Professor Andrej Thomas Starkis


Smith v. Atlantic Properties, Inc. 627



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Smith v. Atlantic Properties, Inc. 627

Paul T. SMITH et al.[FN1] 627

FN1. Lillian Zimble, executrix of the will of Abraham Zimble, and Louis Zimble. William H. Burke was originally a plaintiff. Prior to his death, Atlantic Properties, Inc., purchased Burke's stock in the corporation and it is now held as treasury stock. Mr. Abraham Zimble, while still living, sold twelve shares to Louis Zimble. 627

v. 627

ATLANTIC PROPERTIES, INC. et al.[FN2] 627

FN2. Dr. Louis E. Wolfson. 627

Appeals Court of Massachusetts, Suffolk. 627

Argued April 10, 1981. 627

Decided July 6, 1981. 627

*202 CUTTER, Justice. 627

In December, 1951, Dr. Louis E. Wolfson agreed to purchase land in Norwood for $350,000, with an initial cash payment of $50,000 and a mortgage note of $300,000 payable in thirty-three months. Dr. Wolfson offered a quarter interest each in the land to Mr. Paul T. Smith, Mr. Abraham Zimble, and William H. Burke. Each paid to Dr. Wolfson $12,500, one quarter of the initial payment. Mr. Smith, an attorney, organized the defendant corporation (Atlantic) in 1951 to operate the real estate. Each of the four subscribers received twenty-five shares of stock. Mr. Smith included, both in the corporation's articles of organization and in its by-laws, a provision reading, "No election, appointment or resolution by the Stockholders and no election, appointment, resolution, purchase, sale, lease, contract, contribution, compensation, proceeding or act by the Board of Directors or by any officer or officers shall be valid or binding upon the corporation until effected, passed, approved or ratified by an affirmative vote of eighty (80%) per cent of the capital stock issued outstanding and entitled to vote." This provision (hereafter referred to as the 80% provision) was included at Dr. Wolfson's request and had the effect of giving to any one of the four original shareholders a veto in corporate decisions 627

Atlantic purchased the Norwood land. Some of the land and other assets were sold for about $220,000. Atlantic retained twenty-eight acres on which stood about twenty old brick or wood mill-type structures, which required expensive and constant repairs. After the first year, Altantic became profitable and showed a profit every year prior to 1969, ranging from a low of $7,683 in 1953 to a high of $44,358 in 1954. The mortgage was paid by 1958 and Atlantic has incurred no long-term debt thereafter. **800 Salaries *203 of about $25,000 were paid only in 1959 and 1960. Dividends in the total amount of $10,000 each were paid in 1964 and 1970. By 1961, Atlantic had about $172,000 in retained earnings, more than half in cash 627

For various reasons, which need not be stated in detail, disagreements and ill will soon arose between Dr. Wolfson, on the one hand, and the other stockholders as a group.[FN3] Dr. Wolfson wished to see Atlantic's earnings devoted to repairs and possibly some improvements in its existing buildings and adjacent facilities. The other stockholders desired the declaration of dividends. Dr. Wolfson fairly steadily refused to vote for any dividends. Although it was pointed out to him that failure to declare dividends might result in the imposition by the Internal Revenue Service of a penalty under the Internal Revenue Code, I.R.C. s 531 et seq. (relating to unreasonable accumulation of corporate earnings and profits), Dr. Wolfson persisted in his refusal to declare dividends. The other shareholders did agree over the years to making at least the most urgent repairs to Atlantic's buildings, but did not agree to make all repairs and improvements which were recommended in a 1962 report by an engineering firm retained by Atlantic to make a complete estimate of all repairs and improvements which might be beneficial. 628

FN3. At least one cause of ill will on Dr. Wolfson's part may have been the refusal of the other shareholders to consent to his transferring his shares in Atlantic to the Louis E. Wolfson Foundation, a charitable foundation created by Dr. Wolfson. 628

The fears of an Internal Revenue Service assessment of a penalty tax were soon realized. Penalty assessments were made in 1962, 1963, and 1964. These were settled by Dr. Wolfson for $11,767.71 in taxes and interest. Despite this settlement, Dr. Wolfson continued his opposition to declaring dividends. The record does not indicate that he developed any specific and definitive schedule or plan for a series of necessary or desirable repairs and improvements to Atlantic's properties. At least none was proposed which *204 would have had a reasonable chance of satisfying the Internal Revenue Service that expenditures for such repairs and improvements constituted "reasonable needs of the business," I.R.C. s 534(c), a term which includes (see I.R.C. s 537) "the reasonably anticipated needs of the business." Predictably, despite further warnings by Dr. Wolfson's shareholder colleagues, the Internal Revenue Service assessed further penalty taxes for the years 1965, 1966, 1967, and 1968. These taxes were upheld by the United States Tax Court in Atlantic Properties, Inc. v. Commissioner of Int. Rev., 62 T.C. 644 (1974), and on appeal in 519 F.2d 1233 (1st Cir. 1975). See the discussion of these opinions in Cathcart, Accumulated Earnings Tax: A Trap for the Wary, 62 A.B.A.J. 1197-1199 (1976). An examination of these decisions makes it apparent that Atlantic has incurred substantial penalty taxes and legal expense largely because of Dr. Wolfson's refusal to vote for the declaration of sufficient dividends to avoid the penalty, a refusal which was (in the Tax Court and upon appeal) attributed in some measure to a tax avoidance purpose on Dr. Wolfson's part 628

On January 30, 1967, the shareholders, other than Dr. Wolfson, initiated this proceeding in the Superior Court, later supplemented to reflect developments after the original complaint. The plaintiffs sought a court determination of the dividends to be paid by Atlantic, the removal of Dr. Wolfson as a director, and an order that Atlantic be reimbursed by him for the penalty taxes assessed against it and related expenses. The case was tried before a justice of the Superior Court (jury waived) in September and October, 1979 628

The trial judge made findings (but in more detail) of essentially the facts outlined above and concluded that Dr. "Wolfson's obstinate refusal to vote in favor of ... dividends was ... caused more by his dislike for other stockholders and his desire to avoid additional tax payments than ... by any genuine desire to undertake a program for improving ... (Atlantic) property." She also determined that Dr. Wolfson was **801 liable to Atlantic for taxes and interest *205 amounting to "$11,767.11 plus interest from the commencement of this action, plus $35,646.14 plus interest from August 11, 1975," the date of the First Circuit decision affirming the second penalty tax assessment. The latter amount includes an attorney's fee of $7,500 in the Federal tax cases. She also ordered the directors of Atlantic to declare "a reasonable dividend at the earliest practical date and reasonable dividends annually thereafter consistent with good business practice." In addition, the trial judge directed that jurisdiction of the case be retained in the Superior Court "for a period of five years to (e)nsure compliance." Judgment was entered pursuant to the trial judge's order. After the entry of judgment, Dr. Wolfson and Atlantic filed a motion for a new trial and to amend the judge's findings. This motion, after hearing, was denied, and Dr. Wolfson and Atlantic claimed an appeal from the judgment and the former from the denial of the motion. The plaintiffs (see note 1, supra) requested payment of their attorneys' fees in this proceeding and filed supporting affidavits. The motion was denied, and the plaintiffs appealed 628

1. The trial judge, in deciding that Dr. Wolfson had committed a breach of his fiduciary duty to other stockholders, relied greatly on broad language in Donahue v. Rodd Electrotype Co., 367 Mass. 578, 586-597, 328 N.E.2d 505 (1975), [FN4] in which the Supreme Judicial Court afforded to a minority stockholder in a close corporation equality of treatment (with members of a controlling group of shareholders) in the matter of the redemption of shares. The court (at 592-593, 328 N.E.2d 505) relied on the resemblance of a close corporation to a partnership and held that "stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another" *206 (footnotes omitted). That standard of duty, the court said, was the "utmost good faith and loyalty." The court went on to say that such stockholders "may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation." Similar principles were stated in Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842, 848-852, 353 N.E.2d 657 (1976), but with some modifications, mentioned in the margin,[FN5] of the sweeping language of the Donahue case. See Jessie v. Boynton, 372 Mass. 293, 304, 361 N.E.2d 1267 (1977); Hallahan v. Haltom Corp., 7 Mass.App. 68, 70-71, 385 N.E.2d 1033 (1979). See also Cain v. Cain, 3 Mass.App. 467, 473-479, 334 N.E.2d 650 (1975). 629

FN4. Mr. Justice Wilkins (concurring at 604, 328 N.E.2d 505) expressed agreement "with much of what the" majority opinion said in favor of granting relief. He declined, however, to "join in any implication" that certain statements in the opinion applied "to all operations of ... (a close) corporation as they affect minority stockholders." 629

FN5. The court said (at 850-852, 353 N.E.2d 657) that it was "concerned that (the) untempered application of the strict good faith standard ... will result in the imposition of limitations on legitimate action by the controlling group in a close corporation which will unduly hamper its effectiveness .... The majority ... have certain rights to what has been termed 'selfish ownership' in the corporation which should be balanced against the concept of their fiduciary obligation to the minority .... (W)hen minority stockholders ... bring suit ... alleging a breach of the strict good faith duty ... we must carefully analyze the action taken by the controlling stockholders in the individual case. It must be asked whether the controlling group can demonstrate a legitimate business purpose for its action .... (T)he controlling group in a close corporation must have some room to maneuver in establishing the business policy of the corporation. It must have a large measure of discretion, for example, in declaring or withholding dividends" (emphasis supplied) and in certain other matters. "When an asserted business purpose ... is advanced by the majority, however, ... it is open to minority stockholders to demonstrate that the ... objective could have been achieved through an alternative course ... less harmful to the minority's interest." 629

In the Donahue case, 367 Mass. at 593 n. 17, 328 N.E.2d 505, the court recognized that cases may arise in which, in a close corporation, majority stockholders may ask protection from a minority stockholder. **802 Such an instance arises in the present case because Dr. Wolfson has been able to exercise a veto concerning corporate action on dividends by the 80% provision (in Atlantic's articles or organization and by-laws) already quoted. The 80% provision may have substantially the effect of reversing the usual roles of the majority and *207 the minority shareholders. The minority, under that provision, becomes an ad hoc controlling interest.[FN6] 630

FN6. The majority shareholders, in the event of a deadlock, at least may seek dissolution of the corporation if forty percent of the voting power can be mustered, whereas a single stockholder with only twenty-five percent of the stock may not do so. See G.L. c. 156B, s 99(b), as amended by St.1969, c. 392, s 23. 630

It does not appear to be argued that this 80% provision is not authorized by G.L. c. 156B (inserted by St.1964, c. 723, s 1). See especially s 8(a). See also Seibert v. Milton Bradley Co., --- Mass. ---, --- - ---,[FNa] 405 N.E.2d 131 (1980). Chapter 156B was intended to provide desirable flexibility in corporate arrangements.[FN7] The provision is only one of several methods which have been devised to protect minority shareholders in close corporations from being oppressed by their colleagues and, if the device is used reasonably, there may be no strong public policy considerations against its use. See 1 O'Neal, Close Corporations s 4.21 (2d ed. 1971 & Supp.1980). The textbook just cited contains in ss 4.01-4.30 a comprehensive discussion of the business considerations (see especially ss 4.02, 4.03, 4.06, & 4.24) which may recommend use of such a device. See also 2 O'Neal s 8.07 (& Supp. 1980 which, at 84-90, discusses the Massachusetts decisions). In the present case, Dr. Wolfson testified that he requested the inclusion of the 80% provision "in case the people (the other shareholders) whom I knew, but not very well, ganged up on me." The possibilities of shareholder disagreement on policy made the provision seem a sensible precaution.[FN8] A question is presented, however, concerning the extent to which such a veto power possessed by a minority *208 stockholder may be exercised as its holder may wish, without a violation of the "fiduciary duty" referred to in the Donahue case, 367 Mass. at 593, 328 N.E.2d 505, as modified in the Wilkes case. See note 5, supra. 630

FNa. Mass.Adv.Sh. (1980) 1235, 1237-1241. 630

FN7. See, e. g., Hosmer, New Business Corporation Law, 1964 Ann. Survey of Mass.Law ss 1.1-1.12; Casey, The New Business Corporation Law, 50 Mass.L.Q. (No. 3) 201 (1965); and Boston Bar Assn., Summary of Principal Changes Made by ... Chapter 156B (1964), reprinted as an appendix in Mass.Gen.Laws Ann., at 429. 630

FN8. Dr. Wolfson himself had discovered the business opportunity which led to the formation of Atlantic, had made the initial $50,000 payment which made possible the Norwood land purchase, and had given the other shareholders an opportunity to share with him in what looked like a probably profitable enterprise. It was reasonably foreseeable that there might be differences of opinion between Dr. Wolfson, a man with substantial income likely to be in a high income tax bracket, and less affluent shareholders on such matters of policy as dividend declarations, salaries, and investment in improvements in the property. The other shareholders, two of whom were attorneys, should have known that it was as open to Dr. Wolfson reasonably to exercise the veto provided to him by the 80% provision in favor of a policy of reinvestment of earnings in Atlantic's properties, which would probably avoid taxes and increase the value of the corporate assets, as it was for them (possessed of the same veto) to use reasonably their voting power in favor of a more generous dividend and salary policy. 630

The decided cases in Massachusetts do little to answer this question. The most pertinent guidance is probably found in the Wilkes case, 370 Mass. at 849- 852, 353 N.E.2d 657, (see note 5, supra), essentially to the effect that in any judicial intervention in such a situation there must be a weighing of the business interests advanced as reasons for their action (a) by the majority or controlling group and (b) by the rival persons or group.[FN9] It would obviously be **803 appropriate, before a court-ordered solution is sought or imposed, for both sides to attempt *209 to reach a sensible solution of any incipient impasse in the interest of all concerned after consideration of all relevant circumstances. See Helms v. Duckworth, 249 F.2d 482, 485-488 (D.C.Cir.1957) 630

FN9. The duties and quasi-fiduciary responsibilities of minority shareholders who find themselves in a position to control corporate action are discussed helpfully in Hetherington, The Minority's Duty of Loyalty in Close Corporations, 1972 Duke L.J. 921. The author recognizes (at 944) that, in disputes concerning the wisdom of a particular course of corporate action, the majority (or the ad hoc controlling minority) shareholder may be entitled to follow the course he or it thinks best. 631

The author concludes (at 946) with the general view: "In spite of the ... imprecision of such criteria for evaluating commercial behavior as good faith, commercial reasonableness, and unconscionability, the courts have moved toward imposing minimum requirements of fair dealing in nonfiduciary business situations. The similarly imprecise concept of fiduciary responsibility, at least as applied to majority shareholders ... has clearly promoted fair dealing within business enterprises. The majority may not exercise their corporate powers in a manner which is clearly intended to be and is in fact inimical to the corporate interest, or which is intended to deprive the minority of its pro rata share of the present or future gains accruing to the enterprise. A minority shareholder whose conduct is controlling on a particular issue should be bound by no different standard." 631

2. With respect to the past damage to Atlantic caused by Dr. Wolfson's refusal to vote in favor of any dividends, the trial judge was justified in finding that his conduct went beyond what was reasonable. The other stockholders shared to some extent responsibility for what occurred by failing to accept Dr. Wolfson's proposals with much sympathy, but the inaction on dividends seems the principal cause of the tax penalties. Dr. Wolfson had been warned of the dangers of an assessment under the Internal Revenue Code, I.R.C. s 531 et seq. He had refused to vote dividends in any amount adequate to minimize that danger and had failed to bring forward, within the relevant taxable years, a convincing, definitive program of appropriate improvements which could withstand scrutiny by the Internal Revenue Service. Whatever may have been the reason for Dr. Wolfson's refusal to declare dividends (and even if in any particular year he may have gained slight, if any, tax advantage from withholding dividends) we think that he recklessly ran serious and unjustified risks of precisely the penalty taxes eventually assessed, risks which were inconsistent with any reasonable interpretation of a duty of "utmost good faith and loyalty." The trial judge (despite the fact that the other shareholders helped to create the voting deadlock and despite the novelty of the situation) was justified in charging Dr. Wolfson with the out-of-pocket expenditure incurred by Atlantic for the penalty taxes and related counsel fees of the tax cases.[FN10] 631

FN10. We do not now suggest that the standard of "utmost good faith and loyalty" may require some relaxation when applied to a minority ad hoc controlling interest, created by some device, similar to the 80% provision, designed in part to protect the selfish interests of a minority shareholder. This seems to us a difficult area of the law best developed on a case by case basis. See note 4, supra. 631

*210 3. The trial judge's order to the directors of Atlantic, "to declare a reasonable dividend at the earliest practical date and reasonable dividends annually thereafter," presents difficulties. It may well not be a precise, clear, and unequivocal command which (without further explanation) would justify enforcement by civil contempt proceedings. See United States Time Corp. v. G.E.M. of Boston, Inc., 345 Mass. 279, 282, 186 N.E.2d 920 (1963); United Factory Outlet, Inc. v. Jay's Stores, Inc., 361 Mass. 35, 36- 39, 278 N.E.2d 716 (1972). It also fails to order the directors to exercise similar business judgment with respect to Dr. Wolfson's desire to make all appropriate repairs and improvements to Atlantic's factory properties. See the language of the Supreme Judicial Court in the Wilkes case, 370 Mass. at 850- 852, 353 N.E.2d 657, see note 5, supra 631

The somewhat ambiguous injunctive relief is made less significant by the trial judge's reservation of jurisdiction in the Superior Court, a provision which contemplates later judicial supervision. We think that such supervision should be provided now upon an expanded record. The present record does not disclose Atlantic's present financial condition or what, if anything, it has done (since the judgment under review) **804 by way of expenditures for repairs and improvements of its properties and in respect of dividends and salaries. The judgment, of course, necessarily disregards the general judicial reluctance to interfere with a corporation's dividend policy ordinarily based upon the business judgment of its directors. See Crocker v. Waltham Watch Co., 315 Mass. 397, 402, 53 N.E.2d 230 (1944); Donahue v. Rodd Electrotype Co., 367 Mass. at 590, 328 N.E.2d 505, and authorities cited; 1 O'Neal, Close Corporations s 3.63a and 2 O'Neal s 8.08; Forced Dividends, 1 J.Corp.L. 420 (1976) 632

Although the reservation of jurisdiction is appropriate in this case (see Nassif v. Boston & Maine R.R., 340 Mass. 557, 566-567, 165 N.E.2d 397 (1960); Department of Pub. Health v. Cumberland Cattle Co., 361 Mass. 817, 834, 282 N.E.2d 895 (1972)), its purpose should be stated more affirmatively. Paragraph 2 of the judgment should be revised to provide: (a) a direction that Atlantic's directors prepare promptly financial statements and copies *211 of State and Federal income and excise tax returns for the five most recent calendar or fiscal years, and a balance sheet as of as current a date as is possible; (b) an instruction that they confer with one another with a view to stipulating a general dividend and capital improvements policy for the next ensuing three fiscal years; (c) an order that, if such a stipulation is not filed with the clerk of the Superior Court within sixty days after the receipt of the rescript in the Superior Court, a further hearing shall be held promptly (either before the court or before a special master with substantial experience in business affairs), at which there shall be received in evidence at least the financial statements and tax returns above mentioned, as well as other relevant evidence. Thereafter, the court, after due consideration of the circumstances then existing, may direct the adoption (and carrying out), if it be then deemed appropriate, of a specific dividend and capital improvements policy adequate to minimize the risk of further penalty tax assessments for the then current fiscal year of Atlantic. The court also may reserve jurisdiction to take essentially the same action for each subsequent fiscal year until the parties are able to reach for themselves an agreed program 632

4. The plaintiff shareholders requested an allowance for counsel fees incurred by them in accomplishing the recovery by Atlantic from Dr. Wolfson of the amounts to be paid by him. The trial judge did not state her reasons for denying the motion for such fees. Whether to grant such an allowance was within her sound discretion. See Wilson v. Jennings, 344 Mass. 608, 621, 184 N.E.2d 642 (1962), and cases cited; Cain v. Cain, 3 Mass.App. at 479, 334 N.E.2d 650; Nolan, Equitable Remedies s 244, at 366 (1975). We perceive no abuse of discretion. She was entitled to take into account the considerations mentioned in note 8, supra, and that the controversy involved issues of business judgment and somewhat novel legal questions. See note 10, supra. She also properly could give weight to (a) the circumstance that no fraud or diversion of Atlantic's assets was engaged in by Dr. Wolfson, and (b) the portions of the evidence suggesting that the plaintiffs *212 may have been in some measure responsible for the intensity of the bad feeling among the stockholders 632

5. The judgment is affirmed so far as it (par. 1) orders payments into Atlantic's treasury by Dr. Wolfson. Paragraph 2 of the judgment is to be modified in a manner consistent with part 3 of this opinion. The trial judge's denial of the plaintiff's motion to be allowed counsel fees is affirmed. Costs of this appeal are to be paid from the assets of Atlantic 633

So ordered. 633

Wilkes v. Springside Nursing Home, Inc. 633

Stanley J. WILKES 633

v. 633

SPRINGSIDE NURSING HOME, INC., et al.[FN1] 633

FN1. Barbara Quinn (executrix under the will of T. Edward Quinn), Leon L. Riche, and the First Agricultural National Bank of Berkshire County and Frank Sutherland MacShane (executors under the will of Lawrence R. Connor). 633

Supreme Judicial Court of Massachusetts, Berkshire. 633

Argued March 2, 1976. 633

Decided Aug. 20, 1976. 633

*843 HENNESSEY, Chief Justice. 633

On August 5, 1971, the plaintiff (Wilkes) filed a bill in equity for declaratory judgment in the Probate Court for Berkshire County,[FN2] naming as defendants T. Edward Quinn (Quinn),[FN3] Leon L. Riche (Riche), the First Agricultural National Bank of Berkshire County and Frank Sutherland MacShane as executors under the will of Lawrence R. Connor (Connor), **659 and the Springside Nursing Home, Inc. (Springside or the corporation). Wilkes alleged that he, Quinn, Riche and Dr. Hubert A. Pipkin (Pipkin)[FN4] entered into a partnership agreement in 1951, prior to the incorporation of Springside, which agreement was breached in 1967 when Wilkes's salary was terminated and he was voted out as an officer and director of the corporation. Wilkes sought, among other forms of relief, damages in the amount of the salary he would have received had he continued as a director and officer of Springside subsequent to March, 1967. 633

FN2. Wilkes urged the court, iter alia, to declare the rights of the parties under (1) an alleged partnership agreement entered into in 1951 between himself, T. Edward Quinn (see note 3 infra), Leon L. Riche and Dr. Hubert A. Pipkin (see note 4 infra); and (2) certain portions of a stock transfer restriction agreement exeucted by the four original stockholders in the Springside Nursing Home, Inc., in 1956. 634

FN3. T. Edward Quinn died while this action was sub judice. The executrix of his estate has been substituted as a party-defendant. See note 1 supra. 634

FN4. Dr. Pipkin transferred his interest in Springside to Connor in 1959 and is not a defendant in this action. 634

A judge of the Probate Court referred the suit to a master, who, after a lengthy hearing, issued his final report in late 1973. Wilkes's objections to the master's report were overruled after a hearing, and the master's report was confirmed in late 1974. A judgment was entered dismissing Wilkes's action on the merits. We granted direct appellate review. Mass.R.A.P. 11, 365 Mass. --- (1974). On appeal, Wilkes argued in the alternative that (1) he should recover damages for breach of the alleged partnership agreement; and (2) he should recover damages because the defendants, as majority stockholders in Springside, breached *844 their fiduciary duty to him as a minority stockholder by their action in February and March, 1967. 634

We conclude that the master's findings were warranted by the evidence and that his report was properly confirmed. However, we reverse so much of the judgment as dismisses Wilkes's complaint and order the entry of a judgment substantially granting the relief sought by Wilkes under the second alternative set forth above.[FN5] 634

FN5. In view of our conclusion it is unnecessary to consider Wilkes's specific objections to the master's report and to the confirmation of that report by the judge below. 634

A summary of the pertinent facts as found by the master is set out in the following pages. It will be seen that, although the issue whether there was a breach of the fiduciary duty owed to Wilkes by the majority stockholders in Springside was not considered by the master, the master's report and the designated portions of the transcript of the evidence before him supply us with a sufficient basis for our conclusion. 634

In 1951 Wilkes acquired an option to purchase a building and lot located on the corner of Springside Avenue and North Street in Pittsfield, Massachusetts, the building having previously housed the Hillcrest Hospital. Though Wilkes was principally engaged in the roofing and siding business, he had gained a reputation locally for profitable dealings in real estate. Riche, an acquaintance of Wilkes, learned of the option, and interested Quinn (who was known to Wilkes through membership on the draft board in Pittsfield) and Pipkin (an acquaintance of both Wilkes and Riche) in joining Wilkes in his investment. The four men met and decided to participate jointly in the purchase of the building and lot as a real estate investment which, they believed, had good profit potential on resale or rental. 634

The parties later determined that the property would have its greatest potential for profit if it were operated by them as a nursing home. Wilkes consulted his attorney, who advised him that if the four men were to operate the *845 contemplated nursing home as planned, they would be partners and would be liable for any debts incurred by the partnership and by each other. On the attorney's suggestion, and after consultation among themselves, ownership of the property was vested in Springside, a corporation organized under Massachusetts law. 634

Each of the four men invested $1,000 and subscribed to ten shares of $100 par value stock in Springside.[FN6] At the time of **660 incorporation it was understood by all of the parties that each would be a director of Springside and each would participate actively in the management and decision making involved in operating the corporation.[FN7] It was, further, the understanding and intention of all the parties that, corporate resources permitting, each would receive money from the corporation in equal amounts as long as each assumed an active and ongoing responsibility for carrying a portion of the burdens necessary to operate the business. 635

FN6. On May 2, 1955, and again on December 23, 1958, each of the four original investors paid for and was issued additional shares of $100 par value stock, eventually bringing the total number of shares owned by each to 115. 635

FN7. Wilkes testified before the master that, when the corporate officers were elected, all four men 'were . . . guaranteed directorships.' Riche's understanding of the parties' intentions was that they all wanted to play a part in the management of the corporation and wanted to have some 'say' in the risks involved; that, to this end, they all would be directors; and that 'unless you (were) a director and officer you could not participate in the decisions of (the) enterprise.' 635

The work involved in establishing and operating a nursing home was roughly apportioned, and each of the four men undertook his respective tasks.[FN8] Initially, Riche was *846 elected president of Springside, Wilkes was elected treasurer, and Quinn was elected clerk.[FN9] Each of the four was listed in the articles of organization as a director of the corporation. 635

FN8. Wilkes took charge of the repair, upkeep and maintenance of the physical plant and grounds; Riche assumed supervision over the kitchen facilities and dietary and food aspects of the home; Pipkin was to make himself available if and when medical problems arose; and Quinn dealt with the personnel and administrative aspects of the nursing home, serving informally as a managing director. Quinn further coo rdinated the activities of the other parties and served as a communication link among them when matters had to be discussed and decisions had to be made without a formal meeting. 635

FN9. Riche held the office of president from 1951 to 1963; Quinn served as president from 1963 on, as clerk from 1951 to 1967, and as treasurer from 1967 on; Wilkes was treasurer from 1951 to 1967. 635

At some time in 1952, it became apparent that the operational income and cash flow from the business were sufficient to permit the four stockholders to draw money from the corporation on a regular basis. Each of the four original parties initially received $35 a week from the corporation. As time went on the weekly return to each was increased until, in 1955, it totalled $100. 635

In 1959, after a long illness, Pipkin sold his shares in the corporation to Connor, who was known to Wilkes, Riche and Quinn through past transactions with Springside in his capacity as president of the First Agricultural National Bank of Berkshire County. Connor received a weekly stipend from the corporation equal to that received by Wilkes, Riche and Quinn. He was elected a director of the corporation but never held any other office. He was assigned no specific area of responsibility in the operation of the nursing home but did participate in business discussions and decisions as a director and served additionally as financial adviser to the corporation. 635

In 1965 the stockholders decided to sell a portion of the corporate property to Quinn who, in addition to being a stockholder in Springside, possessed an interest in another corporation which desired to operate a rest home on the property. Wilkes was successful in prevailing on the other stockholders of Springside to procure a higher sale price for the property than Quinn apparently anticipated paying or desired to pay. After the sale was consummated, the relationship between Quinn and Wilkes began to deteriorate. 636

The bad blood between Quinn and Wilkes affected the attitudes of both Riche and Connor. As a consequence of *847 the strained relations among the parties, Wilkes, in January of 1967, gave notice of his intention to sell his shares for an amount based on an appraisal of their value. **661 In February of 1967 a directors' meeting was held and the board exercised its right to establish the salaries of its officers and employees.[FN10] A schuedle of payments was established whereby Quinn was to receive a substantial weekly increase and Riche and Connor were to continue receiving $100 a week. Wilkes, however, was left off the list of those to whom a salary was to be paid. The directors also set the annual meeting of the stockholders for March, 1967. 636

FN10. The by-laws of the corporation provided that the directors, subject to the approval of the stockholders, had the power to fix the salaries of all officers and employees. This power, however, up until February, 1967, had not been exercised formally; all payments made to the four participants in the venture had resulted from the informal but unanimous approval of all the parties concerned. 636

At the annual meeting in March,[FN11] Wilkes was not reelected as a director, nor was he ree lected as an officer of the corporation. He was further informed that neither his services nor his presence at the nursing home was wanted by his associates. 636

FN11. Wilkes was unable to attend the meeting of the board of directors in February or the annual meeting of the stockholders in March, 1967. He was represented, however, at the annual meeting by his attorney, who held his proxy. 636

The meetings of the directors and stockholders in early 1967, the master found, were used as a vehicle to force Wilkes out of active participation in the management and operation of the corporation and to cut off all corporate payments to him. Though the board of directors had the power to dismiss any officers or employees for misconduct or neglect of duties, there was no indication in the minutes of the board of directors' meeting of February, 1967, that the failure to establish a salary for Wilkes was based on either ground. The severance of Wilkes from the payroll resulted not from misconduct or neglect of duties, but because of the personal desire of Quinn, Riche and Connor to prevent him from continuing to receive money from the *848 corporation. Despite a continuing deterioration in his personal relationship with his associates, Wilkes had consistently endeavored to carry on his responsibilities to the corporation in the same satisfactory manner and with the same degree of competence he had previously shown. Wilkes was at all times willing to carry on his responsibilities and participation if permitted so to do and provided that he receive his weekly stipend. 636

1. We turn to Wilkes's claim for damages based on a breach of the fiduciary duty owed to him by the other participants in this venture. In light of the theory underlying this claim, we do not consider it vital to our approach to this case whether the claim is governed by partnership law or the law applicable to business corporations. This is so because, as all the parties agree, Springside was at all times relevant to this action, a close corporation as we have recently defined such an entity in Donahue v. Rodd Electrotype Co. of New England, Inc., --- Mass. ---, --- - ---,[FNa] 328 N.E.2d 505 (1975). 636

FNa. Mass.Adv.Sh. (1975) 1295, 1305--1306. 637

In Donahue,[FN12] we held that 'stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another.' Id. at --- - --- (footnotes omitted),[FNb] 328 N.E.2d at 515. As determined in previous decisions of this court, the standard of duty owed by partners to one another is one of 'utmost good faith and loyalty.' Cardullo v. Landau, 329 Mass. 5, 8, 105 N.E.2d 843 (1952), and cases cited. DeCotis v. D'Antona, 350 Mass. 165, 168, 214 N.E.2d 21 (1966), qyuoting from Mendelsohn v. Leather Mfg. **662 Corp., 326 Mass. 226, 233, 93 N.E.2d 537 (1950). Thus, we concluded in Donahue, with regard to 'their actions relative to the operations of the enterprise and the effects of that operation on the rights and investments of other stockholders,' '(s)tockholders in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standard. *849 They may not act out of avarice, expediency or self- interest in derogation of their duty of loyalty to the other stockholders and to the corporation.' --- Mass. at n. 18, ---,[FNc] 328 N.E.2d at 515. 637

FN12. For legal commentary relating to the Donahue case, see 89 Harv.L.Rev. 423 (1975); 60 Mass.L.Q. 318 (1975); 21 Vill.L.Rev. 307 (1976). 637

FNb. Mass.Adv.Sh. (1975) at 1315--1316. 637

FNc. Mass.Adv.Sh. (1975) at 1315 n. 18, 1316. 637

In the Donahue case we recognized that one peculiar aspect of close corporations was the opportunity afforded to majority stockholders to oppress, disadvantage or 'freeze out' minority stockholders. In Donahue itself, for example, the majority refused the minority an equal opportunity to sell a ratable number of shares to the corporation at the same price available to the majority. The net result of this refusal, we said, was that the minority could be forced to 'sell out at less than fair value,' --- Mass. at ---,[FNd] 328 N.E.2d at 515, since there is by definition no ready market for minority stock in a close corporation. 637

FNd. Mass.Adv.Sh. (1975) at 1315. 637

'Freeze outs,' however, may be accomplished by the use of other devices. One such device which has proved to be particularly effective in accomplishing the purpose of the majority is to deprive minority stockholders of corporate offices and of employment with the corporation. F. H. O'Neal, 'Squeeze-Outs' of Minority Shareholders 59, 78--79 (1975). See --- Mass. at ---, ---, [FNe] 328 N.E.2d 505. This 'freeze-out' technique has been successful because courts fairly consistently have been disinclined to interfere in those facets of internal corporate operations, such as the selection and retention or dismissal of officers, directors and employees, which essentially involve management decisions subject to the principle of majority control. See Note, 35 N.C.L.Rev. 271, 277 (1957). As one authoritative source has said, '(M)any courts apparently feel that there is a legitimate sphere in which the controlling (directors or) shareholders can act in their own interest even if the minority suffers.' F. H. O'Neal, supra at 59 (footnote omitted). Comment, 1959 Duke L.J. 436, 437. 637

FNe. Mass.Adv.Sh. (1975) at 1309, 1310. 637

The denial of employment to the minority at the hands of the majority is especially pernicious in some instances. A guaranty of employment with the corporation may have been one of the 'basic reason(s) why a minority owner has invested capital in the firm.' Symposium--The Close Corporation, 52 Nw.U.L.Rev. 345, 392 (1957). See F. H. *850 O'Neal, supra at 78--79; Hancock, Minority Interests in Small Business Entities, 17 Clev.-Mar.L.Rev. 130, 132--133 (1968); 89 Harv.L.Rev. 423, 427 (1975). The minority stockholder typically depends on his salary as the principal return on his investment, since the 'earnings of a close corporation . . . are distributed in major part in salaries, bonuses and retirement benefits.' 1 F. H. O'Neal, Close Corporations s 1.07 (1971).[FN13] Other noneconomic interests of the minority stockholder are likewise injuriously affected by barring him from corporate office. See F. H. O'Neal, 'Squeeze-Outs' of Minority Shareholders 79 (1975). Such action severely restricts his participation in the management of the enterprise, and he is relegated to enjoying those benefits incident to his status as a stockholder. See Symposium--The Close Corporation, 52 Nw.U.L.Rev. 345, 386 (1957). In sum, by terminating a minority stockholder's employment or by severing him from a position as an officer or director, the majority **663 effectively frustrate the minority stockholder's purposes in entering on the corporate venture and also deny him an equal return on his investment. 638

FN13. We note here that the master found that Springside never declared or paid a dividend to its stockholders. 638

The Donahue decision acknowledged, as a 'natural outgrowth' of the case law of this Commonwealth, a strict obligation on the part of majority stockholders in a close corporation to deal with the minority with the utmost good faith and loyalty. On its face, this strict standard is applicable in the instant case. The distinction between the majority action in Donahue and the majority action in this case is more one of form than of substance. Nevertheless, we are concerned that untempered application of the strict good faith standard enunciated in Donahue to cases such as the one before us will result in the imposition of limitations on legitimate action by the controlling group in a close corporation which will unduly hamper its effectiveness in managing the corporation in the best interests of all concerned. The majority, concededly, have certain *851 rights to what has been termed 'selfish ownership' in the corporation which should be balanced against the concept of their fiduciary obligation to the minority. See Hill, The Sale of Controlling Shares, 70 Harv.L.Rev. 986, 1013--1015 (1957); Note, 44 Iowa L.Rev. 734, 740--741 (1959); Symposium--The Close Corporation, 52 Nw.U.L.Rev. 345, 395--396 (1957). 638

Therefore, when minority stockholders in a close corporation bring suit against the majority alleging a breach of the strict good faith duty owed to them by the majority, we must carefully analyze the action taken by the controlling stockholders in the individual case. It must be asked whether the controlling group can demonstrate a legitimate business purpose for its action. See Bryan v. Brock & Blevins Co., 343 F.Supp. 1062, 1068 (N.D.Ga.1972), aff'd, 490 F.2d 563, 570--571 (5th Cir. 1974); Schwartz v. Marien, 37 N.Y.2d 487, 492, 373 N.Y.S.2d 122, 335 N.E.2d 334 (1975); Hancock, Minority Interests in Small Business Entities, 17 Clev-Mar.L.Rev. 130, 132 (1968); Vorenbefg, Exclusiveness of the Dissenting Stockholder's Appraisal Right, 77 Harv.L.Rev. 1189, 1192--1193, 1195--1196, 1204 (1964); Comment, 14 B.C.Ind. & Com.L.Rev. 1252, 1256 (1973); Comment, 1959 Duke L.J. 436, 448, 458; Note, 74 Harv.L.Rev. 1630, 1638 (1961); Note, 35 N.C.L.Rev. 271, 273--275 (1957); Symposium--The Close Corporation, 52 Nw.U.L.Rev. 345, 389 (1957); Comment, 10 Rutgers L.Rev. 723 (1956); Comment, 37 U.Pitt.L.Rev. 115, 118 (1975). In asking this question, we acknowedge the fact that the controlling group in a close corporation must have some room to maneuver in establishing the business policy of the corporation. It must have a large measure of discretion, for example, in declaring or withholding dividends, deciding whether to merge or consolidate, establishing the salaries of corporate officers, dismissing directors with or without cause, and hiring and firing corporate employees. 638

When an asserted business purpose for their action is advanced by the majority, however, we think it is open to minority stockholders to demonstrate that the same legitimate objective could have been achieved through an alternative *852 course of action less harmful to the minority's interest. See Schwartz v. Marien, supra; Comment, 1959 Duke L.J. 436, 458; Note, 74 Harv.L.Rev. 1630, 1638 (1961); Note, 35 N.C.L.Rev. 271, 273 (1957); Comment, 37 U.Pitt.L.Rev. 115, 132 (1975). If called on to settle a dispute, our courts must weigh the legitimate business purpose, if any, against the practicability of a less harmful alternative. 639

Applying this approach to the instant case it is apparent that the majority stockholders in Springside have not shown a legitimate business purpose for severing Wilkes from the payroll of the corporation or for refusing to ree lect him as a salaried officer and director. The master's subsidiary findings relating to the purpose of the **664 meetings of the directors and stockholders in February and March, 1967, are supported by the evidence. There was no showing of misconduct on Wilkes's part as a director, officer or employee of the corporation which would lead us to approve the majority action as a legitimate response to the disruptive nature of an undesirable individual bent on injuring or destroying the corporation. On the contrary, it appears that Wilkes had always accomplished his assigned share of the duties competently, and that he had never indicated an unwillingness to continue to do so. 639

It is an inscapable conclusion from all the evidence that the action of the majority stockholders here was a designed 'freeze out' for which no legitimate business purpose has been suggested. Furthermore, we may infer that a design to pressure Wilkes into selling his shares to the corporation at a price below their value well may have been at the heart of the majority's plan.[FN14] 639

FN14. This inference arises from the fact that Connor, acting on behalf of the three controlling stockholders, offered to purchase Wilkes's shares for a price Connor admittedly would not have accepted for his own shares. 639

In the context of this case, several factors bear directly on the duty owed to Wilkes by his associates. At a minimum, the duty of utmost good faith and loyalty would demand that the majority consider that their action was *853 in disregard of a long-standing policy of the stockholders that each would be a director of the corporation and that employment with the corporation would go hand in hand with stock ownership; that Wilkes was one of the four originators of the nursing home venture; and that Wilkes, like the others, had invested his capital and time for more than fifteen years with the expectation that he would continue to participate in corporate decisions. Most important is the plain fact that the cutting off of Wilkes's salary, together with the fact that the corporation never declared a dividend (see note 13 supra), assured that Wilkes would receive no return at all from the corporation. 639

2. The question of Wilkes's damages at the hands of the majority has not been thoroughly explored on the record before us. Wilkes, in his original complaint, sought damages in the amount of the $100 a week he believed he was entitled to from the time his salary was terminated up until the time this action was commenced. However, the record shows that, after Wilkes was severed from the corporate payroll, the schedule of salaries and payments made to the other stockholders varied from time to time. In addition, the duties assumed by the other stockholders after Wilkes was deprived of his share of the corporate earnings appear to have changed in significant respects.[FN15] Any resolution of this question must take into account whether the corporation was dissolved during the pendency of this litigation. 639

FN15. In fairness to Wilkes, who, as the master found, was at all times ready and willing to work for the corporation, it should be noted that neither the other stockholders nor their representatives may be heard to say that Wilkes's duties were performed by them and the Wilkes's damages should, for that reason, be diminished. 640

Therefore our order is as follows: So much of the judgment as dismisses Wilkes's complaint and awards costs to the defendants is reversed.[FN16] The case is remanded to the *854 Probate Court for Berkshire County for further proceedings concerning the issue of damages. Thereafter a judgment shall be entered declaring that Quinn, Riche and Connor breached their fiduciary duty to Wilkes as a minority stockholder in Springside, and awarding money damages therefor. Wilkes shall be allowed to recover **665 from Riche, the estate of T. Edward Quinn and the estate of Lawrence R. Connor, ratably, according to the inequitable enrichment of each, the salary he would have received had he remained an officer and director of Springside. In considering the issue of damages the judge on remand shall take into account the extent to which any remaining corporate funds of Springside may be diverted to satisfy Wilkes's claim. 640

FN16. We do not disturb the judgment in so far as it dismissed a counterclaim by Springside against Wilkes arising from the payment of money by Quinn to Wilkes after the sale in 1965 of certain property of Springside to a corporation owned at that tiem by Quinn and his wife. See the discussion at pp. 660--661, supra. 640

So ordered. 640

Merola v. Exergen Corporation 646

Anderson v. Wilder 650

Pinebrook Properties Ltd. V. Brookhaven Lake Propertiy 662

Appendix 1

Appendix 1

Massachusetts General Laws 1

CHAPTER 108A. PARTNERSHIPS 1

(8) (a) A registered limited liability partnership which renders professional services as defined in chapter one hundred and fifty-six A shall carry at least the designated amount of liability insurance of a kind that is designed to cover negligence, wrongful acts, errors and omissions and that insures the partnership and its partners. The term designated amount shall mean the amount designated by the regulating board which regulates the professional service rendered. The regulating boards for each professional service shall adopt regulations requiring such a designated amount of liability insurance. 19

CHAPTER 109. LIMITED PARTNERSHIP 21

CHAPTER 156C LIMITED LIABILITY COMPANY ACT 45

CHAPTER 156D BUSINESS CORPORATIONS 79





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