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Legal Memorandum: Shareholder's Fiduciary Duty in MN

Issue: Under Minnesota law, does a shareholder’s fiduciary duty to other shareholders of a closely held corporation prevent the shareholder from selling his or her stock to a corporate buyer, notwithstanding the effect of the sale on the corporation’s subchapter S status?

Area of Law: Corporate & Securities, Litigation & Procedure
Keywords: Shareholder's fiduciary duty; Sale of shares; Corporation's subchapter S status
Jurisdiction: Minnesota
Cited Cases: 303 F.3d 11; 128 F.3d 1; 489 N.W.2d 798; 308 N.W.2d 709; 602 S.W.2d 143; 837 F. Supp. 130
Cited Statutes: None
Date: 05/01/2004

There are no Minnesota authorities that support a finding that the shareholder may not sell his or her stock and imperil the corporation’s Subchapter S status.  In the First Circuit case of A.W. Chesterton Co. v. Chesterton, 128 F.3d 1 (1st Cir. 1997), which was decided under the law of Massachusetts, a minority shareholder of an S corporation was admittedly found to have consented to the corporation’s Subchapter S election.  The First Circuit found it to be implicit in this consent that there was a general understanding among the shareholders that they would never take any action that would adversely affect the corporation’s Subchapter S status.  The First Circuit referred to no evidence whatsoever supporting this implicit understanding, and pointed to no precedent establishing that this vague understanding, if it existed, was irrevocable. 

It is also noteworthy that in Chesterton, reference is made to the fact that the defendant therein was not able to offer evidence that he would suffer from “phantom income.”  Id. at 3 n.1.  Phantom income describes the liability of a shareholder of a Subchapter S corporation for taxes on his share of the corporation’s profits, even if those profits are not distributed to the shareholders as dividends.  The absence of evidence on this point was raised by the First Circuit in Chesterton as a reason for the finding that the defendant’s actions therein were unjustified and a breach of fiduciary duty. 

Chesterton is not the only reported decision […]

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