The North Carolina Business Court recently issued an opinion in which it suggested a willingness to adopt a position that “controlling” minority shareholders owe a fiduciary duty to their fellow minority shareholders.[1]
The case arose out of a transaction between Reynolds American, Inc. (“Reynolds American”) and Lorillard, Inc. (“Lorillard”), funded in part by shares purchased by Reynolds American’s largest shareholder, British American Tobacco, p.l.c. (“British American”). Reynolds American was formed in 2004 when R.J. Reynolds Tobacco Company acquired British American’s United States subsidiary. British American obtained a forty-two percent (42%) stake in the newly formed Reynolds American. At that time, Reynolds American and British American entered into a Governance Agreement that provided, among other things, British American would purchase no more shares of Reynolds American for a period of ten (10) years (expiring July 30, 2014) and British American was precluded from exercising its voting power to control the election of a majority of the Reynolds American board.
In 2013, British American and Reynolds American began discussing a possibility of an acquisition of Lorillard by Reynolds American. British American indicated that it would be willing to finance part of the transaction to maintain its forty-two percent ownership. On July 15, 2014, Reynolds American and Lorillard executed a merger agreement. Reynolds American acquired Lorillard for cash and stock at the current value of $68.88 per Lorillard share, and Lorillard shareholders received $50.50 in cash and 0.2909 of a Reynolds American share for each Lorillard share they held. British American purchased additional shares to maintain its forty-two percent ownership at $60.16 per share.
Plaintiff Robert Corwin (“Corwin”) brought a putative class action suit on behalf of Reynolds American’s other minority shareholders contending, among other things, a breach of fiduciary duty against British American for their share purchase price being unfair to the other Reynolds American shareholders. As a general rule, shareholders do not owe a fiduciary duty to each other or to the corporation. However, North Carolina courts have recognized that a controlling majority shareholder, at least in closely held corporations, owes a fiduciary duty to minority shareholders, who can bring a direct claim for breach of that duty. North Carolina courts have considered, but never squarely addressed, whether a minority shareholder of a corporations shares can exercise dominion and control over the corporation such that imposing a fiduciary duty is necessary.
In this case, the dominant issue was whether British American controlled Reynolds American with relation to the transaction, even though it owned only a minority share of Reynolds American. British American contended that North Carolina precedent favored a bright-line, straightforward numerical (50% or more) test of majority ownership before imposing a fiduciary duty on shareholders. Corwin argued North Carolina precedent should be more flexible, and the facts should turn on a shareholder’s dominance and control over the company, which can exist without majority ownership or voting control. In support of his argument, Corwin presented the court with a litany of Delaware cases finding that control can be exercised with an ownership level significantly below fifty percent.
The court thoroughly review North Carolina and Delaware law. Its decision turned on the fact that, in the Delaware cases, when transactions were controlled by the corporation’s board, Plaintiff’s were able to show actual domination and control over the board. The Delaware courts used a test that turned on not a single indicator of control, but rather various factors in addition to the percentage of ownership.
The Business Court rejected British American’s bright-line approach, reasoning that its rigidity had the potential for abuse and possible far-reaching consequences. While the court was persuaded by Corwin’s argument, it determined Corwin had not alleged facts sufficient to support a finding of actual, rather than potential, control of the transaction at issue. The court found that while the desire of Reynolds American’s board to continue its relationship with British American may have strongly influenced and shaped the transaction, “extraordinary limitations” on British American were also created by the Governance Agreement, specifically the restrictions on British American’s inability to elect a majority of Reynolds American’s board. Consequently, Corwin’s lawsuit was dismissed for failing to adequately allege that British American’s control over the transaction was considerable enough to be the voting and managerial equivalent of a majority shareholder’s control.
[1] Corwin v. British Am. Tobacco p.l.c., No. 14-CVS-8130, 2015 NCBC 74 (August 4, 2015).
