The Devil is in the Damages
Closely held corporation freezeout claims are daily bread for many business litigators, or at least an occasional diversion from their steady diet of contract disputes, insurance coverage battles or license agreement quarrels.
For most business lit practitioners, the basic characteristics of a closely held corporation and the elements of a freezeout claim are well-trodden ground. However, deciding what remedies one should seek on behalf of a disadvantaged minority shareholder, and then making them stick, is a more nuanced and variable question. As a general matter, the courts have broad equity powers to fashion a remedy that restores to the minority the “reasonable expectations of benefit” withheld by the majority. Brodie v. Jordan, 447 Mass. 866, 870 (2006); Zimmerman v. Bogoff, 402 Mass. 650, 661 (1988). The options are numerous, and often depend on case-specific aspects of the relationship between the minority plaintiff and the corporation. Where the shareholder derived most of her benefit of ownership from employment, lost wages or reinstatement may be the best measure. See, e.g., Wilkes v. Springside Nursing Home Inc., 370 Mass. 842, 854 (1976) (awarding minority shareholder damages for lost employment). In other scenarios, injunctive relief, a share of distributions withheld, diminution in value of the minority’s shares, or disgorgement of excessive compensation might be the most apt forms of redress.
From the plaintiff’s perspective, one of the simplest and most appealing remedies is the forced purchase of a frozen-out minority’s stake, as it: amounts to a decisive and final dissociation from the majority; returns a guaranteed monetary value for the shares; protects the minority from the need for future litigation to enforce injunctive measures; prevents the majority from paying out corporate profits to themselves in surreptitious ways; and avoids the sharing of compelled distributions with the culpable majority that is common in derivative suits.
Interestingly, or confoundingly, perhaps, for those who tend to represent plaintiffs in such cases, the Massachusetts courts have rejected the forced share purchase as a permissible freezeout remedy. It has become clear over the decades since the freezeout claim was first recognized that only minority shareholders who reach a defined threshold of proportional ownership and can meet a demanding set of statutory criteria may force a “clean break” from an abusive majority.
Close Corporation Basics
Closely held corporations, which are sometimes referred to as “incorporated partnerships,” are generally defined by three prominent traits: (1) a small number of shareholders, (2) the lack of a ready market for the corporation’s shares, and (3) substantial majority shareholder participation in the management, direction and operations of the corporation. See Donahue v. Rodd Electrotype Co. of New England Inc., 367 Mass. 578, 586 593, 328 N.E.2d 505 (1975). Close corporation stockholders owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another — that of the utmost good faith and loyalty. See id., 367 Mass. at 593; Cardullo v. Landau, 329 Mass. 5, 9 (1952).
The Massachusetts Business Corporations Act (BCA), M.G.L. c. 156D, § 7.32 provides great flexibility to close corporation incorporators to tailor their rules of governance, and vary the corporate structure. For example, the corporate documents may eliminate the board of directors, reduce the board to one person, authorize distributions not in accordance with percentage ownership, or require dissolution at the request of one or more shareholders on particular terms. M.G.L. c. 156D, § 7.32.
Donahue and Progeny
In Donahue v. Rodd Electrotype Co. of New England Inc., the Supreme Judicial Court (SJC) launched Massachusetts freezeout jurisprudence by describing the numerous ways in which the majority might oppress the minority:
The squeezers [those who employ the freeze-out techniques] may refuse to declare dividends; they may drain off the corporation’s earnings in the form of exorbitant salaries and bonuses to the majority shareholder-officers and perhaps to their relatives, or in the form of high rent by the corporation for property leased from majority shareholders . . . they may deprive minority shareholders of corporate offices and of employment by the company; they may cause the corporation to sell its assets at an inadequate price to the majority shareholders. . . .
367 Mass. 578, 588-89 (1975) (internal citations omitted).
The common denominator in such cases is the majority’s whole or partial denial of the minority’s right to receive his or her reasonably expected benefits of ownership. But the fact patterns vary. In Donahue, the defendants’ principal offense was refusing to redeem the minority plaintiff’s stock on equivalent terms as a member of the controlling majority had received. Donahue, 367 Mass. at 600. In Wilkes v. Springside Nursing Home Inc., 370 Mass. 842, the majority removed the minority shareholder plaintiff and refused to rehire him as a salaried officer/director, while also failing to issue dividends. In Rubin v. Murray, 79 Mass. App. Ct. 64 (2011), minority freezeout took the form of payment of excessive compensation to controlling stockholders, and the accompanying failure to distribute profits. In Brodie v. Jordan, the plaintiff widow of a one-third owner who had served as president prior to his death claimed that the majority excluded her from corporate decision-making, denied her access to company financial information and refused her request that the majority comply with a stock transfer provision requiring the valuation of her shares. See 447 Mass. 866, 870-871 (2006).
As the Donahue court articulated, the freezeout is often followed by a “squeeze out.” An oppressive majority may use the combination of its dominant position and the lack of a ready market for the minority’s stock to force redemption on unconscionable terms:
In a close corporation, the minority stockholders may be trapped in a disadvantageous situation. No outsider would knowingly assume the position of the disadvantaged minority [by purchasing her shares]. The outsider would have the same difficulties. To cut losses, the minority stockholder may be compelled to deal with the majority. This is the capstone of the majority plan. Majority ‘freeze-out’ schemes which withhold dividends are designed to compel the minority to relinquish stock at inadequate prices . . . When the minority stockholder agrees to sell out at less than fair value, the majority has won.
Donahue, 367 Mass. at 592.
Brodie Eliminates the Forced Redemption
In Brodie, the Superior Court ordered the majority to buy out the frozen-out minority’s shares in the belief that this would remedy the defendant’s mistreatment and reward her reasonable expectations as a shareholder. See Brodie, 66 Mass. App. Ct. 371, 385–86, aff’d in part, rev’d in part, 447 Mass. 866 (2006).1 As explained by the Appeals Court in its affirmance of Judge Elizabeth Fahey’s decision, the forced purchase was well within the court’s broad equity powers to fashion appropriate relief, despite the absence of an explicit buy-sell provision in the corporation’s organizing documents: “As is characteristic of equity practice, the final relief awarded in Donahue-type cases has been varied and creative, as trial judges (and, as necessary, appellate courts) have exercised their discretion to tailor their relief to the nearly limitless variety of fact patterns presented.” Id.
The SJC saw things differently, drawing a clear boundary line on the courts’ license to craft “creative” relief. While reaffirming the goal of “restor[ing] to the minority shareholder those benefits” reasonably expected but denied, and the courts’ “broad equitable powers to fashion remedies,” the court nonetheless cautioned against remedies that “grant the minority a windfall [or] excessively penalize the majority.” Id. at 871. The lower court’s order that the shares be bought out at an expert’s estimated value had placed the plaintiff in a significantly better position than she would otherwise have been, the court found, because there was no buy-sell agreement requiring such a transaction. Id.
Surprisingly, the court then justified its decision based upon an idiosyncrasy of the close corporation that the freezeout claim was designed to mitigate: the absence of a ready market for the corporate stock. See id., at 872. Because it was undisputed that no right to redemption existed in the corporate documents, the court found that “[in] ordering the defendants to purchase the plaintiff’s stock at the price of her share of the company, the [Superior Court] judge created an artificial market for the plaintiff’s minority share of a close corporation — an asset that, by definition, has little or no market value.” Id. at 872. The “appealing” and expeditious “clean break” such a remedy provides must be resisted, as it “would require a forced share purchase in virtually every freeze-out case, given that resort to litigation is itself an indication of the inability of shareholders to work together.” Id. at 872-73. The court also supported its ruling by distinguishing Massachusetts corporate dissolution statutes from those in other states, in which “statutes authorize the more drastic remedy of involuntary dissolution [for corporate freezeout], and thus courts have understandably inferred the power to order the lesser remedy of a buyout. In Massachusetts, by contrast, minority shareholders have no statutory right to involuntary dissolution of a corporation due to majority misconduct.” Id. at 873 (internal citations omitted).
In Brodie, the court clearly intended to strike a blow in favor of close corporation continuity and stability. But in the process, the SJC arguably tilted the field sharply against the afflicted minority by ensuring that the majority has no risk of being compelled to pay fair value for the minority’s shares, even where the majority has engaged in an intentional and insidious campaign to freeze them out of the business and squeeze them out of ownership. The ruling favors a sophisticated minority who has the foresight or opportunity to negotiate a buy-sell, as well as an employed minority stockholder, who receives the “value” of their ownership share in salary and thus has quantifiable losses. Conversely, Brodie disfavors a non-employed, passive shareholder (such as the widow/widower of the original shareholder, as in Brodie), a second-generation inheriting stockholder, a minority brought into the corporation under circumstances of unequal bargaining power, and an afflicted minority shareholder holding less than 40% of voting shares, who is thus without any opportunity to compel corporate dissolution under M.G.L. 156D § 14.30.
Koshy v. Sachdev and Section 14.30
Far from swinging the pendulum back in favor of minority owners, the SJC has since explicitly affirmed its decision in Brodie, holding in Pointer v. Castellani, decided in 2009, that “we see no reason to revisit our holding in Brodie”:
[W]e conclude that the trial judge’s order for a forced sale of FGC violated our holding in the Brodie decision. Because we held that a forced buyout of a shareholder was improper without some authorization from shareholders, it would be inconsistent for us now to hold that a forced sale is proper. Brodie v. Jordan, supra at 873 n. 7, 857 N.E.2d 1076 (calling involuntary dissolution “drastic remedy”). Nevertheless, Pointer is entitled to damages or other equitable relief from Castellani, Woodberry, Herbert, and Maurer, which will put him in the position he would have been in had the freeze-out not occurred, and compensates him for the denial of his reasonable expectations. Id. at 871, 873, 857 N.E.2d 1076.
Pointer v. Castellani, 455 Mass. 537, 559–60 (2009).
In Pointer, after finding in favor of the plaintiff, the Superior Court had ultimately ordered the parties to attempt to negotiate a buyout, with a liquidation to take place if they were unsuccessful. See id. Thus, in its wake, one could assume that neither a compelled buyout nor corporate liquidation was a remedy available to address claims of close corporate freezeout. Brodie even appears to have had a chilling effect with respect to remedies that, while not exactly a compelled buyout, come “perilously close to the buyout remedy . . . rejected in Brodie . . .” Mallegni v. 57 E. Main St., LLC, 84 Mass. App. Ct. 1129 (2014) (Superior Court rejected damages sought for majority’s failure to accept third-party offers to purchase the corporation for certain value despite defendants’ “proven breaches of fiduciary duty”).
Until the SJC decided Koshy v. Sachdev in 2017, it was unclear whether a compelled buyout of shares was ever a viable remedy in any close corporation dispute. In Koshy, the SJC ruled that there was such a context, though not as a remedy for breaches of fiduciary duty or majority freezeout claims, but only where the plaintiff could successfully demonstrate “true deadlock” under M.G.L. c. 156D, § 14.30 — the corporate dissolution statute:
The corporate dissolution statute provides that a Superior Court judge “may dissolve a corporation” if the three-part test for “true deadlock” set forth in § 14.30 (2) (i) is met. Given that the statute authorizes the “extreme” remedy of dissolution, see comment to M.G.L. c. 156D, § 14.30, 25A M.G.L. Ann. at 71-72, we conclude that it also authorizes lesser remedies, such as a buyout or the sale of the company as an ongoing entity. See Brodie v. Jordan, 447 Mass. 866, 873 n.7, 857 N.E.2d 1076 (2006) (“In most of these States, statutes authorize the more drastic remedy of involuntary dissolution, and thus courts have understandably inferred the power to order the lesser remedy of a buyout”).
Koshy, 477 Mass. 759, 771–72 (2017) (further internal citations omitted; emphasis supplied).
The Koshy ruling changes little for frozen-out minority shareholders who wish to force the redemption of their shares, unless they hold voting shares of at least 40% and can prove that:
(1) “the directors are deadlocked in the management of the corporate affairs”; (2) “the shareholders are unable to break the deadlock”; and (3) “irreparable injury to the corporation is threatened or being suffered.”
Koshy, 477 Mass. at 765, quoting M.G.L. c. 156D, § 14.30 (2) (i).
Many, or perhaps most, freezeouts do not also touch each of the stones required by Section 14.30, and the redemption remedy thus remains elusive. There are, of course, numerous ways to address this issue at the time of organization or when a minority shareholder buys into the company. But for those who lack the opportunity, bargaining power, sophistication or foresight to negotiate such protections, the fundamental vulnerabilities of the minority identified by the Donahue court persist. The majority’s dominant position and the lack of a ready market for their stock may leave them “trapped,” having to look to alternative damages theories or injunctive relief to help fulfill their “reasonable expectations” of ownership. Matthew J. Ginsburg is co-manager and a member of Ascendant Law Group LLC, a boutique business litigation and bankruptcy firm located in Andover, as well as past chair of the Massachusetts Bar Association’s Complex Commercial Litigation Section Council. He has more than 20 years of experience representing individuals and corporate entities of all sizes in commercial, construction, land-use, employment, insurance and intellectual property disputes before courts, arbitrators and administrative bodies, and has tried civil jury matters in the three states in which he is admitted: Massachusetts, New Hampshire and North Carolina.
1The citation provided is to the Appeals Court’s affirmance of Associate Justice Fahey’s decision in the Superior Court, as the Appeals Court provides a forceful defense of Judge Fahey’s decision.