LEGAL DUTIES OWED TO SHAREHOLDERS OF A CLOSE CORPORATION

Words by Kasey D. McNary, Attorney Serkland Law Firm

The business landscape of Fargo-Moorhead continues to thrive, and our community should take great pride in being an integral part of this region’s ability to foster successful small businesses.

A number of small businesses in our area are family-owned and operated, or started by a group of friends. This often leads to the formation of a “closely held corporation,” which is often referred to as a “close corporation.” By law a close corporation has no more than 35 shareholders. The typical characteristics include: having a few shareholders, often only two or three; the shareholders usually live in the same geographical area, know each other and are familiar with each other’s business skills; nearly all of the shareholders are involved in the dayto-day business; there is no established market for selling corporate stock; and all or most of the shareholders serve as directors, officers, or have some key managerial role in the business.

The Business Corporation Act (“Act”), which is adopted in North Dakota and Minnesota, provides that shareholders in a close corporation owe one another legal duties to act in an honest, fair and reasonable manner in the operation of the corporation. The law also requires shareholders to treat each other with “utmost loyalty” and “good faith.” “Good faith” is defined as being honest in conducting any act or transaction. These legal duties exist to protect each shareholder’s investment and expectations in being part of a corporation with so few shareholders.

For those shareholders that also act as directors or officers it is important to know there are additional duties to act in good faith, in a manner the person reasonably believes to be in the best interests of the corporation and with ordinary care. Directors or those in control of a close corporation also cannot act fraudulently, illegally or in a manner considered “unfairly prejudicial” toward one or more shareholders.

It is not always easy to know what actions could constitute a breach of duty, especially because the Act does not identify particular unlawful actions. Instead, the Act broadly states the duties owed by directors, officers and shareholders of a close corporation. A few actions which could be considered a breach include failing to make appropriate distributions, freezing shareholders out of corporate affairs, or altering a shareholder’s ownership interests.

A shareholder aggrieved by unlawful actions is permitted under the Act to seek a forced buyout of his or her stock. In certain instances the shareholder may even seek a complete dissolution of the corporation, and recovery of his or her costs and attorney fees for pursuing a legal action. It is therefore important for those in control of a close corporation to be mindful of the legal duties owed to the close corporation’s shareholders.

This article was written and prepared by Kasey McNary, an attorney with the Serkland Law Firm in Fargo, North Dakota. For more information call 232.8957, email at kmcnary@serklandlaw.com or visit www.serklandlaw.com.