[Readers: Set forth below is my analysis of another aspect of terminations in closely held companies. To spare you the need to scroll down the Blog to find the question, I have reprinted it below. Regards, Roy]

QQ # 143:

I read with interest your analysis of QQ # 140, dealing with closely held corporations. We are in a similar situation, though we have the sticky additional issue you referenced of the matter involving a family member. This person claims she is entitled to "lifetime" employment. Given that she's only in her late 40s, that's a daunting prospect. Moreover, as her siblings will attest (if forced), she simply is not competent. Does the company really have to employ her for the next several decades?

Analysis:

As I referenced in Quirky Question # 140, issues involving employment in closely held corporations are especially difficult when the employee involved is an owner/shareholder. Those problems are exacerbated when the person employed is a member of the family that owns the closely held company, and is an owner/shareholder herself.

As previously addressed, the rights and responsibilities of the employer and employee alike depend on the closely held corporation law of the state in question, the decisions of your state court on these types of issues, and the particular facts of your situation. Given that many of these cases involve fundamental issues of equity, courts scrutinize the specific factual circumstances underlying the dispute.

For example, in a seminal Minnesota case, Pedro v. Pedro, 489 N.W.2d 798 (Mn. Ct. App. 1992), a dispute arose among three brothers, each one-third owners of the family’s luggage and leather products company. All three brothers had worked for the company for most of their adult lives. Each brother, as an equal shareholder, received the same benefits and compensation as the others, and had an equal vote in the company’s management.

The relationship among the brother deteriorated when Alfred Pedro discovered an “apparent discrepancy” of nearly $330,000 between the internal accounting records and the company’s checking account. The dispute regarding the missing funds resulted in the two other brothers, Carl and Eugene, firing Alfred. When Carl and Eugene fired Alfred, they discontinued his pay and benefits. They also informed other employees that Alfred had had a nervous breakdown, which was not true.

The trial court found that Alfred was entitled to $766,582 as damages for his one-third ownership of the company, and another $58,260 in prejudgment interest on that award. The court also awarded Alfred $563,417 on the ground that his brothers had breached their fiduciary duties to him, as well as an additional $68,690 in prejudgment interest on that part of the award. In addition, the trial court found that Alfred had a contract of lifetime employment and that he had been wrongfully terminated; this finding resulted in an additional award of $256,740, plus $31,750 more in prejudgment interest. The damages for lifetime employment constituted lost wages that Alfred would have received had he worked until age 72. Finally, the court awarded the plaintiff his attorneys’ fees.

The appellate court began its analysis by emphasizing that the “relationship among shareholders in closely held corporations is analogous to that of partners.” Id. at 801 (citations omitted)(“close corporation has been described as partnership in corporate guise”). As ‘partners,’ the shareholders owed each other a fiduciary duty, a relationship that imposed upon them “the highest standards of integrity and good faith in their dealings with each other,” and the obligation to treat each other “openly, honestly and fairly.” Id. (citations omitted).

The appellate court found that there was ample evidence to support the trial court’s finding of a breach of fiduciary duty. The two defendant brothers had not paid Alfred the monies owed pursuant to the shareholders’ agreement, interfered with his execution of his job responsibilities, hired a private investigator to follow him when he was not in the office, threatened to fire him if he did not stop inquiring about the missing funds, fabricated reasons to justify his termination, and falsely represented to other employees that he had had a nervous breakdown. The court found that this conduct did not comport with the defendants’ obligation to treat Alfred openly, honestly and fairly.

With respect to the trial court’s finding that the plaintiff was entitled to damages for “lifetime” employment (through age 72), again the appellate court affirmed. The Court of Appeals found that “[t]he unique facts in the record support the trial court’s finding of an agreement to provide lifetime employment to respondent.” Id. at 803. The appellate court noted that Carl Pedro, Sr., had worked for the company until his death. Eugene Pedro (one of the defendants) had worked for the company for more than 50 years and Carl Pedro, Jr. had worked for the company for over 34 years. At the time of his discharge, Alfred already had worked for the company for 45 years. Given this pattern of longevity, the Court of Appeals found that it was reasonable for the trial court to determine that the plaintiff’s employment was NOT terminable at will.

As the Pedro case illustrates, in certain circumstances, an owner/shareholder may be able to make a persuasive argument that she is entitled to lifetime employment. Clearly, in the closely held corporation context, general principles of at will employment do not apply. Integrity, good faith, honesty and fairness are the touchstone principles that govern the treatment of an owner/shareholder employee.

Subsequent generations of owner/employees, however, may not be in precisely the same position as a company’s founding members. As one New York court observed when confronted with a family member/owner/employee who left a closely held company after having been caught stealing from the business, “Even if an original participant had had a reasonable expectation of personal employment, after his death the surviving shareholders would not be bound to employ any dolt who happened to inherit his stock.” Gimpel v. Bolstein, 477 N.Y.S.2d 1014, 1019 n.6 (Sup. Ct. 1984). The court went on to note that the then-current owners, two generations removed from the founders, “cannot fairly be said [to have] entered into the business with the same ‘reasonable expectations’ as partners do.” Id.

Finally, in your question you state that your employee is not competent. Although privately held companies must ensure that shareholder/owner employees are treated with care, this does not mean that closely held corporations have no flexibility with respect to incompetent employees or employees who have engaged in wrongful conduct. Depending on the nature and severity of your employee’s incompetence, your firm may be positioned to take appropriate disciplinary action against her, up to and including discharge. It is important, however, that your company afford her appropriate procedural safeguards so she cannot make an argument that the company trampled upon her rights. (This topic was covered in the recent QQ # 140, so you may wish to review that analysis if the bases for discharge are