You Could Be Damned if you Fire an Employee-Stockholder in a Small Business

Posted: November 9, 2011 in Hiring and Firing, Shareholder Rights

Massachusetts is an employment at will state, so you can surely fire an employee who has no contract for a term if you have just cause to do so, right? If that employee is a stockholder in a close corporation, the answer may well be no. This is a not well-known area of law, and lawyers can easily make mistakes in this area.

Let’s start with general principles. A “close corporation” is usually a smaller business, such as a family business, with a small number of shareholders where the stock is not publicly traded and there is no ready market for the stock and substantial stockholder participation. A great many smaller businesses will qualify as close corporations.

In Massachusetts at least, a stockholder in a close corporation may have a reasonable expectation of continued employment in the business. This is a question of fact, but if the stockholder either invested in the corporation with the understanding of continued employment, or stayed employed with the expectation of continued employment, then the minority stockholder has certain rights to continued employment. The same is true for partnerships, LLC’s and other business entities where the employee holds an equitable interest in the company.

These cases present a special circumstance of the intersection between employment and business/corporate law. Even for those of us who practice substantially in both employment law and business litigation, the cases can be factually and legally challenging. There are often substantial emotional issues involved, as many close corporations involve family businesses or close friends who are shareholders.

Having a reasonable expectation of employment doesn’t mean that a stockholder employee can never be fired. But, there must be a business purpose for the termination. This is a higher standard than just cause. The controlling stockholders have a fiduciary duty of the utmost good faith and fair dealing to a minority stockholder. In addition to having a business purpose for the termination, the controlling stockholders must consider less harmful alternatives to termination. There is no laundry list of less-harmful alternatives, as every factual scenario is distinct. The less-harmful alternatives which must be considered depends on the business purpose for the termination. For example, if the business purpose for the firing is that the employee is not getting along with other employees, less harmful alternatives could include job-coaching or counseling, moving the employee off-site, etc.

The takeaway is that the attorney representing the close corporation which intends to fire a minority shareholder must proceed with great care. It may well be malpractice to advise the close corporation that it can terminate a minority shareholder – even when the minority shareholder has committed some misconduct and is an employee at will – without identifying the business purpose and advising the client to fully explore less harmful alternatives.

If you are the controlling owner of a small business and you are having trouble with a stockholder, call me to discuss your options and obligation. If you are a minority shareholder and you have been terminated, or suspect that you are about to be terminated, I may be able to help you as well (as long as there is no conflict). We have successfully represented both controlling shareholders and minority owners. As always, the above is general information and not legal advice.

By Adam P. Whitney 617.338.7000.

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