Friday, May 16, 2014

Massachusetts Further Adds to the Mess of Inter-Shareholder Fiduciary Duties

Massachusetts Further Adds to the Mess of Inter-Shareholder Fiduciary Duties

      Massachusetts has long been infamous amongst those who practice business entity law for a string of cases holding, inter alia, that the shareholders of a business corporation, amongst themselves, owed to one another the same fiduciary duties that are owed amongst partners in a general partnership.  Those cases include Rodd v. Donahue Electrotype Co. and Wilkes v. Springdale Nursing Home.  A March decision of the Massachusetts Supreme Court has continued this string of cases and in so doing demonstrated the underlying fallacy of these supposed duties.  Selmark Associates, Inc. v. Erlich, 5 N.E.3d 923 (Mass. 2014).
      The underlying facts of the case are rather involved, but they do not ultimate impinge upon the Court’s analysis.  Essentially, Erlich was a shareholder in a close corporation and as well an employee thereof.  In his employment role, he served as a sales representative, and was the second most productive, in terms of commissions, salesman for the company.  The only person more successful was the other shareholder.  After working together for a number of years, without prior notice, the majority shareholder advised Erlich that his service as an employee was terminated effective immediately.  Suit was brought for breach of fiduciary duty and other claims.  Meanwhile, the minority shareholder, Erlich, went to work for a competitor of his former employer, a corporation in which he remained a shareholder.  Working for that new employer, Erlich solicited customers of his former employer, and was successful in convincing at least one to move their account.  The former employer then filed a counterclaim against Erlich for breach of his fiduciary duties owed to the corporation.
      The case would ultimately be tried by a jury, its decision being appealed to the Massachusetts Supreme Court.
      As to Erlich’s claims for breach of fiduciary duty in his termination from employment, the jury’s verdict in Erlich’s favor upheld.  Erlich had been terminated “without warning on reasonable explanation” and there was “no evidence of poor performance,” or “of an inability to get along with others.”  5 N.E.2d at 935.  Ultimately, “Erlich has demonstrated that [the defendant] could have sought less harmful alternatives before resorting to termination.”  Id.

      Still, the victory was not entirely for Ehrlich.  He remained a shareholder in his former employer, and in that capacity owed it fiduciary duties.  In going to work for a competitor and soliciting customers to move to the competitor Ehrlich was working against the interest of his former employer.  Ergo, Erlich violated his fiduciary duties.  Ehrlich argued against this analytic path, asserting that:
because he was fired [ ] and essentially “frozen out” [of this former employer], he had the right to compete with [his former employer] without committing a breach of his fiduciary duties to the company.  5 N.E.3d at 943.
In rejecting this argument the Massachusetts Supreme Court wrote:
Our cases are clear that shareholders in close corporations owe fiduciary duties not only to one another, but to the corporation as well.  At issue here is whether those fiduciary duties to the corporation continue once a shareholder has been “frozen out,” or wrongfully terminated, by that corporation….
Allowing a party who has suffered harm within a close corporation to seek retribution by disregarding its own duties has no basis in our laws and would undermine fundamental and long-standing fiduciary principles that are essential to corporate governance…. We see no reason to take such a drastic step. “If shareholders take it upon themselves to retaliate any time they believe they have been frozen out, disputes in close corporations will only increase. Rather, if unable to resolve matters amicably, aggrieved parties should take their claims to court and seek judicial resolution.”  5 N.E.3d at 943-44 (citations omitted).
This is Why I’m Glad to be in the Commonwealth of Kentucky and Not the Commonwealth of Massachusetts
            This case demonstrates the utter silliness of imposing upon shareholders fiduciary duties owed among themselves.  Here we have an individual, Ehrlich, who was otherwise an at-will employee of his employer.  However, simply because he was a shareholder the terms of his employment were morphed into employment that could be terminated only upon notice and for cause.  At the same time the corporation became the beneficiary, inter alia, of a non-compete/non-solicitation agreement binding the shareholder.
Fortunately, Kentucky has not adopted fiduciary duties among shareholders.  See Rutledge, Shareholders Are Not Fiduciaries – A Positive and Normative Analysis of Kentucky Law, 51 Louisville Law Review 535 (2012-13).  Here is a LINK to that article.  See also More Evidence that Kentucky Law Does Not Recognize Fiduciary Duties Among Shareholders (March 20, 2013) – LINK.

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