The Massachusetts Supreme Judicial Court recently overturned a court-ordered buy-out of a minority shareholder’s interest in a closely held business, saying it was not an appropriate remedy for a “freeze-out” by the controlling shareholder group.
The trial court’s equitable “buy-out” remedy had been affirmed by the Massachusetts Appeals Court in May 2006, but the SJC saw things differently.
“The problem with this remedy,” according to the SJC, “is that it placed the plaintiff in a significantly better position than she would have enjoyed absent the wrongdoing, and well exceeded her reasonable expectations of benefit from her shares.” Brodie v. Jordan, 2006 Mass. Lexis 696.
The SJC left untouched the lower court rulings in favor of liability.
The Appeals Court decision affirming the lower court ruling ordering the buy-out had been the first appellate case in Massachusetts to do so. See Brodie v. Jordan, 66 Mass. App. Ct. 371 (2006).
The long and circuitous path of the Brodie case is a stark reminder to business owners and their counsel of the necessity of careful advance planning for the inevitable changes in ownership and management that occur in privately held businesses.
The case is a wake-up call for all closely held businesses that currently operate without a clear and comprehensive buy/sell agreement and stock transfer restriction in place. A well-constructed buy/sell agreement should address a variety of contingencies relating to future stock disposition, such as an owner’s death, retirement, disability, or simply the desire to walk away.
Even the best business marriages may end in divorce and the promoters of a closely held corporation need to anticipate a time when the honeymoon comes to an end.
A brief recounting of the facts of the case and the lower court findings and rulings is instructive. In 1973, three individuals – Walter S. Brodie, David J. Barbuto, and Guy J. Agri – organized Malden Centerless Grinding, Inc. to manufacture round metal objects such as ball bearings.
Six years later, Agri resigned and Brodie became president. Brodie and Barbuto remained the only two officers and shareholders of the company until 1984 when Robert J. Jordan became an equal shareholder with Brodie and Barbuto. Jordan soon assumed the daily operations of the company.
Eventually, considerable friction developed between Brodie and Jordan, culminating in the removal of Brodie as a director. Brodie remained, however, a co-equal shareholder with Barbuto and Jordan.
Walter Brodie died in 1997. Upon Brodie’s death, his wife, Mary, became the owner of his shares. She apparently had little or no knowledge of the company’s business. Nevertheless, she sought a position as a director of the corporation. Mary Brodie also sought information on Malden’s financial condition, requested an audit, and sought a determination of the value of her 400 shares.
The majority shareholders denied her requests. As in the case of her husband, Walter, it appeared the controlling shareholders considered Mary Brodie a “nuisance” and an “aggravation.”
Mary Brodie was not, however, without recourse. She sued the other shareholders for breach of fiduciary duty.
While the case was pending, the majority shareholders suggested that if Mary Brodie wanted to offer Malden her shares, she should follow the procedures outlined in the company’s articles of organization.
The articles contained a stock transfer restriction with a built-in stock valuation procedure involving the use of arbitrators to determine share price. The articles, however, did not require the company to purchase the shares once valued. They only required that the shares be offered first to the company, which had the option to decline their purchase. Mary Brodie did in fact commence the requisite procedure, but the majority shareholders stymied her efforts to follow through when they realized the expense which such an appraisal process would entail. She found herself holding 400 shares of stock with no ready market for them, she had no meaningful financial information on the company of which she was part owner, and she was essentially barred from participating in the enterprise.
The lower courts weigh in
Massachusetts law has long held that stockholders in a close corporation such as Malden owe one another “substantially the same fiduciary duty in the operation of the enterprise that partners own to one another.” Donahue v. Rodd Electrotype Co. of New England, Inc. 367 Mass. 578, 593 (1975).
As the Massachusetts Superior Court stated in the trial court ruling in Brodie, the “[c]ontrolling shareholders’ fiduciary duty to minority shareholders includes the duty not to interfere with the minority’s reasonable expectations of the benefits of ownership in the corporation and the duty to disclose information to the minority.”
A court called upon to examine the actions of the majority shareholders vis-à-vis the minority must determine if there was a legitimate business purpose for the controlling group’s actions, and “weigh the asserted business purpose against the practicality of any less harmful alternative.”
The Superior Court, examining Mary Brodie’s predicament, concluded there was “[a]mple evidence presented at trial to support a conclusion that [the] defendants engage[d] in a pattern of conduct that constituted a ‘freeze-out’ of the plaintiff in violation of the defendants’ fiduciary duty.”
The Appeals Court affirmed this finding, agreeing with the Superior Court’s characterization of the majority’s behavior as constituting a pattern of “stonewalling.” The Appeals Court described the litany of oppressive behavior one might expect from the majority: “Typical majority actions constituting a freeze-out include denying a minority a corporate office or employment, refusing to declare dividends, treating the value of the minority’s shares in an unequal manner, and excluding or isolating a minority shareholder from information, operations, and decision-making.” 66 Mass. App. Ct. at 375-76.
In Mary Brodie’s case, this pattern manifested itself when the majority denied her a corporate office, limited her to receiving annual, unaudited financials, and refused to pay dividends – the net effect of which was to ensure she would “derive no benefit from her shares.”
Particularly egregious, the Appeals Court found, was the majority’s refusal to abide the stock transfer restriction in the company’s articles of organization – “a provision of corporate governance…not to be taken lightly.” It was incumbent upon the company’s directors – who were also its majority shareholders – to take the prescribed steps to determine, by arbitration, the value of Brodie’s shares.
Although the directors were not obligated to purchase the shares once valued, their failure to follow through with the arbitration process was a breach of their fiduciary duty to Brodie as a minority shareholder.
The Superior Court ruled the appropriate remedy was a buy-out of plaintiff’s shares at a price informed by the testimony of a court appointed expert.
In affirming this ruling, the Appeals Court wrote: “While there rarely is a market value for a small, close corporation’s shares that bears any relation to the shares’ true value, a freeze-out absolutely destroys whatever value otherwise exists. Where there is a freeze-out, the remedy ordered here restores to the plaintiff what she lost – or an approximation thereof – in the only way possible. Forcing the parties to maintain a relationship none of them wants is not good for them or for the corporation and is bound to breed more litigation.” 66 Mass. App. Ct. at 386.
The SJC rejected this rationale for the forced buy-out remedy, concluding 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.”
Because neither the articles of organization nor the corporation’s buy-laws required Malden to purchase Mary Brodie’s shares, she had no “reasonable expectation of having her shares bought out.”
The SJC also pointed out that minority shareholders in Massachusetts have no statutory right to involuntary dissolution because of majority shareholder misconduct. The SJC did not specify what would be a reasonable remedy under the circumstance, but remanded the case to the Superior Court for an evidentiary hearing on the issue.
The saga of Mary Brodie will doubtless continue.
Andrew P. Botti is a partner at Donovan Hatem LLP where he advises in-house counsel and corporate executives on a wide range of business litigation and employment matters.
He is a graduate of Northeastern University School of Law and Columbia University.