Recently in Shareholder Contracts Category

March 20, 2014

No Breach of Fiduciary Duty by Corporate Shareholder Who Opened Similar Business

In Ricci Consultants, Inc. v. Bournival, a case recently tried in the Norfolk Superior Court, it was determined that a defendant did not breach a fiduciary duty when she left employment with Ricci Consultants, Inc. (RCI), an actuarial consulting firm in which she was a shareholder with a one-third interest, to start her own actuarial consulting firm, KMS Actuaries, Inc. (KMS). Although both firms provided actuarial consulting services for clients, the types of clients each firm serviced differed: RCI specialized in private sector work, while KMS focused on the public sector. Following the defendant's departure from RCI, both parties filed suit against each other, both alleging intentional interference with contractual/advantageous relations with customers, and breaches of fiduciary duties. A jury returned verdicts in favor of the defendant and KMS on the intentional interference claims. The parties waived their right to have a jury decide the breach of fiduciary duty claim, which the judge considered.

RCI alleged that the defendant, through KMS, competed with RCI and thereby stole corporate opportunities from KMS, to which she owed fiduciary duties. In doing so, RCI alleged that the defendant breached her duty of loyalty owed to RCI.

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December 26, 2012

Shareholder Derivative Suit Barred by Three-Year Statute of Limitations and Business Judgment Rule


In Clay v. J.L. Hammett Co., a case recently reviewed by the Massachusetts Appeals Court, the officers, directors, and majority shareholders of the J.L. Hammett & Company, a closely-held corporation, decided to sell a large share of the company to School Specialty, Inc. for $81 million. Prior to the sale, the company's board voted to pay almost $3 million to two of the company's officers and directors for a five-year noncompetition agreement, as well as over $4 million in bonuses to the officers and directors. Thereafter, the estates of two shareholders brought a shareholder derivative suit against the officers and directors, claiming that, by failing to disclose these payments to the shareholders, the defendants breached their fiduciary duty, and therefore the monies diverted to the defendants through these payments belonged to the company and all the shareholders.

Evidence suggested that the plaintiff-shareholders did in fact receive notice of the noncompetition payments, through a letter to the shareholders, which included a balance sheet, and through the defendant's testimony that he personally spoke with the plaintiff-shareholders regarding the noncompetition agreement payments.

The superior court granted the defendants' motion for summary judgment on two grounds. First, the shareholder derivative suit was moot because it was filed outside of the applicable three-year statute of limitations period. Second, the court found no breach of fiduciary duty, on the basis that the defendants, as the majority interests in a close corporation, had great discretion in setting the compensation rates of corporate officers.

The Massachusetts Appeals Court affirmed the superior court's grant of summary judgment, agreeing that the case was barred by the statute of limitations. The Appeals Court further noted that a failure to disclose the noncompetition agreement payments prior to the shareholders' vote did not violate the business judgment rule. Finally, the Appeals Court noted that the plaintiffs' experts agreed that the bonuses were reasonable and did not exceed amounts generally paid for these types of corporate transactions.

March 8, 2012

The Battle Between Fiduciary Duties and Shareholder Contracts

In Massachusetts, majority shareholders in a close corporation owe certain fiduciary duties to minority shareholders, including a duty of utmost good faith and loyalty. However, since the decision in Blank v. Chelmsford OB/GYN, P.C. (1995), Massachusetts also allows majority shareholders to circumvent these fiduciary duties if the parties agree to terms that conflict with these duties in an employment contract or stock buy-back agreement.

In Blank, the majority shareholders terminated the plaintiff's employment on the basis that, under the plaintiff's employment agreement and stock repurchase agreement, he could be terminated without cause upon six months' notice and the repurchase of his shares at book value. Although such termination would typically be a violation of the majority shareholders' fiduciary duties to the plaintiff as a minority shareholder, the Court found the termination to be proper because it was done in compliance with the terms of the contracts to which the plaintiff had agreed at the outset of the parties' relationship. The terms of the agreements superseded the majority's fiduciary duties to the plaintiff, and there was no breach of fiduciary duty.

Since the Blank decision, Massachusetts law has specified important limitations upon the application of Blank. A recent Massachusetts Lawyers Weekly article highlighted such limitations on these "contractually-sanctioned freeze-outs."

For the majority shareholders to be free of liability when exercising contractual "freeze-out" rights, the action by the majority must fall entirely within the scope of the cited agreement. In other words, it must be clear that the challenged action is permissible under the terms of the contract. In addition, the shareholders participating in the complained-of conduct must have complied with the covenant of good faith and fair dealing at the time the agreement permitting the conduct was executed. This represents a lower standard than the duty of utmost good faith and loyalty to fellow shareholders, but still requires that shareholders "act fairly."

The majority must also still comply with the duty of utmost good faith and loyalty in their actions leading up to the exercise of their "freeze-out" rights under the contract. Otherwise, even if the ultimate action is permissible under the agreement, the conduct preceding that ultimate action may still constitute a breach of fiduciary duty. Similarly, the majority must not put their contractual "freeze-out" rights to use in a manipulative manner.

Finally, the majority may be required to employ actions that are "less harmful alternatives" to termination of a minority shareholder-employee. For example, where a minority shareholder is alleged to have engaged in conduct that his employment agreement considered grounds for termination, the majority shareholders may not terminate him under the agreement unless they first attempt to resolve the allegations by less drastic measures.

Should any of the above-referenced circumstances not exist, the majority may be found liable for breach of fiduciary duty to the minority shareholder, despite a good faith belief that they were exercising their rights under a valid agreement.