EUPHEMIA DONAHUE vs. RODD ELECTROTYPE COMPANY OF NEW ENGLAND, INC. & others.
Supreme Judicial Court of Massachusetts, Middlesex.
October 8, 1974. — May 2, 1975.
367 Mass. 578
Present: TAURO, C.J., REARDON, QUIRICO, BRAUCHER, KAPLAN, & WILKINS, JJ.
Corporation, Stockholder, Purchase by corporation of its stock, Close corporation. Sale, Of stock. Fiduciary.
Directors, officers and members of a majority stockholders’ group in a close corporation who authorized and agreed to the corporate purchase of a number of shares at a fixed price for the corporate treasury from one of the majority stockholders’ group, but did not offer the minority stockholder the same opportunity to sell shares to the corporation for the same price, breached their fiduciary duty to the minority stockholder who was entitled to relief in the alternative, namely, either the stockholder whose shares were purchased by the corporation was obligated to remit to the corporation the amount paid to him for the stock plus interest in return for the same number of shares of corporate treasury stock, or the corporation was obligated to purchase a similar number of shares from the minority shareholder for the same price, without interest, as paid to the majority stockholder. [600-604]
BILL IN EQUITY filed in the Superior Court on June 7, 1971.
The suit was heard by Mitchell, J.
After review by the Appeals Court, the Supreme Judicial Court granted leave to obtain further appellate review.
William M. O‘Brien for the plaintiff.
Harold E. Magnuson for the defendants.
The trial judge entered voluntary findings of fact which do not appear to state the complete ground for his decision. The evidence is reported. Accordingly, it is the duty of this court to examine the evidence and to form an independent judgment on the facts in the case. Due weight must be given to the findings of the trial judge, who has heard the witnesses and has had an opportunity to gauge their credibility and reliability. His findings of fact based on oral testimony will not be reversed unless they are plainly wrong. Spiegel v. Beacon Participations, Inc. 297 Mass. 398, 407 (1937). Seder v. Gibbs, 333 Mass. 445, 446 (1956). However, all inferences to be drawn from the facts are open on this appeal. Malone v. Walsh, 315 Mass. 484, 490 (1944). Seder v. Gibbs, supra, at 447.
The evidence may be summarized as follows: In 1935, the defendant, Harry C. Rodd, began his employment
In 1936, the plaintiff‘s husband, Joseph Donahue (now deceased), was hired by Royal of New England as a “finisher” of electrotype plates. His duties were confined to operational matters within the plant. Although he ultimately achieved the positions of plant superintendent (1946) and corporate vice president (1955), Donahue never participated in the “management” aspect of the business.
In the years preceding 1955, the parent company, Royal Electrotype, made available to Harry Rodd and Joseph Donahue shares of the common stock in its subsidiary, Royal of New England. Harry Rodd took advantage of the opportunities offered to him and acquired 200 shares for $20 a share. Joseph Donahue, at the suggestion of Harry Rodd, who hoped to interest Donahue in the business, eventually obtained fifty shares in two twenty-five share lots priced at $20 a share. The parent company at all times retained 725 of the 1,000 outstanding shares. One Lawrence W. Kelley owned the remaining twenty-five shares.
In June of 1955, Royal of New England purchased all 725 of its shares owned by its parent company. The total price amounted to $135,000. Royal of New England remitted $75,000 of this total in cash and executed five promissory notes of $12,000 each, due in each of the succeeding five years. Lawrence W. Kelley‘s twenty-five shares were also purchased at this time for $1,000. A substantial portion of Royal of New England‘s cash expenditures was loaned to the company by Harry
The stock purchases left Harry Rodd in control of Royal of New England. Early in 1955, before the purchases, he had assumed the presidency of the company. His 200 shares gave him a dominant eighty per cent interest. Joseph Donahue, at this time, was the only minority stockholder.
Subsequent events reflected Harry Rodd‘s dominant influence. In June, 1960, more than a year after the last obligation to Royal Electrotype had been discharged, the company was renamed the Rodd Electrotype Company of New England, Inc. In 1962, Charles H. Rodd, Harry Rodd‘s son (a defendant here), who had long been a company employee working in the plant, became corporate vice president. In 1963, he joined his father on the board of directors. In 1964, another son, Frederick I. Rodd (also a defendant), replaced Joseph Donahue as plant superintendent. By 1965, Harry Rodd had evidently decided to reduce his participation in corporate management. That year, Charles Rodd succeeded him as president and general manager of Rodd Electrotype.
From 1959 to 1967, Harry Rodd pursued what may fairly be termed a gift program by which he distributed the majority of his shares equally among his two sons and his daughter, Phyllis E. Mason. Each child received thirty-nine shares.6 Two shares were returned to the corporate treasury in 1966.
We come now to the events of 1970 which form the grounds for the plaintiff‘s complaint. In May of 1970, Harry Rodd was seventy-seven years old. The record indicates that for some time he had not enjoyed the best of health and that he had undergone a number of opera-
A special board meeting convened on July 13, 1970. As the first order of business, Harry Rodd resigned his directorship of Rodd Electrotype. The remaining incumbent directors, Charles Rodd and Mr. Harold E. Magnuson (clerk of the company and a defendant and defense attorney in the instant suit), elected Frederick Rodd to replace his father. The three directors then authorized Rodd Electrotype‘s president (Charles Rodd) to execute an agreement between Harry Rodd and the company in which the company would purchase forty-five shares for $800 a share ($36,000).
The stock purchase agreement was formalized between the parties on July 13, 1970. Two days later, a sale pursuant to the July 13 agreement was consummated. At approximately the same time, Harry Rodd resigned his last corporate office, that of treasurer.
Harry Rodd completed divestiture of his Rodd Electrotype stock in the following year. As was true of his previous gifts, his later divestments gave equal representation to his children. Two shares were sold to each child on July 15, 1970, for $800 a share. Each was given ten shares in March, 1971.7 Thus, in March, 1971, the shareholdings in Rodd Electrotype were apportioned as follows: Charles Rodd, Frederick Rodd and Phyllis Mason each held fifty-one shares; the Donahues8 held fifty shares.
A special meeting of the stockholders of the company was held on March 30, 1971. At the meeting, Charles Rodd, company president and general manager, reported the tentative results of an audit conducted by the company auditors and reported generally on the company events of the year. For the first time, the Donahues learned that the corporation had purchased Harry Rodd‘s shares. According to the minutes of the meeting, following Charles Rodd‘s report, the Donahues raised questions about the purchase. They then voted against a resolution, ultimately adopted by the remaining stockholders, to approve Charles Rodd‘s report. Although the minutes of the meeting show that the stockholders unanimously voted to accept a second resolution ratifying all acts of the company president (he executed the stock purchase agreement) in the preceding year, the trial judge found, and there was evidence to support his finding,9 that the Donahues did not ratify the purchase of Harry Rodd‘s shares. Cf. Braunstein v. Devine, 337 Mass. 408, 413 (1958).
A few weeks after the meeting, the Donahues, acting through their attorney, offered their shares to the corporation on the same terms given to Harry Rodd. Mr. Harold E. Magnuson replied by letter that the corporation would not purchase the shares and was not in a financial position to do so.10 This suit followed.
In her argument before this court, the plaintiff has characterized the corporate purchase of Harry Rodd‘s
The defendants reply that the stock purchase was within the powers of the corporation and met the requirements of good faith and inherent fairness imposed on a fiduciary in his dealings with the corporation. They assert that there is no right to equal opportunity in corporate stock purchases for the corporate treasury. For the reasons hereinafter noted, we agree with the plaintiff and reverse the decree of the Superior Court. However, we limit the applicability of our holding to “close corporations,” as hereinafter defined. Whether the holding should apply to other corporations is left for decision in another case, on a proper record.
A. Close Corporations. In previous opinions, we have alluded to the distinctive nature of the close corporation (e.g., Brigham v. M. & J. Corp. 352 Mass. 674, 678 [1967]; see Samia v. Central Oil Co. of Worcester, 339 Mass. 101, 112-113 [1959]), but have never defined precisely what is meant by a close corporation. There is no single, generally accepted definition. Some commentators emphasize an “integration of ownership and management” (Note, Statutory Assistance for Closely Held Corporations, 71 Harv. L. Rev. 1498 [1958]), in which the stockholders occupy most management positions. Kruger v. Gerth, 16 N. Y. 2d 802, 806 (1965) (Fuld, J., dissenting). Foreward, 18 Law & Contemp. Prob. 433 (1953). See Helms v. Duckworth, 249 F. 2d 482, 486 (D. C. Cir. 1957). Others focus on the number of stockholders and the nature of the market for the stock. In this view, close corporations have few stockholders; there is little market for corporate stock. The Supreme Court of Illinois adopted this latter view in Galler v. Galler, 32 Ill. 2d 16 (1965): “For our pur-
As thus defined, the close corporation bears striking resemblance to a partnership. Commentators and courts have noted that the close corporation is often little more than an “incorporated” or “chartered” partnership.12 Ripin v. United States Woven Label Co. 205 N. Y. 442, 447 (1912) (“little more than [although not quite the same as] chartered partnerships“). Clark v. Dodge, 269 N. Y. 410, 416 (1936). Hornstein, Stockholders’ Agreements in the Closely Held Corporation, 59 Yale L. J. 1040 (1950). Hornstein, Judicial Tolerance of the Incorporated Partnership, 18 Law & Contemp. Prob. 435, 436 (1953). Cf. Barrett v. King, 181 Mass. 476, 479 (1902).
Although the corporate form provides the above-mentioned advantages for the stockholders (limited liability, perpetuity, and so forth), it also supplies an opportunity for the majority stockholders to oppress or disadvantage minority stockholders. The minority is vulnerable to a variety of oppressive devices, termed “freeze-outs,” which the majority may employ. See, generally, Note, Freezing Out Minority Shareholders, 74 Harv. L. Rev. 1630 (1961). An authoritative study of such “freeze-outs” enumerates some of the possibilities: “The squeezers [those who employ the freeze-out techniques] may refuse to declare dividends; they may drain
The minority can, of course, initiate suit against the majority and their directors. Self-serving conduct by directors is proscribed by the director‘s fiduciary obligation to the corporation. Elliott v. Baker, 194 Mass. 518, 523 (1907). Sagalyn v. Meekins, Packard & Wheat, Inc. 290 Mass. 434, 438 (1935). However, in practice, the plaintiff will find difficulty in challenging dividend or employment policies.14 Such policies are considered to be within the judgment of the directors. This court has said: “The courts prefer not to interfere with the sound financial management of the corporation by its directors, but declare as a general rule that the declaration of dividends rests within the sound discretion of the directors, refusing to interfere with their determination unless a plain abuse of discretion is made to appear.”
Thus, when these types of “freeze-outs” are attempted by the majority stockholders, the minority stockholders,
At this point, the true plight of the minority stockholder in a close corporation becomes manifest. He cannot easily reclaim his capital. In a large public corporation, the oppressed or dissident minority stockholder could sell his stock in order to extricate some of his invested capital. By definition, this market is not available for shares in the close corporation. In a partnership, a partner who feels abused by his fellow partners may cause dissolution by his “express will ... at any time” (
Thus, 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. 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. See Lydia E. Pinkham Medicine Co. v. Gove, 303 Mass. 1, 12 (1939); Mansfield Hardwood Lumber Co. v. Johnson, 263 F. 2d 748, 756 (5th Cir.), reh. den. 268 F. 2d 317 (5th Cir.), cert. den. 361 U. S. 885 (1959); Cochran v. Channing Corp. 211 F. Supp. 239, 242-243 (S. D. N. Y. 1962); Gottfried v. Gottfried, 73 N. Y. S. 2d 692, 695 (Sup. Ct. 1947); Patton v. Nicholas, 154 Texas 385, 393 (1955). When the minority stockholder agrees to sell out at less than fair value, the majority has won.
Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence
We contrast19 this strict good faith standard with the somewhat less stringent standard of fiduciary duty to
The more rigorous duty of partners and participants in a joint adventure,21 here extended to stockholders in a close corporation, was described by then Chief Judge Cardozo of the New York Court of Appeals in Meinhard v. Salmon, 249 N. Y. 458 (1928): “Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm‘s length, are forbidden to those bound by fiduciary duties. . . . Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” Id. at 463-464.22
In Samia v. Central Oil Co. of Worcester, 339 Mass. 101 (1959), sisters alleged that their brothers had systematically excluded them from management, income and partial ownership of a close corporation formed from a family partnership. In rejecting arguments that the plaintiffs’ suit was barred by the statute of limitations or laches, we stressed the familial relationship among the parties, which should have given rise to a particularly scrupulous fidelity in serving the interests of all of the
In Wilson v. Jennings, 344 Mass. 608 (1962), the plaintiffs, stockholders in a close corporation, brought suit on their own behalf and on behalf of the corporation against a number of defendants, including the third stockholder who was generally in charge of corporate operations. The corporation had been organized to exploit a “plastic top” for containers invented by the plaintiffs and another. The defendants appealed from a final decree which, inter alia, cancelled shares of stock issued to the operating stockholder after the original issue, voided an employment contract between the operating stockholder and the corporation, and ordered transfer to the corporation of stock in and dividends from a corporation the operating stockholder had established to manufacture the container tops. Although we modified the decree, we sustained the judge‘s finding that the operating stockholder had violated his duty to the other stockholders in causing other shares to be issued to himself. Justice Cutter wrote for the court: “[I]t was open to the judge on the evidence to find that Wilson, Malick, and Jennings, on an informal and somewhat ambiguous basis ..., had entered into what was essentially a joint venture in corporate form to exploit the plastic top invention; that Jennings was obligated in order ‘to get his third [share of the stock] ... to do the financing’ and to be [g]eneral [m]anager of the business, and operate it on behalf of the stockholders‘; and that there was a ‘mutual understanding that . . . [Wilson and Malick] would know what was going on’ on the east coast and that they in turn would keep Jennings informed of their own activities. There was evidence that the three way equal division of stock was to be ‘permanent.’
In these and other cases (e.g., Sher v. Sandler, 325 Mass. 348, 353 [1950]; Mendelsohn v. Leather Mfg. Corp. 326 Mass. 226, 233 [1950]), we have imposed a duty of loyalty more exacting than that duty owed by a director to his corporation (Spiegel v. Beacon Participations, Inc. 297 Mass. 398, 410-411 [1937]) or by a majority stockholder to the minority in a public corporation23 because of facts particular to the close corporation in the cases. In the instant case, we extend this strict duty of loyalty to all stockholders in close corporations. The circumstances which justified findings of relationships of trust and confidence in these particular cases exist universally in modified form in all close corporations. See Kruger v. Gerth, 16 N. Y. 2d 802, 806 (1965) (Fuld, J., dissenting). Statements in other cases (Mairs v. Madden, 307 Mass. 378, 380 [1940]; Leventhal v. Atlantic Fin. Corp. 316 Mass. 194, 198-199 [1944]; Cardullo v. Landau, 329 Mass. 5, 9 [1952]) which suggest that stockholders of a corporation do not stand in a relationship of trust and confidence to one another will not be followed in the close corporation context.
B. Equal Opportunity in a Close Corporation. Under settled Massachusetts law, a domestic corporation, unless forbidden by statute, has the power to purchase its own shares. Dupee v. Boston Water Power Co. 114 Mass. 37, 43 (1873). Dustin v. Randall Faichney Corp. 263 Mass. 99, 102 (1928). Brown v. Little, Brown & Co. (Inc.) 269 Mass. 102, 110 (1929). Barrett v. W. A. Webster Lumber Co. 275 Mass. 302, 307 (1931). Scriggins v. Thomas Dalby Co. 290 Mass. 414, 418 (1935). Winchell v. Plywood Corp. 324 Mass. 171, 174 (1949). An agreement to reacquire stock “is enforceable, subject, at least, to the limitations that the purchase must be made in good faith and without prejudice to creditors and stockholders.” Scriggins v. Thomas Dalby Co., supra. Winchell v. Plywood Corp., supra, at 174-175. When the corporation reacquiring its own stock is a close corporation, the purchase is subject to the additional requirement, in the light of our holding in this opinion, that the stockholders, who, as directors or controlling stockholders, caused the corporation to enter into the stock purchase agreement, must have acted with the utmost good faith and loyalty to the other stockholders.
To meet this test, if the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price.24 Purchase by the corporation confers substantial benefits on the members of the controlling group whose shares were purchased. These benefits are not available to the minority stockholders if the corporation does not also offer them an opportunity to sell their shares. The controlling group may not, consistent with its strict duty to the minority, utilize its control of the corporation to obtain special advantages and disproportionate benefit from its share ownership.
The benefits conferred by the purchase are twofold: (1) provision of a market for shares; (2) access to corporate assets for personal use. By definition, there is no ready market for shares of a close corporation. The purchase creates a market for shares which previously had been unmarketable. It transforms a previously illiquid investment into a liquid one. If the close corporation purchases shares only from a member of the controlling group, the controlling stockholder can convert his shares into cash at a time when none of the other stockholders can. Consistent with its strict fiduciary duty, the controlling group may not utilize its control of the corporation to establish an exclusive market in previously unmarketable shares from which the minority stockholders are excluded. See Jones v. H. F. Ahmanson & Co. 1 Cal. 3d 93, 115 (1969); Reifsnyder v. Pittsburgh Outdoor Advertising Co. 396 Pa. 320, 327 (1959) (Cohen, J., concurring and dissenting).
The purchase also distributes corporate assets to the stockholder whose shares were purchased. Unless an equal opportunity is given to all stockholders, the purchase of shares from a member of the controlling group operates as a preferential distribution of assets. In exchange for his shares, he receives a percentage of the contributed capital and accumulated profits of the enterprise. The funds he so receives are available for his personal use. The other stockholders benefit from no such access to corporate property and cannot withdraw their shares of the corporate profits and capital in this manner unless the controlling group acquiesces. Although the purchase price for the controlling stockholder‘s shares may seem fair to the corporation and other stockholders under the tests established in the prior case law (see
The rule of equal opportunity in stock purchases by close corporations provides equal access to these benefits for all stockholders. We hold that, in any case in which the controlling stockholders have exercised their power over the corporation to deny the minority such equal opportunity, the minority shall be entitled to appropriate relief.25 To the extent that language in Spiegel v. Beacon Participations, Inc. 297 Mass. 398, 431 (1937), and other cases suggests that there is no requirement of equal opportunity for minority stockholders when a close corporation purchases shares from a controlling stockholder, it is not to be followed.
C. Application of the Law to this Case. We turn now to the application of the learning set forth above to the facts of the instant case.
Through their control of these management positions and of the majority of the Rodd Electrotype stock, the Rodds effectively controlled the corporation. In testing the stock purchase from Harry Rodd against the applicable strict fiduciary standard, we treat the Rodd family as a single controlling group. We reject the defendants’ contention that the Rodd family cannot be treated as a unit for this purpose. From the evidence, it is clear that the Rodd family was a close-knit one with strong community of interest. See Samia v. Central Oil Co. of Worcester, 339 Mass. 101, 112 (1959). Harry Rodd had hired his sons to work in the family business, Rodd Electrotype. As he aged, he transferred portions of his stock holdings to his children.26 Charles Rodd and Frederick Rodd were given positions of responsibility in the business as he withdrew from active management. In these circumstances, it is realistic to assume that appreciation, gratitude, and filial devotion would prevent the younger Rodds from opposing a plan which would provide funds for their father‘s retirement.
Moreover, a strong motive of interest requires that the Rodds be considered a controlling group. When Charles Rodd and Frederick Rodd were called on to represent the
On its face, then, the purchase of Harry Rodd‘s shares by the corporation is a breach of the duty which the controlling stockholders, the Rodds, owed to the minority stockholders, the plaintiff and her son. The purchase distributed a portion of the corporate assets to Harry Rodd, a member of the controlling group, in exchange for his shares. The plaintiff and her son were not offered an equal opportunity to sell their shares to the corporation. In fact, their efforts to obtain an equal opportunity were rebuffed by the corporate representative. As the trial judge found, they did not, in any manner, ratify the transaction with Harry Rodd.
Because of the foregoing, we hold that the plaintiff is entitled to relief. Two forms of suitable relief are set out hereinafter. The judge below is to enter an appropriate judgment. The judgment may require Harry Rodd to remit $36,000 with interest at the legal rate from July 15, 1970, to Rodd Electrotype in exchange for forty-five shares of Rodd Electrotype treasury stock. This, in substance, is the specific relief requested in the plaintiff‘s bill of complaint. Interest is manifestly appropriate. A stockholder, who, in violation of his fiduciary duty to the other stockholders, has obtained assets from his corporation and has had those assets available for his own use, must pay for that use. See Silversmith v. Sydeman, 305 Mass. 65, 74 (1940). Cf. Spiegel v. Beacon Participations, Inc. 297 Mass. 398, 420 (1937). In the alternative, the judgment may require Rodd Electrotype to purchase all of the plaintiff‘s shares for $36,000 without interest. In the circumstances of this case, we view this as the equal opportunity which the plaintiff should have re-
The final decree, in so far as it dismissed the bill as to Harry C. Rodd, Frederick I. Rodd, Charles H. Rodd, Mr. Harold E. Magnuson and Rodd Electrotype Company of New England, Inc., and awarded costs, is reversed. The case is remanded to the Superior Court for entry of judgment in conformity with this opinion.
So ordered.
WILKINS, J. (concurring). I agree with much of what the Chief Justice says in support of granting relief to the plaintiff. However, I do not join in any implication (see, e.g., footnote 18 and the associated text) that the rule concerning a close corporation‘s purchase of a controlling stockholder‘s shares applies to all operations of the corporation as they affect minority stockholders. That broader issue, which is apt to arise in connection with salaries and dividend policy, is not involved in this case. The analogy to partnerships may not be a complete one.