fiduciary duty to shareholders

Fiduciary Duty to Shareholders

The Corporation Is a Trustee as to Every Shareholder

Unlike other forms of property ownership, stock ownership involves both a direct aspect—direct ownership of the shareholder’s undivided partial interest in the corporation, represented by the stock certificate—and an indirect aspect—ownership of what the “stock” represents, an undivided partial interest in the assets and business operations owned and controlled by the corporation. The Texas Supreme Court in Sneed v. Webre recently acknowledged that a shareholder’s ownership of “stock” is actually a beneficial or equitable ownership interest in the assets and business enterprise of the corporation.  The Court noted that Texas law “recognized that ‘the stockholders are the beneficial owners of the assets of the corporation’ well over a century ago.”  The “beneficial title to the assets of the corporation is in the stockholders.”

There are certain legal consequences to this beneficial ownership structure in which equitable ownership and legal title are held separately. For example, it is the shareholder’s beneficial ownership that gives the shareholder standing as a plaintiff in a derivative suit, which as the Texas Supreme Court held in Sneed extends to a derivative action brought by shareholder of a parent corporation on behalf of a wholly-owned subsidiary, one of the corporate assets in which the shareholder owns a beneficial interest.

One who holds the legal title to property for the benefit of the beneficial owner is a "trustee,"  and trustees owe legal duties to the beneficiaries of their trust.

Texas courts have held that the corporation holds the shareholders’ property pursuant to a “contractual relation whereby the corporation acquires and holds the stockholder’s investment under express recognition of his right and for a specific purpose.”Therefore, although the shareholder may be said to “possess” the stock,the stock is only an undivided interest in property, the actual possession of which is always with the corporation.  The “nature of the organization and the relation of the stockholders to the corporation and its property”  impose legal duties on the corporation with respect to the stockholder’s ownership interest.  The relationship, and its accompanying duties, have been characterized as “akin to one of trust,”  with the corporation acting as a “quasi-trustee,” holding its stock for the benefit of and in trust for its stockholders. 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.”

Rediscovering Corporate Quasi-Fiduciary Duties to Shareholders

One must go back long before the advent of the shareholder oppression doctrine to find opinions that took any care to define legal relationship between corporation and shareholder and the resulting  duties arising from that relationship. In light of the recent demise of the shareholder oppression doctrine in Texas, those cases are worth a fresh look.

Prior to the adoption of the Uniform Stock Transfer Act  by the states, courts imposed “quasi-fiduciary duties” on corporate issuers and their transfer agents to insure that changes in stock registration were not wrongful as against the true owner.  These duties arose from the courts’ analysis that “a corporation whose stock was transferable only on the books of the company was, to a certain extent at least, a trustee for its shareholders in respect to their stock.”  Under this older line of case law, courts imposed on the corporation, as trustee, the “duty to exercise reasonable care and diligence to protect [the stockholder’s] interests by preventing [wrongful] transfers, and it had to respond in damages.”  The big change that came with the adoption of the Uniform Stock Transfer Act was to render share certificates freely negotiable—the primary effect of which was to protect good faith purchasers and to ease the risks and burdens the courts had imposed on corporations when they register a transfer.  However, Article 8 of the Uniform Commercial Code does not preempt the common law,  and one respected authority has noted that this “large body of case law . . . may still be useful today.”  In light of the Texas Supreme Court’s recent extensive reliance in Ritchie v, Rupe  and Sneed  on pre-shareholder oppression cases from the late nineteenth and early twentieth centuries, this exploration seems particularly appropriate.

Fiduciary Duties to Shareholders Arising from the Trust Relationship

Stock is an abstract concept, an intangible set of rights and interests, not a physical thing. Ownership of stock may be evidenced by a written stock certificate and a written notation on the corporate books; however, the evidence of the thing is not the thing itself.  Ultimately, stock ownership resides in the corporation’s acknowledgement of the existence of the shareholder's ownership interest and the rights and benefits such ownership entails. The stockholder does not own or possess anything tangible but has only a claim on the corporation. That “claim” is meaningless unless the law recognizes enforceable legal duties to each shareholder. The Texas Supreme Court in Yeaman and numerous other Texas cases are emphatic that the trustee-beneficiary relationship between the corporation and its individual shareholders imposes duties on the corporation that are analogous to and derived from the duties that the common law imposes on all trustees.

Corporations owe fiduciary duties to their shareholders -- much like trustees

Distinguishing the Corporate Fiduciary Duty to Shareholders

The legal duties imposed on the corporation are analogous to common-law duties on trustees, but there is not a one-to-one correspondence.

While the corporation is like a trustee to its stockholders in many ways, there are also differences between the legal structure of a corporation and the legal structure of a trust.

The duties that the law imposes on trustees are extremely strict. A trustee owes a trust beneficiary an unwavering duty of good faith, fair dealing, loyalty, and fidelity over the trust’s affairs and its corpus.  The Texas Supreme Court has written:

When persons enter into fiduciary relations, each consents, as a matter of law, to have his conduct towards the other measured by the standards of the finer loyalties exacted by courts of equity. That is a sound rule and should not be whittled down by exceptions. The rule is general in its use and is fundamental. It is for the benefit of the cestui que trust and undertakes to enforce the duty of loyalty on the part of the trustee by prohibiting him from using the advantage of his position to gain any benefit for himself at the expense of his cestui que trust and from placing himself in any position where his self interest will or may conflict with his obligations as trustee. 

The application of those duties in the corporate context, however, must be a little different from the application to a human trustee. A corporation is like a trust in that the corporation owns legal title to its assets and business operations, while the shareholders hold equitable ownership.  In that sense, the corporation is like a trustee, and the shareholders are like the beneficiaries of the trust. However, in other ways, the corporate structure that is unlike a trust.

In an ordinary trust, the trust itself is not considered to be a legal person distinct from its beneficiaries and trustee. Lawsuits for injury to trust property are brought by the trustee (or sometimes derivatively by a beneficiary), not by the trust itself. The human trustee exists separate from and outside of the trust. The human trustee has self-interests that are distinct from and often adverse to the interests of the trust. A corporation, on the other hand, is both the trustee and the trust itself. The corporation is a separate legal person and has the power to sue in its own name for injury to itself.  

Trustees are held to a strict duty not to misappropriate trust property for their own benefit.  However, unlike a human trustee administering a trust, the corporation is both the trustee and the trust and cannot possess property outside of itself; therefore, it would be impossible for a corporation to possess corporate property in which the shareholders would not still own a beneficial interest. Trustees are required to place the interests of the beneficiaries before their own interests.  However, a corporation has no self-interest that is not shared by all the shareholders. (However, corporations can place the interests of some shareholders before others, which would violate the fiduciary duty of impartiality.)

Moreover, the fundamental legal structure of the corporation is the separation of ownership from control. While the corporation holds legal title, it can do nothing apart from its agents.  The corporation owns its assets and operations, but control over the assets and operation is vested in the directors and officers.  A trustee both holds legal title and exercises control.  A corporation only holds legal title; its officers and directors exercise control. These corporate managers are agents of the corporation and exercise the power of control over the assets and operations, because the corporation delegates those powers to them as agents. The management of the corporation owes fiduciary duties to the corporation--that is, to the shareholders collectively, not to the shareholders individually. These are the duties that come out of the exercise of control—duties that are based in the law of agency, not the law of trusts.

None of the courts recognizing this legal relationship of trustee/beneficiary between corporation and shareholder has held that there is a complete one-to-one correspondence to an express trust—rather the cases term the relationship as “akin to one of trust.” Therefore, while the trustee analogy is useful, it has limitations. Corporations owe some of the fiduciary duties to their shareholders that human trustees owe to their beneficiaries, the duties are not identical. The primary difference is that the management and control of the trust assets is exercised by the directors and officers, not the corporation, and the strict duties of loyalty and care in the management and control of those assets are imposed on the directors and officers and are owed solely to the corporation (the trust fund as a whole). Individual shareholders are not owed those duties by the corporation or by the corporate managers and have no ability to bring a claim on their own behalf for breach of those duties when they believe that the managers have damaged the corporation. The exception to this rule is that when the corporation is unable to enforce those duties, then the beneficial owners may bring a derivative claim on behalf of the corporation to do so. Nevertheless, shareholders also have individual rights and interests that are distinct from those of the corporation, and the corporation as trustee owes duties to the shareholder with respect to those rights and interests. We term those duties "quasi-fiduciary" to make the distinction between the full range of duties that human trustees owe beneficiaries and that directors and officers owe the corporation.

Objections to this Analysis

The concept that corporations owe “fiduciary duties” to shareholders has drawn considerable hostility from some commentators and courts in other jurisdictions. In Ritchie, the Texas Supreme Court, in addressing a different legal issue, quoted one commentator who expressed extreme doubt as to fiduciary duties owed by the corporation:

The very idea that a corporation has a fiduciary duty to individual shareholders is troubling. The corporation can act only through its board of directors, officers, employees, and other agents. These actors are obligated to act in the best interests of the corporation, which may not coincide with the best interests of an individual shareholder transacting business with the corporation. There is no reason to impose a fiduciary obligation on these actors to act in the best interests of an individual shareholder when that shareholder proposes a course of conduct not in the best interests of the corporation.

This concern, however, presents a false dilemma. First, the factual situation contemplated is a “shareholder transacting business with the corporation” where the “best interests of the individual shareholder” in that transaction do not coincide with the “best interests of the corporation.” For example, a corporation might need to rent a warehouse, and a minority shareholder might have a suitable property. In that situation, the minority shareholder is not dealing with the corporation as a shareholder but as a prospective landlord. The interests of the shareholder (receiving highest rent) and the interests of the corporation (paying lowest rent) are inherently in conflict. Nothing in Yeaman, or in any case decided under the shareholder oppression doctrine, suggests in the slightest that the corporation would be breaching a duty to the minority shareholder by renting a different warehouse that was better and cheaper. However, when a corporation seeks to redeem or repurchase shares from a minority shareholder—a business transaction between corporation and shareholder clearly acting in his capacity as a shareholder—the corporation indisputably owes fiduciary duties to the individual shareholder, as is acknowledged in numerous Texas cases, including Ritchie.

Second, what is at issue is not a potential conflict between the best interests of the corporation and the best interests of an individual shareholder, but what legal duties do corporations owe to each and every shareholder by virtue of the fact that they are shareholders of the corporation. If, for example, a corporation owed a duty to allow its shareholders to vote and to be bound by the result,  then a corporation would be held to that legal duty regardless of whether the management of the corporation thought that it would be in the “best interest of the corporation” to disenfranchise certain shareholders. The corporation could not unilaterally cancel a troublesome minority shareholder’s stock because management sincerely (and even correctly) believed that the corporation would be better off without him. The corporation would not be permitted to pay dividends to all shareholders except one, based on the determination that the corporation did not have sufficient funds to pay all and that the best interests of the corporation trumped the best interests of one individual shareholder.

A number of courts have also resisted the idea that corporations owe “fiduciary duties” to shareholders based on the concern that this doctrine would result in vicarious liability to the corporation for wrongdoing initiated by and executed by its officers, directors or other shareholders.  The Sixth Circuit stated:

Liability for breach of the directors’ fiduciary obligation could not possibly run against the corporation itself, for this would create the absurdity of satisfying the shareholders’ claims against the directors from the corporation, which is owned by the shareholders. There is not, and could not conceptually be any authority that a corporation as an entity has a fiduciary duty to its shareholders. 

There is widespread agreement with this position.  However, this objection is directed at a different set of duties than those recognized in Yeaman. The officers’ and directors’ duties run to the corporation. Liability for breach of those duties governing control of the corporation, say, stealing corporate funds, is to the corporation (and thus to all of the shareholders collectively). Of course, it is absurd to say that a corporation might be liable to itself when the president steals its money. However, if the corporation owes a legal duty to a shareholder, then there is absolutely nothing “absurd” about a corporation being held liable to injured parties for the decisions or conduct of its agents that violate that legal duty. A corporation can only act through its human agents  and make decisions through its human management.  Every instance of corporate liability results from actions and decisions made by corporate agents. An injured driver may certainly seek compensation from the corporation when a corporate employee negligently causes an accident.  The employee driver causing the accident certainly would have violated a duty to the corporate employer in driving negligently, as would directors seeking to entrench management by blocking the votes of certain shareholders. Likewise, under ordinary tort law, when senior corporate management maliciously commits wrongdoing in the course and scope of their duties, that malicious intent is imputed to the corporation.  If the law recognizes duties that corporations owe to shareholders arising from the legal relationship between a corporation and each of its owners, then the liability falls on the corporation even though officers and directors make the decision to violate such a duty. 

Texas case law is abundantly clear that indirect harm suffered by shareholders caused by violations of duties by officers and directors owed solely to the corporation are actionable only by or on behalf of the corporation—that is, the law requires the corporation (the trustee) to recover for the damage done to the trust as a whole so that all the beneficiaries of the trust may be restored proportionately. If an individual shareholder could simply recast every misappropriation of assets by a director as a breach of fiduciary duty by the corporation to the shareholder, then the distinction between the interests of the corporation and the interests of the shareholder would be obliterated. Courts in other jurisdictions have universally condemned attempts to enforce corporate fiduciary duties to shareholders in this way.

Those criticisms are not valid with respect to the recognition of corporate duties proposed here. The criticisms are largely a matter of nomenclature. Courts rejecting "fiduciary duties" imposed on corporations are chiefly concerned about the confusion between those duties that officers and directors owe to the corporation and those duties that a corporation may owe to its shareholders. Courts do not want shareholders to be able to be able to assert a violation of legal duties owed only to the corporation through the back door by claiming that the corporation owes those same duties to the shareholder. Such a direct claim by a shareholder would render the corporation’s ownership of those claims meaningless and the public policy against multiplying litigation, potentially inconsistent results, and denying creditors and other shareholders of the benefits of the corporation’s recovery would be thwarted. The corporation would, in effect, have to sue itself whenever it was injured.

While there may be some some overlaps, the nature of the duties that the corporation owes to its individual shareholders is different from that of the duties that the officers and directors owe to the corporation. Holding that a corporation does not owe “fiduciary duties” to individual shareholders is not the same as holding that corporations owe no duties to shareholders. Delaware law, for example, emphatically holds that corporations do not owe “fiduciary duties” to shareholders  and does not recognize the shareholder oppression cause of action,but Delaware law still holds that corporations have duties of full disclosure to shareholdersand provides minority shareholders a direct remedy if they are treated inequitably.

The Texas case law recognizing that the corporation as trustee owes enforceable duties directly to shareholders  developed in the same time period as the cases holding that shareholders have no direct recovery for harm done only to the corporation.  There is no inconsistency in these two doctrines as developed and applied by Texas courts. The "fiduciary duties" owed to the corporation and the "quasi-fiduciary duties" owed by the corporation are simply different duties.

duties owed to the corporation and duties owed by the corporation are different duties


Limited Scope of the Corporate Quasi-Fiduciary Duty to Shareholders

Texas case law recognizing legal duties that the corporation as an entity owes directly to each of its shareholders, whether or not characterized as “fiduciary” duties, insists that the scope of such duties is “narrow.”  Nevertheless, there are still distinct and important quasi-fiduciary duties that the corporation owes to the shareholders. These duties arise out of legal ownership for the benefit of someone else—the same kinds of duties that the trustee owes to the beneficiary of the trust by virtue of the separation of legal and equitable title.  The duties described in Yeaman deal only with the impairment of individual shareholders’ recognized rights and interests as shareholders. Shareholders have certain fundamental property rights inherent in share ownership--including, the right to a voice in corporate affairs, the right to information regarding the corporation, the right to their proportional share of the corporate profits, and the right to transfer their share ownership. These rights belong to the shareholders individually. They do not belong to the corporation. These rights should be understood as limits placed on corporate action. A corporation may not violate those rights of its shareholders. While the duty not to violate those rights is owed by the corporation to the shareholders, not by the corporate managers directly, directors and officers of the corporation are constrained by those shareholder rights. The corporate management may only cause the corporation to act in ways that are legally permissible to the corporation. When the management causes the corporation to do something that it is not permitted to do, the management exceeds its authority and commits ultra vires acts.

Because the corporation functions as a trustee, it also has certain affirmative duties to its shareholders. The most important of these duties is to act impartially with respect to the interests of its multiple owners. This duty of impartiality is simply the duty to act in good faith and with basic fairness with respect to conflicting interests among its various shareholders. The corporation also has an affirmative duties to recognize, respect, and not attempt to impair the ownership of its stockholders and to account for the corporate trust assets in its possession and to disclose material information to its stockholders.

Therefore, the quasi-fiduciary duties that a corporation, as trustee, owes to its shareholders, as beneficiaries of the trust, are not far-reaching and vague obligations always to place the interests of each individual shareholder before its own, and certainly not the duty rejected in Ritchie to “act in the best interests of each individual shareholder at the expense of the corporation.”  Rather, the corporation’s trust duties would be limited to the observance and preservation of each individual shareholder’s recognized
property rights and to dealing with its multiple owners fairly and impartially. The violation of those duties, as the Texas Supreme Court held in Yeaman is actionable directly by the individual shareholder who was injured. The cause of action for violation of shareholder rights and breach of corporate quasi-fiduciary duties, was called by early Texas Supreme Court cases "breach of trust." We believe that name is particularly appropriate as the law develops in the wake of the Ritchie opinion to avoid confusion with corporation's cause of action for “breach of fiduciary duties” that directors and officers owe to the corporation.