One claim that corporate attorneys frequently handle in business litigation is breach of fiduciary duty. A breach of fiduciary duty is a key claim in shareholder disputes in corporations, partnership disputes, and among members of limited liability companies (LLCs). Under Massachusetts law, a breach of fiduciary duty claim arises in many business relationships, and courts often apply stringent standards to this duty, especially when in the context of closely held companies.
Under Massachusetts law, shareholders, partners, and members owe a fiduciary duty of “utmost good faith and loyalty,” which is a higher standard than a simple “good faith and inherent fairness” standard. Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578, 594 (Mass. 1975). “Their paramount duty is to the corporation, and their personal pecuniary interests are subordinate to that duty.” Durfee v. Durfee Canning, Inc.3 23 Mass. 187, 196 (1948). This means that such individuals must prioritize the interests of the organization and its stakeholders over their own.
Fiduciary duties arise in various business forms.
Shareholder disputes, Partnership disputes, and LLC member disputes:
Massachusetts law imposes a duty on all shareholders in a closely-held corporation to treat each other with the utmost good faith and loyalty (the fiduciary obligation). Majority shareholders in corporations must protect the interests of minority shareholders, and vice versa. Partners owe one another loyalty, honesty, and full disclosure in the management of partnership assets. And LLC members owe each other fiduciary duties, often focused on transparency and avoiding self-dealing. Of course, this is not an exhaustive list.
A breach of fiduciary duty occurs when one party acts against the interests of the other stakeholders or the business itself, prioritizing personal gain over the obligations owed to the organization, fellow members, shareholders, or partners. Generally, the only way for a shareholder to defeat a claim that they have not dealt with the other shareholders using the utmost good faith and loyalty is if the shareholder can demonstrate a legitimate business purpose for the conduct giving rise to the claim.
The key elements for a breach of fiduciary claim include:
- Existence of Duty: A fiduciary relationship must exist, such as between business partners, members of an LLC, or shareholders in a corporation.
- Breach of Duty: The fiduciary must have acted against the interest of the business or failed to fulfill their obligations.
- Causation: The breach must directly result in harm to the business or other partners, members, or shareholders.
- Damages: The harmed party must show damages resulting from the breach.
Let’s look at some notable Massachusetts case law dealing with breach of fiduciary claims:
- Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578 (1975): This landmark case laid the foundation for fiduciary duties in closely-held corporations. The court ruled that shareholders in such corporations owe each other the same fiduciary duty of loyalty that partners owe to each other. The court emphasized that the majority shareholders must act with utmost good faith toward minority shareholders.
In Donahue, the court recognized that one peculiar aspect of close corporations was the opportunity afforded to majority stockholders to oppress, disadvantage, or “freeze out” minority stockholders. In that case, 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 was that the minority could be forced to “sell out at less than fair value,” 367 Mass. at 592, as there is, by definition, no ready market for minority stock in a close corporation. The Donahue decision acknowledged a strict obligation on the part of the majority stockholders in a close corporation to deal with the minority with the utmost good faith and loyalty. This strict standard has been applied in subsequent cases.
- Zimmerman v. Bogoff, 402 Mass. 650 (1988): Following the Donahue decision, the Massachusetts Supreme Judicial Court addressed a partnership dispute. This case involved a dispute over the misappropriation of partnership assets, and the court ruled that fiduciary duties require transparency and fair dealing among partners. The court found that partners owe each other fiduciary duties, including the duty to act in the best interest of the partnership. Where a shareholder demonstrates a “legitimate business purpose” for a challenged action, they will not be liable “unless the wronged shareholder succeeds in showing that the proffered legitimate objective could have been achieved through a less harmful, reasonably practicable, alternative mode of action.” 402 Mass. at 657.
In Zimmerman, the court noted that “the protections of Donahue are not limited to those with less than 50% share ownership.” 402 Mass. at 658. “While it is true that a minority shareholder is vulnerable to oppression or ‘freeze-out’ by the majority, Donahue itself recognized that, ‘[i]n the close corporation, the minority may do equal damage through unscrupulous and improper ‘sharp dealings.’” Id. (quoting Donahue, 367 Mass. at 593 n.17). Therefore, case law provides that fiduciary obligations may arise regardless of the percentage of share ownership.
- Meehan Shaughnessy, 404 Mass. 419 (1989): This case clarified fiduciary obligations in the context of partnerships, specifically addressing partners’ duty to inform each other of plans that might affect the partnership, such as departing from it. In this case, two law firm partners left to form a new law firm. While planning to leave the old firm, both partners began making lists of clients and of referring attorneys involved in cases they were handling. The Supreme Judicial Court of Massachusetts held that the partners breached their fiduciary duties to the partnership at the old law firm. Specifically, that court stated, “through their preparation for obtaining clients’ consent, their secrecy concerning which clients they intended to take, and the substance and method of their communications with clients, obtained an unfair advantage over their former partners in breach of their fiduciary duties.” 404 Mass. at 436. The court further noted, “[a] partner has an obligation to ‘render on demand true and full information of all things affecting the partnership to any partner”. Id.
- Butler v. Moore, Civil No. 10-10207-FDS (D. Mass. Mar. 26, 2015): This federal case before the United States District Court of Massachusetts addressed the fiduciary duties owed between members of a limited liability company before Massachusetts state courts had provided clear case law on the issue. The District Court noted that an LLC is “something of a hybrid of a corporation and a partnership” and “it would be highly anomalous if members of a closely held LLC had lesser fiduciary duties than those of a closely held corporation or a partnership.” Id. at *125. This case made it clear that members and managers of a closely held limited liability company (LLC) in Massachusetts owed a duty of utmost good faith and loyalty to the LLC and the other members.
- Allison v. Eriksson, 479 Mass. 626 (Mass. 2018): In this case, a majority LLC member undertook a merger in violation of his fiduciary duties. In a case of first impression, the Supreme Judicial Court of Massachusetts clarified that members opposing the merger of their LLC are entitled to equitable remedies if the majority member or members breached their fiduciary duties to the minority member in the process of effectuating the In such cases, the courts have discretion to tailor equitable relief for the dissenting minority while also considering the best interests of the LLC. Equitable relief may include rescinding the merger or modifying the operating agreement of the new limited liability company (LLC). This discretion by courts also applies to “freeze-out mergers,” which occur when the majority members (or member) merge the business into a new entity to eliminate, or “freeze out,” the minority. “In close companies and close corporations, such freeze-outs defeat the reasonable expectations of minority shareholders.” 479 Mass. at 636 (internal quotations omitted).
- Selmark , Inc. v. Ehrlich, 467 Mass. 525 (2014): The Massachusetts Supreme Judicial Court affirmed that majority shareholders breached their fiduciary duties by terminating a minority shareholder’s employment without a legitimate business purpose and without considering less harmful alternatives. The court reiterated that shareholders in closely held corporations owe each other fiduciary duties and that employment termination can violate these duties when a minority shareholder is deprived of employment, or, more generally, when the reasonable expectations of a shareholder are frustrated. 467 Mass. at 536.
In Massachusetts, fiduciary duties are crucial to maintaining fairness and integrity in business relationships, whether in corporations, partnerships, or limited liability companies (LLCs). Breaches of these duties can lead to legal claims and significant consequences, particularly when one party acts in bad faith or contrary to the interests of others involved in the business. Shareholder disputes, partnership disputes, and members disputes often revolve around these fiduciary obligations, which are strictly enforced by Massachusetts courts and are highly fact-intensive. You will need a sophisticated lawyer, like those at Pakrooh Law, P.C. to navigate these waters, especially as the counterparty will raise defenses and potentially counterclaims against you.
These fiduciary duty, business-related claims are the types of claims we constantly take on. Call Pakrooh Law, P.C. at (617) 874-1411 to speak with an attorney who has the sophistication and patience to guide you through the tough, troubling times.
