Invitation to mischief by minority shareholders: a recent court case in Pennsylvania goes too far in assessing a controlling shareholder's duty.

• Author: Raymond, Doug
• Position: LEGAL BRIEF

ALL DIRECTORS and officers know their two principal fiduciary duties of care and loyalty. While these duties have been crystallized through generations of case law and commentary, the legal landscape is murkier for the controlling shareholder, whose duty to the minority and the corporation is far less clear.

As a basic premise, a controlling shareholder has generally enjoyed considerable liberty in how it deals with the corporation and its own interests. To guard against the potential for abuse, the law provides that a controlling shareholder must not take action intended to oppress the minority, use its control for purposes adverse to the corporation, or exclude the minority from its proper share of the benefits of the enterprise. The distinction between what is in a controlling shareholder's legitimate self-interest and what constitutes oppression of the minority can be vague, and so the legal tests have yielded a hazy doctrine.

A recent Pennsylvania case, Stilwell Value Partners I, L.P. v. Prudential Mutual Holding Company, breaks new ground on the duties of controlling shareholders and has rendered the landscape even more murky.

The plaintiff in the Stilwell case sued to prevent the majority shareholder from voting in favor of proposed equity compensation plans. Among other claims, the plaintiff asserted that, because the majority shareholder had not paid for its shares, the stock plans would dilute the minority shareholders unfairly, imposing a disproportionate burden on them and thereby breaching the majority shareholder's duty. The majority shareholder countered that the stock plans would dilute the ownership of all shareholders ratably. The court found that the plaintiff had failed to put forth any evidence that the minority shareholders would be disproportionately financially harmed by the stock plans.

This failure should have been fatal to the case. Absent self-dealing, a controlling shareholder generally has not needed to defend its actions. Nevertheless, the court allowed the case to proceed to trial, where the majority shareholder would have to prove the fairness of its intended vote in favor of the stock plans.

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The court said that to prove fairness, the majority shareholder had to convince the court, among other things, that its vote in favor of the stock plans was in the best interests of the corporation. And, in determining the best interest of the corporation, the court would consider all of the...