Smoke Signals: No Fiduciary Duty For Minority Shareholders — At Least Not Yet
The following excerpt is reprinted with the permission of and with credit to North Carolina Lawyers Weekly.
By Smoke has long been used for sending signals, but the North Carolina Supreme Court has sent some clear signals to stock owners while resolving a spat over smokes.
On Dec. 7 a narrowly divided court stubbed out a shareholders’ revolt over Reynolds American’s purchase of Lorillard Tobacco and reversed a Court of Appeals decision holding that a minority shareholder could owe a fiduciary duty to other shareholders. See Corwin v. British American Tobacco PLC, 2018 WL 6437701, Lawyers Weekly No. 010-093-18. But the court nevertheless strongly implied that it was inclined to accept the reasoning of Delaware courts that such a duty could exist under the right circumstances.
Reynolds, based in Winston-Salem, bought Lorillard in 2014 for a mix of cash and Reynolds stock. At the time, 42 percent of Reynolds’ stock was held by British American Tobacco (BAT) (which now owns the whole lot). BAT helped finance the deal by buying enough shares of Reynolds to maintain its 42 percent stake in the company. Other shareholders were thus left with a smaller slice of a bigger company.
In theory, that should have left them no worse off, but some shareholders alleged that BAT had been permitted to buy the Reynolds stock at a sweetheart price. They sued, claiming that BAT had breached its fiduciary duty to them by using its influence over Reynolds’ board to enrich themselves at the expense of other shareholders.
North Carolina’s courts had never held that a minority shareholder could owe a fiduciary duty to other shareholders (usually that is reserved for majority shareholders), but the plaintiffs argued that North Carolina should adopt the reasoning of Delaware’s courts and hold that a “controlling” shareholder could owe a fiduciary duty even if it owned a minority of shares. (A large number of companies are incorporated in Delaware, so decisions by its business court are unusually influential.)
North Carolina Business Court Judge James Gale dismissed the suit, concluding that even if the Delaware standard applied, BAT was not a controlling shareholder under that state’s law. But in 2016 the Court of Appeals unanimously reversed, adopting the Delaware approach and finding that BAT had in fact acted as a controlling shareholder.
BAT Out of Hell
Like Gale, Chief Justice Mark Martin, writing for a 4-3 majority, did not explicitly adopt the Delaware standard. But also like the Business Court, Martin applied Delaware law in concluding that BAT did not owe any fiduciary duties because it was not a controlling shareholder.
John Wester, a business litigation attorney with Robinson Bradshaw in Charlotte who was not involved in the litigation but reviewed the court’s ruling, said that despite the majority’s decision to leave the question for another day, its reasoning strongly suggests that the court is positively disposed toward the Delaware standard and might well adopt it if a future case forced it to decide the issue.
“You’ve heard the sonnet, ‘How do I love thee? Let me count the ways.’ How do we know that this law is coming? Let me count the pages,” Wester said.
“They say that they need not decide the issue, but then they spend the next seven pages going through the details and evaluating the nuances of the Delaware decisions. There’s a long embrace of Delaware law for it not to count in the jurisprudence in the future. There’s no question that the Delaware courts’ analyses are going to count for a great deal in this process.”
Indeed, Martin, citing Delaware law, held that a minority stockholder is considered a controlling stockholder only if it exercises domination through actual control of corporate conduct. Actual control exists only when the stockholder exercises such formidable voting and managerial power that, as a practical matter, it is no differently situated than if it had majority voting control. That power, Martin said, must be so potent that independent directors cannot freely exercise their judgment without fearing retribution.
“That the actual control standard emphasizes the exercise of actual control over the board—an affirmative act by the minority stockholder—and not just the mere possession of power means that an allegation that a minority stockholder has some leverage over the board of directors is not enough.” Martin said.
Martin said that while the other shareholders had alleged that a governance agreement between BAT and Reynolds gave BAT the ability to control the latter’s board, “in fact the exact opposite is true” because the agreement placed several handcuffs on BAT precisely to prevent that. Although BAT had the ability to veto the proposed Lorillard purchase, it did not have the power to make such a purchase happen, and so it was not in the same position it would be in if it owed a majority of the shares.
Not Dead, Just Resting
Justice Robin Hudson authored a lengthy dissent. The three dissenting justices explicitly endorsed the Delaware approach and argued that the shareholders had sufficiently alleged that BAT had such coercive power over the Reynolds board in the Lorillard acquisition that BAT had exercised actual control. Hudson said the shareholders should have been allowed to move forward with their suit.
Wester said that it’s quite rare for such shareholder disputes to make it all the way to the Supreme Court, much less for the justices to provide such painstakingly detailed legal analysis for attorneys to chew on.
“I think that the scholarship that both opinions provide will be instructive for cases to come as well as for corporate counsel evaluating governance agreements they either have in place in their companies, or they are preparing. I think it holds that kind of significance,” Wester said.
The court may get a chance to revisit the issue sooner rather than later. Earlier this year the Business Court allowed a breach of fiduciary duty claim against a minority shareholder to move forward based on the Court of Appeals’ now-reversed ruling.
In another part of the ruling, the justices ruled for the first time that a stockholder can bring a direct claim for voting power dilution in North Carolina. Again drawing on Delaware law, the court ruled that the plaintiffs had standing to bring their suit directly against BAT rather than having to file a derivative claim.