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Gym co-owner breaches fiduciary duty to partners

Used corporate assets for competing facilities

neih0825_pg6_gymA co-owner of a health club chain who was accused of freezing out the widow of his deceased partner and, in concert with an outside acquaintance, diverting corporate assets and proprietary information to open competing clubs violated his fiduciary duty to fellow shareholders, a Massachusetts Superior Court judge has determined.

The chain, Work Out World New England, consisted of more than a dozen separate limited liability corporations, each operating its own club. Defendant Steven Borghi and the late husband of plaintiff Elizabeth Beninati held a controlling interest in each LLC. Under a set of written operating agreements executed in 2004 and 2005 for most of the LLCs, each member was barred from opening a club within 50 miles of an existing WOW New England club.

Borghi argued that his competing chain (known as “Blast” clubs) did not violate the covenants because a set of “amended and restated operating agreements” that Beninati never agreed to — and which purported to eliminate the restriction on competition — superseded the original operating agreements.

But Judge Janet L. Sanders disagreed, finding that the amended operating agreements were void.

“[T]he Amended and Restated Operating Agreements in their final form promoted the interest of Borghi over that of WOW New England Clubs,” Sanders wrote, holding Borghi liable for breach of fiduciary duty and his outside associate, defendant Harold Dixon, liable for aiding and abetting such a violation.

“The plaintiffs argue that this conflict of interest in which Borghi found himself disqualified him from voting to amend the Operating Agreements. This Court agrees. Manifest justice and fairness require that this Court not recognize them as binding,” Sanders wrote.

At the same time, Sanders decided that Beninati and a pair of minority shareholders who joined in the suit were not entitled to an award equivalent to the entire market value of the competing clubs. Rather, she found, the court would have to take into consideration the extent to which the defendants’ own capital and know-how contributed to the value of the enterprises.

The 67-page decision is Beninati, et al. v. Borghi, et al.

‘Must-read’ for corporate lawyers

The plaintiffs’ lawyer, James L. Messenger of LeClairRyan in Boston, declined to comment on the record.

R. Todd Cronan of Goodwin Procter in Boston represented defendant Dixon and the Blast clubs and could not be reached for comment prior to deadline. But Borghi’s attorney, Charles R. Bennett of Boston’s Murphy & King, noted that the ruling, while “well-reasoned,” left certain issues to be resolved at a later hearing.

Bennett downplayed any potential broader implications of the decision.

“The only issue is whether the judge expands the ‘constructive trust’ concept” as a means of providing relief for the plaintiffs,” he said. “But at this point, I don’t think this has any broader application.”

Meanwhile, David B. Mack, a Burlington, Massachusetts, attorney who handles shareholder litigation, called the decision a “must-read” for any corporate lawyer or business litigator because of the way it lays out and applies a variety of legal issues that commonly arise in shareholder disputes.

“It also is helpful because it demonstrates the wide-ranging but not unlimited options available to the courts to fashion a remedy for breach of fiduciary duty,” said Mack, a partner at O’Connor, Carnathan & Mack. “As the court itself noted several times during the opinion, the plaintiffs threw the ‘kitchen sink’ at the court, which challenged the court in its effort to strike a proper balance between awarding reasonable damages and granting certain injunctive relief, but not going so far as to award the plaintiffs a windfall.”

Business litigator Terry Klein of Henshon Klein in Boston said the decision is a reminder that shareholders and LLC members need to take their fiduciary duties seriously, which, he acknowledged, can be a tough balance to strike.

“Successful businesspeople become successful because they aggressively pursue promising business opportunities,” Klein said. “Fiduciary duties are often lurking in the background of these promising opportunities. Ignoring these duties isn’t going to make them go away.”

Competing venture

In the late 1990s, defendant Steven Borghi and his friend Tony Beninati opened a gym in Randolph, Massachusetts. Borghi enlisted plaintiff Joseph Masotta to perform the build-out work in exchange for an ownership share while Beninati brought in attorney Christopher Sherwood to assist in setting up the business, also in exchange for an ownership share.

The four created an LLC called Cardio Fitness to own and operate the club. In the written 1999 operation agreement, Beninati and Borghi were designated as managers and members, each with a 26 percent ownership share. Sherwood and Masotta were given smaller shares.

A year later, the group opened a second gym in Norwood, Massachusetts, owned by a separate LLC they created with a separate operating agreement, which also gave Borghi and Beninati an equal percentage of shares and a lesser percentage to Sherwood and Masotta.

At some point, the group obtained a license to use the name “Work Out World” from WOW Licensing LLC, a company in New Jersey. In exchange for a fee, WOW owner Stephen Roma agreed not to license the WOW name to any other entity within five miles of the group’s clubs.

Within five years the group opened 10 more gyms in New England, each owned and operated through a separate LLC. Many of the clubs did not have written operating agreements until late 2004, when — a month before Beninati died — their accountant drew them up for the new clubs. The new operating agreements incorporated a non-competition clause barring members from opening and operating competing clubs within 50 miles of any WOW New England facilities.

Three years after Beninati died, Borghi, Masotta and Elizabeth Beninati opened four new clubs under the WOW New England name.

In 2010, while tension was growing between Borghi and Elizabeth, who was taking on a more active role in club management, Borghi met Dixon, a successful Dunkin Donuts franchisee who wanted to get into the health club business.

Borghi apparently saw an opportunity to use Dixon’s business acumen and capital to expand his own health club holdings, while Dixon saw the chance to use Borghi’s inside knowledge of WOW New England operations to help him succeed in the health club field.

Borghi subsequently hired Dixon as a “consultant” and the two began meeting regularly at WOW New England headquarters, a situation that made Elizabeth uneasy.

Over the next two years, Borghi gave Dixon direct access to WOW New England’s most confidential information, including membership data, revenue figures, training manuals and vendor lists. Dixon also met regularly with WOW New England staff to gain further insight.

As that was happening, Elizabeth, who opposed further expansion of WOW New England clubs in New England, realized that Dixon and Borghi wanted to engage in such an expansion. As her relationship with Borghi became more strained, she was no longer invited to management meetings and lost access to company books and records.

In January 2011, Borghi and Dixon set up “Blast Fitness,” an entity that would own and operate health clubs in New England and beyond. Neither Elizabeth nor Masotta knew of that at the time, nor did they realize that Blast — taking advantage of the fact that WOW New England’s written licensing agreement had expired — contacted Roma and negotiated the exclusive right to use the WOW name in New England for itself.

Meanwhile, Borghi’s attorney drew up “amended and restated operating agreements” for most of the WOW New England LLCs. The amended agreements sought to eliminate the 50-mile competition restriction and stated that Elizabeth would be recognized only as a voting member if she executed the new agreements, which she refused to do.

Borghi then offered Masotta certain financial incentives to sign onto the new agreements. Masotta’s shares, together with Borghi’s, would represent a majority of shares assenting.

A month later, Blast opened its first club in Cambridge, Massachusetts, within 50 miles of 10 WOW New England clubs. Though Blast was actually competing with WOW New England, the Cambridge club used the WOW name, offered the same fee structure and benefits, and gave members reciprocity with existing WOW New England clubs.

It was also listed on the WOW New England website, used WOW New England employees, and was publicized through WOW New England’s advertising budget, all without Elizabeth’s input or consent.

In the end, Blast and other Dixon-controlled entities opened 13 health clubs in Massachusetts and Rhode Island operating under the WOW name, each within 50 miles of a WOW New England club.

In 2012, Elizabeth sued Borghi, Dixon, various Blast entities and Masotta in Massachusetts Superior Court alleging breach of fiduciary duty and numerous other claims.

In April 2013, a WOW New England membership meeting voted to remove Borghi as a manager. Ultimately Masotta joined Elizabeth as a plaintiff, and Sanders issued findings following a 20-day bench trial.

Breach of duty

In her findings, Sanders rejected the defendants’ argument that the 50-mile restrictive covenant was voided by the amended operating agreements. Instead, she found that the amended agreements themselves were invalid.

First, she held that, despite the defendants’ arguments to the contrary, Elizabeth was a full voting member of the LLCs and thus her vote would have been necessary for the amended operating agreements to take effect. Though the original operating agreements were ambiguous and contradictory on that point, Sanders based her conclusion “on the words and conduct” of the parties.

“[G]iven the fact that the parties largely appear to have disregarded corporate formalities for many years, their conduct and course of dealings are important — maybe even more important — than the four corners of an agreement that was drafted based on a template,” the judge said.

Sanders also found that Masotta’s cooperation was essentially paid for, in essence invalidating his own vote.

“He was acting less as a WOW New England member with the corresponding obligations that carries and more in his self-interest, thus undermining his ability to bind WOW New England generally,” Sanders said, further finding the agreements invalid because they promoted Borghi’s personal interests over that of the WOW New England Clubs.

Turning to the merits, Sanders found that Borghi, by misappropriating confidential information of WOW New England and using it to build a business in direct competition, was indeed liable for breach of fiduciary duty, and Dixon was liable for aiding and abetting him.

The judge balked, however, at the plaintiffs’ request that damages be based on a constructive trust theory, equal to the market value of each of the Blast clubs, ruling that such an award would unjustly enrich the plaintiffs by failing to account for the defendants’ own investments of time and money into those clubs.

Instead, Sanders found that WOW New England would be entitled to receive some portion of Blast products going forward as well as other injunctive relief and attorneys’ fees.

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