The Rights and Responsibilities of Minority Shareholders

By Jason Pfister

It’s common knowledge in the law that majority shareholders have a fiduciary responsibility to protect the interests of minority shareholders with whom they share ownership in a closely-held corporation. It’s also been accepted, until recently, that minority shareholders owed each other no such consideration—the point being that minority shareholders, even those with considerably larger ownership stakes, couldn’t wield enough influence to justify saddling them with fiduciary responsibility.

But a fairly recent case that played out over the last couple of years in the North Carolina business courts has changed that long-held second assumption regarding minority shareholders, at least those with large non-majority stakes. In the context of business law, we look at fiduciary duties of controlling shareholders (heretofore only thought of as majority shareholders) as operating in good faith and with fairness in their dealings with regard to the interests of minority owners.

The North Carolina Court of Appeals reversed a North Carolina Business Court decision after reviewing the 2015 case of Corwin v British American Tobacco, enshrining a new standard that extends fiduciary responsibility to large minority shareholders. In Corwin, a 42-percent owner had gained a large financial windfall without benefitting its fellow, smaller minority shareholders in a similar fashion.

In 2015, the North Carolina Business Court granted a motion to dismiss a putative class action lawsuit brought against British American Tobacco, PLC (“BAT”) in connection with the $27.6 billion acquisition of Lorillard Inc. by Reynolds American, Inc. The plaintiff, on behalf of a purported class of Reynolds shareholders, claimed that BAT, as Reynolds’s largest shareholder at 42 percent ownership, breached fiduciary duties allegedly owed to other shareholders by causing the transaction to be structured in ways that unduly benefitted BAT, without benefitting its fellow shareholders. In dismissing the suit, the Court concluded that BAT did not exercise sufficient control over Reynolds to owe the remaining shareholders any fiduciary duty. The defendant cited BAT’s minority stake and provisions in a Governance Agreement between BAT and Reynolds that prevented BAT from controlling Reynolds’s board of directors..

In this case, the plaintiff successfully argued that if a minority shareholder exerts enough influence to “control” a corporation (e.g., exerting its will in structuring equity transactions), it could be deemed a “controlling” shareholder and thus have concomitant fiduciary duty to other shareholders. The plaintiff also argued successfully that the minority shareholder in this case, BAT, did exercise actual control over corporate affairs and breached its duty to its fellow minority shareholders.

The original matter in Corwin v British American Tobacco stemmed from the 2004 acquisition of BAT’s American subsidiary, Brown & Williamson, by Winston-Salem’s RJ Reynolds Tobacco Company.  In that transaction, the two companies created a successor entity, Reynolds American, in which BAT would take that 42 percent stake. The original agreement also included a Standstill Agreement, which would prevent BAT from taking a larger stake for 10 years.

Fast forward to 2012. Reynolds American leadership approached BAT to discuss a potential merger involving Reynolds American and Greensboro’s Lorillard. BAT insisted on keeping to its original terms—42 percent undiluted ownership in a new entity, as well as holding to the 2014 expiration of the 10-year Standstill Agreement.

As due diligence moved forward in the spring of 2014, Lorillard questioned terms of the proposed merger, seeking greater equity for its shareholders in the proposed new entity. Reynolds American directors not affiliated with BAT held that BAT should be diluted along with other shareholders, but directors related to BAT held firm at the 42 percent level. Sensing a stalemate that would not result in a true “merger of equals,” Lorillard backed away from the transaction.

Just four months later, after exploring an outright acquisition of Lorillard, Reynolds closed on a transaction to do just that. In July 2014, Reynolds American used cash proceeds from the sale of stock to—you guessed it—BAT to fund the purchase of Lorillard. Providing equity financing for the transaction, BAT netted a post-closing profit of nearly $921 million, exclusively benefitting from the transaction in a profound way not enjoyed by its fellow minority shareholders.

Basically, the result here is that a large minority shareholder that dwarfed the holdings of other shareholders acted firmly within its interests—upholding its previous governance documents—without providing fiduciary flexibility to the others. The appeal of Corwin v British American Tobacco sets some interesting precedents in the world of business law, affecting how corporations move forward with negotiating governance agreements in strategic transactions. Furthermore, the Appeals Court has set a new standard for fiduciary responsibility among large minority shareholder individuals and entities, leaving them liable for solely enforcing their will on the destiny of a corporate entity.

At the Forrest Firm, we help companies every day with issues of corporate governance, strategic transactions, and litigation related to these matters. Contact me at the firm to learn more.