Why Controlling Shareholders Are Not Fiduciaries

Conflicts among shareholders are pervasive, whether rooted in personal animosity or differences of opinion on business matters. They arise in private and public corporations operating in all sectors of the economy. And in some cases, the conflicts are so large that they lead to significant economic waste with spillover effects on parties other than the shareholders in conflict.

How does, and how should, the law approach problems of shareholder conflict, where conflicts implicate shareholders’ use – or alleged abuse – of their rights and powers? And what does, or might, the law’s response to these problems imply about what shareholders owe one another by virtue of their common shareholding?

I address these and related questions in my chapter “Equity, Majoritarian Governance, and the Oppression Remedy.” I note that, in a way entirely consistent with the handling of wider issues of abuse of right in Anglo common law systems, corporate law relies on equitable intervention in addressing shareholder conflicts. Drawing on my own prior writing on equity and that of Henry Smith, I explain that equitable intervention is usually either supplemental or corrective. Where equity intervenes in supplemental mode, it corrects for a generic risk of abuse or misuse of a legal right or power by supplementing the legal right or power with a limiting equitable obligation or other fixed constraint. By contrast, where equity intervenes in corrective mode, it enables ex post judicial review through which judges consider allegations of misuse of a legal right or power and respond to inequity by way of tailored, discretionary equitable remedies.

In my chapter, I argue that there is a choice to be made between supplemental and corrective equitable responses to problems of shareholder conflict, and that Delaware corporate law has made the wrong choice.

Under Delaware law, the risk of abuse of power by a controlling shareholder has been dealt with through imposition of fiduciary duties. Shareholder fiduciary duties operate prospectively to compel controlling shareholders to exercise their rights and powers in the interests of all shareholders, collectively. They are aimed at preventing a certain kind of shareholder – one with a controlling stake – from exercising its rights and powers in its exclusive interests; non-controlling shareholders do not suffer a corresponding legal disability.

Delaware was wrong to have extended fiduciary duties to controlling shareholders. First, legal and factual circumstances in which shareholder abuse of power arise do not follow fixed patterns and, more specifically, do not uniformly involve self-interested appropriation of power or profit by a controlling shareholder. Second, shareholder relationships are not fiduciary. A controlling shareholder enjoys what power it has to control through the accumulation of property in shares; it has not been authorized to act for, and has not undertaken to represent, minority shareholders. Setting to one side institutional investors (most of whom are fiduciaries of investors in funds), each shareholder deals with its own shares and should be understood as exercising rights and powers incident to same on the footing of private ownership. Third, and unsurprisingly in light of the foregoing, Delaware corporate law does not actually follow through on its characterization of controlling shareholders as fiduciaries. It does not require that they forgo any and all profits from their fiduciary position, nor does it subject them to the usual remedies for breach of fiduciary duty.

The path not taken by Delaware corporate law is most popular in other Anglo common law jurisdictions: statutory provision for correctively equitable intervention by way of a shareholder oppression remedy. As is typical of other doctrines that enable and structure equity’s corrective mode of operation, the oppression remedy enables a petitioner (here: an aggrieved shareholder) to make an application for discretionary equitable relief ex post on the basis of an allegation of abuse of right that does not conform to any particular pattern. Usually, relief is premised on the shareholder showing that it suffered inequitable violation of reasonable expectations that were not, and could not, adequately be protected at law. Crucially, there is no suggestion in the law on oppression that prevailing legal rules – whether of corporate law, property, or contract law – stack the deck unfairly in favor of controlling shareholders by giving them the benefits of their control. Rather, intervention is exceptional and limited in recognition that controlling shareholders are not fiduciaries of their fellow shareholders and are entitled to exercise personal judgment in determining whether and how to exercise their rights and powers. The oppression remedy simply allows courts to intervene and to provide flexible, tailored relief where – unusually – a controlling shareholder has exercised its rights or powers inequitably.

In the chapter I suggest that the path not taken by Delaware is the one it should have taken. Majoritarian decision-making by shareholders raises risks of inequity that cannot be addressed by legal rules that operate generally and prospectively, fiduciary or otherwise. Delaware ought to have provided for the more limited, flexible corrective intervention contemplated by a shareholder oppression remedy. That being said, I recognize that there is no panacea for shareholder conflict and that the general utility of an oppression remedy will turn on important design choices, including those in relation to the specification of interests protected by the oppression remedy, standing to bring petitions, and the scope of remedial discretion to be wielded by courts in rectifying oppression. However, I maintain that we’d do better to attend to these questions than to carry on with the ill-founded notion that controlling shareholders are fiduciaries.

This post comes to us from Professor Paul B. Miller at Notre Dame Law School. It is based on his recent chapter, “Equity, Majoritarian Governance, and the Oppression Remedy,” available here.