Background; "It’s alive! It's alive!" The Corporation as a Separate Being
Under North Carolina and federal law (as well as the law of virtually all, if not all, states), a corporation is a legal entity separate from its owners (i.e., its shareholders). While shareholders own the corporation by holding stock in it, they don't control the daily operations of the corporation. They have only very limited rights to vote on structural issues that directly affect the value of their shares (such as the issuance of more shares which will necessarily dilute their ownership interests) and to vote on who will be the directors of the corporation.
But a shareholder has only limited access to the records of the corporation, and cannot bind the corporation to a contract or impose liability on the corporation by the shareholder's own actions. Simply put, a shareholder cannot go out in the world and claim to be the corporation or an agent acting for the corporation, and does not, as a shareholder, have any apparent authority to act on behalf of the corporation. For example, a shareholder of General Motors does not have the power or right to sell a plant belonging to the corporation, no matter how many shares the shareholder owns.
The day-to-day control of a corporation belongs to the corporation's directors and officers. In return for giving them that power, the law imposes upon the directors and officers a fiduciary duty to put the interests of the corporation above their own self-interests.
But what if the shareholder is a sole shareholder who owns all of the corporation's stock? Since the sole shareholder will decide who the officers and directors of the corporation will be without having to confer with anyone else, and may even decide to exercise those roles personally, should the shareholder be held to have the same fiduciary duty to the corporation as is imposed on an independent director or officer?
The North Carolina Court of Appeals has recently decided that issue and its decision might surprise you.
The T-WOL Case
In May, the North Carolina Court of Appeals issued a ruling in a case entitled T-WOL Acquisition Co., Inc. v. ECDG South, LLC, and addressed the distinction between multiple shareholders of a corporation and a sole shareholder.
Upon the creation of T-WOL Acquisition Company, Inc. ("T-WOL"), which was intended to be a real estate development company, Shareholder transferred some of Shareholder's personally-owned real property to T-WOL. Unfortunately, T-WOL was unsuccessful in developing the real estate and, at a time when Shareholder owned all of the stock of T-WOL, Shareholder took it upon himself to transfer some of that real estate to another corporation owned by Shareholder.
At the time of the transfer of the real estate out of T-WOL, the plaintiff was not a shareholder of T-WOL, but allegedly claimed to be a director or officer of T-WOL, perhaps together with a business partner of the plaintiff. The plaintiff attempted to undo the transfer of the real property from T-WOL by Shareholder by challenging Shareholder's right to dispose of the corporate asset, and alleged that Shareholder's actions constituted a breach of the fiduciary duty that Shareholder owed to the corporation. (Although a question arose as to whether the plaintiff was a director of T-WOL, the Court of Appeals determined that this question was irrelevant.)
The Court's Decision
In considering the claims of the plaintiff, the North Carolina Court of Appeals addressed the issue of whether a sole shareholder has the right to dispose of corporate assets because, if a sole shareholder has this right, Shareholder, therefore, could not have breached a fiduciary duty to T-WOL even if Shareholder owed such a duty to the corporation.
The Court acknowledged that there was no law in North Carolina addressing this issue. However, it pointed out that the North Carolina Supreme Court has held that, contrary to the situation where a corporation has multiple shareholders (and, thus, owners), a sole shareholder has the power to act on behalf of the corporation and bind the corporation to contracts and other obligations, even without official corporate authority or action.
Based on the Supreme Court case and cases from other states that had addressed the issue, the Court of Appeals held that a sole shareholder may properly dispose of corporate assets as the shareholder sees fit, except when such an act harms or defrauds a creditor of the corporation or violates public policy. Therefore, Shareholder's actions could not be the basis for a breach of fiduciary duty claim or even a usurpation of a corporate opportunity claim because Shareholder had the right to take such actions. In essence, Shareholder became the sole director of T-WOL and the only person beneficially interested in the affairs of the corporation.
Limitation on T-WOL
It is important for sole shareholders of corporations to note that, despite what looks to be a new theory of the North Carolina law of corporations recognizing power unique to sole shareholders, the T-WOL decision does not change the overriding principles of corporate formalities. In order for a sole shareholder to retain the limited liability protections afforded to shareholders of a corporation in North Carolina, the sole shareholder will still need to adhere closely to the required corporate formalities, such as appointment of a board of directors, holding of the annual and special meetings of shareholders (yes, even just the one), maintenance of a separate bank account for the corporation, and the filing of tax returns. If the proper formalities are not maintained and the sole shareholder fails to honor the separate legal existence of that shareholder's corporation, there is a real risk that the law will likewise ignore the separate existence of the corporation, and the liabilities of the corporation could become the liabilities of the sole shareholder. Maintaining the corporate formalities is neither hard nor expensive. But a sole shareholder must remember that they must be maintained in order for the sole shareholder to continue to enjoy the overarching benefit of doing business through a corporation – freedom from personal liability for the actions of the corporation.
The T-WOL case has recognized the power and right of a sole shareholder to deal with the corporation's property as the sole shareholder desires. However, a sole shareholder would do well to continue to honor the corporate formalities and appoint a director (even if it is the sole shareholder, but preferably a good friend or advisor); keep the corporate books up to date with minutes of properly-held corporate meetings, decisions, and actions; and, especially, keep the financial records of the corporation separate from those of the sole shareholder.
© 2020 Ward and Smith, P.A.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.