Corporate Context

Shares are fungible. Every share of the same class gets the same vote, the same dividend, and is entitled to the same treatment. Texas courts have held that in a dispute among shareholders over who will control the corporation, the corporation must remain strictly neutral. Whenever there are multiple shareholders in a corporation, the corporation is in the same position as a trustee who must act for the benefit of multiple beneficiaries. The common-law of trusts imposes a duty of strict impartiality. A corporation is impartial when it is fair to all and does not act with the intent to favor one and disadvantage another.  Absolute equality in results and effects is not required.    

The most common conduct challenged in oppression cases is manipulation of the control over the corporation to make the majority’s investment disproportionally more valuable than the minority’s or otherwise to use the minority shareholder’s own corporation against him to disadvantage the minority relative to the majority.  In Boehringer v. Konkel, the court found oppression by majority’s $20,000 per month salary increase, which resulted in a “de facto dividend to the exclusion of . . . the minority shareholder.” Similarly, in Davis v. Sheerin, the oppression involved payment of “informal dividends” only to the majority and use of corporate funds to pay the majority shareholder’s legal fees. Actions taken by the corporation that result in the impairment of minority rights and interest to the benefit of the majority shareholder or result in the majority shareholder enjoying a disproportionate share of the profits or capital value to the detriment of the minority violate the duty of impartiality and are a “wrong akin to breach of trust,” as the Texas Supreme Court held in Patton v. Nicholas.  

This basic concept was reflected in the Ritchie opinion by the majority’s argument that the corporation’s interests are not identical to the individual interests of its majority shareholders, and that officers and directors controlling a corporation have a duty “to the corporation and its shareholders collectively, not any individual shareholder or subgroup of shareholders, even if that subgroup represents a majority of the ownership.”

Duty of Good Faith -- Duty of Fair Dealing

Another way to conceptualize the duty of impartiality in the corporate context is by analogy to the twin duties of good faith and fair dealing. Texas law does not impose an implied covenant of good faith and fair dealing onto all contracts, as many states do, but does recognize that the duty of good faith and fair dealing arises as a matter of tort law when the parties are in a "special relationship." Sometimes the special relationship arises out of specific facts; often it is imposed as a matter of law, even in legal relationships that are not fully fiduciary relationships, such as between an insurance carrier and an insured. Although no Texas court has addressed the duty of good faith and fair dealing in the context of corporation and shareholder, Texas Supreme Court cases, such as Yeaman, stating that the corporation is a trustee to its shareholders and owes at least quasi-fiduciary duties certainly describe a special relationship that would give rise to the duty of good faith and fair dealing. Like the duty of impartiality in the trust context, the duty of good faith and fair dealing is a matter of intent. One violates the duty by acting with an improper purpose.

One of the two definitions of oppression as stated by cases decided under the former shareholder oppression doctrine uses the following terminology: "‘a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members,’ or ‘a visible departure from the standards of fair dealing, and an violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely.’" That language comes from Supreme Court cases decided in other jurisdictions, such as Baker v. Commercial Body Builders, Inc., 264 Or. 614, 628–29, 507 P.2d 387, 393 (1973), and White v. Perkins, 213 Va. 129, 134, 189 S.E.2d 315, 319–20 (1972), which in turn relied on academic articles and even older English cases. The point is that the former shareholder oppression doctrine sought to remedy a breach of the duty of fair dealing that the
common law already recognized that corporations owe to every shareholder "who entrusts his money to the company," and that corporations violate those duties when they conduct "the affairs of a company to the prejudice of some of its members." As the Supreme Court noted in Ritchie, “We do not determine the best interest of the corporation by examining only the interest of its majority shareholder(s).” Therefore, a corporation has a duty to deal fairly with it minority owners and not to act for the purpose of favoring majority interests at their expense.