There is arguably no more prevalent legal claim in business divorces than a claim of breach of a fiduciary duty. Simply put (and I do mean simply), when one person owes a fiduciary duty to another, the person with the duty must act in the best interests of the person to whom they owe the duty.
When the co-owner of a closely held business owes a fiduciary duty to another shareholder of the business, the co-owner must act in the best interests of that shareholder. That means, among other things, treating the other shareholder in a way that allows them to realize the value of their interest in the business.
Fiduciary duties owed by 50% co-owners under Pennsylvania law
Under Pennsylvania law, equal shareholders in a business tend not to owe fiduciary duties to each other. That makes perfect sense. It is awfully difficult (though not impossible) for a 50% co-owner of a business to railroad their fellow 50% co-owner. Assuming each co-owner has the same power, control, and rights over the business as the other, neither co-owner should be able to abuse their authority. After all, each co-owner should have the power to stop the other’s abuse.
But when shareholders are not co-equal, Pennsylvania imposes a fiduciary duty on majority shareholders to protect the interests of minority shareholders. Without this duty, majority shareholders could use their power to elbow out minority shareholders and take a disproportionate share of their businesses’ profits or take advantage of other benefits provided by their businesses at the expense of those minority shareholders.
This majority-to-minority fiduciary duty exists when shareholders have equal ownership of the company but not equal power or control. In situations where there are two 50% co-owners of a business, but one has more voting power than the other or has greater authority to run the business than the other, Pennsylvania courts will likely rule that the more powerful 50% co-owner owes a fiduciary duty to the less powerful 50% co-owner.
But what about when two 50% co-owners with equal power, control, and rights have a falling out and one tries to terminate the other’s employment? It would seem neither would owe a fiduciary duty to the other given that they’re on equal footing.
But a recent decision from the U.S. District Court of the Eastern District of Pennsylvania suggests that once that firing occurs, the co-owner doing the firing has more power and control than the co-owner who was just fired and, therefore, would owe a fiduciary duty to the fired co-owner.
Crossing the equality chasm
In Meyers v. Delaware Valley Lift Truck, Inc. et al., No. 18-1118, E.D. Pa. (May 13, 2021), two brothers, Jack and Jim, each owned half the shares of a closely held industrial equipment rental business, Delaware Valley Lift Truck, founded in 1985 by their father John. A shareholder agreement between the brothers contained a clause (albeit a sloppily drafted one) that allowed John to break any ties between them in the event of disagreements about “major decisions.” The brothers had equal power, control, and rights to make business decisions.
In late 2017, the relationship between Jack and Jim soured. They clashed over whether to fire a particular employee. Jack, the president, was intent on terminating this employee, believing that his conduct cost the company an important business deal. Jim, the secretary and treasurer, was close with the employee and tied his own continued employment at the company to the continued employment of the person about to be fired.
John apparently gave his blessing to Jack to “to do what he had to do that was best for the company and the employees” and supported whatever decision Jack made about whether Jim would continue working at DVLT. But John did not attend the meeting between Jack and Jim where their dispute came to a head. Thus, as the court recognized, it wasn’t clear if John broke the tie. The two brothers had differing views about what happened at the meeting, but agreed that Jack fired Jim.
According to the brothers’ shareholder agreement, Jim’s firing triggered a provision where the remaining brother had the legal right to buy out the one who was fired using a particular formula. However, Jack and Jim had different opinions on how the formula was to be applied. Again, the shareholder agreement did their arrangement no favors thanks to poor drafting. The two brothers could not agree on the purchase price, so the recently fired Jim kept his 50% ownership stake in the company.
In deciding whether to grant either party’s motion for summary judgment regarding Jim’s breach of fiduciary duty claim against Jack, U.S. District Judge Wendy Beetlestone broke some new legal ground. After walking through Pennsylvania law on breach of fiduciary duty, Judge Beetlestone determined that there were two separate stages of the brothers’ relationship with each other. When they had equal authority, and John had the tie-breaking power between the two, the court held Jack did not owe Jim a fiduciary duty.
But according to the court, this absence of a fiduciary relationship changed the moment Jack fired Jim. At that point, Jack clearly had more power than Jim, power that he used to bar Jim from the premises and deny him access to corporate records. Ironically, the court imposed a relationship of trust on Jack only after he seemingly broke trust with his brother by firing him.
After explaining that Jack owed Jim a fiduciary duty in this situation, the court held Jim’s breach of fiduciary duty claim against Jack should proceed to trial to determine whether Jack breached that duty.
A new paradigm for equal shareholders in closely held Pennsylvania businesses?
The key holding in Meyer, that a fiduciary duty between co-equal shareholders can come into existence based on shifts in the balance of power between them, is potentially a significant one.
There was no change in the number of shares owned by Jack or Jim, no new operating agreement, no new allocation of voting shares or rights, and no change in corporate structure. The only thing that changed was one co-equal shareholder fired the other co-equal shareholder in connection with a disagreement over a personnel issue that snowballed into a much larger disagreement.
Yet the court looked at that termination as an event that took the brothers off equal footing despite no change in their ownership of their business. When Jack fired Jim, Jack suddenly became, in the court’s eye, the majority shareholder.
Interestingly, Jim alleges Jack breached his fiduciary duty by doing certain things—barring Jim from their business’s premises, denying him access to corporate records, denying him a voice in running the company, misappropriating corporate funds for Jack’s own personal benefit, and initiating bankruptcy proceedings on behalf of the company in bad faith—that seem to be lifted straight out of the playbook for misbehaving majority shareholders. Had Jack simply taken more than his fair share of profits, the court might have ruled differently. But Jack’s actions seem like those of a majority shareholder acting without fear of accountability or reprisal from a less powerful minority shareholder.
The Meyer decision could transform how 50% co-owners interact with each other. Should the balance of power become imbalanced, a court adopting Judge Beetlestone’s reasoning could hold that the imbalance created a fiduciary duty owed by the more powerful 50% co-owner. Additionally, courts may want the parties to develop a more detailed factual record in these cases because the cases will turn on specific facts regarding the relative power, control, and rights a co-owner had and used at the expense of the other.
The ink on the Meyer decision is barely dry, so we will have to wait and see what impact the decision has on business divorce cases in Pennsylvania. But for now, Meyer has injected some uncertainty into what many Pennsylvania businesses thought was not up for interpretation: whether co-equal owners of those businesses are equal in the eyes of the law.